The Slow Winding Road to Intercarrier Compensation Reform

The intercarrier compensation system is outdated, complex, and in need of reform. But due to political pressures, analysis paralysis, or whatever other reasons, the Federal Communications Commission has persistently resisted real reform for a decade or more. Occasional regulatory patches to the intercarrier compensation system only nibble at the edge of hoped-for comprehensive reform. This month brings yet another reminder of the need for the newly constituted FCC to unify the intercarrier compensation system.

The U.S. Court of Appeals for the District of Columbia Circuit upheld the rate cap system for calls from an originating local exchange carrier (LEC) to an Internet Service Provider's (ISP) LEC. Originally established by a 1999 order by the FCC, the rate cap system for inter-LEC ISP-bound traffic has undergone a repeated back-and-forth between the D.C. Circuit and the FCC. Core Communications v. FCC is the latest and probably last round in the bounce-back mini-saga. The D.C. Circuit rejected claims that the FCC's 2008 order rearticulating the statutory basis for the rate cap system was "arbitrary and capricious."

The FCC's 2008 order relied primarily on Section 201 of the Communications Act for authority to regulate inter-LEC ISP-bound traffic. That section prohibits carriers engaged in delivering interstate communications from charging rates that are not "just and reasonable," and it gives the FCC authority to adopt implementing regulations. The D.C. Circuit concluded the FCC provided a solid foundation for treating inter-LEC ISP-bound traffic (i.e., under the rate cap system) differently than it generally treats inter-LEC compensation (i.e., reciprocal compensation through private negotiation and arbitration by state regulators). As Senior Judge Stephen Williams described the rationale of the FCC's order:

In the context to which reciprocal compensation is ordinarily applied, it noted, outgoing calls are generally balanced by incoming ones, so that it matters relatively little how accurately rates reflect costs….Such balance is utterly absent from ISP-bound traffic. Moreover, it found that in fact the rates for such traffic were so distorted that CLECs were in effect paying ISPs to become their customers…To the extent that ILECs simply passed the costs on to their customers generally (rather than having a separate charge for those making ISP-bound calls), they would force their non-internet customers to subsidize those making ISP-bound calls, and the system would send inaccurate price signals to those using their facilities for internet access (in effect the ISPs and their customers) and to those not doing so…the Commission believed that its "failure to act …would led to higher rates for Internet access, as ILECs seek to recover their reciprocal compensation liability from their customers to call ISPs,"…presumably meaning rates "higher" than cost, correctly computed. Thus the continued application of the reciprocal compensation regime to ISP-bound traffic would "undermine[] the operation of competitive markets."

The result of the D.C. Circuit's ruling was hardly surprising given the deferential "arbitrary and capricious" standard being applied. This result was also foreshadowed by last month's ruling by the D.C. Circuit in Rural Cellular Association v. FCC, upholding the "interim, emergency" rate cap system for the high-cost universal service fund (USF) for non-rural telecommunications carriers. (I blogged about the earlier case and related USF issues last month's post: "Reform USF Now: Two New Data Points").

The D.C. Circuit ultimately found persuasive the FCC's concern for arbitrage opportunities that inter-LEC ISP-bound traffic creates under the general reciprocal compensation system. Professor Gerald W. Brock, a member of the FSF Board of Academic Advisors, likewise acknowledged the incentives for such behavior in "Unifying Intercarrier Compensation," an essay published in New Directions in Communications Policy. Writes Brock:

In the late 1990s, the favorable treatment of interconnection among [LECs] created a form of arbitrage in which companies attempted to transform themselves from customers into LECs...If a dial-up ISP could create a CLEC "front" so that the traffic coming to it was treated as incoming reciprocal compensation traffic, then the ILEC would make net payments to the ISP instead of the ISP paying the ILEC.

Thus, the rate cap system makes sense given the broken intercarrier compensation system we have. But even this small "fix" points to the pressing need for comprehensive reform to create a unified intercarrier compensation system that FSF President Randolph May has urged in several blog posts.

As Brock writes in New Directions, "Now, access charges should be abolished and subsidies for universal service should be separated from intercarrier compensation." A meaningful overhaul toward a unified intercarrier compensation system should lean more heavily on private negotiation between parties, with arbitration as a backdrop. An FCC-established framework of presumptions and default arrangements could guide negotiating parties and reduce transaction costs. And expert arbitrators can take stock of regulation-induced arbitragers. Essentially, this kind of reform means a qualified expansion of the reciprocal compensation system, and a clear separation of any subsidies from intercarrier arrangements.

Of course, on the intercarrier compensation side, the FCC has dragged its heels to bring about a unified system since at least 2001. But even though the rate cap system just upheld by the D.C. Circuit hardly constitutes the straight path to badly needed comprehensive reforms, the very resolution of the litigation over inter-LEC ISP-bound traffic now leaves the FCC with one less excuse for delaying those reforms. Little more could be said for the FCC's progress on the comprehensive USF reform side. However, the FCC has been taking public comments on a petition for rulemaking by the National Cable & Telecommunications Association (NCTA) that seeks to reduce universal service subsidies in geographic areas experiencing facilities-based competition that is not subsidized. Now is the time for the FCC to take positive steps forward on intercarrier compensation reform and USF reform.

The Massachusetts Vote and Internet Regulation

In my recent essay opposing net neutrality regulation, entitled "Overregulating the Internet," which ran in the National Review and also on CBS.com, I began this way:

"While health-care reform may be the foremost example of President Obama's overreaching domestic-policy agenda, communications policy deserves attention as well. In October, the Obama administration's Federal Communications Commission unleashed a proposal to regulate a large swath of the Internet under a "net neutrality" regime. If adopted, this policy would likely discourage investment and innovation in broadband Internet networks, a particularly unwelcome development with the nation just emerging from a severe economic slump."

And ended this way:

"The Obama administration's proposals for addressing health care are much too interventionist for my taste. But at least there is widespread agreement that in health care, there are market failures that ought to be addressed in one way or another. Not so with respect to the Internet marketplace. Rather than jeopardizing continued progress, the FCC should jettison its proposal to impose new Internet regulation. It should concentrate instead on producing a plan that will help bring broadband to the remaining 5 percent of American households that are unserved."

In between the beginning and the end, I hope I explained with some persuasiveness why the FCC, in the absence of any demonstrated market failure or consumer abuse, ought not to move forward with its proposal to adopt net neutrality regulation.

I do not want to suggest -– and I am not suggesting -- that FCC decisions should be dictated, or even overly influenced, by messages sent by the Massachusetts electorate regarding concerns about the Obama Administration's health care reform proposals. But I do want to suggest that when, back in a September 21 blog post, I called Chairman Julius Genachowski's proposal for new Internet regulation "an immodest proposal," I was expressing some of the same concern about regulatory overreaching and a certain bureaucratic immodesty that a large body of Americans obviously now feel regarding the pending health care reform proposals. Shortly after my September 21 blog post, in a September 28 editorial entitled "The FCC's Heavy Hand," the Washington Post agreed with me that the FCC's net neutrality regulatory proposal is "immodest." The editorial's subtitle perfectly captured the piece's sentiment: "Federal regulators should not be telling Internet service providers how to run their businesses."

On January 14, FSF submitted lengthy comments to the FCC urging the agency to jettison its proposals for new Internet regulation. On the other hand, the comments supported the notion of adoption of a transparency and disclosure rule, if reasonably drawn. This would be an appropriately modest way of proceeding at this point that would accommodate the agency's desire to act, while doing so in a constructive way that facilitates consumer choice.

A final note on net neutrality: For some time (going back to 2006 here, and especially in this 2007 law review article) I have argued that net neutrality regulation likely would violate the First Amendment. I was gratified to see that eminent constitutional lawyers Laurence Tribe and Thomas Goldstein have raised essentially the same First Amendment free speech concerns in a paper attached to the comments submitted by Time Warner Cable in the net neutrality proceeding. These two have a pretty good track record before the Supreme Court when it comes to constitutional law questions, so I commend their analysis to you. While not heretofore at the forefront of the concerns expressed regarding the FCC's proposal, I submit that, at least in part, some of the palpable unease concerning the FCC's proposed course is attributable to a sense – even amongst those much less schooled in constitutional law that Messrs. Tribe and Goldstein – that net neutrality regulation compromises fundamental free speech rights.

Now, a really final note: If you haven't already registered for the Free State Foundation's January 29 Annual Winter Telecom Policy Conference, you may want to do so now, as spaces are filling up fast. The conference agenda, which will have a significant focus on the FCC's broadband plan and proposed net neutrality regulation, is here. RSVP to Susan Reichbart at: sreichbart@freestatefoundation.org

Clearing the Air on Wireless Text Messaging

The U.S. Department of Justice (DOJ) has finished its inquiry into wireless carriers' text-messaging rates and intends to take no further action. So reports the Wall Street Journal ("Justice Ends Probe of Texting Rates"). Apparently, DOJ could find no evidence sufficient to support claims raised by the U.S Senate Antitrust Subcommittee Chairman that wireless carriers were engaged in illegal collusive price-fixing conduct to keep text messaging prices up. As I pointed out in a blog post from last month ("Getting the Message on Text Messaging Prices"), a federal trial court recently dismissed a nationwide class-action lawsuit against the major wireless carriers based on similar, factual flimsy collusion claims. Skyrocketing numbers of text messages being sent and received by consumers—with 1 trillion sent last year alone—suggest strong consumer demand, not consumer harm. And many text messaging price complaints myopically focused on per-message prices rather than bundled package prices that offer consumers far more economical choices.

Fortunately, the Federal Communications Commission's (FCC) current net neutrality/net neutering rulemaking—i.e., the Preserving the Open Internet proceeding—will likely refrain from imposing any kind of direct regulation on text messaging. But this outcome was not always so likely. Back in late September, FCC Chairman Julius Genachowski's speech at Brookings announcing his plans to impose net neutrality/net neutering regulation asserted "[w]e have even seen at least one service provider deny users access to political content." This line was an apparent reference to Verizon Wireless' employees' initial rejection of a NARAL application for a common short code (CSC)—a text messaging service. (The matter was resolved within 48 hours, with the CSC application granted, all without FCC intervention.)

The Chairman's September speech thus raised the likelihood of FCC regulation of text messaging in the forthcoming proceeding. However, the FCC Notice issued in October says otherwise. Although the FCC proposes to extend net neutrality/net neutering regulation to wireless broadband networks, paragraph 156 of the FCC's Notice states that it will not subject text messaging to any such rules:

Because of the rapid growth and increasing use of mobile wireless as a platform for broadband Internet access, we will examine in greater detail in the following parts the application of the principles to mobile broadband Internet access. We note as a threshold matter that wireless providers may offer a range of services—including traditional voice, short message service (SMS), and media messaging service (MMS)—that are not broadband Internet access services and thus are not included in the scope of the draft rules discussed above.

Given nascent wireless broadband technological limitations, wireless broadband innovation and quality-of-service stands to take a hit from new regulation. (The Free State Foundation just submitted its comments to the FCC in the proceeding.) But at least text messaging will probably come away unscathed in the FCC's proceeding. When it comes to the messaging, the FCC's Notice appears intended to preserve the status quo.

Nonetheless, the status quo for text messaging leaves room for FCC deregulatory reform. As it now stands, text messaging in a kind of regulatory netherworld. It isn't subject to rigorous regulation, but neither is it protected by a deregulatory classification. The FCC's 2007 Wireless Broadband Order classified wireless broadband Internet access service as an information service (subject to less regulation) while it classified the transmission component of wireless broadband Internet access service as a "telecommunications service” (subject to common carrier obligations). The 2007 Order also concluded that the offering of the telecommunications transmission component as part of a functionally integrated Internet access service offering is not "telecommunications service." Although the 2007 Order's description of wireless broadband Internet access services and technologies referred to text messaging as a "mobile data application," the Order did not expressly declare it an information service.

The Commission now has opportunity to clarify that text messaging and related mobile data services are, in fact, "information services." Both the 2007 Wireless Broadband Order and the alleged CSC censorship incident mentioned in Chairman Genachowski's speech set the backdrop to a petition to the FCC by Public Knowledge, Free Press, and others seeking a declaratory ruling that text messaging—including CSCs—are subject to common carrier obligations. To date, the FCC has issued no ruling on the petition. But the FCC can provide deregulatory certainty by declaring text messaging an "information service," thereby rejecting the petitioners' arguments for imposing common carrier regulation.

A New Year, Same Old POTS

It's a new year, but Free Press and other so-called public interest organizations didn't waste any time making it clear that they will be singing the same old tired tune this year as last. They are asking the government to investigate the new TV Everywhere service that is being launched by multichannel video program distributors (MVPDs) such as Time Warner Cable, Comcast, and Cox. In effect, Free Press and company are again urging that the regulatory model that was applied to regulation of POTS, or Plain Old Telephone Service, in the last century when POTS was a monopolistic offering, be applied to today's dynamic broadband Internet environment.

The concept of TV Everywhere is that a subscriber to a multichannel video distributor – without any additional charge – can watch TV programs online. It is likely that one effect of TV Everywhere is that more quality video program will be available over the Internet. And this, in turn, is likely to drive increased broadband adoption, a widely agreed-upon policy objective.

But Free Press and its allies, claiming to be representing consumers, contend the plan of the MVPDs to make television programs available on the Internet to subscribers without charge is actually anti-consumer. Of course, normally consumers are pleased when they are given additional options to make use of a product at no additional charge. And, as a matter of fact, I am not aware of any material opposition to the plan by actual consumers.

Nevertheless, Free Press and company have written to the Department of Justice, the Federal Trade Commission, and legislators to complain that TV Everywhere is "problematic" because it may "upset the emerging market of online video." According to Free Press, "the TV Everywhere model requires consumers who wish to watch popular video content on the Internet to first subscribe" to a MVPD. This is the alleged harm.

I do not have any idea whether the TV Everywhere model ultimately will succeed in the marketplace. In fact, I don't have any idea whether any business model devised by "cable" companies or "telephone" companies or "broadcasters" or "online tvtubes of various stripes" will succeed, or whether the companies that Free Press calls the "incumbents" will even exist in a few years. I know I am not as smart as the prognosticators at these same consumer organizations who predicted that if the AOL-Time Warner merger were allowed to be consummated without stringent "public interest" conditions the merged company surely would dominate both the online and cable market segments. But the communications and media marketplace is simply too dynamic and changing too fast for me to have any confidence at all in making predictions.

Although I am not smart enough to predict the future of markets and successful business models, here's what I do know. Free Press and company exhibit a profound, dogmatic anti-market bias. The only model they believe is appropriate for any communications company that distributes any content is a public utility-model under which regulators determine the prices, and the terms and conditions, under which the product is made available to consumers. This is the regulatory model that was applied to regulation of Plain Old Telephone Service when POTS was a monopolistic analog telephone offering. The only match for Free Press and company's profound anti-market dogmatism is a profound faith in the ability of politicians and regulators to manage communications and media markets "in the public interest," no matter how much more dynamic and competitive the markets have become.

This strong anti-market bias is evidenced in this instance in the same respects that characterize much of Free Press and company's advocacy and which, if accepted, will lead to unsound policies that harm consumers.

• Free Press's modus operandi is always to urge regulation before any material market failure or consumer problem is demonstrated to exist. Here Free Press says TV Everywhere is "problematic" because it might upset the "emerging" online video market. Rather than waiting for the market to develop further to see whether any real problems materialize, rather than hypothesized ones, Free Press hastens to call out the regulators first. The M.O. is the same with regard to net neutrality: Regulate first; don't wait for any real marketplace abuses to be demonstrated.
  

 

• Free Press invariably urges that all communications and media offerings be unbundled under regulatory supervision at its core, even though this unbundling mania runs counter to the way most products are offered in the marketplace.
  

 

• Free Press always ignores the fact that there are costs associated with creating and producing goods and services, whether video programming or other content on the one hand, or broadband networks on the other. Absent government ownership and control, which may be Free Press's true preference, these costs must be recovered. And absent demonstrable market failures, the entities that create and produce the goods and those entities that distribute them to the public ought to be free to negotiate mutually satisfactory business arrangements that, in their view, give them the best opportunity to recover their respective costs. Otherwise, the incentive to create and produce goods (here programming) and modes of distribution (here broadband networks) will be diminished or eliminated. As for TV Everywhere, program producers are under no compulsion to sell programming to MVPDs, but they certainly may view the prospect of doing so at a market price as an opportunity, not a problem. Just as Free Press's net neutrality proposals would foreclose more broadly any future opportunity for the development of two-sided markets between broadband providers and content and applications providers, opposition to TV Everywhere has the same market-foreclosing effect with respect to video programming.
  

I generally prefer the cautious use of antitrust law by antitrust authorities to regulation under the vague public interest theories applied by the FCC. And I have no problem with antitrust authorities investigating and remedying instances of real marketplace abuses attributable to demonstrated market failures as long as the antitrust authorities act consistently with rigorous economic analysis standards. I do have a problem, however, with premature calls for investigations in the technologically dynamic, competitive communications and media markets at a time when new business models are emerging and then evolving as market participants test consumer response and demand.

When Free Press and company acknowledge the online video market is "emerging," they ought to hold fire, at least for a while, to see what actually emerges before asking that the marketplace evolution be stopped in its tracks. If they won't hold fire – which I don't expect them to do – the antitrust authorities, lawmakers, and policymakers should have the good sense to do so.