U.S. Court of Appeals Vacates and Remands FCC Order Concerning Reciprocal Compensation for ISP-Bound Traffic

On March 24, 2000, the United States Court of Appeals for the District of Columbia Circuit (the “Court”) vacated and remanded the Federal Communication Commission’s order (“FCC Order”) concerning reciprocal compensation for Internet service provider (“ISP”)-bound traffic. This decision, as well as the ruling that the Federal Communications Commission (the “FCC” or “Commission”) will render upon remand, will have a significant impact upon local exchange carriers, other telecommunications carriers, ISPs and other enhanced services providers.

Under FCC regulations, for local telecommunications traffic the local exchange carrier (“LEC”) whose customer originates a call must pay reciprocal compensation to the local exchange carrier whose customer receives the call. In the FCC Order, the Commission concluded that telephone calls to ISPs were generally interstate, rather than local, and thus reciprocal compensation for such calls was not necessary unless an agreement between the parties or a state commission ruling required the payment of reciprocal compensation. The FCC reasoned that in considering whether a call is local or interstate, the entire path of the call must be considered (the end-to-end approach), and calls to ISPs extend beyond the ISP to websites out-of-state and around the world.

The Court vacated the FCC Order in part because the Commission failed to adequately explain why its end-to-end approach is the correct approach for ISP-bound traffic. The Court held that the FCC’s reliance on its decisions that the end-to-end approach is proper with regard to circuit-switched traffic is insufficient given the differences between circuit-switched traffic and ISP-bound traffic, the latter of which travels over a packet-switched network. Unlike the conventional circuit-switched network, which uses a single end-to-end path for each transmission, in a single session an Internet user may communicate with multiple destination points, either sequentially or simultaneously, making it far less clear where the termination point of the communication lies. The Court also found that the FCC’s definition of “termination” in its regulations, namely “the switching of traffic . . . at the terminating carrier's end office switch (or equivalent facility) and delivery of that traffic from that switch to the called party's premises,” appears to suggest that calls made to ISPs “terminate” at the ISP, and therefore would be local calls. The Court further stated that the FCC Order appeared to contradict earlier Commission rulings in which the FCC found that enhanced service providers, of which ISPs are a subclass, are not subject to access charges. The Court noted that in arguing this position before the United States Court of Appeals for the Eighth Circuit in a proceeding regarding access charges, the Commission (i) referred to calls to ISPs as local; and (ii) stated that a call to an ISP is like a call to a local business (i.e. a local call) and not like a call to a long distance carrier (i.e. an interstate call). In sum, the Court concluded that the FCC had not adequately explained its reasoning for applying its endtoend approach to ISP-bound traffic when such an approach appears to be inconsistent with both regulation and precedent.

The Court also vacated the FCC Order because the Commission did not adequately respond to an argument from MCI WorldCom regarding whether ISP-bound traffic is “telephone exchange service” or “exchange access.” The FCC acknowledged that under the Telecommunications Act of 1996 ISP-bound traffic must be classified as either “telephone exchange service” (which is subject to reciprocal compensation) or “access service”. MCI WorldCom argued that such traffic cannot possibly be exchange access (because ISPs do not assess toll charges for the service), and therefore such traffic must be telephone exchange service, for which reciprocal compensation is mandated. In response to this argument, the Commission in the FCC Order stated that it consistently has characterized enhanced service providers as "users of access service but has treated them as end users for pricing purposes.” The Court found that since ISP-bound traffic must be either “telephone exchange service” or “exchange access,” the FCC’s reference to such traffic as “access service,” effectively combining the different key words from the two terms, was ambiguous and was not a satisfactory response to MCI WorldCom’s argument.

In light of the Court’s decision, there is continued uncertainty regarding under what circumstances ISP-bound traffic requires a payment of reciprocal compensation. This issue will be addressed by the Commission on remand. The Commission’s ruling on remand will not only affect local exchange carriers, but it will also affect other telecommunications carriers who provide transport services for ISPs because whether such services will be considered to be interstate or intrastate may be impacted by the Commission’s decision. ISPs and other enhanced services providers will be affected by the Commission’s decision as well. If the ISP-bound traffic is considered local, the current reciprocal compensation scheme will continue. If not, the new method for determining compensation could ultimately affect how ISPs and other enhanced service providers are charged by LECs.