Mr. Wheeler Agrees: It’s The “Termination Market”…

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Last Friday, the Wall Street Journal provided a peek at Federal Communications Commission Chairman Tom Wheeler’s latest plan for net neutrality.  Under the reported plan, the Chairman intends to divide the two-sided broadband market into its components—a retail and a termination service—and then reclassify the termination service as a Title II common carrier telecommunications service but leave retail services as a mostly unregulated Title I information service. As the Journal’s article states,

The plan now under consideration would separate broadband into two distinct services: a retail one, in which consumers would pay broadband providers for Internet access; and a back-end one, in which broadband providers serve as the conduit for websites to distribute content. The FCC would then classify the back-end service as a common carrier, giving the agency the ability to police any deals between content companies and broadband providers.

A follow-up article in the Wall Street Journal indicates that many are unhappy with Mr. Wheeler’s attempt at compromise.  For Broadband Service Providers, the plan includes a Title II component so they don’t like it.  For the reclassification advocates, the retail portion of the service is not reclassified, so they’re not getting all of what they wanted. Mozilla and Professor Tim Wu, who had proposed such a bifurcation of the broadband service into retail and terminating components, are likely pleased.

What I like about the announcement is that the Chairman has finally put an end to debates about the relevant transaction of interest (see here, here, and here).  As Larry Spiwak and I detailed in our recent paper, Tariffing the Internet: Pricing Implications of Classifying Broadband as a Title II Telecommunications Service, the relevant transaction is the termination side of the market.  Or, as the Commission’s 2014 Open Internet NPRM describes it, the relevant transaction is in the “second side of the market—between broadband providers and edge providers or other third parties.” (2014 Open Internet NPRM at ¶ 37.)  With Mr. Wheeler now formally talking about carving out the “termination market” (although the Journal’s report refers to it as “the back-end service”), Mr. Wheeler has settled the matter.

Still, we know little about Mr. Wheeler’s “Solomonic” proposal.  The hard fact remains that there are many unanswered questions regarding the specifics of implementing Title II regulation of the terminating market.  Mainly, Mr. Wheeler provides no information as to how the price regulation of this “second side of the market” would proceed under Title II.  After all, the statute holds that common carrier telecommunications services are offered “for a fee.”  Moreover, the D.C. Circuit in Verizon v. FCC makes clear that the “no blocking” and “no paid prioritization” concepts are price regulation, and by statute price regulation is implemented using tariff filings.  As we point out in Tariffing the Internet, a zero price is a difficult sell under the “just and reasonable” standard of Section 201, so it’s plausible that the tariffed termination fee will be positive.  In some cases, a positive fee may be necessary.  With reclassification, rate-of-return companies would be required to allocate operating expenses, capital expenses, and revenue associated with the remote delivery service to regulated accounts (currently they are booked as non-regulated expenses and revenues).  These carriers would be entitled to cost-recovery for reasonably-incurred expenses.

The agency is also going to have to find some legitimate theory of forbearance if it wants to avoid mandatory tariffing under Section 203.  As we explain in both Tariffing the Internet and in our new paper Section 10 Forbearance: Asking the Right Questions to Get the Right Answers, however, this is a tough legal road for the Commission to hoe.  To begin, the agency would have to forbear from price regulating firms it has described as monopolists (i.e., terminating monopolists), and it is exactly this “monopoly” that justifies the agency’s actions on net neutrality.  The agency has never forborne from price regulation under monopoly conditions; declaring a “monopoly” to be non-dominant is without precedent. Moreover, if it does forbear, then the Commission surrenders its control over price, and net neutrality seems to require the agency to control the termination price (at least under certain circumstances). So even the agency does come up with some flaky theory of forbearance, it would seem to nullify the agency’s ability to regulate termination prices.

There are also other technical issues the Commission will need to think through should it choose this “hybrid” path including the CPNI rules in Section 222, the interconnection obligations of Section 251(a), payments to the Universal Service fund, the role of state regulation, and many other deep-in-the-weeds considerations.

Which brings me back to the point of the pencil:  A Section 706 approach to the termination market, however, faces few if any hurdles.  First, under Title I, the carriers are not required to submit tariffs.  The agency can control prices by serving as an arbiter of pricing disputes under the “commercially reasonable” standard as it already does in regulating roaming agreements in the mobile market.  Thus, forbearance from tariffing is not required.  Since Broadband Service Providers haven’t charged edge providers for termination in the past—even though they could—there should be little to nothing for the Commission to arbitrate.  Any mutually-beneficial agreement for paid termination also requires no arbitration, since both parties are on-board.  Yet, if the broadband providers are accused of acting anti-competitively in the termination market, then the agency may inject itself into the dispute.  As far as legal arguments for net neutrality go, Section 706 is as good as it gets.  Notwithstanding all the gnashing of teeth, it’s really pretty damn simple to accomplish everything the Chairman says he wants to do—just go back to the proposal of the 2014 Open Internet NPRM and use Section 706 as the legal basis.

Significantly, the Chairman needs two votes for a Section 706 approach. It’s not clear he has them from his Democrat compatriots.  Considering the ugly consequences of reclassification, and the fact net neutrality rules of some sort are a given, perhaps the two Republican commissioners could swallow that very bitter pill and support the Section 706 approach as the lesser of two evils.  Or, perhaps it is wiser to let the agency go down the Title II rat hole for its third judicial rebuke on net neutrality, which may finally kill the issue until such time there’s a reasonable justification for pursuing it.