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In recent years much ink has been spilled on the problem of online privacy breaches, involving the unauthorized use of personal information transmitted over the Internet.  Internet privacy concerns are warranted.  According to a 2016 National Telecommunications and Information Administration survey of Internet-using households, 19 percent of such households (representing nearly 19 million households) reported that they had been affected by an online security breach, identity theft, or similar malicious activity during the 12 months prior to the July 2015 survey.  Security breaches appear to be more common among the most intensive Internet-using households – 31 percent of those using at least five different types of online devices suffered such breaches.  Security breach statistics, of course, do not directly measure the consumer welfare losses attributable to the unauthorized use of personal data that consumers supply to Internet service providers and to the websites which they visit.

What is the correct overall approach government should take in dealing with Internet privacy problems?  In addressing this question, it is important to focus substantial attention on the effects of online privacy regulation on economic welfare.  In particular, policies should aim at addressing Internet privacy problems in a manner that does not unduly harm the private sector or deny opportunities to consumers who are not being harmed.  The U.S. Federal Trade Commission (FTC), the federal government’s primary consumer protection agency, has been the principal federal regulator of online privacy practices.  Very recently, however, the U.S. Federal Communications Commission (FCC) has asserted the authority to regulate the privacy practices of broadband Internet service providers, and is proposing an extremely burdensome approach to such regulation that would, if implemented, have harmful economic consequences.

In March 2016, FTC Commissioner Maureen Ohlhausen succinctly summarized the FTC’s general approach to online privacy-related enforcement under Section 5 of the FTC Act, which proscribes unfair or deceptive acts or practices:

[U]nfairness establishes a baseline prohibition on practices that the overwhelming majority of consumers would never knowingly approve. Above that baseline, consumers remain free to find providers that match their preferences, and our deception authority governs those arrangements. . . .  The FTC’s case-by-case enforcement of our unfairness authority shapes our baseline privacy practices.  Like the common law, this incremental approach has proven both relatively predictable and adaptable as new technologies and business models emerge.

In November 2015, Professor (and former FTC Commissioner) Joshua Wright argued the FTC’s approach is insufficiently attuned to economic analysis, in particular, the “tradeoffs between the value to consumers and society of the free flow and exchange of data and the creation of new products and services on the one hand, against the value lost by consumers from any associated reduction in privacy.”  Nevertheless, on balance, FTC enforcement in this area generally is restrained and somewhat attentive to cost-benefit considerations.  (This undoubtedly reflects the fact (see my Heritage Legal Memorandum, here) that the statutory definition of “unfairness” in Section 5(n) of the FTC Act embodies cost-benefit analysis, and that the FTC’s Policy Statement on Deception requires detriment to consumers acting reasonably in the circumstances.)  In other words, federal enforcement policy with respect to online privacy, although it could be improved, is in generally good shape.

Or it was in good shape.  Unfortunately, on April 1, 2016, the Federal Communications Commission (FCC) decided to inject itself into “privacy space” by issuing a Notice of Proposed Rulemaking entitled “Protecting the Privacy of Customers of Broadband and Other Telecommunications Services.”  This “Privacy NPRM” sets forth detailed rules that, if adopted, would impose onerous privacy obligations on “Broadband Internet Access Service” (BIAS) Providers, the firms that provide the cables, wires, and telecommunications equipment through which Internet traffic flows – primarily cable (Comcast, for example) and telephone (Verizon, for example) companies.   The Privacy NPRM reclassifies BIAS provision as a “common carrier” service, thereby totally precluding the FTC from regulating BIAS Providers’ privacy practices (since the FTC is barred by law from regulating common carriers, under 15 U.S. Code § 45(a)(2)).  Put simply, the NPRM required BIAS Providers “to obtain express consent in advance of practically every use of a customer[s] data”, without regard to the effects of such a requirement on economic welfare.  All other purveyors of Internet services, however – in particular, the large numbers of “edge providers” that generate Internet content and services (Google, Amazon, and Facebook, for example) – are exempt from the new FCC regulatory requirements.  In short, the Privacy NPRM establishes a two-tier privacy regulatory system, with BIAS Providers subject to tight FCC privacy rules, while all other Internet service firms are subject to more nuanced, case-by-case, effects-based evaluation of their privacy practices by the FTC.  This disparate regulatory approach is peculiar (if not wholly illogical), since edge providers in general have greater access than BIAS Providers to consumers’ non-public information, and thus may appear to pose a greater threat to consumers’ interest in privacy.

The FCC’s proposal to regulate BIAS Providers’ privacy practices represents bad law and horrible economic policy.  First, it undermines the rule of law by extending the FCC’s authority beyond its congressional mandate.  It does this by basing its regulation of a huge universe of information exchanges on Section 222 of the Telecommunications Act of 1996, a narrow provision aimed at a very limited type of customer-related data obtained in connection with old-style voice telephony transmissions.  This is egregious regulatory overreach.  Second, if implemented, it will harm consumers, producers, and the overall economic by imposing a set of sweeping opt-in consent requirements on BIAS Providers, without regard to private sector burdens or actual consumer welfare (see here); by reducing BIAS Provider revenues and thereby dampening investment that is vital to the continued growth of and innovation in Internet-related industries (see here); by reducing the ability of BIAS Providers to provide welfare-enhancing competitive pressure on providers on Internet edge providers (see here); and by raising consumer prices for Internet services and deny discount programs desired by consumers (see here).

What’s worse, the FCC’s proposed involvement in online privacy oversight comes at a time of increased Internet privacy regulation by foreign countries, much of it highly intrusive and lacking in economic sophistication.  A particularly noteworthy effort to clarify cross-national legal standards is the Privacy Shield, a 2016 United States – European Union agreement that establishes regulatory online privacy protection norms, backed by FTC enforcement, that U.S. companies transmitting data into Europe may choose to accept on a voluntary basis.  (If they do not accede to the Shield, they may be subject to uncertain and heavy-handed European sanctions.)  The Privacy NPRM, if implemented, will create an additional concern for BIAS Providers, since they will have to evaluate the implications of new FCC regulation (rather than simply rely on FTC oversight) in deciding whether to opt in to the Shield’s standards and obligations.

In sum, the FCC’s Privacy NPRM would, if implemented, harm consumers and producers, slow innovation, and offend the rule of law.  This prompts four recommendations.

  • The FCC should withdraw the NPRM and leave it to the FTC to oversee all online privacy practices, under its Section 5 unfairness and deception authority. The adoption of the Privacy Shield, which designates the FTC as the responsible American privacy oversight agency, further strengthens the case against FCC regulation in this area. 
  • In overseeing online privacy practices, the FTC should employ a very light touch that stresses economic analysis and cost-benefit considerations. Moreover, it should avoid requiring that rigid privacy policy conditions be kept in place for long periods of time through consent decree conditions, in order to allow changing market conditions to shape and improve business privacy policies. 
  • Moreover, the FTC should borrow a page from former FTC Commissioner Joshua Wright by implementing an “economic approach” to privacy. Under such an approach:  

o             FTC economists would help make the Commission a privacy “thought leader” by developing a rigorous academic research agenda on the economics of privacy, featuring the economic evaluation of industry sectors and practices; 

o             the FTC would bear the burden of proof of showing that violations of a company’s privacy policy are material to consumer decision-making;

o             FTC economists would report independently to the FTC about proposed privacy-related enforcement initiatives; and

o             the FTC would publish the views of its Bureau of Economics in all privacy-related consent decrees that are placed on the public record.   

  • The FTC should encourage the European Commission and other foreign regulators to take into account the economics of privacy in developing their privacy regulatory policies. In so doing, it should emphasize that innovation is harmed, the beneficial development of the Internet is slowed, and consumer welfare and rights are undermined through highly prescriptive regulation in this area (well-intentioned though it may be).  Relatedly, the FTC and other U.S. Government negotiators should argue against adoption of a “one-size-fits-all” global privacy regulation framework.   Such a global framework could harmfully freeze into place over-regulatory policies and preclude beneficial experimentation in alternative forms of “lighter-touch” regulation and enforcement. 

While no panacea, these recommendations would help deter (or, at least, constrain) the economically harmful government micromanagement of businesses’ privacy practices, in the United States and abroad.

Yesterday, the International Center for Law & Economics filed reply comments in the docket of the FCC’s Broadband Privacy NPRM. ICLE was joined in its comments by the following scholars of law & economics:

  • Babette E. Boliek, Associate Professor of Law, Pepperdine School of Law
  • Adam Candeub, Professor of Law, Michigan State University College of Law
  • Justin (Gus) Hurwitz, Assistant Professor of Law, Nebraska College of Law
  • Daniel Lyons, Associate Professor, Boston College Law School
  • Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Paul H. Rubin, Samuel Candler Dobbs Professor of Economics, Emory University Department of Economics

As in our initial comments, we drew on the economic scholarship of multi-sided platforms to argue that the FCC failed to consider the ways in which asymmetric regulation will ultimately have negative competitive effects and harm consumers. The FCC and some critics claimed that ISPs are gatekeepers deserving of special regulation — a case that both the FCC and the critics failed to make.

The NPRM fails adequately to address these issues, to make out an adequate case for the proposed regulation, or to justify treating ISPs differently than other companies that collect and use data.

Perhaps most important, the NPRM also fails to acknowledge or adequately assess the actual market in which the use of consumer data arises: the advertising market. Whether intentionally or not, this NPRM is not primarily about regulating consumer privacy; it is about keeping ISPs out of the advertising business. But in this market, ISPs are upstarts challenging the dominant position of firms like Google and Facebook.

Placing onerous restrictions upon ISPs alone results in either under-regulation of edge providers or over-regulation of ISPs within the advertising market, without any clear justification as to why consumer privacy takes on different qualities for each type of advertising platform. But the proper method of regulating privacy is, in fact, the course that both the FTC and the FCC have historically taken, and which has yielded a stable, evenly administered regime: case-by-case examination of actual privacy harms and a minimalist approach to ex ante, proscriptive regulations.

We also responded to particular claims made by New America’s Open Technology Institute about the expectations of consumers regarding data collection online, the level of competitiveness in the marketplace, and the technical realities that differentiate ISPs from edge providers.

OTI attempts to substitute its own judgment of what consumers (should) believe about their data for that of consumers themselves. And in the process it posits a “context” that can and will never shift as new technology and new opportunities emerge. Such a view of consumer expectations is flatly anti-innovation and decidedly anti-consumer, consigning broadband users to yesterday’s technology and business models. The rule OTI supports could effectively forbid broadband providers from offering consumers the option to trade data for lower prices.

Our reply comments went on to point out that much of the basis upon which the NPRM relies — and alleged lack of adequate competition among ISPs — was actually a “manufactured scarcity” based upon the Commission’s failure to properly analyze the relevant markets.

The Commission’s claim that ISPs, uniquely among companies in the modern data economy, face insufficient competition in the broadband market is… insufficiently supported. The flawed manner in which the Commission has defined the purported relevant market for broadband distorts the analysis upon which the proposed rules are based, and manufactures a false scarcity in order to justify unduly burdensome privacy regulations for ISPs. Even the Commission’s own data suggest that consumer choice is alive and well in broadband… The reality is that there is in fact enough competition in the broadband market to offer privacy-sensitive consumers options if they are ever faced with what they view as overly invasive broadband business practices. According to the Commission, as of December 2014, 74% of American homes had a choice of two or more wired ISPs delivering download speeds of at least 10 Mbps, and 88% had a choice of at least two providers of 3 Mbps service. Meanwhile, 93% of consumers have access to at least three mobile broadband providers. Looking forward, consumer choice at all download speeds is increasing at rapid rates due to extensive network upgrades and new entry in a highly dynamic market.

Finally, we rebutted the contention that predictive analytics was a magical tool that would enable ISPs to dominate information gathering and would, consequently, lead to consumer harms — even where ISPs had access only to seemingly trivial data about users.

Some comments in support of the proposed rules attempt to cast ISPs as all powerful by virtue of their access to apparently trivial data — IP addresses, access timing, computer ports, etc. — because of the power of predictive analytics. These commenters assert that the possibility of predictive analytics coupled with a large data set undermines research that demonstrates that ISPs, thanks to increasing encryption, do not have access to any better quality data, and probably less quality data, than edge providers themselves have.

But this is a curious bit of reasoning. It essentially amounts to the idea that, not only should consumers be permitted to control with whom their data is shared, but that all other parties online should be proscribed from making their own independent observations about consumers. Such a rule would be akin to telling supermarkets that they are not entitled to observe traffic patterns in their stores in order to place particular products in relatively more advantageous places, for example. But the reality is that most data is noise; simply having more of it is not necessarily a boon, and predictive analytics is far from a panacea. In fact, the insights gained from extensive data collection are frequently useless when examining very large data sets, and are better employed by single firms answering particular questions about their users and products.

Our full reply comments are available here.

In the wake of the recent OIO decision, separation of powers issues should be at the forefront of everyone’s mind. In reaching its decision, the DC Circuit relied upon Chevron to justify its extreme deference to the FCC. The court held, for instance, that

Our job is to ensure that an agency has acted “within the limits of [Congress’s] delegation” of authority… and that its action is not “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.”… Critically, we do not “inquire as to whether the agency’s decision is wise as a policy matter; indeed, we are forbidden from substituting our judgment for that of the agency.”… Nor do we inquire whether “some or many economists would disapprove of the [agency’s] approach” because “we do not sit as a panel of referees on a professional economics journal, but as a panel of generalist judges obliged to defer to a reasonable judgment by an agency acting pursuant to congressionally delegated authority.

The DC Circuit’s decision takes a broad view of Chevron deference and, in so doing, ignores or dismisses some of the limits placed upon the doctrine by cases like Michigan v. EPA and UARG v. EPA (though Judge Williams does bring up UARG in dissent).

Whatever one thinks of the validity of the FCC’s approach to regulating the Internet, there is no question that it has, at best, a weak statutory foothold. Without prejudging the merits of the OIO, or the question of deference to agencies that find “[regulatory] elephants in [statutory] mouseholes,”  such broad claims of authority, based on such limited statutory language, should give one pause. That the court upheld the FCC’s interpretation of the Act without expressing reservations, suggesting any limits, or admitting of any concrete basis for challenging the agency’s authority beyond circular references to “abuse of discretion” is deeply troubling.

Separation of powers is a fundamental feature of our democracy, and one that has undoubtedly contributed to the longevity of our system of self-governance. Not least among the important features of separation of powers is the ability of courts to review the lawfulness of legislation and executive action.

The founders presciently realized the dangers of allowing one part of the government to centralize power in itself. In Federalist 47, James Madison observed that

The accumulation of all powers, legislative, executive, and judiciary, in the same hands, whether of one, a few, or many, and whether hereditary, selfappointed, or elective, may justly be pronounced the very definition of tyranny. Were the federal Constitution, therefore, really chargeable with the accumulation of power, or with a mixture of powers, having a dangerous tendency to such an accumulation, no further arguments would be necessary to inspire a universal reprobation of the system. (emphasis added)

The modern administrative apparatus has become the sort of governmental body that the founders feared and that we have somehow grown to accept. The FCC is not alone in this: any member of the alphabet soup that constitutes our administrative state, whether “independent” or otherwise, is typically vested with great, essentially unreviewable authority over the economy and our daily lives.

As Justice Thomas so aptly put it in his must-read concurrence in Michigan v. EPA:

Perhaps there is some unique historical justification for deferring to federal agencies, but these cases reveal how paltry an effort we have made to understand it or to confine ourselves to its boundaries. Although we hold today that EPA exceeded even the extremely permissive limits on agency power set by our precedents, we should be alarmed that it felt sufficiently emboldened by those precedents to make the bid for deference that it did here. As in other areas of our jurisprudence concerning administrative agencies, we seem to be straying further and further from the Constitution without so much as pausing to ask why. We should stop to consider that document before blithely giving the force of law to any other agency “interpretations” of federal statutes.

Administrative discretion is fantastic — until it isn’t. If your party is the one in power, unlimited discretion gives your side the ability to run down a wish list, checking off controversial items that could never make it past a deliberative body like Congress. That same discretion, however, becomes a nightmare under extreme deference as political opponents, newly in power, roll back preferred policies. In the end, regulation tends toward the extremes, on both sides, and ultimately consumers and companies pay the price in the form of excessive regulatory burdens and extreme uncertainty.

In theory, it is (or should be) left to the courts to rein in agency overreach. Unfortunately, courts have been relatively unwilling to push back on the administrative state, leaving the task up to Congress. And Congress, too, has, over the years, found too much it likes in agency power to seriously take on the structural problems that give agencies effectively free reign. At least, until recently.

In March of this year, Representative Ratcliffe (R-TX) proposed HR 4768: the Separation of Powers Restoration Act (“SOPRA”). Arguably this is first real effort to fix the underlying problem since the 1995 “Comprehensive Regulatory Reform Act” (although, it should be noted, SOPRA is far more targeted than was the CRRA). Under SOPRA, 5 U.S.C. § 706 — the enacted portion of the APA that deals with judicial review of agency actions —  would be amended to read as follows (with the new language highlighted):

(a) To the extent necessary to decision and when presented, the reviewing court shall determine the meaning or applicability of the terms of an agency action and decide de novo all relevant questions of law, including the interpretation of constitutional and statutory provisions, and rules made by agencies. Notwithstanding any other provision of law, this subsection shall apply in any action for judicial review of agency action authorized under any provision of law. No law may exempt any such civil action from the application of this section except by specific reference to this section.

These changes to the scope of review would operate as a much-needed check on the unlimited discretion that agencies currently enjoy. They give courts the ability to review “de novo all relevant questions of law,” which includes agencies’ interpretations of their own rules.

The status quo has created a negative feedback cycle. The Chevron doctrine, as it has played out, gives outsized incentives to both the federal agencies, as well as courts, to essentially disregard Congress’s intended meaning for particular statutes. Today an agency can write rules and make decisions safe in the knowledge that Chevron will likely insulate it from any truly serious probing by a district court with regards to how well the agency’s action actually matches up with congressional intent or with even rudimentary cost-benefit analysis.

Defenders of the administrative state may balk at changing this state of affairs, of course. But defending an institution that is almost entirely immune from judicial and legal review seems to be a particularly hard row to hoe.

Public Knowledge, for instance, claims that

Judicial deference to agency decision-making is critical in instances where Congress’ intent is unclear because it balances each branch of government’s appropriate role and acknowledges the realities of the modern regulatory state.

To quote Justice Scalia, an unfortunate champion of the Chevron doctrine, this is “pure applesauce.”

The very core of the problem that SOPRA addresses is that the administrative state is not a proper branch of government — it’s a shadow system of quasi-legislation and quasi-legal review. Congress can be chastened by popular vote. Judges who abuse discretion can be overturned (or impeached). The administrative agencies, on the other hand, are insulated through doctrines like Chevron and Auer, and their personnel subject more or less to the political whims of the executive branch.

Even agencies directly under the control of the executive branch  — let alone independent agencies — become petrified caricatures of their original design as layers of bureaucratic rule and custom accrue over years, eventually turning the organization into an entity that serves, more or less, to perpetuate its own existence.

Other supporters of the status quo actually identify the unreviewable see-saw of agency discretion as a feature, not a bug:

Even people who agree with the anti-government premises of the sponsors [of SOPRA] should recognize that a change in the APA standard of review is an inapt tool for advancing that agenda. It is shortsighted, because it ignores the fact that, over time, political administrations change. Sometimes the administration in office will generally be in favor of deregulation, and in these circumstances a more intrusive standard of judicial review would tend to undercut that administration’s policies just as surely as it may tend to undercut a more progressive administration’s policies when the latter holds power. The APA applies equally to affirmative regulation and to deregulation.

But presidential elections — far from justifying this extreme administrative deference — actually make the case for trimming the sails of the administrative state. Presidential elections have become an important part about how candidates will wield the immense regulatory power vested in the executive branch.

Thus, for example, as part of his presidential bid, Jeb Bush indicated he would use the EPA to roll back every policy that Obama had put into place. One of Donald Trump’s allies suggested that Trump “should turn off [CNN’s] FCC license” in order to punish the news agency. And VP hopeful Elizabeth Warren has suggested using the FDIC to limit the growth of financial institutions, and using the FCC and FTC to tilt the markets to make it easier for the small companies to get an advantage over the “big guys.”

Far from being neutral, technocratic administrators of complex social and economic matters, administrative agencies have become one more political weapon of majority parties as they make the case for how their candidates will use all the power at their disposal — and more — to work their will.

As Justice Thomas, again, noted in Michigan v. EPA:

In reality…, agencies “interpreting” ambiguous statutes typically are not engaged in acts of interpretation at all. Instead, as Chevron itself acknowledged, they are engaged in the “formulation of policy.” Statutory ambiguity thus becomes an implicit delegation of rulemaking authority, and that authority is used not to find the best meaning of the text, but to formulate legally binding rules to fill in gaps based on policy judgments made by the agency rather than Congress.

And this is just the thing: SOPRA would bring far-more-valuable predictability and longevity to our legal system by imposing a system of accountability on the agencies. Currently, commissions often believe they can act with impunity (until the next election at least), and even the intended constraints of the APA frequently won’t do much to tether their whims to statute or law if they’re intent on deviating. Having a known constraint (or, at least, a reliable process by which judicial constraint may be imposed) on their behavior will make them think twice about exactly how legally and economically sound proposed rules and other actions are.

The administrative state isn’t going away, even if SOPRA were passed; it will continue to be the source of the majority of the rules under which our economy operates. We have long believed that a benefit of our judicial system is its consistency and relative lack of politicization. If this is a benefit for interpreting laws when agencies aren’t involved, it should also be a benefit when they are involved. Particularly as more and more law emanates from agencies rather than Congress, the oversight of largely neutral judicial arbiters is an essential check on the administrative apparatus’ “accumulation of all powers.”

The interest of judges tends to include a respect for the development of precedent that yields consistent and transparent rules for all future litigants and, more broadly, for economic actors and consumers making decisions in the shadow of the law. This is markedly distinct from agencies which, more often than not, promote the particular, shifting, and often-narrow political sentiments of the day.

Whether a Republican- or a Democrat— appointed district judge reviews an agency action, that judge will be bound (more or less) by the precedent that came before, regardless of the judge’s individual political preferences. Contrast this with the FCC’s decision to reclassify broadband as a Title II service, for example, where previously it had been committed to the idea that broadband was an information service, subject to an entirely different — and far less onerous — regulatory regime.  Of course, the next FCC Chairman may feel differently, and nothing would stop another regulatory shift back to the pre-OIO status quo. Perhaps more troublingly, the enormous discretion afforded by courts under current standards of review would permit the agency to endlessly tweak its rules — forbearing from some regulations but not others, un-forbearing, re-interpreting, etc., with precious few judicial standards available to bring certainty to the rules or to ensure their fealty to the statute or the sound economics that is supposed to undergird administrative decisionmaking.

SOPRA, or a bill like it, would have required the Commission to actually be accountable for its historical regulations, and would force it to undergo at least rudimentary economic analysis to justify its actions. This form of accountability can only be to the good.

The genius of our system is its (potential) respect for the rule of law. This is an issue that both sides of the aisle should be able to get behind: minority status is always just one election cycle away. We should all hope to see SOPRA — or some bill like it — gain traction, rooted in long-overdue reflection on just how comfortable we are as a polity with a bureaucratic system increasingly driven by unaccountable discretion.

Last week the International Center for Law & Economics filed comments on the FCC’s Broadband Privacy NPRM. ICLE was joined in its comments by the following scholars of law & economics:

  • Babette E. Boliek, Associate Professor of Law, Pepperdine School of Law
  • Adam Candeub, Professor of Law, Michigan State University College of Law
  • Justin (Gus) Hurwitz, Assistant Professor of Law, Nebraska College of Law
  • Daniel Lyons, Associate Professor, Boston College Law School
  • Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Paul H. Rubin, Samuel Candler Dobbs Professor of Economics, Emory University Department of Economics

As we note in our comments:

The Commission’s NPRM would shoehorn the business models of a subset of new economy firms into a regime modeled on thirty-year-old CPNI rules designed to address fundamentally different concerns about a fundamentally different market. The Commission’s hurried and poorly supported NPRM demonstrates little understanding of the data markets it proposes to regulate and the position of ISPs within that market. And, what’s more, the resulting proposed rules diverge from analogous rules the Commission purports to emulate. Without mounting a convincing case for treating ISPs differently than the other data firms with which they do or could compete, the rules contemplate disparate regulatory treatment that would likely harm competition and innovation without evident corresponding benefit to consumers.

In particular, we focus on the FCC’s failure to justify treating ISPs differently than other competitors, and its failure to justify more stringent treatment for ISPs in general:

In short, the Commission has not made a convincing case that discrimination between ISPs and edge providers makes sense for the industry or for consumer welfare. The overwhelming body of evidence upon which other regulators have relied in addressing privacy concerns urges against a hard opt-in approach. That same evidence and analysis supports a consistent regulatory approach for all competitors, and nowhere advocates for a differential approach for ISPs when they are participating in the broader informatics and advertising markets.

With respect to the proposed opt-in regime, the NPRM ignores the weight of economic evidence on opt-in rules and fails to justify the specific rules it prescribes. Of most significance is the imposition of this opt-in requirement for the sharing of non-sensitive data.

On net opt-in regimes may tend to favor the status quo, and to maintain or grow the position of a few dominant firms. Opt-in imposes additional costs on consumers and hurts competition — and it may not offer any additional protections over opt-out. In the absence of any meaningful evidence or rigorous economic analysis to the contrary, the Commission should eschew imposing such a potentially harmful regime on broadband and data markets.

Finally, we explain that, although the NPRM purports to embrace a regulatory regime consistent with the current “federal privacy regime,” and particularly the FTC’s approach to privacy regulation, it actually does no such thing — a sentiment echoed by a host of current and former FTC staff and commissioners, including the Bureau of Consumer Protection staff, Commissioner Maureen Ohlhausen, former Chairman Jon Leibowitz, former Commissioner Josh Wright, and former BCP Director Howard Beales.

Our full comments are available here.

While we all wait on pins and needles for the DC Circuit to issue its long-expected ruling on the FCC’s Open Internet Order, another federal appeals court has pushed back on Tom Wheeler’s FCC for its unremitting “just trust us” approach to federal rulemaking.

The case, round three of Prometheus, et al. v. FCC, involves the FCC’s long-standing rules restricting common ownership of local broadcast stations and their extension by Tom Wheeler’s FCC to the use of joint sales agreements (JSAs). (For more background see our previous post here). Once again the FCC lost (it’s now only 1 for 3 in this case…), as the Third Circuit Court of Appeals took the Commission to task for failing to establish that its broadcast ownership rules were still in the public interest, as required by law, before it decided to extend those rules.

While much of the opinion deals with the FCC’s unreasonable delay (of more than 7 years) in completing two Quadrennial Reviews in relation to its diversity rules, the court also vacated the FCC’s rule expanding its duopoly rule (or local television ownership rule) to ban joint sales agreements without first undertaking the reviews.

We (the International Center for Law and Economics, along with affiliated scholars of law, economics, and communications) filed an amicus brief arguing for precisely this result, noting that

the 2014 Order [] dramatically expands its scope by amending the FCC’s local ownership attribution rules to make the rule applicable to JSAs, which had never before been subject to it. The Commission thereby suddenly declares unlawful JSAs in scores of local markets, many of which have been operating for a decade or longer without any harm to competition. Even more remarkably, it does so despite the fact that both the DOJ and the FCC itself had previously reviewed many of these JSAs and concluded that they were not likely to lessen competition. In doing so, the FCC also fails to examine the empirical evidence accumulated over the nearly two decades some of these JSAs have been operating. That evidence shows that many of these JSAs have substantially reduced the costs of operating TV stations and improved the quality of their programming without causing any harm to competition, thereby serving the public interest.

The Third Circuit agreed that the FCC utterly failed to justify its continued foray into banning potentially pro-competitive arrangements, finding that

the Commission violated § 202(h) by expanding the reach of the ownership rules without first justifying their preexisting scope through a Quadrennial Review. In Prometheus I we made clear that § 202(h) requires that “no matter what the Commission decides to do to any particular rule—retain, repeal, or modify (whether to make more or less stringent)—it must do so in the public interest and support its decision with a reasoned analysis.” Prometheus I, 373 F.3d at 395. Attribution of television JSAs modifies the Commission’s ownership rules by making them more stringent. And, unless the Commission determines that the preexisting ownership rules are sound, it cannot logically demonstrate that an expansion is in the public interest. Put differently, we cannot decide whether the Commission’s rationale—the need to avoid circumvention of ownership rules—makes sense without knowing whether those rules are in the public interest. If they are not, then the public interest might not be served by closing loopholes to rules that should no longer exist.

Perhaps this decision will be a harbinger of good things to come. The FCC — and especially Tom Wheeler’s FCC — has a history of failing to justify its rules with anything approaching rigorous analysis. The Open Internet Order is a case in point. We will all be better off if courts begin to hold the Commission’s feet to the fire and throw out their rules when the FCC fails to do the work needed to justify them.

On Friday the the International Center for Law & Economics filed comments with the FCC in response to Chairman Wheeler’s NPRM (proposed rules) to “unlock” the MVPD (i.e., cable and satellite subscription video, essentially) set-top box market. Plenty has been written on the proposed rulemaking—for a few quick hits (among many others) see, e.g., Richard Bennett, Glenn Manishin, Larry Downes, Stuart Brotman, Scott Wallsten, and me—so I’ll dispense with the background and focus on the key points we make in our comments.

Our comments explain that the proposal’s assertion that the MVPD set-top box market isn’t competitive is a product of its failure to appreciate the dynamics of the market (and its disregard for economics). Similarly, the proposal fails to acknowledge the complexity of the markets it intends to regulate, and, in particular, it ignores the harmful effects on content production and distribution the rules would likely bring about.

“Competition, competition, competition!” — Tom Wheeler

“Well, uh… just because I don’t know what it is, it doesn’t mean I’m lying.” — Claude Elsinore

At root, the proposal is aimed at improving competition in a market that is already hyper-competitive. As even Chairman Wheeler has admitted,

American consumers enjoy unprecedented choice in how they view entertainment, news and sports programming. You can pretty much watch what you want, where you want, when you want.

Of course, much of this competition comes from outside the MVPD market, strictly speaking—most notably from OVDs like Netflix. It’s indisputable that the statute directs the FCC to address the MVPD market and the MVPD set-top box market. But addressing competition in those markets doesn’t mean you simply disregard the world outside those markets.

The competitiveness of a market isn’t solely a function of the number of competitors in the market. Even relatively constrained markets like these can be “fully competitive” with only a few competing firms—as is the case in every market in which MVPDs operate (all of which are presumed by the Commission to be subject to “effective competition”).

The truly troubling thing, however, is that the FCC knows that MVPDs compete with OVDs, and thus that the competitiveness of the “MVPD market” (and the “MVPD set-top box market”) isn’t solely a matter of direct, head-to-head MVPD competition.

How do we know that? As I’ve recounted before, in a recent speech FCC General Counsel Jonathan Sallet approvingly explained that Commission staff recommended rejecting the Comcast/Time Warner Cable merger precisely because of the alleged threat it posed to OVD competitors. In essence, Sallet argued that Comcast sought to undertake a $45 billion merger primarily—if not solely—in order to ameliorate the competitive threat to its subscription video services from OVDs:

Simply put, the core concern came down to whether the merged firm would have an increased incentive and ability to safeguard its integrated Pay TV business model and video revenues by limiting the ability of OVDs to compete effectively.…

Thus, at least when it suits it, the Chairman’s office appears not only to believe that this competitive threat is real, but also that Comcast, once the largest MVPD in the country, believes so strongly that the OVD competitive threat is real that it was willing to pay $45 billion for a mere “increased ability” to limit it.

UPDATE 4/26/2016

And now the FCC has approved the Charter/Time Warner Cable, imposing conditions that, according to Wheeler,

focus on removing unfair barriers to video competition. First, New Charter will not be permitted to charge usage-based prices or impose data caps. Second, New Charter will be prohibited from charging interconnection fees, including to online video providers, which deliver large volumes of internet traffic to broadband customers. Additionally, the Department of Justice’s settlement with Charter both outlaws video programming terms that could harm OVDs and protects OVDs from retaliation—an outcome fully supported by the order I have circulated today.

If MVPDs and OVDs don’t compete, why would such terms be necessary? And even if the threat is merely potential competition, as we note in our comments (citing to this, among other things),

particularly in markets characterized by the sorts of technological change present in video markets, potential competition can operate as effectively as—or even more effectively than—actual competition to generate competitive market conditions.

/UPDATE

Moreover, the proposal asserts that the “market” for MVPD set-top boxes isn’t competitive because “consumers have few alternatives to leasing set-top boxes from their MVPDs, and the vast majority of MVPD subscribers lease boxes from their MVPD.”

But the MVPD set-top box market is an aftermarket—a secondary market; no one buys set-top boxes without first buying MVPD service—and always or almost always the two are purchased at the same time. As Ben Klein and many others have shown, direct competition in the aftermarket need not be plentiful for the market to nevertheless be competitive.

Whether consumers are fully informed or uninformed, consumers will pay a competitive package price as long as sufficient competition exists among sellers in the [primary] market.

The competitiveness of the MVPD market in which the antecedent choice of provider is made incorporates consumers’ preferences regarding set-top boxes, and makes the secondary market competitive.

The proposal’s superficial and erroneous claim that the set-top box market isn’t competitive thus reflects bad economics, not competitive reality.

But it gets worse. The NPRM doesn’t actually deny the importance of OVDs and app-based competitors wholesale — it only does so when convenient. As we note in our Comments:

The irony is that the NPRM seeks to give a leg up to non-MVPD distribution services in order to promote competition with MVPDs, while simultaneously denying that such competition exists… In order to avoid triggering [Section 629’s sunset provision,] the Commission is forced to pretend that we still live in the world of Blockbuster rentals and analog cable. It must ignore the Netflix behind the curtain—ignore the utter wealth of video choices available to consumers—and focus on the fact that a consumer might have a remote for an Apple TV sitting next to her Xfinity remote.

“Yes, but you’re aware that there’s an invention called television, and on that invention they show shows?” — Jules Winnfield

The NPRM proposes to create a world in which all of the content that MVPDs license from programmers, and all of their own additional services, must be provided to third-party device manufacturers under a zero-rate compulsory license. Apart from the complete absence of statutory authority to mandate such a thing (or, I should say, apart from statutory language specifically prohibiting such a thing), the proposed rules run roughshod over the copyrights and negotiated contract rights of content providers:

The current rulemaking represents an overt assault on the web of contracts that makes content generation and distribution possible… The rules would create a new class of intermediaries lacking contractual privity with content providers (or MVPDs), and would therefore force MVPDs to bear the unpredictable consequences of providing licensed content to third-parties without actual contracts to govern those licenses…

Because such nullification of license terms interferes with content owners’ right “to do and to authorize” their distribution and performance rights, the rules may facially violate copyright law… [Moreover,] the web of contracts that support the creation and distribution of content are complicated, extensively negotiated, and subject to destabilization. Abrogating the parties’ use of the various control points that support the financing, creation, and distribution of content would very likely reduce the incentive to invest in new and better content, thereby rolling back the golden age of television that consumers currently enjoy.

You’ll be hard-pressed to find any serious acknowledgement in the NPRM that its rules could have any effect on content providers, apart from this gem:

We do not currently have evidence that regulations are needed to address concerns raised by MVPDs and content providers that competitive navigation solutions will disrupt elements of service presentation (such as agreed-upon channel lineups and neighborhoods), replace or alter advertising, or improperly manipulate content…. We also seek comment on the extent to which copyright law may protect against these concerns, and note that nothing in our proposal will change or affect content creators’ rights or remedies under copyright law.

The Commission can’t rely on copyright to protect against these concerns, at least not without admitting that the rules require MVPDs to violate copyright law and to breach their contracts. And in fact, although it doesn’t acknowledge it, the NPRM does require the abrogation of content owners’ rights embedded in licenses negotiated with MVPD distributors to the extent that they conflict with the terms of the rule (which many of them must).   

“You keep using that word. I do not think it means what you think it means.” — Inigo Montoya

Finally, the NPRM derives its claimed authority for these rules from an interpretation of the relevant statute (Section 629 of the Communications Act) that is absurdly unreasonable. That provision requires the FCC to enact rules to assure the “commercial availability” of set-top boxes from MVPD-unaffiliated vendors. According to the NPRM,

we cannot assure a commercial market for devices… unless companies unaffiliated with an MVPD are able to offer innovative user interfaces and functionality to consumers wishing to access that multichannel video programming.

This baldly misconstrues a term plainly meant to refer to the manner in which consumers obtain their navigation devices, not how those devices should function. It also contradicts the Commission’s own, prior readings of the statute:

As structured, the rules will place a regulatory thumb on the scale in favor of third-parties and to the detriment of MVPDs and programmers…. [But] Congress explicitly rejected language that would have required unbundling of MVPDs’ content and services in order to promote other distribution services…. Where Congress rejected language that would have favored non-MVPD services, the Commission selectively interprets the language Congress did employ in order to accomplish exactly what Congress rejected.

And despite the above noted problems (and more), the Commission has failed to do even a cursory economic evaluation of the relative costs of the NPRM, instead focusing narrowly on one single benefit it believes might occur (wider distribution of set-top boxes from third-parties) despite the consistent failure of similar FCC efforts in the past.

All of the foregoing leads to a final question: At what point do the costs of these rules finally outweigh the perceived benefits? On the one hand are legal questions of infringement, inducements to violate agreements, and disruptions of complex contractual ecosystems supporting content creation. On the other hand are the presence of more boxes and apps that allow users to choose who gets to draw the UI for their video content…. At some point the Commission needs to take seriously the costs of its actions, and determine whether the public interest is really served by the proposed rules.

Our full comments are available here.

Earlier this month, Federal Communications Commission (FCC) Chairman Tom Wheeler released a “fact sheet” describing his proposal to have the FCC regulate the privacy policies of broadband Internet service providers (ISPs).  Chairman Wheeler’s detailed proposal will be embodied in a Notice of Proposed Rulemaking (NPRM) that the FCC may take up as early as March 31.  The FCC instead should shelve this problematic initiative and leave broadband privacy regulation (to the extent it is warranted) to the Federal Trade Commission (FTC).

In a March 23 speech before the Free State Foundation, FTC Commissioner Maureen Ohlhausen ably summarized the negative economic implications of the NPRM, contrasting the FCC’s proposal with the FTC’s approach to privacy-related enforcement (citations omitted):

The FCC’s proposal differs significantly from the choice architecture the FTC has established under its deception authority.  Our [FTC] deception authority enforces the promises companies make to consumers.  But companies are not required under our deception authority to make such privacy promises.  This is as it should be.  As I’ve already described, unfairness authority sets a baseline by prohibiting practices the vast majority of consumers would not embrace. Mandating practices above this baseline reduces consumer welfare because it denies some consumers options that best match their preferences.  Consumer demand and competitive forces spur companies to make privacy promises.  In fact, nearly all legitimate companies currently make detailed promises about their privacy practices.  This demonstrates a market demand for, and supply of, transparency about company uses of data.  Indeed, recent research . . . shows that broadband ISPs in particular already make strong privacy promises to consumers.

In contrast to the choice framework of the FTC, the FCC’s proposal, according to the recent [Wheeler] fact sheet, seeks to mandate that broadband ISPs adopt a specific opt in / opt-out regime.  The fact sheet repeatedly insists that this is about consumer choice. But, in fact, opt in mandates unavoidably reduce consumer choice. First, one subtle way in which a privacy baseline might be set too high is if the default opt in condition does not match the average consumer preference.  If the FCC mandates opt in for a specific data collection, but a majority of consumers already prefer to share that information, the mandate unnecessarily raises costs to companies and consumers.  Second, opt in mandates prevent unanticipated beneficial uses of data.  An effective and transparent opt-in regime requires that companies know at the time of collection how they will use the collected information. Yet data, including non-sensitive data, often yields significantconsumer benefits from uses that could not be known at the time of collection.  Ignoring this, the fact sheet proposes to ban all but a very few uses unless consumers opt in.  This proposed opt in regime would prohibit unforeseeable future uses of collected data, regardless of what consumers would prefer.  This approach is stricter and more limiting than the requirements that other internet companies face. Now, I agree such mandates may be appropriate for certain types of sensitive data such as credit card numbers or SSNs, but they likely will reduce consumer options if applied to non-sensitive data.

If the FCC wished to be consistent with the FTC’s approach of using prohibitions only for widely held consumer preferences, it would take a different approach and simply require opt in for specific, sensitive uses. . . . 

[Furthermore,] [h]ere, the FCC proposes, for the first time ever, to apply a statute created for telephone lines to broadband ISPs. That raises some significant statutory authority issues that the FCC may ultimately need to look to Congress to clarify. . . .

[In addition,] the current FCC proposal appears to reflect the preferences of privacy lobbyists who are frustrated with the lax privacy preferences of average American consumers.  Furthermore, the proposal doesn’t appear to have the support of the minority FCC Commissioners or Congress. 

[Also,] the FCC proposal applies to just one segment of the internet ecosystem broadband ISPs, even though there is good evidence that ISPs are not uniquely privy to your data. . . .

[In conclusion,] [a]t its core, protecting consumer privacy ought to be about effectuating consumers’ preferences.  If privacy rules impose the preferences of the few on the many, consumers will not be better off.  Therefore, prescriptive baseline privacy mandates like the FCC’s proposal should be reserved for practices that consumers overwhelmingly disfavor.  Otherwise, consumers should remain free to exercise their privacy preferences in the marketplace, and companies should be held to the promises they make.  This approach, which is a time-tested, emergent result of the FTC’s case-by-case application of its statutory authority, offers a good template for the FCC.

Commissioner Ohlhausen’s presentation comports with my May 2015 Heritage Foundation Legal Memorandum, which explained that the FTC’s highly structured, analytic, fact-based approach, combined with its vast experience in privacy and data security investigations, make it a far better candidate than the FCC to address competition and consumer protection problems in the area of broadband.

Regrettably, there is little reason to believe that the FCC, acting on its own, will heed Commissioner Ohlhausen’s call to focus on consumer preferences in evaluating broadband ISP privacy practices.  What’s worse, the FTC’s ability to act at all in this area is in doubt.  The FCC’s current regulation requiring broadband ISP “net neutrality,” and its proposed regulation of ISP privacy practices, are premised on the dubious reclassification of broadband as a “common carrier” service – and the FTC has no authority over common carriers.  If the D.C. Circuit fails to overturn the FCC’s broadband rule, Congress should carefully consider whether to strip the FCC of regulatory authority in this area (including, of course, privacy practices) and reassign it to the FTC.

Netflix’s latest net neutrality hypocrisy (yes, there have been others. See here and here, for example) involves its long-term, undisclosed throttling of its video traffic on AT&T’s and Verizon’s wireless networks, while it lobbied heavily for net neutrality rules from the FCC that would prevent just such throttling by ISPs.

It was Netflix that coined the term “strong net neutrality,” in an effort to import interconnection (the connections between ISPs and edge provider networks) into the net neutrality fold. That alone was a bastardization of what net neutrality purportedly stood for, as I previously noted:

There is a reason every iteration of the FCC’s net neutrality rules, including the latest, have explicitly not applied to backbone interconnection agreements: Interconnection over the backbone has always been open and competitive, and it simply doesn’t give rise to the kind of discrimination concerns net neutrality is meant to address.

That Netflix would prefer not to pay for delivery of its content isn’t surprising. But net neutrality regulations don’t — and shouldn’t — have anything to do with it.

But Netflix did something else with “strong net neutrality.” It tied it to consumer choice:

This weak net neutrality isn’t enough to protect an open, competitive Internet; a stronger form of net neutrality is required. Strong net neutrality additionally prevents ISPs from charging a toll for interconnection to services like Netflix, YouTube, or Skype, or intermediaries such as Cogent, Akamai or Level 3, to deliver the services and data requested by ISP residential subscribers. Instead, they must provide sufficient access to their network without charge. (Emphasis added).

A focus on consumers is laudable, of course, but when the focus is on consumers there’s no reason to differentiate between ISPs (to whom net neutrality rules apply) and content providers entering into contracts with ISPs to deliver their content (to whom net neutrality rules don’t apply).

And Netflix has just showed us exactly why that’s the case.

Netflix can and does engage in management of its streams in order (presumably) to optimize consumer experience as users move between networks, devices and viewers (e.g., native apps vs Internet browser windows) with very different characteristics and limitations. That’s all well and good. But as we noted in our Policy Comments in the FCC’s Open Internet Order proceeding,

In this circumstance, particularly when the content in question is Netflix, with 30% of network traffic, both the network’s and the content provider’s transmission decisions may be determinative of network quality, as may the users’ device and application choices.

As a 2011 paper by a group of network engineers studying the network characteristics of video streaming data from Netflix and YouTube noted:

This is a concern as it means that a sudden change of application or container in a large population might have a significant impact on the network traffic. Considering the very fast changes in trends this is a real possibility, the most likely being a change from Flash to HTML5 along with an increase in the use of mobile devices…. [S]treaming videos at high resolutions can result in smoother aggregate traffic while at the same time linearly increase the aggregate data rate due to video streaming.

Again, a concern with consumers is admirable, but Netflix isn’t concerned with consumers. It’s concerned at most with consumers of Netflix, while they are consuming Netflix. But the reality is that Netflix’s content management decisions can adversely affect consumers overall, including its own subscribers when they aren’t watching Netflix.

And here’s the huge irony. The FCC’s net neutrality rules are tailor-made to guarantee that Netflix will never have any incentive to take these externalities into account in its own decisions. What’s more, they ensure that ISPs are severely hamstrung in managing their networks for the benefit of all consumers, not least because their interconnection deals with large content providers like Netflix are now being closely scrutinized.

It’s great that Netflix thinks it should manage its video delivery to optimize viewing under different network conditions. But net neutrality rules ensure that Netflix bears no cost for overwhelming the network in the process. Essentially, short of building new capacity — at great expense to all ISP subscribers, of course — ISPs can’t do much about it, either, under the rules. And, of course, the rules also make it impossible for ISPs to negotiate for financial help from Netflix (or its heaviest users) in paying for those upgrades.

On top of this, net neutrality advocates have taken aim at usage-based billing and other pricing practices that would help with the problem by enabling ISPs to charge their heaviest users more in order to alleviate the inherent subsidy by normal users that flat-rate billing entails. (Netflix itself, as one of the articles linked above discusses at length, is hypocritically inconsistent on this score).

As we also noted in our OIO Policy Comments:

The idea that consumers and competition generally are better off when content providers face no incentive to take account of congestion externalities in their pricing (or when users have no incentive to take account of their own usage) runs counter to basic economic logic and is unsupported by the evidence. In fact, contrary to such claims, usage-based pricing, congestion pricing and sponsored content, among other nonlinear pricing models, would, in many circumstances, further incentivize networks to expand capacity (not create artificial scarcity).

Some concern for consumers. Under Netflix’s approach consumers get it coming and going: Either their non-Netflix traffic is compromised for the sake of Netflix’s traffic, or they have to pay higher subscription fees to ISPs for the privilege of accommodating Netflix’s ever-expanding traffic loads (4K videos, anyone?) — whether they ever use Netflix or not.

Sometimes, apparently, Netflix throttles its own traffic in order to “help” a few consumers. (That it does so without disclosing the practice is pretty galling, especially given the enhanced transparency rules in the Open Internet Order — something Netflix also advocated for, and which also apply only to ISPs and not to content providers). But its self-aggrandizing advocacy for the FCC’s latest net neutrality rules reveals that its first priority is to screw over consumers, so long as it can shift the blame and the cost to others.

The FCC doesn’t have authority over the edge and doesn’t want authority over the edge. Well, that is until it finds itself with no choice but to regulate the edge as a result of its own policies. As the FCC begins to explore its new authority to regulate privacy under the Open Internet Order (“OIO”), for instance, it will run up against policy conflicts and inconsistencies that will make it increasingly hard to justify forbearance from regulating edge providers.

Take for example the recently announced NPRM titled “Expanding Consumers’ Video Navigation Choices” — a proposal that seeks to force cable companies to provide video programming to third party set-top box manufacturers. Under the proposed rules, MVPD distributors would be required to expose three data streams to competitors: (1) listing information about what is available to particular customers; (2) the rights associated with accessing such content; and (3) the actual video content. As Geoff Manne has aptly noted, this seems to be much more of an effort to eliminate the “nightmare” of “too many remote controls” than it is to actually expand consumer choice in a market that is essentially drowning in consumer choice. But of course even so innocuous a goal—which is probably more about picking on cable companies because… “eww cable companies”—suggests some very important questions.

First, the market for video on cable systems is governed by a highly interdependent web of contracts that assures to a wide variety of parties that their bargained-for rights are respected. Among other things, channels negotiate for particular placements and channel numbers in a cable system’s lineup, IP rights holders bargain for content to be made available only at certain times and at certain locations, and advertisers pay for their ads to be inserted into channel streams and broadcasts.

Moreover, to a large extent, the content industry develops its content based on a stable regime of bargained-for contractual terms with cable distribution networks (among others). Disrupting the ability of cable companies to control access to their video streams will undoubtedly alter the underlying assumptions upon which IP companies rely when planning and investing in content development. And, of course, the physical networks and their related equipment have been engineered around the current cable-access regimes. Some non-trivial amount of re-engineering will have to take place to make the cable-networks compatible with a more “open” set-top box market.

The FCC nods to these concerns in its NPRM, when it notes that its “goal is to preserve the contractual arrangements between programmers and MVPDs, while creating additional opportunities for programmers[.]” But this aspiration is not clearly given effect in the NPRM, and, as noted, some contractual arrangements are simply inconsistent with the NPRM’s approach.

Second, the FCC proposes to bind third-party manufacturers to the public interest privacy commitments in §§ 629, 551 and 338(i) of the Communications Act (“Act”) through a self-certification process. MVPDs would be required to pass the three data streams to third-party providers only once such a certification is received. To the extent that these sections, enforced via self-certification, do not sufficiently curtail third-parties’ undesirable behavior, the FCC appears to believe that “the strictest state regulatory regime[s]” and the “European Union privacy regulations” will serve as the necessary regulatory gap fillers.

This seems hard to believe, however, particularly given the recently announced privacy and cybersecurity NPRM, through which the FCC will adopt rules detailing the agency’s new authority (under the OIO) to regulate privacy at the ISP level. Largely, these rules will grow out of §§ 222 and 201 of the Act, which the FCC in Terracom interpreted together to be a general grant of privacy and cybersecurity authority.

I’m apprehensive of the asserted scope of the FCC’s power over privacy — let alone cybersecurity — under §§ 222 and 201. In truth, the FCC makes an admirable showing in Terracom of demonstrating its reasoning; it does a far better job than the FTC in similar enforcement actions. But there remains a problem. The FTC’s authority is fundamentally cabined by the limitations contained within the FTC Act (even if it frequently chooses to ignore them, they are there and are theoretically a protection against overreach).

But the FCC’s enforcement decisions are restrained (if at all) by a vague “public interest” mandate, and a claim that it will enforce these privacy principles on a case-by-case basis. Thus, the FCC’s proposed regime is inherently one based on vast agency discretion. As in many other contexts, enforcers with wide discretion and a tremendous power to penalize exert a chilling effect on innovation and openness, as well as a frightening power over a tremendous swath of the economy. For the FCC to claim anything like an unbounded UDAP authority for itself has got to be outside of the archaic grant of authority from § 201, and is certainly a long stretch for the language of § 706 (a provision of the Act which it used as one of the fundamental justifications for the OIO)— leading very possibly to a bout of Chevron problems under precedent such as King v. Burwell and UARG v. EPA.

And there is a real risk here of, if not hypocrisy, then… deep conflict in the way the FCC will strike out on the set-top box and privacy NPRMs. The Commission has already noted in its NPRM that it will not be able to bind third-party providers of set-top boxes under the same privacy requirements that apply to current MVPD providers. Self-certification will go a certain length, but even there agitation from privacy absolutists will possibly sway the FCC to consider more stringent requirements. For instance, §§ 551 and 338 of the Act — which the FCC focuses on in the set-top box NPRM — are really only about disclosing intended uses of consumer data. And disclosures can come in many forms, including burying them in long terms of service that customers frequently do not read. Such “weak” guarantees of consumer privacy will likely become a frequent source of complaint (and FCC filings) for privacy absolutists.  

Further, many of the new set-top box entrants are going to be current providers of OTT video or devices that redistribute OTT video. And many of these providers make a huge share of their revenue from data mining and selling access to customer data. Which means one of two things: Either the FCC is going to just allow us to live in a world of double standards where these self-certifying entities are permitted significantly more leeway in their uses of consumer data than MVPD providers or, alternatively, the FCC is going to discover that it does in fact need to “do something.” If only there were a creative way to extend the new privacy authority under Title II to these providers of set-top boxes… . Oh! there is: bring edge providers into the regulation fold under the OIO.

It’s interesting that Wheeler’s announcement of the FCC’s privacy NPRM explicitly noted that the rules would not be extended to edge providers. That Wheeler felt the need to be explicit in this suggests that he believes that the FCC has the authority to extend the privacy regulations to edge providers, but that it will merely forbear (for now) from doing so.

If edge providers are swept into the scope of Title II they would be subject to the brand new privacy rules the FCC is proposing. Thus, despite itself (or perhaps not), the FCC may find itself in possession of a much larger authority over some edge providers than any of the pro-Title II folks would have dared admit was possible. And the hook (this time) could be the privacy concerns embedded in the FCC’s ill-advised attempt to “open” the set-top box market.

This is a complicated set of issues, and it’s contingent on a number of moving parts. This week, Chairman Wheeler will be facing an appropriations hearing where I hope he will be asked to unpack his thinking regarding the true extent to which the OIO may in fact be extended to the edge.

Last week, FCC General Counsel Jonathan Sallet pulled back the curtain on the FCC staff’s analysis behind its decision to block Comcast’s acquisition of Time Warner Cable. As the FCC staff sets out on its reported Rainbow Tour to reassure regulated companies that it’s not “hostile to the industries it regulates,” Sallet’s remarks suggest it will have an uphill climb. Unfortunately, the staff’s analysis appears to have been unduly speculative, disconnected from critical market realities, and decidedly biased — not characteristics in a regulator that tend to offer much reassurance.

Merger analysis is inherently speculative, but, as courts have repeatedly had occasion to find, the FCC has a penchant for stretching speculation beyond the breaking point, adopting theories of harm that are vaguely possible, even if unlikely and inconsistent with past practice, and poorly supported by empirical evidence. The FCC’s approach here seems to fit this description.

The FCC’s fundamental theory of anticompetitive harm

To begin with, as he must, Sallet acknowledged that there was no direct competitive overlap in the areas served by Comcast and Time Warner Cable, and no consumer would have seen the number of providers available to her changed by the deal.

But the FCC staff viewed this critical fact as “not outcome determinative.” Instead, Sallet explained that the staff’s opposition was based primarily on a concern that the deal might enable Comcast to harm “nascent” OVD competitors in order to protect its video (MVPD) business:

Simply put, the core concern came down to whether the merged firm would have an increased incentive and ability to safeguard its integrated Pay TV business model and video revenues by limiting the ability of OVDs to compete effectively, especially through the use of new business models.

The justification for the concern boiled down to an assumption that the addition of TWC’s subscriber base would be sufficient to render an otherwise too-costly anticompetitive campaign against OVDs worthwhile:

Without the merger, a company taking action against OVDs for the benefit of the Pay TV system as a whole would incur costs but gain additional sales – or protect existing sales — only within its footprint. But the combined entity, having a larger footprint, would internalize more of the external “benefits” provided to other industry members.

The FCC theorized that, by acquiring a larger footprint, Comcast would gain enough bargaining power and leverage, as well as the means to profit from an exclusionary strategy, leading it to employ a range of harmful tactics — such as impairing the quality/speed of OVD streams, imposing data caps, limiting OVD access to TV-connected devices, imposing higher interconnection fees, and saddling OVDs with higher programming costs. It’s difficult to see how such conduct would be permitted under the FCC’s Open Internet Order/Title II regime, but, nevertheless, the staff apparently believed that Comcast would possess a powerful “toolkit” with which to harm OVDs post-transaction.

Comcast’s share of the MVPD market wouldn’t have changed enough to justify the FCC’s purported fears

First, the analysis turned on what Comcast could and would do if it were larger. But Comcast was already the largest ISP and MVPD (now second largest MVPD, post AT&T/DIRECTV) in the nation, and presumably it has approximately the same incentives and ability to disadvantage OVDs today.

In fact, there’s no reason to believe that the growth of Comcast’s MVPD business would cause any material change in its incentives with respect to OVDs. Whatever nefarious incentives the merger allegedly would have created by increasing Comcast’s share of the MVPD market (which is where the purported benefits in the FCC staff’s anticompetitive story would be realized), those incentives would be proportional to the size of increase in Comcast’s national MVPD market share — which, here, would be about eight percentage points: from 22% to under 30% of the national market.

It’s difficult to believe that Comcast would gain the wherewithal to engage in this costly strategy by adding such a relatively small fraction of the MVPD market (which would still leave other MVPDs serving fully 70% of the market to reap the purported benefits instead of Comcast), but wouldn’t have it at its current size – and there’s no evidence that it has ever employed such strategies with its current market share.

It bears highlighting that the D.C. Circuit has already twice rejected FCC efforts to impose a 30% market cap on MVPDs, based on the Commission’s inability to demonstrate that a greater-than-30% share would create competitive problems, especially given the highly dynamic nature of the MVPD market. In vacating the FCC’s most recent effort to do so in 2009, the D.C. Circuit was resolute in its condemnation of the agency, noting:

In sum, the Commission has failed to demonstrate that allowing a cable operator to serve more than 30% of all [MVPD] subscribers would threaten to reduce either competition or diversity in programming.

The extent of competition and the amount of available programming (including original programming distributed by OVDs themselves) has increased substantially since 2009; this makes the FCC’s competitive claims even less sustainable today.

It’s damning enough to the FCC’s case that there is no marketplace evidence of such conduct or its anticompetitive effects in today’s market. But it’s truly impossible to square the FCC’s assertions about Comcast’s anticompetitive incentives with the fact that, over the past decade, Comcast has made massive investments in broadband, steadily increased broadband speeds, and freely licensed its programming, among other things that have served to enhance OVDs’ long-term viability and growth. Chalk it up to the threat of regulatory intervention or corporate incompetence if you can’t believe that competition alone could be responsible for this largesse, but, whatever the reason, the FCC staff’s fears appear completely unfounded in a marketplace not significantly different than the landscape that would have existed post-merger.

OVDs aren’t vulnerable, and don’t need the FCC’s “help”

After describing the “new entrants” in the market — such unfamiliar and powerless players as Dish, Sony, HBO, and CBS — Sallet claimed that the staff was principally animated by the understanding that

Entrants are particularly vulnerable when competition is nascent. Thus, staff was particularly concerned that this transaction could damage competition in the video distribution industry.

Sallet’s description of OVDs makes them sound like struggling entrepreneurs working in garages. But, in fact, OVDs have radically reshaped the media business and wield enormous clout in the marketplace.

Netflix, for example, describes itself as “the world’s leading Internet television network with over 65 million members in over 50 countries.” New services like Sony Vue and Sling TV are affiliated with giant, well-established media conglomerates. And whatever new offerings emerge from the FCC-approved AT&T/DIRECTV merger will be as well-positioned as any in the market.

In fact, we already know that the concerns of the FCC are off-base because they are of a piece with the misguided assumptions that underlie the Chairman’s recent NPRM to rewrite the MVPD rules to “protect” just these sorts of companies. But the OVDs themselves — the ones with real money and their competitive futures on the line — don’t see the world the way the FCC does, and they’ve resolutely rejected the Chairman’s proposal. Notably, the proposed rules would “protect” these services from exactly the sort of conduct that Sallet claims would have been a consequence of the Comcast-TWC merger.

If they don’t want or need broad protection from such “harms” in the form of revised industry-wide rules, there is surely no justification for the FCC to throttle a merger based on speculation that the same conduct could conceivably arise in the future.

The realities of the broadband market post-merger wouldn’t have supported the FCC’s argument, either

While a larger Comcast might be in a position to realize more of the benefits from the exclusionary strategy Sallet described, it would also incur more of the costs — likely in direct proportion to the increased size of its subscriber base.

Think of it this way: To the extent that an MVPD can possibly constrain an OVD’s scope of distribution for programming, doing so also necessarily makes the MVPD’s own broadband offering less attractive, forcing it to incur a cost that would increase in proportion to the size of the distributor’s broadband market. In this case, as noted, Comcast would have gained MVPD subscribers — but it would have also gained broadband subscribers. In a world where cable is consistently losing video subscribers (as Sallet acknowledged), and where broadband offers higher margins and faster growth, it makes no economic sense that Comcast would have valued the trade-off the way the FCC claims it would have.

Moreover, in light of the existing conditions imposed on Comcast under the Comcast/NBCU merger order from 2011 (which last for a few more years) and the restrictions adopted in the Open Internet Order, Comcast’s ability to engage in the sort of exclusionary conduct described by Sallet would be severely limited, if not non-existent. Nor, of course, is there any guarantee that former or would-be OVD subscribers would choose to subscribe to, or pay more for, any MVPD in lieu of OVDs. Meanwhile, many of the relevant substitutes in the MVPD market (like AT&T and Verizon FiOS) also offer broadband services – thereby increasing the costs that would be incurred in the broadband market even more, as many subscribers would shift not only their MVPD, but also their broadband service, in response to Comcast degrading OVDs.

And speaking of the Open Internet Order — wasn’t that supposed to prevent ISPs like Comcast from acting on their alleged incentives to impede the quality of, or access to, edge providers like OVDs? Why is merger enforcement necessary to accomplish the same thing once Title II and the rest of the Open Internet Order are in place? And if the argument is that the Open Internet Order might be defeated, aside from the completely speculative nature of such a claim, why wouldn’t a merger condition that imposed the same constraints on Comcast – as was done in the Comcast/NBCU merger order by imposing the former net neutrality rules on Comcast – be perfectly sufficient?

While the FCC staff analysis accepted as true (again, contrary to current marketplace evidence) that a bigger Comcast would have more incentive to harm OVDs post-merger, it rejected arguments that there could be countervailing benefits to OVDs and others from this same increase in scale. Thus, things like incremental broadband investments and speed increases, a larger Wi-Fi network, and greater business services market competition – things that Comcast is already doing and would have done on a greater and more-accelerated scale in the acquired territories post-transaction – were deemed insufficient to outweigh the expected costs of the staff’s entirely speculative anticompetitive theory.

In reality, however, not only OVDs, but consumers – and especially TWC subscribers – would have benefitted from the merger by access to Comcast’s faster broadband speeds, its new investments, and its superior video offerings on the X1 platform, among other things. Many low-income families would have benefitted from expansion of Comcast’s Internet Essentials program, and many businesses would have benefited from the addition of a more effective competitor to the incumbent providers that currently dominate the business services market. Yet these and other verifiable benefits were given short shrift in the agency’s analysis because they “were viewed by staff as incapable of outweighing the potential harms.”

The assumptions underlying the FCC staff’s analysis of the broadband market are arbitrary and unsupportable

Sallet’s claim that the combined firm would have 60% of all high-speed broadband subscribers in the U.S. necessarily assumes a national broadband market measured at 25 Mbps or higher, which is a red herring.

The FCC has not explained why 25 Mbps is a meaningful benchmark for antitrust analysis. The FCC itself endorsed a 10 Mbps baseline for its Connect America fund last December, noting that over 70% of current broadband users subscribe to speeds less than 25 Mbps, even in areas where faster speeds are available. And streaming online video, the most oft-cited reason for needing high bandwidth, doesn’t require 25 Mbps: Netflix says that 5 Mbps is the most that’s required for an HD stream, and the same goes for Amazon (3.5 Mbps) and Hulu (1.5 Mbps).

What’s more, by choosing an arbitrary, faster speed to define the scope of the broadband market (in an effort to assert the non-competitiveness of the market, and thereby justify its broadband regulations), the agency has – without proper analysis or grounding, in my view – unjustifiably shrunk the size of the relevant market. But, as it happens, doing so also shrinks the size of the increase in “national market share” that the merger would have brought about.

Recall that the staff’s theory was premised on the idea that the merger would give Comcast control over enough of the broadband market that it could unilaterally impose costs on OVDs sufficient to impair their ability to reach or sustain minimum viable scale. But Comcast would have added only one percent of this invented “market” as a result of the merger. It strains credulity to assert that there could be any transaction-specific harm from an increase in market share equivalent to a rounding error.

In any case, basing its rejection of the merger on a manufactured 25 Mbps relevant market creates perverse incentives and will likely do far more to harm OVDs than realization of even the staff’s worst fears about the merger ever could have.

The FCC says it wants higher speeds, and it wants firms to invest in faster broadband. But here Comcast did just that, and then was punished for it. Rather than acknowledging Comcast’s ongoing broadband investments as strong indication that the FCC staff’s analysis might be on the wrong track, the FCC leadership simply sidestepped that inconvenient truth by redefining the market.

The lesson is that if you make your product too good, you’ll end up with an impermissibly high share of the market you create and be punished for it. This can’t possibly promote the public interest.

Furthermore, the staff’s analysis of competitive effects even in this ersatz market aren’t likely supportable. As noted, most subscribers access OVDs on connections that deliver content at speeds well below the invented 25 Mbps benchmark, and they pay the same prices for OVD subscriptions as subscribers who receive their content at 25 Mbps. Confronted with the choice to consume content at 25 Mbps or 10 Mbps (or less), the majority of consumers voluntarily opt for slower speeds — and they purchase service from Netflix and other OVDs in droves, nonetheless.

The upshot? Contrary to the implications on which the staff’s analysis rests, if Comcast were to somehow “degrade” OVD content on the 25 Mbps networks so that it was delivered with characteristics of video content delivered over a 10-Mbps network, real-world, observed consumer preferences suggest it wouldn’t harm OVDs’ access to consumers at all. This is especially true given that OVDs often have a global focus and reach (again, Netflix has 65 million subscribers in over 50 countries), making any claims that Comcast could successfully foreclose them from the relevant market even more suspect.

At the same time, while the staff apparently viewed the broadband alternatives as “limited,” the reality is that Comcast, as well as other broadband providers, are surrounded by capable competitors, including, among others, AT&T, Verizon, CenturyLink, Google Fiber, many advanced VDSL and fiber-based Internet service providers, and high-speed mobile wireless providers. The FCC understated the complex impact of this robust, dynamic, and ever-increasing competition, and its analysis entirely ignored rapidly growing mobile wireless broadband competition.

Finally, as noted, Sallet claimed that the staff determined that merger conditions would be insufficient to remedy its concerns, without any further explanation. Yet the Commission identified similar concerns about OVDs in both the Comcast/NBCUniversal and AT&T/DIRECTV transactions, and adopted remedies to address those concerns. We know the agency is capable of drafting behavioral conditions, and we know they have teeth, as demonstrated by prior FCC enforcement actions. It’s hard to understand why similar, adequate conditions could not have been fashioned for this transaction.

In the end, while I appreciate Sallet’s attempt to explain the FCC’s decision to reject the Comcast/TWC merger, based on the foregoing I’m not sure that Comcast could have made any argument or showing that would have dissuaded the FCC from challenging the merger. Comcast presented a strong economic analysis answering the staff’s concerns discussed above, all to no avail. It’s difficult to escape the conclusion that this was a politically-driven result, and not one rigorously based on the facts or marketplace reality.