properly viewed as an alternative regulatory approach, an alternative to traditional title II-type regulation where it is deemed that technological and market conditions as well as public interest considerations call for something other than detailed price/earnings regulation. Because of the inherent limitations of the separate subsidiary approach, that is, its inability to act fundamentally on corporate incentives and its reliance on separation requirements, accounting, disclosure, and behavioral proscriptions to forestall anticompetitive abuses, the effectiveness of the approach will depend primarily on the nature and stringency of the structural separation conditions and competitive safeguards which are imposed as well as on the quality of their implementation and enforcement. It is with these considerations in mind that we have reviewed the directives made by FCC in its Computer II proceeding, and it is on these grounds that we have found them wanting as a means of preventing anticompetitive abuse of monopoly power and of promoting the continued development of competition. The separate subsidiary approach adopted by the Commission does not go far enough, in our view, in providing for organizational restructuring and separation of the activities of the dominant carrier. By allowing the dominant carrier the option of creating a single conglomerate subsidiary, offering both enhanced services and competitive terminal equipment, the Commission, we feel, is setting the stage for the creation of a huge deregulated entity that would be endowed from the moment of its creation with substantial market dominance, as well as a significant potential for internal cross-subsidy and a host of other anticompetitive actions. By the same token, by refraining from imposing structural separation in such vitally important areas as manufacturing and applied research and development, the Commission has left a considerable potential for cross-subsidy and improper sharing of inside information and has rendered its own regulatory tasks (to detect and prevent anticompetitive actions) immeasurably more difficult. In every area where a significant potential for anticompetitive action exists and where the Commission has opted for minimal or no separation in preference to maximal separation which aims at reducing to the absolute minimum joint and common costs and other potentials for anticompetitive abuse, we believe the Commission needs to reconsider its approach and to impose the types of separation, conditions, and safeguards which will more assuredly protect and promote competition and render more feasible and effective its regulatory oversight responsibilities. Finally, we believe that the Commission has moved too quickly toward implementating the separate subsidiary regulatory scheme, before many of the essential methodological and enforcement tools have been fully developed and before undertaking a systematic and thorough assessment of what will be required--in the way of resources, staffing, functional organization--to give the approach credibility and a realistic chance of success. The Commission, we believe, has not taken sufficiently into account either the resource implications of the approach it has chosen or the fundamental prerequisites for successful implementation of the separate subsidiary deregulatory scheme. It has not made adequate provision, in our view, for expeditious and timely resolution of a large number of issues which are crucial to the feasibility and workability of its chosen regulatory strategy. These open questions and unresolved issues include development of costing principles and an appropriate costing methodology (ch. 4), a Uniform System of Accounts appropriate for determining cost of service and equipment offerings and verifying the cost compensatory nature of intracorporate transactions (ch. 5), and depreciation issues, questions concerning deregulation of customer premises equipment (ch. 7), and questions regarding the appropriate form of capitalization and financing of separate subsidiaries. At the same time, the Commission has given virtually no attention to the resource and organizational requirements implicit in the implementation and enforcement of the separate subsidiary regulatory scheme. This includes needs regarding the size and organization of staff; the specific analytical, monitoring, enforcement, and other functions that will need to be performed; the mix of skills, experience, and training that will be required; and the types of support systems and facilities (e.g., record and report filings and electronic data processing equipment) which will be needed to carry out and facilitate the Commission's regulatory tasks. As a result, it is unlikely that the Commission will be able to proceed according to its present schedule to implement the separate subsidiary approach by March 1, 1982. We believe implementation should not begin until the Commission is fully prepared and equipped to ensure the efficacy of separate subsidiaries as a device for promoting competition and protecting against the abuse of market power. At the same time, (see p. 125) the Commission should be mindful of the need to preserve the boundaries it has established between basic and enhanced services. Looking beyond Computer II and its somewhat narrow focus on dominant carrier-provided enhanced services and customer premises equipment, we believe that the Commission needs to examine how its procompetitive objectives might be further advanced through broadened application of the principle of maximal separation. One area in which additional structural separation might yield significant competitive benefits involves distinct separation of a carrier's interexchange transmission facilities and activities from its local exchange operations. FCC has not to date, either in Computer II or in other proceedings, evaluated the cost and benefits of structural separation as a means to reduce or eliminate the incentives and opportunities for the bottleneck local exchange monopolist, who is also a major supplier of basic interexchange transmission services, to abuse its market power to the detriment of competitors and communications consumers who benefit from competition. As a result, the Commission has overlooked an important area of anticompetitive abuse--one which is directly relevant to the ability of competitive suppliers of enhanced services to reach their potential customers--and has thereby rendered more difficult its task of preventing crosssubsidy as well as price and nonprice discrimination in matters of access and interconnection to bottleneck local exchange facilities. RECOMMENDATIONS TO THE CHAIRMAN, FCC We recommend that the Commission, as part of implementing any deregulatory scheme for enhanced service and customer premises equipment offerings based on the use of fully separated subsidiaries: --Resolve outstanding costing, accounting, and depreciation issues which must be implemented prior to establishing separate subsidiaries. --Assemble, organize, and train a staff for the essential tasks of monitoring, auditing, and enforcing compliance with its structural separation requirements and associated conditions. --Give full and careful consideration to the potential bene- We further recommend that the Commission, in using the separate subsidiary device for enhanced services and customer premises equipment, adopt an approach which more closely approximates true maximal separation. This implies: --Separate directors, officers, and operating personnel for the separate subsidiaries. -- Separate books of accounts, records and reports maintained in appropriately detailed and fully auditable form for FCC review. -Separate physical facilities and space. --Appropriate restrictions on the rotation of officers and --Separate subsidiaries performing for themselves the bulk of basic operating functions such as marketing, advertising, applied research and development, procurement and manufacturing. --Administrative services provided by the parent (or In addition, in place of a single conglomerate subsidiary for all of the dominant carrier's deregulated enhanced service and customer premises equipment offerings, we recommend that the Commission, in the context of its intended review of subsidiary capitalization plans, include an assessment of requiring the dominant firm to establish multiple, fully separated subsidiaries. One possibility would be a requirement for separate, stand-alone, subsidiaries for both enhanced services and customer premises equipment. Looking beyond the limited concerns of Computer II, we further recommend the Commission initiate a proceeding to evaluate the need for structural separation of a dominant carrier's interexchange facilities and activities from its purely intraexchange operations. CHAPTER 7 DEPRECIATION RATE SETTING AND ITS IMPLICATIONS IN A MORE COMPETITIVE ENVIRONMENT FCC's review of depreciable assets in prescribing depreciation rates is an important regulatory tool. Depreciation charges are a large part of a carrier's expenses and are a major factor in determining the carrier's rate base, both of which affect the overall revenue requirement. During 1980 and 1981 FCC made changes to its methods and practices for setting depreciation rates. These have been largely in response to the rapid change in technology and are reflective of FCC's overall thrust for a more competitive environment. These changes along with interrelated issues directly affect competitive development and the efficiency of future regulatory oversight. These issues, involving the determination of depreciation reserves by plant account, the recovery of reserve deficiencies, and the valuation of assets, must be resolved, we believe, before FCC proceeds in using the separate subsidiary device described in chapter 6. We also believe that FCC's program for prescribing depreciation rates must continue but in a manner which provides for active and thorough review by the Commmission and participation by the State regulatory commissions. ACCOUNTING FOR DEPRECIABLE ASSETS The concept of matching expenses with the period in which they result in revenues is a central principle of accounting theory. Depreciation accounting, as generally recognized in accounting literature, attempts to recover invested capital at a rate which is consistent with the rate at which the assets are consumed. Thus, the rate of depreciation should correspond to the expiration of an asset's service value and the depreciation expense should be assigned to each accounting period in which the asset provides a service. In determining the rate of depreciation, estimating an asset's probable service life and the method or procedure by which the service value of property is allocated to operating expenses are crucial points. Service life estimation Probable service life estimation for telecommunications plant is influenced by many factors including: (1) physical factors such as wear and tear, actions of the elements or deterioration and (2) functional factors such as inadequacy, obsolescence, changes in the art, changes in demand, and requirements of public authorities. Mortality data, a history of past service lives and recent life trends of like or similar plant, is the foundation of FCC's life estimation process. Depreciation engineers by studying the patterns of asset survivorship calculate for |