So What’s This “Designated Entity” Thing, and Why Does DISH Owe The FCC $3 bn When They Didn’t Break The Rules?

Generally, I loath the cliche “be careful what you wish for.” But I can think of no better way to describe the vast consternation in the spectrum world over the licenses won by SNR and Northstar in the AWS-3 Auction. If you don’t recognize the names off-hand, that’s because most of the time people just refer to them as the “DISH Designated Entities” or the “DISH DEs.” As detailed in many articles and petitions to deny SNR and Northstar their DE credits (totaling $3.3 billion), most people regard SNR and Northstar as “sham” or “fake” DEs, owned and controlled by DISH.

But here’s the funny thing. As far as anyone can tell from the filings, DISH, SNR and Northstar followed the precise letter of the law. And, what’s even more surprising, if you look at the results, this was the most successful auction ever for DEs. Both SNR and Northstar are minority owned (as defined by the FCC’s rules). All the “loopholes” DISH used with regard to ownership interest and bidding coordination were designed to make it easier for DE’s to get capital, win licenses, and benefit from partnering with a larger telecommunications company — which SNR and Northstar certainly did.

As a result, as noted by my usual frenemies at Phoenix Center, as measured by every traditional metric, the AWS-3 auction was the single most successful auction in awarding licenses not merely to small businesses, but to minority owned firms specifically. By every past criteria ever used, the AWS-3 auction results ought to be celebrated as a ginormous success for the DE program. Every aspect worked exactly as intended, and the result was exactly what people claimed to want. Indeed, as noted by Phoenix Center, even the $3.3 bn in bidding credits was in line with other spectrum auctions as a percentage of revenue.

Except, in classic “be careful what you wish for” fashion, when you scaled these results up to their logical outcome, no one was really happy with the result (except for DISH). Which has now prompted FCC Chairman Tom Wheeler to circulate an order denying SNR and Northstar their designated entity credits. As a result, SNR and Northstar (meaning their financial backer DISH) must cough up $3.3 bn within 30 days of issuance of the Order or — unless granted a stay or extension — the licenses will revert back to the FCC. Oh yes, and the FCC might need to deduct an additional $10 bn from the auction revenue. And there might be default charges (the FCC charges a penalty for defaulting on payments so people don’t bid and hope they find the money later). Or it might get more complicated, since there has never been a clawback of this magnitude before.

 

In Part 1, I will explain what exactly happened, why DISH did not violate the rules as written and why SNR and Northstar are technically “minority owned.” Along the way, we will consider some delightful ironies about the whole business.

In Part 2, I’ll tackle why the FCC decided that it could yank the DE discount anyway, and try to figure out what happens next.

More below . . . .

 

As always, it helps to start with the basic rules. You’ll find the initial FCC Order authorizing the AWS-3 Auction here, the Public Notice adopting the bidding procedures here, and the FCC’s AWS-3 Auction (aka Auction 97) page here. You can find the docket on the SNR application here. Docket for Northstar here. (My thanks to Tim Farar for the links. These dockets are actually stored on the Universal License Service (ULS) database rather than the Electronic Comment Filing System (ECFS), so I missed them initially.) The Order denying SNR and Northstar their bidding credits is here.

 

So What Is This Whole “Designated Entity” Credit Thingy?

 

Long time readers — and I mean really, really long time readers — will remember that I have been working on this issue since 2006. (More info here and here.) To try to sum this up briefly, Congress recognized when it went to distributing licenses by auction that small businesses, rural businesses and businesses owned by women and people of color (which generally have a much harder time getting access to capital, and have been traditionally excluded from the industry generally) could get squeezed out by much bigger companies. So they directed the FCC to figure out how to make sure these businesses could still get licenses. The FCC decided to give these “designated entities” or “DEs” bidding credits. If you fit the criteria for a DE, you get X% off your actual bid.

 

Various Supreme Court decisions since Congress passed the spectrum auction statute in 1993 make it impossible to have “race conscious” measures, so we no longer look at minority or women ownership as a criteria. Instead, we have pretty much relied on “small business” as the criteria since the late 1990s. But promoting opportunities for women-owned and minority-owned businesses remains one of the core justifications of the program. This is why traditional civil rights organizations care so deeply about it. At the same time, as the price of auctions has sky-rocketed, the rural carriers who are too big to qualify but too small to face off against major carriers have pushed for a separate rural credit.

 

So How Has The DE Thing Worked Out?

 

Designing a good DE program turns out to be really hard. Essentially, any program good enough to provide bidding credits for the businesses that we want to help ends up attracting bigger companies trying to game the system. In particular, the question of what kind of investments bigger companies can make in the DE, what kind of business arrangements bigger companies can make in the DE, and how long you have to hold the licenses, are always tough issues.

Flashback to when I first got involved in this in 2006. At that time, the problem was that all the major carriers had figured out how to game the system and use DEs to get discounts and (because they had deeper pockets), could outbid small businesses unaffiliated with major carriers. According to this old USA Today piece, 78% of the licenses acquired by the 5 national carriers were acquired in partnership with DEs. (Amusing side note, read the USA Today piece from 2006 and count how many of the carriers they talk about no longer exist because they got bought out.)

So the FCC reformed the rules to cut down on the fraud and stuff. But they swung the pendulum too far the other way. In the AWS-1 Auction after the DE reforms kicked in, DE participation (and licenses won by DEs) dropped like a rock. So the FCC readjusted the nozzle again to come up with the following (I will do this at a high level so as not to get too technical):

 

  1. Limit how ownership of DEs is structured and the ability of large companies to exercise control through having control of board members, holding large amounts of company stock or debt that would let you control the company (“active ownership”) or just owning too much of the company even if you don’t get to vote as a shareholder or get to manage the company (“passive interest”).
  2. No leasing more than 25% of the spectrum to any one company, so even if the DE is a “sham” the company that is “calling the shots” can’t get more than 25% of the capacity.
  3. The DE must hold the licenses for at least 5 years before selling them and must actually build out facilities to provide service. If it looks like the DE merely held the licenses with the intent to sell them and no intent to provide service, the DE credit can get yanked back.

 

The FCC screens companies looking for the DE credit in two ways. First, the FCC takes applications to participate when an entity indicates whether it will seek a DE credit. This is called the “short form” application. After the auction, the winning bidders file their “long form” applications to show that they meet the requirements to hold a license and/or receive a DE credit.

Additionally, if the entity violates the terms of the DE rules after it gets the license, it can be subject to enforcement action. Traditionally, the FCC has used an expedited process to get licenses out to the bidders (since that will allow for providers to start building), and relies on after the fact enforcement to determine if the DE is a false front for a large company or speculator.

 

So Why Is This So Hard To Create Rules?

 

Small businesses need a lot of things to get going as wireless companies. This was true when we instituted the DE program in 1994, and is even more true today. A good wireless license in a major urban area can cost upwards of a billion dollars. Licenses in rural areas are cheaper, but then you need to spend more money to deploy the systems and you have many fewer potential customers (which, of course, is why licenses in these areas are so much cheaper). Also, if they intend to break into the already crowded wireless business, they will initially need to partner with other providers if they want to provide service outside their license area.

So you end up with two kinds of entities that can actually provide the fledgling DE with the capital and expertise and business connections it needs to survive as a business: venture capitalists and existing giant telecom businesses. VCs want to acquire an investment and flip it for huge profit – which raises the concern about speculation and sham DEs used to acquire licenses to resell later to major wireless companies. Large telecom businesses present the other problem – the temptation to use sham DEs to get licenses directly but with a discount.

In other words, any set of DE rules that allows DEs to get what they need – capital, experienced management, connections in the industry – also opens the door to potential gaming. Furthermore, neither a VC nor a major company, even with the purest of motives, is going to lend several billion dollars without collateral or influence to safeguard the investment. So how does the FCC structure a program that allows small businesses, minority owned businesses and women owned businesses to get what they need to acquire licenses and stay in the game (as required by Sec. 309(j)) while simultaneously preventing the proliferation of “sham” DEs that rip off tax payers and make a mockery of the program?

Answer: with considerable difficulty. Many small rural providers use the DE credit and it works out fine for them (in that they are existing companies and clearly not a front for others). But expanding beyond existing small carriers has proven difficult since the industry matured in the late 1990s and early 00s.

The response of the FCC is to use a complicated set of ownership and attribution rules that encourage major investors to take a “passive” interest in the company as collateral while leaving management in the hands of the DE. The FCC also relies on its post auction enforcement to ensure that DEs follow the conduct rules designed to limit how major companies can take advantage of the licenses won with DE credits.

 

So What Happened With DISH?

 

DISH looked at the complicated rules governing the ownership limitations and set out to follow them exactly. DISH also took advantage of a rule that allows separate entities to bid in the auction to work together as a “bidding consortium.” Normally, bidders cannot coordinate their bidding activity. This violates the rules. But if bidders form a bidding consortium in advance, and check the box on the short form “we are a bidding consortium and will totally collude with each during the auction to maximize our mutual benefit because, duh, that is what a bidding consortium is and the rules allow it and you set the rules up so don’t complain that we are colluding – because checking this box makes our collusion totally legal.”

Oddly, as far as anyone can tell, no non-DE has ever thought of checking this box before to team up with a bunch of DEs to coordinate in this way before (although I’m told there have been other bidding consortia before among DEs). No one I talked to even remembers why the box is on there (and I have not bothered to look up the first time this appeared to see the justification). But for whatever reason, the “bidding consortium” rule is there and DISH, along with Northstar and SNR, declared they were forming a bidding consortium.

 

The DISH DEs Conformed Exactly To Precedent And Are Not Only Small Businesses, But Minority Owned Businesses.

 

And now we start to get to the ironies of this whole business and the “be careful what you wish for, it probably doesn’t scale” cliché. First, we must note that I am in total agreement with sometime frenemie Phoenix Center. Remember how Phoenix Center and I kept going back and forth on net neutrality and forbearance? This time, amusingly enough, we happen to agree with each other that DISH followed all the rules and did everything exactly right, so it makes no sense for the FCC to deny them the DE credit. You can read the Phoenix Center piece here, which has the virtue of more math and less focus on all the ironies.

 

DISH worked with a large hedge fund called BlackRock to finance two new groups (yes, groups!) of nested business corporations to bid in the auction: SNR Wireless (described here), and Northstar Wireless (described here). To make my life easier, I will not describe the layers of control and will refer to “SNR” and “Northstar.” SNR is managed (and therefore technically “owned”) by Atelum LLC, which is 100% owned by former FCC Wireless Bureau Chief John Muleta. Atelum (and therefore Muleta) also own a small percentage of “active” (i.e. voting) stock in SNR. For Northstar, the manager and owner of the “active” stock is Doyon Limited, an Alaskan Native American company.

 

Both Atelum/John Muleta and Doyon come with genuine bona fides as exactly the kind of minority owners that the DE rules (and Section 309(j)) are designed to help. Muleta, former Chief of the FCC Wireless Bureau, has more than 25 years in the wireless business working for large companies, then trying his hand as a wireless entrepreneur with the unfortunately ill-fated M2Z effort, then as a consultant and spectrum manager with his private LLC Aletum. Doyon is a large Native American holding company with experience managing utilities and numerous other businesses.

 

So what’s the problem? Between them, DISH and Blackrock own the vast majority of the company, but – because of the way the FCC’s ownership and and attribution rules work, they hold only an indirect interest in SNR and Northstar. DISH and Blackrock have first say or control over a limited set of decisions in a manner previously approved by the Commission to protect their investment – so they can, for example, require SNR and Northstar to check with them first before selling the wireless licenses to someone else. Additionally, DISH will actually build out the wireless network for both SNR and Northstar. Various other contractual provisions guarantee that any technology they adopt must be compatible with DISH, but they don’t force the DEs to lease capacity to DISH (or agree to roaming terms).

 

Every single one of these ownership structures, passive investments, protections for passive investments, and whacky ownership structures has been previously passed as legal by the Commission. The rules have affirmed each one of these arrangements as a useful tool to allow bona fide minority-owned businesses like Atelum and Doyon to get spectrum licenses. Furthermore, neither SNR or Northstar can lease more than a quarter of its spectrum capacity to DISH. So for the price of a 25% discount, DISH is taking a significant hit on its ability to directly access the spectrum (at least for 5 years, after that it could just buy out the DE interests, subject to Commission review to ensure it was not a sham transaction).

 

But no DE entity (and passive investors) has ever put all these contractual provisions together like this. And, if you read them all, together in a very impressive list, it does make you wonder how either SNR or Northstar could ever really say no to something DISH really wants, or that they would do a deal that would piss off DISH.

 

 

Stage 2, Bidding Consortium Fun.

 

 

This alone would make giving SNR and Northstar a $3.3 bn DE bidding credit controversial. But what really put it over the top was the bidding consortium. This part is so difficult to understand that almost no one in the press bothers with it, but it was actually the most effective piece in the whole business.

 

As noted above, under the rules, independent entities can form a bidding consortium as long as they declare it before the auction. This allows bidders to coordinate their bidding activity. DISH’s bidding entity (“American AWS-3 Wireless”) formed a consortium with SNR and Northstar. This allowed DISH, SNR and Northstar to coordinate their bidding activity to maximize their effectiveness.

 

In the first 20 or so rounds of the auction, DISH, SNR and Northstar used their consortium to make simultaneous bids on multiple licenses that they wanted. This improved their chances in several ways. First, when multiple parties bid the same amount for a license, resulting in a tie, the FCC uses a random number selection to choose the winner. By using 3 entities, the DISH/SNR/Northstar consortium tripled their odds of winning any specific license in the event someone else also bid the maximum bid for that license.

 

Additionally, collisions allow bidders in the auction to preserve what is called “eligibility.” This is complicated and designed to keep bidders from holding back their bids until the end. Think of it like this. Bidders pay an “up front” payment to get “eligibility points” which limit how many dollars you can bid (there is a multiple so you don’t need to deposit the entire payment for the license at once). Every round, bidders need to bid a certain amount to keep their eligibility points. If you don’t meet a “minimum activity level,” you lose eligibility points until you drop down to zero. The auction ends when two rounds pass with no activity or no one can actually make another bid.

 

If a bidder is the current high bid on a license, the activation points equal to the value of the bid is tied up in the license (the whole reason for this being so that people don’t bid billions of dollars they can’t pay, so if you are the “provisional winning bid (PWB) on a license, your eligibility is locked into the license). This also prevents players from bidding on licenses just to be active, since if you are the PWB you can’t withdraw the bid later. But if you bid for a license and lose that round, you keep your eligibility. Also, if you were the PWB but then someone bids higher, you get your eligibility back.

 

As a result, the DISH/SNR/Northstar alliance could maintain their eligibility much further into the auction than they otherwise could. They bid against each other, with the two “losers” retaining full eligibility. If you are having difficulty following this, just take it from me that this is a huge advantage.

 

How Did The AWS-3 Auction Go?

 

The mechanics of the auction as it played out showed the advantages to DISH of using this strategy. You can download round-by-round bidding from the FCC’s Auction 97 page if you are curious and can follow the math. The DISH/SNR/Northstar alliance became, in effect, a super bidder, combining the eligibility of all three entities. By the time the auction crossed the $20 bn mark, the DISH/SNR/Northstar alliance is looking in pretty good shape. AT&T and Verizon are also doing OK. T-Mo has a modest showing, and a number of other players have some licenses.

 

At this point, two things happen. First, SNR and Northstar displace American AWS-3 Wireless (the bidding entity directly controlled by DISH and which does not claim DE status). That means that all the licenses held by the DISH/SNR/Northstar consortium are now held either by SNR or Northstar, giving DE credit to every license to which DISH has an indirect ownership interest. Or, in other words, this maximizes DISH’s disount.

 

The other thing that happens, however, is that Verizon and AT&T go back and buy more eligibility (this is allowed, and several other bidders did this as well as the auction values skyrocketed well above expectation). VZ and AT&T then begin pouring money into the auction until they drive the DISH DEs off most of the good licenses. At this point, nearly everyone else gets crushed. T-Mo ends up paying $1.7 bn for almost nothing. Verizon pays $10 bn and AT&T pays $18 bn, concentrating in the paired spectrum. SNR and Northstar bid a total of $13 bn, which translates to a payment of $10 bn after discount. They also do reasonably well for themselves, but not as well as VZ and AT&T (well, AT&T did bid a heck of a lot more). SNR and Northstar end up with a lot of “supplemental uplink” spectrum. Never mind what that is, just suffice it to say it is not as good as paired spectrum and is therefore cheaper.

 

Best . . . Auction . . . EVAR?

 

Which brings us back to the evaluation of the AWS-3 auction. Like everyone else, I guessed utterly wrong on how much the auction would gross. I had estimated that $15 bn total bids seemed likely. The range of estimates ran from a conservative $10 bn used by OMB and the FCC for planning purposes to some estimates in the $25 bn. But most folks expected a $15-20 bn revenue.

 

Instead, the auction brought in gross bids of slightly less than $45 bn. Even giving SNR and Northstar a $3 bn discount, the auction comfortably brought in $40 bn in cash (assuming DISH doesn’t end up defaulting on the $3 bn). So by any estimate, the AWS-3 Auction was the most financially successful auction ever.

 

Which brings us to Irony #1. As demonstrated by auction expert Peter Crampton (in this filing for T-Mo on spectrum reserve stuff), the DISH/SNR/Northstar bidding consortium contributed directly to getting the auction about $20-25 bn over the original estimate. Even if we don’t buy DISH CEO Charlie Ergen’s statement that we ought to attribute the full $20 bn+ over the initial estimates to DISH and the DEs, it’s hard to classify this as a tax payer rip off. If we assume DISH was prepared to bid $10 bn (the net after subtracting the DE discount) rather than $13 bn, that $3 bn extra in bidding credit probably contributed to AT&T and Verizon paying an additional $5 bn or so in bids to outbid SNR and Northstar.

 

But even if this merely ripped off AT&T and Verizon, rather than the American taxpayer, was that fair? Well, it depends on if we believe in demand pricing and auction theory. In theory, AT&T and Verizon paid what they considered the value of the licenses they won. Whether or not you believe AT&T and Verizon paid a foreclosure value premium to win licenses from SNR and Northstar or whether they paid what a rational actor in their position would pay based on the net present value (NPV) of the licenses, AT&T and VZ paid what they thought the license was worth. True, AT&T and VZ would have gotten the same licenses cheaper if DISH hadn’t played under the assumption it would get a DE credit. But I am constantly told by economists that letting consumer get access to stuff like unlicensed spectrum or unlimited data is a “subsidy,” and therefore creating artificial scarcity to make consumers pay more is “more efficient” because then consumers are actually paying the “real value” rather than getting a “subsidy” by getting the spectrum access or unlimited data that they obviously value for free.

 

So how do we call this a rip off for tax payers when it resulted in getting overall closer to the “true” value of the spectrum?

 

 

Most . . . Competitive . . . Auction . . . EVAR?

 

 

As I’ve noted in the past, it has grown increasingly harder for new entrants generally to win valuable spectrum licenses. Over time, AT&T and Verizon accumulate significant enough advantages (and the value of foreclosure increases) so as to rationally justify AT&T and Verizon bidding ever more ridiculous amounts to capture whatever remaining spectrum comes to market.

 

On the one hand, as I noted when news of the AWS-3 auction results first broke, the AWS-3 auction seems to confirm that. AT&T and Verizon appeared capable during the auction of raising endless amounts of money from capital markets to keep bidding on licenses until they drove SNR and Northstar off most of the paired spectrum and into the unpaired supplementary uplink licenses.

 

Even so, the AWS-3 Auction turned out to be the most substantial auction for competitors to AT&T and Verizon in years. Which brings us to yet another delightful irony. Everyone, Democrat and Republican alike, claims they absolutely worship competition and want to see a vibrant and competitive wireless auction. Except when it actually happened, in full compliance with the FCC’s rules, everyone got pissed about it.

 

 

Most . . . Diverse . . . Auction . . . EVAR?

 

 

In addition to the most major wins by competing providers (or potentially competing providers), the AWS-3 auction was, technically, the biggest win for minority owned firms ever. Because, as explained above, both SNR and Northstar are technically minority owned firms, award of the licenses to SNR and Northstar marks the first time ever that minority-owned firms have won $13 bn in wireless licenses.

 

Of course, the fact that I repeated the word “technically” throughout the above paragraph illustrates why NAACP is so absolutely pissed off about this. But now we get to the next irony. Every single “loophole” DISH “exploited” has been vigorously defended over time as essential to promote minority ownership. And it worked exactly as intended. Or, as Phoenix Center put it: “It appears that DISH did not abuse the rules, but embraced them.”

 

Which just makes this so much more frustrating for those who care about diversity and want a DE program that actually works to create it. From the perspective of NAACP, the system scaled up and worked perfectly to deliver a huge number of licenses to two companies controlled by an old white guy. That goes so totally beyond “rain on your wedding day” levels of irony into full “Hasa Diga Eebowai” levels.

 

On the other hand, the National Association of Black Broadcasters (NABOB) filed reply comments in defense of granting SNR and Northstar the DE credits and lauding the outcome here as an important milestone in minority ownership. It would be easy to cast this, therefore, as a battle of the idealists v. the pragmatists, with NAACP arguing that DISH makes a mockery of the idea of DE credit while NABOB argues ‘hey, as the guys who actually have licenses and have to bid in auctions, we know the real score here. We need companies like DISH to get in the game in the first place.’ But it is far more accurate to say that, as always, difficult policy questions make for tough choices. No one should be surprised at a difference of opinion among organizations both run by African Americans and both devoted to nurturing economic opportunities for people of color in the wireless industry.

 

Ultimately, of course, the difference between a genuine minority owned firm that satisfies the diversity goals of Section 309(j) and a “sham” is whether the Des actually are independent, or if DISH exercises control. But that brings us to the next irony.

 

We only know for sure if the Des are shams if we let them have the licenses and see what happens. But once the FCC issues the licenses, it becomes much harder to for the FCC to do anything about it. That’s one of the reasons it took so long to clean up the mess in the mid-00s. Which is why the FCC makes such a big deal about its pre-screening process to make sure that it doesn’t give out DE credits to sham DEs.

 

So Why Doesn’t the FCC pre-Screen for DE credits Before The Auction That Stuff Like This Doesn’t Even Happen In The First Place?

 

Well, if it is any consolation, that’s what the FCC has resolved to do next time given its most recent rule changes for the DE credits.

 

Traditionally, however, the FCC waits until after the bidding to determine if the entity qualifies for DE credit because:

(a) Making the decision in advance of the auction might delay the auction if you have a hard case like this that is controversial and takes time to resolve.

(b) Most DE applications are pretty straightforward, and manually processing and reviewing every DE application would be incredibly time and resource intensive. This leads us to-

(c) The FCC hopes the problem will go away on its own because if a problematic DE doesn’t win any licenses, you don’t need to waste time doing the analysis.

 

All of which are perfectly logic reasons that totally make sense, until something like this happens.

 

All of this gives you the background to understand Part 2, which I will get up after I read the FCC Order Denying SNR and Northstar their DE credits.

 

Update: As Julia Tanner pointed out to me, the Order gives SNR and Northstar a way to buy itself more time to get the money by securing a Letter of Credit within 30 days.

Stay tuned . . .

Click here for DISH DE Debacle Part 2: How did the FCC decide?

 

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

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