Jules M. Perlberg, Chicago, Ill., with whom David J. Lewis, Washington, D.C., Howard J. Trienens, Judith A. Maynes, New York City, and O. Carey Epps, Oklahoma City, Okl., were on the brief for intervenor American Telephone & Telegraph Corp. in Nos. 82-1237 & 82-1456. Alfred Winchell Whittaker, Keith E. McClintock, New York City, and Raymond F. Scully, Washington, D.C., also entered appearances for American Telegraph & Telephone Corp.

Richard McKenna and James R. Hobson, Washington, D.C., were on the brief for intervenors GTE Service Corp., et al. in Nos. 82-1237 and 82-1456.

J. Roger Wollenberg, William T. Lake, Roger M. Witten and Thomas F. Connell, Washington, D.C., were on the brief for International Business Machines Corp. in Nos. 82-1237 and 82-1456.

Thomas J. O'Reilly, Washington, D.C., was on the brief for intervenor United States Independent Telephone Ass'n in No. 82-1237.

John L. Bartlett and Howard D. Polsky, Washington, D.C., entered appearances for intervenor Aeronautical Radio, Inc. in No. 82-1237.

James M. Tobin, Daniel A. Huber, Mitchell F. Brecher and Mark P. Bresnahan, Washington, D.C., entered appearances for intervenor Southern Pacific Communications Co. in Nos. 82-1237 and 82-1456.

Michael L. Glaser, Washington, D.C., entered an appearance for intervenor Anchorage Telephone Utility in Nos. 82-1237 and 82-1456.

John A. Ligon, New York City, entered an appearance for intervenor United States Transmission Systems in Nos. 82-1237 and 82-1456.

Joseph M. Kittner and Edward P. Taptich, Washington, D.C., entered appearances for intervenor, Ad Hoc Telecommunications Committee in Nos. 82-1237 and 82-1456.

F. Thomas Tuttle, McLean, Va., Harold David Cohen, Jack N. Goodman, J. Laurent Scharff, W. Theodore Pierson and Richard M. Singer, Washington, D.C., entered appearances for intervenor Satellite Business Systems in Nos. 82-1237 and 82-1456.

Alan Y. Naftalin, Margot Smiley Humphrey, David Cosson, Amy S. Gross, David A. Irwin and Ellen S. Deutsch, Washington, D.C., entered appearances for intervenors Rural Telephone Coalition et al. in Nos. 82-1237 and 82-1456.

Carolyn C. Hill, Washington, D.C., entered an appearance for United Telephone System, Inc. in Nos. 82-1237 and 82-1456.

Paul Rodgers, Charles D. Gray and Deborah A. Dupont, Washington, D.C., entered appearances for intervenor Nat. Ass'n of Regulatory Utility Com'rs in No. 82-1237.

Donald A. Low, Topeka, Kan., entered an appearance for intervenor State Corp. Com'n of the State of Kan. in No. 82-1237.

Before WILKEY* and MIKVA, Circuit Judges, and BAZELON, Senior Circuit Judge.

Opinion for the Court filed by BAZELON, Senior Circuit Judge.

Petitioners challenge a Federal Communications Commission's (FCC) decision modifying the formula that separates costs for telephone equipment used in both interstate and intrastate services. In these consolidated cases, two issues are raised. First, the MCI Telecommunications Corporation (MCI) and the Louisiana Public Service Commission (PSC) contest the FCC's adoption of an interim freeze of the separations formula allocating the costs of non-traffic sensitive plant between intrastate and interstate jurisdictions. Second, the PSC also challenges the phase-out of the costs of embedded customer premises equipment from the separations process. Because the FCC is working to achieve a reasonable cost apportionment, the FCC's decision is affirmed.

Much telephone equipment is jointly used to provide both interstate and intrastate services. Subscriber plant equipment includes the telephone, the wiring inside a customer's home, the line connecting homes to the local switching office, and the termination of that access line in the local switching office. Subscriber plant equipment is termed non-traffic sensitive, because its costs do not vary with the level of use. Customer plant equipment (CPE) is part of the jointly used plant. CPE includes telephones, answering machines, key systems, and private branch exchange switchboards.

"Jurisdictional separation" is a procedure that determines what proportion of jointly used plant should be allocated to the interstate and intrastate jurisdictions for ratemaking purposes. Jointly used plant whose costs are traffic sensitive is generally allocated on the basis of actual or relative use. On the other hand, non-traffic sensitive plant has been more difficult to allocate appropriately. The FCC has been struggling for many years to derive a reasonable apportionment formula for nontraffic sensitive plant costs.

Jurisdictional separations since 1947 have been performed almost entirely on the basis of a separations manual. This manual is developed jointly by the FCC and the National Association of Regulatory Utility Commissioners. The 1947 manual provided for the allocation of subscriber plant equipment between the interstate and intrastate jurisdictions on the basis of relative use. This basis of relative use is commonly referred to as subscriber line use (SLU). Since 1947, there have been five major revisions of the manual, the most recent being the 1970 Ozark Plan.1

Under the Ozark Plan, subscriber plant costs were allocated pursuant to a formula that has the effect of assigning approximately 3.3 percent of the non-traffic sensitive costs of subscriber plant equipment to the interstate jurisdiction for every 1 percent of interstate calling.2 This percentage allocation is called a subscriber plant factor (SPF), which is determined by the formula. The purpose of SPF was to compensate for the deterrent effect of toll rate schedules on interstate calling.3 No one sought judicial review of the Ozark Plan, and it has since its inception determined jurisdictional separations.

Following the adoption of the Ozark Plan, the telecommunications industry underwent fundamental changes. Overall, the provision of long-distance services has become subject to intense and increasing competition.4 The recent political climate in which agencies must operate has been characterized as a "rush to deregulate."5 In addition, rapid technological advances may create the need for interim solutions. Here the merging of computer and communications technologies redefined the equipment that was part of CPE.6 Amidst these sweeping changes, two specific factors generated the FCC's concerns about whether the existing separations manual should be revised. First, there has been a great increase in the level of interstate calling relative to intrastate calling. While interstate usage was estimated to increase from 5.5% to 8.3% from 1972-83, the non-traffic sensitive costs allocated to the interstate jurisdiction increased from approximately $1.9 billion to $11.2 billion.7 This resulted from the use of the SPF factor that caused the allocation to the interstate jurisdiction to grow about three times as fast as usage. Second, the FCC concluded in Computer II,8 that the provision of CPE should no longer be considered a common carrier activity subject to tariff regulation.

In response to these developments, the FCC, in June 1980, initiated Docket No. 80-286 by establishing a Federal-State Joint Board9 to reexamine the FCC's separations procedures.10 The Joint Board invited public comment on a specific plan for phasing CPE out of the separations process. The Joint Board also set forth questions relating to the general treatment of non-traffic sensitive plant in the separations process.11 After considering the comments of the parties, the Joint Board issued its recommendations on December 14, 1981.

After inviting public comment on the recommended orders,12 the FCC adopted the Joint Board's proposals with minor modifications.13 3] Pursuant to that decision, SPF is frozen at the average 1981 annual percentage levels as an interim measure pending the development of comprehensive revisions in the separations procedures. The FCC also instituted a five-year phase-out of embedded CPE costs from the separations process at the rate of one-sixtieth per month.

The FCC concluded that use of SPF had increased the proportion of non-traffic sensitive plant allocated to the interstate jurisdiction dramatically, and that this trend was likely to continue. The FCC indicated that:

[T]welve years of experience have shown that the adjustment made in the present allocation formula for whatever deterrence that may exist is excessive .... [I]nterstate usage has risen substantially enough to significantly inflate the non-traffic sensitive costs allocated to interstate above the level considered acceptable in 1970.14

Furthermore, the concomitant increase in interstate rates spurred the prospect of bypass--the use of facilities other than the telephone companies' existing local exchange networks to originate and terminate interstate calls.15 The halt of the growth of SPF was an interim measure--a means of preserving the status quo pending completion of the comprehensive separations package. Because this was an interim measure, the FCC deferred consideration of basic issues that were being evaluated by the Joint Board in the design of a comprehensive and permanent plan.16

The freeze was preferred as an interim measure because it maintained allocations for non-traffic sensitive plant at a fixed percentage level. Other possible interim measures might "benefit some users and prejudice others as a result of usage fluctuations during the course of Joint Board and Commission deliberations."17 Furthermore, while the freeze imposed a cap on the percentage of non-traffic sensitive costs allocated to the interstate jurisdiction, it allowed a growth in the absolute dollar allocation. Hence, if non-traffic sensitive total costs increase as a result of inflation or additional investment, the interstate share of those total costs also will increase.18

In Computer II, the FCC determined that CPE should not be a common carrier service offered under tariff regulation.19 Because CPE is readily severable from basic transmission service, tariff regulation might inhibit effective competition.20 The FCC decided to bifurcate the deregulation of CPE. CPE acquired after January 1, 1983 would be excluded from a carrier's rate base and from tariff regulation. CPE already embedded in the rate base ("embedded CPE") was more troublesome. This was because reimbursement through interstate rates provided important revenues to carriers with embedded CPE. Significant economic dislocations would be caused by an abrupt removal of embedded CPE from regulation. Furthermore, detariffing embedded CPE would take time, because of the difficulties of valuing CPE.21

The FCC required carriers to identify a base amount of CPE as of January 1, 1983, for use in the separations process. The base amount reduces at a rate of one-sixtieth per month over a five-year period, corresponding to the time in which the FCC anticipates that embedded CPE will be removed from the rate base of all carriers.22

The FCC preferred this solution over a number of other methods that were considered because it would encourage states to adopt policies favoring the sale or transfer from the rate base of embedded CPE. This transitional solution would therefore implement the goals and policies of Computer II more readily. The phased removal of CPE was determined to be a reasonable compromise of the FCC's twin objectives of encouraging a competitive marketplace and of avoiding undue dislocations during the transition.23

Petitioner MCI challenges the FCC's decision to freeze SPF, claiming that it is unconstitutional and unreasonable. Petitioner PSC takes the opposite view, arguing that the order is an unreasonable attempt to halt the growth of the SPF. PSC also challenges the validity of the FCC's order phasing out embedded CPE from the separations process. Because the orders are reasonable and are not unconstitutional, the FCC's decision is affirmed.

The FCC's plans were based upon the Commission's expertise and experience in regulating the communications industry and upon hearing the comments of that industry's members.24 Our review is limited to whether the separation requirements resulted from a consideration of relevant factors and whether there was a clear error of judgment.25 Furthermore, substantial deference by courts is accorded to an agency when the issue concerns interim relief.26 Here the FCC engaged in reasoned decisionmaking well within the scope of its discretion.

Petitioner MCI contends that the continued use of SPF is unlawful under the requirements of Smith v. Illinois Bell Telephone Co.27 MCI urges that Smith requires cost separation based upon a relative usage principal (SLU). MCI's claim, however, must only be considered in the context of the regulation that is actually being challenged here.28 Hence, the question that must be addressed is whether Smith constitutionally requires that the interim freeze is per se unlawful because the transitional separations process is not based on relative use.

MCI's interpretation of Smith must be rejected here. The Smith court was not considering the constitutionality of an interim ratemaking solution. Substantial deference must be accorded an agency when it acts to maintain the status quo so that the objectives of a pending rulemaking proceeding will not be frustrated. What needs to be shown to uphold the FCC is that "existing, possibly inadequate rules" had to be frozen to avoid "compounding present difficulties."29 This standard was easily met. The record before the FCC contained substantial evidence of the need for an interim freeze of SPF. The FCC explained that the basis for the SPF freeze was to preserve its ability to implement comprehensive separations revisions in a manner that would cause the least upheaval in the industry. It is reasonable for the FCC to take into account the ability of the industry to adjust financially to changing policies.

Furthermore, Smith appears to be based on the limits of state jurisdiction, rather than on constraints imposed on federal agencies by the due process clause.30 Smith does not constitutionally compel use of a particular formula. Smith compels "only reasonable measures,"31 because the "[a]llocation of costs is not a matter for the slide-rule," but "involves judgment on a myriad of facts."32 Cost allocation is not purely an economic issue--it necessarily involves policy choices that are not constitutionally prescribed. Interim solutions may need to consider the past expectations of parties and the unfairness of abruptly shifting policies.

For similar reasons, petitioner PSC's contention that it was unreasonable to freeze SPF must be rejected. The FCC concluded that an interim freeze was necessary because SPF had not performed as an allocative factor as had been originally envisioned. The freeze was a response to an unanticipated rise in the percentage of interstate costs. Given the changes in the competitive structure of the telecommunications industry, it was likely that the FCC would reduce the allocation to the interstate jurisdiction.33 Had the FCC allowed the SPF percentage to continue to rise, the anticipated restructuring would have been exceedingly disruptive. The FCC reasonably concluded that the SPF freeze would best preserve the status quo and cushion the effects of future rulemaking. The record shows that there was sufficient attention to required rulemaking procedures.

The PSC challenges the five-year phase-out of CPE. It contends that the FCC did not adequately explain the need for any action with respect to embedded CPE.34 Furthermore, PSC argues that the FCC did not take into account the effect of its decision on local rates, and that its order will eventually result in intrastate ratepayers shouldering an undue cost burden.

The FCC's decision in Computer II,35 however, forecloses these arguments. In Computer II, it was decided that the provision of CPE, whether new or embedded, should no longer be a common carrier and therefore not subject to tariff regulation. In affirming the FCC's decision, this court held:

both the Commission's finding and its conclusion were reasonable. Because CPE charges are not based on usage, including the costs of providing CPE in the calculus for determining the reasonableness of a carrier's rates makes it difficult to identify accurately the costs of providing transmission services, which are priced according to usage. It was therefore reasonable for the Commission to exercise jurisdiction over carrier-provided CPE to ensure that rates for carrier transmission services are not based upon costs associated with the provision of CPE.36

Since the FCC could deregulate all CPE today, it is unreasonable to preclude the agency from avoiding hardships by denying it the power to phase-out the regulations. Because there is no purely economic allocation of common costs, elements of fairness and other values must enter the analysis of the choice to be made.37 The FCC's actions in the prevailing climate of deregulation are not invalid. The five-year phase-out implements a policy in a way that has minimal impact on local rates, consistent with the goal of detariffing. The phase-out helps to avoid undue economic dislocations.38

Again, the FCC followed correct procedures and its conclusions are justified. The estimates made by an agency, if rationally explained, are entitled to deference by courts.39 Here the removal of CPE separations reasonably accommodates the separations process to the deregulation of CPE.

The Federal Communications Commission properly explained its reasons for the interim freeze of SPF and the phase-out of embedded CPE. These temporary and ameliorative solutions are supported by adequate evidence. For the foregoing reasons, the decision of the Commission is

Affirmed.