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If you need the complete document, download the WordPerfect version or Adobe Acrobat version, if available. ***************************************************************** Before the Federal Communications Commission Washington, D.C. 20554 In the Matter of) ) Implementation of the ) Telecommunications Act of 1996:)CC Docket No. 96-150 ) Accounting Safeguards Under the) Telecommunications Act of 1996 ) REPORT AND ORDER Adopted: December 23, 1996 Released: December 24, 1996 By the Commission: TABLE OF CONTENTS I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . 1 II. BACKGROUND AND OVERALL GOALS. . . . . . . . . . . . . . . 3 A. Summary of the Relevant Statutory Provisions. . . . . 3 B. Goals of the Proceeding . . . . . . . . . . . . . . 13 C. Scope of Commission's Authority . . . . . . . . . . . 29 D. Structure of this Order . . . . . . . . . . . . . . . 47 III. SAFEGUARDS FOR INTEGRATED OPERATIONS . . . . . . . . . . 48 A. General . . . . . . . . . . . . . . . . . . . . . . . 48 B. Specific Services . . . . . . . . . . . . . . . . . . 51 1. Section 260 - Telemessaging Service. . . . . . . 51 2. Section 271 - InterLATA Telecommunications Services 61 a. Incidental InterLATA Services . . . . . . . 62 b. Integrated Provision of InterLATA Services. 66 c. Other Matters . . . . . . . . . . . . . . . 77 3. Section 275 - Alarm Monitoring Services. . . . . 88 4. Section 276 - Payphone Services. . . . . . . . . 93 IV. SAFEGUARDS FOR SEPARATED OPERATIONS . . . . . . . . . . 101 A. General. . . . . . . . . . . . . . . . . . . . . . . 101 B. Specific Services . . . . . . . . . . . . . . . . . 110 1. Section 272 - Manufacturing and InterLATA Services 110 a. Statutory Language. . . . . . . . . . . . 110 b. "Arm's Length" Requirement of Section 272(b)(5) 111 i. Prevailing Company Prices. . . . . . 125 ii. Valuation Methods for Assets and Services. 138 iii. Fair Market Value. . . . . . . . . 149 iv. Tariffed-based Valuation. . . . . . 155 v. Return Component for Allowable Costs 160 c. Accounting Requirements of Sections 272(b)(2) and (c)(2) 167 d. Application to InterLATA Telecommunications Affiliates 171 e. Application to Sharing of Services. . . . 179 f. Audit Requirements. . . . . . . . . . . . 184 2. Section 273 - Manufacturing by Certifying Entities 206 a. Statutory Language. . . . . . . . . . . . 206 b. Comparison of Sections 273 and 272. . . . 208 3. Section 274 - Electronic Publishing. . . . . . 213 a. Statutory Language. . . . . . . . . . . . 213 b. Comparison of Sections 274 and 272. . . . 214 c. Compliance Review . . . . . . . . . . . . 220 d. Section 274(f)'s Reporting Requirement. . 227 e. Section 274 Transactional Requirements. . 231 f. Miscellaneous . . . . . . . . . . . . . . .245 4. Separated Operations under Sections 260 and 271 through 276248 V. OTHER MATTERS. . . . . . . . . . . . . . . . . . . . . . .259 A. Price Caps. . . . . . . . . . . . . . . . . . . . . .259 1. General. . . . . . . . . . . . . . . . . . . . .259 2. Exogenous Costs and Part 64. . . . . . . . . . .260 3. Part 64 and Sharing. . . . . . . . . . . . . . .267 B. Section 254(k). . . . . . . . . . . . . . . . . . . .272 VI. FINAL REGULATORY FLEXIBILITY ACT ANALYSIS . . . . . . . .277 VII. FINAL PAPERWORK REDUCTION ACT ANALYSIS . . . . . . . . .284 VIII. ORDERING CLAUSES. . . . . . . . . . . . . . . . . . . .285 I. INTRODUCTION 1.In this Report and Order ("Order") we address the accounting safeguards necessary to satisfy the requirements of sections 260 and 271 through 276 of the Communications Act of 1934, as amended by the Telecommunications Act of 1996. This Order prescribes the way incumbent local exchange carriers, including the Bell Operating Companies ("BOCs"), must account for transactions with affiliates involving, and allocate costs incurred in the provision of, both regulated telecommunications services and nonregulated services, including telemessaging, interLATA telecommunications, information, manufacturing, electronic publishing, alarm monitoring and payphone services, to ensure compliance with the Act. In particular, the Order adopts the tentative conclusion in the Notice of Proposed Rulemaking ("NPRM") in this proceeding that our current cost allocation rules generally satisfy the Act's accounting safeguards requirements when incumbent local exchange carriers, including the BOCs, provide services permitted under sections 260 and 271 through 276 on an integrated basis (i.e., within the telephone operating companies). The Order also adopts the tentative conclusion in the NPRM that our current affiliate transactions rules generally satisfy the Act's accounting safeguards requirements when incumbent local exchange carriers, including the BOCs, are required to, or choose to, use an affiliate to provide services permitted under sections 260 and 271 through 276. The Order adopts most of the NPRM's proposed modifications to the affiliate transactions rules to provide greater protection against subsidization of competitive activities by subscribers to regulated telecommunications services. 2.By applying our current cost allocation rules and modified affiliate transactions rules to incumbent local exchange carriers, including the BOCs, that provide services permitted under sections 260 and 271 through 276, we seek to protect regulated service ratepayers from bearing the risks and costs of carriers' nonregulated ventures. We also seek to promote competition by preventing carriers from using their market power in local exchange services to obtain an anti-competitive advantage in the markets that they seek to enter. We will monitor the development of competition to determine whether further changes to these accounting safeguards are needed to achieve the objectives of the Act. II. BACKGROUND AND OVERALL GOALS A. Summary of the Relevant Statutory Provisions 3.The Act permits the BOCs to engage in previously proscribed activities if the BOCs satisfy certain conditions that are intended to prevent them from recovering costs of their new ventures from subscribers to local exchange and exchange access services and from discriminating against their competitors in these new markets. The Act places similar conditions on other incumbent local exchange carriers electing to enter or continue to participate in certain markets. 4.The Act prescribes structural and nonstructural safeguards that are intended to protect ratepayers, consumers, and competitors against the effects of potential improper cost allocation and discrimination. These structural and nonstructural safeguards apply to activities such as payphone services that BOCs are currently permitted to provide and to activities such as alarm monitoring services that BOCs are currently permitted to provide in certain markets. In addition, these safeguards apply to other activities that incumbent local exchange carriers may now provide as a result of the Act. 5.Sections 260 and 271 through 276 outline the conditions under which incumbent local exchange carriers may offer telemessaging and alarm monitoring services and under which the BOCs may manufacture and provide telecommunications equipment, may manufacture customer premises equipment ("CPE"), and may offer interLATA telecommunications, information, electronic publishing and payphone services. While the Act requires that many of these services must be provided through separate affiliates, it also permits some to be offered on an integrated basis. 6.Sections 260 and 275 generally prohibit an incumbent local exchange carrier, including the BOCs, from subsidizing its telemessaging and alarm monitoring services with revenues from regulated telecommunications services. Section 260 provides that an incumbent local exchange carrier, including a BOC, that provides telemessaging service "shall not subsidize its telemessaging service directly or indirectly from its telephone exchange service or its exchange access," but does not require a separate affiliate. Section 275(b)(2) bars an incumbent local exchange carrier, including a BOC, that provides alarm monitoring services from "subsidiz[ing] its alarm monitoring services either directly or indirectly from telephone exchange service operations," but does not require a separate affiliate. 7.Section 271(b) authorizes the BOCs to immediately provide "out-of-region" interLATA services but requires the BOCs to obtain Commission approval before providing "in-region" interLATA services. Section 271(g) lists specific "incidental interLATA services" that BOCs and their affiliates may provide after February 8, 1996. Section 271(h) states that "[t]he Commission shall ensure that the provision of services authorized under [section 271(g)] by a Bell operating company or its affiliate will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market." 8.Section 272 permits a BOC (including any affiliate) that is subject to section 251(c) to manufacture equipment (as defined in the AT&T consent decree), originate in- region interLATA telecommunications services, other than incidental and previously authorized interLATA services, and provide certain interLATA information services only if it does so through one or more separate affiliates. Each of the separate affiliates must "maintain [separate] books, records, and accounts in the manner prescribed by the Commission" and "shall conduct all transactions with the Bell operating company of which it is an affiliate on an arm's length basis." In its dealings with the separate affiliate, each BOC must "account for all transactions . . . in accordance with accounting principles designated or approved by the Commission." 9.Section 273(d)(3) imposes separate affiliate requirements for the manufacture of telecommunications equipment and customer premises equipment upon entities that certify the same class of telecommunication equipment and customer premises equipment produced by unaffiliated entities. 10.Section 274(a) prohibits any "Bell operating company or any affiliate [from] engag[ing] in the provision of electronic publishing that is disseminated by means of such Bell operating company's or any of its affiliates' basic telephone service," other than through "a separated affiliate or electronic publishing joint venture." This separated affiliate or electronic publishing joint venture must, among other requirements, "maintain separate books, records, and accounts and prepare separate financial statements." 11.Section 276(b)(1)(C) directs the Commission to prescribe rules for BOC provision of payphone service that, "at a minimum, include the nonstructural safeguards equal to those adopted in the Computer Inquiry-III (CC Docket No. 90-623) proceeding." Section 276(a)(1) states that any BOC that provides payphone service after the effective date of those rules "shall not subsidize its payphone service directly or indirectly from its telephone exchange service operations or its exchange access operations." 12.Finally, section 254(k) imposes a more general prohibition against cross- subsidization by barring telecommunications carriers from "us[ing] services that are not competitive to subsidize services that are subject to competition." B. Goals of the Proceeding 13.In our NPRM, we set forth two goals for this proceeding: (1) preserving for the benefit of interstate telephone ratepayers legitimate economies of scope that could be realized by BOCs and other incumbent local exchange carriers when entering markets from which they were previously barred or in which they continue to participate; and (2) discouraging, and facilitating detection of, improper cost allocations in order to prevent incumbent local exchange carriers from imposing the costs of their competitive ventures on interstate telephone ratepayers. In the NPRM, we asked the threshold question: to what, if any, extent should we rely on our existing accounting safeguards in Parts 32 and 64 of our rules to achieve these two goals. We tentatively concluded that our existing accounting safeguards, with the modifications described in the NPRM, would best meet the requirements and underlying goals of sections 260 and 271 through 276. We invited comment on this tentative conclusion. We also sought comment on whether less detailed accounting safeguards would suffice to achieve the objectives of the Act. 14. To the extent that BOCs or other incumbent local exchange carriers maintain control over the bottleneck facility, these BOCs or other incumbent local exchange carriers could potentially engage in predatory behavior. In the NPRM, we also sought comment on how the extent to which a BOC or other incumbent local exchange carrier has the opportunities to engage in predatory behavior should affect our decisions in this proceeding. Comments: 15.Worldcom contends that the Act does not support the Commission's statement in the NPRM concerning the need to preserve "economies of scope" for the BOCs. SBC, however, maintains that, except to the extent Congress imposed temporary separation requirements as well as other restrictions such as the nondiscrimination provisions on incumbent local exchange carriers, Congress did not deny incumbent local exchange carriers the benefits of their own efficiencies. 16.Several parties, including NYNEX, contend that existing accounting safeguards are more than adequate to meet the requirements of sections 260 and 271 through 276 and no additional safeguards are required. In particular, Cincinnati Bell argues that incumbent local exchange carriers will not be able to raise prices based upon improperly allocated costs given the choices that will be available to customers in a competitive market. Many parties, including States, interexchange carriers, and trade associations, generally support our proposal to use current Part 32 and Part 64 accounting rules, with some modifications. USTA and SBC argue that given the pro-competitive, deregulatory goals of the Act and the increase in competition since the adoption of the accounting safeguards in the Joint Cost and Computer III Proceedings, we should not impose more stringent rules. Ameritech contends that we should adopt less detailed accounting rules consistent with the Act's mandate to foster a national deregulatory policy framework. 17.Sprint, GSA, Puerto Rico Telephone and several BOCs argue that a new system of accounting safeguards would require the BOCs to develop new systems and retrain employees, requiring substantial investments of time and resources without any assurance that a new system will be more effective. Ameritech adds that the substantial costs associated with the adoption of a different accounting safeguards approach would not be justified by the benefit. 18.USTA maintains that where we determine that current accounting safeguards will continue to apply to incumbent local exchange carriers, we should streamline those safeguards to the extent possible to ensure fair competition and to make the rules clear and predictable. USTA recommends streamlining our current rules as follows: (1) modify the shared forecast investment rules; (2) modify the affiliate transactions valuation standards; (3) simplify the Part 64 administrative process; and, (4) modify the frequency of the independent audit. Ameritech and SBC recommend adoption of USTA's streamlining proposals to implement provisions under the Act related to both separated and integrated operations. Several parties, including USTA, allege that competition and a number of existing safeguards, most notably price cap regulation, provide the most effective constraints on the ability of incumbent local exchange carriers to cross-subsidize. 19.In contrast, APCC argues that existing safeguards have not adequately prevented cross-subsidization. In particular, APCC suggests that we should make extensive changes to the cost allocation manuals, impose additional requirements to annual attestation audits, and reconsider the allocation methodology presently employed by incumbent local exchange carriers. ESI recommends that we adopt rules that ensure that vertically integrated telecommunications carriers with proven market power be more strictly regulated than carriers without the potential to price squeeze. 20.MCI maintains that the Act clearly recognizes the incentives for incumbent local exchange carriers to shift costs between their new competitive activities and their monopoly local exchange and exchange access operations. Accordingly, MCI asserts that we must adopt safeguards stricter than our existing accounting safeguards to account for the increased opportunities for BOCs to enter new lines of nonregulated businesses and for the increased incentives and opportunities for incumbent local exchange carriers to shift costs following passage of the 1996 Act. In particular, MCI suggests that we adopt a rule requiring carriers to maintain a complete audit trail of all cost allocations and affiliate transactions. 21.GTE agrees with our contention that any commenter urging us to adopt more detailed accounting safeguards than those in our current rules or those specifically mandated by the Act bears a heavy burden of persuading us to adopt such safeguards. Ameritech alleges, however, that we have not satisfied this heavy burden of persuasion test with regard to the more detailed accounting safeguards proposed in the NPRM. 22.With respect to our concerns regarding opportunities for incumbent local exchange carriers to engage in predatory behavior, Worldcom argues that "the very act of competing head-on with the BOCs creates a heightened degree of reliance on the BOCs' bottleneck facilities that did not exist before." AT&T alleges that the BOCs still control bottleneck facilities and that as long as their control continues, the BOCs will be able to engage in predatory behavior, forcing non-affiliated interexchange carriers to absorb high access charges as a real cost and allowing the BOCs and their interexchange affiliates to underprice these non-affiliated carriers. 23.Ameritech and USTA, however, contend that predatory behavior is not likely to occur. In particular, USTA argues that given the difference in resources between incumbent local exchange carriers and competitors, such as AT&T and MCI in the interexchange market, it is more likely that incumbent local exchange carriers will be the victims of predatory behavior, not the perpetrators of it. SBC maintains that predatory behavior concerns prices in competitive markets and has no place in an accounting safeguards proceeding. Discussion: 24.In addressing the issues in this proceeding, we adopt and follow the two fundamental goals for this proceeding articulated in the NPRM and discussed above. We are committed to facilitating the development of competitive telecommunications service offerings and, in particular, to giving effect to the provisions relating to incumbent local exchange carrier entry into, or expansion within, the markets covered by sections 260 and 271 through 276. We affirm that protecting ratepayers from cross-subsidizing competitive ventures is a primary goal behind all our cost allocation and affiliate transactions rules. The 1996 Act clarifies the meaning of what constitutes just and reasonable rates by adding to the Communications Act of 1934 section 254(k), which provides that incumbent local exchange carriers may "not use services that are not competitive to subsidize services that are subject to competition." 25.Many commenters endorse adoption of the goals we set forth in the NPRM. The primary objective of this proceeding is to examine whether our existing accounting safeguards adequately respond to new competitive opportunities created by the 1996 Act. These accounting safeguards consist of cost allocation and affiliate transactions rules that were designed to keep incumbent local exchange carriers from imposing the costs and risks of their competitive ventures on interstate telephone ratepayers, and to ensure that interstate ratepayers share in the economies of scope realized by incumbent local exchange carriers when they expand into additional enterprises. Our cost allocation and affiliate transactions rules, in combination with audits, tariff review, and the complaint process, have proven successful at protecting regulated ratepayers from bearing the risks and costs of incumbent local exchange carriers' competitive ventures. 26. With respect to affiliate transactions, we note that the Act requires BOCs to create a separate affiliate for certain services. While the volume of affiliate transactions may increase as the result of this requirement, we do not believe that the nature and type of such transactions will raise any accounting concerns that our current rules do not already address. Similarly, the 1996 Act will also likely increase the scope of nonregulated activities in which BOCs participate because they may now provide, on an integrated basis, services that they were previously prohibited from providing. Since the inception of our Part 64 cost allocation rules, the type and level of nonregulated activities have continued to grow. We designed our cost allocation rules to accommodate the growth of these nonregulated activities and affiliate transactions. We conclude that our existing cost allocation and affiliate transactions rules, as modified herein, are appropriate for any of the new activities described in Sections 260 and 271 through 276. Where we find that our accounting safeguards should be strengthened, we do so in this Order. We therefore find that adoption of the existing cost allocation rules and the affiliate transactions rules, as modified herein, will successfully achieve our goals. 27.We noted in the NPRM that any commenter urging us to adopt more detailed accounting safeguards than those in our current rules or those specifically mandated by the Act bears a heavy burden in demonstrating the necessity to adopt such safeguards. The imposition of this burden is consistent with the requirement of the Administrative Procedure Act that our actions be supported by the language of the Act as well as substantial evidence in the record. 28.Finally, we see no need for additional accounting safeguards designed specifically to prevent predatory behavior by incumbent local exchange carriers. We believe that the accounting rules we adopt here will effectively prevent predatory behavior that might result from cross-subsidization. None of the commenters proposed any additional accounting rules to guard against predatory behavior. C. Scope of Commission's Authority 29. In the NPRM, we asked whether the Act grants the Commission authority to establish accounting safeguards for the intrastate services described in sections 260 and 271 through 276. With respect to interLATA services of the types described in sections 271 and 272, we tentatively concluded, in accordance with the analysis developed and discussed in the BOC In-Region NPRM, that the Commission has authority to set the accounting safeguards for both interstate and intrastate interLATA services and interLATA information services governed by these sections. With respect to payphone service, we tentatively concluded that the language of section 276 specifically grants the Commission jurisdiction to preempt any State regulations that may be inconsistent with the Commission's regulations. With respect to manufacturing by certifying entities, we tentatively concluded that the provisions of section 273 apply to all BOC manufacturing activities, irrespective of any jurisdictional distinctions. 30.We sought comment in the NPRM on the role the states might have in implementing the accounting safeguards provisions of sections 260 and 271 through 276. We also sought comment on whether, if these sections do not specifically grant the Commission jurisdiction over intrastate services, the Commission has the authority to preempt State regulation with respect to accounting matters addressed by these sections pursuant to Louisiana Public Service Commission v. F.C.C. ("Louisiana PSC"). We tentatively concluded that if the Commission has the authority to preempt pursuant to Louisiana PSC, we should refrain from exercising that authority and retain our policy of not preempting States from using their own accounting safeguards for intrastate purposes. Comments: 31.Sprint asserts that the Act grants the Commission jurisdiction over section 260 telemessaging services without regard to either State or LATA boundaries. Voice-Tel maintains that the inherent interstate nature of telemessaging services permits the Commission to preempt States even with respect to an individual local exchange carrier operating in a single state. BellSouth, however, argues that there is no basis for the Commission to preempt State Commission actions that are consistent with section 260 and the Part 64 rules. 32.In general, interexchange carriers contend that sections 271 and 272 grant the Commission authority to regulate all interLATA services including intrastate, interLATA services because sections 271 and 272 expressly address BOC provision of interLATA services, making no distinction between interstate and intrastate aspects of those services. NARUC and the States generally disagree. CTA and Sprint contend that the Commission should preempt the States with regard to intrastate, intraLATA telecommunications services and information services if the lack of sufficient cross-subsidization safeguards by a State will hinder the development of competition and allow the BOCs to abuse their market power in the intraLATA market. California and Wisconsin PSC allege that the Commission has no authority to preempt States from using their own accounting safeguards unless individual State rules compromise the goals and intent of the Act. US West argues that we should consider the necessity of preemption on a case-by-case basis because there is no record to justify a blanket preemption of State accounting safeguards procedures for intrastate purposes. 33.Sprint and AICC argue that the Act grants the Commission jurisdiction over alarm monitoring under section 275 without regard to either State or LATA boundaries. AICC argues that even if section 275 does not, by its terms, grant the Commission jurisdiction over all alarm monitoring services, the Commission has the power to preempt State regulation in order to ensure that alarm monitoring services are not subsidized by exchange and exchange access ratepayers. Florida PSC contends, however, that the Commission has no authority to preempt the States from applying their own cost allocation systems for intrastate alarm monitoring services. 34.BellSouth and NYNEX contend that section 276 contains express language that, with respect to payphone service, specifically grants the Commission authority to preempt any State regulations that may be inconsistent with the Commission's regulations. California and NYDPS contend that the Act does not authorize the Commission to preempt States from imposing accounting safeguards on payphone service. 35.Sprint and TIA maintain that the Commission has jurisdiction over all manufacturing activities under section 273 because manufacturing cannot be segregated into interstate and intrastate portions. NYDPS, however, argues that the Act does not limit States from exercising jurisdiction over manufacturing. 36.All commenters that addressed the Commission's scope of authority over electronic publishing services agree that section 274 covers both interLATA and intraLATA electronic publishing. YPPA contends that if Congress had intended to distinguish between interLATA and intraLATA electronic publishing, it would have done so, as it did in section 272. NYDPS argues that the Act does not preclude States from exercising jurisdiction over electronic publishing. NAA maintains that the requirements of section 274 apply when the electronic publishing is disseminated by means of a BOC's "basic telephone service." Thus, NAA argues that the Commission's authority with respect to complaints and cease and desist orders applies to interstate and intrastate electronic publishing. NAA contends, however, that Congress has manifested no intent to preclude the States from also enforcing section 274. 37.AT&T contends that the role of the States in implementing the Act's various prohibitions against cross-subsidization arises in the auditing process. According to AT&T, States will also continue to have authority to use their own accounting methods for intrastate services that have not been preemptively deregulated by the Commission or for which jurisdiction has not been expressly vested in the Commission under the Act. 38.With respect to the Commission's authority to preempt State accounting regulations pursuant to Louisiana PSC, NYDPS contends that because two sets of accounting regulations can co-exist and have co-existed in the past, the Commission's tentative conclusion to refrain from preempting States under Louisiana PSC is correct as a matter of law. TIA contends that any State regulation with respect to BOC manufacturing that is inconsistent with the requirements of section 272 or 273 would necessarily "thwart or impede" federal policies and should therefore be preempted. Discussion: 39. Sections 260, 271, 274, 275 and 276 of the Communications Act of 1934 all expressly prohibit BOCs and, in some cases, other incumbent local exchange carriers from subsidizing services permitted under those sections from their "telephone exchange service" or their "basic telephone service." The term "telephone exchange service" as defined under section 3(47) of the Act is a primarily intrastate service. Moreover, the term "basic telephone service" as defined under section 274(i)(2) is a primarily intrastate service. Therefore, by barring BOCs and, in some cases, other incumbent local exchange carriers from subsidizing activities permitted pursuant to sections 260, 271, 274, 275 and 276 from their "telephone exchange service" or their "basic telephone service," these sections of the Act expressly reach intrastate services. In addition, section 273(g) states that the Commission may prescribe such additional rules and regulations as may be necessary to prevent cross- subsidization. 40. The relevant statutory references to intrastate services are extensive. Section 260(a)(1) provides that "[a]ny local exchange carrier subject to the requirements of section 251(c) that provides telemessaging service . . . (1) shall not subsidize its telemessaging service directly or indirectly from its telephone exchange service or its exchange access." Section 274(a) provides that "[n]o Bell operating company or any affiliate may engage in the provision of electronic publishing that is disseminated by means of such Bell operating company's or any of its affiliates' basic telephone service." Similarly, section 275(b)(2) provides that an incumbent local exchange carrier shall "not subsidize its alarm monitoring services either directly or indirectly from telephone exchange service operations," while section 276(a)(1) prohibits any BOC that provides payphone service from subsidizing its payphone service "directly or indirectly from its telephone exchange service operations or its exchange access operations." Further, section 271(h), pertaining to BOC entry into interLATA services, states that the "Commission shall ensure that the provision of services authorized under subsection (g) by a Bell operating company or its affiliate will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market." 41. In addition, we note that in the companion Non-Accounting Safeguards Order, we conclude that sections 271 and 272 give us jurisdiction over all interLATA services covered by those sections, including intrastate, interLATA services. The Act defines "interLATA services" as "telecommunications between a point located in a [LATA] and a point located outside such area." The definition does not distinguish between domestic and international interLATA services. Further, international telecommunications services, which originate in a LATA and terminate in a country other than the United States, or vice versa, fit within the statutory definition of interLATA services. Thus, we conclude, as we do in the Non-Accounting Safeguards Order that Congress intended the section 272 safeguards to apply to all domestic and international interLATA services. Because the scope of sections 271 and 272 extends to both interstate and intrastate services, carriers must comply with the requirements of those sections for both interstate and intrastate services. We emphasize, however, that the scope of the Commission's authority under sections 271 and 272 extends only to matters covered by those sections. Those sections do not alter the jurisdictional division of authority with respect to matters falling outside their scope. For example, rates charged to end users for intrastate interLATA service have traditionally been subject to state authority, and will continue to be. 42. Based on the express statutory language prohibiting cross-subsidization, as well as our interpretation of the term "interLATA," as discussed in the Non-Accounting Safeguards Order, and our interpretation of the terms "telephone exchange service" and "basic telephone service," as discussed above, we conclude that the reach of sections 260, 271, 272 and 274 through 276 extends to intrastate services, and that the Commission has jurisdiction, under the cross-subsidization prohibitions contained in these sections, to adopt regulations governing intrastate services. Again, we emphasize that the scope of the Commission's authority under sections 260, 271, 272, and 274 through 276 extends only to matters covered by those sections. Those sections do not alter the jurisdictional division of authority with respect to matters falling outside their scope, including rates charged to end users for intrastate interLATA service. 43.We also find, as discussed in the Non-Accounting Safeguards Order, that section 2(b) of the Communications Act of 1934 does not limit the Commission's authority to establish regulations governing intrastate matters under these sections. For the reasons explained below, however, we decline to impose any additional accounting rules on carriers' intrastate services. We note that the language of sections 260, 271, 272 and 274 through 276 that extends our jurisdiction to include certain intrastate activities is both more recent and more specific than section 2(b). As a result, the language of these more recent provisions is controlling. 44. As we discuss in section II.B. above, we already have an accounting safeguards system in place that prevents incumbent local exchange carriers from imposing the costs and risks of their competitive ventures on interstate telephone ratepayers and ensures that interstate ratepayers share in the economies of scope that incumbent local exchange carriers may realize upon expansion into additional enterprises. In this Order, we apply our existing accounting safeguards system, consisting of our cost allocation and modified affiliate transactions rules in Parts 32 and 64 of our rules, to the services permitted by sections 260, 271, 272 and 274 through 276. Our experience with these safeguards has demonstrated their ability to protect interstate ratepayers from improper cross-subsidization. The cross-subsidization prohibitions of sections 260, 271, 272 and 274 through 276, however, cover certain intrastate services, as noted in the previous paragraph. Neither the information contained in the record nor our experience provides us with any basis to conclude that existing state accounting systems that differ from our federal system will result in the type of subsidization of competitive activities prohibited by sections 260, 271, 272 and 274 through 276. Therefore, we decline to impose any additional accounting rules on intrastate services. 45. Regardless of whether we or the States adopt accounting rules to prevent subsidies flowing from regulated services within our respective jurisdictions to the services permitted under sections 260, 271, 272 and 274 through 276, carriers must comply with the cross-subsidization prohibitions in those sections of the Act. Any ratepayer or other person alleging a violation of these provisions by a carrier may file a complaint with the Commission pursuant to section 208 of the Communications Act. In the event that a carrier or customer believes that any State has imposed accounting rules that may force a carrier to violate the cross-subsidization prohibitions of sections 260, 271, 272 and 274 through 276, then the carrier or customer may seek declaratory relief from the Commission pursuant to section 1.2 of the Commission rules on a case-by-base basis. 46. With regard to the manufacturing activities covered by section 273, we conclude that States are preempted from implementing any part of that section, including its accounting safeguards provisions. We base this conclusion on the fact that such manufacturing activities cannot be separated between the interstate and intrastate jurisdictions, rendering any separation between interstate and intrastate jurisdictions infeasible. As a result, we must preempt States from implementing accounting safeguards related to manufacturing activities. Moreover, while section 2(b) of the Communications Act of 1934 limits the Commission's authority over "charges, classifications, practices, services, facilities, or regulation for or in connection with intrastate communications service," we find that the manufacturing activities addressed by section 273 do not fit within any of these categories and therefore are not within the scope of section 2(b). We therefore conclude that section 2(b) does not preclude our assertion of jurisdiction over manufacturing activities, as required by section 273. D. Structure of this Order 47.Section III of this Order addresses accounting safeguards that apply when an incumbent local exchange carrier, including a BOC, provides on an integrated basis a service within the ambit of sections 260 and 271 through 276. Section IV discusses the accounting safeguards that apply when an incumbent local exchange carrier, including a BOC, uses an affiliate to provide a service within the ambit of sections 260 and 271 through 276. Within sections III and IV, we address the application of accounting safeguards to meet the individual requirements of each statutory section addressed in this Order. Section V of this Order presents our analysis as to why price cap regulation does not obviate the need for accounting safeguards to ensure against the subsidization of services permitted under sections 260 and 271 through 276 with revenues from regulated telecommunications services. III. SAFEGUARDS FOR INTEGRATED OPERATIONS A. General 48.In this section of the Order, we discuss the provisions in sections 260, 271, 275, and 276 relating to accounting safeguards for telemessaging, certain interLATA telecommunications and information, alarm monitoring, and payphone services that the BOCs and other incumbent local exchange carriers may provide on an integrated basis. In the NPRM, we tentatively concluded that our existing Part 64 cost allocation rules, developed in our Joint Cost and Computer III proceedings, satisfy the requirements of these sections of the Act that certain competitive telecommunications and information services not be subsidized by subscribers to regulated telecommunications services. We invited comment on this tentative conclusion. In the NPRM, we asked whether the benefits of a fundamentally different approach to cost allocation would be outweighed by the costs that implementation of such a change would impose. Alternatively, we asked commenters to discuss how, if necessary, we might adapt the existing cost allocation system to accommodate the services discussed in section III of the NPRM. Comments: 49.Most parties, including several BOCs, support the Commission's tentative conclusion that our existing Part 64 cost allocation rules generally satisfy the requirements of the Act that certain competitive and information services not be subsidized by subscribers to regulated telecommunications services. In particular, Puerto Rico Telephone contends that we need not modify our cost allocation rules because competition in the local exchange and exchange access markets will ensure that local exchange carriers do not shift costs of nonregulated services to regulated ratepayers. In contrast, MCI maintains that additional safeguards for integrated operations are necessary to protect the public interest. Ameritech argues that our current cost allocation rules exceed the statutory requirements of the Act. Discussion: 50.We developed our cost allocation rules in the Joint Cost and Computer III Proceedings to help ensure that interstate ratepayers do not bear the costs and risks of the telephone companies' nonregulated activities. These rules prescribe how subject carriers must separate the costs of activities regulated under Title II from the costs of nonregulated activities when the nonregulated activities are performed directly by the carrier rather than through an affiliate. Under these rules, incumbent local exchange carriers may not apportion the costs of nonregulated activities to regulated products and services. We adopt our tentative conclusion that our existing Part 64 cost allocation rules satisfy the requirements of sections 260, 271, 275, and 276 that certain competitive telecommunications and information services not be subsidized by subscribers to regulated telecommunications services. Incumbent local exchange carriers have implemented internal cost allocation systems to help ensure their compliance with these rules. No commenter has presented a plan for redesigning these internal systems to accommodate a fundamentally different cost allocation approach. We discuss below the application of our cost allocation rules to services permitted under sections 260, 271, 275, and 276. B. Specific Services 1. Section 260 - Telemessaging Service 51.Section 260(a)(1) provides that each "local exchange carrier subject to the requirements of section 251(c) that provides telemessaging service . . . shall not subsidize its telemessaging service directly or indirectly from its telephone exchange service or its exchange access." Section 251(c), in turn, applies to every "incumbent local exchange carrier." Section 260(c) defines "telemessaging service" as "voice mail and voice storage and retrieval services, any live operator services used to record, transcribe, or relay messages (other than telecommunications relay services), and any ancillary services offered in combination with these services." 52.In the NPRM, we tentatively concluded that applying our Part 64 rules to telemessaging will safeguard against the cross-subsidies prohibited by section 260(a)(1). We also tentatively concluded, as we did in a companion NPRM, the BOC In-Region NPRM, that telemessaging is an information service and that our authority under sections 271 and 272 over interLATA information services extends to intrastate, interLATA information services provided by BOCs or their affiliates. Therefore, BOC provision of telemessaging service on an interLATA basis would be subject to the separate affiliate requirements of section 272. We invited comment on these tentative conclusions. Comments: 53.In general, incumbent local exchange carriers assert that the existing Part 64 rules will effectively prevent cross-subsidization of telemessaging services. ATSI contends that existing rules applicable to telemessaging are not sufficient to safeguard against the subsidies prohibited by section 260 because they fall short of equalizing cost attributions. 54.Voice-Tel maintains that existing accounting safeguards in Parts 32 and 64 cannot ensure that telemessaging services that are marketed and provided by incumbent local exchange carriers on an in-house basis will not be subsidized by ratepayers. Voice-Tel argues that because telemessaging is part of basic service offered by a local exchange carrier and is marketed by customer service representatives at the same time that other basic service options are presented, there are no easily identifiable separate marketing activities that can be isolated and separately costed. Telemessaging often uses the same facilities that are used for other basic and optional services provided by the local exchange carrier, and the switch is not necessarily partitioned in a manner that permits direct allocation. Voice-Tel contends that even if the switch can be partitioned, it is questionable whether the use of lines and trunks can be properly allocated because most telemessaging services permit access to a mailbox by dialing either a special number or by dialing one's own number. In both cases, there is no separate trunk or line cost to allocate. Accordingly, Voice-Tel's advocates that we should require all incumbent local exchange carriers that wish to offer telemessaging services to do so through a separate affiliate in order to meet the goals of section 260. 55.MCI and Voice-Tel contend that telemessaging is an information service, and that when a BOC provides telemessaging on an interLATA basis, it must do so in accordance with the section 272 separate affiliate requirements. Certain local exchange carriers argue that section 272 only requires that interLATA information services, not intraLATA information services such as many existing telemessaging services, be offered through a separate affiliate. BellSouth asserts that the requirement of a separate subsidiary for the provision of interLATA information services facially violates incumbent local exchange carriers' First Amendment right to freedom of speech. Discussion: 56.We concur with the incumbent local exchange carriers that assert that our existing accounting safeguards will effectively prevent cross-subsidization of telemessaging services in accordance with section 260(a)(1). We presently classify telemessaging service as a nonregulated activity for Title II accounting purposes. Consequently, costs associated with the provision of telemessaging services are already addressed by our Part 64 cost allocation rules and, to the extent telemessaging is provided through affiliates, our affiliate transactions rules also apply. Our Part 64 rules require carriers to allocate a portion of their network investment plant used to provide telemessaging services to nonregulated accounts. 57.We find unpersuasive Voice-Tel's assertion that existing accounting safeguards in Parts 32 and 64 cannot ensure that telemessaging services that are marketed and provided by incumbent local exchange carriers on an in-house basis will not be subsidized by ratepayers. Our Part 64 cost allocation rules require local exchange carriers providing services in addition to local exchange service to use a cost allocation methodology based on fully distributed costs ("FDC"). This methodology establishes a hierarchy of cost apportionment rules designed to prevent cross-subsidies. These rules are applied to costs recorded in the accounts specified in the Uniform System of Accounts ("USOA") set out in Part 32 of our rules. The methodology requires carriers to assign costs directly, wherever possible, to regulated or nonregulated activities. If costs cannot be directly assigned, they are considered "common costs" and must be placed in homogenous cost pools. The carrier must then divide the costs in each pool between regulated and nonregulated activities using formulas or factors known as "allocators." Depending upon the information available, carriers must apply these allocators in the following order. Whenever possible, common costs must be directly attributed based upon a direct analysis of the origins of those costs. Common costs that cannot be directly attributed must be indirectly attributed based on an indirect, but cost-causative, linkage to another cost pool or pools for which a direct assignment or attribution is possible. Only if direct or indirect attribution factors are not available may the carrier allocate a pool of common costs using what is known as a "general allocator." Our Part 64 cost allocation rules are designed to prevent cross-subsidization of nonregulated activities such as telemarketing by establishing a methodology for allocating joint and common costs such as those described by Voice-Tel between regulated and nonregulated activities. 58. Our cost allocation and affiliate transactions rules have been in place for approximately ten years. As already observed, these rules and procedures, in combination with audits, tariff review, and the complaint process, have proven successful at protecting regulated ratepayers from bearing the risks and costs of incumbent local exchange carriers' competitive ventures. Since the inception of our Part 64 cost allocation rules, the types of nonregulated activities have continued to grow. The Commission designed the cost allocation system in such a way that it can accommodate the evolving nature of nonregulated activities, such as telemessaging services. Thus, we conclude that our current rules protect local exchange service subscribers from subsidizing telemessaging services that are marketed and provided by incumbent local exchange carriers on an integrated basis. 59.Based upon the analysis set forth in our companion item, the Non-Accounting Safeguards Order, we adopt our tentative conclusion that telemessaging is an information service. We also adopt, as we do in our companion item, our tentative conclusion that BOCs providing telemessaging services that meet the definition of interLATA information services must comply with the section 272 separate affiliate requirements, in addition to the section 260 requirements. 60.BellSouth has argued that requiring BOCs to provide out-of-region interLATA information services through a section 272 separate affiliate violates the First Amendment. As noted above, we find that this result is required by the Act. Although the courts have ultimate authority to determine the constitutionality of this and other statutes, we find it appropriate to state that we find BellSouth's argument to be without merit. BellSouth bases its argument on an assertion that information services are commercial speech entitled to First Amendment protections. We conclude, first, that with respect to certain information services, a BOC neither provides, nor exercises editorial discretion over, the content of the information associated with those particular services, and therefore provision of those information services does not constitute speech subject to First Amendment protections. Second, to the extent that BOC provision of other interLATA information services constitutes speech for First Amendment purposes, the section 272 separate affiliate requirement neither prohibits the BOCs from providing such services, nor places any restrictions on the content of the information the BOCs may provide. Instead, the section 272 separate affiliate requirement is a content-neutral restriction on the manner in which BOCs may provide interLATA information services, intended by Congress to protect against improper cost allocation and discrimination concerns. Thus, we conclude that the separate affiliate requirement imposed by section 272 of the Communications Act on BOC provision of interLATA information services does not violate the First Amendment. 2. Section 271 - InterLATA Telecommunications Services 61.The NPRM noted that section 272(a)(2)(B) permits BOCs to provide on an integrated basis certain regulated, interLATA telecommunications services, including out-of- region services and certain types of incidental services. In our Interim BOC Out-of-Region Order, we determined that the BOCs must provide out-of-region interstate, interexchange services (including interLATA and intraLATA services) through separate affiliates, at least on an interim basis, in order to qualify for non-dominant regulatory treatment in the provision of those services. Under the Interim BOC Out-of-Region Order, however, a BOC could still choose to provide these services on an integrated basis, subject to dominant carrier regulation. Accordingly, this Order addresses the cost allocation rules that should be applied to BOCs that choose to provide certain regulated, interLATA telecommunications services, including out-of-region services and certain types of incidental services, on an integrated basis. a. Incidental InterLATA Services 62.Section 271(h) states that "[t]he Commission shall ensure that the provision of services authorized under [section 271(g)] by a Bell operating company or its affiliate will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market." In the NPRM, we sought comment on whether our present Part 64 cost allocation rules are adequate to prevent the adverse effects proscribed by section 271(h) with respect to incidental interLATA services. We asked commenters to describe in detail the modifications or additions to Part 64 they believe necessary, to explain how these modifications or additions would better enable the Commission to fulfill its obligations under section 271(h), and to identify the category of ratepayers or markets the proposed modifications or additions would protect. Comments: 63.Incumbent local exchange carriers generally assert that our current cost allocation rules are adequate to "ensure that the provision of services authorized under [section 271(g)] by a Bell operating company or its affiliate will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market" in accordance with section 271(h). 64.Worldcom contends that the language of section 271(h) strongly implies that the Commission's current cost allocation rules are not adequate to ensure that the BOC's provision of incidental interLATA services would not adversely affect ratepayers and competitors. Worldcom asserts that at a minimum we should apply the same cost allocation requirements to incidental interLATA services as are applied to other interLATA services provided by the BOCs on an integrated basis. Discussion: 65.We incorporate our conclusions regarding the accounting safeguards necessary to prevent the adverse effects proscribed by section 271(h) with respect to the integrated provision of incidental interLATA services by the BOCs in our discussion of accounting safeguards to be applied to BOC provision of interLATA services. That discussion appears in Section III.B.2.b. below. b. Integrated Provision of InterLATA Services 66.The NPRM tentatively concluded that we should apply our Part 64 cost allocation rules to regulated services other than local exchange and exchange access services, including out-of-region services and certain types of incidental services, provided by BOCs on an integrated basis in accordance with section 272(a)(2)(B). We invited comment on this tentative conclusion. We also asked whether we needed to develop different cost allocation rules for these regulated services other than local exchange and exchange access to prevent allocation of the costs of such regulated services to local exchange and exchange access customers. We suggested two possible solutions: (1) the creation of a separate category for Title II accounting purposes to include regulated services other than local exchange and exchange access services, or (2) the classification of any regulated services other than local exchange and exchange access services that are provided on an integrated basis as nonregulated activities for Title II accounting purposes. We invited comment on these solutions. 67.In the NPRM, we asked whether, if incumbent local exchange carriers provide out-of-region interstate interexchange services on an integrated basis, our accounting rules for such incumbent local exchange carriers should be similar to those we adopt for the BOCs. Comments: 68.Many parties support our proposal to apply our Part 64 cost allocation rules to regulated interLATA telecommunications services, including out-of-region services and certain types of incidental services, that may be provided by BOCs on an integrated basis and contend that such services should be treated like nonregulated activities for federal accounting purposes. In particular, TRA maintains that treating such services like nonregulated activities for federal accounting purposes will lessen the chance that costs associated with such services are inadvertently assigned to a local exchange or exchange access category. Worldcom asserts that the potential for improper cost allocation is greater between two regulated categories than between regulated and nonregulated activities. 69.SBC argues that it would be improper to treat all incidental interLATA services like nonregulated activities for federal accounting purposes because a number of the activities that these incidental interLATA services support would be regulated Title II activities. SBC contends that the costs of such incidental services are supposed to flow through the Part 36 process to separate integrated plant serving state and interstate jurisdictions. 70.MCI proposes that, as in the Video Dialtone Proceeding, we should create a separate category for Title II accounting purposes to include regulated services other than local exchange and exchange access services in order to clearly identify the allocation of costs between a BOC's local and interLATA operations. In contrast, the BOCs generally argue that no separate regulated category is needed for interLATA telecommunications services provided on an integrated basis, such as out-of-region services and certain types of incidental services, because our current accounting safeguards rules ensure that ratepayers do not subsidize interexchange operations. In particular, several of the BOCs assert that Part 36 will separate the costs of these services into state and interstate portions, and Part 69 will allocate the costs of all regulated, interLATA telecommunications services to the interexchange basket separate from local exchange and exchange access costs. BellSouth and PacTel argue that there is also no need to treat these services like nonregulated activities for federal accounting purposes because the Commission can review the costs of providing such services, including the allocation of overhead, during the tariff review process. 71.Several parties contend that we should require all incumbent local exchange carriers, including non-BOCs, to treat any regulated services other than local exchange and exchange access like nonregulated services for Title II accounting purposes to ensure the prevention of subsidies flowing from the latter services to the former. 72.Cincinnati Bell and USTA argue that sections 271 through 276 apply solely to BOCs and the Commission has no authority to apply additional accounting safeguards to non- BOC incumbent local exchange carriers. Discussion: 73.Section 254(k) prohibits a "telecommunications carrier" from using "services that are not competitive to subsidize services that are subject to competition." We conclude that section 254(k) bars all incumbent local exchange carriers, including BOCs, from subsidizing competitive interLATA telecommunications services, such as out-of-region services and certain types of incidental interLATA services, with revenues from exchange services and exchange access that are not subject to competition. Section 271(h) specifically requires the Commission to ensure that the provision of incidental interLATA telecommunications services by a BOC or its affiliate "will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market." Accordingly, we concur with the parties that assert that our Part 64 cost allocation rules should apply to interLATA telecommunications services, including out-of-region services and certain types of incidental services, that may be provided by incumbent local exchange carriers on an integrated basis. 74.Our Part 64 cost allocation rules require a carrier to assign costs directly, wherever possible, to regulated or nonregulated activities. These rules protect subscribers to interstate exchange and exchange access services from bearing the costs and risks of the carrier's nonregulated activities provided on an integrated basis. These rules do not, however, protect against improper cost allocations from one regulated activity to another regulated activity. Therefore, if interLATA telecommunications services, including out-of-region services and certain types of incidental services, that may be provided by incumbent local exchange carriers on an integrated basis, were treated as regulated for accounting purposes, our Part 64 rules would not prevent any improper cost allocations that may occur between local exchange and exchange access services and these interLATA telecommunication services. 75.For these reasons, we agree with TRA, GSA and AT&T that under our current cost allocation rules we can most efficiently and comprehensively satisfy sections 254(k) and 271(h) if, solely for federal accounting purposes, we treat like nonregulated activities both out- of-region and certain types of incidental interLATA services that may be provided by incumbent local exchange carriers on an integrated basis. We believe that this should sufficiently safeguard against cross-subsidization without imposing additional accounting requirements on carriers. This would parallel the approach taken in the Interim BOC Out-of- Region Order that classified out-of-region interstate, interexchange services provided by BOC affiliates as nonregulated activity for accounting purposes. Because incumbent local exchange carriers currently have internal accounting systems in place to allocate costs fairly between nonregulated activities and regulated services provided on an integrated basis, such a requirement will not impose extensive expense upon incumbent local exchange carriers. 76.We agree with several of the BOCs that assert that Part 36 will jurisdictionally separate the costs of regulated, interLATA telecommunications services into state and interstate portions, and Part 69 will allocate the costs of all regulated interstate, interLATA telecommunications services to the interexchange basket separate from local exchange and exchange access costs. We conclude, however, that the Part 36 jurisdictional separations process and the Part 69 access charge process were not designed to prevent subsidization of competitive telecommunications services by subscribers to exchange and exchange access services. Although the Part 36 and Part 69 processes produce the secondary effect of assigning the costs of regulated interstate, interLATA telecommunications services to the interexchange basket, classifying both out-of-region and certain types of incidental interLATA services as nonregulated activities for federal accounting purposes will achieve greater accuracy in safeguarding against cross-subsidization. Classifying such services as nonregulated activities allows the allocation of costs for these activities to occur immediately after such costs are assigned to Part 32 accounts. Such treatment avoids the necessary imprecisions inherent in the Part 36 jurisdictional separations process, the Part 69 access charge process, and our Part 61 price cap rules. Moreover, we concur with TRA that treating such services like nonregulated activities for federal accounting purposes will lessen the chance that costs associated with such services are inadvertently assigned to a local exchange or exchange access category. c. Other Matters 77.Section 272(e)(3) requires that "[a] Bell operating company . . . impute to itself (if using [exchange] access for its provision of its own services), an amount for access that is no less than the amount charged to any unaffiliated interexchange carriers for such service." In the NPRM, we invited comment on how BOCs should account for these access charges. The NPRM suggested that one possible approach would be for BOCs to record these imputed exchange access charges as an expense that would be directly assigned to nonregulated activities with a credit to the regulated access revenue account. We invited comment on this approach as well as alternative approaches. 78.Section 272(e)(4) states that "[a] Bell operating company and an affiliate that is subject to the requirements of section 251(c) . . . may provide any interLATA or intraLATA facilities or services to its interLATA affiliate if such services or facilities are made available to all carriers at the same rates and on the same terms and conditions, and so long as the costs are appropriately allocated." In the NPRM, we invited comment on whether and, if so, how the requirements of sections 272(e)(3) and (4) should affect our rules for allocating costs between activities regulated under Title II and nonregulated activities for those BOCs that provide interLATA services on an integrated basis. We also requested comment on whether, in light of section 272(e)(4), we may require BOCs that provide interLATA or intraLATA facilities or services on an integrated basis to provide these facilities or services to their own internal operation only at the same rates as those facilities or services are made available to all carriers. When those rates differ for different carriers, we sought comment on which rate should be applicable to BOC affiliate transactions. We also invited comment on whether we should adopt specific accounting procedures to address the difference, if any, between those rates and the costs that would be appropriately allocated for the underlying facilities or services. Comments: 79.AT&T and Worldcom agree with the tentative conclusion in the NPRM that BOCs should record imputed exchange access charges as an expense that would be directly assigned to nonregulated activities with a credit to the regulated access revenue account. In general, incumbent local exchange carriers disagree with the tentative conclusion stated in the NPRM. In particular, PacTel contends that the approach suggested in the NPRM is only workable for structurally separate affiliates where revenues and expenses of the BOC and its affiliate are each stated correctly for regulated reporting purposes (each entity separately reports the results of its own operations). US West and GSA argue that recording imputed access charges as a nonregulated expense might result in a doubling of overhead costs allocated to the nonregulated activity because the imputed charge would already contain an element of overhead. 80.Several incumbent local exchange carriers argue that we should require imputed access charges to be recorded as debits to nonregulated revenues and credits to regulated access charge revenues. In general, incumbent local exchange carriers maintain that section 32.5280 of our rules defines the accounting treatment for regulated services provided on an integrated basis: "[the nonregulated operating revenue] account shall be debited, and regulated revenue accounts credited at tariffed rates when tariffed services are provided to nonregulated activities." 81.NYNEX contends that imputing exchange access charges is not necessary because treating interexchange service as nonregulated would trigger the application of the Part 64 requirement that nonregulated services record the use of the underlying tariffed services at tariff rates, satisfying section 272(e)(3)'s requirements and ensuring against cross- subsidization. 82.AT&T and Worldcom assert that we must ensure that the full access charge is reflected in a BOC's end-user rates, and is not merely a book entry in the case of a BOC that uses exchange access for the provision of its own services. AT&T argues that in order to ensure that the full access charge is reflected in a BOC's end-user rates, we should establish price floors at a level equal to the amount of the access charge plus the incremental cost of the non-access portions of the service. Wisconsin PSC states that it presently makes use of price floors such that when a carrier subject to Wisconsin PSC's regulations uses a noncompetitive service in the provision of its own competitive service, the competitive service must be priced to exceed total service long-run incremental cost ("TSLRIC"). Accordingly, like AT&T, Wisconsin PSC argues that we should adopt a price floor to prevent cross-subsidization. 83.With respect to whether the requirements in sections 272(e)(3) and (e)(4) should affect our rules for allocating costs between activities regulated under Title II and nonregulated activities for those BOCs that provide interLATA services on an integrated basis, SBC argues that sections 272(e)(3) and (e)(4) relate solely to in-region interLATA services that BOCs are required to provide through an affiliate and are not relevant to the interLATA services that the BOCs are permitted to provide on an integrated basis. 84.TRA and Worldcom argue that when a BOC charges different rates to different unaffiliated carriers for facilities or services, the BOC must impute the highest rate paid for the same facilities or services to the BOC's integrated operations. USTA, however, alleges that an approach requiring the BOC's integrated operations to pay the highest rate paid for the same facilities or services by unaffiliated carriers would unnecessarily constrain a BOC from volume discount purchases. 85.Bell Atlantic and US West assert that what local exchange carriers charge for interLATA services is not an accounting issue, but rather a pricing issue and has no place in this proceeding. Discussion: 86.We conclude that we should not require BOCs to record imputed exchange access charges required under section 272(e)(3) as an expense that would be directly assigned to nonregulated activities with a credit to the regulated access revenue account. We conclude that the approach suggested in the NPRM would result in an overstatement of operating revenues. Instead, we concur with the BOCs that the logic of section 32.5280 of our rules provides the proper framework for recording imputed exchange access charges. Accordingly, to record imputed exchange access charges required under section 272(e)(3), BOCs should debit the nonregulated operating revenue account by the amount of the imputed exchange access charges and credit the regulated revenue account by the amount of the imputed exchange access charges. By requiring BOCs to account for imputed exchange access charges in this manner, the accounting for this imputed revenue will be consistent with our current accounting rules adopted in the Joint Cost Proceeding for imputing revenues derived from services provided to nonregulated affiliates. 87.Section 272(e)(3) requires a BOC to impute to itself an amount for access it provides to its telephone exchange service "that is no less than the amount charged to any unaffiliated interexchange carriers for such service." Accordingly, where a BOC charges different rates to different unaffiliated carriers for access to its telephone exchange service, the BOC must impute to its integrated operations the highest rate paid for such access by unaffiliated carriers. In determining the highest rate paid by unaffiliated carriers, the BOC may consider the comparability of the service provided. If, for example, rates charged unaffiliated carriers vary based on the volume purchased, the BOC may consider comparable volume in determining the highest rate to impute to its integrated operations. Accordingly, a BOC's integrated operations may take advantage of the same volume discount purchases offered to its interLATA affiliate and other unaffiliated carriers. As for AT&T's and Worldcom's concerns regarding the reflection of the full access charge in a BOC's end-user rates, we agree with Bell Atlantic and US West that those concerns involve pricing issues, rather than accounting issues, and therefore lie beyond the scope of this proceeding. 3. Section 275 - Alarm Monitoring Services 88.Section 275(e) defines "alarm monitoring service" as "a service that uses a device located at a residence, place of business, or other fixed premises (1) to receive signals from other devices located at or about such premises regarding a possible threat at such premises to life, safety, or property, from burglary, fire, vandalism, bodily injury, or other emergency, and (2) to transmit a signal regarding such threat by means of transmission facilities of a local exchange carrier or one of its affiliates to a remote monitoring center to alert a person" about the emergency. Section 275(a)(1) delays entry by the BOCs not already providing alarm monitoring services until five years from the date of enactment of the 1996 Act. If a BOC or BOC affiliate provided alarm monitoring services as of November 30, 1995, it may continue to do so, but cannot expand its alarm monitoring business by acquiring "any equity interest in, or obtain financial control of, any unaffiliated alarm monitoring service entity" during the five-year period after the date of enactment of the 1996 Act. 89.Section 275(b)(2) specifies that an incumbent local exchange carrier engaged in the provision of alarm monitoring services "not subsidize its alarm monitoring services either directly or indirectly from telephone exchange service operations." As with the prohibition against subsidizing telemessaging services, this prohibition against subsidizing alarm monitoring services specifically applies to incumbent local exchange carriers. 90.In the NPRM, we asked whether our present Part 64 cost allocation rules are necessary or sufficient to prevent subsidization of alarm monitoring services either directly or indirectly from telephone exchange service operations in accordance with section 275(b)(2). Comments: 91.Commenters generally agree that the Commission's present Part 64 cost allocation rules are sufficient to prevent subsidization of alarm monitoring services from telephone exchange service operations because alarm monitoring services are presently treated as nonregulated activities for Title II accounting purposes and the Commission's Part 64 cost allocation rules require carriers to allocate the costs of alarm monitoring services to nonregulated activities. SBC believes that the language of section 275 does not require the imposition of any accounting safeguards with respect to alarm monitoring services. Discussion: 92.We concur with the numerous commenters that assert that application of our present Part 64 cost allocation rules to alarm monitoring services will adequately safeguard against the subsidies prohibited by section 275(b)(2) because our rules require that the fully distributed cost of providing alarm monitoring service be removed from the carrier's regulated activities. We presently classify alarm monitoring services as nonregulated activities for Title II accounting purposes. Consequently, our cost allocation rules and affiliate transaction rules apply to alarm monitoring services. Carriers are required to allocate a portion of their network investment plant used to provide alarm monitoring services to these nonregulated activities. We already have experience with the application of our existing rules to alarm monitoring services because some companies already provide alarm monitoring services on a nonregulated basis. 4. Section 276 - Payphone Services 93.Section 276(a)(1) states that "any Bell operating company that provides payphone service shall not subsidize its payphone service directly or indirectly from its telephone exchange service operations or its exchange access operations." This prohibition against cross-subsidization is an integral part of the statutory plan "to promote competition among payphone providers and promote the widespread deployment of payphone services to the benefit of the general public." To implement the prohibition, section 276(b)(1)(C) directs the Commission to prescribe nonstructural safeguards for BOC payphone service that, "at a minimum, include the nonstructural safeguards equal to those adopted in the Computer Inquiry-III (CC Docket No. 90-623) proceeding." In Computer III, we examined our regulatory regime for the provision of enhanced services and replaced the Computer II requirements with a series of nonstructural safeguards. These safeguards included the Part 64 cost allocation rules and the affiliate transactions rules that we developed in the Joint Cost Order. 94.In the NPRM, we tentatively concluded that we should apply accounting safeguards identical to those adopted in the Computer III proceedings to prevent the cross- subsidization of payphone services by BOC telephone exchange service or exchange access operations in accordance with sections 276(a)(1) and (b)(1)(C). We invited comment on this tentative conclusion. 95.The provision of payphone service by local exchange carriers has traditionally been treated as a regulated activity for Title II accounting purposes. In the NPRM, we tentatively concluded that we should reclassify payphone service as a nonregulated activity for accounting purposes so that its costs will be separated from telephone exchange service and exchange access operations. Under this proposal, BOCs would classify their payphone investment, expenses and revenues as nonregulated for Title II accounting purposes while continuing to use the Commission's Part 32 accounts to record their payphone service activities. We invited comment on this tentative conclusion and asked whether this proposal would provide nonstructural accounting safeguards equivalent to those adopted in the Computer III proceeding and whether such changes would prevent subsidization of payphone services by BOC telephone exchange service or exchange access operations. 96.Section 276 does not prescribe accounting safeguards to govern the provision of payphone service by incumbent local exchange carriers other than the BOCs. We also asked in NPRM whether we should require non-BOC incumbent local exchange carriers to reclassify their payphone service operations as a nonregulated activity for Title II accounting purposes. Comments: 97.In general, BOCs and interexchange carriers contend that payphone service should be treated like a nonregulated activity for federal accounting purposes. Several BOCs assert that adoption of the Computer III safeguards is sufficient to prevent cross-subsidization of payphone services. Coalition argues that section 276(b) specifically identifies the nonstructural safeguards in Computer III as an appropriate standard. MCI maintains that any new safeguards or revisions adopted pursuant to our reconsideration of Computer III on remand should also apply to the provision of payphone service. 98.Worldcom, CTA and APCC argue that Computer III safeguards are insufficient to satisfy section 276. APCC asserts that our Computer III safeguards were devised to incorporate concerns regarding efficiency that are outside the realm of section 276. APCC also contends that incumbent local exchange carriers have dominated the payphone industry for some time and their payphone operations have traditionally benefitted from cross- subsidization. Accordingly, APCC concludes that stronger safeguards are needed in the payphone context. 99.Several parties maintain that the Computer III safeguards should be applied to all incumbent local exchange carriers providing payphone service. APCC contends that any proposed accounting safeguard should apply, at a minimum, to all incumbent local exchange carriers with greater than $100 million in annual revenues, as well as local exchange carriers serving island territories such as Puerto Rico and the Virgin Islands. Discussion: 100.The Commission reclassified pay telephone service as a nonregulated service in the Pay Telephone Reclassification Order. As a result, carriers must apportion payphone service costs to nonregulated and common cost pools, ensuring that subscribers to interstate exchange services and exchange access do not bear the costs and risks of the carrier's payphone service. Our Pay Telephone Reclassification Order also requires that BOCs and incumbent local exchange carriers providing payphone service on an integrated basis follow the nonstructural safeguards described in Computer III in order to provide sufficient protection against the possibility that payphone service could be subsidized by local exchange service or exchange access operations. The nonstructural safeguards in Computer III include our Part 64 cost allocation rules and our Part 32 affiliate transactions rules adopted in the Joint Cost Order. This requirement satisfies both the prohibition against cross-subsidization in section 276(a)(1) and the requirement in section 276(b)(1)(C) that we adopt a set of nonstructural safeguards at least equal to those adopted in Computer III. Although Worldcom, CTA and APCC argue that Computer III safeguards are insufficient to satisfy section 276, these parties offer no substitute safeguards to implement the requirements of section 276. Our experience with accounting safeguards in Computer III has demonstrated that these safeguards can effectively guard against the subsidization of competitive activities by regulated ratepayers, which section 276 prohibits. In fact, section 276(b) specifically identifies the Computer III safeguards as the appropriate standard for nonstructural safeguards regarding payphone service. Accordingly, we adopt our tentative conclusion that we should apply accounting safeguards identical to those adopted in Computer III to BOCs and incumbent local exchange carriers providing payphone service on an integrated basis. IV. SAFEGUARDS FOR SEPARATED OPERATIONS A. General 101.Section 272(a)(2) allows BOCs to provide the following services only through a separate subsidiary: the sale of telecommunications equipment and manufacturing of telecommunications equipment and customer premises equipment; origination of interLATA telecommunications services, other than incidental, out-of-region, and previously authorized services; and interLATA information services other than electronic publishing and alarm monitoring services. Section 273(d)(3) requires "any entity which certifies telecommunications equipment or customer premises equipment manufactured by an unaffiliated entity . . . only [to] manufacture a particular class of telecommunications equipment or customer premises equipment for which it is undertaking or has undertaken, during the previous eighteen months, certification activity for such class of equipment through a separate affiliate." Section 274(a) requires that BOCs providing electronic publishing must do so only through a "separated affiliate" or electronic publishing joint venture. These requirements for "separate" or "separated" affiliates or joint ventures implicitly assume that structural safeguards limit the carrier's ability to engage in cross-subsidization and discrimination, and enhance the ability of the Commission or a State to detect cross- subsidization and discrimination. 102.In the NPRM, we tentatively concluded that, except where the Act imposes specific additional requirements, our current affiliate transactions rules generally satisfy the Act's requirements on safeguards to ensure that the services that section 272, 273 and 274 require BOCs to provide through a separate or "separated" affiliate are not subsidized by subscribers to regulated telecommunications services. We invited comment on this tentative conclusion as well as whether the benefits of any fundamentally different approach to affiliate transactions would be outweighed by the costs that implementation of such a system would entail. 103.We also sought comment in the NPRM on whether we should modify our affiliate transactions rules in certain respects. In 1993, we released an Affiliate Transactions Notice proposing certain rule changes, including changes in how subject carriers would value for Title II accounting purposes services they provide, or receive from, nonregulated affiliates in order to provide more complete protection against cross-subsidization. In the NPRM, we invited comment on whether, in implementing the Act's provisions regarding cross- subsidization, we should amend the current affiliate transactions rules to incorporate certain of the modifications proposed in the Affiliate Transactions Notice or any other changes. We also sought comment on whether the affiliate transactions rules we adopt in this proceeding should apply to all transactions between incumbent local exchange carriers and their affiliates, or simply to entities that engage in activities for which the Act requires the use of a separate or separated subsidiary. Comments: 104.Most parties support our tentative conclusions that our current affiliate transactions rules generally satisfy the Act's requirements except where amendments made by the 1996 Act impose specific additional requirements. In particular, AT&T contends that existing accounting rules could be extended to new separated operations with a minimum of disruption because incumbent local exchange carriers have already implemented internal accounting systems designed to ensure compliance with the Commission's existing accounting rules. MCI, however, maintains that we must adopt more stringent affiliate transactions rules to account for the increased opportunities for BOCs to enter new lines of nonregulated businesses and for the increased incentives and opportunities for incumbent local exchange carriers to shift costs. Specifically, MCI argues that we should adopt a rule requiring carriers to maintain a complete audit trail for all cost allocations and affiliate transactions. 105.TIA sets forth three justifications for strengthening the affiliate transactions rules in the manner described in the NPRM. First, TIA contends that the Commission has had almost a decade of experience with the existing affiliate transactions rules and that the Commission found the current rules to be inadequate as far back as 1993 in its Affiliate Transactions NPRM. Second, TIA alleges that a number of recent State and federal audits have indicated improper allocations of costs by the BOCs under the current rules. Finally, TIA contends that the removal of the MFJ's restrictions on BOC entry into competitive markets has increased the risk of cross-subsidization. 106.The BOCs generally oppose the modifications to the affiliate transactions rules that we proposed in the NPRM. They assert that any benefits of new or modified affiliate transactions rules would be outweighed by the costs of implementing these new or modified rules. In particular, SBC maintains that parties advocating additional and more detailed affiliate transactions rules have not provided sufficient justification to outweigh the increased burden that would result. SBC and US West contend that, if we decide to modify our affiliate transactions rules, we should apply those modifications only to transactions involving BOCs and their section 272 separate affiliates. Discussion: 107.In the Joint Cost Order, we adopted rules to govern how costs are recorded, for Title II accounting purposes, when a regulated carrier does business with nonregulated affiliates. These affiliate transactions rules were designed to protect ratepayers from subsidizing the competitive ventures of incumbent local exchange carriers' affiliates. The affiliate transactions rules do not require carriers or their affiliates to charge any particular price for assets transferred or services provided; rather, the rules require carriers to use certain specified valuation methods in determining the amounts to record in their Part 32 accounts, regardless of the prices charged. 108.In agreement with most commenters, we adopt our tentative conclusion that, except where the 1996 Act imposes specific additional requirements, our current affiliate transactions rules generally satisfy the statute's requirement of safeguards to ensure that these services are not subsidized by subscribers to regulated telecommunications services. We have previously concluded that these rules provide effective safeguards against cross- subsidization. Moreover, incumbent local exchange carriers have already implemented internal accounting systems for affiliate transactions to help ensure compliance with these rules. These systems have proven generally effective and we see no reason to require a change to a different system. 109.While we decline to alter our prescribed accounting treatment of affiliate transactions, we do adopt several of the modifications to the affiliate transactions rules initially proposed in the NPRM. We now have had approximately ten years experience with the cost allocation and affiliate transactions regime created by the Joint Cost Order. This experience has convinced us that amending certain aspects of the affiliate transactions rules would provide more complete protection against cross-subsidization. We first presented in the 1993 Affiliate Transaction Notice some of the proposed modifications incorporated in our NPRM. We discuss these modifications and present our rationale for adopting or rejecting them below. We note that modifications that we make to improve the affiliate transactions rules will apply to all transactions between incumbent local exchange carriers currently subject to these rules and their affiliates, not just to transactions between a BOC and an affiliate required under the Act. B. Specific Services 1. Section 272 - Manufacturing and InterLATA Services a. Statutory Language 110.Section 272(a) prohibits a "Bell operating company (including any affiliate) which is a local exchange carrier that is subject to the requirements of section 251(c)" from "provid[ing] any service described in [section 272(a)(2)] unless it provides that service through one or more affiliates that (A) are separate from any operating company entity that is subject to the requirements of section 251(c); and (B) meet the requirements of [section 272(b)]." Section 272(a)(2) states that: [t]he services for which a separate affiliate is required by [section 272(a)(1)] are: (A) [m]anufacturing activities (as defined in section 273(h)); (B) [o]rigination of interLATA telecommunications services, other than (i) incidental interLATA services described in [section 271(g)(1)-(3) and (5)-(6)]; (ii) out-of-region services described in section 271(b)(2); or (iii) previously authorized activities described in section 271(f); [and] (C) [i]nterLATA information services, other than electronic publishing (as defined in section 274(h)) and alarm monitoring services (as defined in section 275(e)). Section 272(b)(2) requires each of these separate affiliates to "maintain books, records, and accounts in the manner prescribed by the Commission which shall be separate from the books, records, and accounts maintained by the [BOC] of which it is an affiliate." Under section 272(b)(5), each of these separate affiliates must "conduct all transactions with the [BOC] of which it is an affiliate on an arm's length basis with any such transactions reduced to writing and available for public inspection." Pursuant to section 272(c)(2), BOCs must account for all transactions with these affiliates "in accordance with accounting principles designated or approved by the Commission." b. "Arm's Length" Requirement of Section 272(b)(5) 111.Section 272(b)(5) requires that transactions between the BOC and its affiliates engaged in the manufacturing activities, origination of interLATA telecommunications services, and offering of interLATA information services described in section 272(a)(2) be conducted on "an arm's length basis." In the Computer II Final Decision, we required AT&T to provide enhanced services and customer premises equipment only through a "separate corporate entity" that would "deal with any affiliated manufacturing entity only on an 'arm's length'" basis. We stated that "the transfer of any products" between this separate corporate entity and "any affiliated equipment manufacturer must be done at a price that is compensatory." In the NPRM, we asked commenters to address whether we should adopt requirements similar to those in the Computer II Final Decision in order to implement section 272(b)(5). We also asked whether a requirement that all transfers of products between the BOC and its affiliates be done at a price that is compensatory would be consistent with the congressional intent behind section 272(b)(5). In Computer III and the Joint Cost Proceeding, we re-examined our regulatory regime for the provision of enhanced services and replaced the Computer II requirements with a series of nonstructural safeguards, including affiliate transactions rules. In the NPRM, we invited comment on whether our affiliate transactions rules, incorporating some of the changes proposed in the Commission's Affiliate Transactions NPRM to provide greater protection against cross-subsidization, would be necessary or sufficient to ensure compliance with the "arm's length" requirement of section 272(b)(5). 112.In the NPRM, we sought comment on whether and, if so, how we should amend our rules to address section 272(b)(5)'s requirement that all transactions be "reduced to writing and available for public inspection." We also asked whether Internet access to information about these transactions would be sufficient to comply with the "public inspection" requirement and whether we need to adopt safeguards to protect any confidential or sensitive information contained in these publicly available documents. 113.In the NPRM, we tentatively concluded that a "request" by an affiliate to its BOC for telephone exchange service or exchange access constitutes a "transaction" within the meaning of section 272(b)(5) which must be "reduced to writing and available for public inspection." We invited comment on this tentative conclusion and asked whether we need to adopt safeguards to protect any confidential or sensitive information related to these types of transactions. Comments: 114.The BOCs generally contend that we need not prescribe any particular accounting methods to ensure that the "arm's length" requirement of section 272(b)(5) is met. In contrast, MCI argues that our existing affiliate transaction rules, without modification, do not satisfy the "arm's length" requirement because the existing rules give the BOCs too much latitude in valuing their affiliate transactions. MCI and AT&T assert that we should adopt the modifications to the existing affiliate transactions rules proposed in the Affiliate Transactions NPRM. TRA maintains that in order to successfully demonstrate satisfaction of the "arm's length" requirement of section 272(b)(5), a BOC must be able to provide evidence that the terms and conditions of its transactions with affiliates are comparable to the terms and conditions that would have been secured from non-affiliates. Accordingly, TRA suggests that we should require each BOC to accumulate and retain information regarding affiliate transactions. 115.TIA contends that section 272(b)(5)'s requirement that affiliate transactions be conducted on an "arm's length basis" requires that all transfers of assets or services between a BOC and its affiliate required under section 272(a) must occur at a price that is "compensatory." TIA and TRA argue that the affiliate transactions rules, with the modifications proposed in the NPRM, would help ensure that BOCs are fully compensated for any goods or services provided to an affiliate and that BOCs pay reasonable prices for any goods or services procured from an affiliate. Several of the BOCs assert that because the Commission, in its Computer III decision, retained the notion of compensatory pricing in Parts 32 and 64, existing affiliate transactions rules already ensure that such transactions are conducted at compensatory prices. 116.MCI argues that section 272(b)(5)'s requirement that transactions be "reduced to writing and available for public inspection" indicates that Congress contemplated vigorous involvement by interested third parties in deterring cross-subsidization and discriminatory activity by BOCs. Accordingly, MCI suggests that BOCs should be required to provide to the Commission and make publicly available a complete list of transaction activities with their interLATA and manufacturing affiliates on a periodic basis, at least quarterly, specifying all contracts, arrangements, and other agreements between the BOC and its affiliates, providing a description of the asset or service transferred, the transfer price, and the method of valuation. 117. The BOCs generally argue that there is no need for the Commission to amend its rules to address section 272(b)(5)'s requirement that transactions be "reduced to writing and available for public inspection" because the Commission's rules already require carriers to disclose certain information regarding affiliate transactions in section V of their cost allocation manuals. MCI, however, asserts that the "reduced to writing and available for public inspection" requirement of section 272(b)(5) cannot be satisfied by the Commission's existing cost allocation manual filing requirements because the information in the BOCs' cost allocation manuals is not sufficiently detailed. 118.MCI and Worldcom contend that Internet access to information about transactions between BOCs and their affiliates required under section 272(a) would be sufficient to comply with section 272(b)(5)'s requirement that transactions be "reduced to writing and available for public inspection." Although US West agrees that Internet access would meet the obligations of section 272(b)(5), US West maintains that we should not require companies to post internal documents on the Internet because the companies could not monitor who was inspecting the documents. In contrast, TRA and APCC argue that, while the Commission should encourage Internet access to information concerning affiliate transactions, Internet access alone does not satisfy section 272(b)(5)'s "available for public inspection" requirement because Internet access is still unavailable to many. USTA asserts that we should simply require that documents related to affiliate transactions be available at a location designated by the carrier. Several parties oppose a rule that would allow BOCs to choose a single location where documents concerning affiliate transactions are available to the public and contend that such a rule would severely limit a third party's ability to gain access to such information. 119.With regard to concerns about the protection of confidential or sensitive information contained in any documents that BOCs make "available for public inspection" in accordance with section 272(b)(5), APCC contends that pricing information based upon tariffed rates, prevailing market prices, or fair market value should not involve proprietary information. According to APCC, only pricing based upon fully distributed costs might be considered proprietary, and, for the sake of ensuring arm's length transactions, the Commission should impose a heavy burden on BOCs and independent local exchange carriers of demonstrating that such information warrants proprietary status. TIA asserts that to the extent that relevant documents contain proprietary information, the Commission should use reasonable non-disclosure agreements to ensure that such information is not misused. The BOCs urge the Commission to adopt and apply the standards for the protection of confidential information are contained in the Comments of the Joint Parties in response to the Commission's Confidential Information Notice. 120.Several interexchange carriers support our tentative conclusion that a request by an affiliate to its BOC for telephone exchange service or exchange access constitutes a "transaction" within the meaning of section 272(b)(5) which must be "reduced to writing and available for public inspection." TRA asserts that only by requiring all requests by affiliates to their BOCs for telephone exchange service or exchange access to be available for public inspection will the public and the Commission be able to evaluate the BOCs' compliance with section 272(e)(1). US West disagrees with our tentative conclusion and contends that only once the BOC and its affiliate have agreed upon the terms and conditions for telephone exchange and exchange access does the agreement constitute a "transaction." Discussion: 121.We decline to adopt Computer II type requirements in order to implement section 272(b)(5). We agree with several of the BOCs that because our Computer III decision retained the concept of compensatory pricing in Parts 32 and 64, our existing affiliate transactions rules already ensure that affiliate transactions are conducted at compensatory prices. We conclude that our affiliate transactions rules, developed in Computer III and the Joint Cost Proceeding, with some of the changes proposed in the Commission's Affiliate Transactions NPRM, will ensure compliance with the "arm's length" requirement of section 272(b)(5). We discuss the requirements of these rules in section IV.B.1.b.ii. below. 122.To satisfy section 272(b)(5)'s requirement that transactions between section 272 affiliates and the BOC of which they are an affiliate be "reduced to writing and available for public inspection," we require the separate affiliate, at a minimum, to provide a detailed written description of the asset or service transferred and the terms and conditions of the transaction on the Internet within 10 days of the transaction through the company's home page. The broad access of the Internet will increase the availability and accessibility of this information to interested parties, while imposing a minimal burden on the BOCs. We require that the description of the asset or service and the terms and conditions of the transaction should be sufficiently detailed to allow us to evaluate compliance with our accounting rules. This information must also be made available for public inspection at the principal place of business of the BOC. The information made available at the principal place of business of the BOC must include a certification statement identical to the certification statement currently required to be included with all Automated Reporting and Management Information System ("ARMIS") reports. Such certification statement declares that an officer of the BOC has examined the submission and that to the best of the officer's knowledge all statements of fact contained in the submission are true and the submission is an accurate statement of the affairs of the BOC for the relevant period. Information contained in a BOC's cost allocation manual is not sufficiently detailed to satisfy section 272(b) because the BOC's cost allocation manual contains only a general description of the asset or service and does not describe all of the terms and conditions of each transaction. While section 272(b)(5) requires BOCs to reduce their transactions to writing and make them "available for public inspection," we will continue to protect the confidential information of BOCs, as well as other incumbent local exchange carriers. 123.We recognize a need to clarify how the requirements of section 273(e)(5) relate to the full scope of a BOC's reporting obligations under section 272(b)(5) of the Act. Section 273(e)(5)'s general mandate that BOCs "shall protect the proprietary information submitted for procurement decisions from release not specifically authorized by the owner of such information" neither curtails nor obviates section 272(b)(5)'s requirement that transactions between BOCs and their manufacturing affiliates be reduced to writing and made available for public inspection. Section 273(e)(5) addresses a BOC's duties solely with regard to submissions for procurement decisions, either by an affiliate or a third party. Only after a BOC consummates a transaction with a manufacturing affiliate would the reporting requirements of section 272(b)(5) trigger. Transactions between BOCs and third parties are not subject to the reporting requirements of section 272(b)(5). Section 272(b)(5)'s requirement that BOCs reduce their transactions with manufacturing affiliates to writing and make them available for public inspection permits the Commission and competitors to ensure that the BOCs are complying with the nondiscrimination and accounting safeguards of the Act. 124.We decline to adopt our tentative conclusion that a "request" by an affiliate to its BOC for telephone exchange service or exchange access constitutes a "transaction" within the meaning of section 272(b)(5) which must be "reduced to writing and available for public inspection." We note, however, that once the BOC and its affiliate have agreed upon the terms and conditions for telephone exchange and exchange access such agreement would constitute a "transaction." For clarification, we also find that agreements between a BOC and its affiliate for the provision of unbundled elements and facilities pursuant to explicit terms and conditions also constitutes a "transaction." i. Prevailing Company Prices 125.In the NPRM, we asked whether affiliate transactions conducted "on an arm's length basis" would necessarily entail the same marketing efforts and transactional costs as transactions with non-affiliates. We also solicited comment on the impact that any differences in marketing efforts and transactional costs might have in accurately valuing affiliate transactions and how such differences should affect our use of the prevailing price method to record affiliate transactions between the BOCs and their affiliates engaged in activities described in section 272(a)(2). 126.We also sought comment on whether we should eliminate the use of the prevailing price method as a valuation method for recording affiliate transactions between the BOCs and their affiliates engaged in activities described in section 272(a)(2). The prevailing price describes the price at which a company offers an asset or service to the general public. A carrier subject to our current affiliate transactions rules records non-tariffed assets or services at their prevailing prices if such prices exist. Prevailing price currently represents one component in the hierarchy of methods for valuing transactions between a carrier and its affiliate. A carrier subject to our current affiliate transactions rules uses one of the following methods to value asset transfers for regulated accounts: (1) tariffed rates, (2) prevailing company prices, (3) net book cost, or (4) estimated fair market value. These valuation methods apply when the carrier is either the purchaser or seller of the asset according to the following set of rules. First, carriers must record each asset transferred to an affiliate pursuant to tariff at the tariffed rate. Second, if no tariff exists and an affiliate that transfers or sells an asset to its regulated carrier also sells the same kind of asset to third parties at a generally available price, then the carrier must record the asset sale or transfer at that prevailing company price. Non-tariffed assets that are sold or transferred by the carrier to its affiliates and are sold to third parties at a generally available price, must also be recorded by the carrier at that price. Third, all other asset transfers must be recorded at the higher of net book cost and estimated fair market value when the carrier is the seller, and at the lower of net book cost and estimated fair market value when the carrier is the buyer (i.e., from the affiliate). The United States Court of Appeals for the District of Columbia Circuit affirmed the valuation methods for asset transfers, finding them "reasonably designed to prevent systematic abuse of ratepayers." 127.In comparison to our method for valuing asset transfers, carriers must record transactions involving services in their Part 32 accounts according to one of three valuation methods: (1) tariffed rates, (2) prevailing company prices, or (3) fully distributed cost. These valuation methods are applied when the carrier is either the purchaser or seller of the service according to the following set of rules. First, carriers must record services provided to an affiliate pursuant to tariff at the tariffed rate. Second, if no tariff exists and a carrier transfers or sells a service to its regulated affiliate that it also provides to third parties, the carrier must record the transaction at the prevailing company price. Non-tariffed services that are sold or transferred by an affiliate to its regulated carrier and are also sold to third parties at a generally available price, must also be recorded by the carrier at that price. Third, all other services provided to affiliates must be recorded at the service provider's fully distributed costs. Comments: 128. TRA argues that a company transacting business with its affiliate will benefit from lower or non-existent marketing costs because the company is already known to the affiliate, thereby minimizing transactional costs during affiliate transactions. Therefore, according to TRA, if a BOC is permitted to use prevailing price to value a transaction with its affiliate, both parties will be able to transfer all avoided marketing and transactional costs to their advantage. Several other parties, including PacTel and Sprint, contend that the idea that an entity operating in a highly competitive market does not need to devote the same amount of effort and resources to win business from its affiliates as it does from non-affiliates is incorrect. In particular, Sprint maintains that "in a competitive market with a variety of suppliers offering a plethora of price and service options, an entity has to work just as hard to sell to its affiliates as it does to non-affiliates. Otherwise, its affiliates will look to other suppliers." 129.Several parties support the Commission's proposal to eliminate the use of the prevailing price method to record affiliate transactions between the BOCs and their affiliates engaged in the activities described in section 272(a)(2). These parties contend that the Commission's present prevailing price method is difficult to apply and affords carriers too much discretion. A number of other parties, including the BOCs, AT&T and Sprint, argue against the Commission's proposal to eliminate the prevailing price method. Puerto Rico Telephone, in particular, maintains that the importance of using prevailing prices will increase in the future as interconnection agreements are established and tariffs are eliminated. APCC argues that the prevailing price method is more objective than fair market value or fully distributed costs. SBC and US West argue that if we eliminated the prevailing price method, BOCs would be required to conduct fully distributed costs studies of their affiliate transactions even if all of the products and services involved in the transaction are available to third parties at a prevailing price. BellSouth contends that the elimination of the prevailing price valuation method would impose significant administrative costs and burdens on the BOCs with virtually no additional protection for customers. 130.AT&T recognizes the difficulties in determining prevailing price; AT&T, however, maintains that rather than eliminating prevailing price, the Commission should modify its rules so that prevailing price is only available if the affiliate sells a substantial percentage by quantity of that product line to nonaffiliated customers. TIA contends that the Commission should adopt a rule that allows a carrier to value affiliate transactions at prevailing price only when the affiliate can demonstrate that it has made substantial sales of the same product to third parties. Sprint argues that sales to third parties cannot reliably be used to establish prevailing price when an affiliate operates in a non-competitive market or a market where there are few third-party transactions. In addition, TRA argues that if the percentage of third-party business is small, there will be little assurance that an affiliate transaction would truly be conducted at arm's length. 131.NYNEX contends that the adoption of a clear definition of what constitutes prevailing price would clarify our rules and establish consistency. In particular, NYNEX argues that if the Commission should determine that some baseline percentage of third-party sales is necessary to establish prevailing price, then the Commission should adopt a baseline percentage much less than the 75 percent figure proposed in the Commission's Affiliate Transactions Notice. MCI maintains that the prevailing price method is particularly difficult to apply because of the difficulties in determining whether a substantial portion of an affiliate's production is being provided to third parties. MCI argues that in order to correct such difficulties, the Commission would need to apply any baseline percentage necessary to establish prevailing price on a product-by-product basis. Discussion: 132.We find unpersuasive TRA's argument that a company transacting business with its affiliate will significantly benefit from lower or non-existent marketing costs because the company is already known to the affiliate. In competitive markets, companies devote significant resources to attracting and retaining customers through sales presentations, advertising campaigns, volume purchase discounts, or long-term commitments. In addition, any potential benefits to a carrier in transacting business with its affiliate are diminished to some extent by the system and transaction costs incurred in complying with our affiliate transactions rules. Accordingly, we conclude that any differences in marketing efforts and transactional costs that might exist are not significant and should not affect our use of the prevailing price method to record affiliate transactions. 133.We decline to adopt our proposal to eliminate prevailing price as a valuation method under our affiliate transactions rules. Initially, we selected prevailing price as a valuation method because we believed that those prices would provide a reliable measure of fair market value. Our experience in auditing carriers' application of the prevailing price method to determine how inter-affiliate transfers of services should be recorded has revealed difficulties in determining what is necessary to establish a prevailing price. Rather than rejecting prevailing price valuation, however, we conclude that these difficulties are best addressed by modification and clarification of the prevailing price valuation method. 134.One of the difficulties we have identified with respect to prevailing price valuation has been determining when carriers should apply the prevailing price method to transfers of particular assets or services. The mere offering of an asset or service to unaffiliated entities is not sufficient to establish a prevailing price. A substantial quantity of business must be conducted with unaffiliated third parties in order to establish a true prevailing price. Specifically, if the percentage of third-party business is small, there can be no assurance that the price agreed upon by the carrier and its affiliate represents the true market price, thus raising legitimate questions as to whether the parties actually negotiated "on an arm's length basis." In such situations, the use of prevailing prices to value transactions could permit an affiliate to charge inflated prices to its affiliated regulated carrier, possibly leading to higher prices for customers purchasing the regulated services. 135.Our previous rules did not clarify the meaning of a "substantial" amount of third-party business for the purpose of establishing a true prevailing price. We agree with MCI that without clarification of the meaning of "substantial" in this context, the retention of the prevailing price method places a difficult burden on the Commission in verifying compliance with the affiliate transactions rules. Accordingly, we find that a clear definition of what constitutes prevailing price is necessary to clarify our affiliate transactions rules and establish consistency. We conclude that annual sales, as measured by quantity, of greater than 50 percent of a particular product or service to third parties must occur to satisfy the requirement that there be a "substantial" amount of outside business in order to produce a true prevailing price for that particular product or service. We find that third-party sales of 50 percent or less are evidence of the fact that a party's primary function is to provide products or services to affiliates, rather than to outside market participants, and, consequently, those sales to unaffiliated entities are not sufficient to establish a true prevailing price. We note that our modifications here to clarify the prevailing price method apply to all assets and services transactions governed by our affiliate transactions rules. 136.We conclude that the 50 percent threshold established in this Order must be applied on a product-by-product and service-by-service basis, rather than on a product-line or service-line basis. Application of the 50 percent threshold on a product-line or service-line basis would give carriers the incentive to define product lines and service lines as broadly as possible in order to be able to value as many transactions as possible at prevailing price. Additionally, if the 50 percent threshold were applied to a product line or service line, then products or services that are sold to third parties in quantities of 50 percent or less could be grouped in the same line with different products or services that are sold primarily to third parties, qualifying the entire line of products for prevailing price valuation. Such grouping would allow products or services for which no true prevailing price exists to be valued by a carrier at a fabricated prevailing price to the harm of ratepayers if the cost or market value of such products or services is actually different from this fabricated prevailing price. Moreover, verifying that product lines and service lines have been properly defined would place a significant burden on the Commission. 137.We do allow one exception to our rule that only a product or service for which annual sales to third parties, measured by quantity sold, exceed 50 percent of total sales of that product or service may be recorded by carriers at prevailing price. Section 272 requires BOCs to charge their section 272 affiliates the same rates as unaffiliated third parties for facilities, services, and information. Because the rates for services subject to section 272 must be made generally available to both affiliates and third parties, we adopt a rebuttable presumption that these rates represent prevailing company prices. Accordingly, products and services subject to section 272 need not meet the 50 percent threshold in order for a BOC to record the transaction involving such products and services at prevailing price. ii. Valuation Methods for Assets and Services. 138.In the Joint Cost Order, we did not prescribe uniform valuation methods for all affiliate transactions. The Part 64 cost allocation rules direct subject carriers to use different methods to value transfers of assets and transfers of services. In the NPRM, we proposed to direct carriers to apply the valuation method currently prescribed for asset transfers to service transfers. The NPRM did propose, however, to continue to define the cost of asset transfers in terms of net book cost and the cost of service transfers in terms of fully distributed costs. We sought comment on whether these proposed modifications to the affiliate transactions rules would meet the objectives of section 272 better than the existing rules. We asked commenters to discuss whether, and under what circumstances, we should allow carriers and their affiliates to use any alternative valuation methods. We also sought comment on how the elimination of a sharing obligation from our price cap rules would affect the validity of our tentative conclusion in the Affiliate Transactions NPRM that our treatment of the provision of services that are neither tariffed nor subject to prevailing company prices may reward a carrier's imprudent acts of buying services from affiliates for more than, and selling services to affiliates for less than, fair market value. 139.Section 272(e)(3) requires that "[a] Bell operating company and an affiliate that is subject to the requirements of section 251(c) . . . shall charge the affiliate described in subsection (a) or impute to itself (if using the access for its provision of its own services), an amount for access that is no less than the amount charged to any unaffiliated interexchange carriers for such service." Section 272(e)(4) states that "[a] Bell operating company and an affiliate that is subject to the requirements of section 251(c) . . . may provide any interLATA or intraLATA facilities or services to its interLATA affiliate if such services or facilities are made available to all carriers at the same rates and on the same terms and conditions, and so long as the costs are appropriately allocated." We also sought comment on how these requirements should affect our rules for implementing the "arm's length" requirement of section 272(b)(5). In addition, we invited comment on whether we should adopt specific accounting procedures to address the difference, if any, between the rates charged by BOCs when they provide interLATA or intraLATA facilities or services on a separated basis and "the costs [that would be] appropriately allocated" for the underlying facilities or services. Comments: 140.Many commenters, including AT&T, Wisconsin PSC and GSA, support the Commission's proposal to conform the valuation methods under the affiliate transactions rules governing service transfers and asset transfers. Several of these commenters argue that the current valuation method for services does not adequately ensure compliance with section 272(b)(5)'s "arm's length" requirement because it rewards a carrier for buying services from affiliates at more than, and selling them to affiliates for less than, fair market value. AT&T further contends that our current valuation rules, by allowing a carrier to sell services for less than fair market value, would allow carriers to violate section 254(k)'s prohibition against cross-subsidizing competitive operations. 141.The BOCs and Sprint oppose the Commission's proposed change to the affiliate transactions rules. They argue that any attempt to establish fair market value for services would prove inherently subjective. USTA and several BOCs note that in our reconsideration of the Joint Cost Order, we rejected a similar proposal to utilize estimates of fair market value for the transfer of services, stating that "such a valuation standard is fraught with potential for abuse, and would be difficult to monitor." PacTel argues that section 272(e)(2)'s nondiscrimination requirement has eliminated any potential for harm. PacTel further contends that the Commission should not require fair market valuation for governance functions provided to carriers by their regional holding companies. BellSouth contends that application of the "asset transfer rules" to transactions involving services will require the BOCs and their affiliates to incur hundreds of millions of dollars in increased annual administrative cost. 142. APCC argues that the Commission should adopt a rule that requires carriers to value services at the lower of fully distributed costs and estimated fair market value when it is the purchaser with a price ceiling set at prevailing price. APCC contends that prevailing price serves as a check to ensure that the carrier has not overstated the price determined using the lower of fully distributed costs and estimated fair market value, preventing an affiliate from charging its affiliated carrier more than a competitor. APCC similarly argues that the Commission should set a price floor at prevailing price when the carrier is the seller. 143.AT&T argues that with regard to the requirements of section 272(e)(3), the BOC must charge its affiliate, at a minimum, the tariffed rate for access services. AT&T maintains that the Commission should require a BOC's interLATA affiliate to reflect these access charges in end-user rates, at least as long as the BOC retains dominance in the provision of exchange access services. AT&T asserts that the Commission should impose price floors for interLATA services at a level equal to a BOC's access charges plus the incremental cost of the non-access portions of the service to ensure an affiliate's imputation of access charges. Discussion: 144.In the Joint Cost Proceeding, we considered identical valuation methods for assets and services. These methods would have required carriers to record all affiliate transactions that are neither tariffed nor subject to prevailing company prices at the higher of cost and estimated fair market value when it is the seller, and at the lower of cost and estimated fair market value when the carrier is the purchaser. As USTA and several BOCs point out, however, the Joint Cost Order ultimately did not prescribe uniform valuation methods for all affiliate transactions. In the case of services, the Joint Cost Order requires carriers to record all non-tariffed services other than those having prevailing company prices at the providers' fully distributed costs while all nontariffed assets other than those having prevailing company prices must be recorded at the higher of cost and estimated fair market value when it is the seller, and at the lower of cost and estimated fair market value when the carrier is the purchaser. 145.The Commission based its decision not to apply the asset transfer rules to services on commenters' suggestions that those rules would reduce or eliminate "the incentive for certain service activities to be provided in a more efficient manner than that which the regulated entity would alone achieve." Since the adoption of the affiliate transactions rules, we have adopted price cap regulation that gives the largest incumbent local exchange carriers efficiency incentives far stronger than those the valuation methods for affiliate services sought to preserve. These changes in regulation have caused us to re-evaluate the effect of our valuation methods for affiliate services on carrier incentives. That re-evaluation makes clear that our current treatment of services that are neither tariffed nor subject to prevailing company prices made generally available may in fact reward a carrier that acts imprudently when buying services from affiliates for more than, and selling services to affiliates for less than, fair market value. Our current valuation rules require a carrier to record services sold to nonregulated affiliates at the carrier's fully distributed cost. These rules apply even when the carrier's fully distributed cost for the service is less than the fair market value of that service. Under these circumstances, our current valuation rules result in a smaller profit for the carrier in a service transaction with its nonregulated affiliate than would a similar transaction with a third party for the same service. Our current valuation rules also require a carrier to record services purchased from a nonregulated affiliate at the affiliate's fully distributed cost. These rules apply even when the affiliate's fully distributed cost for the service is greater than the fair market value of that service. Accordingly, our current valuation rules may entice a carrier to pay its nonregulated affiliate more for a service than the carrier would pay a third party for the same service. In either set of circumstances, ratepayers may be harmed if the carrier's smaller profits or increased costs as a result of our services valuation rules are reflected in rates for regulated telecommunications services. Ratepayers and service providers not affiliated with carriers may also be harmed if the valuation methods for affiliate transactions induce carriers and their affiliates to "use services that are not competitive to subsidize services that are subject to competition," thereby putting service providers not affiliated with the carrier at a competitive disadvantage. 146.We believe that requiring carriers to use the same valuation methods for both services and asset transfers would also reduce the incentive to record an affiliate transaction as a service transfer, rather than an asset transfer, especially in the context of procurement activities. Under our current rules for recording transfers of services, carriers may record services sold to their affiliates at cost even if the fair market value of such services is actually much higher, allowing the carrier's affiliates to take advantage of services at below market costs to the detriment of the carrier's ratepayers. With respect to the sale of assets, however, carriers must record the sale at the higher of cost or fair market value. Our current rules also allow carriers to record services purchased from their affiliated carriers at cost even if the fair market value of such services is actually much lower, allowing the carrier's affiliates to receive the benefit of higher than market value sales to the detriment of the carrier's ratepayers. In the case of the purchase of an asset, however, carriers must record the purchase at the lower of cost or fair market value. Requiring a carrier to value transfers of services using the same valuation methods currently used for asset transfers would reduce the carrier's ability to value a transfer so that a carrier can pass on to their affiliates any financial advantages flowing from how they choose to characterize the transaction. 147.Because of the concerns identified in the preceding paragraph, we believe that the current rules regarding the valuation of affiliate services may not be consistent with the requirement of section 272(b)(5) that transactions be conducted "on an arm's length basis." The rule we adopt above--requiring carriers to record all affiliate transactions that are neither tariffed nor subject to prevailing company prices at the higher of cost and estimated fair market value when the carrier is the seller or transferor, and at the lower of cost and estimated fair market value when the carrier is the buyer or transferee--appears more likely to ensure that the transactions between carriers and their nonregulated affiliates take place on an "arm's length" basis, guarding against cross-subsidization of competitive services by subscribers to regulated telecommunication services. This rule will conform the valuation methods under the affiliate transactions rules for the provision of services to those methods we currently use to value asset transfers. We continue, however, to define the cost of asset transfers in terms of net book cost and the cost of service transfers in terms of fully distributed costs because the net book cost of an asset is comparable to the fully distributed cost of a service. 148.We do allow one exception to our rule conforming the valuation methods under the affiliate transactions rules for the provision of services to those methods we currently use to value asset transfers. Under the rule adopted in this Order, when a carrier purchases from its affiliate services that are neither tariffed nor subject to prevailing company prices and such affiliate exists solely to provide services to members of the carrier's corporate family, the carrier would be required to value the transaction at the lower of fair market value and fully distributed cost. Under our existing valuation rules, however, such service transactions would simply be valued at fully distributed cost because insufficient third-party sales exist to substantiate a prevailing price for these services that are often tailored to the corporate family's unique needs. We conclude that these transactions where a carrier purchases from its affiliate services that are neither tariffed nor subject to prevailing company prices and such affiliate exists solely to provide services to members of the carrier's corporate family should continue to be valued at fully distributed cost. We find that when an affiliate is established to provide services solely to the carrier's corporate family in an effort to take advantage of economies of scale and scope, the benefits of such economies of scale and scope are reflected in such affiliate's costs and are ultimately transferred to ratepayers through transactions with the carrier for such services valued at fully distributed costs. Requiring carriers to perform fair market valuations for such transactions would increase the cost to ratepayers while providing limited benefit. iii. Fair Market Value 149.In the NPRM, we proposed to require carriers to make good faith determinations of fair market value, rather than specifying methodologies that carriers must follow to estimate fair market value, where such a valuation is required under the affiliate transactions rules. We invited comment on this proposal. We sought comment on whether we should set criteria for determining what constitutes a good faith estimate of market value. We also asked whether we should require carriers to support their valuations by reasonable and appropriate methods in situations involving transactions that are not easily valued. Comments: 150.Several State PUCs and TIA favor the adoption of the proposed good faith requirement on estimates of fair market value. Most interexchange carriers, however, oppose its adoption. MCI argues that adoption of the proposed good faith requirement would make it easier for the BOCs to shift costs. Worldcom contends that the Commission should establish a uniform set of requirements for fair market value to apply to all the BOCs. AT&T argues that, at a minimum, the Commission should apply the criteria discussed in the NPRM. AT&T further asserts that the Commission should require a carrier that applies fair market valuation to a transaction to retain records documenting the methodology used in a form that would enable third parties to reproduce the analysis in the context of an audit or investigation. TRA maintains that because transactions between a carrier and its affiliate do not involve a "willing" buyer and seller, the Commission should establish specific criteria to determine fair market value. TRA asserts that the Commission should not allow carriers to use alternative valuation methods without obtaining a waiver from the Commission based on a clear demonstration of the alternative method's accuracy. 151.GTE contends that purchases by unaffiliated companies provide an excellent benchmark because unaffiliated purchasers have no reason to pay unreasonably high prices. In particular, GTE argues that if sales to unaffiliated companies of a product at a particular price generate large revenues then this is "strong evidence" that the price is "a valid price in market terms." 152.While most of their objections appear to relate to the use of fair market value if the use of prevailing price is eliminated, USTA and several BOCs argue against a good faith requirement because of the difficulties in determining fair market value. US West contends that there is no need to impose a good faith requirement on carriers. Discussion: 153.We find that the procedures carriers use in estimating fair market value should vary with the circumstances of each transaction. We consequently conclude that we should not specify the methodologies that carriers must follow to estimate fair market value where such a valuation method is required under the affiliate transactions rules. While many commenters attack the use of fair market value generally in the affiliate transactions rules, we find that no commenters have provided a sufficient reason why, having determined that fair market value should be used, we should not impose a good faith requirement. We believe that allowing carriers to make good faith determinations of fair market value, rather than prescribing specific methodologies, will provide them with the flexibility to use a methodology appropriate for the circumstances of the transaction. We find that the good faith requirement will help ensure that transactions involving a BOC and its section 272 affiliate satisfy the "arm's length" requirement of section 272. We therefore adopt our proposal to require carriers to make good faith determinations of fair market value for purposes of our affiliate transactions rules. We further conclude that we should impose a good faith requirement on all affiliate transactions between an incumbent local exchange carrier currently subject to our affiliate transactions rules and any of its affiliates, not just to affiliate transactions involving the activities described in section 272(a). 154.While we decline to specify the methodologies that carriers must follow to estimate fair market value, we do set the baseline for a good faith determination of fair market value by requiring carriers to use methods that are routinely used by the general business community. For example, when carriers can estimate the market value of transactions using independent valuation methods, carriers should apply such methods to ascertain fair market value. Depending on the type of transaction, examples of methods for determining fair market values for both assets and services include appraisals, catalogs listing similar items, competitive bids, replacement cost of an asset, and net realizable value of an asset. We agree with GTE that sales to third parties can provide a benchmark and we conclude that if sales to third parties of a product at a particular price generate large revenues then the sale price is strong evidence of a good faith estimate of fair market value. When situations arise involving transactions that are not easily valued by independent means, we require carriers to maintain records sufficient to support their value determination. Specifically, the valuation method chosen by the carrier must succeed in capturing the available supporting information regarding the transaction and must utilize generally accepted techniques and principles regarding the particular type of transaction at issue. We note that nothing discussed here exempts carriers from their statutory obligation under section 220(c) to justify their accounting entries. iv. Tariffed-based Valuation 155.Under section 252, incumbent local exchange carriers may submit agreements adopted by negotiations or arbitration to State commissions for approval or rejection without filing a tariff. Alternatively, they may file statements of generally available terms pursuant to section 252(f) that state terms on which these incumbent local exchange carriers would provide services to all customers who desire them. In the NPRM, we sought comment on whether, and to what extent, our affiliate transactions rules should be amended to substitute rates appearing in such publicly filed agreements and statements for tariffed rates. We also sought comment on whether such amendments would be consistent with, or required by, sections 272(e)(3) and 272(e)(4). Comments: 156.Most BOCs argue that the Commission should amend its affiliate transactions rules to allow them to use rates appearing in publicly filed agreements submitted to a State commission pursuant to section 252(e) or statements of generally available terms pursuant to section 252(f) in the place of tariffed rates. NYNEX contends that such rates reflect "arm's length" transactions. PacTel argues that because such rates will be subject to review by State regulators similar to tariff review, such rates provide the same protection against cross- subsidization. Ameritech and USTA, however, argue that the Commission need not amend the affiliate transactions rules in this instance because under the current rules, BOCs must value transactions at either the prevailing price or cost, which would include rates filed in interconnection and collocation agreements. SBC and TRA maintain that the Commission should allow BOCs to use terms contained in negotiated or arbitrated interconnection agreements or statements of generally available terms and conditions only to the extent a tariff is not available. 157.Worldcom argues that amending the affiliate transactions rules to substitute rates appearing in such publicly filed agreements and statements for tariffed rates would be premature because the Commission has not yet proposed to eliminate the tariff requirements for BOCs' local exchange and exchange access services. AT&T contends that such an amendment to the Commission's rules is unnecessary. AT&T argues that section 272(b)(1)'s requirement that an affiliate operate independently from the BOC of which it is an affiliate prohibits any integration of exchange and interexchange facilities, including the purchase of interconnection and collocation services and network elements. AT&T maintains that the Commission should prohibit BOC affiliates from offering any exchange service, except through total service resale at tariffed rates, and should require them to obtain all transmission capacity from the BOC pursuant to tariff as was the case under Computer II. Discussion: 158.We concur with the majority of BOCs that we should amend our affiliate transactions rules to allow incumbent local exchange carriers to use charges appearing in publicly-filed agreements submitted to a State commission pursuant to section 252(e) or statements of generally available terms pursuant to section 252(f) in the place of tariffed rates when tariffed rates are not available. Because charges appearing in such publicly-filed agreements and statements are subject to State review, we find it unlikely that allowing incumbent local exchange carriers and their affiliates to record non-tariffed transactions using such rates when available would lead to the subsidization of competitive services by subscribers to regulated telecommunications services. Because carriers must comply with the cross-subsidization prohibitions of the Act regardless of what accounting rules we or the States adopt, neither a carrier nor its affiliate may use a charge appearing in publicly-filed agreements or statements of generally available terms if the use of such charge would violate the Act. We do not believe that the fact we have not yet eliminated the tariff requirements for a BOC's local exchange and exchange access services forecloses us from establishing accounting safeguards now in anticipation of changes in the telecommunications market permitted by Section 252. 159. We do not read section 272(b)(1)'s requirement that a BOC affiliate "operate independently" from the BOC so broadly, as AT&T suggests, that it prohibits all integration of exchange and interexchange facilities, including the purchase of interconnection and collocation services and network elements by such an affiliate. We conclude that section 272(b)(1) does not prohibit BOC affiliates from receiving the same rates that any unrelated party could receive through publicly-filed agreements submitted to a State commission pursuant to section 252(e) or statements of generally available terms pursuant to section 252(f) instead of a tariffed rate. v. Return Component for Allowable Costs 160.In the Joint Cost Proceeding, the Commission determined that fully distributed costs should include a return on investment, but no "profit" in excess of the return then prescribed for the carrier's interstate regulated activities. Consequently, carriers that utilize fully distributed cost to value affiliate transactions include in their cost computations a component for rate of return. In the NPRM, we proposed that all carriers providing services subject to section 272 should use a uniform rate of return to determine the fully distributed costs associated with affiliate transactions. The Commission has prescribed a unitary, overall rate of return for those incumbent local exchange carriers still subject to rate-of-return regulation to use in computing interstate revenue requirements, unless a carrier can show that such use would be confiscatory. The current prescribed rate of return on interstate services is 11.25 percent. We sought comment on our proposal. Comments: 161.Most commenters that address this issue argue that the Commission should require the BOCs to use the prescribed interstate rate of return for valuing transactions with their affiliates engaged in activities permitted under section 272. PacTel and SBC contend that the prescribed interstate rate of return is consistent with the return on investment that a BOC could anticipate if it were to use its investment to provide services to third parties. TRA argues that allowing carriers to select their own rate of return, instead of using the prescribed interstate rate of return, would run counter to the Commission's efforts to promote arm's length transactions and would unduly burden the Commission with numerous rate-of- return prescription proceedings. 162.US West, however, disagrees. US West argues that the Commission should permit any BOC to determine the return component included in its cost computations for valuing affiliate transactions using a composite of the prescribed interstate rate of return and the intrastate rates of return prescribed or authorized for that carrier. US West contends that this approach would recognize that transactions between a BOC and its affiliate benefit both the interstate and intrastate services that a BOC provides to third parties. USTA argues that the current rules are adequate because they permit a BOC to utilize a rate of return that is "appropriate for affiliate transactions" and require the carrier to reference that rate of return, if different from the prescribed interstate rate of return, in its cost allocation manual. 163.MCI argues that the Commission should set the uniform rate of return for determining the fully distributed costs associated with affiliate transactions involving the services permitted by section 272 at 10.25 percent, the lowest point of the range that the Commission allows under its price cap plan. MCI maintains that an affiliate relationship reduces a supplier's business risks and therefore lowers the necessary return. NYNEX argues that the Commission should reject MCI's suggestion. NYNEX contends that the fact that a price cap carrier subject to sharing/low-end adjustments can seek a low-end adjustment if its interstate earnings fall below 10.25 percent does not provide a basis to establish 10.25 percent as a reasonable return component. NYNEX notes that many carriers are not subject to sharing/low-end adjustments. Finally, NYNEX argues that determination of business risk, cost of capital and rate of return for particular nonregulated affiliates would be extremely complicated. Discussion: 164.When an incumbent local exchange carrier provides services or assets to an affiliate, or an affiliate provides services or assets to an incumbent local exchange carrier, where the transferred goods or services are not provided pursuant to tariff or eligible for prevailing price valuation (i.e. substantial amount of the transferred goods or services are not provided to unaffiliated third parties), the transactions typically do not involve the risk inherent in providing services or assets in a competitive market. This is because any investment required to provide the service or asset will not be subject to competitive pressure from alternative suppliers. The cost of capital to be imputed in such transactions should meet two criterion: one, it should impute a reasonable rate of return, and two, it should be uniform for all carriers and transactions. The latter criteria, uniformity, avoids the unduly burdensome calculation of a rate of return and time-consuming carrier-specific rate of return prescription. 165.We conclude that a reasonable rate of return to be used by all incumbent local exchange carriers in determining the fully distributed costs associated with affiliate transactions is the rate of return on interstate services, as amended periodically by the Commission. In establishing the prescribed interstate rate of return, the Commission considered the cost of capital to provide interstate access services and prescribed a rate of return of 11.25% for the local exchange carriers. The Commission concluded that this rate of return for the regulated activities of local exchange carriers would maintain the carriers' financial integrity and enable them to attract new capital necessary to serve the public. The Commission followed the Supreme Court's holding in FPC v. Hope Natural Gas Co. that the rate prescribed should be "commensurate with returns on investments in other enterprises having corresponding risks." In concluding that the prescribed interstate rate of return is a reasonable rate of return to be used in affiliate transactions, we agree with PacTel and SBC that the prescribed interstate rate of return is consistent with the return on investment that an incumbent local exchange carrier could anticipate if it were to use its investment to provide services to third parties. We also disagree with the approach of US West to use a blended rate of return for interstate and intrastate services because there are states that no longer prescribe a rate of return for intrastate services. The approach of US West and that of USTA also would not allow the application of a uniform or easily determinable rate of return. 166.In the Interconnection Order, we concluded that "the currently authorized rate of return at the federal or state level is a reasonable starting point . . . and incumbent [local exchange carriers] bear the burden of demonstrating with specificity that the business risks that they face in providing unbundled network elements and interconnection services would justify a different risk-adjusted cost of capital." We similarly conclude that for all affiliate transactions, incumbent local exchange carriers bear the burden of demonstrating with specificity that the business risks that they face in providing services to their affiliates would justify a risk-based adjustment to the cost of capital that would result in a rate of return different than 11.25%. We note, however, that we apply the prescribed rate of return on interstate services to affiliate transactions solely to determine the fully distributed costs associated with such transactions for accounting purposes and not to determine the prices charged for these services. c. Accounting Requirements of Sections 272(b)(2) and (c)(2) 167.Section 272(b)(2) requires the separate affiliates prescribed under section 272(a)(2) to "maintain books, records, and accounts in the manner prescribed by the Commission which shall be separate from the books, records, and accounts maintained by the [BOC] of which it is an affiliate." In the NPRM, we asked what steps the Commission should take in order to implement this requirement and, in particular, whether we should mandate that separate affiliates required under section 272(a)(2) maintain their books, records, and accounts in accordance with generally accepted accounting principles ("GAAP") or whether it is necessary for the Commission to adopt any additional accounting, bookkeeping or record-keeping requirements for affiliates prescribed under 272(a)(2). Comments: 168.Most parties, including several BOCs, argue that at most we should require separate affiliates under section 272(a)(2) to maintain their books, records, and accounts in accordance with GAAP. TRA contends that GAAP will ensure that costs are based upon reliable data and will create a more uniform audit trail with minimal cost and without a drastic restructuring of carriers' accounting systems. US West maintains that GAAP is a reasonable requirement because it is widely employed and commonly understood. 169.AT&T and MCI argue that all BOC affiliates except non-carrier affiliates should maintain their books pursuant to the Commission's Uniform System of Accounts. In particular, MCI contends that standardization of Part 32 accounting between a BOC and its in- region interLATA affiliate will enable the Commission to make earnings comparisons and comparisons of investment and expenses that are critical to the Commission's ability to identify instances where a BOC is possibly subsidizing an interLATA affiliate. Worldcom maintains that we should require all BOC affiliates to maintain books in conformance with Part 32's Uniform System of Accounts to facilitate auditing. Discussion: 170.We conclude that the separate affiliates prescribed under section 272(a)(2) must maintain their books, records, and accounts in accordance with GAAP. We concur with TRA that a requirement that these affiliates maintain their books, records, and accounts in accordance with GAAP will result in a uniform audit trail at minimal cost. Moreover, a requirement of GAAP for separate affiliates required under section 272(a)(2) imposes some degree of uniformity upon these affiliates. We are not persuaded by parties' comments, however, that we should impose Part 32 accounting systems on BOC affiliates in order to facilitate auditing. We currently do not impose Part 32 accounting on the interexchange telecommunications affiliates of non-BOC incumbent local exchange carriers. Moreover, BOCs are currently required to clearly and completely document the manner in which affiliates' accounting systems flow into the BOCs' Part 32 accounts. Accordingly, we find no reason to impose the additional burden of requiring separate affiliates required under Section 272(a)(2) to maintain their books, records, and accounts in accordance with the Part 32 Uniform System of Accounts. d. Application to InterLATA Telecommunications Affiliates 171.Our existing affiliate transactions rules are designed solely for transactions between regulated carriers and their nonregulated affiliates. InterLATA telecommunications services, however, are subject to Title II of the Act, and, absent a Commission determination to the contrary, the affiliates that offer those services would classify interLATA telecommunications services as "regulated" for Title II accounting purposes. In the NPRM, we tentatively concluded that we should apply our affiliate transactions rules to transactions between each BOC and any regulated interLATA telecommunications affiliate it establishes under section 272(a). We invited comment on this tentative conclusion and asked how we would need to modify our affiliate transactions rules if applied to such transactions. 172.Section 272 does not prohibit a BOC from providing more than one nonregulated service (e.g., manufacturing and an interLATA information service) through the same affiliate. It also does not prohibit an affiliate that provides regulated services such as interLATA telecommunications services, from engaging in other activities not regulated under Title II. In the NPRM, we sought comment on whether, in this context, we should apply our cost allocation rules to prevent subsidization of nonregulated activities by subscribers to interLATA telecommunications services, and whether section 254(k) authorizes such an application of our cost allocation rules. Comments: 173.Most commenters addressing this issue argue that the Commission should treat interLATA telecommunications services, such as in-region interLATA services, like a nonregulated activity for accounting purposes. As a result, these commenters maintain that the existing affiliate transactions rules will prevent subsidization between local exchange and exchange access services and these interLATA telecommunications services. 174.BellSouth, however, opposes application of the affiliate transactions rules to transactions between a BOC and its affiliate established under section 272(a). BellSouth contends that there is no need to apply these rules because both the BOC and the new interLATA telecommunications affiliate are subject to Title II of the Act and, therefore, must establish just, reasonable and nondiscriminatory rates. In addition, BellSouth argues that, because the separate affiliate requirement of section 272 sunsets after three years, the costs incurred to create internal accounting and tracking systems to comply with the affiliate transactions rules would increase administrative costs with no corresponding benefit. 175.Worldcom and MCI argue that the Commission should apply its cost allocation rules to prevent subsidization of nonregulated activities by interLATA services. USTA and all of the BOCs that address this issue, however, oppose the application of cost allocation rules to prevent subsidization of nonregulated activities by subscribers to interLATA telecommunications services. They contend that BOC affiliates have no incentive to subsidize nonregulated activities by subscribers to interLATA telecommunications services because both services are competitive. Bell Atlantic further argues that the Commission has no authority to regulate transactions within or among affiliates. Discussion: 176.Section 272(b)(5) requires BOC affiliates established under section 272(a), such as an affiliate providing in-region services, to "conduct all transactions with the Bell operating company of which it is an affiliate on an arm's length basis." Our existing affiliate transactions rules are designed solely for transactions between regulated carriers and their nonregulated affiliates. These rules therefore do not currently protect against a flow of subsidies from a BOC's exchange services and exchange access to its affiliate providing regulated interLATA telecommunications services, such as in-region services. We conclude that under the current affiliate transactions rules, we can satisfy section 272(b)(5)'s "arm's length" requirement by treating interLATA telecommunications services like a nonregulated activity strictly for accounting purposes. We therefore adopt our tentative conclusion that we should apply our affiliate transactions rules to transactions between each BOC and any interLATA telecommunications affiliate it establishes under section 272(a), such as an affiliate providing in-region services, and order that the BOCs treat such services like nonregulated activities for accounting purposes. 177.We find unpersuasive BellSouth's assertion that there is no need to apply our affiliate transactions rules to transactions between each BOC and any interLATA telecommunications affiliate it establishes under section 272(a), such as an affiliate providing in-region services. Despite BellSouth's assertion that interLATA telecommunications affiliates established under section 272 are subject to Title II of the Act and, therefore, must establish just, reasonable and nondiscriminatory rates, we believe we should apply our affiliate transactions rules, as modified in this Order, to satisfy our obligation to ensure that all transactions between BOCs and their section 272 affiliates are conducted at "arm's length." Moreover, we disagree with BellSouth's contention that the administrative costs of imposing our affiliate transactions rules outweigh the corresponding benefit. To the greatest extent possible, we have relied upon our existing affiliate transactions rules to minimize the administrative burden associated with the implementation of a new system of accounting safeguards. 178.When a BOC affiliate provides both regulated Title II services permitted under sections 271 and 272, such as interLATA telecommunications services, and nonregulated activities, such as interLATA information services, we conclude that we need not apply our cost allocation rules to prevent subsidization of nonregulated activities by subscribers to these interLATA telecommunications services. We agree with those commenters that argue that market forces leave BOC affiliates with little ability to subsidize nonregulated activities by interLATA telecommunications services. e. Application to Sharing of Services 179.In the NPRM, we tentatively concluded that if our companion Non-Accounting Safeguards Order were to conclude that an affiliate may share marketing personnel with a BOC then we should apply our cost allocation and affiliate transactions rules, as we proposed to modify them in our NPRM, to the BOC's Part 32 accounts to govern any joint marketing of interLATA and local exchange services. We invited comment on whether any additional accounting safeguards may be necessary. Comments: 180.MCI, NYNEX, Worldcom and TRA argue that if the BOC In-Region Order concludes that an affiliate may share marketing personnel with a BOC, the Commission's cost allocation and affiliate transactions rules must apply to the joint marketing of interLATA and local exchange services. MCI contends that the BOCs' cost allocation manuals must specify how they plan to estimate the fair market value of the marketing services they provide to their interLATA affiliates. 181.Washington maintains that the Commission should require that the affiliate employ and pay for the shared marketing personnel with the costs allocated to the BOC based on time reporting and other auditable documentation. USTA and several BOCs argue that the Commission need not impose any additional safeguards when a separate affiliate subject to the requirements of section 272(b)(3) shares in-house or outside services with a BOC. USTA contends that although section 272 prohibits the BOCs and their affiliates from sharing employees, nothing in the language of that section prohibits a BOC and its affiliate from entering into "arm's length" transactions that allow the affiliate to purchase administrative functions from the BOC. Discussion: 182.Our Non-Accounting Safeguards Order concludes that BOCs are permitted to share in-house services other than operating, installation, and maintenance services with their section 272 affiliates if the agreement to share in-house services complies with the requirements of section 272, including section 272(b)(1)'s "operate independently" requirement, section 272(b)(3)'s "separate officers, directors, and employees" requirement, section 272(b)(5)'s "arm's length" requirement, and section 272(c)(1)'s nondiscrimination requirements. Earlier in this Order, we determined that our affiliate transactions rules should apply to transactions between BOCs and their section 272 affiliates in order to satisfy section 272(b)(5)'s "arm's length" requirement. We conclude, therefore, that our affiliate transactions rules apply to transactions between BOCs and their section 272 affiliates for the sharing of in-house services, including joint marketing services. Moreover, the sharing of in- house services by a BOC and its section 272 affiliate constitutes a "transaction" within the meaning of section 272(b)(5) that must be "reduced to writing and available for public inspection." 183. Our Non-Accounting Safeguards Order further concludes that section 272(b)(3) does not preclude an affiliate of the BOC, such as a services affiliate, or the parent company of both the BOC and its section 272 affiliate from performing functions for both the BOC and its section 272 affiliate. Our affiliate transactions rules apply to transactions between the BOC and a nonregulated affiliate of the BOC, such as a services affiliate, and to transactions between the BOC and its parent company. Under the principle of "chain transactions," our affiliate transactions rules also apply to any transactions between the section 272 affiliate and a nonregulated affiliate of the BOC, such as a services affiliate, that ultimately result in an asset or service being provided to the BOC. f. Audit Requirements 184.Section 272(d) requires that a company required to operate a separate subsidiary under section 272 "shall obtain and pay for a joint federal/State audit every two years conducted by an independent auditor to determine whether such company has complied with this section and the regulations promulgated under this section, and particularly whether such company has complied with the separate accounting requirements under [section 272(b)]." 185.In the NPRM, we tentatively concluded that the independent auditor's report required under section 272(d) should be filed with the Commission and each relevant State commission and should include a discussion of: (1) the scope of the work conducted, including a description of how the affiliate's or joint venture's books were examined and the extent of the examination; (2) the auditor's conclusion on whether the examination of the books has revealed compliance or non-compliance with the affiliate transactions rules and any non- discrimination requirements in the Commission rules; (3) any limitations imposed on the auditor in the course of its review by the affiliate or joint venture or other circumstances that might affect the auditor's opinion; and (4) a statement by the auditor that the carrier's cost allocation methodologies conform to the Act and the Commission's rules and that the carrier has accurately applied the methodologies described in those rules. We invited comment on this tentative conclusion. We also asked whether the independent auditor's report should address the carrier's compliance with sections 272(e)(3) and 272(e)(4). Comments: 186.With respect to the form and content of the audit report, TRA and TIA support the Commission's conclusion regarding the information that should be provided in the independent auditor's report required by section 272(d). In contrast, Ameritech, Kiesling, US West, and USTA contend that the independent auditor, in conformance with professional standards, should determine the content and report format. BellSouth and PacTel state that the Commission should not adopt its proposal to require a statement by the auditor that the carrier's cost allocation methodologies conform to the Act. BellSouth contends that this requirement is redundant in light of the Commission's proposal that the auditor include a conclusion as to whether examination of the books has revealed compliance with the affiliate transactions rules and any nondiscrimination requirements. PacTel argues that this requirement exceeds what Congress intended, compelling a broader and more costly audit than required by the plain language of section 272(d). 187.Worldcom, Missouri PSC and CTA state that the audit report should address whether the carrier has complied with sections 272(e)(3) and 272(e)(4). Worldcom further argues that the independent audit required by section 272(d) should include a detailed examination of the BOCs' methods of access imputation. TRA recommends that the Commission require the audit to include a "positive opinion" concerning the carrier's obligation to charge its affiliate or impute to itself an amount for access no less than that charged to an unaffiliated carrier, the carrier's obligation to provide facilities and services to affiliates at the same rates and on the same terms as all other carriers, and the carrier's obligation to allocate all costs in accordance with Commission rules. 188.The commenters also addressed other aspects of the joint federal/State audit required under section 272(d). Regarding the timing of the audit, MCI, AT&T and NARUC maintain that the Commission should not wait two years to initiate the first audit of BOC compliance with section 272. NARUC states that an audit should be performed and submitted for the first full year of operations after the new subsidiary begins to provide services. AT&T and CTA contend that the Commission should time the first audit so that one additional audit can be performed before section 272's provisions sunset under section 272(g). AT&T and MCI further argue that the Commission should require an annual audit. They maintain that while section 272(d) requires an audit every two years, nothing precludes the Commission from exercising its general authority with regard to accounting matters to require annual audits. Several BOCs argue that the most logical reading of section 272 is that the first audit should not occur until two years after a BOC's section 272 affiliate commences operation. They contend that a Commission requirement of an annual audit would directly conflict with the congressional mandate in section 272. 189.With respect to coverage of the audit, MCI and NARUC maintain that audits should be required of all affiliates whose activities involve or whose revenues are derived from the services specified in section 272, including resale. MCI and NARUC recommend that one audit be submitted for each of the three services required by section 272 and that each audit cover the last two years of operations. 190.Regarding access to audit workpapers, PacTel and US West urge the Commission to state that workpapers, including material obtained from the examined entities, will receive confidential treatment consistent with section 220(f) and the Commission's policy for Part 64 audits. Ameritech and USTA, however, contend that section 272(d)'s requirements on access to documents, as well as scope and distribution, are clearly articulated and require no further specification by the Commission. MCI and NARUC maintain that access should be given to all working papers with no restriction or time limit placed upon access to data from prior years. NARUC indicates that any State commission having access to the audit workpapers should have provisions in place to ensure the protection of proprietary information as required by section 272(d)(3)(C). NYDPS contends that federal and State regulators should have access to the auditor's workplan and correspondence with the BOC and should be able to attend meetings between the auditor and the BOC where audit procedures and findings are discussed. APCC disagrees that access to auditors' workpapers should be limited only to State utility commissions, the Commission, and any joint audit team formed. APCC argues that access should be provided to any interested party so that such parties can challenge the audit results. 191.To facilitate the biennial audit, AT&T states that the Commission should require all BOC affiliates to make available to the public on a quarterly basis financial reports, an income statement, a balance sheet, and a statement of cash flows. 192.Regarding the relation of the biennial audit to the cost allocation manual audit under Part 64, MCI, NYNEX and TIA state that the Commission should clarify that the audit specified in section 272(d) supplements the annual audit required by section 64.904 of the Commission's rules. To the extent that these audits overlap, PacTel contends that the Commission should permit the audit required by section 272(d) to meet the requirement of the section 64.904 annual audit. Ameritech, BellSouth and US West argue that the Commission should conduct the section 64.904 audit in alternate years from the audit required by section 272(d). Ameritech further maintains that each audit should cover only the most recent fiscal period. 193.A number of parties offered recommendations in their comments, replies, and ex parte presentations regarding the audit process and the manner in which the Commission, States and the particular BOC should participate in the audit process. NYDPS recommends that the BOC, the Commission and the State affected by the audit should jointly select the auditor. NYNEX states that each carrier subject to a section 272 audit should have the opportunity to participate in the formulation of the audit to ensure its fairness. 194.In its comments, NARUC proposed that the Commission adopt specific audit guidelines for the federal/State joint participation in the audit process. These guidelines would require that a separate federal/State joint audit team be established to oversee the audit process as it relates to compliance with section 272. The NARUC guidelines would establish procedures for selecting the independent auditor through a competitive bidding process using Requests for Proposals ("RFP"). The RFP would address audit purpose and scope, auditor selection criteria, project controls, audit report content, and protection of proprietary data. The federal/State joint audit team would develop a set of standards or objectives that every audit must meet. These standards or objectives also would be incorporated into the RFP. 195.The NARUC guidelines would require that a staff member of the federal/State joint audit team follow the progress of the audit and determine whether deadlines and objectives are being met. Upon completion of the audit, the NARUC guidelines would require that the federal/State joint audit team verify that the audit program objectives have been met and determine whether it is necessary for the independent auditor to perform additional audit work. 196.Several State public service commissions recommended that the Commission adopt the proposals advanced by NARUC. USTA and several BOCs, however, argue that the NARUC proposals far exceed the statutory requirements of the Act, and that the Commission should therefore reject them. US West specifically objects to NARUC's proposal to require incumbent local exchange carriers to use an RFP process to select an independent auditor. US West claims that the premise behind NARUC's RFP proposal is apparently that an independent auditor can only be "independent" if selected through a competitive bidding process. US West disagrees, stating that independence is one of the central tenets of the public accounting profession. US West also opposes NARUC's proposal to permit the federal/State audit team to participate in developing the audit program and in determining the scope of the audit. US West argues that this proposal could unnecessarily interfere with the independent auditor's professional responsibility under General Accepted Auditing Standards. Discussion: 197.We conclude that some of the recommendations in the NARUC comments should be adopted. The purpose of the required audits is to determine whether the BOCs and their separate subsidiaries are complying with the accounting and structural safeguards required by section 272 and to report the audit results to the Commission and the state regulatory agencies. To obtain a fair assessment of BOC compliance, we must ensure adequate oversight. From our experience with the cost allocation manual audits under Part 64, we have learned that Commission guidance of the audit process is crucial to assuring that the accounting and structural safeguards are in place and functioning properly. Because of the critical nature of accounting safeguards in promoting competition in the telecommunication marketplace and the critical role the biennial audit will play in ensuring that the safeguards are working, it is essential that we establish effective biennial audit rules at the outset. We conclude that the Commission and the States need to oversee the scope, terms and conditions of the biennial audit. Without such oversight, it would be uncertain whether the audits will achieve their primary objective of ensuring that the carriers have, in fact, complied with section 272 of the Act and our rules. 198.We therefore adopt the NARUC recommendations with certain modifications. Under the rules we now adopt, we delegate authority to the Chief, Common Carrier Bureau to form a federal/State joint audit team with the States having jurisdiction over a BOC's local exchange service. This joint audit team will review the conduct of the audit and direct the independent auditor to take such action as the team finds necessary to ensure compliance with the audit requirements. The new rules require that the structural and transactional requirements and the nondiscrimination safeguards set forth in sections 272(b) 272(c) and 272(e) be subject to audits. The rules, however, do not require the BOCs to choose the independent auditor through a competitive bidding process using a request for proposals as NARUC recommends. The rules preclude the BOCs from hiring independent auditors who have participated during the two years preceding the biennial audit in designing any of the systems under review in the audit. As with the cost allocation manual audits, we conclude that the independent auditor who designs a system should not be the one to certify that it is operating properly. 199.The rules set an orderly schedule for conducting the audit and for submitting the audit report to the Commission and the States as well as to interested parties for comment. The rules call for participation and agreement by the BOC and by the federal/State joint audit team in defining the scope and purpose of the audit prior to its commencement. The rules also allow the federal/State joint audit team to review and, if necessary, direct modifications to the design of the independent auditor's audit program. Allowing the federal/State joint audit team to participate in this manner at the beginning of the audit is consistent with section 272, because the audit is being conducted to satisfy the Commission and the State public service commissions that the prescribed nonstructural and accounting safeguards have been implemented and are working. Early input from federal/State joint audit team will ensure that the needs of the Commission and the States will be met. 200.The rules prescribe a number of deadlines that parties must meet to avoid prolonged delays in the audit's completion. The final audit report must include: (1) the findings and conclusions of the independent auditor; (2) exceptions of the federal/State joint audit team to the auditor's findings and conclusions; (3) response of the BOC to the auditor's findings and conclusions, and (4) reply of the independent auditor to both the exceptions of the federal/State joint audit team and the response of the BOC. Because the final audit report will become a single source for the audit findings and any exceptions or comments regarding them, interested parties wishing to comment on a particular audit could obtain this information without difficulty. 201.With one exception, discussed below, we have decided to adopt our tentative conclusion regarding the form and content of the auditor's section of the report. We disagree with the parties that contend that we should permit independent auditors to select the content and format of the audit reports. By prescribing a specific report format, we will ensure the consistency and adequacy of all such audit reports. Therefore, in our rules governing the biennial audits required by section 272(d), we will require that the independent auditor's section of the audit report include a discussion of: (1) the scope of the work conducted, with a description of how the affiliate's or joint venture's books were examined and the extent of the examination; (2) the auditor's findings and conclusions on whether examination of the books, records and operations has revealed compliance or non-compliance with section 272 and with the affiliate transactions rules and any applicable nondiscrimination requirements; and (3) a description of any limitations imposed on the auditor in the course of its review by the affiliate or joint venture or other circumstances that might affect the auditor's opinion. 202. We do not require a statement by the auditor that the carrier's cost allocation methodologies conform to the Act. The carrier's conformance is already reviewed in our cost allocation manual audits under Part 64. Biennial audits review subsidiaries' transactions with the BOCs to which our affiliate transactions rules apply. Based on the reasoning presented in comments filed by CTA, Missouri PSC and Worldcom, we will require that the auditor's section of the report address whether the carrier has complied with sections 272(e)(3) and 272(e)(4). These sections contain provisions that are intended to deter cross-subsidization by the BOCs and, thus, we must know whether the BOCs are complying with them. It is not necessary, however, to adopt TRA's recommendation and require a separate "positive opinion" concerning carrier compliance with sections 272(e)(3) and 272(e)(4) because we are including these requirements as part of the biennial audit. 203. We agree with MCI, AT&T and NARUC that we should not wait two years to require the first audit of BOC compliance with section 272 and we adopt NARUC's suggestion to require the audit to begin at the close of the first full year of operations. We agree with these commenters that nothing in the Act compels us to wait two years after the subsidiary is formed and offering service to begin the audit. The next audit will begin two years later and will cover the operations of the previous two years. This schedule should assure an operational period with adequate information and data to audit. Moreover, such a schedule will allow at least one, and possibly two, audits before the sunset provision of section 272(f) is considered. We will also require that each BOC obtain one audit that covers all affiliates engaged in services specified in section 272(a)(2), including resale, rather than requiring individual audits for each of these services. We believe that one audit of such affiliates should provide the same degree of assurance as could be derived from audits of individual services and has the advantage of providing a comprehensive overview. We do not order an annual audit under our general accounting powers as suggested by AT&T and CTA, because there is no indication that the two-year requirement in the Act will not be sufficient. 204.Workpapers related to the biennial audits, including material obtained from the examined entities, will receive confidential treatment consistent with section 220(f) and the Commission's policy for Part 64 audits. We believe that the requirements in section 272(d)(3) regarding access by the Commission and State commissions to audit workpapers and documents, are clearly articulated and require no further specification by the Commission at this time. As suggested by MCI and NARUC, we interpret these provisions to require access by the Commission and States to all working papers with no restriction or time limit placed upon access to prior years' papers. Any State commission having access to the audit workpapers should have provisions in place to ensure the protection of proprietary information as required by section 272(d)(3)(C). Without such provisions in place, a State commission could neither be represented on the federal/State joint audit team nor participate in the biennial audit. Section 272(d)(3) limits access to audit workpapers and documents under section to representatives of the Commission and of the State public utility commissions. We will not extend this access to other parties as suggested by APCC. This is clearly beyond the scope of section 272(d). We have already addressed NYDPS's contention that federal and State regulators should have access to the auditor's workplan and correspondence with the BOC and should be able to attend meetings between the auditor and the BOC where audit procedures and findings are discussed. 205.We agree with the commenters that suggest that, to the extent the biennial audit and the cost allocation manual audit under Part 64 overlap, we should permit the biennial audit to meet the requirement of the section 64.904 annual audit. This requirement will meet our needs and reduce audit costs for the companies. For a biennial audit to satisfy any part of a cost allocation manual audit, we will require a statement by the auditor that the carrier's cost allocation methodologies conform to the Act. We also note that, unlike the biennial audits, the cost allocation manual audits under Part 64 do not involve State participation. Thus, by relying on the biennial audit, we will allow State participation in the overlapping areas of the audits. In their cost allocation manual audit workpapers, the independent auditors should include copies of the audit work performed under the biennial audit. 2. Section 273 - Manufacturing by Certifying Entities a. Statutory Language 206.Section 273(d) requires entities that certify telecommunications or customer premises equipment to maintain separate affiliates in order to engage in certain types of manufacturing activities. Under section 273(d)(3), when such an entity certifies telecommunications equipment or customer premises equipment manufactured by an unaffiliated entity, the certifying entity "shall only manufacture a particular class of telecommunications equipment or customer premises equipment for which it is undertaking or has undertaken, during the previous eighteen months, certification activity . . . through a separate affiliate." "[N]otwithstanding [section 273(d)(3)]," section 273(d)(1)(B) prohibits "Bell Communications Research, Inc., or any successor entity or affiliate" from "engag[ing] in manufacturing telecommunications equipment or customer premises equipment as long as it is an affiliate of more than 1 otherwise unaffiliated [BOC] or successor or assign of any such company." 207.Section 273(d)(3)(B) requires the separate affiliate to "maintain books, records, and accounts separate from those of the entity that certifies such equipment, consistent with generally acceptable accounting principles[,]" and to "have segregated facilities and separate employees" from the certifying entity. Section 273(g) permits "[t]he Commission [to] prescribe such additional rules and regulations as the Commission determines necessary to carry out the provisions of this section, and otherwise to prevent discrimination and cross- subsidization in a [BOC's] dealings with its affiliates and with third parties." b. Comparison of Sections 273 and 272 208.Both sections 272 and 273 require the use of a separate affiliate to engage in different specified activities. In the NPRM, we asked whether section 273's different statutory language requires or permits different accounting treatment for standard-setting organizations and their manufacturing affiliates from that required or permitted for BOCs under section 272. We also asked whether we should apply our affiliate transactions rules, as we proposed to modify them, to transactions between all certifying entities, whether regulated carriers or not, and the affiliates they must maintain under section 273(d). 209.In the NPRM, we tentatively concluded that application of our affiliate transactions rules, as we proposed to modify them, would be sufficient to satisfy section 273(g)'s requirement that the Commission "prescribe such additional rules and regulations as the Commission determines necessary . . . to prevent subsidization in a [BOC's] dealings with its affiliates and with third parties." We invited comment on this tentative conclusion. Comments: 210.Several local exchange carriers argue that the affiliate transactions rules should not be modified to govern transactions between a certifying entity and its affiliate if that certifying entity is not also a regulated carrier. In particular, these local exchange carriers argue that it is not within the Commission's authority under the Act to impose regulations on nonregulated affiliates. Ameritech contends that the provisions of section 273(d)(3)(B) that require compliance with GAAP are sufficient and affiliate transactions rules need not be applied to certifying entities and their manufacturing affiliates. Ameritech and USTA contend that to the extent our affiliate transactions rules are considered necessary, these rules satisfy the requirements of section 273(g). 211.TIA argues that the Commission's affiliate transactions rules must be applied, in particular, to transactions between Bellcore and any manufacturing affiliate that it may create in order to prevent cross-subsidization because Bellcore is currently owned by the seven regional BOCs and may remain affiliated with regulated carriers even after it is permitted to manufacture pursuant to section 273. On the other hand, Bellcore argues that its accounting system already provides the protection required by section 273. Discussion: 212.We conclude that our affiliate transactions rules, as modified here, satisfy section 273(g)'s requirement that we "prescribe such additional rules and regulations as [we] determine are necessary to . . . prevent . . . cross-subsidization in a [BOC's] dealings with its affiliate." Elsewhere in this Order, we concluded that BOCs are subject to the modified affiliate transactions rules in their dealings with their affiliates engaged in activities permitted under section 272(a), including manufacturing affiliates, in order to assure compliance with the "arm's length" requirement of section 272(b)(5). Accordingly, BOCs that perform certification activities are already subject to the affiliate transactions rules in dealings with their manufacturing affiliates under section 272(b)(5) and current conditions do not warrant additional rules to satisfy section 273(g). In addition, under the principle of "chaining," as long as a certifying entity, such as Bellcore, remains affiliated with a regulated BOC, our affiliate transactions rules apply to any transactions between that certifying entity and its section 273 separated, nonregulated manufacturing affiliate that ultimately result in an asset or service being provided to the BOC. 3. Section 274 - Electronic Publishing a. Statutory Language 213.Section 274 prescribes the terms under which a BOC may offer electronic publishing. In the NPRM, we noted that section 274(a) permits a BOC or its affiliate to provide electronic publishing over its own or its affiliate's basic telephone service only through a "separated affiliate" or an "electronic publishing joint venture." Section 274(i)(9) defines "separated affiliate" as "a corporation under common ownership or control with a Bell operating company that does not own or control a Bell operating company and is not owned or controlled by a Bell operating company and that engages in the provision of electronic publishing which is disseminated by means of such Bell operating company's or any of its affiliate's basic telephone service." Section 274(i)(8), in turn defines "own" as having "a direct or indirect equity interest (or the equivalent thereof) of more than 10 percent of an entity, or the right to more than 10 percent of the gross revenues of an entity under a revenue sharing or royalty agreement." Section 274(i)(4) states that "'control' has the meaning that it has in 17 C.F.R. 240.12b-2, the regulations promulgated by the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) or any successor provision to such section." Section 274(i)(5) defines an "electronic publishing joint venture" as "a joint venture owned by a Bell operating company or affiliate that engages in the provision of electronic publishing which is disseminated by means of such Bell operating company's or any of its affiliates' basic telephone service." b. Comparison of Sections 274 and 272 214.In the NPRM, we noted that the language of section 274's structural and transactional requirements differs from that of the structural and transactional requirements of section 272. We invited comment on whether the distinction between a "separated" affiliate under section 274 and a "separate" affiliate under section 272 requires or permits different accounting treatment for affiliate transactions. Specifically, we sought comment on whether we should apply our affiliate transactions rules, as we proposed to modify them, to transactions between a BOC and its "separated" electronic publishing affiliate or joint venture. We sought comment on whether application of these rules would provide adequate accounting safeguards for the joint activities permitted under section 274(c)(2). We also invited comment on whether, because section 274 allows a BOC to provide electronic publishing through either a "separated" affiliate or a joint venture, we should distinguish for Title II accounting purposes between transactions involving a BOC and its "separated" affiliate and those involving a BOC and its electronic publishing joint venture. Comments: 215.NAA and several BOCs contend that the differences in language between sections 274 and 272 do not require the Commission to impose different accounting treatments for those affiliate transactions governed by section 274 and those governed by section 272. They also argue that the Commission's affiliate transactions rules provide adequate accounting safeguards for the joint activities permitted under section 274(c)(2). In contrast, YPPA argues that, by placing electronic publishing in a separate section of the Act, Congress intended the Commission to implement different accounting requirements for sections 272 and 274. YPPA does not, however, suggest how the requirements should differ. In addition, USTA and several BOCs argue that the Commission need not distinguish for Title II accounting purposes between transactions involving a BOC and its "separated" affiliate and those involving a BOC and its electronic publishing joint venture. 216.SBC notes that the Commission's existing affiliate transactions rules would not apply to transactions between a BOC and certain "separated" affiliates and joint ventures when the BOC has insufficient ownership interest in the "separated" affiliate or joint venture for those entities to qualify as BOC affiliates under section 32.9000 of the Commission's rules. 217.BellSouth maintains that section 274's requirement of a "separated" affiliate for the provision of interLATA information services facially violates BOCs' First Amendment right of freedom of speech and constitutes an unconstitutional Bill of Attainder. Discussion: 218.We conclude above that our affiliate transactions rules must be applied to transactions between BOCs and their section 272 affiliates in order to satisfy section 272(b)(5)'s "arm's length" requirement. The language of section 274's structural and transactional requirements differs from that of the structural and transactional requirements of section 272. Section 274 does not specifically use the phrase "arm's length" to describe the required nature of transactions between BOCs and their section 274 "separated" electronic publishing affiliates or joint ventures. Section 274(b), however, requires that "separated" electronic publishing affiliates or joint ventures "be operated independently from the [BOC]," and section 274(b)(3)(A) requires that transactions between a "separated" electronic publishing affiliate or joint venture and its affiliated BOC be carried out "in a manner consistent with such independence." Moreover, section 254(k) prohibits incumbent local exchange carriers, including the BOCs, from using non-competitive exchange service and exchange access to subsidize competitive services, such as electronic publishing. We conclude that in order to satisfy sections 274(b) and 254(k), we must apply our affiliate transactions rules, as modified in this Order, to transactions between BOCs and their "separated" electronic publishing affiliates or joint ventures. Applying our affiliate transactions rules to transactions between BOCs and their "separated" electronic publishing affiliates or joint ventures will serve as a safeguard against the misallocation of costs from a BOC's nonregulated services, such as electronic publishing services, to regulated telecommunication services. Our affiliate transactions rules, as modified in this Order, prevent the BOCs' ratepayers from bearing the costs of competitive services provided by BOC affiliates and are, therefore, sufficient to implement section 254(k)'s requirement that carriers not "use services that are not competitive to subsidize services that are subject to competition." 219.BellSouth has argued that requiring BOCs to provide electronic publishing services through a "separated" affiliate or joint venture violates the First Amendment. As noted above, we find that this result is required by the Act. Although the courts have ultimate authority to determine the constitutionality of this and other statutes, we find it appropriate to state that we find BellSouth's argument to be without merit. To the extent that BOC provision of electronic publishing services constitutes commercial speech for First Amendment purposes, the section 274 "separated" affiliate or joint venture requirement neither prohibits the BOCs from providing such services, nor places any restrictions on the content of the information the BOCs may provide. Instead, the section 274 "separated" affiliate or joint venture requirement is a content-neutral restriction on the manner in which BOCs may provide electronic publishing services, intended by Congress to protect against improper cost allocation and discrimination concerns. Thus, we conclude that the "separated" affiliate or joint venture requirement imposed by section 274 on BOC provision of electronic publishing services does not violate the First Amendment. BellSouth has also argued that requiring BOCs to provide electronic publishing services through a "separated" affiliate or joint venture constitutes an unconstitutional Bill of Attainder. Although the courts have ultimate authority to determine the constitutionality of this and other statutes, we find it appropriate to state that we find BellSouth's argument to be without merit. We agree with NAA that section 274 does not single out the BOCs for punishment, but merely imposes temporary, narrowly-focused, economic regulations. c. Compliance Review 220.Section 274(b)(8) requires that a BOC and its electronic publishing "separated" affiliate or joint venture each perform an annual compliance review conducted by "an independent entity" to determine compliance with section 274. In the NPRM, we sought comment on how such compliance reviews should be conducted and specifically what matters the reviews should encompass. We proposed to require the independent entity to prepare and file with the Commission reports describing: 1) the scope of its compliance review, including a description of how the affiliate's or joint venture's books were examined and the extent of the examination; (2) the independent entity's conclusion on whether examination of the books has revealed compliance or non-compliance with the affiliate transactions rules and any other non-discrimination requirements imposed by Commission rules; (3) a description of any limitations imposed on the independent entity in the course of its review by the affiliate or joint venture or other circumstances that might affect the entity's opinion; and (4) statements by the independent entity as to whether the carrier's accounting and affiliate transactions methodologies conform to the Act and the Commission's rules and whether the carrier has accurately applied the methodologies. We sought comment on the necessity or desirability of this approach. We also sought comment on what safeguards we may need to adopt to protect proprietary information contained in the compliance review report "from being used for purposes other than to enforce or pursue remedies under [section 274]." Comments: 221.NAA is the only commenter to support the Commission's proposal related to the method for conducting, and the scope of, annual compliance reviews. Ameritech and PacTel contend that section 274(b)(8) clearly establishes the requirements of the annual compliance review and therefore argue that the Commission should not specify any procedures for conducting the annual compliance reviews. USTA proposes that the annual compliance reviews be conducted in accordance with standards set forth by the American Institute of Certified Public Accountants. YPPA argues that the independent compliance review required by section 274(b)(8) should consist only of an examination of the written records of transactions between a BOC and its electronic publishing "separated" affiliate or joint venture and should include a report detailing the scope and conclusion of the examination and any limitations placed on the examiner. Wisconsin PSC recommends the use of NARUC's resolution discussed in section IV.B.1.f. above as a "starting point for discussions between the states and the FCC concerning [compliance reviews under section 274]." 222.PacTel recommends that to the extent overlap exists, the Commission should allow the annual compliance review under section 274 to satisfy the requirement of an annual cost allocation manual audit. US West recommends that the Commission require the annual cost allocation manual audit to be conducted biennially to streamline current regulations and reduce redundancy. 223.YPPA notes that the timing of the annual compliance review may vary, depending on whether the affiliate provided electronic publishing services at the time of the enactment of the 1996 Act. YPPA argues that the first audit for grandfathered services should be conducted by February 8, 1998 because affiliates need not comply with the requirements of section 274 until February 8, 1997. For non-grandfathered services, YPPA contends that the first audit should be conducted one year after the affiliate starts to engage in electronic publishing activities. 224.Most commenters that address the matter argue that the Commission's policies regarding protection of proprietary information would adequately protect proprietary information contained in the compliance review report. PacTel does contend, however, that the BOCs should be allowed to exclude any competitively-sensitive information from the compliance review report because of the competitive nature of the electronic publishing business. BellSouth recommends the Commission allow the BOCs and their electronic publishing "separated" affiliates or joint ventures to file two versions of the compliance review report--a public version with proprietary information omitted and a confidential version. BellSouth argues that the Commission should release the confidential version under a protective order only after a persuasive showing that access is necessary to enforce or pursue remedies under section 274. Discussion: 225.We decline to adopt the proposal presented in the NPRM related to the method for conducting, and the scope of, annual compliance reviews. We note that the language of section 274(b)(8) provides less stringent requirements than section 272(d)'s audit requirement. For example, section 274(b)(8) only requires a compliance review performed by an independent entity, rather than a federal/State joint audit conducted by a trained independent auditor. Under section 274(b)(8), the party obtaining the compliance review need only file a report of exceptions and corrective action to the Commission for public inspection, making the compliance review itself available only to "lawful authorities." In contrast, section 272(d) requires the BOC to file the final audit report required under that section with the Commission and with the State commission of each state in which the BOC provides service, which will make such report available for public inspection and comment. Moreover, section 274(e) provides a right of action to any person claiming that an act or practice of the BOC, affiliate, or "separated" affiliate has violated the requirements of section 274. In view of this, we find that an oversight mechanism similar to the one we adopt in this Order for section 272(d) is not necessary to implement the provisions of section 274(b)(8) and we conclude that we need not adopt any rules regarding the compliance review beyond the plain language of section 274(b)(8)(A). Because of the differences between a compliance review under section 274 and an audit, we further conclude that a carrier may not use the electronic publishing compliance review to satisfy any portion of the annual cost allocation manual audit required by section 64.904 of the Commission's rules. 226.Section 274(b)(9) requires the BOC and its electronic publishing "separated" affiliate or joint venture to file a report with the Commission of any exceptions and corrective action resulting from the compliance review. Section 274(b)(9) further requires the Commission to "allow any person to inspect and copy such report subject to reasonable safeguards to protect any proprietary information contained in such report from being used for purposes other than to enforce or pursue remedies under [section 274]." We find that these requirements of section 274(b)(9) are self-effectuating and, therefore, we need not adopt any rules regarding this requirement beyond the plain language of section 274(b)(9). We will apply the same treatment to confidential information in such reports as we apply to confidential information contained in other Commission filings. d. Section 274(f)'s Reporting Requirement 227.Section 274(f) requires any "separated" affiliate under section 274 to file annual reports with the Commission "in a form substantially equivalent to the Form 10-K required by regulations of the Securities and Exchange Commission." In the NPRM, we tentatively concluded that to minimize burdens on the filing companies, we should require the "separated" affiliate to file the Form 10-K with us as well as the SEC. We recognized, however, that not all "separated" affiliates providing electronic publishing services would be subject to the SEC's 10-K requirement and sought comment on what "substantially equivalent to the Form 10-K" means with regard to these "separated" affiliates. Comments: 228.BellSouth agrees that the filing requirements we proposed in the NPRM will satisfy section 274(f). For those electronic publishing "separated" affiliates not subject to the SEC's Form 10-K requirement, BellSouth recommends that the Commission adopt a standard report that solicits information relevant to the concerns outlined in section 274 and not require the Form 10-K itself. BellSouth argues that this report should contain a description of the entity filing the report, summary financial statements with representations of management, a list of the officers and directors of the entity, a description of any financing activity the entity undertakes, and specific transactional compliance results obtained from the annual compliance review required by section 274(b)(8). 229.YPPA and NAA argue that the Commission should accept the electronic publishing "separated" affiliate or joint venture's Form 10-K if its stock is publicly traded. YPPA contends that if the "separated" affiliate's stock is not publicly traded, the Commission should accept the Form 10-K of the "separated" affiliate's holding company. NAA disagrees. NAA maintains that the language of the Act clearly requires "[a]ny separated affiliate," not the holding company, to file the annual report. NAA argues that the Form 10- K of a holding company would fail to provide the Commission and third parties with essential financial and other information about the "separated" affiliate's operations. Instead, NAA proposes that the "separated" affiliate should file a report containing the same information as in a Form 10-K, except for such information that would only be relevant to a publicly-traded corporation. YPPA argues that, if neither the "separated" affiliate nor the holding company are required to file a Form 10-K with the SEC, then the Commission should require the "separated" affiliate to complete and file a Form 10-K with the Commission. Discussion: 230.To minimize burdens on the filing companies, we adopt our tentative conclusion that when an electronic publishing "separated" affiliate already files a Form 10-K with the SEC, the "separated" affiliate may file the same Form 10-K with the Common Carrier Bureau within 90 days after the end of the "separated" affiliate's fiscal year in satisfaction of section 274(f)'s requirements. We disagree with BellSouth that, for electronic publishing "separated" affiliates not subject to the SEC's Form 10-K filing requirement, we should adopt a standard report that solicits only "that information that is relevant to the concerns outlined in section 274." Such a requirement would not satisfy the explicit language of section 274, that requires that "separated" affiliates "file with the Commission annual reports in a form substantially equivalent to the form 10K required by [the SEC]." Moreover, we believe that by requiring all electronic publishing "separated" affiliates to file annual reports containing the same information in the same format, we will improve our ability to ensure compliance with the provisions of section 274. We agree with NAA that the Form 10-K of a "separated" affiliate's holding company would fail to provide the Commission and third parties with adequate information about the "separated" affiliate's operations to ensure compliance with section 274. Because the Form 10-K of the holding company would present only consolidated information, the Commission and third parties could not identify from that form the account balances related to the activities of the electronic publishing "separated" affiliate. For each "separated" affiliate not subject to the SEC's Form 10-K requirement, however, we conclude that the "separated" affiliate need not file an actual SEC Form 10-K with the Commission. Instead, such affiliates must file with the Commission a report containing the same information as is required in the SEC's Form 10-K. In accordance with section 274(f), the report must be organized "in a form substantially equivalent to the Form 10-K required by regulations of the [SEC]." e. Section 274 Transactional Requirements 231.Section 274(b)(1) requires the "separated" affiliate or joint venture and the BOC with which it is affiliated to "maintain separate books, records, and accounts and prepare separate financial statements." In the NPRM, we invited comment on the steps we should take to implement this provision. We also asked commenters to address whether it is necessary for the Commission to adopt any additional accounting, bookkeeping,or record- keeping requirements for these affiliates and joint ventures and, if so, what those additional requirements should be. 232.Section 274(b) requires the "separated" affiliate or joint venture to "be operated independently from the [BOC]." Pursuant to section 274(b)(3), the "separated" affiliate or joint venture and the BOC with which it is affiliated must "carry out transactions (A) in a manner consistent with such independence, (B) pursuant to written contracts or tariffs that are filed with the Commission and made publicly available, and (C) in a manner that is auditable in accordance with generally accepted auditing standards." We also sought comment on the meaning of "in a manner consistent with such independence." In addition, we sought comment on whether any regulations are necessary to implement the provisions of section 274(b)(3)(A) and (B). 233.In the NPRM, we further sought comment on whether, and if so, how we should amend our rules to implement the requirement under section 274(b)(3)(C) that transactions be "auditable in accordance with generally accepted auditing standards." We noted that generally accepted auditing standards refer to standards and guidelines promulgated by the American Institute of Certified Public Accountants that an independent auditor must follow when preparing for and conducting an audit of a company's financial statements. These standards require, inter alia, that the auditor review a company's internal controls and determine whether adequate documentation exists to verify that the company has recorded transactions on its books in a manner consistent with generally accepted accounting principles. 234.Section 274(b)(4) requires the "separated" affiliate or joint venture to "value any assets that are transferred directly or indirectly from the [BOC] to a separated affiliate or joint venture, and record any transactions by which such assets are transferred, in accordance with such regulations as may be prescribed by the Commission or a State commission to prevent improper cross subsidies." We proposed elsewhere in the NPRM to conform our valuation methods under the affiliate transactions rules governing provision of services to those governing asset transfers. Regardless of the resolution of that issue in this proceeding, because section 274 specifically addresses asset transfers between a BOC and its "separated" affiliate or joint venture, we sought comment in the NPRM on whether we should distinguish between asset transfers and the provision of services in the context of electronic publishing affiliate transactions. Comments: 235.NAA and PacTel argue that section 274(b)(1)'s requirement of separate books, records, accounts, and financial statements is self-effectuating and, therefore, the Commission need not establish any additional regulations. BellSouth and NYNEX contend that the Commission should direct the "separated" affiliate or joint venture to keep their books, records, and accounts in accordance with GAAP in order to satisfy section 274(b)(1). Ameritech argues that application of the SEC's Form 10-K reporting regulations, discussed in section IV.B.3.d. above, would ensure that a "separated" affiliate maintains its books, records, and accounts in accordance with GAAP and would therefore obviate the need for any additional rules to implement section 274(b)(1). 236.NAA argues that section 274(b)(3)(A)'s requirement that transactions be carried out "in a manner consistent with such independence" requires transactions to occur as they would between unrelated parties (i.e., on an "arm's length basis"). PacTel and US West contend that the requirements of section 274(b)(3)(A) are self-effectuating and, therefore, the Commission need not establish any additional regulations. 237.NAA contends that section 274(b)(3)(B)'s requirement that transactions be carried out "pursuant to written contracts or tariffs that are filed with the Commission and made publicly available" is self-effectuating and, therefore, the Commission need not establish any additional regulations. 238.BellSouth maintains that section 274(b)(3)(C)'s requirement that transactions be carried out "in a manner that is auditable in accordance with generally accepted auditing standards" requires that the section 274 "separated" electronic publishing affiliate or joint venture maintain its books in accordance with GAAP. PacTel and US West contend that the requirements of section 274(b)(3)(C) are self-effectuating and, therefore, the Commission need not establish any additional regulations. 239.Ameritech contends that to the extent the affiliate transactions rules apply, the Commission need not distinguish between asset transfers and services in the case of electronic publishing. Discussion: 240.We agree with NAA and PacTel that section 274(b)(1)'s requirement of separate books, records, accounts, and financial statements is self-effectuating and, therefore, we need not adopt any rules regarding this requirement beyond the plain language of section 274(b)(1). 241. We agree with NAA that section 274(b)(3)(A)'s requirement that transactions be carried out "in a manner consistent with such independence" requires that transactions between a "separated" electronic publishing affiliate or joint venture and its affiliated BOC occur on an arm's length basis, as the transaction would occur between unrelated parties. The phrase "such independence" in section 274(b)(3)(A) refers to section 274(b)'s requirement that a "separated" electronic publishing affiliate or joint venture "be operated independently from the [BOC]." Consistent with this conclusion, we determined in section IV.B.3.b. above that we should apply our affiliate transactions rules, as modified in this order, to transactions between BOCs and their "separated" electronic publishing affiliates or joint ventures. 242.We are unpersuaded by NAA's argument that the language of section 274(b)(3)(B) is self-effectuating. We find the language of section 274(b)(3)(B) to be ambiguous. Pursuant to this section, a BOC and its separated affiliate shall carry out transactions "pursuant to written contracts or tariffs that are filed with the Commission and made publicly available." From this language it is unclear whether written contracts must be filed with the Commission or whether only tariffs are required to be filed with the Commission. It is also unclear whether written contracts must be made publicly available or whether only tariffs are required to be made publicly available. We therefore intend to seek further comment on the meaning of section 274(b)(3)(B) in CC Docket No. 96-152. 243.We agree with BellSouth that the section 274 "separated" electronic publishing affiliate or joint venture must maintain its books, records, and accounts in accordance with GAAP in order to satisfy section 274(b)(3)(C)'s requirement that transactions be "auditable in accordance with generally accepted auditing standards." A requirement of GAAP imposes a set of uniform accounting principles. Such uniformity will assist the Commission in ensuring that transactions between "separated" affiliates or joint ventures required under section 274 and their affiliated BOCs are conducted "in a manner consistent with such independence" in accordance with section 274(b)(3)(A). 244.For the same reasons discussed in section IV.B.1.b. above with regard to section 272, we conclude that we should conform our valuation methods governing the provision of services between an electronic publishing "separated" affiliate or joint venture and the BOC with which it is affiliated to those governing asset transfers. We therefore will require all non-tariffed affiliate transactions to be recorded at prevailing price if such price exists, and otherwise at the higher of cost and estimated fair market value when the carrier is the seller or transferor, and at the lower of cost and estimated fair market value when the carrier is the buyer or transferee. We will continue to define the applicable cost benchmarks as net book cost for asset transfers and fully distributed costs for service transfers. Although section 274(b)(4) only refers to asset transfers, we read section 274's requirement that the "separated" affiliate or joint venture and the BOC with which it is affiliated "carry out transactions . . . in a manner consistent with such independence" to prohibit the "separated" affiliate or joint venture and the BOC with which it is affiliated from subsidizing electronic publishing services from regulated telecommunications services. We designed our affiliate transactions rules to prevent such cross-subsidization. We therefore conclude that the affiliate transactions rules, as we modify them in this Order, should apply to all transactions--both asset transfers and the provision of services--between a BOC and its "separated" affiliate or joint venture engaged in electronic publishing activities permitted under section 274. f. Miscellaneous 245.Section 274(d) requires a BOC under common ownership or control with a electronic publishing "separated" affiliate or joint venture to "provide network access and interconnections for basic telephone service to electronic publishers at just and reasonable rates that are tariffed (so long as rates for such services are subject to regulation) and that are not higher on a per-unit basis than those charges for such services to any other electronic publisher or any separated affiliate engaged in electronic publishing." In the NPRM, we tentatively concluded that we should apply our modified affiliate transactions rules to the provision of "network access and interconnections for basic telephone service" by a BOC under common ownership or control with an electronic publishing "separated" affiliate or joint venture to such a "separated" affiliate or joint venture to ensure compliance with the requirements of section 274(d). We sought comment on this tentative conclusion. Comments: 246.BellSouth and NAA support the Commission's tentative conclusion that our affiliate transactions rules should be applied to the provision of "network access and interconnections for basic telephone service" by a BOC under common ownership or control with an electronic publishing "separated" affiliate or joint venture to such a "separated" affiliate or joint venture to ensure compliance with the requirements of section 274(d). YPPA disagrees. YPPA maintains that the Act requires that network access and interconnection be just, reasonable, and according to a filed tariff (so long as rates for such services are subject to regulation). Therefore, YPPA asserts that section 274(d) requires that the rates charged to affiliated and unaffiliated electronic publishers must be the same. Discussion: 247.We adopt our tentative conclusion that our modified affiliate transactions rules apply whenever a BOC under common ownership or control with an electronic publishing "separated" affiliate or joint venture provides network access and interconnections for basic telephone service to such "separated" affiliates or joint venture. YPPA's argument that section 274(d) requires that the rates charged to affiliated and unaffiliated electronic publishers must be the same was raised, and will be addressed, in a separate proceeding. 4. Separated Operations under Sections 260 and 271 through 276 248.Even when sections 260 and 271 through 276 do not require BOCs or other incumbent local exchange carriers to offer services through a separate affiliate, an incumbent LEC might choose to perform these activities through an affiliate. At paragraph 118 of the NPRM, we tentatively concluded that application of our affiliate transactions rules, as we proposed to modify them, to transactions between an incumbent local exchange carrier and any of its affiliates engaged in activities that sections 260, 275, and 276 might permit or require the carrier to offer through a separate affiliate would safeguard against the subsidies prohibited by sections 260, 275, and 276. We invited comment on this tentative conclusion. 249.In the NPRM, we also asked commenters to identify any interLATA telecommunications services, besides the interLATA telecommunications services that section 272 requires BOCs to provide through a separate affiliate, that the BOCs might choose to provide through a separate affiliate and for which we should develop appropriate affiliate transactions rules. We tentatively concluded that we should apply our affiliate transactions rules to transactions between each BOC and any interLATA telecommunications services affiliate it establishes. We invited comment on this tentative conclusion. We also asked whether and how we should adapt our affiliate transactions rules for such transactions and whether we should adopt special valuation methodologies for these transactions that would recognize the regulated status of the affiliates on both sides of the transactions. Comments: 250.Most parties, including interexchange carriers, BOCs, and trade associations agree with the Commission's proposal to apply affiliate transactions rules to transactions between a BOC and its separate affiliates, even if the Act does not require the activities at issue in the transactions to be conducted through a separate affiliate. In particular, AT&T contends that any contrary rule would allow a BOC to transfer operations that it could offer on an integrated basis to an affiliate in order to circumvent affiliate transactions rules and engage in cross-subsidization. APCC argues that the "available for public inspection" requirement of section 272(b)(5) should cover all transactions between BOCs or other incumbent local exchange carriers and these "voluntary" affiliates. Discussion: 251.We agree with the commenters that assert that our affiliate transactions rules should apply to transactions between an incumbent local exchange carrier and any of its affiliates engaged in activities of the types permitted by sections 260 and 271 through 276, regardless of whether the Act requires those activities to be conducted through a separate affiliate. As discussed in detail below, various provisions of the Act prohibit cross- subsidization through transactions between incumbent local exchange carriers and any affiliates that these incumbent local exchange carriers choose to establish in order to provide the competitive activities permitted under sections 260 and 271 through 276. 252.Earlier we concluded that telemessaging is an information service and that BOC provision of telemessaging on an interLATA basis is subject to the separate affiliate requirements of section 272. Non-BOC incumbent local exchange carriers, however, are not required to offer telemessaging services through a separate affiliate, but rather may choose to do so subject to section 260's requirement that "[a]ny local exchange carrier subject to the requirements of section 251(c) . . . shall not subsidize its telemessaging service directly or indirectly from its telephone exchange service or its exchange access." In order to protect against the subsidies prohibited by section 260, we conclude that we must apply our affiliate transactions rules to all transactions between non-BOC incumbent local exchange carriers and their affiliates engaged in telemessaging activities. 253.Although section 272(a)(2)(B) does not require BOCs to provide certain types of incidental interLATA services, defined in section 271(g), through an affiliate, a BOC could still choose to provide these services through an affiliate subject to section 271(h)'s requirement that provision of these services by a BOC "will not adversely affect telephone exchange service ratepayers or competition in any telecommunications market." In order to protect against the subsidies prohibited by section 271(h), we conclude that we must also apply our affiliate transactions rules to all transactions between BOCs and their affiliates providing incidental interLATA services. 254.Non-BOC incumbent local exchange carriers, although not required to do so, may choose to offer alarm monitoring services through a separate affiliate subject to section 275's requirement that an incumbent local exchange carrier "not subsidize its alarm monitoring services either directly or indirectly from telephone exchange service operations." In order to protect against the cross-subsidies prohibited by section 275, we conclude that we must apply our affiliate transactions rules to all transactions between non-BOC incumbent local exchange carriers and their affiliates engaged in alarm monitoring activities. 255.Incumbent local exchange carriers, including BOCs, although not required to do so, may choose to offer payphone service through a separate affiliate. Our Pay Telephone Reclassification Order reclassified payphone service as a nonregulated activity and required that the nonstructural safeguards described in our Computer III Orders, which include our affiliate transactions rules, be applied to the provision of payphone services by local exchange carriers. As a result, our existing affiliate transactions rules apply to transactions between incumbent local exchange carriers and their affiliates engaged in payphone service. 256.Although section 272(a)(2)(B) does not require BOCs to provide out-of-region interLATA telecommunications services through an affiliate, a BOC could still choose to do so. Moreover, non-BOC incumbent local exchange carriers, although not required to do so, may choose to provide interLATA telecommunications services of the types described in section 271 through an affiliate. Sections 271 and 272, however, contain no language prohibiting cross-subsidization in the case of activities voluntarily provided through affiliates. Although sections 271 and 272 contain no language prohibiting cross-subsidization, Section 254(k) mandates that "[a] telecommunications carrier may not use services that are not competitive to subsidize services that are subject to competition." The language of section 254(k) is broad in scope, prohibiting cross-subsidization in all transactions between an incumbent local exchange carrier and any affiliate that provides any of the competitive services permitted under sections 260 and 271 through 276. Accordingly, in order to protect against the subsidies prohibited by section 254(k), we conclude we must apply our affiliate transactions rules to all transactions between incumbent local exchange carriers and their affiliates providing any of the competitive services of the types permitted under sections 260 and 271 through 276. 257.Our existing affiliate transactions rules do not protect against subsidies from an incumbent local exchange carrier's exchange services and exchange access flowing to its affiliate providing regulated telecommunications services, such as in-region services, out-of- region services, or certain types of incidental services. Our affiliate transactions rules, however, are necessary to ensure that cross-subsidization of these services is prevented as required by sections 271(h) and 254(k). Earlier we concluded that interLATA telecommunications services, including in-region services, out-of-region services and certain types of incidental services, should be treated by the BOCs like nonregulated activities for federal accounting purposes. This treatment will prevent cross-subsidization by triggering the application of our affiliate transactions rules. Accordingly we conclude that interLATA telecommunications services should be treated like nonregulated activities for federal accounting purposes whenever these services are provided by any incumbent local exchange carrier through an affiliate. 258.We find unpersuasive APCC's assertion that the requirement in section 272(b)(5) that transactions be "available for public inspection" should apply to all transactions between incumbent local exchange carriers and their affiliates. The language of section 272(b)(5) clearly imposes the "available for public inspection" requirement only upon transactions between BOCs and their affiliates that are specifically required under section 272, and not to transactions involving activities that a BOC merely chooses to provide through an affiliate. Moreover, the "available for public inspection" requirement of section 272(b)(5) does not apply to transactions involving non-BOC incumbent local exchange carriers and their affiliates. V. OTHER MATTERS A. Price Caps 1. General 259.Our existing Part 64 cost allocation rules were developed when all local exchange carriers were still subject to cost-based, rate-of-return regulation. Today, we rely upon price cap, rather than rate-of-return regulation to ensure that rates for the interstate services of the largest incumbent local exchange carriers, including the BOCs, are reasonable. In adopting the federal price cap plan, we were influenced by some State plans that moved away from the traditional rate-of-return regulation. Under the Commission's plan, price cap indices limit the prices that incumbent local exchange carriers may charge for their regulated interstate services. The indices are adjusted each year in accordance with a formula that accounts for changes in inflation and industry-wide changes in productivity. 2. Exogenous Costs and Part 64 260.Under our price cap rules for incumbent local exchange carriers, most changes in a carrier's costs of providing regulated services are treated as "endogenous," which means they do not result in adjustments to the carrier's price cap indices. Certain cost changes, however, triggered by administrative, legislative, or judicial action that are beyond the control of the carriers may result in adjustments to those indices. The Commission concluded that failing to recognize these cost changes by adjusting price cap indices would either unjustly punish or reward the carrier. Price cap carriers may claim adjustments to their indices based on costs that are beyond their control if those costs are not otherwise accounted for in the price cap formula. Such costs are defined as "exogenous." The Commission has found that those types of cost changes should be treated "exogenously" to ensure that price cap regulation does not lead to unreasonably high or unreasonably low rates. 261.Our price cap rules for incumbent local exchange carriers specify that "[s]ubject to further order of the Commission, those exogenous cost changes shall include cost changes caused by . . . [t]he reallocation of investment from regulated to nonregulated activities pursuant to [section 64.901 of the Commission's rules]." In the NPRM, we tentatively concluded that a strict reading of our price cap rules requires exogenous adjustments to price cap indices only to the extent amounts are reallocated "from regulated to nonregulated activities." We invited comment on this tentative conclusion and asked whether all such reallocation to nonregulated activities that may result from the provision of telemessaging service should trigger an adjustment to lower price cap indices. We also sought comment on the potential exogenous treatment of new investment in network plant to be used for telemessaging service. Comments: 262.The BOCs argue, without exception, that section 61.45(d)(1)(v) does not require a price cap adjustment for reallocation of network investment from regulated to nonregulated activities. Several of the local exchange carriers argue that the exogenous cost rule in section 61.45(d)(1)(v) was only intended to deter under-forecasting of nonregulated usage pursuant to section 64.901(b)(4). USTA, US West and Bell Atlantic assert that exogenous treatment would act as a disincentive for future investment in telecommunications capabilities. NYNEX, Bell Atlantic, USTA, Ameritech and US West all assert that exogenous treatment would result in a double counting of the cost of network investment. NYNEX further argues that a reallocation of costs from regulated to nonregulated activities would only result in a change in how costs are recorded and not a change in economic cash flow which would require exogenous treatment. 263.Parties other than local exchange carriers generally contend that exogenous adjustments to price cap indices are required when costs are reallocated from regulated to nonregulated activities. In particular, Sprint maintains that the current price cap indices do not reflect the reallocated costs and therefore would not amount to a double counting of network investment. Furthermore, because exogenous treatment does not apply to new investment, Sprint argues that no disincentive is created. 264.Sprint and GSA contend that new investment associated with nonregulated services should initially be associated to a nonregulated activity. Discussion: 265.Under the current regulatory scheme, only exogenous treatment can ensure that the benefits of competition are in fact shared with regulated ratepayers. When the Commission adopted its cost allocation requirements, it specifically found that "the reallocation rules are essential to the integrity of a cost allocation system . . . which seeks to prevent regulated activities from absorbing nonregulated costs, either at the start of a forecast period or subsequently." We find unpersuasive the argument that exogenous treatment of reallocated costs would in some way discourage local exchange companies from investing in telecommunications capabilities. We agree with Sprint that exogenous treatment of reallocated costs will not result in double counting of network investment because those costs are not reflected in the current price cap indices. Moreover, while it is true that exogenous treatment of reallocated costs will reduce the rate base for non-competitive services, such as exchange service and exchange access, the 1996 Act allows local exchange companies to take advantage of new competitive markets with new resulting revenue streams virtually unfettered by regulation. Thus, we conclude that when costs are reallocated from regulated to nonregulated activities, exogenous adjustments must be made to price cap indices in accordance with section 61.45(d)(1)(v). Exogenous adjustments to the price cap indices will only be eliminated when competition in the local service market eliminates the need for cost allocation rules altogether. 266.We agree with Sprint and GSA that any portion of new investment associated with nonregulated services should be booked initially to a nonregulated activity and, therefore, will not receive exogenous treatment. 3. Part 64 and Sharing 267. Under our price cap rules, incumbent local exchange carriers can select the productivity factor they will use to determine annual adjustments to their price cap indices. If they choose not to select the highest productivity factor permitted under our rules, they are required to "share." Under sharing, incumbent local exchange carriers earning in excess of prescribed earnings levels must refund a portion of the excess earnings in subsequent rate periods by reducing their price cap indices. Those earnings are equal to the incumbent local exchange carrier's interstate revenues less the regulated interstate costs. Improper cost allocation can increase the incumbent local exchange carrier's regulated interstate costs and therefore can reduce the carrier's sharing obligations. We note, however, that in their most recent annual tariff filings all but four price cap local exchange carriers elected the highest interim productivity factor we had prescribed, which exempts them from sharing obligations for the 1995-96 access year. 268.In the NPRM, we asked commenters to address whether our elimination of sharing obligations permanently for price cap carriers would eliminate the need for Part 64 cost allocation processes in our regulation of these companies. We also sought comment on how the relationship of our cost allocation rules to price cap local exchange carriers should influence the outcome of this proceeding. Comments: 269.The BOCs generally argue that we should eliminate our accounting safeguards or forebear from enforcing them under section 10 of the Act on the ground that our current price cap plan removes any incentive or ability for local exchange carriers to cross-subsidize competitive services. The BOCs generally emphasize that no-sharing price cap carriers cannot cross-subsidize because no link between costs and rates exists in the absence of a sharing requirement. Ameritech argues that even if it were possible to misallocate costs, it would be practically insignificant because local exchange carriers would have to incorporate the increased costs into higher rates while competing with other providers to retain customers. USTA argues that any attempt to misallocate costs from nonregulated to regulated activities would serve no purpose because economies of scope are realized through the productivity offset. 270.Parties other than local exchange carriers generally maintain that there is a linkage between costs and rates under price caps that justifies the continued application of our accounting safeguards. These parties generally argue that under our current price cap plan, local exchange carriers retain the annual option of selecting a productivity factor subject to sharing requirements that are dependent on rate of return, thereby preserving the incentive to shift costs. These parties also generally contend that our accounting safeguards are necessary to monitor the BOCs' rates of return for regulated services in order to evaluate whether the price cap system is in the public interest, and determine whether adjustments to the productivity factor must be made. Sprint and APCC argue that even in the absence of a sharing requirement, carriers are able to request adjustments to their price cap indices for exogenous cost changes, which requires the Commission to review costs. Discussion: 271.The fact that an incumbent local exchange carrier subject to the Commission's price cap regulation does not currently have a potential sharing obligation does not obviate the need for rules governing their allocations of costs between regulated and nonregulated activities. As described above, our interim price cap rules permit incumbent local exchange carriers to select the productivity factor they will use to determine annual adjustments to their price cap indices. Incumbent local exchange carriers may select among three productivity factor choices, two of which impose sharing obligations if the local exchange carrier's interstate earnings exceed specified benchmarks and permit low-end adjustments if interstate earnings fall below specified benchmarks. In addition, our price cap rules permit incumbent local exchange carriers to file rate increases that exceed their applicable price cap indices, provided they can satisfy a stringent cost showing. Consequently, our current system of interstate price cap regulation does not eliminate the need for cost allocation rules. Moreover, because these incumbent local exchange carriers' intrastate services may be subject to cost-of- service regulation or to a form of price cap regulation that involves potential sharing obligations or periodic earnings reviews, the incumbent local exchange carriers may still have an incentive to assign a disproportionate share of costs to regulated accounts. We recognize that changes in the competitive conditions of local telecommunications markets in the future may cause us to re-examine the continued need for our Part 64 cost allocation rules; but, based on the record in this proceeding, those rules remain important to our efforts to ensure that the rates for regulated services are just, reasonable, and non-discriminatory. B. Section 254(k) 272.In the NPRM, we sought comment on whether our proposals related to sections 260 and 271 through 276 are sufficient to implement section 254(k)'s requirement that carriers not "use services that are not competitive to subsidize services that are subject to competition." Comments: 273.NYNEX and BellSouth contend that the Commission's accounting safeguards are sufficient to satisfy the requirements of section 254(k). 274.Several commenters addressed the portion of section 254(k) that requires "[t]he Commission, with respect to interstate services . . . [to] establish any necessary cost allocation rules, accounting safeguards, and guidelines to ensure that services included in the definition of universal service bear no more than a reasonable share of the joint and common costs of facilities used to provide those services." Discussion: 275.We conclude that the accounting safeguards that we adopt in this Order with respect to sections 260 and 271 through 276 are sufficient to implement section 254(k)'s requirement that carriers not "use services that are not competitive to subsidize services that are subject to competition." Our existing accounting safeguards, with the modifications that we adopt in this Order, prevent subsidization of competitive nonregulated services, such as those addressed in Sections 260 and 271 through 276 by subscribers to an incumbent local exchange carrier's regulated telecommunications services. We find that the Act does not require additional safeguards for these particular statutory services. 276.We note that the portion of section 254(k) that requires "[t]he Commission, with respect to interstate services . . . [to] establish any necessary cost allocation rules, accounting safeguards, and guidelines to ensure that services included in the definition of universal service bear no more than a reasonable share of the joint and common costs of facilities used to provide those services" will not be addressed in this Order but will be the subject of a separate rulemaking proceeding. VI. FINAL REGULATORY FLEXIBILITY ACT ANALYSIS 277.As required by section 603 of the Regulatory Flexibility Act ("RFA"), as amended, an Initial Regulatory Flexibility Analysis ("IRFA") was incorporated in the NPRM. In the NPRM, the Commission certified that the rules it proposed to adopt in this proceeding would not have a significant economic impact on a substantial number of small entities because the proposed rules did not pertain to small entities. No comments were received concerning the proposed certification. For the reasons stated below, we certify that the rules adopted herein will not have a significant economic impact on a substantial number of small entities. This certification conforms to the RFA, as amended by the Small Business Regulatory Enforcement Fairness Act of 1996 ("SBREFA"). 278.The RFA defines a "small business" to be the same as a "small business concern" under the Small Business Act. Under the Small Business Act, a "small business concern" is one that: (1) is independently owned and operated; (2) is not dominant in its field of operation; and (3) meets any additional criteria established by the Small Business Administration. Section 121.201 of the Small Business Administration regulations defines a small telecommunications entity in SIC code 4813 (Telephone Companies Except Radio Telephone) as any entity with 1,500 or fewer employees at the holding company level. Entities directly subject to these rule changes are engaged in the provision of local exchange and exchange access telecommunications services. These entities are generally large corporations that are dominant in their fields of operations and thus, are not "small entities" as defined by the Act. While these companies may have fewer than 1,500 employees and thus fall within the SBA's definition of small telecommunications entity, we do not believe that such entities should be considered small entities within the meaning of the RFA. Because the small incumbent LECs subject to these rules are either dominant in their field of operations or are not independently owned and operated, consistent with our prior practice, they are excluded from the definition of "small entity" and "small business concerns." Accordingly, our use of the terms "small entities" and "small businesses" does not encompass small incumbent LECs. Out of an abundance of caution, however, for regulatory flexibility analysis purposes, we will consider small incumbent LECs within this analysis and use the term "small incumbent LECs" to refer to any incumbent LECs that arguably might be defined by SBA as "small business concerns." 279.The rules adopted in this Order are threefold. First, the rules adjust the methodologies by which a carrier must account for transactions or sales of assets and services with its affiliates ("accounting modifications"). Second, the rules require that BOCs operating separate affiliates under section 272 of the 1996 Act obtain and pay for a Federal/State joint audit every two years by an independent auditor. Finally, BOC electronic publishing "separated" affiliates must file either a Securities and Exchange Commission ("SEC") Form 10-K or a report "substantially equivalent" to an SEC Form 10-K with the Commission. We consider these in turn. 280.Accounting Modifications. We certify that although there are a substantial number of small entities affected by the accounting modifications adopted herein, the accounting modification rules we adopt in this Order will not have a substantial economic impact on those affected small entities. Entities directly subject to the rules adopted herein either provide local exchange and exchange access telecommunications services or are owned by or affiliated with entities that provide such services, and, in the case of smaller incumbent local exchange carriers, settle their NECA cost pool on an actual cost basis. We note that prior to the adoption of this Order, these small entities could already provide nonregulated services and were already subject to our affiliate transactions rules. Neither of the two changes to these rules will have a substantial economic impact on small entities. We note that the accounting modifications adopted here are simply accounting changes with no substantial long- term economic impact. Moreover, we do not believe that the smaller entities that are affected by these rules operate with as many affiliates as do larger entities, and thus the changes will not have a substantial economic impact on small entities. Under the rules modified here, the prevailing price methodology will be retained in a modified form. Previously, a carrier could use the prevailing price method only when a substantial amount of business was conducted with third parties. Our previous rules, however, did not clarify the meaning of a "substantial" amount of third-party business for the purpose of determining whether the carrier could set a prevailing price. Under the rules modified here, if an entity's annual sales, as measured by quantity, to unaffiliated third parties exceed 50 percent of total annual sales of a particular product or service then the "substantial" amount of third-party business requirement has been satisfied and a prevailing price has been established for that particular product or service. Also, these entities will have to value assets in a similar manner as they value services. As the companies already are familiar with this method of valuation, there will not be a substantial economic impact from the transition to the new methodology. We therefore certify that the accounting modifications adopted in this Order will not have a significant economic impact on a substantial number of small entities. 281.Periodic Audit. Under the rules adopted herein, a BOC operating a separate subsidiary under section 272 is required to obtain and pay for a biennial Federal/State joint audit conducted by an independent auditor to determine whether the BOC has complied with the rules promulgated under section 272. None of the BOCs is a small entity, since each BOC is an affiliate of a Regional Holding Company ("RHC"), and all of the BOCs or their RHCs have more than 1,500 employees. We therefore certify that the periodic audit requirements adopted in this Order will not have a significant economic impact on a substantial number of small entities. 282.Filing Form 10-K with the Commission. Finally, our rules will require that BOC affiliate entities engaged in electronic publishing file a report "substantially equivalent" to an SEC Form 10-K with the Commission. BOC affiliates that already file a Form 10-K with the SEC may satisfy this requirement by simply filing a copy of that Form 10-K with the Commission. BOC affiliates that are not subject to the SEC's 10-K filing requirement, however, must file with the Commission a report containing the same information in the same format as the SEC's Form 10-K. These rules do not apply to small entities because the entities subject to this rule are BOCs or entities associated or affiliated with the BOCs. None of the BOCs is a small entity, since each BOC is an affiliate of a Regional Holding Company ("RHC"), and all of the BOCs or their RHCs have more than 1,500 employees. Moreover, the entities affected by this rule that are affiliated or associated with the BOCs are not independently owned and operated, and therefore do not meet the definition of small entities. We therefore certify that the SEC Form 10-K filing requirement adopted in this Order will not have a significant economic impact on a substantial number of small entities. 283.The Commission shall provide a copy of this certification to the Chief Counsel for Advocacy of the SBA, and include it in the report to Congress pursuant to the SBREFA. The certification will also be published in the Federal Register. VII. FINAL PAPERWORK REDUCTION ACT ANALYSIS 284.The decision herein has been analyzed with respect to the Paperwork Reduction Act of 1995, Pub. L. 104-13, and has been approved in accordance with the provisions of that Act. The Office of Management and Budget ("OMB") encouraged the Commission, to the greatest extent possible, to use its existing cost allocation and affiliate transactions rules to address the requirements established in sections 260 and 271 through 276 of the 1996 Act. Furthermore, OMB recommended that the FCC should, where possible, establish industry and market conditions that, once met, would allow certain provisions of this collection to be eliminated or mitigated. First, we believe we have complied with OMB's request to use the existing cost allocation and affiliate transactions rules wherever possible. We have amended the existing rules only where we are certain that the existing rules will not fulfill the overall goals of the Communications Act of 1934, as amended by the 1996 Act. Second, in accordance with the overall policy underlying the 1996 Act, we will revisit these issues in the future to determine if our regulations are still necessary once competition increases. VIII. ORDERING CLAUSES 285.Accordingly, IT IS ORDERED that, pursuant to sections 4(i), 4(j), 201-205, 218, 220, 260, 271-76, 303(r), 403 of the Communications Act of 1934, as amended by the 1996 Act, 47 U.S.C.  154(i), 154(j), 201-205, 218, 220, 260, 271-176, 303(r), 403, the rules, requirements and policies discussed in this Order ARE ADOPTED and sections 32.27, 53.209, 53.211, and 53.213 of the Commission's rules, 47 C.F.R.  32.27, 53.209, 53.211, and 53.213 ARE AMENDED as set forth in Appendix B. 286. IT IS FURTHER ORDERED that the requirements and regulations established in this decision shall become effective upon approval by OMB of the new information collection requirements adopted herein, but no sooner than thirty days after publication in the Federal Register. FEDERAL COMMUNICATIONS COMMISSION William F. Caton Acting Secretary Appendix A List of Commenters in CC Docket No. 96-150 AT&T Corp. ("AT&T") Alarm Industry Communications Committee ("AICC") American Public Communications Council ("APCC") Ameritech Operating Companies ("Ameritech") Association of Telemessaging Services International ("ASTI") Bell Communications Research, Inc. ("Bellcore") Bell Atlantic Telephone Companies ("Bell Atlantic") BellSouth Corporation and BellSouth Telecommunications, Inc. ("BellSouth") Cincinnati Bell Telephone Company ("Cincinnati Bell") Competitive Telecommunications Association ("CTA") Florida Public Service Commission ("Florida PSC") GTE Service Corporation and its affiliated domestic telephone operating, long distance and wireless companies ("GTE") General Services Administration ("GSA") Kiesling Associates LLP ("Kiesling") LDDS Worldcom ("Worldcom") MCI Telecommunications Corporation ("MCI") Missouri Public Service Commission ("Missouri PSC") NYNEX Telephone Companies ("NYNEX") National Association of Regulatory Utility Commissioners ("NARUC") National Newspaper Association ("NNA") New York State Department of Public Service ("NYDPS") Newspaper Association of America ("NAA") Pacific Telesis Group ("PacTel") People of State of California & Public Utilities Commission of the State of California ("California") Public Service Commission of Wisconsin ("Wisconsin PSC") Puerto Rico Telephone Company ("Puerto Rico Telephone") SBC Communications Inc. ("SBC") Sprint Corporation ("Sprint") Telecommunications Resellers Association ("TRA") U S West, Inc. ("US West") United State Telephone Association ("USTA") Voice Tel ("Voice-Tel") Yellow Pages Publishers Association ("YPPA") List of Reply Commenters in CC Docket No. 96-150 AT&T Corp. ("AT&T") American Public Communications Council ("APCC") Ameritech Operating Companies ("Ameritech") Bell Atlantic Telephone Companies ("Bell Atlantic") BellSouth Corporation and BellSouth telecommunications, Inc. ("BellSouth") Economic Strategy Institute ("ESI") Florida Public Service Commission ("Florida PSC") GTE Service Corporation and its affiliated domestic telephone operating, long distance and wireless companies ("GTE") General Services Administration ("GSA") LDDS Worldcom ("Worldcom") MCI Telecommunications Corporation ("MCI") Missouri Public Service Commission ("Missouri PSC") Newspaper Association of America ("NAA") NYNEX Telephone Companies ("NYNEX") Pacific Telesis Group ("PacTel") Public Utilities Commission of Ohio ("Ohio") RBOC Payphone Coalition ("Coalition") SBC Communications Inc. ("SBC") Sprint Corporation ("Sprint") Telecommunications Industry Association ("TIA") US West, Inc. ("US West") United States Telephone Association ("USTA") Washington Utilities and Transportation Commission ("Washington") Appendix B Final Rules AMENDMENTS TO THE CODE OF FEDERAL REGULATIONS 1. Part 32 of Title 47 of the Code of Federal Regulations (C.F.R.) is amended to read as follows: PART 32 -- UNIFORM SYSTEM OF ACCOUNTS FOR TELECOMMUNICATIONS COMPANIES Subpart B - General Instructions  32.27Transactions with affiliates. ** *** (b) Assets sold or transferred between a carrier and its affiliate pursuant to a tariff, including a tariff filed with a state commission, shall be recorded in the appropriate revenue accounts at the tariffed rate. Non-tariffed assets sold or transferred between a carrier and its affiliate that qualify for prevailing price valuation, as defined in part (d) below, shall be recorded at the prevailing price. For all other assets sold by or transferred from a carrier to its affiliate, the assets shall be recorded at the higher of fair market value and net book cost. For all other assets purchased by or transferred to a carrier from its affiliate, the assets shall be recorded at the lower of fair market value and net book cost. For purposes of this section carriers are required to make a good faith determination of fair market value. (c) Services provided between a carrier and its affiliate pursuant to a tariff, including a tariff filed with a state commission, shall be recorded in the appropriate revenue accounts at the tariffed rate. Non-tariffed services provided between a carrier and its affiliate pursuant to publicly-filed agreements submitted to a state commission pursuant to section 252(e) of the Communications Act of 1934 or statements of generally available terms pursuant to section 252(f) shall be recorded using the charges appearing in such publicly-filed agreements or statements. Non-tariffed services provided between a carrier and its affiliate that qualify for prevailing price valuation, as defined in part (d) below, shall be recorded at the prevailing price. For all other services provided by a carrier to its affiliate, the services shall be recorded at the higher of fair market value and fully distributed cost. For all other services received by a carrier from its affiliate, the service shall be recorded at the lower of fair market value and fully distributed cost, except that services received by a carrier from its affiliate that exists solely to provide services to members of the carrier's corporate family shall be recorded at fully distributed cost. For purposes of this section carriers are required to make a good faith determination of fair market value. (d) In order to qualify for prevailing price valuation in sections (b) and (c) of this rule, sales of a particular asset or service to third parties must encompass greater than 50 percent of the total quantity of such product or service sold by an entity. Carriers shall apply this 50 percent threshold on a asset-by-asset and service-by-service basis, rather than on a product line or service line basis. In the case of transactions for assets and services subject to section 272, a BOC may record such transactions at prevailing price regardless of whether the 50 percent threshold has been satisfied. ***** 2.Part 53 of Title 47 of the C.F.R. is added to read as follows: PART 53 -- SPECIAL PROVISIONS CONCERNING BELL OPERATING COMPANIES Subpart C - Separate Affiliate; Safeguards.  53.209Biennial audit (a) A Bell operating company required to operate a separate affiliate under section 272 of the Act shall obtain and pay for a Federal/State joint audit every two years conducted by an independent auditor to determine whether the Bell operating company has complied with the rules promulgated under section 272 and particularly the audit requirements listed in paragraph (b) of this section. (b) The independent audit shall determine: (1) Whether the separate affiliate required under section 272 of the Act has: (i) Operated independently of the Bell operating company; (ii) Maintained books, records, and accounts in the manner prescribed by the Commission that are separate from the books, records and accounts maintained by the Bell operating company; (iii) Officers, directors and employees that are separate from those of the Bell operating company; (iv) Not obtained credit under any arrangement that would permit a creditor, upon default, to have recourse to the assets of the Bell operating company; and (v) Conducted all transactions with the Bell operating company on an arm's length basis with the transactions reduced to writing and available for public inspection, (2) Whether or not the Bell operating company has: (i) Discriminated between the separate affiliate and any other entity in the provision or procurement of goods, services, facilities, and information, or the establishment of standards; (ii) Accounted for all transactions with the separate affiliate in accordance with the accounting principles and rules approved by the Commission. (3) Whether or not the Bell operating company and an affiliate subject to section 251(c) of the Act: (i) Have fulfilled requests from unaffiliated entities for telephone exchange service and exchange access within a period no longer than the period in which it provides such telephone exchange service and exchange access to itself or its affiliates; (ii) Have made available facilities, services, or information concerning its provision of exchange access to other providers of interLATA services on the same terms and conditions as it has to its affiliate required under section 272 that operates in the same market; (iii) Have charged its separate affiliate under section 272, or imputed to itself (if using the access for its provision of its own services), an amount for access to its telephone exchange service and exchange access that is no less than the amount charged to any unaffiliated interexchange carriers for such service; and (iv) Have provided any interLATA or intraLATA facilities or services to its interLATA affiliate and made available such services or facilities to all carriers at the same rates and on the same terms and conditions, and allocated the associated costs appropriately. (c) An independent audit shall be performed on the first full year of operations of the separate affiliate required under section 272 of the Act, and biennially thereafter. (d) The Chief, Common Carrier Bureau, shall work with the regulatory agencies in the states having jurisdiction over the Bell operating company's local telephone services, to attempt to form a Federal/State joint audit team with the responsibility for overseeing the planning of the audit as specified in section 53.211 and the analysis and evaluation of the audit as specified in section 53.213. The Federal/State joint audit team may direct the independent auditor to take any actions necessary to ensure compliance with the audit requirements listed in paragraph (b) of this section. If the state regulatory agencies having jurisdiction choose not to participate in the Federal/State joint audit team, the Chief, Common Carrier Bureau, shall establish an FCC audit team to oversee and direct the independent auditor to take any actions necessary to ensure compliance with the audit requirements in paragraph (b) of this section.  53.211Audit planning. (a) Before selecting a independent auditor, the Bell operating company shall submit preliminary audit requirements, including the proposed scope of the audit and the extent of compliance and substantive testing, to the Federal/State joint audit team organized pursuant to section 53.209(d); (b) The Federal/State joint audit team shall review the preliminary audit requirements to determine whether it is adequate to meet the audit requirements in paragraph (b) of section 53.209. The Federal/State joint audit shall have 30 days to review the audit requirements and determine any modifications that shall be incorporated into the final audit requirements. (c) After the audit requirements has been approved by the Federal/State joint audit team, the Bell operating company shall engage within 30 days an independent auditor to conduct the biennial audit. In making its selection, the Bell operating company shall not engage any independent auditor who has been instrumental during the past two years in designing any of the accounting or reporting systems under review in the biennial audit. (d) The independent auditor selected by the Bell operating company to conduct the audit shall develop a detailed audit program based on the final audit requirements and submit it to the Federal/State joint audit team. The Federal/State joint audit team shall have 30 days to review the audit program and determine any modifications that shall be incorporated into the final audit program. (e) During the course of the biennial audit, the independent auditor, among other things, shall: (1) Inform the Federal/State joint audit team of any revisions to the final audit program or to the scope of the audit. (2) Notify the Federal/State joint audit team of any meetings with the Bell operating company or its separate affiliate in which audit findings are discussed. (3) Submit to the Chief, Common Carrier Bureau, any accounting or rule interpretations necessary to complete the audit.  53.213Audit analysis and evaluation. (a) Within 60 dates after the end of the audit period, but prior to discussing the audit findings with the Bell operating company or the separate affiliate, the independent auditor shall submit a draft of the audit report to the Federal/State joint audit team. (1) The Federal/State joint audit team shall have 45 days to review the audit findings and audit workpapers, and offer its recommendations concerning the conduct of the audit or the audit findings to the independent auditor. Exceptions of the Federal/State joint audit team to the finding and conclusions of the independent auditor that remain unresolved shall be included in the final audit report. (2) Within 15 days after receiving the Federal/State joint audit team's recommendations and making appropriate revisions to the audit report, the independent auditor shall submit the audit report to the Bell operating company for its response to the audit findings and send a copy to the Federal/State joint audit team. The independent auditor may request additional time to perform additional audit work as recommended by the Federal/State joint audit team. (b) Within 30 days after receiving the audit report, the Bell operating company will respond to the audit findings and send a copy of its response to the Federal/State joint audit team. The Bell operating company's response shall be included as part of the final audit report along with any reply that the independent auditor wishes to make to the response. (c) Within 10 days after receiving the response of the Bell operating company, the independent auditor shall make available for public inspection the final audit report by filing it with the Commission and the state regulatory agencies participating on the joint audit team. (d) Interested parties may file comments with the Commission within 60 days after the audit report is made available for public inspection.