No More Free Ride?

Posted: 12/2003

No More Free Ride?
Regulators Consider Rules for Internet Phone Companies
By Josh Long

A new breed of phone companies is rapidly sprouting. They are hip.

They are cheap. And for now, they are unregulated.

Enter the world of IP telephony, a realm beset by technological challenges over the last several years, but today poised to win the loyalty of millions of Americans looking to cut the fat out of their telephone bill. These phone mavericks control a microscopic market share compared to the likes of AT&T Corp. and Verizon Communications Inc., but they claim they are growing swiftly among broadband-equipped consumers.

In September, Vonage, reputed to be the largest Internet telephone company, announced it had activated 50,000 lines on its network since launching service in April 2002. Research firm In-Stat/MDR forecasts 1.3 million subscribers in 2003  a small fraction of the total U.S. voice services market. In- Stat/MDR senior analyst Daryl Schoolar notes the potential is much greater as evidenced by the interest state regulators recently have shown in controlling them. He explains the states primary concerns are IP telephony providers paying their fair share of statelevied service fees, taxes and support for 911.

ATLANTIC-ACM analyst Joyce Lo agrees, and notes, A growing number of states are connecting the dots and recognizing potential losses in tax revenue as customers shift from traditional carriers to VoIP providers.

She says traditional telecom players  namely Bell companies  are lobbying for VoIP regulation. This is a clear signal that, although adoption has been miniscule to date, VoIP technologies could threaten their long-standing dominance of the voice markets, she says. It also is noteworthy that cable companies  the competitors the Baby Bells fear the most  are planning to launch VoIP services.

Should Vonage Holdings Corp., Net2Phone Inc., 8x8 Inc. and other phone companies routing calls over the Internet be subject to the same regulations as old Ma Bell, a company with roots  and to a large extent technology  dating back more than a century?

The Minnesota Public Utilities Commission thinks so. In September, it ruled New Jersey-based Vonage is subject to telecom regulations and must comply with various requirements. The commission finds that what Vonage is offering is two-way communication that is functionally no different than any other telephone service, the Minnesota regulator stated.

There is only one problem.

U.S. District Court Judge Michael Davis disagreed, finding state regulation over VoIP services is not permissible because of the recognizable congressional intent to leave the Internet and information services largely unregulated.

Of course, the debate wont end there. Minnesota could appeal the decision to a higher court, and other states are grappling with the same challenge: whether and how to regulate phone companies routing calls over the Internet.

I think everyone including Minnesota agrees it would be useful to have the FCC help provide a framework, says William Wilhelm, a partner with Swidler Berlin Shereff Friedman, LLP, representing Vonage.

That is going to happen.

In November, the FCC announced plans to initiate a notice of public rulemaking to look at how to regulate Internet-based phone companies.

We have actually accelerated the timetable on this notice of public rulemaking, said FCC spokesman Richard Diamond. The court decision in Minnesota and other developments show the importance of examining and settling the questions involved.

During a speech in October, FCC Chairman Michael Powell reaffirmed his position that the nations top telecom regulator must not apply old rules to new technologies based on a century-old phone monopoly.

Over the course of the next year, after full public comment and thoughtful consideration of the record, the FCC plans to follow up the NPRM with a report and order on the VoIP issues raised in the proceeding, Powell said in a letter to U.S. senator Ron Wyden (D-Ore.).

Meantime, state regulators are investigating VoIP regulation. In a letter sent to six phone companies, including Vonage, that route calls over the Internet, the California Public Utilities Commission directed the telcos to be regulated as licensed telecom providers by Oct. 22. Based on our monitoring of the telecommunications market and actions being taken by other state regulatory commissions, the telecommunications division concludes that your company  is offering intrastate telecommunications service for profit in California without having received formal certification from this commission to provide such service, writes John Leutza, director of the California PUCs telecommunications division.

In September, broadband phone company 8x8 Inc., said it had been notified by the Public Service Commission of Wisconsin that it appeared 8x8 was offering telecom services without getting the proper certification from the commission. Linda Barth, a spokeswoman for the Wisconsin PSC, says the commission had not decided to regulate 8x8. We are in an information-gathering phase to see if they are providing telecommunications services according to our statutes, she said.

Wilhelm, Vonages lawyer, says Vonage does not oppose all form of regulation, but the rules must be appropriate for a nascent industry and common carrier regulation is inappropriate for Internet applications.

In the most general terms, Minnesota regulators ruled Vonage must be subject to the same regulations as other telecom providers because it is essentially providing customers the same thing: phone service.

Vonage says it offers an information service, which is not subject to common carrier regulations under federal law.

Vonage says its phone service is distinctly different from a traditional phone company, such as AT&T. Vonage provides local and longdistance phone service to consumers and small businesses over the Internet, rather than via a traditional switched phone network. Vonage customers must have a high-speed Internet connection and special customer premises equipment.

Analyst Schoolar says a hodgepodge stateby- state approach [to regulating VoIP] has the potential to strangle one of the more innovative Internet applications to have come along by drying up capital investment.

Raising money to grow a business is tough enough; now try it with the threat of a regulatory ruling putting you out of business. Now try it when it isnt just one threat, but fifty. That is what many IP telephony providers are facing when they try to raise money. Investors arent going to put their money into a business until questions of legality are resolved.

Analyst Lo agrees startups would face increasing financial pressure in the face of regulation. VoIP providers will have to pass on regulatory recovery fees, taxes and the like to consumers, which ultimately equates to higher prices for IP telephony, she says. These regulatory hurdles and extended financial implications for customers will slow adoption.

Qwest to Offer VoIP to Avoid Regulatory Expenses, CEO Says

Qwest Communications International Inc. plans to offer Internet-based phone service to the mass market in part of its local territory, says chief executive Richard Notebaert.

Speaking at a forum in Arlington, Va., Notebaert revealed Qwest plans to offer VoIP in Minnesota and possibly Arizona to save on regulatory expenses and other costs, the Minneapolis Star Tribune reported Nov. 5.

A federal court recently ruled Minnesota regulators do not have the authority to treat Internet telephone companies, such as Vonage Holdings Corp., as they do traditional phone companies. However, the FCC has yet to rule on how, if at all, to regulate IP phone companies.

Our objective in offering voice over IP at the mass market level  because we already do it in the enterprise space  will be to explore this path, to take this journey as the path to deregulation, the Star Tribune quotes Notebaert.

Qwest spokeswoman Kate Varden says she could not offer any details. We are still developing the strategy and deployment plans, she says.