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Is Title II good for information content entrepreneurs? No

Later today I will participate in a Congressional Black Congress Foundation panel discussion on telecommunications and media.  I’ll be sharing my thoughts and insights on how a Title II classification of broadband access could impact information service providers in general and minority-owned information services providers in particular.

It should be no surprise, if you are one of the three or four people who follow this blog, that I see no social policy benefits in treating broadband access as a Title II common carrier.  Title II does not encourage broadband deployment or investment.  It does not even promote the neutral and open platform necessary for encouraging the development and deployment of the software applications that have provided us with familiar services like e-mail and video streaming.

The main reason that Title II is ineffective in a 21st century broadband world is that Title II was intended to regulate services and pricing for telecommunications services provided in an analog, point-to-point, switched circuit world with an emphasis on regulating prices and charges for services.  While the early days of the Internet were driven by a philosophy of openness intended to encourage application development and deployment necessary for exchanging information, Title II was intended to facilitate the universal access of American households to a legacy switched-circuit telephone infrastructure.

Title II says nothing about digital networks much less net neutrality.  Title II says nothing about democratizing access to or app development on the Internet.  In fact, the entire Communications Act of 1934 doesn’t speak to net neutrality.  Section 1302 (section 706 under the Telecommunications Act that amended the Communications Act) boils down to encouraging the deployment of advanced services, where advanced services have been determined to mean broadband.

Title II has become the backdoor approach used by net neutrality proponents to get to regulation of broadband services and the Internet as opposed to the old fashioned method of proposing legislation to Congress that would expressly authorize net neutrality as a policy tool and provide the Federal Communications Commission with the authority to create net neutrality rules.

But what proponents of net neutrality rarely discuss are the negative impacts Title II would have on information and content entrepreneurs.  Take for example section 203 of the Communications Act.  This section discusses schedule and charges assessed by common carriers.  To analyze what a Title II eco-system would look like for broadband operators, replace the term “common carriers” with the term “broadband operators.”

So, according to this section broadband operators would have to keep on file with the FCC a schedule of their rates and charges, whether for traffic sent solely on their networks or traffic exchanged with other broadband operators.  At first blush this may seem like just a mere compliance or administrative inconvenience.  What this requirement would do, however, is introduce more uncertainty for information and content entrepreneurs.

For the broadband operators it may mean calling out of retirement a few of their tariff experts.  (Don’t call me.  I hated drafting the damned things.)  The real inconvenience will fall on entrepreneurs.  For example, if the broadband operator has to change rates or charges to accommodate changes in his relationship with video distributors like Netflix, price changes, pursuant to section 203(b) of the Act, would take place after 120 days notice of the price change.

Would a broadband operator want to put off collecting additional revenues while waiting for the FCC to approve a rate change?

Can an information provider afford to have a broadband operator say no to its additional traffic because the broadband operator has not instituted the appropriate price points to compensate for additional traffic?

Another source of uncertainty for information and content entrepreneurs may come from section 204(a)(1) of the Act.  This section allows the FCC to hold hearings to challenge the lawfulness of new charges.  These challenges may come from the FCC or from a consumer.  Along with the challenge would be a suspension of the rate for up to five months.

Broadband operators may be walking on eggshells when a content or data entrepreneur wants to run a service that calls for a change in rate only to be turned down because the operator doesn’t want the headache  of a future refund headache down the road.

Information and content entrepreneurs should also be concerned about section 211(a) which would require a broadband operator file with the FCC other contracts that the operator has with other broadband operators.  Why should this concern information and data entrepreneurs?  Because if the terms and conditions of these contracts includes third-party, information and content entrepreneur information, it may expose these entrepreneurs to competitive risks.

Title II puts entrepreneurs at risk as collateral damage in attempts to regulate hypothetical broadband operator bad behavior.  Investors in online start ups should consider the impact of Title II on their investments.

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The FCC has no reason to pre-empt state laws banning municipal broadband

I just filed the following comments in WCB Docket Numbers 14-115 and 14-116.

The Electric Power Board of Chattanooga, Tennessee and the City of Wilson, North Carolina have asked the Federal Communications Commission to pre-empt statutes that ban or restrict the provision of broadband services by municipalities to the public.  The parties seek pre-emption pursuant to section 1302 of the Communications Act of 1934 as amended by the Telecommunications Act of 1996.  Pursuant to the reasons I lay out below, I ask the Commission to deny their petitions.

The Supremacy Clause of the United States Constitution gives Congress the authority to pre-empt state laws that conflict with the exercise of federal power [Schwartz 2010].  Congress may express its intent to preempt conflicting state law by saying so in the text of a statute or imply the intent to pre-empt state law based on the structure or purpose of the federal law.  In addition, where Congress intended to occupy an entire regulatory field or there is a conflict between federal and state law, the federal law would trump state law.  The courts may provide federal agencies considerable deference where the federal agency finds that state law conflicts with the federal law an agency is authorized to administer. [Schwartz, 2010]

Although the Commission is an independent agency, it should be able to find guidance on preemption from a May 2009 memorandum issued by President Obama on the issue of preemption.   Here is an excerpt from that memorandum:

“An understanding of the important role of State governments in our Federal system is reflected in longstanding practices by executive departments and agencies, which have shown respect for the traditional prerogatives of the States. In recent years, however, notwithstanding Executive Order 13132 of August 4, 1999 (Federalism), executive departments and agencies have sometimes announced that their regulations preempt State law, including State common law, without explicit preemption by the Congress or an otherwise sufficient basis under applicable legal principles.

The purpose of this memorandum is to state the general policy of my Administration that preemption of State law by executive departments and agencies should be undertaken only with full consideration of the legitimate prerogatives of the States and with a sufficient legal basis for preemption. Executive departments and agencies should be mindful that in our Federal system, the citizens of the several States have distinctive circumstances and values, and that in many instances it is appropriate for them to apply to themselves rules and principles that reflect these circumstances and values. As Justice Brandeis explained more than 70 years ago, ‘[i]t is one of the happy incidents of the federal system that a single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country.’”

It appears that the President wants the federal government to recognize that federal and state governments are not only partners in serving the public interest, but that the specific circumstances of each state should be taking into account before the federal government risks exercising unnecessary overreach.  Using section 1302 as basis for preempting state law would constitute such overreach.  Section 1302 (b) reads as follows:

“The Commission and each State commission with regulatory jurisdiction over telecommunications services shall encourage the deployment on a reasonable and timely basis of advanced telecommunications capability to all Americans (including, in particular, elementary and secondary schools and classrooms) by utilizing, in a manner consistent with the public interest, convenience, and necessity, price cap regulation, regulatory forbearance, measures that promote competition in the local telecommunications market, or other regulating methods that remove barriers to infrastructure investment.”

The Petitioners argue that state legislation banning or restricting municipal broadband somehow lessens competition or works against deploying broadband and by preempting state legislation the Commission would in essence put in place a policy that encourages the deploying high-speed broadband.  I argue that it was never the intent of the Telecommunications Act of 1996 to see municipalities deploy broadband or telecommunications.  The Telecommunications Act of 1996 was primarily designed to open the telecommunications markets to more competition between private sector players.  Section 1302 was an attempt to recognize the importance of this thing called the Internet and allow the commercialized Internet to grow and flourish with private sector players deploying broadband in a least restrictive regulatory setting.

Ironically over that 18 year period we have gone from the thing called the Internet to an Internet of Things.  This is a testament to how a private sector subject to light touch regulation has been able to innovate both broadband and edge services for the benefit of consumers.

Going back to the legislation, there is no language in section 1302 that expressly preempts the states from implementing legislation that bans municipal deployment of broadband.  Also, there is nothing in the structure or intent of the Telecommunications Act that implies preemption.

States have been encouraging private sector innovation through deregulation.  In Florida where I served on the Florida Public Service Commission’s staff, I witnessed Florida’s attempts in 1994 and 1995 to deregulate Florida’s communications market.  We were not encouraging cities and towns to provide Internet access or local phone services.  We recognized that the emerging technology at the time allowed for cable companies and resellers to enter the market and sell local and long distance services.  The Telecommunications Act continued and built on what the states were doing to encourage competition via a light touch regime, a regime that the Petitioners want to attack by encouraging preemption.

In sum, the structure of federal communications law does not imply preemption but cooperation with and deference to the states and recognizes that the private sector, given its scale and access to capital was best suited to build a nationwide broadband network.  The states that ban or restrict municipal broadband deployment also recognize that capital will turn away from a market where a “competitor” is heavily subsidized with free money from tax payers.  The private sector, even at today’s low rates of interest, cannot compete with free money or a competitor who may not be subject to the same, onerous net neutrality principles or other rules that a private sector provider has to or may have to abide by.

For the reasons I shared above, the Federal Communications Commission should deny the Electric Board of Chattanooga and the City of Wilson’s petition.

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Taxation, broadband adoption, and edge provider doo doo

Posted August 1st, 2014 in Broadband, capital, edge providers, Internet, taxes and tagged , , , by Alton Drew

Last week, the U.S House of Representatives gave edge providers a little love when the Republican-controlled chamber of Congress voted to make permanent a 1998 moratorium on Internet taxes.  The moratorium, scheduled to expire on 1 November 2014, prohibits states or their political subdivisions from imposing taxes on Internet access or from applying multiple or discriminatory taxes on electronic commerce.  The bill, H.R. 3086, is now in the U.S. Senate waiting for their review.

Needless to say, state and local governments have their underwear in a bunch over the bill.  According to congressional estimates, states and local governments stand to lose hundreds of millions of dollars annually should the moratorium become permanent.  For example, the Center on Budget and Policy Priorities argues that Congress has no business trying to boost the consumption of Internet access at the expense of state and local revenues.  The Internet, according to the Center, is no longer the nascent industry that needs exemption from taxation in order to grow and flourish.

States that may be particularly hit the hardest are the states who were taxing Internet transactions before the moratorium was put in place and right before the first Internet bubble popped. These states collect taxes under a grandfather clause in the moratorium and include Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin.  In addition, Tennessee, Washington, and New Hampshire may also collect taxes but currently do not do so.

The National League of Cities argues that current tax policy advantages online retailers at the expense not only of revenue collection by localities but of main street retailers as well.  In a statement released last June, the NLC argued that “Main Street retailers are the backbone of our local communities.  These Brick and mortar shops need Congress to end the special tax status for online retailers and allow for fair competition.”

While the arguments made by the critics tug at the heartstrings, or I should say, reverberate the fiscal purse strings, they fail to take into account Congress’ responsibility to regulate commerce, the impact a failure to make permanent the moratorium will have on capital flow to edge providers, the very drivers of the Internet eco-system, the incentives presented to edge providers to move offshore that increased taxes would create, and the negative impact Internet taxes would have on broadband access adopters, the very adopters that create the derived demand necessary for a flourishing Internet eco-system.

First, Constitutional Law 101.  The Congress has the power to regulate commerce among the states.  The Internet is the conduit through which electronic commerce traverses and given the redundancy and virtual characteristics of the protocol that pushes data across some 67,000 globally connected computer networks, I think it’s safe to say that, at least inside the United States, the U.S. Congress has the option of regulating the Internet in a manner that promotes the consumption of Internet access.

Second, Economics 101.  The real backbone of any economy, whether local, regional, or national are the consumers, not the retailers.  Demand for goods and services are derived from consumer demand and more and more consumers are demanding goods and services via the Internet and at speeds that only high-quality broadband networks can provide.  Kimberlee Morrison, in a post for SocialTimes, reports that e-commerce is a $220 billion industry driven by consumers that search online for products before either entering into brick-and-mortar stores to make a purchase or just purchasing online.

Chuck Jones, in a piece for Forbes.com, wrote last fall that mobile commerce or m-commerce is expected to grow to over $100 billion in sales in 2017, up rather appreciably from the estimated $47 billion in 2013.

In a sluggish recovery where 70% of gross domestic product is driven by personal consumption, why would municipalities and states want to retard the level of consumer spending online with taxes?  And given the overindexing of people of color that use mobile broadband to access services online, is imposing a tax on Internet sales good economic policy?

According to the Pew Research Center’s Internet Project, 92% of African American adults have a cell phone and 56% of black adults have a smartphone.  Mobile broadband access is the primary mode for accessing electronic commerce as evidenced by lower adoption rates among blacks for broadband at home.  Pew reports that while 87% of white Americans make use of the Internet, 80% of blacks are traveling the information superhighway.  The gap in broadband access is wider, where 74% of whites have adopted broadband at home while the percentage of blacks who are wired at home comes in at 62%.

But Internet taxation does not only impact consumption of e-commerce or broadband adoption by people of color.  It impacts providers of services on the edge.  On one extreme is Internet information and content provider Yahoo!, a multinational corporation based in Sunnyvale, California.  Yahoo! is known primarily as a search engine, providing consumers with financial, entertainment, and cultural content.

Taxation is a threat to Yahoo!’s bottom-line according to its most recent 10-K filing.   Yahoo! notes in their 10-K that they may have exposure to additional tax liabilities which could potentially impact their income tax provision, net income, and tax flow.  Newly enacted tax law could have a materially adverse impact on the company’s cash flow.  Yahoo! cites the possibility of several jurisdictions seeking to increase government revenues by either taxing Internet advertising revenues or by increasing general business taxes.

Smaller players would not be immune from this threat according to Melbourne, Florida-based entrepreneur, web designer, and software engineer Maurice Newton.  Mr. Newton puts it succinctly and colorfully.  “The tax is a big factor.  Some companies will even go offshore to save money.  The FCC is up to their ears in edge provider doo doo and the smoke will not clear for a long time.”

The U.S. Senate needs to follow the House’s lead and listen to Internet entrepreneurs, the industries larger players, and the consumers that use broadband to access services.  A permanent moratorium on taxing Internet access will keep businesses here in the U.S. while encouraging further broadband adoption.

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A public utility is regulated for what it provides, not for how it provides it.

FPL, known to us old heads as Florida Power & Light, is a public utility under Florida law.  Section 366.02, Florida Statutes, defines a public utility as ” … every person, corporation, partnership, association, or other legal entity and their lessees, trustees, or receivers supplying electricity or gas (natural, manufactured, or similar gaseous substance) to or for the public within this state …”   In declaring its rationale for regulating public utilities, the Florida Legislature, in section 366.01, F.S., states that:

“The regulation of public utilities as defined herein is declared to be in the public interest and this chapter shall be deemed to be an exercise of the police power of the state for the protection of the public welfare and all the provisions hereof shall be liberally construed for the accomplishment of that purpose.”

In other words, Florida believes that because the products provided by utilities; electricity, water, natural gas, are of such necessity to its citizens, that regulating how they are provided and the rates they are provided at is essential to the well being of the states’s citizens.  Imagine the levels of disease or hunger that would emanate from a prolonged loss of electricity, water, or natural gas.  Commerce would come to a grinding halt without the electricity needed for energizing transportation facilities and the transfer of financial assets.

The economic reasons for regulating public utilities stem from their roles as natural monopolies.  Richard A. Posner wrote in his text, Economic Analysis of the Law, that natural monopoly presents three problems that warrant regulation in some form or the other.  One is monopoly pricing.  The second is inefficient market entry resulting from the natural monopoly’s reaction to potential entrants.  The third is the difficulty of devising an efficient pricing structure.

Judge Posner’s answer to the natural monopoly dilemma is public utility regulation, an approach to regulating a natural monopoly based on three elements: profit control, entry control via some license or certificate of necessity and convenience, and control over price structure.

At this point every investor should be sucking air in great pause  were this type of framework be applied to broadband access providers.  The framework introduces another level of uncertainty for broadband providers especially where regulation may lessen rates of return on capital or equity.

What I also find curious is why net neutrality proponents do not get this granular in their advocacy for common carrier or public utility regulation, preferring to stick to the narrative that broadband providers should be regulated because they might do something wrong that negatively impacts the consumer’s ability to get to a website.

I’m equally curious as to why net neutrality advocates never bother explaining why communications or broadband companies are not included in the statutory definition of a public utility.  Some academics have tried.  For example, Fordham University professor Rick Geddes includes communications firms in the definition of public utilities.  He cites as a common thread between telecoms, electrics, and natural gas firms three components: production, transmission, and distribution.  The problem with his analysis is that telecommunications firms don’t produce anything.

Whereas an electric company generates electricity, a secondary form of energy, and transmits and distributes the energy over its facilities, all a broadband or telecommunications firm does is transmits the messages or data that I request it to send.  My original message gets to its recipient in the same form that I send it in; in the form I generated it in.

From a social perspective, while I am basically shy, I can warm up a bit and be pretty sociable.  However, while I do need to eat properly cooked food and take a bath everyday, I don’t need to talk to anyone everyday.  Broadband adds efficiency to my ability to gather, process, and disseminate information, but I don’t need it in order to collect or send information.  It’s not a necessity.

Yes, that runs completely counter to the narrative pushed by the net neutrality types; that without broadband the whole world will come to an end and for that reason we should regulate the crap out of Comcast and Verizon, but that narrative is not steeped in law or the common view, not when you have fifteen to twenty percent of the American population getting along just fine without broadband.

The net neutrality narrative that broadband should be regulated like a public utility exposes another fatal flaw.  If the true product being generated is information then in order to apply the public utility model the information generators i.e. end-users and edge providers, will have to be dragged into the regulatory eco-system.  Privacy concerns and law may keep the hands of the Federal Communications Commission off of end-users, but edge providers such as Amazon, Facebook, and Google would be fair game, especially given their market dominance in publishing, online advertising, and search.

It’s no wonder they have been sitting on the fence during the net neutrality debate.  Hopefully for them the wire is not barbed.

Bottom-line, broadband providers are not public utilities.  They lack the generation component typically associated with a public utility.  They are, for the most part, connectivity providers.  One could argue that their portals provide news and information, but until they declare themselves media companies, providing a portal does not make you an information generator.  If anything they are merely aggregating information from other sources that you can go directly to yourself.

 

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The FCC is still opaque on commercially unreasonable standards

Recently Federal Communications Commission general counsel Jon Sallet introduced the concept of “jurisprudence of innovation” at a Federal Communications Bar Association function.  Jurisprudence and innovation doesn’t come off at first glance as two concepts that should mix.  Jurisprudence is defined as the philosophy or science of law while innovation is defined as the process of introducing new devices or methods.

I hear jurisprudence and I think of intellectual meandering locked within a mental ward.  When I hear innovation, I think of entrepreneurial freedom meeting the needs of an expansion of consumer welfare.  Bottom line, Mr. Sallet’s remarks were an attempt to put fresh paint on a regulatory prison cell the FCC seems so desperately eager to keep building with entrepreneurs as unwilling guests.

Here is the framework laid out by Mr. Sallet for jurisprudence of innovation.  The mandate for a jurisprudence of innovation framework is that entrepreneurship, competition, innovation, and consumer benefits are to be maximized with the goal of permitting the creation of new markets while subjecting old markets to the challenge of creative destruction.  Public policy tools for achieving this social policy include the certainty emanating from balancing potential public interest benefits against potential public interest harms; development of flexible standards for assessing the public interest; and access to resources.

The problem with Mr. Sallet’s model is that it still assumes that the FCC has a crystal ball that it can use to determine what innovation will look like in the future and whether this future will be disturbed by an acquisition applicant’s actions today.

Yes, the markets thrive on certainty, flexibility, and access to resources because these are the ingredients that entrepreneurs need to succeed.  The consensus held by entrepreneurs and producers is that they need clear rules of the regulatory road so that they can do business and best gauge the flexibility they have in developing and deploying new products and services.  The model Mr. Sallet presents adds no clarity as to how far the FCC would intervene on the front end of the innovative process.

Either the FCC will wait for a substantiated complaint to be filed (versus one based on a consumer’s feelings) so that it can weigh actual facts before crafting a resolution or it will step in along certain points or milestones during the innovation, marketing, and deployment process and hinder the very innovation it professes to want.

If the latter course is the one the FCC plans to take, I have a hard time seeing why an investor would be confident in leveraging capital in the broadband or Internet space.