Alien ownership conditions imposed on Internet radio service when it tries to buy small-town radio station

This is the story of how Pandora, in an effort to cut its copyright royalty costs, managed to saddle itself with a complex array of ownership reporting requirements designed by the FCC to keep Box Elder, South Dakota safe from aliens. It’s a true story.

Pandora, of course, is the prominent Internet music streaming operator. Since its business consists of transmitting recorded music digitally, it’s on the hook for a lot of copyright royalties payable, through ASCAP, BMI and SESAC, to the composers of the music it transmits. The precise rates it pays are generally subject to direct negotiation between Pandora and the performance rights organizations (PROs).

In contrast to Pandora and other streaming services that are limited exclusively to Internet distribution, radio broadcasters do not have to negotiate individually with respect to royalties. Rather, broadcasters’ rates are set industry-wide through negotiations between, on the one hand, the Radio Music License Committee (RMLC) acting on behalf of broadcasters and, on the other, the various PROs. (The federal courts are also involved in the process to a degree.) Those negotiations have been good for traditional over-the-air broadcasters, who as a result pay lower royalties for their own digital transmissions than do Pandora and other Internet-only services. And those lower rates apply even if the broadcaster’s stream(s) carry content other than what the broadcaster is sending over-the-air.

Pandora has been involved in acrimonious negotiations, and even litigation, with ASCAP regarding its royalty rates. But then it had an idea: why not take advantage of the attractive over-the-air broadcaster rates by simply becoming a broadcaster?

And so it was that Pandora came to Box Elder (pop. 7,800), where the only local radio station in town was for sale.

After cutting a deal to buy the station, Pandora filed an application for approval of the acquisition. In that application it was upfront about its motivations for purchasing the station, i.e., it was looking, among other things, to lower its copyright royalty burden. Not surprisingly, the application drew opposition from ASCAP. 

In its Petition to Deny, ASCAP argued that Pandora’s proposed acquisition was essentially a sham to attempt to obtain better royalty rates. Perhaps recognizing that this argument by itself was unlikely to persuade the FCC, ASCAP also challenged Pandora’s compliance with the Commission’s ownership rules. Specifically, ASCAP alleged that Pandora had failed to properly disclose all of its ownership; more importantly, it alleged that Pandora had failed to show that it complies with the FCC’s limits on foreign ownership in broadcast licensees.

The Communications Act limits direct foreign investment in broadcast licensees to 20% and indirect ownership by foreign entities to 25%. While these limits are frequently waived for non-broadcast licensees, they have long been essentially hard and fast rules for broadcast licensees. Although the Commission has in recent years indicated a willingness to loosen the limits for broadcasters on a case-by-case basis, that willingness has not yet evolved into any actual loosening.  

The alien ownership charge posed considerable problems for Pandora – not necessarily because it was in violation, but because it couldn’t prove that it wasn’t in violation. That’s because it’s a publicly traded company whose stock is widely held by companies or individuals, some foreign, some not. For a number of reasons it was impossible for Pandora to determine with confidence the nationalities of all of its shareholders.

Nevertheless, it tried. Initially, Pandora submitted a NASDAQ survey of a sampling of its stockholders’ mailing addresses, which showed foreign ownership of around 16%. It argued that its Board of Directors was composed entirely of U.S. citizens, and that eight of ten of its executive officers were also U.S. citizens, greatly reducing the possibility of foreign influence or control over broadcast operations. That wasn’t enough for the FCC, primarily because mailing addresses aren’t necessarily a reliable indicator of nationality.

Pandora then tried a second approach based on an analysis of SEC filings by its shareholders. That study showed that around 18% of its voting interests might be held by foreign individuals or entities. The FCC still wasn’t satisfied because this alternate approach measured only voting interests, rather than equity interests. The Communications Act limits foreign ownership of both types of interests. 

Finally, Pandora gave up. It acknowledged that it couldn’t prove the level of its foreign ownership to the FCC’s satisfaction, in part because of SEC regulations designed to protect shareholders. Those regs prevent Pandora from requiring its shareholders to disclose their citizenship. (While the organizational documents of most publicly-traded broadcast companies include provisions requiring shareholders to waive this SEC protection, Pandora’s did not – because it had never been a broadcaster and thus hadn’t had to worry about this sort of thing.)

Still confident that its foreign ownership was well under the limit but unable to demonstrate compliance with the FCC’s rules, Pandora asked the FCC for a declaratory ruling. Specially, it asked the Commission to confirm either that: (a) foreign investors could hold up to an aggregate 49.99% voting interest and 100 percent equity interest in Pandora’s parent company without additional FCC approval; or (b) in processing Pandora’s application, the FCC would use the policy it routinely applies in the common carrier context. That latter option would permit 100% foreign equity and voting interests without prior Commission approval, subject to certain conditions.

After cogitating on all this for the better part of a year, the Commission finally agreed to cut Pandora some slack. In so doing, it blew past ASCAP’s arguments about how Pandora is just trying to get better copyright royalty rates. As far as the FCC is concerned, Pandora’s motivation has nothing to do with the foreign ownership rules, which were, after all, the sole focus of Pandora’s declaratory ruling request. And anyway, the Commission said, if ASCAP thinks that Pandora’s acquisition of a station will undermine the existing copyright licensing regime, ASCAP should take that up with some other agency, or maybe Congress, or maybe the courts – but not the FCC.

As far as Pandora’s alien ownership is concerned, the Commission concluded that the information submitted by Pandora had “not raise[d] immediate concerns regarding foreign influence or control”. That was the good news for Pandora.

The bad news was that, in order to make sure that aliens don’t sneak in and take over Pandora, the FCC imposed a long list of rigorous requirements on it. As a result, if Pandora wants to become a broadcast licensee, it will have to:

obtain prior Commission approval before any foreign citizen or entity obtains a greater than 5% equity or voting interest (10% for certain institutional investors). Prior approval will also be required before (a) Pandora’s aggregate foreign ownership (equity or voting) can exceed 49.99%, or (b) foreign citizens comprise a majority of the Board of Directors.  

amend its certificate of incorporation, bylaws or other corporate documents to ensure that it can determine its levels of foreign ownership and otherwise comply with the other terms of the Declaratory Ruling. Those amendments must provide Pandora not only the right to require disclosure of its shareholders’ citizenship, but also the right to “take any and all actions that the Board of Directors deems necessary to so comply or cure any noncompliance”, including (but not limited to) the right to compel the redemption of shares held by aliens.

monitor its foreign ownership percentages and, with every biennial ownership report, certify to its continued compliance with the conditions set out in the Declaratory Ruling. The Commission provides six suggested monitoring methods.

submit to the Commission, within 90 days, a list of steps it has taken, or plans to take, to ensure compliance with all of these condition. That submission must also include a detailed description of the methods Pandora plans to use to determine its foreign ownership percentages. If the Commission approves that submission, the terms described by Pandora in that submission will themselves become part of the conditions of the Declaratory Ruling.  

So Pandora has its work cut out for it. And get this: Pandora’s application still hasn’t been granted. In fact, processing of the application won’t even pick up again until Pandora has satisfied the various conditions described above. So while Pandora’s petition for a declaratory ruling may technically have been granted, Pandora still has a ways to go before it can become a broadcast licensee. 

And all of this effort is intended to prevent Box Elder’s only radio station from falling under the control of aliens. Really?

As Commissioners Pai and O’Rielly observed in separate concurring statements, this decision highlights flaws in the Commission’s treatment of foreign investment in broadcast licenses. Had Pandora been trying to acquire a license in some other regulated service – including, say, wireless licenses giving it access to the bazillions of smartphones in everyone’s hands – its foreign ownership levels could have been approved presumptively, without the need for exhaustive, and in Pandora’s case unavailable, documentation. The FCC’s insistence on such documentation here is especially bizarre in view of the fact that (as Pai points out) the available evidence indicates that Pandora already meets the existing alien ownership limits.

And let’s not forget that, whatever Pandora’s foreign ownership might be, Pandora already provides its Internet service to more than 79,000,000 Americans (according to Commissioner Pai). So if Pandora’s foreign interests do indeed have some insidious and malevolent plan afoot, it’s possible that Box Elder is the only place where Pandora could not, right now, this instant, implement its nefarious little plan.

So the extensive hoops that Pandora will have to jump through just to get its application processed seem a bit silly. But at least the FCC didn’t simply slam the door on Pandora. The Commission’s willingness, however heavy-handed and begrudging, to leave the door slightly ajar does suggest a continued openness to the relaxation of its approach to broadcast alien ownership, relaxation that the Commission promised a couple of years ago.

In the meantime, we can only hope that, if Pandora does eventually acquire its Box Elder station, the resulting savings in copyright royalties will make it all worthwhile.