Exposing One of the Largest Accounting Scandals in American History

Why is America not in the Top 20 in the world in wired or wireless broadband speeds? Why are America's communications prices higher than many other countries? Why is there no serious competition -- and how do we fix this mess?

Verizon's Manipulated Accounting & the FCC's Big Freeze: 15 Years of Neglect

New Networks Institute just released two reports in a new series, "Fixing Telecommunications". It is based on mostly public, but unexamined information that exposes one of the largest financial accounting scandals in American history. It impacts all wireline and wireless phone, broadband, Internet and even cable TV/video services, and it continues today with impunity.

Verizon, AT&T, CenturyLink, and other large telephone companies have been able to manipulate their financial accounting to make the local phone networks and services look unprofitable and have used this 'fact' in many public policy and regulatory decisions that benefited the incumbent telecommunications utilities.

But the core of this scandal, which we dubbed the "FCC's Big Freeze", is so bizarre that no one would believe it if it was detailed in some thriller about financial chicanery. I'll get to this in a moment.

Why Does this Matter to All Communications Services?

In NY State, Verizon used this so-called 'unprofitable' excuse to raise local rates multiple times, stopped deploying and upgrading the fiber optic-based wired networks used for FiOS services, and even stopped maintaining the existing copper networks with the plan to shut off the copper and force customers onto wireless. This has left most cities with deployment gaps or no upgrades at all.

But this is a national story and it impacts the price and availability of all services, as these networks aren't just the copper-based wires for phone service but are the copper and fiber wires that are used for wireless services, as almost all mobile data, video or calls end up riding over a wire, known as 'special access'. These services are mostly controlled by Verizon, and in their own separate territories, AT&T and Centurylink (they do not compete among themselves for this business in any significant way).

And this means that the incumbent utilities, AT&T, Verizon and Centurylink, also control the costs that all competitors pay to use these networks including the wireless companies, T-Mobile or Sprint. And they control the costs to wireless hot spots and any DAS, small wireless cell sites that ride over a Verizon et al. wire. And they also control the costs and access for all CLECs, Competitive Local Exchange Companies, offering phone calling, broadband, or Internet service.

Adding insult to injury, the losses were caused, not by expenses for traditional wireline local voice and DSL Internet services, but by the cross-subsidies of Verizon's other new unregulated lines of business that dump expenses into the regulated state utility. Much of Verizon Wireless's fiber wires to the cell towers, it appears, were paid for by local phone customer rate increases -- which helped to make local service look 'unprofitable'.

Finally, this impacts every aspect of the FCC's Internet Order, commonly known as Net Neutrality, which is now in court. The massive cross-subsidies between and among Verizon NY and Verizon's other subsidies have allowed the company to control the networks and services over them -- which caused Net Neutrality concerns in the first place.

The FCC's Big Freeze --15 Years of Regulatory Neglect

However, while there are multiple questionable acts, the core of this scandal is the fact that the losses were created, in large part, by the FCC, which sets the rules about the incumbent phone companies' accounting. Simply put:

  • In 2001, the FCC "froze" the calculations of expenses that are used in every state, based on the year 2000 -- and this freeze will continue until the year 2017. It assigns the majority of all expenses to the local phone service category.

You can't make this stuff up. And when we use the term "freeze", we are actually quoting the FCC.

"Freezing of jurisdictional separations category relationships and/or allocation factors.

"(a) Effective July 1, 2001, through June 30, 2017, all local exchange carriers...shall apportion costs to the jurisdictions using their study area and/or exchange specific jurisdictional allocation factors calculated during the twelve month period ending December 31, 2000, for each of the categories/sub-categories as specified herein."

What this gobblygook says -- all phone companies will keep the percentage of all expenses for each line of business, as if it was the year 2000. So literally, the FCC 'froze' these expenses based on the year 2000. This is the current model used in every state in America.

And so, for the last 15 years there have been no major audits and no examination by either the state commissions or the FCC. This phrase, more or less, has appeared since 2001 in FCC materials -- "until comprehensive reform could be achieved".

Example of the Big Freeze

In previous articles we detailed that Verizon New York charges each line of business expenses; these include "Corporate Operations" expenses, (which is everything from lawyers to lobbying) as well network construction and maintenance costs, customer service handling, and advertising, among others.

  • In 2003, Verizon NY's (VNY) Local Service brought in 65% of revenues and paid 65% of the "Corporate Operation" expenses.
  • In 2014, VNY's Local Service generated only 27.6% of revenues, about $1.4 billion, but it paid the majority of the "Corporate Operation" expense, over 60%, which came to $1.6 billion -- making it unprofitable.
  • And to illustrate this in very stark contrast, check out this next exhibit. The pattern is clear that Verizon New York's Local Service "revenues" declined, but the expenses did not.

    2015-12-10-1449730158-1478715-Verizonfreeze.png

    This happened with every major expense area: Verizon NY's Local Service category paid 57% of all expenses, from network costs to advertising and marketing.

    For example, take network construction and maintenance costs, (known as "Plant & Non-Specific Plant" expenses). In just 2014, Local Service paid $1.5 billion.

    This is crazy on the face of it. Local Service is mostly the copper-based, POTS, Plain Old Telephone Service, and add-on features. There should be no major network costs for Local Service. In fact, according to Verizon:

    "Since 2008, Verizon has spent more than $200 million on its copper network."

    This is for ALL Verizon territories and for the last seven years. This means that every other service that uses the wires -- from special access, to FiOS, to the wires to the cell towers to... well everything, DID NOT PAY THEIR FAIR SHARE FOR THE LAST DECADE and it appears to be subsidized by Local Service, which then is used to say that the Local Service networks are 'unprofitable'.

    Manipulation of the Counting of Access Lines Is also Part of this Deception.

    But isn't Verizon losing 'access lines'? Verizon NY claims that in 2000 they had over 11 million access lines and yet today there are only 2.7 million access lines in NY State.

    We agree that there has been a drop in one class of access lines -- regular POTS', Plain Old Telephone Service, which relies on copper wires, but it is a small subset of the total number of actual copper and fiber optic lines in service, especially business broadband and data lines known as special access.

    As we document, in 2007, the FCC's last accounting showed that basic phone lines represented only 18% of total lines. The FCC's data showed that Verizon New York's Local Service had about 7 million lines, but the company had a total of 47 million access lines (and 'equivalent' lines) in service.

    NOTE: One wire can handle more than one service or call at the same time. One business service, known as a 'T1", is one wire but it is the equivalent of 24 lines.

    Meanwhile, everyone trots out the Center for Disease Control's, (CDC) information about 'wireless-only' households. The CDC, also only counts 'voice calling' and has nothing to do with counting actual lines in service.

    Both Verizon and CDC leave out whole categories of lines that are part of the state utility, which include alarm services or DSL or Verizon's fiber optic FiOS TV or any business service, like a wire for an ATM cash machine, or the wire to the WiFi hot spot.

    In fact, we estimate that there could be over 65 million total access lines (and equivalent lines) in service in NY in 2014. How can we say this? Our estimate is based on the FCC's recent announcement that Special Access is now a $40 billion market and that 60%, or $24 billion, is mostly the copper telecommunications (TDM) services.

    "Despite the growth of newer technologies, preliminary analysis of the Commission's special access data collection shows that revenues from such TDM services (usually copper) continue to make up in the range of sixty percent of the roughly $40 billion annual special access market."

    In 2014, Verizon New York's Special Access service revenue was $1.8 billion (larger than Local Service) -- but nowhere can you find any information about the number of access lines it represents. Using the FCC's previous data and this new information, our estimates of lines blows up the phone company or the CDC's incomplete accounting. (We cover this topic in detail in a separate upcoming report.)

    AT&T and Verizon have filed with the FCC to block our access to the recently collected special access information. Now you know why we want to see the information and now you know why they are trying to block our access.

    Thus, every phone company is essentially manipulating the number of total lines in service in every state because they can leave out ALL of the other lines of business and all lines associated with them, even though they are part of the state utility and may using the old copper wires. And this is important because if they included all of the other lines in service, and thus the revenues they generate, it would show that the networks were profitable.

    There are Many Impacts on Customers and Cities

    Claiming that the wired networks are 'unprofitable', Verizon New York has been able to manipulate public policy and regulatory decisions in their favor.

    • Multiple Rate Increases: Verizon NY's local phone rates went up 84%, costing customers about $996.00 a line extra from 2006-2015; add-ons added $300-$600 per service.
    • Harvesting Regulated Utility Customers: The price of service should have been in steep decline. Instead, the plan was to raise rates until customers left for wireless.
    • Cities Aren't Getting Upgraded: Verizon stopped building out the fiber optic networks and left 900+ NY cities undone or incomplete, including NY City.
    • Massive Losses Reported: Verizon NY claimed to have lost $2.6 billion in just 2014 and had an "income tax benefit" of $1.3 billion. Starting in 2009, for this six-year period, Verizon NY lost $13.63 billion and had an income tax benefit of $6.34 billion. (with a caveat about 2013).
    • Paid No Income Tax: Verizon NY did not pay state or federal income taxes for over a decade.
    • Massive Cross-Subsidies: Verizon NY local phone customers paid the majority of the construction expenses, much of which funded other lines of business, such as wireless.
    • How much money are we talking about? Billions per year, per state: In New York, Verizon's Local Service was over-expensed by $2.1 billion for 2014 alone. On a national basis, this over-expensing would be around $24 billion annually. This doesn't account for rate increases paid or otherwise inflated pricing or the other economic harms incurred.

    The Manipulation of Expenses Impacts Every State and FCC Proceeding Where "Local Service" has been Deemed "Unprofitable".

    There are a slew of current state and federal proceedings that this manipulated financial accounting impacts today. From the IP Transition to the "migration" from the copper networks or the shutting off of those networks, or the claim that the companies can't upgrade cities because it is 'unprofitable', or increases to prices of broadband and data services to every business (including special access) -- there has been a massive, nationwide shell game as this has happened in every state in America and impacts every city in America.

    In short:

    • Price increases on local service that were based on 'losses'-- were manipulated.
    • Losses that were used to not pay state or federal income tax -- are in question.
    • Not building out the networks because they were 'unprofitable' -- is based on manipulated financial accounting.

    And, as we discuss in other upcoming reports, there are a host of other related actions being taken that are helped by this total lack of regulatory oversight and the manipulation of the financial accounting.

    • Local phone customers paid for building out the wireless networks as well as the special access networks.
    • The price of even wireless service is based on the cost associated with special access and tied to the costs of local service networks.
    • The price for competitors to use the networks has been manipulated.
    • Verizon's own affiliate companies get perks no other competitor receives, including not paying market prices.

    These are the first two reports. Over the next six months, another eight are slated to be released to address each of these topics -- and more.

    No more talking. No more hand waiving. It's time to fix telecommunications.