Third Circuit sends 2006 DE rules back to FCC for further consideration; $14B auction results from 2006 left untouched

Back in 2006, with big-ticket wireless auctions fast approaching, the FCC hustled through revisions of a number of rules affecting bidding credits in those auctions. The bad news for the FCC: the U.S. Court of Appeals for the Third Circuit has now sent two of the three rule changes back to the agency for a re-do because of procedural shortcomings in the 2006 rulemaking process. The good news for the FCC: the Court decided that the Commission will not have to re-do the auctions conducted pursuant to those flawed rules and, perhaps more importantly, will not have to give back the $14 billion or so it raked in in the August, 2006 auctions.

The bidding rules at issue involve eligibility for “Designated Entity”, or “DE”, status. Bidders entitled to that status are smaller companies that might otherwise find it hard, if not impossible, to compete with larger, well-established telecom companies in a dollar-for-dollar face-off. Committed to encouraging new entrants into the telecom universe, Congress instructed the Commission (in 47 U.S.C. §307(j)) to ensure opportunities for small businesses by, among other things, making bidding credits available to them. A bidding credit is defined by the FCC as a “percentage discount applied to the high bid amount for a license.” Practical illustration: if a bidder with a 25% bidding credit wins an auction with a bid of, say, $1 million, that bidder would have to pay only $750,000 after the credit is applied.

Credits of 15%, 25% or 35% were available (depending on various factors). With wireless prices hovering in the nine- and ten-figure range (T-Mobile alone bid a total of more than $4 billion-with-a-“b” – in the 2006 auction; four other bidders also tendered aggregate bids topping the $1 billion level), the credits were obviously worth serious money. With an eye toward ensuring that bidding credits were awarded only to companies deserving them, the Commission tried, in the run-up to the August, 2006 auctions, to tighten up the eligibility standards. 

That’s where it ran into problems.

Since DE status is supposed to be reserved for the Little Guy (relatively speaking), the Commission wanted to prevent Big Guys from using corporate sleight of hand to try to garner undeserved DE status. [We say “relatively speaking” because we’re not really talking about mom-and-pop operations here: the smallest companies entitled to the largest bidding credit are those with no more than $3 million in average revenues over the three years preceding the auction. Even companies with annual gross revenues of up to $40 million are entitled to the low-end DE 15% credit.] The Commission uses various attribution mechanisms to discourage such folderol. Several such mechanisms, adopted in 2006, were the target of the recent Third Circuit appeal.

The targeted provisions (which appear in Sections 1.2110 and 1.2111 of the FCC’s rules) included:

The 25% Attribution Rule, which provides that a bidder’s DE status depends not only on its own revenues, but also on those of any other single entity which happens to lease or resell 25% or more of the bidder’s spectrum capacity.

The 50% Impermissible Relationship Rule, which renders licensees ineligible for DE status if they lease or resell (including at wholesale) more than 50% of their spectrum capacity. So, for example, if a concededly “small” (by any measure) bidder elected to lease 5.1% of its capacity to each of 10 other concededly “small” entities, the bidder would be absolutely barred from DE status.

The 10-Year Repayment Schedule, which kicks in if a successful bidder, having used DE-based bidding credits, happens to lose its DE eligibility at some point after the auction. As the name implies, this provision calls for repayment of the bidding credit amount if DE eligibility is lost. The 2006 amendment of the rules extended the time, from five to 10 years, during which loss of eligibility would trigger repayment. (Full repayment of credits is required if eligibility is lost in the first five years after the auction; the percentage required to be re-paid then decreases over the next five years.) Importantly, the new time frame would apply to DE eligibility arising not only from the newly-adopted rules, but also from previously-established DE standards.

These new rules imposed significantly greater limits on DE wannabes. Accordingly, a number of DE-related entities – an investor in DEs, a small wireless carrier owned by Alaskan natives, a trade group representing minority-owned telecom companies – asked the Third Circuit to take a look at the FCC’s proceedings that resulted in the adoption of the rules.

The Court concluded that the 25% Attribution Rule was OK. According to the Court, the new rule was properly within the scope of the FCC’s rulemaking proceeding (that is, anyone interested in that proceeding could have reasonably guessed that the FCC might adopt the 25% Attribution Rule, or at least something like it). Even though the rule does have a damping effect on the ability of DEs to secure financing, and even though the Commission barely even alluded to the likely adverse effects of the rule on DEs, and even though the Court felt the lack of any supporting findings made this a “close question”, the Court ultimately deferred to the agency and let this one slide.

Not so with respect to the other two rules. 

As the Third Circuit read the record, the FCC hadn’t bothered even to suggest, much less formally propose, the gist of what became the 50% Impermissible Relationship Rule. For decades, however, the Administrative Procedure Act has provided that, before an agency can impose new rules, it must afford reasonable notice and an opportunity to comment on them. Since the Commission hadn’t done so here, the 50% Impermissible Relationship Rule was toast. 

Because the Court tossed that rule on procedural grounds, the Court didn’t have to address the rule’s substantive shortcomings in that rule which had been called to the Court’s attention by the petitioners. But the Court did take the opportunity, in a footnote, to “commend . . . to the Commission’s attention on remand” a number of questions about the rationale supposedly underlying the rule.

With respect to the 10-Year Repayment Schedule, the Court reached a similar conclusion. While the Commission had indicated in its initial proposals that a new repayment schedule might apply to any new eligibility criteria it might adopt, the Commission never let on that that new schedule could also apply to existing criteria. That lack of notice was fatal here. Accordingly, the Court sent the new schedule back to the Commission for further consideration. Again, though, the Court inserted a footnote in which it raised serious questions about the validity of the FCC’s analysis of this issue and, again, “commended” the issue to the FCC’s attention on remand.

The real drama in this case was not in the Court’s analysis of the arguments above. Rather, it was in the practical issue that confronted the Court once that analysis had been completed. Back in 2006, having rushed through the new DE eligibility rules, the Commission conducted the wireless auction pursuant to those rules. But now that, in 2010, two of those rules have been vacated by the Third Circuit, what should be done about the 2006 auction. That auction was, after all, conducted pursuant to rules which have now been declared invalid. Doesn’t that mean that the auction should be rescinded?

That’s what the petitioners urged. They stopped short of urging rescission of all other intervening auctions which have been conducted subject to the DE rules adopted in 2006. . . BUT the petitioners did note that, logically, those other auctions would be equally subject to rescission.

Not surprisingly, the FCC – joined by at least some of the winners in the 2006 auction – “vigorously” opposed touching the results of the auction. And in an apparent triumph for the tried-and-true 21st Century precept of “Too Big To Fail”, the Court sided with the Commission.

In the Court’s view, rescinding the auction

would involve unwinding transactions worth more than $30 billion, upsetting what are likely billions of dollars of additional investments made in reliance on the results, and seriously disrupting existing or planned wireless service for untold numbers of customers. Moreover, the possibility of such large-scale disruption in wireless communications would have broad negative implications for the public interest in general.

So the auction results will not be upset, but the FCC is still left with the chore of revisiting its DE provisions. The Commission hasn’t announced how it plans to proceed with that chore, but in the meantime, the 50% Impermissible Relationship Test and the 10-Year Repayment Schedule have been vacated, and the previous version of Section 1.2111(d)(2) of the rules – i.e., the section which contains the repayment schedule provision – is to be reinstated until further notice.