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To read the recent Comments (PDF) To read the recent Press Release
Five Years Late and the Bells are Five to Nineteen Billion Dollars Short. SUMMARY: This paper tries to give the reader a clear picture of the recently released FCC audit reports of the Baby Bells and what does it means for customers. If these audits prove to be correct, then the price of local telephone services, which is supposed related to the costs of the network, should have been lowered.
Introduction to the FCC's Baby Bell Audits (To read the original FCC audits and press releases, click here) On March 12, 1999 the FCC released a set of seven long awaited audits of the Baby Bells. The FCC's press release focused on the fact the Bells may have "overstated" parts of their network costs by $5 billion dollars. However, a closer reading of the report finds there is an additional $14 billion in "Unverifiable Assets" and other problems. (Unverifiable Assets are items that did not match the information that had been filed with the FCC.) NOTE: The FCC issued seven audit reports representing the original seven Baby Baby Bells. The companies were Ameritech, BellSouth, Bell Atlantic, NYNEX, Pacific Telesis, Southwestern Bell (SBC Communications) and US West. To put these statistics and terms in perspective, the FCC found all the Regional Bell Operating Companies (RBOCs) had massive problems with their records that were supposed to be available, based on FCC rules. In the case of BellSouth, 29% of the information required was missing or couldn't be found or had serious errors. "252,700 of 859,800 records under review, or 29 percent of the reviewed records, contained serious errors." And what is a serious error? The FCC wrote of Bell Atlantic's audit, that 24% of items either couldn't be matched with the FCC records, or the equipment simply wasn't there: "Specifically, in our audit of a random sample of 1,152 line-items from Bell Atlantic's (CPR for Hard-wired) Equipment, we found that 24.1 percent of the records that we sampled contained substantial deficiencies and did not comply with the Commission's rules. Of these deficient records, 12.5 percent described equipment that could not be found by the auditors or by company representatives ("not found" equipment). The remaining 11.6 percent could not be verified with certainty because the equipment shown to the auditors could not be matched to the record in some important respect such as location or description." What makes this situation so incredible is that in 1994 the FCC audited the Bells and found almost identical problems, and that audit was never released. We believe it most likely due to political pressures. In fact, this report may have also been tied up, had it not been for publications including Washington Telecom Week, the newslettter that broke the story almost a year ago, the Washington Post, and America's Network, who filed a Freedom of Information Act complaint. However, though the FCC has released this report, it is obvious that the majority of Commissioners refuse to back these findings. The FCC's report states: "The commission did not pass any judgment on the accuracy of these reports, the reasonableness of their conclusion or recommendation or the RBOC's responses." This has been a common pattern of almost all other audits the FCC has done with NARUC, the National Association of Regulatory Utility Commissioners, such as Ohio and Wisconsin, that showed obvious wrongdoing. Fortunately, there are some at the FCC who are defending the Pubic Interest,and we applaud those at the FCC for releasing these audits...finally. And what does this mean for customers? If these audits prove to be correct, then the price of local telephone services, which is supposed related to the costs of the network, should have been lowered. Understanding the FCC Audits The rest of this document will highlight the FCC's audit, discuss the methodology used, exactly what was examined, the FCC's findings, and the RBOC's total denial of the entire audit. 1) Let's start with the FCC's definition of what was examined. The FCC states that they require the Bells to keep an accurate accounting of the equipment used to supply customers with telephone services. "Continuing Property Record, CPR's, are a component of the telephone company's accounting record that provide descriptive inventories and cost documentation of the company plant, property and equipment used for producing regulated telephone services. Approximately one half of a telephone company's costs are associated with the capital investment that is record in their CPR" And why do it? The FCC is clear on that--- it's in the public interest for the FCC to make sure that the phone companies are only charging customers for specific costs related to phone service. "We find that release of this audit report to the public serves the public interest by providing interested state regulatory commissions and ratepayers with information gathered during the audit. The findings of the audit report relate to joint assets of the carrier that are used for both state and interstate ratemaking purposes; thus, state commissions and ratepayers have an obvious interest in this information. An additional compelling reason for disclosure is that the audit report provides the basis for further inquiry to safeguard the public interest. We believe that the public policy interests favor release of this audit report."
2) The Audit and the FCC's Methodology The FCC released seven separate audits of the original Seven Bells, as well as a summary of the original 1994 Audits. Also, the FCC's web site includes the Bell Responses. Let's try to explain the FCC's methodology in simple terms. (A long and involved description appears in each Bell Audit) To be blunt, the Bells are supposed to keep accurate records of every piece of central office equipment. It is similar to any other business who would take any normal business expense. For example, almost all small businesses keep daily logs of travel and entertainment, supplies, etc., but also answers the fundamental questions --- Who was visited, for what purpose, how much was lunch, etc. It can be argued that the primary reason is so that in case of an audit by the IRS, the customer had ALL of the records documented. (Anyone who has ever been audited knows that is essential.) Also, the costs of these networks are being passed through to customers and customers should be protected from overcharges, even if it occurs through sloppy bookkeeping. And the FCC's audit used a straightforward accepted random sampling to first conclude how many central offices would be examined and then how many specific cost items would be examined in each central office. And using what amounts to a check list, they compared what was supposed to be at that location with a list of items. However, when the auditors questioned staff and examined the logs, many of the items were missing, about 22% of all items on the average. Equipment couldn't be identified or there were a number of Bell accounts that had no details. For example the FCC wrote that large amounts were cubbyholed into things like "Undetailed Investment" or "Unallocated other costs".- covering over hundreds of millions of dollars. "In addition to finding errors in Ameritech's CPR for Hard-wired Equipment, we found that a significant number of line-items in the Ameritech's CPR contain the notation "Undetailed Investment" or Unallocated Other Costs." These items had no description of either the equipment or its location, in apparent violation of the Commission's rules. We found more than 4,200 such line-items representing $260.7 million in Undetailed Investment. Ameritech has not shown any specific physical plant or provided sufficient or convincing cost support data relating to any of the line-items for Undetailed Investment. We also found more than 7,300 line-items representing $64.6 million in Unallocated Other Costs. We are deferring final determination on the amounts associated with Unallocated Other Costs until we receive sufficient documentation from the company explaining the nature of these costs." And just how much of this was common to all the other Bells?
3) Just how much money? 5 or 19 Billion? The FCC report clearly states that there's approximately $5 billion of charges that can't be found. But a closer reading of these documents shows an additional $12 billion dollars in "Unverifiable assets" and "Value of missing portion". Below is a summary we created from the seven companies. Approximately 20% of all records were either "not found" or were missing some portion or were "unverifiable". Assets found $
78,056,994,000 78.94% Value of Found
portion $1,882,891,000 1.84% Value of Missing
Portion $1,818,516,000 1.71% No Assets found $5,263,181,000 4.90% Unverifiable
Assets $11,529,325,000 11.94% Total Assets $98,736,573,000
100% Here's the definitions used by the FCC for Bell Atlantic. Each report has a separate breakout for that specific Bell, but the findings are quite similar. Assets Found: We found all of the equipment in this category. For 825 of these line-items, equipment was found that matched description and location information in the CPR. For the remaining 49 line-items in this category, the CPR did not indicate a specific location in the building, but we were satisfied that the equipment observed was the equipment described in the record. Assets Partially Found: We found some of the equipment in this category but the quantity found was less than the quantity specified in the record. For each record, we prorated the cost of the equipment between the equipment found and the equipment not found based on the relative quantity of each group. No Assets Found: Neither we nor the company personnel could find the equipment in this category. Unverifiable Assets: We were shown equipment but were unable to determine with certainty that it was the equipment described in the CPR because of either deficiencies in the CPR or discrepancies between the CPR and equipment shown. This category included equipment that could not be matched with the CPR as to location, description, or identification number because of incomplete or missing information. And how much did each audit find? When adding Value of Missing portion, No Assets Found and Unverifiable assets, we come up with 18.6 billion dollars of questionable charges, or 19% of the Bells total network surveyed.
Ameritech $2,145,610 Bell Atlantic $3,317,018 BellSouth $1,920,761 NYNEX $2,558,057 Pac Bell $2,925,505 SBC $2,216,603 US West $3,527,468 TOTAL $18,611,022 This obvious failure to discuss this excess monies in the press release is a clear indication that the FCC is trying to downplay this entire affair. Though the FCC's report uses strong accusations.
And unfortunately, none of this is new problem 4) These Audits only represent 1/4 of the problem. The FCC’s press release on the audits made this point cleat "The audits examined the hard-wired central office equipment of the companies. "Hard-wired" equipment in central offices represents the items generally fixed in place (frames, switches, batteries), as opposed to "plug- ins," which are relatively portable (line cards). The hard-wired investment in central offices represents approximately one-fourth of the total capital investment for a telephone company. For example, for the RBOCs, the total investment in network plant is about $200 billion; of this, hard-wired central office equipment represents approximately $47 billion. The audit reports found that the RBOCs' book costs may be overstated by approximately $5 billion." The Implication is simple --- the total amount of Missing equipment could be as high as $20 billion while the total unverifiable network could be over $75 billion. 5)The Audit that never came to light --- 1993-1994. The problem of missing records and equipment IS NOT new. In 1993-94, another audit showed virtually identical problems. Here's what the FCC wrote about the 1993 and 1997 Bell Atlantic audits. "The findings of this audit highlight the significance of our previous concern about the integrity of Bell Atlantic's recordkeeping. In 1993, our audit of Bell Atlantic's CPR relating to COE revealed numerous errors and instances of insufficient information. In addition, our review of Bell Atlantic's CPR recordkeeping procedures, both in 1993 and 1997, found that the procedures were not being followed or were ineffective. We found that these procedures, which have been in place for many years, do not ensure that all investment recorded in the carrier's COE accounts is associated with equipment in service." And this is not simply the case of the old Bell Atlantic. ALL of the Bells had similar problems. For example, NYNEX, (here called Bell Atlantic North) was taken to task for these problems and they did not get better, nor does the FCC believe they will on their own. "We conclude that NYNEX/Bell Atlantic North has not maintained its basic property records and its CPR in a manner consistent with the Commission's rules. We base this conclusion on the findings of our statistical sampling of Hard-wired Equipment and actual records of Undetailed Investment and Unallocated Other Costs that show a high percentage of records with substantive deficiencies, such as inadequate or no asset descriptions, inaccurate quantities, missing and inaccurate location descriptions, and the high percentage of assets that could not be found by either our auditors or NYNEX/Bell Atlantic North's technical staff. We also base this conclusion on NYNEX/Bell Atlantic North's inability to provide supporting cost information and other data to substantiate the existence of a large number of entries in its CPR." 6) What does all this mean to the customer? And what does all this mean to the customer? It had led the auditors to conclude that the high percentage of inaccurate records, and the Bells' continued failure to have fixed the problems, inflated the Bells' network accounts. "The inability of the company to demonstrate the existence of such a high percentage of the equipment contained in its records raises significant questions about the valuation of Bell Atlantic's plant accounts. At its worst, failure to provide sufficient and convincing documentation for the acquisition of the assets in question and for their placement into regulated accounts raises doubts about whether policymakers can rely on these records." NNI's belief is simple. While the Bells and others trash the FCC's auditors, NNI's research clearly indicates that this audit is just the tip of the iceberg. Info-scandal calls for the FCC and Congress to initiate other related audits and investigations. We believe that over $30 billion has been overcharged and that the Bell's network costs are inflated, and that write-offs and other related activities need to be open for public scrutiny. Also, the Bells had five years to correct these problems and it is obvious that they have done little if anything to remedy the problem. We believe that: * the FCC should calculate the missing money into networks costs and refund customers appropriately. * all Bell new business activities should be put on hold until this new evidence is taken into consideration.
7) The Bells Point of View--- Everything is wrong. Of course the Bells continue to state that every finding is wrong and that the Audit was a waste of time and has no impact on rates. Their primary arguments are that more recently enacted regulations negate the need for these audits, that the equipment does exist if the FCC just looked harder, that these audits waste government resources, and that numerous technical issues (Price Caps, Productivity models, etc) all superceded any need for this investigation. SBC and Pac Bell put it this way: "First, the audit reports are simply wrong. Second, even if true, the audit results have no impact on consumers, or the prices they pay. Third, the CPR audit process wastes government and corporate resources that should be committed to achieving the goals of the Federal Telecommunications Act. Fourth, the audits extend the inequitable regulatory treatment of LECs, because FCC obligates no other competitors in the telecommunications industry to comply with CPR audit requirements. Considering the FCC's well known commitment to forward-looking costs, SBC LECs find surprising the FCC's sudden attention to backward-looking audits of assets governed by an antiquated regulatory process and a 30 year-old agreement. FCC Commissioner Susan Ness summed up her conversations pertaining to the Bells rebuttal by docusing on the more arcane technical issues. "I know, from discussions held already, that incumbent local exchange carriers believe the property record discrepancies have no significance for (1) the reasonableness of "going-in" price cap rates, (2) the computations under price caps of (a) low-end adjustments, (b) sharing, and (c) total factor productivity, (3) calculations under the Telecommunications Act of 1996 relating to (a) universal service support and (b) pricing of unbundled network elements, and (4) the merits of "takings" claims and "stranded cost" recovery issues. These arguments merit full discussion on the part of all stakeholders before I am willing to render a decision on the merits." Commissioner Tristani is the only Commissioner to stand up for the work that her agency has done. And she should be commended. She said: "Over the past year, the BOCs have lobbied the Commission heavily on this matter. They have aggressively attacked the audits, the competence of the auditors, and the credibility of the audit design. I have reviewed the audit reports and met with Bureau staff several times to discuss the audit findings, the audit procedures, and the specific attacks leveled by the companies. I find the Bureau's audit staff has been very thorough and careful in performing these audits. The staff has years of experience and specialized knowledge in this area and I am confident that the audits were well designed and executed." The Bells other rebuttal is that the equipment does exist. It's the auditors that couldn't find it. Using high paid consulting accounting firms, the Bells produced reports which showed that 96% or 97% of all equipment etc can be accounted for. "U S WEST's investigation has verified the existence of approximately 96 percent of the items in the audit sample. As the above table illustrates, U S WEST was unable to locate 4.0 percent -- or 48 -- of the items representing about 1.3 percent of the total value of the audit sample. U S WEST classified these 48 items as "not found" after an extensive examination." It is odd that almost all of the Bells state that it is 96 or 97% that can be found.
8) Here's some more quote from the audits. Though we use Bell Atlantic for most of them, the name of the other Bells can be substituted easily. * We find that Bell Atlantic has not maintained its basic property records and CPR in a manner consistent with the Commission's rules. |