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., 8×8 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 8×8 Inc., said it had
been notified by the Public Service Commission of Wisconsin that it appeared 8×8
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 8×8. 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.