DISH DE Debacle Part 2: So What Did The FCC Actually Do?

In Part 1, I gave a rather lengthy explaination of the factual background why DISH now owes the FCC another $3.3 billion dollars more than the $10 billion it already owed for licenses won in the big FCC spectrum auction at the end of last year (the AWS-3 auction). Here, I give my analysis of the Order denying SNR and Northstar applications for designated entity (DE) credits. Some thoughts on broader implications, what may or may not happen next, and my personal opinion on whether the FCC was right or wrong, I save for Part 3.

 

More below . . .

 

I will go into this noting that this case illustrates both the good and the bad of case-by-case adjudication. On the plus side, you get the flexibility to deal with situations that no one has previously considered. If you think DISH was “pulling a fast one” and subverting the rules, then case-by-case adjudication like this is what allows an agency to properly safeguard the intent of the law and protect the integrity of the system. If you think DISH scrupulously followed the rules to the letter, then this case illustrates the arbitrary nature of case-by-case adjudication and how a company that invested billions of dollars in reliance on its interpretation of the rules can get screwed after the fact.

 

Mind you, I prefer to look at it in a third way. No matter how clear you make the rules, there will always be a need for an umpire to actually call the balls and strikes. Sometimes the calls are going to be close calls where reasonable folks can differ depending on the point of view. My emotional belief that a player was “robbed” by a ‘bad call’ may or may not be accurate in some scientific sense (and others may just as passionately feel the call was good and how can i possible think otherwise?), but it doesn’t make the system of having an umpire call balls and strikes an inherently bad or arbitrary one.

 

How the FCC Analyzed the Case.

 

It’s important to understand the legal process of how this works, because the FCC’s decision rests on viewing this from the perspective of FCC-legal land and not from normal understanding. Most folks assume that the FCC “permitted” SNR and Northstar to bid as designated entities and that the FCC is now evaluating whether DISH, SNR and Northstar “lied” about SNR and Northstar being independent small businesses rather than being controlled effectively by DISH.

 

But, as the Order is at great strains to stress, that is not how this works. From an FCC perspective, describing the process this way is like saying the Sun rises in the East and Sets in the West. Sure, it looks that way. But it is actually the Earth rotating around the Sun rather than the other way around.

 

So too here. As noted at considerable length in Part 1, the FCC did not approve SNR and Northstar as DEs before the auction. The legal process works like this. SNR and Northstar submitted “short forms” describing themselves and their relationship with DISH and stating their intent to claim a DE credit. The FCC accepted SNR and DISH as eligible to bid and eligible to apply for DE status after the auction. However, as the rules always stress and the Commission stressed again before the AWS-3 auction, the acceptance of a short form and allowing a company to bid does not mean that the company will even get awarded licenses it won, let alone a DE credit. The evaluation of whether to grant a license, and the separate evaluation of whether to grant a licensee seeking a DE credit the requested bidding credit, takes place after the auction on submission of the long forms.

 

A Brief But Important Sidebar for Those Not Familiar With Spectrum Law and Policy.

 

 

Contrary to what most people think, you don’t win ownership of the spectrum license through the auction. Rather, for reasons I won’t explain now (Google “Coase” and “FCC” if you are interested), we decided in 1993 that we would use auctions as a proxy for determining who would best use the license in a way that serves the public interest. No, I’m not going to explain the logic. The reason this is significant here, however, is because it means even auction winners have no property right or legal entitlement to the license. The FCC makes an independent determination after the auction whether granting the license to the auction winner serves the public interest.

 

The company therefore participates and bids at its peril. Generally, this is not a problem because the FCC will – on the basis of the preliminary short-form screening — assume that you meet the requirements and winning the auction shows you value it enough to put it to productive use. But there is no similar presumption in favor of granting a DE credit. To get the DE small business credit, you need to show that (a) you have not made more than (whatever amount of money) over the last 3 years combined, and (b) you are not controlled by someone who makes more than X amount of money.

 

People are smart enough to recognize that you can effectively control a company without owning it or running it. The FCC also recognizes that even major companies like Verizon need financing to bid in spectrum auctions, so investors are going to want to have some level of oversight of the company as a way to protect their investment. Likewise, the FCC recognizes that a small business can benefit a lot from partnering with a larger business, but that here is a difference between a “partner” and a “puppet” controlled by the larger company. So the FCC has a list of specific red flags it looks for, but also makes clear that it will look at the reality on the ground, aka the “totality of the circumstances,” to make a predictive judgment about whether it’s believable that a small business with the agreements and debt load described in the long-form application could act independently of the big company (here, DISH).

 

Since this is not about whether you broke an auction rule, but whether you qualify for a discount after you won the license, there is nothing particularly illegal or wrong in getting told you don’t qualify. However, if you bid and won licenses expecting a discount, that doesn’t help much. You’re still on the hook for the full price when you expected to get a 25% discount.

 

Think of being denied a DE discount as being like getting told you don’t qualify for a particular tax deduction your accountant told you that you did qualify for because you ended up making more money selling your house than you thought you would. It doesn’t mean you cheated on your taxes, but it does mean you don’t get the tax deduction and you now owe back taxes.

 

So How Did The FCC Analyze the Case and Why Did It Come Out Like This?

 

The FCC did two things. First, it went through each agreement DISH had with the DEs and explained that while DISH was correct that the FCC had, in each case, approved similar kinds of agreements as being reasonable investment protections or conferring benefits to the DE such as management services, DISH pushed the limit on each one of these individually further than anyone else had. Next, the FCC looked at how the combination of these things would work in the real world. The FCC concluded that, while any one of these contractual provisions might not impermissibly compromise the independence of the DEs, the combination of all these contractual provisions made it impossible for the FCC to believe that SNR and Northstar could act as independent companies.

 

For example, while agreements traditionally give an investor a right to limit how much more debt a DE can take on, the DISH DE agreements gave DISH so much more oversight that it would be impossible (in the FCC’s opinion) for the DE’s to develop alternate financing that would allow them to borrow money to pay off their debt to DISH and thus eliminate some of the other controls associated with paying off the debt.

 

In particular, the FCC did not like the provision that prevented the DEs from going after any other spectrum licenses without DISH’s prior approval. OTOH, since licenses are (as we have seen) very expensive, this is not an unreasonable investor protection in the abstract. But the Commission noted that this was a red flag because it prevented the DE from ever branching out into a new spectrum service without DISH’s approval, which the FCC found compromised the DE’s independence as a wireless company. Additionally, although the FCC has previously permitted requirements that the DE chose technology interoperable with the investor’s technology, it has never permitted such a provision when the investor does not already have a system in place. It is one thing for an independent DE to know what kind of system a partnering company has deployed, reasoned the FCC, and make a decision to select interoperable technology as a condition of financing. It is another thing, reasoned the FCC, to tell a DE ‘when we make a decision on what technology we want you to use, we’ll let you know.’

 

To any of these individual provisions and clauses, one can always answer, “yes but.” And the FCC acknowledged that no one of these alone might trigger a denial. But the FCC also found a bunch of other things that contributed to its overall conclusion. First, the structure protected DISH more so than any other investor, including the other big money investor – BlackRock. Again, DISH put up a substantially bigger chunk of cash than anyone else, so on the one hand that makes sense. But it still means that as a practical matter, DISH has much more practical oversight of SNR’s and Northstar’s business decisions and strategy. Additionally, the huge size of the debt – about $5 billion per business – means that, as a practical matter, neither Northstar or SNR can ever hope to pay off the debt other than by selling out to DISH. DISH is providing management services, which is consistent with precedent as long as the DE can overrule the management decisions of DISH or can terminate its management , but DISH also has approval over the salaries to the primary officers of SNR and Northstar. Again, that is perfectly fine based on precedent because it protects an investor from employees looting the company. But it also makes it less likely that SNR or Northstar will actually overrule a DISH management decision.

 

Taking all these things together, even if any one of them or a couple of them were OK, the FCC paints a picture of two small businesses nominally independent but effectively controlled by DISH. As a result, the FCC denied the DE credit.

 

What About the Auction Behavior?

 

I gotta confess, this is the part I find weakest in no small part because I can’t find any actual rules on how a bidding consortia is supposed to work and what level of coordination is or isn’t permissible. Importantly, the Commission did not find that DISH, SNR or Northstar violated any of the FCC’s anti-collusion rules (I’ll deal with the antitrust stuff further on). But the FCC placed considerable weight on the fact that SNR at one point withdrew a bid and allowed Northstar to take the high bid, a strategic move which the FCC found made no sense if SNR were genuinely independent because it cost SNR a penalty to withdraw. The move only made sense, the FCC decided, if the three bidders lacked independence and were all controlled by DISH – since the penalty would be offset by the advantage gained to Northstar.

 

This is the part where I confess I get lost because I thought the whole point of the bidding consortium was to allow the bidders in the consortium to act together to maximize their total overall advantage. In that event, how do you distinguish the rational thing – maximizing overall advantage – from control? Yes, SNR normally would not find it rational to suffer a penalty, but by maximizing the advantage to Northstar, it also maximizes the advantage to itself because the two are allied. The joint mutual advantage could offset the individual penalty to SNR for withdrawal.

 

Part of the problem is that bidding consortia are just weird and I am frankly glad that the FCC seems to have eliminated them in its most recent rules. But I can’t really evaluate how good the FCC’s analysis is here because I just don’t understand the limits of joint action permitted for bidding consortia in Auction 97 (the AWS-3 auction).

 

In any event, the FCC found lots of other stuff that, when taken together, the FCC decided amounted to sufficient evidence that DISH retained sufficient control of SNR and Northstar that the FCC should attribute to SNR and Northstar DISH’s earnings. Since DISH earned waaaaaay more than the limit for a designated entity credit, the FCC denied the credits to SNR and Northstar.

 

So Why Do SNR and Northstar Still Get The Licenses?

 

My father, who teaches tax law, always likes to remind his students of the following principle: “Answer the question asked, not the question you wish were asked.”

 

The question presented to the FCC in the first instance was “should the FCC attribute to Northstar and SNR the revenue from DISH, or are SNR and Northstar sufficiently independent that the FCC should regard them as separate companies for purposes of the DE rules?” Having concluded that DISH retained sufficient control to make its revenue attributable to SNR and Northstar, the FCC denied the credit. But that says nothing about whether DISH, SNR and Northstar ‘cheated’ in the auction or ‘lack the moral character’ to hold a Commission license.

 

Taking these questions in turn, the FCC found that DISH had totally played by the rules and had not in any way, shape or form violated the auction rules. To the contrary, as the Commission noted, DISH had been utterly up front in declaring everything in total conformance with the rules. The fact that DISH guessed wrong about whether it would be entitled to a bidding credit is irrelevant to the question of whether DISH violated the anti-collusion rules by engaging in a bidding consortium with 2 other entities. Since the bidding consortia was legal under the rules, and properly declared by the bidders in the short forms as required, there was – by definition – no violation of the anti-collusion rules, which permit precisely this kind of bidding consortia and coordinated activity by the consortia members.

 

Since no one violated any FCC rules, there is no question that SNR and Northstar “lack the requisite character” to hold FCC licenses. Guessing wrong on your eligibility for a discount hardly means you aren’t moral enough to hold Commission licenses.

 

Importantly, the FCC also declined to either run the auction again or give the licenses to next highest bidders. As the FCC noted (a) such relief is utterly unprecedented, the FCC never does that; and (b) SNR, Northstar and DISH didn’t violate the rules, so there are no grounds to deny them licenses. If DISH can’t come up with the additional $3.3 billion, it will default on the licenses, they revert back to the Commission, and the Commission will reauction them.

 

What About the Antitrust Stuff?

 

I confess I find the allegations of an antitrust violation here rather silly. As the Commission itself pointed out, the theory of an antitrust violation set forth by the parties filing Petitions to Deny SNR and Northstar the licenses relies on a conspiracy between the parties in restraint of trade. But if SNR and Northstar are considered one entity, how is there a conspiracy? It is a legal fact that you can’t conspire with yourself, and the whole point of Petitioners’ arguments is that SNR and Northstar were ‘really’ the same as DISH.

 

Much is made by some (including Commissioner Pai in his concurrence) that the FCC rejected DISH’s argument that by complying with the FCC’s auction rules, it rendered itself immune to any antitrust violation. I don’t see this as prelude to any antitrust enforcement action by DoJ. It simply states the existing law that a party can violate the antitrust laws despite compliance with relevant FCC regulations. (As the FCC Order points out, the Commission recites this in every Order setting rules for auction, including the rules for Auction 97, so no one can seriously claim blanket immunity to antitrust.) To my mind, the FCC pretty much resolved its opinion on the matter by refusing to refer the matter to DoJ or to its own Enforcement Bureau.

 

Setting aside the problem of the lack of conspiracy, it is hard to see how DISH’s conduct could violate antitrust rules. What’s the relevant market? AWS-3 licenses? Wireless services? DISH has no market power in either market. Trying to raise the cost of an essential facility to its rivals? Dude, this is an auction. In theory, everyone bid what they thought the licenses were worth.

 

It is easier to make a case that AT&T and Verizon violated the antitrust rules by acting foreclose rivals from winning the licenses by bidding well above the “fair market value” than it is to say DISH violated the antitrust rules by bidding above the “fair market value.” After all, as the DoJ has said a couple of times, AT&T and Verizon already have a dominant position in spectrum and have incentive and ability to foreclose their rivals from getting sufficient licenses to challenge their dominance. Either we accept that AT&T and Verizon spent what they considered to be the fair market value of the licenses – as predicted by auction theory – or we should conclude their willingness to bid $18 billion and $10 billion are as much an “antitrust violation” as DISH’s willingness to bid $10 billion (now $13 billion following denial of the discount).

 

Conclusion

 

So that’s what the FCC said and how it came to its result. As I will discuss at greater length in Part 3, I would probably have decided things differently, but I can’t say the FCC was crazy for doing what it did or that it so violates all past. I also can’t say what would happen on appeal, or predict with certainty how this will impact the Incentive Auction. Life is like that, sometimes. Or, to conclude with my favorite quote from the Mikado: “I’m really very sorry for you all, but it’s an unjust world and virtue is triumphant only in theatrical performances.”

 

Stay tuned . . . .

 

Click here for DISH DE Debacle Part 3: What Happens Now.

Click here for DISH DE Debacle Part 1: What’s a DE and Why Does DISH Owe $3.3 bn?

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