Wednesday, February 25, 2015

Plain Packaging Mandates Push Tobacco Consumption into Black Markets

On February 15th, John Oliver’s HBO show “Last Week Tonight” featured a segment that tackled the tobacco industry. In the segment, Oliver showed disgust that tobacco companies have become more profitable over time despite decreasing rates of tobacco consumption.
There is an easy explanation for this. Tobacco products are heavily regulated and taxed in most states throughout the US. The costs of these regulations and taxes push smaller tobacco companies who cannot afford them out of the market. This leaves larger market shares and profit shares for the bigger companies who can afford to cover the costs of these regulations. So while John Oliver is supporting heavy regulations because he thinks they are reducing the profits of these big tobacco companies, in reality, these companies are benefitting from them.
Oliver pointed to the Australian tobacco market and praised its government for its plain packaging mandate, which eliminates branding and requires all similar tobacco products to look the same. Oliver suggested that the United States adopt a similar policy because tobacco companies are too profitable and he claims such a policy would help lower tobacco consumption. Not only is a plain packaging mandate a massive violation of intellectual property rights because it strips companies of their trademarks and branding, but there is also no evidence that the Australian plain packaging regulations have caused lower levels of tobacco consumption.
Sinclair Davidson and Ashton de Silva, authors of “The Plain Truth about Plain Packaging: An Econometric Analysis of the Australian 2011 Tobacco Plain Packaging Act” found that the plain packaging policy introduced in Australia “has not reduced household expenditure[s] of tobacco once we control for price effects.” The last part is important because over the same span that plain packaging was introduced, Australia imposed a 12.5 percent excise tax increase. This tax increase likely is the driver of any decreases in tobacco consumption, not plain packaging regulations.
Ernst & Young LLP also released a paper entitled “Historical Trends in Australian Tobacco Consumption: A Case Study” which found “no evidence that plain packaging in Australia has reduced total consumption to date.” But plain packaging has had an effect on the tobacco market. Since Australia’s mandate went into effect, consumption of black market tobacco products has increased by roughly 55 percent. Because the supply of black market tobacco products has increased, the access to children has also increased, resulting in a 30 percent hike in daily smoking rates of 12-17 year olds, according to the International Property Rights Index. I doubt these are the results John Oliver is trying to promote.
Granted, these are results from Australia, but the results should not go unnoticed. We already know that tobacco tax rates are so high in some states in the US that individuals are selling “loose cigarettes” despite the aggressive enforcement from police. Removing trademarks and branding, which tobacco users place a high value on, would violate the intellectual property rights of tobacco companies and certainly would push tobacco consumption into a black market.

Tuesday, February 24, 2015

Is the FCC Unlawful? – A Reprise

This Thursday, February 26, will be a fateful day for the future of the Internet. As I wrote recently in a Washington Times op-ed, “The FCC’s Coming Internet Regulations,” “in the nearly 40 years that I have been involved in communications law and policy, including serving as FCC Associate General Counsel, this action, without doubt, is one of the agency’s most misguided.”

As the vote approaches, I don’t have any second thoughts regarding that statement. Reduced to its essence, the way I put it at the beginning of the Washington Times piece gets to the nub of the matter: “Regulating Internet providers as public utilities in order to enforce net neutrality mandates will discourage private sector investment and innovation – and lead to even more special interest pleading at the FCC for favored treatment, and heightened litigation for years to come.

For those interested in learning more about the forthcoming decision of the FCC’s Democrat majority to regulate Internet providers, even wireless companies, there are literally dozens, if not hundreds, of publications on the Free State Foundation’s website and its blog. And in a moment, I want to call your attention especially to three pieces published just within the past two weeks that are worthy of your attention.

But first this: The initial essay I published this year, on January 2, was titled, “A Question for 2015: Is the FCC Unlawful?” The piece bears revisiting as the FCC is poised to expand its control over the Internet in ways that threaten its future without any present justification – that is, without a justification that is not trumped up. The reality is that there is no evidence of present market failure and consumer harm that justifies the Commission asserting more control over the Internet – regardless of which theory of law the Commission relies upon.

But here’s an important point I wish to make regarding the FCC “lawfulness” in advance of Thursday’s vote. As Philip Hamburger discusses in his new book, “Is Administrative Law Unlawful?”, one of the objectives of our Founders was to control, if not eliminate, what in England was known as the “dispensing” power. Simply put, the “dispensing” power – and this power is much discussed in English constitutional history – was a form of exercise of royal prerogative under which the King could avoid, or dispense with, complying with particular laws, including those enacted by Parliament. As Professor Hamburger discusses at some length, today’s administrative agencies, in essence, have resurrected the “dispensing” power by the way they often use waivers to award favored treatment.

Here is the way Professor Hamburger puts it:

“After administrators adopt a burdensome rule, they sometimes write letters to favored persons telling them that, notwithstanding the rule, they need not comply. In other words, the return of extralegal legislation has been accompanied by the return of the dispensing power, this time under the rubric of ‘waivers.’”

And then he goes to the heart of the matter:

“Like dispensations, waivers go far beyond the usual administrative usurpation of legislative or judicial power, for they do not involve lawmaking or adjudication, let alone executive force. On the contrary, they are a fourth power – one carefully not recognized by the Constitution.”

Now, I understand that seeking and receiving “waivers” of the FCC’s rules (regardless of the precise name applied to such dispensations) is an established part of FCC practice. And in some instances, such waivers, in light of unique circumstances or hardships, are no doubt justified. But I am convinced that under the new set of Internet regulations about to be adopted by the Commission, we are likely to witness the exercise of the agency’s “dispensing” power – this power which the Founders wished to eliminate – in ways, and to such an extent, that rule of law norms at the FCC will be called into further question.

This is what I meant when I said above that the new regulations are likely to raise pleading for special treatment and favors to new heights at the FCC. As the agency gains even more control over various participants in the Internet and communications marketplace, it will be subject to increasing pressures to use its dispensing power to grant this or that company (or market segment) favored treatment. For example, despite FCC protestations to the contrary, which protestations, by the way, do violence to the ordinary usage of the English language, the FCC will regulate the rates of some firms but not others, by holding unlawful the usage plans, sponsored data, or zero-rating plans, of some firms and not others. Or, to be sure, under its new inherently vague “good conduct” rule, the agency will be granting dispensations to some firms and not others, based on the exercise of discretion untethered to any standard in any law duly enacted by Congress.

This is part of what I mean by asking the question: “Is the FCC Unlawful?”

Now, for further readings in advance of the FCC’s February 26 vote (if you haven’t had a chance to read them already, I commend to you these excellent Perspectives from FSF Scholars published in the past two weeks: 

Each of them alone makes a convincing case that the course upon which the agency is about to embark – imposing Title II public utility regulation on Internet providers – will be harmful to consumers and to the future development of the Internet by thwarting investment, innovation, and consumer choice. Taken together, the case is devastating.

Now the act of imposing public utility regulation on Internet providers that I decried this past September in “Thinking the Unthinkable” is about to become reality. In the aftermath of the significant extension of government control over the Internet that, absent intervention by the courts or Congress, will ensue, I am convinced the question I posed at the beginning of the year – “Is the FCC Unlawful?” – will be asked with increasing frequency and seriousness of purpose.  

Thursday, February 19, 2015

Despite What FCC Chairman Wheeler Says, His Proposal Will Increase Taxes

The common perception among Title II opponents is that reclassification of broadband as a telecommunications service would levy a massive amount of new taxes and fees on Internet users. Robert Litan and Hal Singer of the Progressive Policy Institute estimated in a December 2014 policy brief that Title II regulations will add about $11 billion in new taxes.
Free Press claims that the extension of the Internet Tax Freedom Act (ITFA) by Congress eliminates the possibility of Title II reclassification resulting in any new taxes or fees. Now that FCC Chairman Tom Wheeler released a synopsis of his proposal (he has not released full proposal to the public), it is important that we get a straight answer.
Although Chairman Wheeler did not mention anything about new taxes or fees in his Wired blog post on his proposal on February 4th, the FCC Fact Sheet on the proposal clearly states:
The Order will not impose, suggest or authorize any new taxes or fees – there will be no automatic Universal Service fees applied and the congressional moratorium on Internet taxation applies to broadband.
So it is clear? Chairman Wheeler’s proposal to reclassify broadband under Title II will not add any new taxes or fees, right? Wrong!

FCC Commissioner Ajit Pai released a February 6th
statement on the 332 page proposal stating:
The plan explicitly opens the door to billions of dollars in new taxes on broadband. Indeed, states have already begun discussions on how they will spend the extra money. These new taxes will mean higher prices for consumers and more hidden fees that they have to pay.
Okay, so which statement is true?
Mr. Litan and Mr. Singer clarified the results of their paper in a blog post after Free Press claimed the findings were inaccurate due to the extension of the ITFA. Despite the passing of ITFA which generally bans Internet sales and access taxes, the Litan and Singer policy brief takes into account state-based telecom related fees for which there is no federal preemption.
Additionally, Hal Singer wrote a Forbes article after Chairman Wheeler released his blog. He said that even if the proposal does not include any new federal taxes, “state and local fees that apply to the ‘obligations of a telecommunications carrier’ could easily be extended to Internet service after reclassification.” Mr. Litan and Mr. Singer estimated in their policy brief that Title II regulations will cause annual state and local fees levied on wireline and wireless broadband subscribers to increase by $67 and $72, respectively.
Here is what seems to be going on. Chairman Wheeler is promising forbearance from the imposition of new taxes and fees, but he has no control over the actions of state and local governments which levy taxes on telecommunications providers. Additionally, the forbearance process likely will take months to years to complete and Chairman Wheeler has no authority to overrule the decisions of current or future commissioners. In other words, the proposal promises no new taxes, not because Title II regulations do not levy them, but because Chairman Wheeler hopes that future commissioners will vote to take federal taxes off the table and that state and local governments will not levy existing tax laws on Internet service providers. At least, this is the political agenda Chairman Wheeler is promoting at the moment.
When it comes to the forbearance of new taxes and fees under Title II, we should expect the worst and hope for the best. Unfortunately, the uncertainty of the forbearance process is enough to ensure that not all taxes and fees, if any, will be eliminated from Title II regulations.

Tuesday, February 17, 2015

Congress Should Pursue Royalty Reforms Urged in Copyright Office Report

One of the basic purposes of government is to protect private property rights. Article I, Section 8 of the U.S. Constitution recognizes copyright as property right and empowers Congress to secure royalties for copyright holders. But when it comes to copyright in sound recordings and music performances, current federal policy contains critical flaws. Reforms are needed to provide more adequate and equal protection for those rights.
A report issued by the Copyright Office on February 5 sets out laudable principles for moving copyright policy in a more free market-based and equitable direction. The report also recommends specific measures to improve copyright policy.
Congress should take the Copyright Office report’s principles and recommendations seriously. It should act to ensure public performance rights apply equally to all technology platforms, including terrestrial broadcast radio. Similarly, Congress should adopt a uniform, market-based rate standard for royalties that is applicable to all platforms. And it is noteworthy that the Copyright Office Report acknowledges that, in one way or the other, public performances of sound recordings made prior to 1972 should be subject to compensation so that the property rights of artists and creators of the pre-1972 recordings are secured.
As a general matter, current federal copyright law recognizes that public “performances” of musical sound recordings by commercial music service providers entitle the holder of a song’s copyright to royalty payments. But when the copyright’s holder and providers of music services cannot agree on royalties, federal law imposes a compulsory licensing and rate requirement. For most music services, the Copyright Royalty Board conducts ratemaking proceedings to establish sound recording copyright holder royalties. Copyright Judges set rates for traditional media like CDs and vinyl and for Internet-based digital music services. They also set rates for satellite providers, non-commercial broadcasting, and certain cable providers.
According to the Register of Copyrights, “[t]here is a widespread perception that our licensing system is broken.” This month, the Copyrights Office released its lengthy report, titled “Copyright and the Music Marketplace.” The report lays down several guiding principles for reform of federal copyright policy regarding sound recordings and music public performances. Among them:
  • Government licensing processes should aspire to treat like uses of music alike.
  • Government supervision should enable voluntary transactions while still supporting collective solutions.
  • A single, market‐oriented ratesetting standard should apply to all music uses under statutory licenses.
Based on those and other principles, the report offers a series of preliminary recommendations for copyright policy change. Three report recommendations for advancing parity in licensing deserve particularly close attention from Congress.

First, Congress should: “Extend the public performance right in sound recordings to terrestrial radio broadcasts.” Existing law allows broadcasts of copyrighted music content without any need for copyright holders’ mutual agreement. But it is only equitable that terrestrial or over-the-air broadcast radio should have to respect performance rights of copyright holders. Current policy unfairly gives terrestrial broadcast radio a privileged position vis-à-vis commercial music services that use different transmission technologies and business models. This puts satellite and at a competitive disadvantage. A 2013 Green Paper by the Department of Commerce made these same points. It is now time for Congress to act.
Second, Congress should: “Adopt a uniform marketbased ratesetting standard for all government rates.” The current federal policy of applying varying rate standards dependent on the underlying service technology is nonsensical and should be discarded. And in achieving uniformity in rate standards, Congress should prefer a standard that at least seeks to approximate free market outcomes rather than perform protectionist functions.
That is, Congress should only apply a “willing buyer/willing seller” standard for “reasonable” rates, definable as payments that “most clearly represent the rates and terms that would have been negotiated in the marketplace between a willing buyer and a willing seller.” This standard currently applies to non-interactive Internet-based digital music services such as Pandora, Spotify, and iHeartRadio – but not to cable and satellite video service providers. Congress should jettison the so-called 801(b) rate standard, which among things is calculated to “minimize any disruptive impact on the structure of the industries involved and on generally prevailing industry practices.” As I have written previously, Section 801(b)’s “anti-disruption proviso epitomizes what is wrong with the existing regulatory regime controlling music copyright royalties.”
Finally, it is useful that the Copyright Office Report acknowledges that the performance of pre-1972 sound recordings should be subject to compensation. While the Copyright Act of 1976 largely preempted state copyright law, Section 301(c) left intact state jurisdiction over rights in sound recordings fixed before February 15, 1972. The issue of state copyright protection in pre-72 sound recordings has been the subject of recent litigation involving digital music services such as Sirius XM. To date, courts that squarely faced the issue have recognized the existence of public performance rights under state law causes of action for copyright holders in pre-72 sound recordings. These recent cases are significant developments because the courts recognize that artists and creators of pre-1972 recordings have property interests that may not be misappropriated without compensation.
The report considers full federalization of the pre-1972 recordings – that is, federal field preemption of state law – one approach to achieving the desired result of ensuring compensation for performance of such recordings. Another possible approach is embodied in the RESPECT ACT. This previously introduced legislation does not preempt the field of state law protection in pre-1972 sound recordings as such. Instead, it provides that digital music services providers – such as Internet radio, cable, or satellite – must pay royalties for public performances of pre-1972 sound recordings in the same manner as they now do for post-1972 sound recordings. The RESPECT ACT would make such payment a safe harbor from state copyright infringement claims.
It may be that the federalization approach would be an acceptable means of achieving proper compensation for use of the pre-1972 recordings. And if so, there may be other changes in the Copyright Act – such as improving the efficacy of the DMCA procedures – that should accompany such federalization. In any event, it is important that the property rights in pre-1972 sound recordings be secured.  

The Copyright Office report contains many other reform proposals worth considering. But the report recommendations for advancing parity in licensing should be critical components of any congressional efforts to reform copyright policy for sound recordings and music performances. Congress should act to make copyright policy more amenable to free market transactions and to equitable treatment of music copyright holders and music service providers alike.

New Initiative Emerges with Goal of Diminishing Ad-Supported Piracy

The Trustworthy Accountability Group (TAG) recently launched what it is calling the Brand Integrity Program Against Piracy. The program will coordinate with companies in need of advertising and reliable advertising agencies in an attempt to diminish the number of advertisements that appear on websites which facilitate access to illegal content or counterfeit goods.
The Brand Integrity Program Against Piracy was supported at its launch by the U.S. Chamber of Commerce and a several organizations and companies involved in advertising, online publishing, advertising technology, media, and consumer protection, including: 
  • Advertising: Association of National Advertisers (ANA), American Association of Advertising Agencies (4A’s), Interactive Advertising Bureau (IAB), GroupM Interaction
  •  Advertising Technology: Collective, DoubleVerify, Integral Ad Science, L-3 and MiMTiD, sovrn, Veri-Site, whiteBULLET
  • Media: Recording Industry Association of America (RIAA), Motion Picture Association of America (MPAA), Independent Film & Television Alliance (IFTA), CreativeFuture, Copyright Alliance
  • Consumer Protection: International AntiCounterfeiting Coalition (IACC)
Any advertising agency that wants to participate in TAG’s new initiative can do so by using validated tools and services to identify and prevent advertising from running on websites which violate core IP principles.
TAG will also work with third party validators, such as Ernst & Young and Stroz Friedberg, to certify ad agencies as “Digital Advertising Assurance Providers” (DAAPs). In order to be certified as a DAAP, advertising agencies must be able to identify ad risk entities, prevent advertisements on undesired ad risk entities, detect, prevent or disrupt fraudulent or deceptive transactions, and eliminate payments to undesired ad risk entities. Once an ad agency is certified as a DAAP, it can work with companies to ensure that their ads do not end up on websites with illegal content.
This is a very important initiative considering there has been a rise in the number of ad-supported piracy websites. The Digital Citizens Alliance released a February 2014 report entitled “Good Money Gone Bad,” concluding that websites selling advertising against illegal content make roughly $227 million in annual ad revenue. The largest Bit Torrent websites are making more than $6 million a year, but even some of the smallest websites make more than $100 thousand a year.
While it is hard to estimate how much of this ad revenue is lost to the original artists and brand owners, even a $1 loss to innovators and entrepreneurs due to theft of IP is very unfortunate. This initiative and other private tools, such as and Rightscorp, are a step in the right direction towards diminishing the size and scope of online piracy and the sale counterfeit goods and content.
Strong IP rights are important for ensuring that content providers, artists, innovators, and marketers can earn a return on their ideas and labor, incentivizing more innovation, investment, and economic growth.  

Thursday, February 12, 2015

"The Walking Dead" Has Millions of Pirates

The midseason premiere of AMC’s hit show “The Walking Dead” set a new record for the series in terms of illegal downloads. Variety reported that within 20 hours of the February 8th premiere approximately 1.29 million Internet addresses had pirated the episode. Although HBO’s “Game of Thrones” season four premiere has the record with 1.86 million pirated copies within 24 hours of the debut, “The Walking Dead” seems to be the second most pirated show.
It is unfortunate that these pirate parties continue to occur and in record-setting fashion. (See here and here.) Innovative tools, such as and Rightscorp, have emerged in order to diminish piracy and protect intellectual property rights. But as long as these unfortunate events continue to occur, new efforts should be made to severely diminish the size and scope of theft of intellectual property. The protection of intellectual property rights is essential for encouraging more innovation, creative content, and economic growth, because it gives individuals the ability and incentives to provide valuable goods and services for consumers.

Tuesday, February 10, 2015

GIPC Releases International IP Index and the US is on Top

On February 4th, the Global IP Center at the US Chamber of Commerce released its 3rd edition of the International IP Index. The Index scores 30 countries, representing 80 percent of the world’s gross domestic product, between 0 and 1 for 30 indicators across six separate categories. The six categories are: 
  • Patents, Related Rights, and Limitations
  • Copyrights, Related Rights, and Limitations
  • Trademarks, Related Rights, and Limitations
  • Trade Secrets and Market Access
  • Enforcement
  • Membership and Ratification of International Treaties
The United States scored the highest with a 28.53 (out of 30) followed by the United Kingdom and Germany with scores of 27.61 and 27.28, respectively. The countries with the lowest scores were Vietnam, India, and Thailand at 7.84, 7.23, and 7.1, respectively.

The index also found some interesting correlations concerning strong IP rights across all countries:
  • Strong IP rights and research and development (R&D) expenditure: Companies in economies with advanced IP systems are 40% more likely to invest in R&D.
  • Strong IP rights and high-value job growth: Economies with favorable IP regimes employ more than half their workforce in knowledge-intensive sectors.
  • Strong IP rights and foreign direct investment (FDI): Strong IP protections in the life sciences sector account for 40% of life sciences investment. Additionally, economies with beneficial IP protection see 9–10 times more life sciences investment than economies with weak IP protections.
  • Strong IP rights and innovative activity: Economies with robust IP environments yield 50% more innovative output compared with economies with IP regimes in need of improvement.
The United States is certainly a world leader with respect to IP rights and enforcement. But while the United States is at the top of the index, it would be better off if all countries caught up to its leadership in IP. In fact, the entire global economy is better off when developing countries adopt stronger IP policies, because strong institutions, such as IP, have a positive externality on the global economy. When one country adopts stronger IP rights, it makes its surrounding countries and trading partners better off, because it encourages more innovation and more economic activity. Even if one country has weak IP rights protections, it can import goods from a country with strong IP rights, which will hopefully lead to better policies as the benefits from strong IP rights are realized. Thus, the gains from global trade are much higher in a world with robust IP rights.

The Ambassador of the Republic of Singapore to the US, H.E. Ashok Kumar Mirpuri, stated during the ceremony at which the index was released that policymakers should use the index as a guide for how their country can improve. The index provides sound analysis for areas in which specific countries can gain ground in coming years, and it shows as 20 of the 30 countries improved their score over the past year.
The data shows that strong IP protections incentivize investment in R&D, innovation, and creative content, because entrepreneurs can earn a return on their labor and ideas. In turn, this means that economies can grow and prosper if individuals have the ability and incentives to provide valuable goods and services for consumers.
Hopefully we will see even higher scores next year!

Monday, February 09, 2015

Tom Giovanetti's "How to Fix the Internet"

There are a lot of very good pieces in the blogosphere and elsewhere -- including our own! -- explaining why the FCC should not adopt Title II regulation for Internet providers.

But for some time now I have been meaning to commend to you one of the really good ones, a satiric essay by the Institute for Policy Innovation's Tom Giovanetti that ran in the National Review Online. I guarantee that you'll smile -- or laugh out loud -- while you're ready it. But it will be a knowing smile or knowing laugh.

Knowing as in knowing that the government shouldn't convert the Internet into a public utility.

Nice work, Tom!

Strong Safeguards of Scarce Funds Should Govern FCC Broadband Experiments

The Federal Communications Commission has a paramount duty to protect consumers. In fulfilling that duty it must not squander Universal Service Fund “surcharges” imposed on consumers’ telephone bills that have the same economic effect as taxes. Like tax dollars, consumer surcharges must be used efficiently and not put at unnecessary risk.

But the FCC is considering whether to waive important financial safeguards of its rural broadband experiments program. Seven rural electrical co-operatives hand-picked by the FCC to become broadband service providers with the aid of federal subsidies want letters of credit rules watered down. Those subsidies are funded by de facto taxes on voice consumers. Just last year, the FCC deemed establishment of strong safeguards to protect against misuse of funds its “paramount objective.” The FCC should hold fast to that objective by maintaining strong letters of credit requirements.

The Rural Broadband Experiments program is one aspect of the Connect America Fund’s Phase II plan for bringing universal service into the broadband era. All universal service programs are ultimately funded by voice consumers. The 16.8% line-item surcharge on the long-distance portion of consumers’ monthly bills effectively operates like a tax. The FCC sets the surcharge rate and oversees use of the surcharges collected.

Through its Rural Broadband Experiments program the FCC is slated to give nearly $40 million dollars drawn from voice consumers to rural electrical co-operatives. The money is to fund the co-ops’ entry into the broadband business. 

Yet, as I explained in a prior blog post, the “FCC Should Not Use Scarce Universal Service Funds to Subsidize Unproven Start-Ups.” (Also see FSF President Randolph J. May’s follow-up blog.) That post drew upon a basic principle: it is not government’s job to create new businesses using consumers’ hard-earned dollars. Granting special favors to would-be business entrants distorts the role of government as a neutral enforcer of the law. Giving favored interests start-up money to move into new lines of business similarly undermines government impartiality.

In the time since my November blog post, the FCC decided to fund new co-op ventures in broadband. Now what’s done may be done. But another basic principle which that blog drew upon still holds: government must protect consumers by carefully using scarce funds. The FCC must steadfastly adhere to this principle in implementing its Rural Broadband Experiments program.

Right now the FCC is weighing whether it will significantly weaken financial safeguards for funds to be doled out for rural broadband experiments. An alliance of rural electrical co-ops is seeking a waiver from rules requiring letters of credit (LOCs) that were established by the FCC in its Rural Broadband Experiments Order (2014).

The Order sensibly required that recipients of funds for rural broadband experiments obtain letters of credit from banks. LOCs are intended to ensure that the full amount of disbursed funds will be returned to the FCC should the recipients fail to use those funds as pledged or otherwise fail to meet build-out and service obligations.

The FCC’s Order emphasized the financial responsibility and security reasons for its rules: 
LOCs are an effective means of securing our financial commitment to provide Connect America support. LOCs permit the Commission to protect the integrity of universal service funds that have been disbursed and immediately reclaim support that has been provided in the event that the recipient is not using those funds in accordance with the Commission’s rules and requirements to further the objectives of universal service. Moreover, LOCs have the added advantage of minimizing the possibility that the support becomes property of a recipient’s bankruptcy estate for an extended period of time, thereby preventing the funds from being used promptly to accomplish our goals. These concerns are relevant to both new entrants and established providers.
Our paramount objective is to establish strong safeguards to protect against misuse of the Connect America Fund. We conclude that requiring all entities to obtain a LOC is a necessary measure to ensure that we can recover support from any recipient that cannot meet the build-out obligations and public service obligations of the rural broadband experiments.
The FCC is now taking public comments on the waiver petition filed by the rural electrical co-ops. In their petition, the co-ops contend that banks are unwilling to extend them LOCs on terms required by the FCC. They also claim the FCC’s rules are too financially burdensome.

But the need to protect limited funds from risk should keep the FCC from cutting corners on financial safeguards. The FCC should keep its focus on its paramount objective of safeguarding scarce USF funds against misuse. That certainly means being mindful of the reasons for LOC requirements set out in the Rural Broadband Experiments Order.

Without fixating on specific dollar figures or timeframes that should govern LOC requirements, a few more considerations weigh against rolling back safeguards. First, keep in mind that the FCC is funding experiments. Typically, market investors and entrepreneurs bear the risk of financial mishaps and failures. Here, however, funds collected from consumers are devoted to entrants lacking business and technical experience in providing retail broadband Internet services. Rural electrical co-ops are rate-of-return monopoly service providers that have historically operated in a market environment and line of business quite different from broadband. The highly experimental nature of subsidizing co-op entry into broadband services requires protections against the heightened risk that carries.

Second, prior occasions in which federal agencies allocated limited resources to entities lacking adequate financial and technical capabilities resulted in costly problems. For instance, when the FCC selected certain “designated entities” for favored treatment in its PCS spectrum auction, valuable spectrum allocated to NextWave went unused for years as NextWave’s bankruptcy battle played out in the courts. More recently, the Rural Utility Service’s rural broadband loan program has come under scrutiny for inadequate safeguards. A May 2014 report by the Government Accountability Office, for example, ascertained that of 100 loans approved since 2002, “43 loans are no longer active, either because they have been rescinded or are in default.” The inactive loans constituted 54% of the approximately $2 billion dollars awarded by RUS up to that time. Both episodes serve as reminders of the need for safeguarding rural broadband experiment subsidies.

And third, any unwillingness by banks to provide financial security to rural electrical co-op broadband experiments through LOCs suggests unnecessary risk and lack of feasibility in such undertakings. If banks are unwilling to bear the financial risk of failure by co-op broadband experiments, why should voice consumers be made to take on that risk? When in doubt, safeguarding scarce funds for the benefit of consumers takes priority over inconvenience to subsidy recipients.

In administering the Rural Broadband Experiments program, the FCC must continue to ensure scarce funds collected from consumers are used efficiently and protected from unnecessary risk. The FCC should adhere to its stated “paramount objective” by maintaining strong safeguards to protect those funds against misuse. It should refuse to cut corners on its letters of credit rules.