The FCC and the 'second side of the market'

Last month, the D.C. Circuit heard oral arguments in the appeal of the Federal Communications Commission's (FCC) net neutrality order. At the heart of the appeal is the FCC's controversial decision to reverse nearly two decades of bipartisan policy by reclassifying broadband Internet access from a lightly regulated "information service" under Title I of the Communications Act to a heavily regulated common carrier "telecommunications service" under Title II of the Communications Act. The appellants argued that given the way the Internet works, the plain language of the Communications Act prohibits reclassification; the commission, in turn, argued that as the expert agency, it has wide latitude to change its mind so long as it provides a reasonable explanation.

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Without getting into the merits of this debate, let's assume for the moment that the D.C. Circuit agrees with the FCC and finds the commission's reclassification decision to be lawful. What is important to understand is that this ruling is not the end of the story: The next legal question to be resolved is whether the FCC properly applied Title II to the Internet in accordance with the plain terms of the statute and established case law.

While this question will be ultimately decided by the court, there is no dispute that great pressure from the White House forced the FCC to engage in some serious legal gymnastics to reach a predetermined political outcome. However, by taking various legal liberties and shortcuts, the commission may have left itself vulnerable to remand (if not outright reversal).

Let me explain.

Shortly before the FCC was to vote on its Open Internet Order, we at the Phoenix Center published an article in the Federal Communications Law Journal entitled "Tariffing Internet Termination: Pricing Implications of Classifying Broadband as a Title II Telecommunications Service." In this paper, we presented a detailed legal and economic analysis which demonstrated that if the FCC moves forward with reclassification of broadband Internet access as a common-carrier telecommunications service under Title II, then edge providers become "customers" of broadband service providers (BSPs) and, as such, BSPs must be allowed to charge edge providers a positive price for terminating access (or, as the FCC itself described this service in its May 2014 "Notice of Proposed Rulemaking," the "second side of the market").

Soon after our paper was published, it was widely reported that edge providers aggressively lobbied the FCC to prevent this outcome. With an FCC largely in the edge providers' pockets (at the behest of the White House), the agency agreed. Given time exigencies, the FCC attempted a last-minute fix by folding "terminating access" (i.e., the relationship between edge providers and BSPs) into the consumer-facing "broadband Internet access service" (BIAS), even though they are distinctly different services serving entirely different customers (a point made plain by the D.C. Circuit in Verizon v. FCC). In fact, FCC Chairman Tom Wheeler's original idea was to reclassify as a Title II service only the termination side of the two-sided broadband market. Stuck with the apparent requirements of reclassification on the termination service (detailed in our paper), the befuddled agency concluded that it "need not reach the regulatory classification" for terminating access because termination is, the agency asserted, merely a component of end-user broadband service. Whether the FCC reclassified termination (by virtue of reclassifying BIAS) or did not (leaving it an "information service") remains unclear and is still debated.

But as we detailed in our amicus brief before the D.C. Circuit, the FCC's reclassification razzle-dazzle makes no difference. In Verizon, the court made it abundantly clear that, among other things, termination was a separate and unique service. Consequently, irrespective of how the FCC's action is translated, there's plenty of trouble.

First, let's assume arguendo that the FCC, as it stated in its order, was not reclassifying terminating access as a Title II service. In this case, the FCC runs into trouble because under the plain terms of its net neutrality rules, the commission nonetheless clearly intends to regulate terminating access as a common-carrier service (as the D.C. Circuit in Verizon previously recognized) by virtue of its no-blocking and no-paid-prioritization rules. As such, the FCC's decision is a direct affront to the D.C. Circuit's holding in Verizon, which clearly holds that the commission cannot regulate a Title I information service as a Title II common-carrier service. However, if we assume that terminating access is in fact a Title II service (by virtue of it being a part of BIAS), then the FCC's paid prioritization rule violates basic principles of rate-making because it both requires a confiscatory price of "zero" under Section 201 of the Communications Act (even though edge providers impose a cost on the network) and prevents "reasonable" discrimination as expressly permitted by Section 202 of the Communications Act. Either way, the agency's order runs afoul of both the clear language of the statute and the relevant case law.

Based on the tenor of the oral arguments earlier this month, it seemed that the panel was very interested in the arguments we made. (Some have erroneously described "terminating access" as "interconnection," but "terminating access" is a distinct service from termination. Blocking and paid prioritization would target, presumably by deep packet inspection, one of many "signals" traversing a single interconnection circuit.) A number of questions indicated that the judges were well aware of basic rate-making practices. Will the FCC net neutrality regulations fall on these grounds? It's hard to say. Reading the tea leaves of an oral argument is a dangerous exercise and courts are largely unpredictable. We will all have to wait and see how the D.C. Circuit reacts when it issues its opinion a few months from now.

Still, what's interesting about this take on the case is that if the court upholds the agency on reclassification, then it may be the most Pyrrhic of victories. If the D.C. Circuit decides that termination is permissibly a Title II common-carrier telecommunications service, then the commission may be precluded from imposing its no-blocking and no-paid-prioritization" rules that lie at the heart of its net neutrality policies. Such a finding would leave the FCC unable to implement its bright-line regulation of the Internet under either Title I or Title II of the Communications Act.

The sad thing is that the commission could have easily achieved much (but not all) of what the White House wanted under a Title I net neutrality regime without such legal wrangling. Unfortunately, both President Obama's and Chairman Wheeler's hubris got in the way.

Spiwak is the president of the Phoenix Center for Advanced Legal & Economic Public Policy Studies, a nonprofit 501(c)(3) research organization that studies broad public-policy issues related to governance, social and economic conditions, with a particular emphasis on the law and economics of the digital age.

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