February 2009
Cable and Telecommunications Policy Newsletter
In This Issue
TAX-EXEMPT BONDS
COMCAST/BIT TORRENT
RURAL EXEMPTION
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My office is pleased to present the first monthly issue of my Cable and Telecommunications Policy Newsletter.  The newsletter provides analysis and opinion on issues facing the cable and telecommunications industry.  The newsletter is free.  Feel free to pass it on to your colleagues or anyone you think may have an interest in the contents.

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Tony Mendoza
 
PERMISSIBLE USES OF TAX-EXEMPT BOND PROCEEDS

Municipalities Continue to Rely on Tax-Exempt Bond Financing for Municipal Broadband Projects

Tax-exempt bonds provide local governments with advantageous debt financing because interest paid to bondholders is not included as gross income on the bondholders' federal income tax return.  Local governments have used tax-exempt bond issues to finance a variety of government projects - solid waste treatment facilities, electric utility plant, medical centers, and stadiums.  Local governments are increasingly using tax-exempt bond issues to finance the construction of telecommunications networks in partnership with private third parties.
 
Under the Internal Revenue Code (Code), a tax-exempt governmental bond is a state or local bond that is neither a "private activity bond" nor an "arbitrage bond".  This article discusses the IRS's test for defining a "private activity bond."  If a bond is determined to be a "private activity bond," the bond issue loses its tax-exempt status.
 
Section 141 of the Code sets forth the tests for determining whether a bond issue constitutes a "private activity bond."  The basic policy behind section 141 is to limit the amount of tax-exempt financing that benefits entities other than state and local governments.  The tests set forth in the Code provide a way of identifying financing arrangements that transfer the benefits of tax-exempt financing to nongovernmental entities.  A bond issue constitutes "private activity bonds" if there is a reasonable expectation that, on the issue date, it will pass both the "private business use test" and the "private payment or security test."
 
The "private business use" test is met if more than 10% of the proceeds of an issue will be used for any "private business use."  "Private business use" is defined as the use of bond proceeds or bond-financed property by a nongovernmental person in furtherance of a trade or business activity.  Under the statutory test, indirect uses of proceeds must also be considered in determining whether more than 10% of the proceeds of an issue are for private use.  Management contracts between local governments and private entities under which private entities receive compensation for services provided with respect to a bond-financed facility can result in the loss of tax-exempt status.
 
If a project meets the definition of the "private business use" test, then it must also meet the "private payment or security test" to lose its tax-exempt status.  The "private payment or security" test is met if more than 10% of the payment of principal or interest on the bond issue is either made or secured (directly or indirectly) by payments or property used or to be used for a private business use.
 
Private telecommunications service providers operating in areas where local governments are considering using tax-exempt bonds to finance municipal telecommunications networks should carefully study local governmental telecommunications business plans, paying particular attention to the financial arrangements between the local government and third party vendors to determine whether the project qualifies for tax-exempt financing.
 
THE FCC COMCAST/BIT TORRENT ORDER

FCC Order A Call For FCC Reform, Not Net Neutrality

Internet public interest groups like Free Press and Public Knowledge are using the FCC's Memorandum Opinion and Order in their complaint against Comcast regarding "reasonable network management practices" (commonly referred to as the Bit Torrent case) as a call to arms for legislation and/or regulation regarding so-called "net neutrality."
 
Other than the Bit Torrent Order, which as discussed below provides no basis for further internet regulation, net neutrality advocates cite to a few isolated instances of content discrimination by internet service providers.  In NATOA's comments to the FCC in the Bit Torrent docket, it cited to an incident in which AT&T selectively muted certain lyrics in a performance by the band Pearl Jam, and Verizon's now famous decision (quickly reversed by the company) to reject a text message from NARAL to be delivered over its mobile phone network.  Other instances of net neutrality "violations" are far and few between, and perhaps non-existent.  Even the comments of Free Press and Public Knowledge fail to identify other instances in which ISPs have specifically discriminated among users on the basis of content.
 
Moreover, the FCC's Bit Torrent Order cannot be used as a call to arms for "net neutrality" legislation or regulation.  This is because the FCC's Bit Torrent Order is a product of the extremely poor fact finding practices of the FCC and the obvious contempt that ex-FCC Chairman, Kevin Martin held for the cable industry.  The FCC's Bit Torrent Order is stunning in its lack of record evidence in support of its many far-flung conclusions.  One of the bigger stretches the FCC Order makes is its "prima facie" finding that Comcast intentionally discriminated among users on the basis of content in order for Comcast to protect content favored by Comcast.  In support of this conclusion, the FCC cites to informal complaints filed by peer-to-peer users that informed the FCC about the specific applications they were having trouble downloading.  However, this testimony provides no basis for a conclusion that Comcast's network management practices were in any way discriminating on the basis of the content.  The FCC learned of the content from the customer well after the customer's download was interrupted.  Comcast has steadfastly denied that it has ever inspected the content of any IP packets as part of its network management practices.
 
This particular unsupported conclusion of the FCC unmistakably bears ex-FCC Chairman Kevin Martin's fingerprints.  Since Martin took a seat on the FCC, he has been on a crusade against the cable industry over a la carte programming.  So, it is not surprising that Martin would unfairly impute such a rationale to Comcast for its network management practices.
 
The FCC has always struggled with its role as a quasi-executive, legislative, and judicial body.  Particularly in exercising its judicial authority, as it did in the Bit Torrent case, the FCC's fact-finding practices are particularly troubling.  Contrast FCC practices to the fact-finding practices of many state public utility commissions, which utilize administrative law judges to more carefully develop factual records in complaint proceedings.  In a judicial setting, affected parties ought to have the ability to engage in at least limited discovery, the ability to cross examine witnesses, and object to or at least argue about the credibility or weight of evidence offered for the record.  None of these tools are used by the FCC in complaint proceedings.  Instead, FCC orders in complaint proceedings, are replete with references to ex parte communications by all of the parties.  This results in the FCC exercising its judicial functions in a legislative manner.  Depending on the political winds, everyone will, or already has, ended up on the losing end of this process.  At one time or another judgments are made not on the merits of a position, but on the current political environment at the FCC.
 
There is real danger here, no matter whom you represent.  Decisions in complaint dockets like the Bit Torrent case can have a substantial impact on the national policy direction taken on a certain matter.  Congress will often take its cues from high profile complaints.  The media and the prevailing parties will use an order like the FCC's Bit Torrent order, which improperly conflates "content regulation" by ISPs with non-content based network management practices to embark on terrible government policy - like more intrusive and unworkable government regulation of the internet.
UNDERSTANDING THE RURAL EXEMPTION

The Telecommunications Act of 1996 obligated all local exchange carriers (LECs) to allow their services to be resold, provide local number portability, dialing parity, provide access to right-of-way, and reciprocal compensation for the exchange of local telecommunications traffic.  Additional obligations were placed on incumbent local exchange carriers (ILECs), including the duty to negotiate interconnection agreements in good faith, provide interconnection on a non-discriminatory basis, provide access to certain unbundled network elements, discounted resale, and collocation.
 
The Act also provides certain exemptions from these requirements for small and rural carriers.  Rural telephone companies are exempt from the ILEC interconnection obligations unless a state regulatory commission terminates the exemption.  Moreover, the rural telco exemption does not apply to requests from cable operators seeking to also provide telecommunications services in an area where the rural telco began providing video programming service after the effective date of the 1996 Act (February 8, 1996).
 
Another exemption under the Act allows small telephone companies (serving less than 2% of all the nation's subscriber lines) to petition a state commission for suspension or modification from either or both the LEC and ILEC interconnection requirements.  The small carrier must demonstrate extraordinary circumstances to win this exemption - either (i) that the failure to grant the exemption would have a significant adverse impact on consumers; (ii) the requirement is unduly economically burdensome; or (iii) the requirement is technically infeasible.  The exemption must also be consistent with the public interest.
 
In its first order on local number portability issued in 1997, the FCC ruled that LECs need only provide LNP capability if they serve customers in one of the largest 100 MSAs, or if outside the largest 100 MSAs upon the request of a competing carrier.  The FCC denied the small and rural telcos request for a blanket exemption from LNP requirements.  The FCC advised small and rural telcos that they could apply for an extension of time to comply with LNP provisioning request from a competing carrier upon a showing of extraordinary circumstances causing a delay in complying with a request.  Or, the FCC advised, small and rural telcos could petition a state commission for suspension or modification of the LNP requirement pursuant to the federal exemption provided under the Act. 
 
The FCC clarified that the exemption for rural telephone companies only applies to those companies meeting the definition of a rural telephone company under federal law.  The second exemption, allowing small carriers to petition state commissions for suspension or modification applies to a different subset of carriers - only those serving less than 2% of the nations telephone subscriber lines.
 
Federal case law places the burden of proof on the carrier seeking the termination of the rural ILEC exemption.  State commissions have followed this rule.  However, those states that have considered petitions from small telcos for a suspension or modification exemption have placed the burden of proof on the incumbent small telco.  State courts have ruled that suspension or modification exemptions should not be granted easily.  Small telcos carry a heavy burden of proof.