Thursday, June 11, 2015

Designating Designated Entities for Reform

The Federal Communications Commission needs to designate the so-called “Designated Entities” program for meaningful reform.

Although the legislation authorizing the FCC to conduct spectrum auctions promotes allocation of spectrum for the highest and best use, it also permits the FCC to give preferences, in the form of “bidding credits,” to Designated Entities in order to promote participation by small businesses in the auctions. Not surprisingly, the FCC has struggled over the years, with limited success, to implement the “small business” program in a way that avoids abusive conduct. I say, “not surprisingly,” because it is not easy to devise a complicated regulatory regime – one that, by design, promises special preferences and large financial rewards to particular “designated entities” – in a way that does not invite abuses and unjust enrichment.

And in the case of spectrum auctions, while certain parties taking advantage of their favored designation may be unjustly enriched, taxpayers are unjustly harmed by the same measure. In the most recent controversy surrounding the program, it appears that substantial, non-controlling interests from large bidders raise concerns about the integrity of the program, particularly when joint bidding is involved.

In many respects, the recent AWS-3 auction, which garnered nearly $45 billion in revenues (reduced by about $3.3 billion because of DE bidding credits), was a success. However, whatever success the auction enjoyed has been somewhat called into question by the joint bidding of Dish and two small DEs, Northstar, and SNR Wireless. It turns out Dish has a non-controlling 85 percent ownership interest in the DEs. All three firms together accounted for about $10.3 billion in winning bids. Although large bidders have had substantial, non-controlling interests in DEs in the past, the type of joint bidding arrangement used in the AWS-3 auction apparently is unprecedented.

FCC Commissioners Pai and O'Rielly have expressed concerns regarding the operation of the DE program, including in the context of the AWS-3 auction. Commissioner Clyburn also has expressed concern, albeit more mildly. And Chairman Wheeler, to his credit, ordered the staff to take a close look at the program and issued a detailed Public Notice seeking comment.

Based on an economic analysis of the auction bidding, Verizon has suggested that Dish, Northstar, and SNR Wireless engaged in anti-competitive, collusive bidding. A coalition of mobile companies, including AT&T and a number of small companies, propose to reform the DE program by eliminating joint bids by a bidder with significant ownership interests in other joint bidders seeking to utilize DE bidding credits. The coalition proposes to preserve DE credits for genuine small businesses as well as rural telephone companies. It suggests that its reform proposal would preserve the DE program’s original intent, without giving unfair advantages to multi-billion dollar bidders.

Dish, of course, argues that it, Northstar, and SNR complied with the existing rules, including bidding disclosure requirements. Dish argues that its participation increased auction receipts, financing for small companies, and the diversity of bidders.

Whether or not Dish, Northstar, and SNR complied with the existing bidding rules is not irrelevant, of course. But, for me, it is not the main point, which is that spectrum auctions, to the maximum extent possible, should be conducted on an unencumbered, free market basis, without special dispensations and preferences. This will ensure that spectrum is put to the highest and best use, maximizing consumer welfare. In the bargain, it will maximize auction revenues to the benefit of the nation’s taxpayers.

The DE program, obviously a special carve-out to the unencumbered auction principle, is meant to help small businesses, rural telephone companies, and businesses owned by minority groups gain access to spectrum. Unfortunately, however, the DE program has not been very successful in achieving its objectives, however valid they may be. And in the past the program has arguably produced skewed bidding results. Moreover, the majority of small business bidders, excluding companies associated with rural telephone companies, end up selling their spectrum to the highest bidders, rather than building out networks. On top of all this, DE auction awardees often are mired in post-auction litigation for long periods, resulting in network build-out delays that otherwise might not have occurred.

All this said, the FCC is right to designate the Designated Entities program for meaningful reform to curb abuses. When abusive conduct occurs that is inconsistent with the underlying public policy purposes of the DE program, it undermines the integrity of particular auction results. Perhaps more importantly, abuses also undermine public confidence in the Commission’s ability to carry out its duties effectively and efficiently.