Rerouting Telecom Law

As a 12-year-old, John La Rue scavenged wires and parts from a local junkyard to build a crude telephone network connecting his neighborhood buddies through relay switches attached to an abandoned doghouse.

It didn’t take long for the telephone police to catch on.

“One afternoon, when I came home from school, there was this man who appeared to me to be about 25 feet tall standing on the front porch,” said La Rue, now 54. “He told me that I needed to cease and desist from operating my illegal telephone utility.”

Four decades later, the law is on his side. The company he founded, Pac-West Telecomm Inc., is challenging big phone companies with the encouragement of state and federal regulations.

Pac-West’s primary business is to route calls by Internet users in California to their service providers, like EarthLink Inc., in a way that makes the calls local, not long-distance. SBC Communications Inc. and Verizon Communications Inc. carry the traffic on their networks to three Pac-West switching centers in California, a strategy that saves Internet providers and their customers a bundle in toll charges.

It’s an arrangement made possible by the federal Telecommunications Act of 1996, which was designed to spur competition in local phone service after a century of monopoly.

Since Congress passed the act, dozens of companies like Pac-West have found niches in California, giving customers an array of new services and saving them hundreds of millions of dollars.

Now the law’s future is in doubt. A series of court decisions have thrown out key rules written in Washington to carry out the act, and politicians are considering revamping it. Baby Bells are demanding significant increases in state-regulated rates that they are allowed to charge rivals to use Bell lines and gear to deliver service to homes and small businesses.

And new technologies are threatening to upend the phone industry’s intricate and intertwined financial structure: voice over Internet protocol, or VOIP, for example, uses data lines to bypass not only the traditional phone network but also state and federal regulations and taxes.

The court rulings and the pressure on regulators have put the “critical mission” of promoting local phone competition in jeopardy, Federal Communications Commissioner Kevin J. Martin recently told Bell rivals.

“Policymakers in Washington are not debating the benefits of the services that you all are providing,” he told members of a trade group meeting of Bell rivals in Anaheim. “They are too frequently debating how much of the rules should be eliminated.”

At Pac-West, executives say the rules have too often been ignored.

Although 20% of the dial-up Internet traffic in California travels through Pac-West switches, the company last year lost $15.2 million on revenue of $134.6 million, after a profit of $2 million on revenue of $164.1 million in 2002. The reduced revenue and nearly all the loss were caused by Verizon and SBC withholding payments that Pac-West said were due under contracts for connecting Bell lines with Pac-West switches. A federal court ordered the FCC two years ago to resolve the pay dispute, but the agency hasn’t acted.

La Rue -- who sold most of the company in 1998 but is a director on Pac-West’s board -- worries that Martin may be right.

“It would be a huge disservice to the citizens of the country to have competition squashed,” La Rue said.

Early Distaste for Bells

His antipathy toward the Bells goes back to when he was a boy. His father, Knox, owned a Stockton radio station and telephone answering service and disliked Pacific Telephone, then a division of AT&T.; When the federal government broke up the company known as Ma Bell in 1984, local service was split into seven regional Baby Bells -- including Pacific Bell, which would later be acquired by SBC.

La Rue became interested in phones at age 8, when a family friend gave him an old telephone and challenged him to figure out how it worked. Four years later, La Rue was spending a good part of his summer vacation building his Backyard Telephone & Telegraph Co., the name he gave to the straggly network he put together.

“I used to ride my bicycle over to the phone company’s yard at about 6 o’clock on Saturday mornings to beat the dumpster man, and I’d just scrounge parts,” La Rue said. “Plus, my father liked collecting stuff, not to be called junk, and occasionally there would be a couple of phone things that I couldn’t find at surplus yards.”

It was the ultimate party-line system: Make one call, and everyone could join in the conversation.

But a phone company worker on a nearby pole spotted the network and told his supervisor.

That person was most likely the man who was waiting for him on the porch, La Rue said. Later that night, several local Bell executives showed up, and La Rue’s father left his son in charge to talk with them.

“They finally admitted they were wrong” to try to interfere with his neighborhood network, “and we all smiled and they went their way,” La Rue recalled. The phone company began sending the young boy science kits, which he enjoyed. “But that didn’t make me particularly like them any more.”

That disdain led him to found Pac-West in 1980, after stints in the Navy and at the Atomic Energy Commission as a telecommunications technician. Pac-West started out selling and servicing telephone systems -- everything needed to connect a business with the Bell line outside -- and added long- distance service after the breakup of AT&T.;

At one point, the company ran a nationwide paging operation with tens of thousands of customers, including other paging companies that bought hardware and difficult-to-get numbers for their pagers from Pac-West.

The numbers issue proved to be what pushed Pac-West into becoming a full-service telephone carrier. In the summer of 1995, Pac-West put in an order for half a million new numbers from PacBell, its only source. PacBell balked, telling La Rue he might not get his order filled.

That August, Congress was working through what would become the Telecommunications Act, which would open the Bell monopolies to competition. Pac-West’s regulatory lawyer called La Rue.

“He said, ‘John, do you want to become a CLEC?’ ”

“I said, ‘What’s that?’

“He said, ‘We’re not really sure yet, but that’s where you get to be your own phone company and sell phone lines to others,’ ” La Rue recalled.

These competitive local exchange carriers could get their own phone numbers from a federal agency, and La Rue desperately needed numbers. Pac-West was one of the first companies to file an application to become a Bell rival, and PacBell lost a big sale.

Focusing on the Internet

As a new phone company, Pac-West targeted Internet service providers, or ISPs, which were starting to build up their subscriber bases for dial-up service. PacBell and California’s second-largest local phone company, GTE Corp., which is now Verizon, were forcing ISPs to put modems in every town they wanted to serve and to lease expensive data circuits. And the Bells refused to rent central office space to ISPs, which would have lowered those companies’ costs.

So Pac-West, which owned phone numbers galore and already had interconnection agreements with the Bells, built big switching centers in Los Angeles, Oakland and Stockton and rented space there to the ISPs.

In negotiating the interconnection agreements, Pac-West Chairman Wallace W. Griffin said, the Bells had insisted on a payment method called reciprocal compensation: The Bells would pay Pac-West so that their customers could use Pac-West facilities to access the Internet, and Pac-West would pay the Bells when its clients wanted to place calls back to Bell customers.

But the calling was going only one way. Pac-West’s customers typically had no need to call Bell customers. But when Bell customers dialed local numbers to get to their ISPs, the Bells had to haul those calls to Pac-West switching centers. PacBell stopped paying Pac-West in 1997 and Pac-West sued, settling two years later for $40 million, or two-thirds of what it figured it was owed.

“Some heads rolled on that contract,” said an SBC executive who asked not to be named.

Now, SBC, which has been gradually phasing out the PacBell name in recent years, wants Pac-West to put more switches and equipment further into SBC’s territory.

Last year, SBC won a California Public Utilities Commission order forcing Pac-West to expand its facilities or pay SBC $40 million a year for the traffic its delivers to Pac-West’s three centralized switching centers.

Separately, both SBC and Verizon invoked a much lower federal payment schedule last year to get around the reciprocal compensation terms in their contracts. The lower payments led to last year’s drop in Pac-West’s revenue and the net loss. Pac-West is challenging their actions at the PUC, at the FCC and in court.

“Now they’d like to have us out at every nook and cranny and force us to go broke,” said John Sumpter, Pac-West vice president for regulatory affairs.

Pac-West is moving deeper into the Bells’ market with help from a $40-million investment by Deutsche Bank. The company also is taking advantage of VOIP to offer new services to small and medium-size companies. That market is helping to lessen dependence on ISP traffic, which accounts for 70% of the company’s revenue.

The strategy makes efficient use of Pac-West’s switches and other gear, Griffin said, because corporate customers use the system most during the day, and ISP customers go online mostly at night.

Stag’s Leap Wine Cellars in Napa was one of Pac-West’s first VOIP customers

“What I love about Pac-West is that when I have a problem, I’ve got one number to call,” said Dan McPherson, information technology director at Stag’s Leap, which has more than 60 lines at its headquarters and sales offices. “At PacBell, I feel like a Ping-Pong ball.”

Homage to Phones

Since La Rue sold most of the company to investors, who took it public in November 1999, he has spent much of his time tending to the 10,000-square-foot private telephone museum he built in the hills east of Stockton.

Besides showcasing nearly 1,000 phones that date back a century and three operating central offices with 600 phone numbers, the museum contains old manuals and telephone directories that include instructions on how customers should address and talk with Bell employees.

“There are instructions that you will not even put a cover over your telephone directory because it’s their telephone directory,” La Rue said.

Outside the museum sits a 1923 Cincinnati & Suburban Bell service truck he bought through EBay last year. An owner’s manual explains how to operate cranks, pulleys and three pedals. Instructions start with “Lift hood on passenger side and turn on fuel valve” and end with “For stopping in an emergency, stomp on any two pedals.”

La Rue meets often with Pac-West workers for French dip sandwiches at the Scores Sports Bar inside West Lane Bowl, a Stockton hangout he helped make popular among colleagues.

Besides conveying his antipathy for the Bells, La Rue shares his love of telephony, both old and new. He enjoys showing people around his museum and explaining how things work.

“There are tens of millions of standard telephone sets out there, and they still have to work,” he said. “You’ve got to make the new stuff work with the old stuff.”

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Coming Monday: Telscape Communications Inc. builds a business around Latino customers. Also, SBC Communications Inc., California’s dominant telephone company, is fighting back by building modern fiber-optic networks it doesn’t have to share with rivals.