Advances in technology often make competition possible where it wasn’t before. And in the public utility realm, competition (or the potential for it) often opens the door for deregulation. The debate over when and how to deregulate and the implications of such deregulation are inevitably contentious. This article examines a recent example of how that debate has played out (so far) in one context, creating an empirical test bed for the impact of deregulation on investment and competition.
August 13, 2019 Feature
Eighth Circuit Largely Affirms FCC Deregulatory Pirouette on Business Data Services
By Christian F. Binnig, J. Tyson Covey, and Kara K. Gibney
Ex Ante and Ex Post—A Pre-Election NPRM and Post-Election Decision
In 2005, the Federal Communications Commission (“FCC”) sought comment on revising its price-cap regulations for special access services provided by telecommunications carriers, principally local exchange carriers (“LECs”). Special access services, which the FCC now calls business data services (“BDS”), are generally high-speed, high-capacity, point-to-point connections between larger (primarily business) customers and their long-distance telecommunications service providers over which those business customers send and receive long-distance telecommunications traffic. By 2005, the market for all telecommunications services had grown more competitive, but there was substantial debate about how “competitive” the market for BDS/special access services was.
Time passed as the record and competition grew, and in 2016 the FCC issued its most recent Further Notice of Proposed Rulemaking on that same topic, seeking comment on a number of proposals (“2016 Notice”).1 That Notice was issued before the 2016 presidential election. As a result of the election, however, the reins of power at the FCC switched. Republican Commissioners Ajit Pai and Michael O’Rielly—who vigorously dissented from the 2016 Notice, asserting that it was not deregulatory enough—now held the majority, with Pai as Chairman. Together, they adopted the BDS Order by a 2–1 vote, removing ex ante regulation of some services and creating a test for future deregulation of other services.2 Democratic Commissioner Mignon Clyburn adamantly dissented. Some competitive local exchange carriers (“CLECs”) viewed the BDS Order as far more deregulatory than expected in light of their reading of the 2016 Notice. Appeals naturally followed. In 2018, the Eighth Circuit rejected the challenges to the BDS Order, with one exception, in Citizens Telecommunication Company v. FCC.3
Background
Some background is required to appreciate the significance of the Eighth Circuit’s decision. BDS, formerly called special access service, provides “dedicated point-to-point transmission of data at certain guaranteed speeds and service levels using high-capacity connections.”4 BDS primarily consists of two services: (1) end-user channel terminations (or “channel termination services”), which connect the main provider’s office to a customer’s building, and (2) dedicated “transport services,” which connect a provider’s offices to other network locations.5 In simple terms, BDS involves high-capacity telecommunications lines, such as DS1s and DS3s,6 that large customers use for secure and reliable data transfers, for connecting to the Internet and cloud-based services, and for private and virtual networks.7 Importantly, CLECs also buy BDS from incumbent LECs to reach large end-user customers.8
BDS is migrating from traditional time division multiplexing or “TDM” services (in which an identifiable physical circuit path is maintained throughout the time of a particular transmission) to packet-based “Ethernet” services (in which virtual connectivity is created from a multitude of physical transmission paths). TDM services traditionally have been heavily regulated, while packet-based services have been lightly regulated.9
In considering changes to BDS regulation, the FCC’s 2016 Notice articulated “four fundamental principles” for the proposed new regulations. “First, competition is best.”10 “Second, the new regulatory framework should be technology-neutral.”11 “Third, Commission actions should remove barriers that may be inhibiting the technology transitions.”12 “Fourth, the Commission should construct regulation to meet not only today’s marketplace, but tomorrow’s as well.”13
In the BDS Order, the FCC, in its new 2017 configuration, stated that “ex ante pricing regulation is of limited use—and often harmful—in a dynamic and increasingly competitive marketplace” and carries a “significant likelihood” of “inhibit[ing] growth and investment in many cases,” and therefore “[w]e intend to apply ex ante regulation only where competition is expected to materially fail to ensure just and reasonable rates.”14 Consistent with that overarching view, the FCC took three main actions to remove ex ante regulation for many services and establish a test for removing ex ante regulation for other services on a county-specific basis. First, the FCC continued its forbearance from ex ante price regulation of higher bandwidth TDM services (above a DS3 level) and of all Ethernet (packet-switched) services.15 Second, the FCC eliminated ex ante price regulation of TDM transport services.16 Third, the FCC established a “competitive market test” for lower-bandwidth (DS1 or DS3) TDM end-user channel termination services provided by an incumbent LEC, which is used to decide, on a county-specific basis, where ex ante price regulation of those services can be removed.17
Too Much, Too Soon, and Not Enough Notice?
Like any major ruling, the BDS Order gave almost everyone something to complain about.18 Various CLECs challenged the BDS Order on the grounds that: (1) the 2016 Notice provided insufficient notice that the FCC might adopt generally broad deregulation measures and insufficient notice of specific steps the FCC ultimately took, and (2) the adoption of the competitive market test was so unreasonable as to be arbitrary and capricious.
The notice argument turned on Section 553(b) of the Administrative Procedure Act (“APA”). Section 553(b) requires a notice of proposed rulemaking to include, among other things, “either the terms or substance of the proposed rule or a description of the subjects and issues involved.”19 In applying this section, the courts have held that “an agency’s notice is sufficient if it allows interested parties to offer ‘informed criticism and comments.’”20 Staging a broad attack, the CLEC petitioners sought to vacate the entire BDS Order because “the 2016 Notice requested comments on a heightened regulatory scheme while the 2017 Order was broadly deregulatory,” and that, based on the 2016 Notice, it had been “impossible for them to anticipate deregulation.”21
The Eighth Circuit panel rejected that argument because the 2016 Notice had not been so one-sided. The Notice had a “somewhat Orwellian” flavor in that it stated a goal of broad deregulation but asked for comment on several suggestions to increase regulation (so much so that Commissioners Pai and O’Rielly characterized the 2016 Notice as “mak[ing] ex ante regulation the main course” and proposing “plain, old fashioned rate regulation” so clearly that “the outcome is predetermined”).22 That, however, was not enough to run afoul of Section 553(b). After all, the court observed, the 2016 Notice did speak of “large scale de-regulation” that “goes hand in hand with the use of tailored rules where competition does not exist” and also suggested other problems with the existing rules that “implie[d] shifting the rules in favor of a better-tailored deregulatory approach.”23 The court noted that the 2016 FCC well might have done things differently, but that nothing in the 2016 Notice compelled the 2017 FCC to refuse to consider “large-scale deregulation” or failed to alert parties that large-scale deregulation was on the table.
The CLEC Petitioners also challenged the criteria the FCC adopted in the competitive market test—(1) the presence of competitive providers within half a mile of the examined service location and (2) the presence of competitive cable providers within the relevant census block—as being adopted without sufficiently specific notice. The court rejected that argument because both criteria “adhered to the particularized requests for comment in the 2016 Notice.”24 While acknowledging that the first criterion (nearby competitors) was not mentioned in the part of the 2016 Notice that addressed the competitive market test, the court found it sufficient that other parts of the 2016 Notice had noted that fiber-based competition within half a mile generally affected BDS prices and had sought comment on “how close competition must be to place material competitive pressure on supply at a given location.”25 In other words, while the 2016 Notice could have been “better organized,” the court thought it was enough that some part of the Notice had precisely asked for comment on the competitive impact of nearby providers.26
The court’s willingness to find adequate notice stopped, however, when it came to the BDS Order’s decision to end ex ante regulation of TDM transport services. The court found a lack of adequate notice with respect to this potential outcome because the 2016 Notice’s proposal to address channel termination service and transport service under the same regulations did not “request[] comment on treating the two services differently” and did not “propose completely ending ex ante regulation of transport services.”27 The FCC contended that there was no prejudice from this lack of notice because it issued a draft order proposing to end ex ante regulation of BDS transport services and gave parties three weeks to comment, but the court rejected that argument, finding no support for the idea that “a three-week notice of a complex issue is sufficient.”28
The court likewise rejected the argument that there could be no prejudice because the CLEC petitioners could not precisely identify what more they would have said on the matter. Focusing on the importance of process itself, the court emphasized that even if “everything that needed to be said” about transport services had been said in the 12-year odyssey of the proceeding, “the law regarding prejudice under the APA ensures procedural integrity,” and “[l]osing the opportunity to dissuade an agency from adopting a particular rule is prejudicial.”29 As the court saw it, a procedural violation of the APA is prejudicial in and of itself, and requiring parties to show some additional harm on top of the procedural violation would “risk virtually repealing the APA’s procedural requirements.”30
Testing the Competitive Market Test
Turning to substantive issues, the CLEC petitioners raised a slew of attacks on the competitive market test, which determines on a county-specific basis where lower bandwidth (DS1 or DS3) end-user channel termination services of an incumbent LEC can be deemed competitive and relieved of ex ante price regulation. Regarding economic theory, the CLEC petitioners argued that the FCC’s citation to the FTC/DOJ Horizontal Merger Guidelines in the BDS Order required the FCC to follow those guidelines throughout its analysis. The Eighth Circuit panel, however, found that the FCC’s analysis was not required to be so confined, and it noted that the CLECs’ view ignored the FCC’s disavowal of traditional antitrust principles and a traditional market power framework.31 The CLEC petitioners similarly argued that a prior FCC decision precluded the FCC from finding that a duopoly market can be competitive, but the Eighth Circuit panel concluded that the CLECs had overstated the prior decision, which “did not create any bright line rules about when duopolies are competitive.”32 The court further found that the FCC’s decision was a prediction about what will happen in the market in the future and that such predictions are entitled to deference.33
The CLEC petitioners also challenged the reasonableness of the two criteria the FCC adopted for the competitive market test, as well as the FCC’s cost-benefit analysis. In rejecting those arguments, the Eighth Circuit panel deferred to agency expertise in weighing evidence and arguments and to agency authority to make predictive judgments about competition: “We recognize that the relevant data present radically different pictures of the competitiveness of the market depending on the economic theory applied and the weight given to conflicting pieces of evidence. But the FCC may rationally choose which evidence to believe among conflicting evidence in its proceedings, especially when predicting what will happen in the markets under its jurisdiction.”34 In other words, the FCC gave reasons for its decisions, and as long as those reasons were not clearly unreasonable, the court concluded it must defer to the FCC’s judgment.
Certain ILEC petitioners also appealed the BDS Order, but their only challenge concerned the FCC’s decision, with regard to BDS services still subject to ex ante price regulation, to set the “X-factor” annual price-cap reduction for productivity at 2.0 percent.35 The FCC had stated that it believed the KLEMS data set36 that it used to set the X-factor “was likely too high, but that it did not have information in the record from which it could quantify either the magnitude or direction of bias.”37 The ILEC petitioners argued that the FCC “failed to account for the overstated productivity in the KLEMS” data and failed “to adjust the KLEMS data set downward for the effect of declining utilization of TDM services on ILECs’ unit costs.” The court rejected those challenges, stating that the “best reading” of the BDS Order is that “the FCC rejected all of the data offered to it for adjusting the KLEMS data set as insufficiently precise” and that it was reasonable for the FCC to decline to adjust the KLEMS data set “considering the limited and potentially unreliable data at hand.”38 In other words, the court again deferred to the FCC’s ability to interpret and weigh the record evidence, recognizing that with a large record and complex evidence and concepts at issue, and with the necessity of asking predictive economic judgments, different people can come to very different conclusions while assessing the same facts.
Putting Deregulation to the Test
It is no surprise that the BDS Order, like many recent FCC orders, reflects fundamental philosophical differences between commissioners and their views of how less regulation will affect consumers and the marketplace. Chairman Pai, for example, wrote in his separate statement that price regulation “is seductive” and has “an allure,” but often creates incentives that “are poisonous to consumer welfare.” He also opined that “heavy-handed economic regulation of the BDS market . . . often locks consumers out of consumer benefits,” using the example of how unbundled network element regulation led to less network investment and delayed real facilities-based competition. This sentiment was a natural reflection of his dissent from the 2016 Notice, where he stated that the FCC should not act from “an ideological drive to regulate.” Commissioner Clyburn, however, was equally emphatic on the other side of the divide, characterizing the BDS Order as “a 186-page all-out assault on America’s small business, schools and local economies,” released in a “rush to deregulate” that “upend[ed] decades of competition analysis” and “provide[d] as much notice as a run-away train” while “ruthlessly target[ing] areas that most desperately need help.” Commissioner Clyburn’s primary fear is that the BDS Order “open[s] the door to immediate price hikes for small business broadband service in rural areas and hundreds of communities across that country” so that “distressed rural communities” will “bear the brunt of the decision.”
Chairman Pai’s dissent from the 2016 Notice and separate statement in the BDS Order used Alice in Wonderland as “a parable of the dangers of over-regulation in the communications sector.” With the Eighth Circuit’s almost complete affirmance of the BDS Order, the telecom industry now has the opportunity to demonstrate whether deregulation will in fact foster more investment and competition.
Endnotes
1. Business Data Services in an Internet Protocol Environment, Tariff Investigation and Further Notice of Proposed Rulemaking, 31 FCC Rcd. 4723 (rel. May 2, 2016) [hereinafter “2016 Notice”].
2. Business Data Services in an Internet Protocol Environment, Report and Order, 32 FCC Rcd. 3459 (rel. Apr. 28, 2017) [hereinafter “BDS Order”].
3. 901 F.3d 991 (8th Cir. 2018).
4. BDS Order ¶ 6.
5. Id. CLECs can compete for customers by purchasing one or both of these services. For example, if a competitor has equipment in the main provider’s office, it would need to purchase only channel termination service that would provide a dedicated connection from the provider’s office to the customer. If a competitor does not have equipment in the main provider’s office, it would purchase dedicated transport service to connect to the provider’s office from another network location and also purchase channel termination service to connect to the customer.
6. Digital Signal 1 (or DS1) and Digital Signal 3 (or DS3) refer to bandwidth. A DS1 line is capable of transmitting 24 multiplexed voice or data calls over a telephone line at a data rate of approximately 1.5 megabits per second (“Mbps”). A DS3 line is capable of transmitting 28 DS1 level signals at a data rate of approximately 45 Mbps.
7. BDS Order, ¶ 6.
8. Citizens Telecomms., 901 F.3d at 996.
9. Id.
10. 2016 Notice ¶ 5.
11. Id. ¶ 6.
12. Id. ¶ 7.
13. Id. ¶ 8.
14. BDS Order ¶¶ 4, 86.
15. Id. ¶¶ 87–89.
16. Id. ¶¶ 90–93.
17. Id. ¶¶ 9–171.
18. As Chairman Pai’s separate statement observed, “some believe this Order doesn’t go far enough. Others think it goes too far. I think we’ve got it just right.”
19. 5 U.S.C. § 553(b)(3).
20. Citizens Telecomms., 901 F.3d at 1001.
21. Id. at 1001–02.
22. 2016 Notice, Dissenting Statements of then-Commissioner Pai and Commissioner O’Rielly.
23. 2016 Notice ¶ 4.
24. Citizens Telecomms., 901 F.3d at 1004.
25. Id. at 1003.
26. Id. at 1004.
27. Id. at 1004–05.
28. Id. at 1005.
29. Id.
30. Citizens Telecomms., 901 F.3d at 1005.
31. Id. at 1007–08.
32. Id. at 1010.
33. Id.
34. Id. at 1011.
35. Prior to issuance of the order under review, price caps on BDS were subject to two adjustments: an annual increase to account for inflation and an annual decrease to account for productivity in telecommunications that exceeds productivity in the general economy. The annual decrease is known as the “X-factor.”
36. KLEMS refers to the U.S. Bureau of Labor Statistics’ Capital, Labor, Energy, Materials, and Services data for the broadcasting and telecommunications industries.
37. Citizens Telecomms., 901 F.3d at 1013.
38. Id. at 1013–14.