Net Neutrality, Investment & “Title II”: Almost All that You Heard Is Not True.

Excerpt: Verizon NY 2017 Financial Annual Report, Published June 2018

Verizon New York 2017 Annual Report Excerpt
  • Ever hear of the 75%-25% rule for network “investment” expenses? 75% of the construction budgets are being paid by “Local Service” (state-based services) while only 25% are billed to services classified as “interstate”.
  • Did you know that the fiber optic wires for FiOS broadband and much of the fiber optic wires for Verizon’s Wireless services are using the construction (investment) budgets of the state utilities and this was done claiming that these networks are Title II (and the services are classified as ‘interstate’)?
  • Did you know that the FCC’s accounting rules that are used to allocate expenses of the different lines of business using the state-based utility infrastructure were set to reflect the year 2000 and this makes the majority of expenses (and investment) end up being charged to Local Service — and used for rate increases of Local Service?
  • Did you know that these same rules have inflated the profits of these other services, so that America pays some of the highest wireless prices per-gig, among other harms?
  • Did you know that 5G Wireless requires a fiber optic wire every 1–2 blocks, and ‘in-region’ this appears to be coming out of the wireline utility budgets.

While the oral arguments are being made about the fate of Net Neutrality, one thing is abundantly clear — all of the statistics about investments in America’s networks for broadband being presented on either side of the aisle are fundamentally wrong — no one actually details that the majority of this ‘investment’ are the construction expenditures that are part of the state utilities. More importantly, these seat-of-the-pants analyses by the Free State Foundation, Information Technology & Innovation Foundation (ITIF), Hal Singer, the Georgetown Center for Business and Public Policy, Phoenix Center and others stretch the data to make their point, then the FCC selects what they think is best to tilt public policy towards AT&T et al. While they sound plausible, it is all make-believe.

And virtually no one; not the experts, pundits or even the FCC, has ever acknowledged that there are still state telecommunications utilities, much less have examined the financial reports. This is not surprising as the FCC stopped publishing the basic financial state data in 2007 and except for NY, no other state we could find is still publishing basic financial reports.

Follow the Money: Follow the Numbers

Let’s go through some shocking financials. The excerpt above is taken directly from the Verizon NY 2017 Annual Report, published in June 2018, which is the primary state-based telecommunications utility in New York State.

However, we know that the Verizon New York financials have the same characteristics as every other state utility because they were based on federal FCC accounting rules, and they all matched in 2007.

Hiding Billions in Financial Cross-Subsidies (Rounding used for simplicity.)

1) Verizon New York had revenues of almost $5 billion in 2017.

2) Verizon New York’s Local Service category had almost $1.1 billion, which are mainly the revenues from basic copper phone lines. (NOTE: This is not the total revenues from the copper-based lines of Verizon in NY State.)

3) Local Service is paying $1.2 billion in construction and maintenance expenses — (commonly called “Plant” and “Non-specific Plant”) and it is paying the majority as compared to the other categories, such as “Access” services and the “Nonregulated” services.

4) “Access” services were almost $2.4 billion in revenue in 2017 and this includes almost $2 billion in “Business Data Services”. These are also called “backhaul” networks and are used by the wireless companies.

5) “Nonregulated” category includes FiOS video and “VOIP” and other nonregulated, deregulated or never-regulated services.

§ Local Service revenues are from the the copper-based basic phone lines and in other documents we find that it spent an estimated $100 -$125 million in construction in 2017.

§ This means that $1.1 billion has been cross-subsidized to fund other lines of business. And this investment is not paid by investors but through excess charges on phone rates.

6) Note that Local Service was also charged a whopping $1.8 billion in something called “Corporate Operations” expense, paying for the corporate jets and executive pay as well as lobbyists, lawyers, and even golf tournaments.

7) This made the Local Service category unprofitable, with $2.9 billion in losses, and a large part was from these two expenses, Construction and Corporate Operations.

8) This made Verizon New York, the entire utility, appear unprofitable, with $2.6 billion in losses.

Question: Why is Local Service Paying this Excess in Construction and Corporate Operations Expenses?

Answer:

  • The FCC Cost Accounting Rules Created These Cross-Subsidies. There is a massive financial shell game here. The FCC’s cost accounting rules are now set to put the majority of all of expenses into Local Service because the FCC’s rules are ‘frozen’ to the year 2000 and were never changed. And if you want perversity, in December 2018 the FCC extended this ‘freeze’ for 6 more years.
  • I.e.; these rules divide up the expenses to be paid by these different lines of business. And this was set to reflect the year 2000 when Local Service was 65% of revenues and paid 65% of expenses; now it is 22% and still paid 62% of the Corporate Operations expense — $1.8 billion, in just Verizon NY, in just 2017.
  • At the core, this manipulation of the accounting rules allowed for the cross-subsidizing all of the other lines of business that have been declared “interstate”.
  • 75%-25% Rule. But that is not even close to being the most perverse part. The construction costs have been allocated to Local Service based on an additional accounting rule: the 75%-25% rule. I.e., Seventy-Five percent of the construction, conduit, etc., costs are charged to Local Service; 25% to the ‘interstate’ services.

This rule means that the other lines of business, like Access, are paying a fraction of the construction expenses.

9) Local Service is paying $1.2 billion in construction, while the Access services are paying only $600 million, but it has double+ the revenues, (but there are other parts of the report that supply more details).

  • Based on these financials, the Local Service basic phone lines had multiple rate increases that were, as we can see, artificially created.

Five Other Points

10) These Construction Budgets Were for FiOS and the Wires to the Cell Sites.

It would appear that the wireless company was cross-subsidized by this extra $1.1 billion in construction that was placed into Verizon New York Local Service in 2017.

Fran Shammo, Verizon’s former Chief Financial Officer stated to investor representatives that the wireline construction budgets have been diverted to charge regulated wireline budgets for the less regulated wireless affiliate’s construction needs.

“The fact of the matter is Wireline capital — and I won’t get the number but it’s pretty substantial — is being spent on the Wireline side of the house to support the Wireless growth. So the IP backbone, the data transmission, fiber to the cell that is all on the Wireline books but it’s all being built for the Wireless Company.”

11) The Fiber Optic Networks are Part of the State Utility and are Title II.

This is from a Verizon New York FiOS franchise. It specifically states that the “FTTP”, “Fiber-to-the Premises”, is Title II.

Not one lawyer for either side bothered to mention this fact. Verizon has been talking out of both-sides of their mouth when they claim that Title II harmed investment. It is the investment.

12) Then Comes the Timeline of Net Neutrality and Title II.

The FCC’s Net Neutrality decision states that broadband capital investment increased from 2009–2014, and it was only when “Title II” was applied, in 2015, that there was a drop.

“We first look to broadband investment in the aggregate and find that it has decreased since the adoption of the Title II Order. ISP capital investment increased each year from the end of the recession in 2009 until 2014, when it peaked. In 2015, capital investment by broadband providers appears to have declined for the first time since the end of the recession in 2009.” (Emphasis added.)

This is the Verizon New Jersey construction expenditures by year, 1993–2014. It would appear that the time-frame mentioned by the FCC is just made up as it has no resemblance to this state-based utility — which is the majority of Verizon investment in the Garden State. Going through each state, had the FCC bothered to collect the data, it would have contradicted their — Let’s wing it and pick data that we can use for our argument — — Title II bad — Net Neutrality bad,’ stance.

According to an op-ed by the Phoenix Center in Bloomberg Law, Free Press, Hal Singer, ITIF, Free State Foundation, and Georgetown, all have investment theories, attempting to tie it to the application of Title II, which supposedly harmed investment — or didn’t.

But How to Measure the Effect of a Regulation on Investment?
“Most of the debate in the record revolves around competing calculations from Free Press (which purport to show that investment rose post-reclassification) and economist Hal Singer (which purport to show that investment fell post-reclassification), both of which offer simplistic comparisons of capital expenditures by major Broadband Service Providers in the few years before and after the 2015 reclassification decision.
“The FCC was unimpressed by such comparisons, and for good reason. As the commission recognized, simple comparisons of capital spending trends “can only be regarded as suggestive, since they fail to control for other factors that may affect investment ….” For this reason, the commission also relegated to the “suggestive” bin the bulk of the record evidence on investment effects, including works by the Information Technology & Innovation Foundation (ITIF), the Georgetown Center for Business and Public Policy, the Free State Foundation, among others.”

Phoenix Center claims its approach is different because it is “counterfactual”.

“Thus rejecting simplistic comparisons of capital expenditures made by both sides of the dispute, the FCC instead properly focused on the “counterfactual” — that is, what would investment had been “but for” reclassification?”

Counter-factual in this case means counter to basic facts.

13) Structural Flaw in Every FCC Proceeding.

Net Neutrality is a popular meme but at the core, Net Neutrality still leaves a broken mess. The FCC’s entire analyses all leave out the primary issue –the FCC ignored all state-based — everything. The FCC never acknowledges that there is a state utility, that the utility is the primary source of investment for broadband and that local customers have become the primary defacto investor due to expenses being placed into the state utility by the FCC’s accounting rules.

Net Neutrality doesn’t stop the cross-subsidies, the harvesting of local phone customers, the failed broadband deployments that were supposed to show up or most importantly, the vertical integration of the services and the conduit; all of the company’s networks and services, wireline and wireless, are tied together to be keep more control, block competitors, and make it easier to track you and then sell the data.

14) Zombie Rules: The FCC Cost Accounting Rules and Forbearance Decisions.

The FCC will claim that the FCC cost accounting rules have been “forborne”, meaning still in place but no longer required. And over the last 2 years the FCC has had multiple proceedings to make sure that they erase anything left standing, including the latest, which was just decided to keep the ‘freeze’ for an additional 6 years.

They referred to this as “weed whacking”.

Yet, the FCC took these actions without any audits or examination of the impacts the rules had for 19 years already, so it can’t say a word about the harms caused or how the Verizon NY financial books ended up showing the massive cross-subsidies — based on the rules.

Moreover,

  • The FCC’s rules are still in use. In New York they were used by the NY Public Service Commission in the investigation of Verizon New York and settlement which occurred in July 2018.
  • No state we can find removed or changed their accounting, which means every state is still using the rules.
  • The impacts from these rules that are still in use were rate increases and claims of ‘losses’ in multiple states.

We called this “Zombie rules”, because, like the Walking Dead, they may be dead but they still harm us.

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Last year we wrote a report on the FCC’s structural flaw and Net Neutrality issues. New reports are coming in February 2019.

  • REPORT: Solving Net Neutrality: There is a Fatal Structural Flaw in All FCC Proceedings.