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Court hangs up state VoIP rules

A broadly worded decision finds Vonage's Net phone service beyond the reach of traditional telephone regulations.

A court opinion released Thursday could help propel the upstart Internet phone industry to the front ranks of telecommunications.

The industry stands to benefit from a legal distinction drawn by a U.S. District judge in defining Internet and traditional telephone services. The ruling is being closely watched by industry executives and consumers nationwide as voice over Internet Protocol (VoIP) services struggle to move into the mainstream.

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What's new:
A federal judge explains his decision on a ruling that permanently bars Minnesota from applying traditional telephone rules to Vonage, a pioneer in Internet telephone calls.

Bottom line:
The decision, which says that Internet phone companies should not be held to the same regulations as traditional telephone services, could be used to nullify future VoIP regulations expected from about a dozen states now deciding whether to use Minnesota's model.

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In a 22-page opinion released Thursday, Judge Michael J. Davis of the district of Minnesota wrote that VoIP provider Vonage is an "information service" rather than a "telecommunications service" and therefore exempt from state regulation. The opinion was issued a week after the judge ordered an injunction permanently barring Minnesota's Public Utilities Commission from forcing Vonage to get a telephone operator's license to do business in the state.

Legal experts said the decision offers an early win for VoIP in what's sure to be a drawn-out legal battle with state regulators and local phone carriers worried about losing market share to a new brand of competitor.

"This is a transformational issue that will rock the phone industry to its core," said one VoIP industry advocate, who asked to remain anonymous.

The Minnesota opinion furthers a contentious debate over how--or even if--governments should regulate new Internet services. Earlier this month, the 9th U.S. Circuit Court of Appeals came down on the opposite side of the debate, throwing out the Federal Communication Commission's classification of cable broadband as an information service.

State regulators have threatened to stall VoIP's growth by forcing providers to follow the same rules as do traditional phone companies.

Unlike phone networks, data networks have been left largely unregulated and untaxed to help spur growth. This has raised concerns for groups such as the Multistate Tax Commission that Internet-style services could jeopardize billions of dollars in state funding for programs, including universal telephone service, 911 emergency services and the e-rate school technology fund.

Revising definitions
Thursday's opinion highlights growing pressure on the rules and definitions that have molded the telephone industry for much of the past century. It also sharpens the focus on those rules' exemptions carved out by Congress and the FCC for new services arising from the Internet. Since the passage of the 1996 Telecommunications Act, regulators have sought to draw a strict division between voice networks and data networks. But with the rise of VoIP, that distinction is rapidly collapsing.

"It's a mess," said Kevin Werbach, founder of consulting firm Supernova Group and former FCC counsel for new technology. "The distinction between information and telecommunications services is in the 1996 act, but it assumes they are completely distinct...Today, all networks are digital and can provide many services in many different ways. (Regulators) are trying to come to an end result within a flawed legal framework."

Vonage filed suit against Minnesota's PUC after the agency in August became the first in the United States to claim authority over VoIP. Since Minnesota's order, California has asserted authority over VoIP providers, and other states say they are reviewing their policies.

Six VoIP companies have until Oct. 22 to get a California telephone license or face disciplinary action.

California has said it plans to move forward with its efforts regardless of the Minnesota case, while others have taken a wait-and-see approach pending the release of Davis' opinion.

'Congress has spoken'
Thursday's broadly worded decision could prove influential in setting a framework for VoIP regulation.

In the opinion, Davis relied heavily on interpretations of information services developed by the FCC in light of anti-Internet regulation policies put forward by Congress.

"Congress has spoken with unmistakable clarity on the issue of regulating the Internet," Davis wrote, noting exemptions for Internet service providers from interstate taxes as one sign of Congress' intent to leave the Net unregulated.

Drawing on an FCC policy paper known as the Universal Service Report, Davis spelled out a four-part test for determining whether a phone service should be classified as a telecommunications service, rather than an information service. Vonage has asserted that it fails two of the four tests.

Davis concluded that Vonage's DigitalVoice service does not match all of the FCC's criteria and that it is therefore an information service. Namely, he said, Vonage uses a digital converter that translates data between an IP format and an analog phone signal to complete computer-to-phone and phone-to-computer calls.

Legal experts observed that the decision could leave the door open for regulators to assert limited authority over some types of VoIP calls. AT&T, for example, has petitioned the FCC for a ruling that VoIP traffic carried on its network should not be subject to normal completion tolls paid to local phone companies. But those calls might still be found to be telecommunications services under Davis' interpretation of the FCC's four-part test.

About 1 million people use VoIP in the United States, using paid services such as Vonage, Net2Phone and Packet8. Others use free services such as Skype, Free World Dial-Up, SIPphone or those from major instant messaging providers to chat only between computers.

In addition, about 2.1 million cable subscribers now use a broadband connection to make phone calls that use non-VoIP technology. Cable providers are now deciding whether to upgrade those networks to VoIP systems, which are a more cost-effective method than the telephone switches they now use.

The main draw for consumers is the price of a phone call. Subscription services are either free or cheaper than traditional phone service by as much as $20 a month. VoIP calls are cheaper because they avoid the toll roads of the telephone companies' private networks.

Major telephone companies are also using VoIP to route calls at significantly lower costs. For now, about 10 percent of all telephone calls use the Internet in some way. But most analysts believe that in about a decade, nearly every call will use the Internet.

Phone companies weighed in on Thursday's opinion with a call for further deregulation of VoIP.

"The problem is that the FCC and the state commissions have not rationalized the level of regulations that should apply to different participants and different technologies," said Steve Davis, senior vice president of public policy at Qwest Communications. "The government needs to stop regulating based on the technology or the provider. Instead it should look at the service if the service is something based in a competitive market where regulations are no longer necessary."

VoIP "should be allowed to grow and shouldn't be held captive to the old regulatory regime that current telephony is saddled with," added an AT&T representative.

CNET News.com's Jim Hu contributed to this report.