January 6, 2007

January 6, 2007 | Commentary on Internet And Technology

AT&T-BellSouth Merger: Regulation Through the Backdoor

The Federal Communications Commission is rarely accused of moving too quickly.  Although telecommunications itself is one of the fastest-changing industries in the U.S. economy, the FCC itself is famous for moving at a snail's pace.  Last week, as the clock ticked down on 2006, the agency reinforced that reputation-finally approving AT&T's merger with BellSouth almost nine full months after the transaction was announced. More troubling, however, the approval came with enough strings to fly a kite, including imposition of "net neutrality" rules.   

AT&T and BellSouth announced their intent to merge their companies on March 5, 2006.  From the start, it was clear that the deal raised few competitive questions. Though both companies provide telephone and broadband Internet services, they largely don't compete with each other. AT&T's local services focused largely in the west and Midwest. BellSouth-as the name implies-had operations mostly in the southeast.

Before the FCC acted, the merger was approved by no less than 19 other regulatory agencies: 18 state utility commissions and the Antitrust Division of the Department of Justice, which concluded the deal "is not likely to reduce competition substantially," and would likely lead to "efficiencies which should help consumers".

Despite these green lights from other agencies, the transaction faced an endless red light at the Federal Communications Commission. This was more than the typical FCC delay-the merger had become entangled in the ongoing fight over "net neutrality" regulations. The fight over neutrality rules-which would bar network owners from charging content providers (such as e-bay and Amazon.com) extra for premium access to their networks-has been simmering on Capitol Hill for close to a year. In its most recent session, Congress declined to regulate. Nonetheless, two members of the FCC insisted that neutrality regulation be imposed on AT&T as a condition of its approval.

This idea was strongly opposed-for compelling substantive and procedural reasons-by two other members, including the chairman, Kevin Martin.  A fifth commissioner recused himself due to a conflict of interest, leaving the FCC deadlocked.

Substantively, government rules mandating neutrality are a bad idea. Price discrimination-charging premium prices for premium service-can help smooth out demand and provide capital for further investment, which would benefit all Internet users.

Instead of a fair review on the merits, transactions are held hostage to political whims.

Imposing these regulations as a condition of merger approval is a bad idea for procedural reasons as well. Antitrust authorities such as the Justice Department and Federal Trade Commission normally impose conditions when the merger itself would create undue market power-typically with specific remedies, such as divesting an affiliate or overlapping facilities.  But neutrality rules don't address any problem caused by the AT&T-BellSouth deal. The merger simply became a vehicle for the backdoor imposition of rules that had failed to gain acceptance through normal FCC and congressional processes.

In the end, holding the deal hostage was an effective FCC strategy. With its merger on indefinite hold due to the FCC deadlock, AT&T agreed to accept 19 pages of conditions on the deal-including net neutrality rules. In a December 28 letter to the FCC, AT&T agreed to abide by net neutrality restrictions, specifically committing itself  "not to provide or to sell to Internet content, application, or service providers…wireline broadband Internet access service based on its source, ownership or destination." The next day, the FCC voted 4-0 to approve the merger, subject to the conditions outlined.

This victory for net neutrality rules is not complete, however. AT&T limited its commitment in several crucial ways. The restrictions it agreed to only apply for 30 months, then automatically expire. Moreover, the neutrality rule does not apply to the new Internet-based video distribution network AT&T is building. That's important because many believe that this high-bandwidth system could become AT&T's primary distribution network for Internet traffic of all kinds. As a result, the new restrictions may not be as economically harmful as they could have been.  Still, the new restrictions are important-for the first time broad neutrality rules have been imposed.  By providing a foothold for net neutrality regulations, efforts to impose more comprehensive controls could be re-energized.

Even those who favor net neutrality should be upset that this rule was imposed through the backdoor of the FCC, after failing to gain acceptance through Congress's front door.  Backdoor policymaking hurts the public, as the checks and balances of the normal policymaking process are short-circuited. More directly, hijacking merger reviews to alter policy hurts firms and their customers-instead of a fair review on the merits, transactions are held hostage to political whims.  Will this become a precedent for future FCC reviews? Perhaps not-this case may be unique. But don't count on it.

James Gattuso is a research fellow in regulatory policy at The  Heritage Foundation, a Washington-based public policy research institute.

About the Author

James L. Gattuso Senior Research Fellow in Regulatory Policy
Thomas A. Roe Institute for Economic Policy Studies

First appeared on American.com