Those Darn Designated Entity Rules
Liz Sachs - Partner, Lucas Nace Gutierrez & Sachs and Regulatory Counsel, EWA
Those darn Designated Entity rules! The FCC keeps scratching at them, but just can’t seem to make the itch go away.
It now seems like a hundred years ago when the FCC first introduced the auction concept. In an effort to appease those who feared it would cause all spectrum to end up in the hands of the big guys, the Commission made lots of noise about providing special auction opportunities for small and underrepresented businesses. That didn’t last long, since the Supreme Court promptly shot down set asides for these same classes of entities in construction contracts and set a very high bar for their use in other contexts. The Commission gulped, went back to the drawing board, and came out with three concepts to promote auction participation by other than the “haves” – bidding credits, installment payments and “DE set-asides.”
The first were intended to give small businesses a leg up in the auction itself. The FCC defines what constitutes a “small” or “very small” business in each auction based on revenues over the past three years and gives qualifying entities credits against what they bid in the auction. The baseline dollar amounts for determining who is small and very small can change depending on the auction (and the FCC’s perception of how big you need to be to build out the system you “win”), as may the credit percentage given to those who do qualify. But the result is the same: small and very small businesses can bid the same amount as their biggest competitors, but actually pay up to 35% less for the spectrum.
The second – installment payments – were another way of encouraging applicants without deep pockets to participate in auctions. Like any other installment payment program, it permitted successful bidders to pay off their “loans” to the Federal Treasury over time, using the licenses themselves as collateral. This repayment process even provided for interest payments only during the first few years after the license was issued, on the theory that available funds should be devoted to system build-out so that revenues could be generated more quickly.
Installment payments were sabotaged by a number of factors, the most notorious of which was NextWave. Part of the problem, of course, was that the FCC was never set up to act as a lending institution and really didn’t have the expertise to manage such a process. Depending upon the source, the FCC either told the Treasury Department to butt out since the FCC was qualified to handle the program, or the Treasury Department told the FCC to buzz off when asked for assistance. However it happened, the FCC was left as both banker and regulator of spectrum that in those dizzying years of the late 1990s was valued at billions of dollars.
Like most economic fiascos, all went fine as long as the value of the asset continued to increase. But when the market fell – indeed crashed – leaving companies such as NextWave with big spectrum mortgages and no financiers or buyers, the installment payment concept itself met an untimely death. The FCC spent seven years in various courts trying to wrest the public’s spectrum back from NextWave only to be rebuffed by, first, the bankruptcy court wherein NextWave had sought protection and, ultimately, the Supreme Court which declared that bankruptcy rights trump FCC regulations, at least under the facts of that particular case. The Commission ultimately declared a truce with NextWave and accommodations were reached. But the FCC had by then washed its hands of the installment payment program, even though it was the single, most valuable tool for leveling the auction playing field.
The third concept, DE set-asides, was another hapless victim of the NextWave debacle, although unlike installment payments, the wound was not fatal. NextWave had acquired its spectrum from a pool that was “set-aside” for applicants that ostensibly were small businesses in which ownership and management often was in the hands of minorities and women. Of course, surely even the FCC was not surprised that telecommunications companies too well-financed to qualify as DEs, plus the usual telecom financing sources, twisted themselves into pretzels coming up with arrangements that satisfied the FCC’s elaborate rules governing DE eligibility but kept the usual suspects in the game. If the FCC was “shocked, shocked” to find out that gambling was going on in that backroom, it was the only part of the wireless industry that didn’t know about those relationships. The NextWave imbroglio exposed some of the arrangements, but even then the FCC has been reluctant to abandon the DE approach entirely, since doing so effectively would abandon the field to only deep pocket, established players.
So the Commission continues to tinker with the DE-related rules in an effort to find the right balance of new blood and old money. The latest effort to fine-tune these provisions triggered a firestorm of objections that was substantial even by FCC standards.
The FCC has been looking forward to auctioning what typically is referred to as the AWS, advanced wireless spectrum, in the 1.7 GHz band for some time. It is viewed as having the potential for bringing broadband wireless access to the hinterlands, an objective near and dear to this administration’s heart. While none of this spectrum is set-aside for DE bidders only, the bidding credits for which DEs would qualify made that categorization valuable.
That prompted some small entities to urge the FCC to deny bidding credits based on certain “material relationships” parties might have with entities that themselves would not qualify for the credits. But the parties that originally promoted the effort may have gotten more than they bargained for. At what some would describe as the 11th hour before the auction was to begin, the FCC adopted sweeping changes in these rules prohibiting not just the types of arrangements the instigating DEs believed to be objectionable, but also arrangements on which they had expected to rely for auction financing.
The new rules triggered opposition from another group as well. In addition to extending significantly the period of time during which a license would need to be held by the original DE or another entity that qualified for that same status to avoid repaying some portion of the bidding credit, the FCC – inexplicably – made that rule change retroactive. Entities that had held licenses for several years already and that had entered into agreements to assign licenses based on the then current repayment provisions suddenly found themselves facing additional repayments of as much as tens of millions of dollars.
The industry was up in arms, the money people began to back peddle furiously, and the auction was postponed while the FCC retrenched.
The FCC has now revisited its new DE rules and, interestingly, has retained them for the most part. In almost withering terms, it explained that the repayment horizons of the financing community were of limited interest to the FCC and that it expected its licensees to either find sources that were in for the longer haul or skip the auction. However, it did make one important “clarification.” It explained that its previous language didn’t really mean what it said and that the changes to the bidding credit repayment rules were not actually retroactive, but would be applied only to licenses issued after April 2006. That takes one group out of the fray: the group with the strongest legal argument for derailing this FCC initiative.
But does it mean that the landscape on this matter is settled? With a third Republican joining the Commission, giving them again a 3-2 majority, it wouldn’t be wise to conclude that any issue as politically sensitive as DEs will be off the table for long.
Stay tuned for the next installment.
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