Only connected to 'earth' at the exchange - nowhere else (at least in the UK). Used to be a shared service arrangement here, where two subscribers shared a pair. Signalling - ringing and 'request for dial tone' were done between A-leg or B-leg to local earth (at the subs end). This was the only time a local earth was used (although, I believe suppressors would be fitted to local earth where there was known to be high lightning activity). 'A and B' were used in place of Tip and Ring in the GPO.)

If there is any leakage to earth from either leg at the subs end, all the difference in voltage between exchange and telephone will generate nasty (usually) 50/60Hz noises on the line (basic common mode theory). Telephone service providers ALWAYS insist on a certified, isolated interface between their wires and any subs device that has external power. Usually a special transformer called a 'hybrid', that matches the line and also controls 'sidetone' (the amount of the speakers voice that is fed back to his earphone).

Dave