Draining the incumbent: US LEC's reciprocal comp charges deemed illegal

When competitive carriers mix reciprocal compensation from incumbent carriers, revenue-sharing agreements and management ownership in customers, the combination can be lethal. That's essentially what US LEC learned last week when the North Carolina Utilities Commission ruled that BellSouth did not owe US LEC $153 million in reciprocal compensation fees billed on traffic originating from a corporate customer's network.

The NCUC's decision, based on a complaint that BellSouth filed in September 1998, said that the customer, Metacomm, was "induced" by US LEC to establish an "always-on" system through the public network to generate a steady stream of reciprocal compensation for US LEC. In return, US LEC agreed to pay Metacomm 40% of the interconnection revenue generated by minutes of use from Metacomm's network.

The commission also said that Metacomm had very few customers or even a discernible business plan and that it was directed by US LEC to keep its network connections "nailed up" on a near-continuous basis so that US LEC could bill BellSouth the maximum amount for the open connections. To further complicate matters, Richard Aab, US LEC's chairman, owns a controlling interest in Metacomm.

While BellSouth said the ruling sent a clear signal that carriers doing business in North Carolina can't "game the system," US LEC executives said they were disappointed with the ruling and that the case was not as "black and white" as the NCUC's order portrayed. "We didn't induce anyone. The words [in the order] do not reflect some of the facts here," said Aaron D. Cowell Jr., president of US LEC.

For example, Cowell pointed out that Metacomm's BellSouth and US LEC benefited from the switched-network setup, Cowell said. BellSouth earned close to $1 million per month for leasing ISDN lines and DS-3 facilities to Metacomm, Cowell said. "Neither [of us] had the incentive to have it be a private-line network."

In addition, Aab's controlling investment in Metacomm in June 1998 was designed to spur a change in the company's management team and bring more customers onto the network, Cowell said. However, although Metacomm entered into an agreement with The Learningstation.com to host educational applications on the network, the NCUC found that only one customer ever accessed those applications.

In the meantime, US LEC was advancing Metacomm up to $500,000 per month to keep open the "empty connections" that were routed to US LEC numbers and generating a reciprocal compensation imbalance with BellSouth.

Records show that US LEC recorded $50 million in reciprocal compensation revenue related to Metacomm network traffic in 1998 and $98 million in 1999. In the past, reciprocal compensation fees had accounted for about 65% of US LEC's revenue, said Chief Financial Officer Michael K. Robinson, but that would decline to 10% of its revenue stream in 2000.

The order will result in a pre-tax, nonrecurring charge of about $55 million in the first quarter of 2000, Robinson said. The company had $39 million in reserves set aside to cover possible losses from the case.

US LEC also is near completion of a $300 million private equity transaction, Robinson said, and the company has the full backing of its investors.