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A Federal Nuisance

The government might crash AOL Time Warner in the race to compete on the Internet

By Randolph J. May
Legal Times, February 12, 2001

In a speech delivered on July 24, 2000, then Federal Communications Commission Chairman William Kennard, looking backward, declared that "perhaps the FCC's most important decision" was when it "decided to leave the Internet unregulated." Last month, in his last major action before resigning from the commission, Kennard decided, in the context of considering the AOL-Time Warner merger, not to leave the Internet unregulated after all.

Kennard's reference in his July speech was to the FCC's 1980 decision in its landmark Computer II proceeding not to regulate the then-fledgling online service providers as common carriers. Remember, this was years before the Internet as we know it today, and even pre-AOL. It was the fundamental regulatory distinction that the commission drew then between what the agency called "basic" transmission services (pure communications pipelines) and "enhanced" services (basic service plus computer processing)-which allowed online services and the Internet to develop free from traditional public utility-type regulation.

Under the Computer II regime-and the provisions of the Telecommunications Act of 1996, which carried forward its precepts-providers of basic telephone services have been subject to the traditional common carrier obligation of making their facilities generally available on a nondiscriminatory basis and at reasonable rates. Enhanced service providers, which morphed into today's Internet service providers (ISPs) such as AOL, Earthlink, and Juno, have not been subject to access obligations or rate regulation. The rationale for the basic/enhanced services distinction was simple: left unregulated, the online marketplace would develop on a competitive basis, with innovative new services blossoming.

Unfortunately, even as he packed boxes to take his leave from the agency's still new headquarters building (appropriately named, given the Internet issues being considered, Washington's Portals complex), Kennard led a majority of the five-member commission a considerable way down the road to regulation of the Internet. With the commission's two other Democrats, Susan Ness and Gloria Tristani, Kennard voted to approve the license transfer applications associated with the AOL-Time Warner merger subject to conditions that, in effect, impose public utility-like obligations on AOL's service and the Time Warner cable systems that can deliver high-speed Internet access.

Troubling Conditions

The most troubling set of conditions centers around AOL's popular instant messaging service. As anyone with kids in the house knows, instant messaging alerts AOL members when their "buddies" are online so they can activate a real-time messaging capability. Currently, AOL subscribers cannot send or receive instant messages to or from the similar systems of AOL's online competitors, such as Microsoft and Yahoo!. AOL claims that it is working to resolve certain security issues in order to make its service compatible with other systems.

AOL's competitors argued that unless the government compels AOL to make its system compatible with theirs, AOL will cement its current dominance in the instant messaging marketplace due to what economists call the "network effects" phenomenon. This refers to the condition under which the most popular service remains more attractive than competing services by virtue of the fact there are already more people using it.

Responding to the competitors' concerns, the majority ruled that AOL may not add any new high-speed capabilities to its instant messaging service until it demonstrates that it has opened it up. To implement this condition, the agency created a new regulatory classification that it called "advanced, instant messaging-based high speed services" (and, quite naturally, came up with a new acronym-AIHS). Suffice it to say that what the commission seems to have in mind are the next generation instant messasing services predicted to include audio and video streaming capabilities.

The other set of Internet conditions mandates that unaffiliated ISPs be given "open access" to the high-speed bandwidth on Time Warner's cable systems. In effect, Time Warner must not provide AOL with access to its cable system on terms more favorable than it provides access to unaffiliated ISPs. Here the majority mostly just adopted the access requirements already imposed by the Federal Trade Commission in December when it approved the merger under its antitrust review.

But it added a few new conditions for good measure, such as a mandate that unaffiliated ISPs be permitted to determine the content of the subscriber's first screen. Curiously, the day after Chairman Kennard voted to impose these conditions, he issued a document touting as one of his principal achievements the fact that "the Commission has not imposed 'open access' obligations on cable television companies." Come again?

The commission's two Republican members, Michael Powell and Harold Furthgott-Roth, dissented from the imposition of the foregoing conditions. Because President Bush quickly named Powell the commission's new chairman (the president can designate a sitting commissioner chairman at any time), it is especially worth considering his objections, as set forth in his opinion and in an accompanying statement.

With regard to the instant messaging interconnection condition, Powell chastised the majority for imposing a regulatory mandate on "a hypothesized product in a hypothesized market" based on "its own sweeping technical conclusion that [instant messaging] is an essential facility for nearly all future real time, interactive Internet communications." He bemoaned the majority's action for embracing the position that "the FCC has jurisdiction to regulate virtually every Internet product or service that facilitates communications," this despite the fact that under the Computer II regime, the commission "has expressly declined to regulate similar computer, data processing and information services for the very reason that such interference would undermine the energy and drive toward innovation that characterizes these highly competitive markets."

Powell distinguished instant messaging, which he called a "software application born purely of the mother Internet," from "telecommunications infrastructure, like cable or DSL, that affect Internet transmission." Thus, with regard to the open access issue, although he thought the merger enhanced competitive risks somewhat in the Internet access market, he considered the FTC's conditions sufficient, without more, to address these competitive concerns. And he worried that the FCC's imposition of merger-specific conditions would prejudice its consideration, in a recently opened generic inquiry, of whether any access requirements at all should be adopted for cable and other broadband Internet platforms.

Powell's criticism of the majority's handling of the merger is valid, and now he has an opportunity to lead the FCC back on track. The commission had no business imposing either the interconnection requirement on AOL's instant messaging offering or the access mandate on Time Warner's cable service. This is particularly so in the context of the license transfer proceeding in which the guiding statutory standard is nothing more specific than "the public interest."

Not only does the majority's action for the first time impose a direct regulatory requirement on an Internet service, it does so for one not yet in existence. This action likely will retard the development of the very new services that are the object of the commission's preemptive regulatory attack. Similarly, there has been no showing yet that common carrier-type "open access" regulations are necessary for cable operators such as Time Warner in order to promote a competitive Internet access market. Indeed, the FCC twice has concluded in recent months that the market for broadband platforms that support high-speed Internet services is developing on a competitive basis, with cable operators, telephone companies, wireless providers, and satellite companies vying for both residential and business customers.

Restraining Regulation

Former Chairman Kennard had it right last July when he explained to Congress that the agency consistently had refused to impose public utility-type regulations on providers entering new markets because, in a dynamic environment, "regulatory restraint was the best way to further the Act's goal of encouraging facilities-based investment and innovation." And he had it right in September 1999 when, a bit more prosaically, he said, "I have been there on the telephone side," and it would be wrong to "just pick up this whole morass of [telephone] regulation and dump it wholesale on the cable pipe."

Under Powell's leadership, the commission should initiate a proceeding to consider removing the AOL-Time Warner merger conditions. This would send two signals. First, that the agency is going to retreat from the wayward steps it took down the path of Internet regulation. Second, that it is going to retreat from the practice of using license transfer proceedings to duplicate the competitive analysis performed by the antitrust authorities and as a forum for imposing new regulatory conditions that ought to be considered, if at all, in industrywide rule-making proceedings.

Such bold action would be a welcome sign that a refreshing deregulatory breeze is blowing through the FCC's portals. And it would be consistent with Powell's admonition in a recent speech that "our bureaucratic process is too slow to respond to the challenges of Internet time."

Randolph J. May is a senior fellow and director of communications policy studies at the Progress & Freedom Foundation in Washington, D.C. The views expressed are his own and do not necessarily reflect the views of the foundation.

© 2001 Legal Times. All rights reserved. This article is reprinted with permission from Legal Times.



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