Verizon Pennsylvania, Inc. v. Pennsylvania Public Utility Commission (380 F. Supp. 2d 627, 2005)

MEMORANDUM & ORDER

KATZ, Senior District Judge.

Plaintiff Verizon Pennsylvania, Inc. (“Verizon”) brings this claim against the Pennsylvania Public Utility Commission (“PUC”) and its individual officers challenging the PUC’s Order setting the rates that Verizon must charge competitors for access to components of its local telephone network. MCIMetro Access Transmission Services, LLC (“MCI”) and AT & T Communications of Pennsylvania, LLC (“AT & T”), two such competing carriers who currently lease local network components from Verizon, intervened as Defendants, Counter-Claimants, and Cross-Claimants.

Verizon alleges that the PUC’s Order, which represents the commission’s third attempt to establish rates for these unbundled network elements (“UNEs”) that comport with the requirements of the Telecommunications Act of 1996, 47 U.S.C. § 251 et seq., sets rates that are illegal, unsupported by substantial .record evidence, and confiscatory. The PUC, however, maintains that the rates comply with the Act and are supported by record evidence. For its part, MCI argues that many of the commission’s determinations must be reversed both because the PUC improperly based UNE rates on Verizon’s actual or overstated costs and because it failed to support its conclusions with substantial record evidence. The parties have filed motions for summary judgment, all of which are presently before the court. For the reasons set forth below, the court will affirm the rates set by the PUC.

7. Background

A. Statutory and Regulatory Framework

Congress passed the Telecommunications Act of 1996 with the objective that “local service, which was previously operated as a monopoly overseen by the several states, be opened to competition according to standards established by federal law.” MCI Telecomm. Corp., 271 F.3d at 497. Characterized as an “extraordinary” piece of legislation, the Act sought not merely to balance interests between sellers and buyers, but to meaningfully reorganize utilities markets by rendering monopolies vulnerable to competition. Verizon Communications, Inc. v. F.C.C., 535 U.S. 467, 488-89, 122 S.Ct. 1646, 152 L.Ed.2d 701 (2002). See also AT & T Corp. v. Iowa Utils. Bd., 525 U.S. 366, 371, 119 S.Ct. 721, 142 L.Ed.2d 835 (1999) (characterizing the Act as ending the long-standing regime of state-sponsored monopolies by fundamentally restructuring local telephone markets). In order to accomplish this goal of fostering competition, the 1996 Act imposes a series of affirmative duties upon incumbent local exchange carriers (“ILECs”), the “foremost” of which is to share their networks with competing local exchange carriers (“CLECs”). Iowa Utils. Bd., 525 U.S. at 371, 119 S.Ct. 721.

In particular, the Act requires ILECs to lease certain components of their local networks to CLECs on an unbundled basis. 47 U.S.C. § 251(c)(3). • In fulfilling this obligation, incumbent carriers must charge rates for UNEs that are “just, reasonable, and nondiscriminatory.” Id. In addition; the rates must be “based on the cost (determined without reference to a rate-of-return or other rate-based proceeding) of providing the interconnection, or network element.” 47 U.S.C. § 252(d)(1)(A). See also Verizon Communications, Inc., 535 U.S. at 467, 122 S.Ct. 1646 (explaining that Congress’ novel, rate-setting mandate stood in stark contrast to the familiar public utility model of rate-of-return rate-setting and was set forth in order to give aspiring competitors “every possible incentive to enter local retail telephone markets, short of confiscating the incumbents’ property”).

Congress directed the FCC to promulgate regulations implementing the substantive requirements of the Act, and the commission responded by issuing an Order, which set forth, among other things, the methodology that state commissions must use in setting UNE rates. 47 U.S.C. § 251(d)(1); In re Implementation of the Local Competition Provisions in the Telecommunications Act of 1996, 1996 WL 452885, 11 F.C.C.R. 15499 (1996) (“Local Competition Order”). This methodology, known as the total element long run incremental cost (“TELRIC”) methodology, measures the forward-looking, economic costs of providing a network element because those costs best replicate the conditions of a competitive market. Local Competition Order at ¶ 679. See also Bell Atl.-Del., Inc. v. McMahon, 80 F.Supp.2d 218, 237 (D.Del.2000) (“[C]osts calculated according to the TELRIC methodology mimic those costs that an efficient company, constrained by competitive market forces, would incur in providing the requested network element.”). Thus, rather than determining costs based on an ILEC’s actual or embedded costs — which reflect past inefficiencies, older technologies, and outdated operating practices — TELRIC rates are based upon long-run costs in light of “the use of the most efficient telecommunications technology currently available and the lowest cost network configuration, given the existing location of the incumbent LEC’s wire centers.” 47 C.F.R. §§ 51.505(b)(1), (d)(1).

The FCC has explained that adherence to the TELRIC methodology is critical to achieving the goals behind the 1996 Act because, without it, CLECs’ costs of providing local service would be greater than those of incumbents, allowing the established monopolies to remain in place and effectively eliminating any chance for meaningful competition. Local Competition Order at ¶¶ 662-706. Two features of TELRIC are most significant in this regard.

First, TELRIC measures costs in the long run, a time frame lengthy enough to allow all of an incumbent’s costs to become variable and, thus, to allow all embedded costs to drop out. Id. at ¶ 677. Second, TELRIC is based not on an ILEC’s actual network but instead on a hypothetical network that uses the least cost technology and most efficient design currently available, given the existing location of the ILECs’ wire centers. Id. at ¶ 685; Verizon Communications, Inc., 535 U.S. at 522, 122 S.Ct. 1646. Despite these technical features, however, TELRIC is not a specific, mathematical formula but rather a framework of methodological principles that states retain flexibility to use in conjunction with local technological, environmental, regulatory, and economic conditions in order to arrive at forward-looking rates that are both just and reasonable. AT&T Corp. v. F.C.C., 220 F.3d 607, 615 (D.C.Cir.2000). See also AT&T Communications of Ill., Inc. v. Ill. Bell Tel. Co., 349 F.3d 402, 405 (7th Cir.2003) (explaining that TELRIC is a “framework rather than a formula” and that there is “considerable play in the joints”).

B. Factual and Procedural History

This case arises from a long-standing dispute between Verizon, the incumbent carrier in the Pennsylvania local telephone market, and CLECs MCI and AT & T over the rates at which Verizon is legally obligated to lease its network elements to the competitors. The PUC has thrice attempted to set these rates, and it is the commission’s third and most recent rate-setting Order that is presently before the court.

Shortly after the passage of the 1996 Act and subsequent to various phases of negotiation and arbitration, Verizon and MCI reached an interconnection agreement and submitted it to the PUC for review and approval. The commission conducted rate-setting proceedings, known as “MFS-III”, and issued its Final Order on August 7, 1997. Therein, it directed that the rates established during the proceedings — which were based on a cost model submitted by Verizon — be incorporated into the existing agreement. MCI filed suit in the Middle District of Pennsylvania to challenge those rates as incompatible with the TELRIC methodology, and, in an unpublished opinion, that court agreed. The Middle District reached the merits only after finding that the PUC was not entitled to Eleventh Amendment immunity.

Following MFS-III, the PUC initiated a second round of rate-setting proceedings, known as the “Global Proceedings,” which resulted in the commission’s 1999 Global Order. This time, it was Verizon which filed suit to challenge the new rates as inconsistent with the 1996 Act. On review, this court found that the Eleventh Amendment was not a bar to suit but certified the question for appeal and declined to reach the dispute’s merits. Bell Atl.-Pa. v. Pa. Pub. Util. Comm’n, 107 F.Supp.2d 653 (E.D.Pa.2000). The Third Circuit then handed down companion opinions in the two cases, affirming the twin Eleventh Amendment rulings but reversing in part the Middle District opinion regarding TELRIC based on its finding that the trial court did not properly analyze the substance of the PUC’s cost model in light of the 1996 Act. MCI Telecomm. Corp., 271 F.3d at 522-23. It then consolidated the two cases and remanded them to this court for consideration on the merits.

Approximately three months before the Court of Appeals rendered its companion decisions, the PUC began its third generation UNE rate-setting proceeding, known as the “Generic Investigation,” and it issued its Final Order in that proceeding on December 11, 2003. Therein, the PUC made final decisions on all of the disputed input and modeling issues that were concurrently before this court. It also directed Verizon to make a compliance filing recalculating the rates based on the final order and offered the parties the opportunity to submit limited comments on that filing.

Eight days later, on December 19, 2003, this court held a hearing and, over the objection of MCI, issued an Order dismissing the consolidated cases as moot. The court agreed with the arguments of both Verizon and the PUC that the commission had already granted the relief sought by the competitors by reviewing the Global Order rates and issuing a Final Order that would change those rates upon compliance therewith.

On July 16, 2004, the PUC issued its final Compliance Order in the Generic Investigation. This Order both resolved the issues raised by the parties’ comments to the compliance filing and attached a new schedule of UNE rates that would become effective after Verizon filed a tariff revision, which it was directed to do by August 2, 2004. Verizon complied and began charging the new rates — as directed by the July 16 Order — on October 1 on that same year.

II. Discussion

A. Standard of Review

This court exercises de novo review over whether the PUC’s pricing determinations are consistent, as a matter of law, with the 1996 Act and binding FCC regulations. MCI Telecomm. Corp., 271 F.3d at 516-17 (explaining that federal courts owe no deference to the legal determinations of state commissions).

By contrast, the PUC’s factual findings are subject only to substantial evidence review. Id. Under this more deferential standard, a reviewing court must affirm a state commission’s factual findings if they have “substantial support in the record as a whole.” Id. See also GTE S., Inc. v. Morrison, 199 F.3d 733, 745-46 (4th Cir.1999) (holding that the court does not “sit as a super public utilities commission” and that where a decision is supported by the record, “a court is not free to substitute its judgment for the agency’s”). Essentially the same as the “arbitrary and capricious” standard, the substantial evidence standard is “the least demanding form of judicial review of administrative action” and requires only that an agency offer a reasoned explanation based on the record evidence for a particular outcome. Mich. Bell Tel. Co. v. Strand, 305 F.3d 580, 587 (6th Cir.2002); MCI Telecomm. Corp., 271 F.3d at 515.

B. Recurring Cost Model

The court will first consider MCI’s claim that the PUC’s adoption of Verizon’s recurring cost model violated TELRIC because that model was illegally based on the incumbent’s embedded network. The competitor asserts that even though the PUC made various adjustments to Verizon’s model for the specific purpose of bringing it into compliance with federal regulations, no amount of modification could cure the model’s inherent infirmities. This court disagrees. The commission’s decision was consistent with federal law and is, therefore, affirmed.

Recurring costs are those costs that an incumbent incurs on a monthly basis when leasing UNEs to competitors. As with other types of costs, they must conform to the FCC’s TELRIC methodology; that is, they must reflect the forward looking costs that an efficient carrier would incur using the least cost network configuration. 47 C.F.R.- §§ 51.505(b)(1), (d)(1). During the Generic Investigation, both sides presented recurring cost models to the PUC. Because the commission found flaws with each submission, it ultimately chose a compromise solution by adopting Verizon’s model but adjusting it in several respects with forward-looking modifications in order to bring it into compliance with TEL-RIC. Final Order at 22, Sealed Joint Appendix (“SJA”) at 279.

Although the PUC agreed with MCI’s initial argument that Verizon’s model did not comport with the FCC’s methodology because it was based upon the incumbent’s embedded network, the commission concluded that the extensive modifications eliminated the model’s inefficiencies and produced rates within the TELRIC range. Id. It explained that its choice was aided by the fact that it had significant reservations about using MCI’s model. Id. (noting that it was particularly concerned with the MCI model’s apparent inability to calculate costs for advanced services, which are expected to form an important part of the network in the long run).

MCI now submits to this court that despite the adjustments, the PUC’s adoption of Verizon’s model should be overturned because any model that is based on the incumbent’s actual — as opposed to a hypothetical — network, even as a starting point, cannot possibly be modified to become TELRIC-compliant. The competitor, however, cites to no authority in support of this extreme position, and this court can find none. To the contrary, TELRIC does not mandate that state commissions rigidly apply a formula. Instead, it simply provides them with a methodology for establishing just and reasonable rates that approximate what it would cost a perfectly efficient incumbent carrier — given the actual location of that carrier’s existing wire centers — to supply UNEs to competitors in a perfectly competitive market. Local Competition Order at ¶ 679. As such, TELRIC is a “framework rather than a formula,” and there is “considerable play in the joints.” AT&T Communications of Ill., Inc., 349 F.3d at 405.

In light of these principles, it seems clear that TELRIC would not be violated by a cost model that was adjusted to eliminate embedded inefficiencies even though, at the outset, it was based in part on pieces of the incumbent’s existing network. This is especially true in light of the fact that the only other option was a model that clearly violated federal regulations by being based exclusively and uncompromisingly on existing infrastructure. Although the model adopted by the PUC started with pieces of Verizon’s existing network, the commission concluded that these adjusted inputs — based upon least cost technology and efficient network design — modified that starting point in such a way as to eliminate embedded inefficiencies and produce costs consistent with those that an efficient carrier would incur in the future. Final Order at 22, SJA 279. The elimination of inefficiencies is the driving purpose behind the FCC regulations. Even though the PUC employed some creativity to explore TELRIC’s capacity for flexibility, it ultimately constructed a model that was entirely consistent with that underlying purpose.

The PUC’s extensive modification of the Verizon model is highlighted by the following forward-looking adjustments: (1) reducing Verizon’s proposed cost of capital from 12.95% to 12.37%; (2) adopting FCC prescribed depreciation lives instead of Verizon’s proposed, shorter lives; (3) rejecting Verizon’s forward looking conversion factor; (4) adopting an 85.5% switch discount rate, which was higher than that submitted by Verizon; and (5) directing Verizon to recalculate its rates for port features. Based on the effectiveness of these adjustments, the court rejects MCI’s argument and concludes that TELRIC was satisfied. Having done so, it will now consider the parties’ specific challenges to these input adjustments.

1. Inputs

a. Cost of Capital

The PUC made its first adjustment to Verizon’s recurring cost model by adopting a 12.37% cost of capital rather than the incumbent’s higher proposal of 12.95%. MCI, which argued for a significantly lower 9.54%, contends that the PUC’s decision to choose a percentage so close to the figure proposed by Verizon violated TELRIC principles. This court disagrees. The PUC’s determination with respect to the cost of capital input complied with the FCC’s regulations and was supported by substantial record evidence. Therefore, it is affirmed.

Cost of capital is the return that an investor can expect on an investment in a given enterprise as that enterprise raises capital to finance its operations. Once the cost of capital is determined, it is applied as a percentage markup to the costs of all UNEs that a competitor may obtain from an incumbent under the Act’s unbundling regime. It is thus a crucial input in every rate-setting proceeding because it affects costs across the board.

Any calculation of cost of capital is comprised of three inputs: the cost of debt, the cost of equity, and the debt to equity ratio. In the proceeding below, the PUC arrived at a 12.37% cost of capital, which was comprised of a 7.86% cost of debt, a 14.75% cost of equity, and a ratio of 34.5% debt to 65.5% equity. Final Order at 62, Joint Appendix (“JA”) 419. The issue before this court concerns the cost of equity, which is the most difficult factor to determine because, unlike debt, which can be measured using long-term interest rates, it requires economic modeling to forecast a company’s long-term market performance. MCI argues that the cost of equity figure adopted by the PUC — 14.75% as opposed to the 10.42% that it proposed- — violated federal law both because it was impermis-sibly based on Verizon’s short-run, as opposed to long-run, cost of equity and because it did not take into account the risk assumptions required by TELRIC. For th'e reasons set forth below, the court disagrees.

TELRIC dictates that UNE rates be set according to a forward-looking framework that approximates an incumbent’s long-run costs. Local Competition Order at ¶ 677. As such, the FCC has instructed that the cost of capital should “reflect the competitive risks associated with participating in the type of market that TELRIC assumes.” In Re Review of the Section 251 Unbundling Obligations of Incumbent Local Exchange Carriers, 2003 WL 22175730, at ¶ 681, 18 F.C.C.R. 16978 (2003) (“Triennial Review Order”). Thus, in determining cost of capital, state commissions should assume a telecommunications market “in which facilities-based carriers would risk losing customers to other facilities-based carriers.” Id. at 2003 WL 22175730, ¶ 680, 18 F.C.C.R. 16978. The appropriate level of risk is, therefore, not the actual competitive risk that an ILEC faces at the present time but rather the risk associated with TELRIC’s competitive assumptions in the long run. Id. at 2003 WL 22175730, ¶¶ 678-80, 18 F.C.C.R. 16978. According to the FCC, increased competition leads to increased risk, which, in turn, warrants an increased cost of capital. Id. at 2003 WL 22175730, ¶ 681 18 F.C.C.R. 16978. See also Verizon Communications, Inc., 535 U.S. at 520, 122 S.Ct. 1646 (“[T]he Commission specifically permits more favorable allowances for cost of capital ... than were generally allowed under traditional ratemaking practice.”).

MCI first argues that the cost of capital proposal adopted by the PUC violated TELRIC because it was not forward-looking. Although cast as a legal argument, MCI is actually contending not that the PUC failed to utilize a long-run framework but rather that its determination of what conditions will apply in the long run was incorrect. As such, this is a factual argument that the court must reject because the PUC’s determination was supported by substantial record evidence.

During the proceedings below, the PUC was presented with two versions of the Discounted Cash Flow (“DCF”) equation, which translates market data such as share prices and dividend yields into a cost of equity percentage. The first version, proposed by Verizon and dubbed the “single-stage model,” assumed that the incumbent’s current growth rate will remain constant in the long run. The second, endorsed by MCI and known as the “multistage model,” used the projected overall growth rate of the economy to forecast a firm’s current growth rate over the long term. The PUC adopted the former and explained its decision to do so in light of TELRIC principles and the record evidence. Final Order at 60-61, JA 418-19.

The1 essence of MCI’s argument is that the PUC’s adoption of the single-stage model violated TELRIC because it is inevitable that Verizon — as a telecommunications company in a relatively new and rapidly expanding industry — will not be able to sustain its current high growth rate as the market saturates in the long run. The PUC, however, found otherwise and determined Verizon could indeed sustain its current rate of growth in the type of long-run, competitive market assumed by TELRIC. Such a conclusion was supported by substantial record evidence. See, e.g., Verizon Stmt. 4.1 (Rebuttal Testimony of James H. Vander Weide) at 52, JA 2919 (offering the PUC an explanation as to why the single stage model is a reasonable approximation of reality even though firms cannot grow at the current rates forever). Indeed, there were dozens of pages of testimony devoted to the relative merits of the single-stage as opposed to the multi-stage DCF model, and the PUC considered the evidence and reasonably adopted the former. The mere fact that the commission did not agree with MCI’s forecast of events in the long run is not grounds for reversal.

MCI’s second argument is that the PUC’s cost of capital determination violated federal law because the commission did not make the risk assumptions required by TELRIC. In particular, MCI contends that the PUC erred both by assuming that Verizon would be engaged only in the provision of UNEs and not in facilities-based competition and by adopting Verizon’s proxy group for measuring forward-looking risk. Neither of these reasons, however, can convince the court to disturb the PUC’s determination.

MCI contends that the PUC violated TELRIC by assuming that Verizon would be engaged exclusively in the provision of UNEs, an assumption that would inflate costs because UNE provision carries a higher risk than facilities-based competition. This argument, while plausible, must fail because it mischaracterizes the PUC’s holding. Contrary to MCI’s claim, the commission did not make such an assumption. Instead, the PUC properly adhered to the FCC standard and attempted to find a level of risk consistent with facilities-based competition in the type of market that TELRIC assumes.

Specifically, the PUC found that “an appropriate common equity cost rate ... should ... reflect those risks associated with a firm engaged solely in a competitive market for facilities-based telecommunications service. ” Final Order at 60, JA 417 (emphasis added). See Triennial Review Order at ¶¶ 678-80. The commission heard testimony that there are no publicly traded companies devoted solely to UNE provision. As such, it reasonably adopted a proxy group of companies that it found to face risks comparable to those that would confront a company in a telecommunications market with facilities-based competition. Final Order at 61, JA 418 (“The telecommunications industry is consistently evolving, and at this time the return associated with [the proxy group chosen] reflects the best proxy of the investment risk, and therefore, resulting return that a TELRIC-style competitive entity would experience.”). See also Verizon Stmt. 4.2 (Direct Testimony of Dr. James H. Van-der Weide) at 32, JA 2846 (explaining that there are no publicly-traded companies whose sole business is offering UNEs); Verizon Stmt, h.2 (Surrebuttal Testimony of Dr. James H. Vander Weide) at 28-35, SJA 2053-60 (explaining why Verizon’s proxy group was superior to that submitted by MCI). This approach was both consistent with the TELRIC standard and supported by substantial record evidence. It is, therefore, affirmed.

b. Depreciation Lives

The second modification made by the PUC to Verizon’s recurring cost model was the adoption of FCC-developed, regulatory depreciation lives proposed by MCI, as opposed to the economic depreciation lives proposed by Verizon. The incumbent argues that the PUC’s decision to adopt the former was both arbitrary and capricious and that it violated TELRIC by resulting in rates substantially lower than legally required. The court, however, finds Verizon’s argument unconvincing and holds that the PUC!s decision was both consistent with federal law and supported by substantial record evidence.

Like cost of capital, depreciation lives are an important input to the calculation of recurring rates because they affect an incumbent’s overall costs. A depreciation life measures the time period over which a company’s capital assets are assumed to have economic value and allows it to recover the cost of its investment in those assets over time. If a company is required to depreciate an asset over too long a time period — a life extending beyond the time during which the asset actually has economic value — then the company will be unable to fully recover its costs. On the other hand, if the depreciation life is too short and, therefore, assumes that a capital asset is worthless even when it retains real-world value, the company will recover the difference and be over-compensated for its investment. As such, longer lives result in lower UNE- rates, while shorter lives bring about higher ones. In essence, Verizon contends that the lives adopted by the PUC were too long and resulted in rates that were too low.

As with all inputs, depreciation lives must comply with TELRIC methodology. The FCC hás explained that “in calculating-depreciation expense ... the rate of depreciation over the useful life [of an asset] should reflect the actual decline in value that would be anticipated in the competitive market TELRIC assumes.” Triennial Review Order at ¶ 689. The commission has also advised that “state commissions continue to have discretion” in determining what depreciation lives comply with this standard, and, as such, it has declined to endorse either economic or regulatory lives as more likely to produce a TELRIC-consistent result than the other. Id. at ¶ 688. Thus, state commissions are free to adopt either, as' long as they reflect the forward-looking decline in value that would result in a competitive market.

The PUC was presented with two sets of depreciation lives during the proceeding below. On the one hand, Verizon advocated the use of economic depreciation lives, which are generally used for financial accounting purposes and which the PUC had adopted during its MFS-III and Global proceedings. The incumbent argued that these lives — which were shorter and thus produced higher fates than those proposed by MCI — were TELRIC-compliant because they were based upon a competitive market in an industry characterized by rapid technological developments. On the other hand, MCI advocated the use of longer regulatory lives, which had been set by the FCC in 1995 and which resulted in substantially lower rates. Departing from both its prior conclusions and the recommended decision of the ALJ (which was based in large part on adhering to those conclusions), the PUC chose the FCC lives proposed by MCI. In so doing, the commission found that “the FCC-prescribed depreciation lives are more reflective of the forward-looking, economic criteria required by the FCC rules.” Final Order at 62, JA 419. Verizon challenges this determination on both legal and factual grounds.

The incumbent’s first argument is that the PUC’s decision to adopt the FCC regulatory lives sponsored by MCI must be reversed because those lives are not TEL-RIC-compliant. In support of this position, Verizon contends that because the regulatory lives were developed in 1995— before the passage of the 1996 Act and the adoption of the TELRIC methodology— they must be rejected as outdated. It also points to language in the FCC’s Triennial Review Order suggesting that an accelerated depreciation mechanism may be a more accurate means of measuring the useful life of an asset in the type of market TELRIC assumes. The court, however, rejects these contentions and holds that the FCC lives comply with federal law.

Verizon’s argument that the FCC regulatory lives are obsolete simply because they pre-date the 1996 Act must be rejected. While it is true that the commission developed its regulatory lives in 1995, it reviewed and updated those lives four years later, well after the Act’s passage. Recommended Decision at 22, SJA 182 (advising the PUC that Verizon’s argument that the regulatory lives established in 1995 were outdated was “less than candid” because they had been reviewed and modified by the FCC in 1998-99). Furthermore, in 2003, the FCC conducted rate-setting proceedings in Virginia and, when faced with the same arguments as those presented by Verizon here, reached the same conclusion as did the PUC. In particular, it rejected Verizon’s argument that the FCC regulatory lives were not sufficiently forward-looking and adopted the 1995 fives, which were “the most recent ones prescribed by the Commission.” In re Petition of WorldCom, Inc. Pursuant to Section 252(e)(5) of the Communications Act for Preemption of the Jurisdiction of the Virginia State Corporation Commission Regarding Interconnection Disputes with Verizon Virginia Inc. and for Expedited Arbitration at 2003 WL 22038242, ¶ 115, 18 F.C.C.R. 17722 (2003) (“Virginia Pricing Order”). In addition, approximately 20 other states have used these FCC regulatory fives to calculate depreciation. Tentative Order at 48, SJA 305.

In response to this evidence tending to show that the FCC fives remain acceptable to calculate depreciation, Verizon makes a host of arguments, the most significant of which relates to the Virginia Pricing Order. In essence, the ILEC contends that this court should not rely upon the Virginia Pricing Order — both because it was handed down by the FCC’s Wireline Bureau and, therefore, does not constitute agency policy, and because it was legally erroneous — and that, even if it does, it should distinguish that decision from the instant case. These arguments, however, miss the mark.

The FCC opined in its Triennial Review Order that regulatory fives may be TEL-RIC-compliant, and it did so with the knowledge that its 1995 fives were the most recent regulatory fives it had established. Triennial Review Order at ¶ 688. Thus, the fact that the 1995 fives could comply with TELRIC under certain circumstances was implicit in the Triennial Review Order. With this FCC guidance as a backdrop, the PUC carefully eonsid-ered the record evidence and found that the 1995 lives did indeed comply with TELRIC. That the Commission reviewed and modified those lives in 1999 — and that its Wireline Bureau found them to comport with TELRIC in another context in 2003— merely supports, but was not necessary to, the PUC’s determination that, based on the record evidence, the FCC regulatory lives were lawful.

Verizon also argues that the FCC’s statement that “the use of an accelerated depreciation mechanism may present a more accurate method of calculating economic depreciation” supports the proposition that only lives shorter than the FCC’s regulatory lives would comply with TEL-RIC. Id. at ¶ 688 (emphasis added). The incumbent’s reliance on this statement, hbwever, is misguided. The FCC clearly phrased this sentence not as a directive but instead as a suggestion offered to aid state commissions in the exercise of their discretion to choose any depreciation lives that comply with federal law. Furthermore, even if this court were to hold that the clearly suggestive language actually sets forth a mandate, the PUC could not have complied therewith because Verizon never even proposed that the commission adopt an accelerated depreciation mechanism. Thus, Verizon’s argument based on this language from the Triennial Review does not persuade the court that the regulatory lives adopted by the PUC violated TELRIC.

In addition to arguing that the FCC lives are unlawful, Verizon also contends that the PUC’s decision to adopt those lives was arbitrary and capricious. This court, however, finds otherwise and affirms the commission’s decision as supported by substantial evidence. The PUC was presented with considerable evidence from both sides with respect to depreciation lives, and it concluded that the weight of that authority supported the adoption of

the FCC lives. Tentative Order at 47-49, JA 304-06. The commission did not do so arbitrarily but instead specifically explained that it reversed its prior precedents and disagreed with the ALJ’s recommended decision because it found, for a host of enumerated reasons, that the FCC lives were more consistent than Verizon’s proposed economic lives with TELRIC’s forward-looking assumptions. Id. at 49, JA 306. Because this determination was supported by substantial record evidence, it is affirmed. See, e.g., MCI Stmt. 2.2 (Surrebuttal Testimony of Terry L. Murray) at 36-38, JA 4821-23 (explaining that, contrary to Verizon’s assertion, technological innovation in the telecommunications industry could lengthen depreciation lives and that, therefore, the FCC regulatory lives were appropriate inputs for the cost model); MCI Stmt. 5.1 (Direct Testimony of Richard B. Lee) at 4-7, JA 3751-54 (explaining that financial book reporting lives such as those advocated by Verizon are designed to protect investors and would, therefore, be inappropriate to calculate depreciation expense in a regulatory context).

c. Switching Rates

The third modification made by the PUC to Verizon’s recurring cost model was to adopt MCI’s proposed switch discount mix. Verizon argues that this decision resulted in illegally low switching rates and was unsupported by the record. The court, however, disagrees and will affirm the PUC’s decision as both consistent with TELRIC and supported by substantial evidence.

Carriers can purchase switches — critical pieces of a telephone network that route calls to their intended destinations — in one of two ways: as brand-new switches or, in the alternative, as add-on, or growth switches, which either upgrade or increase the capacity of existing switches. McMahon, 80 F.Supp.2d at 236. A typical vendor offers new switches at deep discounts in order to make buyers dependent on its particular equipment so that they will upgrade their networks by purchasing its more expensive add-on switches. Tentative Order at 130, SJA 387. Thus, an efficient carrier will attempt to purchase as many new switches as possible at the deep discounts but will necessarily be forced to purchase a certain number of growth switches at the less discounted prices.

In order to set the switching rates in the proceeding below, the PUC was called upon to determine exactly what percentage of an efficient carrier’s switches would be purchased at each of these discounts. Predictably, MCI advocated a mix weighted towards new switches — a proposal which would result in lower rates — while Verizon argued that it would be more realistic to assume that a carrier would be forced to purchase a greater number of growth switches — an assumption that would result in higher rates. After being presented with alternative proposals from both sides, the commission adopted an MCI-sponsored version, which contained a mix of 85.5% new switch discounts and 14.5% add-on switch discounts. Id. at 137-38, SJA 393-94. This decision both complied with TELRIC and was supported by substantial evidence.

TELRIC requires that costs be modeled on a forward-looking, long-term basis. 47 C.F.R. 51.505(b). Accordingly, UNE rates — switching rates included — should reflect the needs of an efficient carrier using the latest technology in a fully competitive environment. Id. Thus, under TELRIC methodology, the cost of an incumbent’s existing network is irrelevant, and state commissions must, therefore, forecast a carrier’s long-run purchase of switches without regard to previous investments. Although the FCC has not endorsed as optimal a specific numerical mixture of new and growth switches, it is clear that TELRIC assumes that an efficient carrier would incrementally build its switch network with a mixture of the two, as opposed to 100% of one or. the other. See e.g., AT&T Corp., 220 F.3d at 616-18 (upholding FCC approval of switching rates based upon the assumption that carrier would purchase a mix of new and growth switches); In re Review of the Commission’s Rules Regarding the Pricing of Unbundled Network Elements and the Resale of Service by Incumbent Local Exchange Carriers, 2003 WL 22119504, ¶ 77, 18 F.C.C.R. 18945 (2003) (noting that the FCC has rejected an assumption that the appropriate switching discount must be based on a purchase of 100% new switches); In re Joint Application by Bell-South Corp. et al. for Provision of In-Region, InterLATA Services in Ala., Ky., Miss., N.C., & S.C., 2002 WL 31084940, ¶ 80, 17 F.C.C.R. 17595 (2002) (“[Sjwiteh-ing prices may be based on a meld of new and growth discounts ... [Cjertain vendors have provided a greater discount for new switches and smaller discounts for growth or expansion of existing switches ... [S]uch discounts were only valid when an overall purchase of both new and growth equipment was made.”).

During the proceeding below, both sides presented the PUC with alternative proposals, which included an MCI-sponsored model that assumed a 100% new switch discount and one submitted by Verizon that was comprised of 97% growth switches. The PUC, however, rejected both of these extremes and settled on a model in between the two. Proposed by MCI, the compromise model adopted by the commission assumed that an efficient carrier entering the market would purchase a partial network of all new switches and would then add on to that network with growth switches as the original switches became ineffective or obsolete. Although the original purchase at the moment of market entry would be of 100% néw switches, those new switches would comprise only 85.5% of the carrier’s switching network in the long-run. The model assumed that the competitor would make up the balance of its long-run network by purchasing growth switches.

Verizon attacks the PUC’s adoption of this model as inconsistent with TELRIC and advances two main arguments in support of its position. First, the incumbent argues that because the model assumed that an efficient market entrant would purchase all new switches at the outset, it violated TELRIC because that methodology mandates that carriers purchase a mix of new and growth switches.' This argument, however, confuses the issue. Although the model assumes 100% of a carrier’s initial purchase would be comprised of new switches, that initial purchase would make up only 85.5% of the long-run switching network. Thus, the authority cited by Verizon in support of the proposition that a carrier cannot be assumed to purchase 100% new switches is inapposite. The model selected by the PUC does indeed contemplate a mix of new and growth switch purchases over the long run and, therefore, is consistent with TELRIC principles. Tentative Order at 137, SJA at 394 (adopting an approach of melding new switch and growth discounts by using a figure based upon the discounts expected for fhe purchase of an average switch and growth additions over the switch life).

Second, Verizon contends that the model violates TELRIC because its assumption that a carrier could purchase new switches that comprise 85.5% of its long-run network at deeply discounted rates is unrealistic. It argues that because vendors typically offer large discounts on new switches in order to lock carriers in such that they will be forced to purchase growth switches at less discounted rates, no rational vendor would be able to offer these deep discounts on such a large percentage of the overall anticipated purchase. See AT&T Corp., 220 F.3d at 618 (referencing the FCC’s argument that “growth additions to existing switches cost more than new switches only because vendors offer substantial new switch discounts in order to make telephone companies dependent on the vendors’ technology to update the switches”). Verizon bases its argument on the claim that the largest discounts it can expect to receive are based on an average of 50% new and 50% growth switches. This projection, regardless of its accuracy, is irrelevant to the court’s analysis.

TELRIC contemplates not what prices an existing carrier — bound by its embedded inefficiencies and previous investments — could actually receive, but instead what vendors would charge an efficient carrier constructing a new, cost-effective network using the most efficient technology available. 47 C.F.R. 51.505(b)(1). The PUC complied with this standard when it adopted MCI’s switch discount model. Tentative Order at 139-40, SJA 396-97 (explaining that the touchstone of forward-looking pricing is not Verizon’s existing network but what an efficient provider would do if unconstrained by previous investments and concluding that MCI’s alternative proposal is consistent with TELRIC). Its determination is, therefore, affirmed as consistent with federal law.

In addition to attacking the PUC’s decision on switching rates as illegal, Verizon also argues that it was arbitrary and capricious. This contention, however, lacks merit because the commission’s decision was supported by substantial record evidence. Indeed, MCI specifically addressed the merits of its model and explained why the PUC should adopt it over Verizon’s proposals. Joint Exceptions of AT & T and MCI at 49-52, JA 3485-88. In addition, the commission considered testimony that criticized Verizon’s proposed models as neither plausible in practice nor compliant with TELRIC principles. MCI Stmt. 2.1 (Rebuttal Testimony of Terry L. Murray) at 33t-35, SJA 3840-42 (demonstrating the problems with Verizon’s proposals and explaining that it is implausible that an efficient carrier would enter a competitive market by purchasing bulk quantities of growth switches instead of more heavily discounted new switches). As such, the court affirms the PUC’s decision to adopt MCI’s proposal in lieu of Verizon’s because it was supported by substantial record evidence.

d. Common Overhead Costs

The PUC’s fourth modification to Verizon’s recurring cost model was to reject the incumbent’s Forward-Looking Conversion Factor (“FLC”), a mathematical device designed to increase costs and, thereby, increase UNE rates. Although this adjustment would theoretically benefit MCI by decreasing costs, it is the competitor which raises a challenge here because it contends that Verizon employed the FLC in its calculations despite the PUC’s clear directive to the contrary. It argues both that the FLC was illegal because it drove costs up to their embedded levels and that the PUC’s determination was arbitrary and capricious. This court disagrees. For the reasons set forth below, it will reject those arguments and affirm the PUC’s decision.

MCI first claims that the FLC was illegal because it impermissibly inflated the cost of Verizon’s Common Overhead Factor (“COH”), an Annual Cost Factor (“ACF”) that measures overhead costs for executive salaries, external relations, human resources, legal expenses, and other general and administrative functions. This argument, however, lacks merit. Although application of the FLC did increase Verizon’s COH, it was nonetheless consistent with TELRIC methodology.

During the proceeding below, the PUC considered extensive evidence with respect to the application of the FLC to all ACFs. On the one hand, Verizon argued that because its current annual expenses were already made forward-looking by application of productive and inflation factors, the cost-inflating FLC was necessary to avoid a double TELRIC adjustment. On the other, MCI contended that Verizon’s original expenses were not forward-looking and that they, therefore, needed to be adjusted downward — and not upward- — -to comply with TELRIC. The PUC agreed with MCI and directed Verizon to rerun its cost study after applying the FLC in a different manner. Final Order at 40-41, JA 397-98 (explaining that multiplying costs by the .692 FLC was permissible but that later dividing them by that same number was error because it canceled the effects of the multiplication). Noting that it was not rejecting the FLC “in all respects” but instead as implemented in Verizon’s COH calculations, the PUC concluded that the incumbent’s compliance with its order would result in “an overall reduction” of Verizon’s UNE rates. Id. at 38, 39, JA 395, 96.

Verizon then returned to the PUC with new calculations that it maintained were consistent with the commission’s instructions, and, as the PUC had predicted, this new math resulted in an overall reduction of the other ACFs by between 12% and 18%. Id. at 39, JA 396; Verizon’s Reply Comments Regarding Compliance Filing at 2, JA 588. Nevertheless, MCI argued that Verizon failed to comply with the PUC’s directive because it still employed the FLC in calculating its COH, which increased by almost 2% with the new calculations. Compliance Order at 8-9, JA 462-63. Although the competitor contended that this increase violated TELRIC because the FLC was based on Verizon’s actual costs and, therefore, drove the COH up to its embedded levels, the PUC rejected this argument. This court agrees and will affirm the PUC’s determination as consistent with the applicable law.

The commission concluded that Verizon complied with its instructions and properly applied the FLC based on its finding that “the estimation of overhead expense in a TELRIC environment should not reasonably differ from those expenses in the present environment.” Id. at 8, JA 462. For example, the PUC explained, because common costs such as those for executive salaries and corporate offices do not necessarily decrease with the advent of newer technologies, basing overhead expenses on existing costs was indeed forward-looking. Id. This reasoning was sound.

Contrary to MCI’s suggestion, the fact that the PUC based its COH input on Verizon’s actual costs does not automatically render its decision legally deficient. Although TELRIC methodology mandates that costs be based on those that would be incurred by a hypothetical, most efficient carrier, that requirement is logically satisfied where the actual ILEC’s costs are found to be the same as those of the hypothetical. carrier. Local Competition Order at ¶ 685. Here, the PUC found that an efficient competitor’s hypothetical, forward-looking overhead costs would be approximately the same as those actually incurred by Verizon. Thus, TELRIC was satisfied. Furthermore, the fact that the ACFs were reduced in aggregate after Verizon completed its new calculations corroborates the PUC’s finding that Verizon did indeed follow its instructions and produce rates within the TELRIC range.

MCI argues in the alternative that even it this court finds that the FLC complied with TELRIC, it should nevertheless conclude that the common cost calculation violated federal law because it impermissibly included common costs that can be attributed in part to Verizon’s retail operations. See 47 C.F.R. § 51.505(2)(d)(2) (prohibiting inclusion of any retail costs in calculation of common costs). In support of this argument, MCI relies on AT & T Communications of Cal., Inc. v. Pac. Bell Tel. Co., in which the Ninth Circuit reversed the California Public Utilities Commission’s (“CPUC”) calculation of common costs as violating § 51.505(2)(d)(2) even though it excluded retail-only common costs because it nevertheless included overhead costs common to both retail and wholesale operations. 375 F.3d 894 (9th Cir.2004). The incumbent essentially argues that the PUC committed the same error in the present case. This court, however, declines to follow the Ninth Circuit’s decision because it rested upon a faulty interpretation of TELRIC. As. such, it will reject MCI’s argument.

In AT & T Communications of Cal., the Ninth Circuit explained that a common cost mark-up — which allows incumbents to recover all costs properly attributable to the provision of a given UNE — should be calculated by dividing the firm’s costs common to all of its wholesale operations by its direct costs associated with providing that UNE on a wholesale basis. 375 F.3d at 905. This “apples to apples” calculation, with wholesale common costs in the numerator and wholesale direct costs in the denominator, the court opined, is consistent with TELRIC. Id. Despite the fact that the CPUC employed such a formula, the Ninth Circuit overturned its decision because the commission assumed that the incumbent engaged only in wholesale — as opposed to retail — operations. Id. at 906. The court explained that this assumption was not required by — and indeed violated — TELRIC because it inflated the numerator by attributing to wholesale operations common costs that were, in reality, partly attributable to the firm’s retail business, which was assumed by the commission to be non-existent. Id.

While this court agrees with the Ninth Circuit that TELRIC does not require a hypothetical, wholesale-only environment, it disagrees that such an assumption is necessarily unlawful. To the contrary, federal law seems to suggest that it is at least permissible. In particular, the FCC’s regulations provide that the marked-up cost of a UNE shall not exceed the total forward-looking costs that would be incurred by an efficient firm that produced only that element. 47 C.F.R. § 51.505(c)(2)(ii). Because a firm producing one and only one UNE would naturally provide that element to other carriers on a wholesale basis — as opposed to a firm that provided various telephone services to individual and business customers on retail bases — this court cannot conclude that the assumption of a wholesale-only environment violates TELRIC. As such, it declines to follow the Ninth Circuit’s decision.

Furthermore, after its review of the record, this court is satisfied that the approach taken by the PUC — an approach which applied a “retail-avoided cost percentage” to effectively eliminate retail costs from the common overhead figure— was consistent with federal law. See 47 C.F.R. § 51.505(2)(d)(2) (retail costs not to be considered in calculation of common costs); Verizon Stmt. 1.0 (Direct Panel Testimony on Recurring Costs) Attachment B at 17, SJA 982 (explaining the method used for the “avoidance of retail-related costs” in the FLC). Thus, the commission’s determination is affirmed.

In addition to attacking the legality of the FLC, MCI also attacks the PUC’s decision as arbitrary and capricious. The competitor argues that the commission’s approval of Verizon’s use of the FLC factor in its Compliance Order should be reversed both because it was inconsistent with the PUC’s conclusion in its Final Order that the factor violated TELRIC by raising costs to their embedded levels, and because it was based on a theory that the PUC articulated for the first time in the Compliance Order. The court disagrees. As the court has already explained, the PUC in its Final Order rejected the FLC factor as implemented in Verizon’s filing, and it set forth instructions as to how the incumbent could cure the infirmity by rerunning the cost model to arrive at an overall decrease in the ACFs. Verizon, in turn, reran its model and claimed to have followed those instructions, and the PUC determined after careful consideration that it had indeed done so. That it based its finding of compliance on what MCI characterizes as a novel theory is irrelevant to the analysis because the PUC explained its rationale, and this court has upheld that rationale TELRIC-compliant. The commission’s determinations with respect to the FLC were neither arbitrary nor capricious and are, therefore, affirmed.

e. Port Features

Fifth and finally, the PUC modified Verizon’s recurring cost model by rejecting the incumbent’s proposal to change the port feature structure from that set by the 1999 Global Order. Final Order at 49, JA 406. Verizon argues that this decision violated federal law because it prevented the incumbent from recovering ‘all of the costs that it would incur in providing certain port features to competitors. 47 U.S.C. § 252(d)(1)(A)© (requiring UNE rates to be “based on the cost” of providing the network element). The court, however, rejects this contention based on its finding that the PUC’s decision was supported by substantial evidence.

Although set forth as a legal argument, the essence of Verizon’s claim is not that the PUC applied an improper framework that would preclude the incumbent from recovering its costs, but instead that the Commission arbitrarily rejected Verizon’s submission as to what its actual costs of providing the port features would be. As such, this is a factual argument, and the court will treat it accordingly. See MCI Telecomm. Corp., 271 F.3d at 517 (factual findings of state commissions must be affirmed if they have “substantial support in the record as a whole”).

Ports are line terminations in a carrier’s central office switch that provide user customers with dial tones. As technology has advanced, carriers have added various features to ports — well-known examples of which include Call Waiting and Caller ID — to increase their functionality. Incumbents can either package some or all of these features and sell them to competitors along with the ports themselves, or they can offer the ports and features for sale separately. The structure dictated by the Global Order was a two-tiered approach: Verizon was to offer a full feature port at $2.67 per month and a limited feature port — which excluded four features that were offered in the full feature edition — at the monthly rate of $1.90. Final Order at 48, JA 405.

Despite the fact that the two-tiered structure set by the Global Order remained in effect at the time of the Generic Investigation — and despite the fact that the purpose of the new proceeding was to review the existing rates as opposed to the existing structure — Verizon’s initial filing therein contained a proposal for a substantially different port structure. In particular, the incumbent suggested a lower port rate that reflected only the cost of the port itself and then sought to offer every additional feature for sale separately based on its individual cost. ■ Verizon Recurring Cost Summary at 28, 53 JA 3793, 3818. The incumbent, however, failed to highlight this unexpected change, and both the PUC and MCI claim that they did not notice it during the early stages of the Generic Investigation. PUC Opposition Brief at 23; MCI Opposition Brief at 50.

Indeed, MCI claims that it did not become aware of the revised port structure- — • which consisted of a full feature port nearly twice as expensive as the Global Order rate and a limited feature port that excluded a host of features beyond those left off of the Global Order limited port offering— until Verizon’s December 4, 2002 filing. The competitor then submitted objections to the PUC, which, after finding that Verizon’s proposed full and limited port rates represented 77% and 138% respective increases over the current rates, directed Verizon to retain the same port feature structure as set forth in the Global Order. Final Order at 48-50, JA 405-07.

In response, Verizon submitted two more filings — one on January 26, 2004, which provided for a limited port that excluded six more features than had been excluded by the Global Order’s limited port offering, and one of March 8 of that same year, which revised the language for the full feature port and removed those same six features from that offering as well. Compliance Order at 13, JA 467. MCI objected and argued that Verizon had failed to comply with the PUC’s directive to revert to the Global Order structure and rates.

Verizon, however, maintained that it had indeed complied with the PUC’s mandate. In its comments to the March 8 filing, the incumbent explained that despite its excluding the six features from both its full and limited feature ports, its filing was nevertheless consistent with the Global Order because “at the time of the Global Order these features were quite new and available only in limited areas.” Verizon’s Reply Comments Regarding Compliance Filing at 6, JA 592. As such, Verizon argued, their costs were not included in the Global Order rates and, in order to comply with federal law, those costs had to be recovered by charging for the new features on an a la carte basis. Id. at 7, JA 593. See 47 U.S.C. § 252(d)(l)(A)(i) (requiring UNE rates to be “based on the cost” of providing the network element).

The PUC rejected Verizon’s argument and found that MCI’s contrary assertion that the excluded features were not new but instead had been offered for years in Pennsylvania “raised substantial questions of fact” and concluded that, because the issue had been raised during the late stages of the proceedings, Verizon’s exclusion of the six additional factors was improper. Compliance Order at 15-16, JA at 469-70. It explained that despite Verizon’s argument that it used a new port rate structure early on in the proceedings, “it appears from our review of the record in these proceedings that the port rate discussions all proceeded on the assumption that the two-tiered structure of the Global Order was not modified.” Id. at 16, JA 470. Based on that assumption, the PUC rejected Verizon’s argument that it was unlawfully prohibited from recovering its costs for the six features at issue. Although Verizon argues that the PUC’s decision was arbitrary, this court concludes otherwise. The commission’s rejection of Verizon’s contention was both supported by substantial evidence and reasonable on the record before it.

Despite Verizon’s argument that it presented clear and detailed evidence on the costs of the six excluded features throughout the proceeding, this court’s review of the record supports the PUC’s finding that thé port rate discussions proceeded on the assumption that the Global Order structure would remain intact. Indeed, the testimony that Verizon cites in support of its position is somewhat misleading. Although the incumbent characterizes that testimony as specifically explaining that it “had proposed a different port structure from that in its existing tariffs,” the testimony on record provides that the Generic Investigation structure was “consistent but not identical” to that of the Global Order and that it was “consistent with the rate structure used in New York that was cited in the Global Order.” Compare Verizon Reply Brief at 40, with Verizon Stmt. 1.0 (Direct Testimony Panel Testimony on Recurring Costs) at 83-84, JA 871-872. The testimony suggests that there existed only minor, almost inconsequential differences between the two structures, and the PUC cannot be faulted for relying on Verizon’s representations in the context of such a large and complex proceeding. The fact that the specific purpose of the proceeding was to challenge the Global Order rates— and not the port st