Adam Thierer's Blog, page 151

Obama Admin's "Let's-Be-Europe" Approach to Privacy Will Undermine U.S. Competitiveness

Reading through the respective December 2010 privacy reports from the Federal Trade Commission (FTC) and Department of Commerce (DoC), one cannot help but be struck by the Obama Administration's seeming desire to make America's tech sector — and the regulatory regime that governs it — more closely resemble Europe's.  The push for an ambitious new "privacy framework" and set of "fair information practices" is just a riff borrowed from the EU data directive.  And although the Obama team stops short of calling privacy a "dignity right" as many European policymakers are prone to do, it's clear from both the FTC and DoC reports that that's were they want to take us.

It's interesting to me, though, that the Obama Administration relies on two fundamentally flawed rationales for the "European-ification" of American privacy law.  In this regard, I'll reference some passages from the DoC's report that appear in the section on "The Economic Imperative" for a new regime, which appears on pages 13-16 of the report.

Myth #1: Privacy Regs Are Needed to Get More People Online or Using Digital Technology

First, the DoC pulls out the old saw about the need for expanded privacy regs to ensure greater online trust and, as a result, promote increased online interactions.  The report claims that "maintaining consumer trust is vital to the success of the digital economy" and that "an erosion of trust will inhibit the adoption of new technologies" (p. 15)  The problem with the theory that online commerce or consumer interactions online are somehow being thwarted by a lack of more privacy regulation is that it is plainly contradicted by the facts. 

Interestingly, you need do nothing more that scan back just a couple of paragraphs in the DoC report to find some of those facts! For example, on pg. 14, the report notes: "The Internet is also increasingly important to the personal and working lives of individual Americans.  Ninety-six percent of working Americans use the Internet as part of their daily life, while sixty-two percent of working Americans use the Internet as an integral part of their jobs."  Does the DoC not see the contradiction here, or is the Obama Administration claiming that we cannot rest until we move the needle from 96% to 100%?!

Then we have the DoC's claim that "an erosion of trust will inhibit the adoption of new technologies."  Really?  What, then, are we to make of the 500 million people who have flocked to Facebook despite repeated claims by some that it is a privacy pariah? And there are plenty of other examples of the explosion of online activity over the past decade.  The fact is, online participation and technology adoption is growing like wildfire. If you need more evidence, go through the data sets from the Pew Internet & American Life Project about Internet usage over time and try to find one metric that is decreasing.  [Just as an unrelated aside, I am still sometimes astonished by how many people use eBay despite continuing concerns about online fraud, which is a far more serious and legitimate "harm" than most supposed privacy violations.  Yet, eBay is now the world's largest online marketplace with more than 90 million active users globally and $60 billion in transactions annually, or $2,000 every second.]

In sum, advocates of increased privacy regulation have fed the DoC a catchy line about the need for more privacy regulation in the name of encouraging greater online participation and the DoC has bought into that theory despite a lack of evidence that there is any real problem here.

Myth #2: Privacy Regs Are Needed to Promote the Competitiveness of U.S. High-Tech Firms

Second, we hear of the DoC speak of the need for "interoperability" or harmonization of privacy policies internationally to facilitate smoother online commercial interactions or data flows.  Despite the report's admission that "a considerable amount of global commerce takes place on the Internet [and] global online transactions currently total an estimated $10 trillion annually" and is growing, the DoC continues on to argue that:

the lack of cross-border interoperability in privacy principles and regulations creates barriers to cross-border data flow and significant compliance costs for companies. Improving the global interoperability of data privacy approaches could enable increased exports of U.S. services and… support the overall objective of creating jobs by promoting exports. Thus, commercial data privacy considerations are vital not only to our domestic commerce, but also to international trade.

In other words, says the DoC, things are pretty good right now, but they will get a lot better once we harmonize privacy regulations in the direction of the E.U. and other regions.  But here's the problem with that theory: The DoC is assuming that the benefits of regulatory harmonization — which, to be perfectly clear, would arrive in the form increased regulation on U.S. operators – would outweigh the cost of complying with those new rules.

The DoC says it wants to "prevent conflicting policy regimes from serving as a trade barrier" (p. 20), but should the U.S. impose burdensome new regulations on American companies to achieve that goal?  Would we really be better off if all U.S. firms and policy more closely resembled the E.U. in this regard?   To answer that question, you might conduct the simple experiment of stopping the average person in the street — here in the U.S. or even abroad — and asking them to name five major U.S. digital economy companies and then see if they can even name one major European competitor in the same arena. Needless to say, it's hard to find many European counterparts that rival Google, Amazon, Apple, Facebook, eBay, Microsoft, etc.   Now, why is that?  Why is it that the information technology sector has thrived in America and that U.S. companies are leaders in many of their respective sectors across the globe?  Might it be precisely because we did not follow others down the path of "data directives" and heavy handed, top-down regulation of the Internet more generally?

Do you want some empirical evidence for why it's a bad idea to achieve parity or harmonization in the fashion the DoC suggests?  Well then, consider this recent study by Avi Goldfarb and Catherine Tucker which found that "after the [European Union's] Privacy Directive was passed [in 2002], advertising effectiveness decreased on average by around 65 percent in Europe relative to the rest of the world."  They argue that because regulation decreases ad effectiveness, "this may change the number and types of businesses sustained by the advertising-supporting Internet." Regulation of advertising and data collection for privacy purposes, it seems, can affect the global competitiveness of online firms.

The other problem with the DoC's appeal for harmonization of privacy regulatory regimes through increased regulation is that it sets a horrible precedent.   At least thus far this has not been the approach the U.S. government has taken in most other Internet policy contexts, and with good reason.  Think about this in the context of speech controls.  When we see the Europeans or other regions and countries stifling free speech and expression online, has our response been to say, "Well, in the name of policy harmonization and improving cross-border interoperability, we Americans need to accept the wisdom of censoring the Net."  Of course not!  That would be insane.  Instead, when confronted with conflicting regulatory regimes abroad, our response here in the States has usually been to proudly boast to the world that we have the more sensible approach to Net regulation, which is to say, it should be tightly limited so as not to stifle speech or commerce.  I really don't care if you want to call that "American exceptionalism" or whatever else; I just think it's plain old common sense.

And yet, in the case of privacy regulation, the Obama Administration's Department of Commerce wants to throw that notion to the wind and harmonize in the direction of more regulation of U.S. companies.  Isn't the Commerce Department supposed to be in the business of helping to promote U.S. trade, exports, commerce, and global competitiveness?  If so, the right approach to "leveling the playing field" in this context should be the same as it is in relation to speech policy or trade law: the rest of the world should deregulate down to our level; we should absolutely not regulate up to theirs.

"Fake Neutrality" or Government Takeover?: Reading the FCC's Net Neutrality Report (Part III)

In Part I of this analysis of the FCC's Report and Order on "Preserving the Open Internet," I reviewed the Commission's justification for regulating broadband providers.   In Part II, I looked at the likely costs of the order, in particular the hidden costs of enforcement.  In this part, I compare the text of the final rules with earlier versions.  Next, I'll look at some of the exceptions and caveats to the rules—and what they say about the true purpose of the regulations

In the end, the FCC voted to approve three new rules that apply to broadband Internet providers.  One (§8.3) requires broadband access providers to disclose their network management practices to consumers.  The second One (§8.4) prohibits blocking of content, applications, services, and non-harmful devices.  The third One (§8.5) forbids fixed broadband providers (cable and telephone, e.g.) from "unreasonable" discrimination in transmitting lawful network traffic to a consumer.

There has of course been a great deal of commentary and criticism of the final rules, much of it reaching fevered pitch before the text was even made public.  At one extreme, advocates for stronger rules have rejected the new rules as meaningless, as "fake net neutrality," "not neutrality," or the latest evidence that the FCC has been captured by the industries it regulates.  On the other end, critics decry the new rules as a government takeover of the Internet, censorship, and a dangerous and unnecessary interference with a healthy digital economy.  (I agree with that last one.)

One thing that has not been seriously discussed, however, is just how little the final text differs from the rules originally proposed by the FCC in October, 2009.  Indeed, many of those critical of the weakness of the final rules seem to forget their enthusiasm for the initial draft, which in key respects has not changed at all in the intervening year of comments, conferences, hearings, and litigation.

The differences—significant and trivial—that have been made can largely be traced to comments the FCC received on the original draft, as well as interim proposals made by industry and Congress, particularly the framework offered by Verizon and Google in August and a bill circulated by Rep. Henry Waxman just before the mid-term elections.

1.      Transparency

Compare, for example, the final text of the transparency rule with the version first proposed by the FCC.

Subject to reasonable network management, a provider of broadband Internet access service must disclose such information as is reasonably required for users and content, application and service providers to enjoy the protections specified in this part. (Proposed)

A person engaged in the provision of broadband Internet access service shall publicly disclose accurate information regarding the network management practices, performance and commercial terms of its broadband Internet access service sufficient for consumers to make informed choices regarding use of such services and for content, application, service and device providers to develop, market and maintain Internet offerings. (Final)

The final rule is much stronger, and makes clearer what it is that must be disclosed.  It is also not subject to the limits of reasonable network management,  Rather than the vague requirement of the draft for disclosures sufficient to "enjoy the protections" of the open Internet rules, the final rule requires disclosures sufficient for consumers to make "informed choices" about the services they pay for, a standard more easily enforced.

By comparison, the final rule comes close to the version that appeared in draft legislation circulated but never introduced by Rep. Henry Waxman in October of 2010. It likewise reflects the key concepts in the Verizon-Google Legislative Framework Proposal from earlier in the year.

As the Report makes clear (¶¶ 53-61), the transparency rule has teeth.  Though the agency declines for now from making specific decisions about the contents of the disclosure and how is must be posted, the Report lays out a non-exhaustive list of nine major categories of disclosure, including network practices, performance characteristics, and commercial terms, that must be included.  It's hard to imagine a complying disclosure that will not run to several pages of very small text.

That generosity, of course, may be the rule's undoing.  As anyone who has ever thrown away a required disclosure from a service provider (mortgage, bank, drug, electronic device, financial statement, privacy, etc.) knows full well, information "sufficient" to make an informed choice is far more information than any non-expert consumer could possibly absorb and evaluate, even if they wanted to.   The more information consumers are given, the less likely they'll pay attention to any of it, including what may be important.

The FCC recognizes that risk, however, but believes it has an answer.  "A key purpose of the transparency rule," the Commission notes (¶ 60), "is to enable third-party experts such as independent engineers and consumer watchdogs to monitor and evaluate network management practices, in order to surface concerns regarding potential open Internet violations."

Perhaps the agency has in mind here organizations like BITAG, which has been established by a wide coalition of participants in the Internet ecosystem to develop "consensus on broadband network management practices or other related technical issues."  Or by consumer watchdogs, perhaps the agency imagines that some of the public interest groups who have most strenuously rallied for the rules will become responsible stewards of their implementation, trading the acid pens of political rhetoric for responsible analysis and advocacy to their members and other consumers.

We'll see.  I wish I shared the Commissions confidence that, "for a number of reasons" (none cited), "the costs of the disclosure rule we adopt today are outweighed by the benefits of empowering end users and edge providers to make informed choices…."  (¶ 59).  But I don't. Onward.

2.       Blocking

The final version of the blocking rule (§8.5) consolidated the Content, Applications and Services and Devices rule of the original draft.  The final rule states:

A person engaged in the provision of fixed broadband Internet access services, insofar as such person is so engaged, shall not block lawful content, applications, services or non-harmful devices, subject to reasonable network management.

A more limited rule applies to mobile broadband providers, who

[S]hall not block consumers from accessing lawful websites, subject to reasonable network management, nor shall such person block applications that compete with the providers' voice or video telephony services, subject to reasonable network management

Much of the anguish over the final rules that has been published so far relates to a few of the limitations built into the blocking rule.  First, copyright-reform activists object to the word "lawful" appearing in the rule.  "Lawful" content, applications, and services do not include activities that constitute copyright and trademark infringement.  Therefore, the rule allows broadband providers to use whatever mechanisms they want (or may be required to) to reduce or eliminate traffic that involves illegal fire-sharing, spam, viruses and other malware, and the like.

A provider who blocks access to a site selling unlicensed products, in other words, is not violating the rules.  And as the agency finds it is "generally preferable to neither require not encourage broadband providers to examine Internet traffic in order to discern which traffic is subject to the rules" (¶ 48), there will be considerable margin of error given to providers who block sites, services, or applications which may include some legal components.

On this view, though the FCC otherwise contradicts it—see footnote 245 and elsewhere—a complete ban on the BitTorrent protocol, for better or worse, might not be a violation of the blocking rule.  Academic studies have shown that over 99% of BitTorrent traffic constitutes unlicensed file sharing of protected content.  Other than inspecting individual torrents, which the agency disfavors, how else can an access provider determine what tiny minority of BitTorrent traffic is in fact lawful?

A second concern is the repeated caveat for "reasonable network management," which gives access providers leeway to balance traffic during peak times, limit users whose activity may be harming other users, and other "legitimate network management" purposes.

Finally, disappointed advocates object to the special treatment for mobile broadband, which may, for example, block applications, services or devices without violating the rule.  There is an exception to the exception for applications, such as VoIP and web video, that compete with the provider's own offerings, but that special treatment doesn't keep mobile providers from using "app stores" to exclude services they don't approve.  (See ¶ 102)

Of course even the original draft of the rules included the limitation for "reasonable network management," and refused to apply any of the rules to unlawful activities.  The definition of "reasonable network management" in the original draft is different, but functionally equivalent, to the final version.

The carve-out for mobile broadband, however, is indeed a departure from the original rules.  Though the Oct. 2009 Notice of Proposed Rulemaking expressed concern about applying the same rule to fixed and mobile broadband (see  13, 154-174), the draft blocking rule did not distinguish between fixed and mobile Internet access.  The FCC did note, however, that different technologies "may require differences in how, to what extent, and when the principles apply."  The agency sought comment on these differences (and asked for further comment in a later Notice of Inquiry).  Needless to say, they heard plenty.

Wireless broadband is, of course, a newer technology, and one still very much in development.  Spectrum is limited, and capacity cannot easily be added.  Those are not so much market failures as they are regulatory failures.  The FCC is itself responsible for managing the limited radio spectrum, and has struggled by its own admission to allocate spectrum for its most efficient and productive uses—indeed, even to develop a complete inventory of who has which frequencies of licensed spectrum today.

Adding additional capacity is another regulatory obstacle.  Though mobile users rail against their providers for inadequate or unreliable coverage, no one, it seems, wants to have cellular towers and other equipment near where they live.  Local regulators, who must approve new infrastructure investments, take such concerns very much to heart.  (There is also rampant corruption and waste in the application, franchising, and oversight processes at the state and local levels, a not-very-secret secret.)

The FCC, it seems, has taken these concerns into account in the final rule.  Its original open Internet policy statements—from which the rules derive—applied only to fixed broadband access, and the October, 2009 draft's inclusion of mobile broadband came as a surprise to many.

The first indication that the agency was considering a return to the original open Internet policy came with the Verizon-Google proposal, where the former net neutrality adversaries jointly released a legislative framework (that is, something they hoped Congress, not the FCC, would take seriously) that gave different treatment to mobile.  As the V-G proposal noted, "Because of the unique technical and operational characteristics of wireless networks, and the competitive and still-developing nature of wireless broadband services, only the transparency principle would apply to wireless at this time."

The Waxman proposal didn't go as far as V-G, however, adding a provision that closely tracks with the final rule.  Under the Waxman bill, mobile providers would have been prohibited from blocking "lawful Internet websites", and applications "that compete with the providers' voice or video communications services."

So the trajectory of the specialized treatment for mobile broadband is at least clear and, for those following the drama, entirely predictable.  Yet the strongest objections to the final rule and the loudest cries of betrayal from neutrality advocates came from the decision to burden mobile providers less than their fixed counterparts.  (Many providers offer both, of course, so will be subject to different rules for different parts of their service.)

At the very least, the advocates should have seen it coming.  Many did.  A number of "advocacy" groups demonized Google for its cooperation with Verizon, and refused to support Waxman's bill.  (It should also be noted that none of the groups objecting to the final rules or any interim version ever actually proposed their own version—that is, what they actually wanted as opposed to what they didn't want.)

3.      Unreasonable discrimination

The final rule, applicable only to fixed broadband providers, demands that a provider not "unreasonably discriminate in transmitting lawful network traffic over a consumer's broadband Internet access service."  (§ 8.7, and see ¶¶ 68-79 of the Report).

Though subtle, the difference in language between the NPRM and the final rule are significant, as the FCC acknowledges.  The NPRM draft rule noted plainly that "a provider of broadband Internet access service must treat lawful content, applications, and services in a nondiscriminatory manner."

The difference here is between "nondiscrimination," which prohibits all forms of differential network treatment, and "unreasonable discrimination," which allows discrimination so long as it is reasonable.

The migration from a strict nondiscrimination rule (subject, however, to reasonable network management) to a rule against "unreasonable" discrimination can be seen in the interim documents.  The Verizon-Google proposal, which called for a "Non-Discrimination Requirement," nonetheless worded the requirement to ban only "undue discrimination against lawful Internet content, application, or service in a manner that causes meaningful harm to competition or to users." (emphasis added)

Rep. Waxman's draft bill, likewise, would have applied a somewhat different standard for wireline providers, who "shall not unjustly or unreasonably discriminate in transmitting lawful traffic over a consumer's wireline broadband Internet access service," also subject to reasonable network management.

Over time, the FCC recognized the error of its original draft and now agrees "with the diverse group of commenters who argue that any nondiscrimination rule should prohibit only unreasonable discrimination." (¶ 77)

As between the suggested limiting terms "undue," "unjust" and "unreasonable," the FCC chose the latter for the final rule.  Though many have complained that "unreasonable" is a nebulous, subjective term, it should be noted that of the three it is the only one with understood (if not entirely clear) legal meaning, particularly in the context of the FCC's long history of rulemaking and adjudication.

The earliest railroad regulations, for example, which also provided the beginning of the FCC's eventual creation and authority over communications industries, required reasonable rates of carriage, and empowered the Interstate Commerce Commission to intervene and eventually set the rates itself, much as the FCC later did with telephony.

One lesson of the railroad and telephone histories, however, is the danger of turning over to regulators decisions about what behaviors are reasonable. (Briefly, regulatory capture often ends up leaving the industry unable to respond to new forms of competition from disruptive technologies, with disastrous consequences.)

The V-G proposal gets to the heart of the problem in the text I italicized.  Despite the negative connotations of the word in common use, "discrimination" isn't inherently bad. As the Report makes clear, in managing Internet access and network traffic, there are many forms of discrimination—which means, after all, affording different treatment to different things—that are entirely beneficial to overall network behavior and to the consumer's experience with the Internet.

The draft rule, as the FCC now admits (see ¶ 77 of the Report), was dangerously rigid.  If any behavior should be regulated, it is the kind of discrimination whose principal purpose is to harm competition or users—though that kind of behavior is already illegal under various antitrust laws.

For one thing, users may want some kinds of traffic – e.g., voice and video – to receive a higher priority over text and graphics, which do not suffer from latency problems.  Companies operating Virtual Private Networks for their employees may likewise want to limit Web access to selected sites and activities for workers while on the job.

A strict nondiscrimination rule would have also discouraged or perhaps banned tiered pricing, harming consumers who do not need the fastest speeds and the highest volume of downloads to accomplish what the want to online.  (Without tiered pricing, such consumers effectively subsidize power users who, not surprisingly, are the most vociferous objectors to tiered pricing.)

Discrimination may also be necessary to manage congestion during peak usage periods or when failing nodes put pressure on the backbone.  Discrimination against spam, viruses and other malware, much of which is not "lawful," is also permitted and indeed encouraged.  (See ¶ 90-92.)

By comparison, the Report notes three (¶ 75) types of provider discrimination that are of particular concern.  These are:  discrimination that harms competitors (e.g., VoIP providers of over-the-top telephone service, such as Skype or Vonage, that competes with the provider's own telephone service), "inhibiting" end users from accessing content, services, and applications of their choice (but see the no-blocking rule, above, which already covers this), and discrimination that "impairs free expression," including slowing or blocking access to a blog whose message the broadband provider does not approve.

On that last point, however, it's important to note that Congress has already given broadband providers (and others) broad freedom to filter and otherwise curate content they do not approve of or which they believe their customers don't want to see.  Under Section 230 of the Communications Decency Act,

"No provider or user of an interactive computer service shall be held liable on account of . . . any action voluntarily taken in good faith to restrict access to or availability of material that the provider or user considers to be obscene, lewd, lascivious, filthy, excessively violent, harassing, or otherwise objectionable, whether or not such material is constitutionally protected."

The goal of Section 230 was to immunize early Internet providers including CompuServe and Prodigy from efforts to exercise editorial control over message boards whose content was provided by customers themselves.  But it gives providers broad discretion in determining what kind of content it believes its customers don't want to see.  So long as the filtering is undertaken in "good faith" (e.g., not with the intent of harming a competitor), there is no liability for the provider, who does not, for example, become a "publisher" for purposes of defamation law.

The FCC (¶ 89) acknowledges the limit that Section 230 puts on the discrimination rule.

On the harm to competitors prong, the FCC waffles (see ¶ 76) on whether "pay for priority"—the bugaboo that launched the neutrality offensive in the first place, actually constitutes a violation of the rules.  While a broadband provider's offering to prioritize the traffic of a particular source for a premium fee "would raise significant cause for concern," the agency acknowledges that such behavior has occurred and thrived for years in the form of third party Content Delivery Networks.  (See footnote 236)  CDNs are allowed.   (More on CDNs in the next post.)

So in the end the discrimination rule doesn't appear to add much to the blocking rule or existing antitrust laws.  Discrimination against competing over-the-top providers would violate antitrust.  Blocking or slowing access to disfavored content is already subject to the blocking rule.  And interfering with "free expression" rights of users is already significantly allowed by Section 230.

What's left?   "The rule rests on the general proposition," the agency concludes (¶ 78), "that broadband providers should not pick winners and losers on the Internet," even when doing so is independent of competitive interests.  What exactly this means—and how "reasonable" discrimination will be judged in the course of enforcing the rules—remains to be seen.

Next:  The exceptions and what they say about the real purpose of the rules

More on Facebook's "Private IPO," Securities Regs & Unintended Consequences

In my essay yesterday, "How Federal Accounting & Securities Regs Screw Up Your Chance to Invest in Facebook," I noted how America's counter-productive accounting, disclosure, and governance regulations are increasingly thwarting the ability of average Americans to invest in some of the leading capitalist innovators of the Digital Age. In this case it's Facebook, but there are plenty of other innovative companies out there sticking with private shareholders so as not to trigger burdensome securities and accounting regs.  In my essay, I also noted how this represented another prime example of well-intentioned regulation having profoundly unintended, anti-consumer, anti-competitive consequences.  America's convoluted and onerous securities regulations are choking off capital infusions into innovative companies and denying average investors a chance to own a share a piece of the American dream.

So, what does the Securities and Exchange Commission (SEC) plan to do about this fine mess?  Regulate more, of course!  As The Wall Street Journal reports today:

The Securities and Exchange Commission has begun examining whether disclosure rules for privately held firms need to be rewritten as a result of recent deals allowing investors to buy shares in Internet companies such as Facebook Inc. and Twitter Inc., according to people familiar with the situation.  The review is at an early stage, these people cautioned, and SEC officials looking at the recent deals haven't concluded that any of them run afoul of the 47-year-old rules governing private companies. The rules require firms with 500 or more shareholders of record in a given type of stock to publicly disclose certain financial information. The requirement is designed to protect investors from risking money on companies that say little about their operations and performance.

Yes, but that requirement can also trigger an onslaught of new regulatory burdens, as the Journal story continues on to note:

While SEC officials could decide the rules need to be updated in order to provide adequate protection for investors, the agency is trying to balance that with the demands of private companies that want to raise capital. As part of the investigation, SEC officials plan to scrutinize special-purpose vehicles like the one being created by Goldman and Facebook to determine if they are being designed primarily to circumvent the so-called 500-shareholder rule, according to people familiar with the matter.

Well of course Facebook is sticking under the 500-shareholder threshold to avoid triggering an avalanche of new regulation!  Wouldn't you?  This isn't shady business as some naively suggest, this is smart business.  Facebook wants to be able to continue to invest, innovate, and grow.  Going public in the current regulatory environment, however, might undermine those goals because of the new regulatory burdens that would accompany expanding the pool of shareholders.

America needs to get smart about its overly burdensome securities laws before more damage is done.  As Marc Morgenstern, a securities lawyer in San Francisco and the managing partner of Blue Mesa Partners, a venture capital firm told DealBook: "Companies forming today, like Facebook, are growing so quickly, and their stocks are being distributed so broadly, that they may not fit neatly within securities laws enacted decades ago."  That's exactly right. Even the 500-shareholder threshold is a relic of the 1960s.  But the newer regulatory burdens are the real killers. As Anupreeta Das and Amir Efrati explained in yesterday's Wall Street Journal:

The [Facebook private offering] is the latest example of how Silicon Valley's newest generation of Web companies is taking capital to stay private for longer. While as recently as a decade ago it was a status symbol in Silicon Valley to go public quickly, Facebook, Twitter Inc., Groupon Inc. and others are among the new crop of firms that have recently raised big money in private financing rounds that provides them a cash cushion to continue remaining private.

Across Silicon Valley, "the incentive for going public has lowered and the penalty for going public has increased," said Ben Horowitz, a partner at venture-capital firm Andreessen Horowitz, which in November bought Facebook shares from venture-firm Accel Partners in a private transaction. "Compared to the 1990s when everybody went public as soon as possible at much lower revenues," the regulatory environment and the rise of hedge funds has made it "dangerous" for start-ups go to public without a large cushion of cash, said Mr. Horowitz. "In general, we recommend that our companies be very careful about going public."

Why should tech companies tread cautiously in this regard?  Why must they, as Mr. Horowitz suggests, "be careful about going public?"  Well, for starters, read this excerpt from a 2006 submission to the SEC by the Silicon Valley Leadership Group regarding the burdens imposed just by the Sarbanes-Oxley Act of 2002 (SOX):

SOX compliance brings with it a heavy burden that strains resources that could otherwise be used for critical research and development or other corporate initiatives to improve company management, expand into new markets and increase investor value.  Initially, the SEC suggested that the average company would have to spend $91,000 dollars annually.   However, in a recent survey of National Association of Manufacturers members about 50% of respondents reported spending more than $5 million in 2004 to comply.   More recently, a Financial Executives International (FEI) survey of 274 public companies indicated a 16.3 % reduction in SOX related costs in 2005 from the year previously, but that the total average cost for compliance was $3.8 million.

And there's plenty more red tape to contend with when companies go public.  Again, this hurts not merely the companies but also those average investors who'd like a chance to buy in to hold a small share of the American Dream. As Albert Wenger of Union Square Ventures correctly notes in his essay, "The Private IPO":

These deals should really be a wake-up call to politicians and regulators.  They are a great example of how well-intentioned regulations can backfire.  The net result of the Wall Street research settlement, SARBOX and other protections for small investors has been: small investors now have no access to the most interesting investment opportunities.  Instead, these companies are going to be more or less fully developed by the time they eventually come to the public markets, with most of the upside having been captured by private investors.  That's especially annoying when it seems that with the Internet we should be seeing IPO 2.0 — direct to small investors without the historic flip opportunity for well connected investors.

How incredibly sad. And how incredibly frightening for the future of American competitiveness.

Let's be clear, cleaning up this mess doesn't mean the SEC would be devoid of any role in policing capital markets for fraud.  A certain amount of transparency is essential for good corporate governance.  But the path we are now is instead wrapping companies and capital markets in layers of red tape that suffocate investment and innovation.  Moreover, as today's news from the SEC proves, regulatory intervention in these cases simply begets more and more intervention to correct the inevitable failures of, or dissatisfaction with, previous interventions.

In that regard, I'm reminded of what Austrian economist Ludwig von Mises had to say about government intervention in his 1949 classic, Human Action:

All varieties of interference with the market phenomena not only fail to achieve the ends aimed at by their authors and supporters, but bring about a state of affairs which — from the point of view of their authors' and advocates' valuations — is less desirable than the previous state affairs which they were designed to alter. If one wants to correct their manifest unsuitableness and preposterousness by supplementing the first acts of intervention with more and more of such acts, one must go farther and farther until the market economy has been entirely destroyed and socialism has been substituted for it."  at 858 (3rd ed. 1963) (1949).

No, I do not believe we are headed into a socialist hell-hole any time soon.  Nonetheless, the SEC appears poised to dig us into an even deeper ditch before thinking about an escape plan to get us out of this mess.

Inching Closer to a Consistent First Amendment for the Information Age

Back in 2007 I penned a law review article, "Why Regulate Broadcasting: Toward a Consistent First Amendment Standard for the Information Age" in which I argued that "If America is to have a consistent First Amendment in the Information Age, efforts to extend the broadcast regulatory regime must be halted and that regime must be relegated to the ash heap of history." I made that argument based not only upon the fundamental bankruptcy of the rationales supporting the old broadcast regulatory regime, or its unfairness to broadcasters relative to other media competitors, but also because such asymmetrical regulations no longer make sense — and are increasingly impractical to enforce — in an age of technological convergence and media abundance.

The good news is that, slowly but surely, the courts are coming around to this logic, at least as it pertains to speech controls.  We saw that again today with a ruling by the Second Circuit Court of Appeals that held as unconstitutional $1.2 million in fines that the Federal Communications Commission (FCC) levied on ABC broadcast affiliates seven years ago for airing a brief glimpse of Charlotte Ross' bare buttocks on the cop drama "NYPD Blue."   As the Wall Street Journal's Amy Schatz notes, "Broadcasters have now won a series of court victories against government efforts to police airwaves and fine stations for airing risqué content. The Supreme Court could soon get a chance to review the issue. In the meantime, the FCC's campaign to enforce indecency rules has ground to a halt."

It remains to be seen whether the Supreme Court will throw the whole regime out, but I can't help but think that's where we are headed. The only real argument left for retaining the old regulatory regime it is that broadcast television should be treated as one massive safe harbor, where people could find squeaky-clean content 24/7.  The current regime is a partial safe harbor for the hours of the day when children are supposedly present in the viewing audience (6am – 10pm).  Some have argued that safe harbor should be retained or even expanded such that parents have a place that they know will supposedly always be "safe" for their kids.  But the problem with that notion is that (1) parents already have plenty of other things to let their kids see or hear if they are nervous about what might be on broadcast TV, and (2) we can't stop viewers or listeners from flocking away from more heavily regulated broadcast platforms, as they have already been doing for years.  In a sense, therefore, technological advances make this regime less relevant with each passing day and eventually may make it moot altogether even if it's not tossed out by the Supreme Court for being so hopelessly vague.

As a matter of principle, however, this old regime needs to go because it was never justifiable to begin with.  The courts should have never allowed a technology-specific carve-out to the First Amendment to take root in the law. Again, we need to get back to a consistent First Amendment that protects all speech and media platforms equally.

P.S. I'm forced to agree with Joe Flint's quip in the L.A. Times that "There is nothing indecent about actress Charlotte Ross' rear end."  Frankly, I've never understood why her bare butt earned the wrath of the FCC.  Now, on the other hand, when we had to see Dennis Franz's flabby rear-end in that one painful shower scene in season 2, well, that was just plain wrong.  Blatantly obscene. The FCC should have commandeered DoD drones and taken out all the ABC broadcast towers in America that night.  (Kidding!)

How Federal Accounting & Securities Regs Screw Up Your Chance to Invest in Facebook

As Henry Blodget explained in his excellent Business Insider column yesterday, "Goldman Sachs Clients Can Invest In Facebook's IPO — But You Can't," America's increasingly counter-productive accounting, disclosure, and governance regulations are increasingly thwarting the ability of average Americans to invest in the leading capitalist companies of the Digital Age:

in an effort to protect investors from fraud (which is actually not the reason most IPOs fail), the government erected huge new barriers to going public, making it prohibitively expensive for most small companies to IPO.  So now small, speculative companies generally don't IPO.  Instead, they stay private. And/or they do what Facebook just did, which was do a "private IPO" with Goldman Sachs. What's a private IPO?  It's a mechanism in which Goldman's rich clients can invest in Facebook. But you can't.  Seriously!

And that's why Facebook, among others, don't want to go public. Over at the Truth on the Market Blog, Larry Ribstein elaborates on the insanity of this:

the increased costs of being public have helped exclude ordinary people from the ability to own the stars of the future.  Back in the 1980s, you could just call your broker and get rich off of the Microsoft IPO.  Now you have to be a wealthy Goldman client to do it.  Of course you also got to get poor off of a company that turned out to be a dog.  Now both options are reserved for wealthy people in the name of increasingly onerous disclosure regulation and federal governance requirements such as board structure, proxy access, and whistleblowing rules.

Each of these rules was thought to have some benefit at the time they were enacted.  Nobody really considered how private markets would react (e.g., by establishing alternatives to public markets) or the long-run effects of substituting quasi-private for public markets.  So rules designed to make the markets safe for ordinary investors have ended by excluding them.

Maybe it's time to start considering whether we got what we wanted.

Amen, brother. This is another classic example of well-intentioned regulation having profoundly unintended, anti-consumer, anti-competitive consequences.  People are being denied the ability to own a piece of the American dream and the competitiveness of some of America's leading businesses is being adversely impacted at the same time.  What a shame.

Book Review: The Net Delusion by Evgeny Morozov

In his new book, The Net Delusion: The Dark Side of Internet Freedom, Evgeny Morozov aims to prick the bubble of hyper-optimism that surrounds debates about the Internet's role in advancing human freedom or civic causes.  Morozov, a native of Belarus, is a tremendously gifted young cyber-policy scholar affiliated with Stanford University and the New America Foundation.  He's an expert on the interaction of digital technology and democracy and writes frequently on that topic for a variety of respected media outlets.

In Net Delusion, as with many of his previous columns and essays, Morozov positions himself the ultimate Net "realist," aiming to bring a dose of realpolitik to discussions about how much of a difference the Net and digital technologies make to advancing democracy and freedom.  His depressing answer: Not much.  Indeed, Morozov's book is one big wet blanket on the theory that "technologies of freedom" can help liberate humanity from the yoke of repressive government.

Morozov clearly relishes his skunk at the garden party role, missing few opportunities to belittle those who subscribe to such theories.  If you're one of those who tinted your Twitter avatar green as an expression of solidarity with Iranian "Green Movement" dissidents, Morozov's view is that, at best, you're wasting your time and, at worst, you're aiding and abetting tyrants by engaging in a form of "slacktivism" that has little hope of advancing real regime change.  The portrait he paints of technology and democracy is a dismal one in which cyber-utopian ideals of information as liberator are not just rejected but inverted.  He regards such "cyber-utopian" dreams as counter-productive, even dangerous, to the advance of democracy and human freedom.

Against Cyber-Utopianism

In the opening pages of The Net Delusion, Morozov explains it is his mission is to beat back "cyber-utopianism," at least as it relates to international affairs and diplomacy.  He defines cyber-utopianism as "a naïve belief in the emancipatory nature of online communication that rests on a stubborn refusal to acknowledge its downside." He blames "the starry-eyed digital fervor of the 1990s" and the "former hippies… [now] ensconced in some of the more prestigious universities in the world" for giving rise to the notion that "the Internet could deliver what the 1960's couldn't" in terms of building a better, more peaceful world. (p. xiii)  He also aims to counter what he has elsewhere referred to as "the public's penchant for fetishizing the engineer as the ultimate savior."

Much of the scorn he heaps on the cyber-utopians is well-deserved, although I think there are far fewer of them around than Morozov imagines. Nonetheless, there certainly is a bit too much Pollyanna-ish hyper-optimism at play in debates about the Net's role in advancing liberation of those peoples who are being subjected to tyrannical rule across the planet.

But Morozov simply doesn't know when to quit. His relentless and highly repetitive critique goes overboard when it veers into all-too familiar territory already plowed by other Internet pessimists and cultural critics beginning back in the 1980s with the late social critic Neil Postman.  Indeed, what Postman's Amusing Ourselves to Death (1985) and Technopoly (1992) were to early discussions about information technology and culture, Morozov's Net Delusion is to modern debates about the Net and political change.

Like Postman, Morozov wants us to believe that increased access to entertainment and communications technologies breeds societal indifference, and that increased consumerism breeds civic lethargy.  Morozov paints a portrait of world affairs in which the Internet inevitably pushes us into something akin to Idiocracy; it's a world in which all these digital gadgets, communications devices, and entertainment options turn us all into unthinking, anti-intellectual, apolitical pawns who can be easily manipulated by the State.  "Where new media and the Internet truly excel is in suppressing boredom.  Previously, boredom was one of the few truly effective ways to politicize the population denied release values for channeling their discontent, but this is no longer the case." (p. 80)  He continues on: "Those of us rooting for the further spread of democracy around the globe must stop dreaming and face reality: The Internet has provided so many cheap and easily available entertainment fixes to those living under authoritarianism that is has become considerably harder to get people to care about politics at all." (p. 81)

Morozov thinks that the "ridiculously easy group-forming" that his leading nemesis Clay Shirky described in his recent book Cognitive Surplus is, in reality, leading largely to cognitive crap, at least as it pertains to civic action and political activism.  Indeed, at one point in Chapter 7 (the creatively-titled, "Why Kierkegaard Hates Slacktivism"), Morozov speaks of the development of what we might think of as a "tragedy of the civic commons" (my term, not his).  He argues that:

When everyone in the group performs the same mundane tasks, it's impossible to evaluate individual contributions, and people inevitably begin slacking off… Increasing the number of participants diminishes the relative social pressure on each and often results in inferior outputs. (p 193)

It's an interesting theory, as far as it goes, but Morozov doesn't muster much more than a handful of anecdotes in support of it.  He notes, for example, that even back in the Berlin Wall era, young East German students were more likely to know intimate facts about popular American dramas like Dallas and Dynasty than current political affairs.  And, echoing the recent laments of Andrew Keen (Cult of the Amateur) and Lee Siegel (Against the Machine), Morozov worries about the "narcissism" and "attention seeking" of social networking denizens. "There's nothing wrong with the self-promotion per se, but it seems quite unlikely that such narcissistic campaigners would be able to develop true feelings of empathy or be prepared to make sacrifices that political life, especially political life in authoritarian states, requires." (p 187)

But this ignores many legitimate forms of social organization / protesting that have been facilitated by the Net and digital technologies.  Despite what Morozov suggests, we haven't all become lethargic, asocial, apolitical cave-dwelling Baywatch­ rerun-watching junkies.  If all Netizens are just hooked on a cyber-sedative that saps their civic virtue, what are we to make of the millions of progressives who so successfully used the Net and digital technologies to organize and elect President Obama? (Believe me, I wish they wouldn't have been so civic-minded and rushed to the polls in record numbers to elect that guy!)

Similarly, Morozov belittles some of the online communities that have formed to support various charitable or civic causes by arguing that if you divide the number of members of such online groups by the aggregate amount of money they raise, it comes out to mere pennies on the dollar per community member. But so what?  Do we know if those communities or causes would have come together at all or spent more money without digital communications and networking technologies?  It is certainly true that merely setting up a new cyber-cause and giving a few bucks to it isn't the same as going on a mission to Africa to build homes and water systems, but does Morozov really want to us to believe that more of that sort of thing would happen in the absence of the Net and digital technology?  Were African relief charities better off in the days when Sally Struthers lectured us on late-night TV about giving more to such causes?  I find that very hard to believe.

Regardless, here's where we can all agree: Technology is just one of many tools that can be harnessed to keep the power of the State in check or advance important civic / charitable causes.  I am entirely sympathetic to Morozov's argument that other factors and forces play an even more important role in promoting democracy and, in particular, ending tyranny. (Personally, I think we'd do more to assist repressed dissidents by sneaking them copies of Guns and Ammo or Soldier of Fortune instead of Wired, but I digress.)  "The calculus of measuring quality of life demands a few more steps than simply adding all the efficiencies and subtracting all the inefficiencies," he says, "it also requires a good understanding of what particular values are important in a particular context of human relations." (p. 198) Who could disagree with such a statement?

Yet, in his zeal to counter those who have placed too great an emphasis on the role of information technology, Morozov himself has gone too far in the opposite extreme in The Net Delusion by suggesting that technology's role in transforming States or politics is either mostly irrelevant or even, at times, counter-productive.  I'm just not buying it.  I think you'll find a more nuanced and balanced set of conclusions in this new white paper, "Political Change in the Digital Age: The Fragility and Promise of Online Organizing," by Bruce Etling, Robert Faris and John Palfrey.  In it, they conclude:

The Internet has an important role in increasing information sharing, access to alternative platforms, and allowing new voices to join political debates.  The Internet will continue to serve these functions, even with state pushback, as activists devise ways around state online restrictions.  Conditions that contribute to success are likely determined not by the given technological tool, but by human skill and facility in using the networks that are being mobilized.  …  It is less clear how far online organizing and digital communities will be allowed to push states toward drastic political change and greater democratization, especially in states where offline restrictions to civic and political organization are severe.  As scholars, we ought to focus our attention on the people involved and their competencies in using digitally-mediated tools to organize themselves and their fellow citizens, whether as flash mobs or through sustained social movements or organizations, rather than the flow of information as such.

In other words, we should view information as one of many means to the end and not the end in and of itself.  But we also shouldn't discount its importance too lightly.

But What's the Ultimate Goal Here?

There's a more profound problem with Morozov's thesis. If he is correct that the Net poses such risks, or undermines the cause of democracy-promotion, isn't the logical recommendation that flows from it technology control or entertainment repression?  If, as Morozov implies, Netizens are spending too much time viewing Lolcats and not enough in the streets protesting or running down to the Peace Corps to sign up for a tour of duty, then what would he have us do about it?  Shall we restrict access to the growing abundance of technological / entertainment choices that he laments?

Amazingly, he never really clarifies his views on this important point. Like so many other cultural critics before him, Morozov finds it easy to use caustic wit to tear apart inflated arguments and egos on the other side while also conveniently ignoring the logical consequences of their critiques or bothering to set forth a constructive alternative.

About the closest he comes is to detailing his views is Chapter 9, which focuses on the danger of the Net and modern digital technology being used to spread extremist views.  Even though he refuses to get more specific about potential responses, what, exactly, are we to conclude when we hear Morozov speak of the need for "measures to mitigate the negative side effects of increased interconnectedness." (p. 261) And what are we to make of his claim that "More and cheaper tools in the wrong hands can result in less, not more, democracy." (p. 264)  Or, his argument that:

The danger is that the colorful banner of Internet freedom may further conceal the fact that the Internet is much more than a megaphone for democratic speech, that is other uses can be extremely antidemocratic in nature, and the without addressing those uses the very project of democracy promotion might be in great danger."(p. 265-6)

Or, finally, his conclusion in that chapter that:

If the sad experience of the 1990s has taught us anything, it's that successful (democratic) transitions require a strong state and a relatively orderly public life. The Internet, so far, has posed something of a threat to both. (p. 274)

Reading those passages — especially the words I've highlighted — it's hard not to conclude that Morozov would like to put the information genie back in the bottle.  To be clear, he never says that directly since he simply refuses to be nailed down on specifics.  But, again, his tone seems to suggest that some form of technological control or information repression may be necessary.  I hope that in coming essays Evgeny will be willing to clarify his views on this issue since The Net Delusion leaves us scratching our heads and wondering just how far he would go to counter the supposed "danger" or "threat" posed by digital technology.

On the Voluntary Surrender of Privacy via Social Sharing Technologies

Morozov is on somewhat stronger footing in highlighting the paradoxical danger of voluntary information exposure in an age of ubiquitous digital connectivity and communications. "While it is tempting to encourage everyone to flock to social networking sites and blogs to avoid the control of the censors, it would play into the hands of those in charge of surveillance and propaganda. The more connection between activists it can identify, the better for government," he notes. (p. 83) "[I]n too many contexts," he argues, "it empowers the strong and disempowers the weak." (p. xvii)  In another creatively-titled chapter, "Why the KGB Wants You to Join Facebook," he goes so far as to argue that "membership in a [social] network is a double-edged sword: Its usefulness can easily backfire if some segment gets compromised and their relationships with other members become common knowledge.  Before the advent of social media, it took a lot of effort for repressive governments to learn about the people dissidents are associated with," but "today, they simply need to get on Facebook," Morozov argues. (p. 156)

This is a fair point, and one that is much harder to know how to deal with.  But let's say it is true that social networking tools and other digital technologies which allow greater online personalization and socialization also potentially facilitate increased government surveillance by the State.  What are we to do about that?  Again, we're right back at the specter of information / technology repression and, once again, Morozov largely dodges that discussion. (Instead of direct regulation, I would think the better answer would be to educate users about sensible use of those sites or technologies and then work to empower them with more tools to better manage their privacy and/or evade surveillance).

Moreover, Morozov once again overplays his hand here.  He spends so much time arguing that digital technologies have made our lives more transparent to the State that he underplays the myriad ways it has simultaneously made government activities more visible than at any point in history.  It is extraordinarily difficult for even the most repressive of States today to completely bottle up all its secrets and actions.  Morozov says modern China, Putin's Russia and Hugo Chavez are embracing new digital technologies in an attempt to better control them or learn how to use them to better spy on their citizens, and he implies that this is just another way they will dupe the citizenry and seduce them into a slumber so they will avert their eyes and ears to the truth of the repression that surrounds them.  Sorry, but once again, I'm not buying it.  Repressive regimes really do face a tension when they embrace modern information and communications technologies. It does force them to make certain trade-offs as they look to modernize their economies.  Morozov thinks this so-called "dictator's dilemma" hypothesis is largely bunk, but he seems to expect this process to unfold overnight once new technology moves in.  In reality, these things take more time. The general progression of things in most states is toward somewhat greater transparency and openness, even if it does not magically spawn regime change overnight.

Importantly, he never really offers a credible cost-benefit analysis of the life of citizens in those regimes today relative to the past. Are we seriously supposed to believe that information-deprived Chinese peasants of the Mao era were somehow better positioned to influence positive regime change than the more empowered modern Chinese citizen?  It's a tough sell.  Are their downsides associated with those new technologies (especially the potential for citizen surveillance)?  Yes, of course.  But let's not use that as an excuse for marching backwards, technologically-speaking.

On America's "Contradictions," and Morozov's

Chapter 8 of the book focuses on what Morozov describes as the "Cultural Contradictions of Internet Freedom." He again scores some points for rightly pointing to the hypocrisy at play in the United States today — by both government and corporations — when it comes to the promotion of Net freedom globally.  He correctly notes that "while American diplomats are preaching the virtues of a free and open Internet abroad, an Internet unburdened by police, court orders, and censorship, their counterparts in domestic law enforcement, security, and military agencies are preaching — and some are already pursing — policies informed by a completely different assessment of those virtues."  (p. 218)  Similarly, Morozov castigates many of America's leading high-tech companies — Facebook, Google, Microsoft, Apple, Twitter, etc. – for preaching the values of Net freedom but then all too willingly handed over information about dissidents to repressive State actors, or playing ball with foreign thugs in other ways.

Morozov is right; American leaders in both government and business need to better align their actions with their rhetoric when it comes to the interaction of government and technology.  Too often, both groups are guilty of talking a big game about the Internet and freedom, only to later take steps to undermine that cause.  As Morozov asks in a recent New York Post column, "Shouldn't America's fight for Internet freedom start at home for it to be taken seriously by the rest of the world?"  Yes, it should.

Morozov's critique of these "cultural contradictions" continues on, however, and it leads him to a surprising conclusion that is contradictory in its own right.  He says that the real problem here is that we're all being seduced by those silly libertarian types with their crazy ideas about keeping the Net largely unfettered.  He says, for example:

The way forward is to acknowledge that the public pressure to regulate the Web is growing and that not all of the ensuing regulation should be resisted because the Internet is the favorite sacred cow of most libertarians.  The only way to get it right is to avoid holding on to some abstract truths – e.g., that the internet is a revolutionary force that should be spared any regulation whatsoever — but rather to invest one's energy into seeking broad public agreement on what acceptable, transparent, and just democratic procedures by which such regulation is to occur should look like. (p. 218)

Thus, on one hand, Morozov laments the fact that U.S. politicians and corporations are far too willing to cave to political pressure, which results in the undermining of online freedoms.  On the other, he says that we all need to just chill out and accept the increasing politicization of the Net.  He never identifies the potential contradiction in his own thinking here.

Will increased meddling will the Net really help advance his cause?  I can't see how but, then again, I'm one of those cyber-libertarians that Morozov would dismiss as unrealistic or "utopian."  Morozov apparently thinks there is some process out there that will help us determine the "acceptable, transparent, and just democratic procedures [for] regulation" yet, once again, he never lets us in on the details.  All we know from his book is that the way the past three U.S. presidential administrations have approached Internet policy is not to his liking.  And even though it would be hard to call any of them "libertarian" in their approach to Net policy, Morozov clearly thinks the days of "Hands Off the Net" are over and were overrated to begin with.

Conclusion

To summarize, Morozov is quite right about the excessive euphoria currently surrounding the relationship of the Net to politics and regime change, but I think he's gone a bit overboard in The Net Delusion. I realize how much fun playing the role of cranky contrarian must be for him since he's addressing a target-rich environment, full of irrational Internet exuberance.  But Morozov just lays it all on a bit too thick for my taste.  "[T]he important thing is to acknowledge that the debate about the Internet's effects on democracy isn't over and to avoid behaving as if the jury is already out," he argues.  (p. 241)  Fair enough.  The problem is, based on the tone of The Net Delusion and some of its conclusions, it appears that Evgeny Morozov has already sent the jury home and rendered a guilty verdict against the Net.

Additional Reading / Links:

Evgeny Morozov's homepage, his blog, and some of his other writings
The official book site for The Net Delusion.
Jerry Brito's podcast interview with Morozov about the book
Morozov's TED Talk on "How the Net Aids Dictatorships" (also embedded below)
The London Review of Books review of the book Kirkus Reviews .
… and follow Evgeny on Twitter here.

Evgeny Morozov on the dark side of internet freedom

On this week's podcast Evgeny Morozov, a visiting scholar at Stanford University, a fellow at the New America Foundation, and a contributor to Foreign Policy, the Boston Review, and the Wall Street Journal, talks about his new book, The Net Delusion: The Dark Side of Internet Freedom. Morozov first discusses misperceptions about the effectiveness of American broadcasts and pamphlets to promote democracy and liberty during the Cold War. He then suggests consequences of bringing such historical baggage to internet policymaking, pointing out that many people today have faulty assumptions about the power of internet freedom to effect change in places like China, Russia, and Iran.

Related Links


"Freedom.gov: Why Washington's support for online democracy is the worst thing ever to happen to the Internet", by Morozov
"Technological Utopianism", by Morozov
"Battling the Cyber Warmongers", by Morozov

To keep the conversation around this episode in one place, we'd like to ask you to comment at the web page for this episode on Surprisingly Free. Also, why not subscribe to the podcast on iTunes?

A Hundred Years of Coase: Reading the Net Neutrality Order (Part II)

In my previous post on the FCC's Open Internet Report and Order, I looked at the weak justification given for the new rules the Commission approved on Dec. 21, 2010

In this post, an aside on the likely costs of the rules, and in particular the costs of enforcement.

Last week was the 100th birthday of Nobel prize-winning economist Ronald Coase, a remarkable man I have had the great fortune to know personally. Among his many contributions to the field, Coase has always advocated for more empirical research and other data collection to help lead the field out of its theoretical quagmire. To that end, Coase co-founded the International Society for New Institutional Economics, and served as its first President in 1996.

Unfortunately, the FCC, which owes a great debt to Coase for his early championing of auctions for radio spectrum, does not seem to have learned much else from his work. In a section optimistically captioned, "The Benefits of Protecting the Internet's Openness Exceed the Costs" (¶¶ 38-42), the Commission makes no effort to calculate either with any hint of rigor. Wishing away serious economic analysis, the Report simply states that "By comparison to the benefits of these prophylactic measures, the costs associated with the open Internet rules adopted here are likely small."

The sole citation for this remarkable claim is to comments filed by Free Press, one of fifty citations to Free Press in the Report. So far as I know, Free Press does not keep economists on staff, nor did they perform any economic analysis of the benefits or costs of rules that, of course, weren't in any case finalized until months after comments were filed.

So the belief that the costs are likely small, let alone the value of the benefits not of the open Internet but of the rules adopted to salvage it, is simply that—a belief, or, more likely, a mere hope.

The Report goes on to note that openness and no-blocking are already the "norm" and the "status quo" for broadband Internet providers (so, again, why are new rules so urgently required?), and therefore the only significant compliance cost the FCC envisions is for the new transparency rule, which will require disclosure of network management practices that consumers are imagined to use in deciding which broadband provider to choose. (See ¶¶ 39, 43, and 53-61)

The transparency rule itself, § 8.3, will be discussed in a later post. But assuming that complying with this rule represents the only significant change to existing practices by broadband Internet providers required by the new rules, it probably won't add enormous new costs. On the other hand, this is also the rule least likely to deliver much in the way of benefits. (Just take a look at the Truth in Lending Disclosure on your last mortgage refinance or read the required FDA disclosure for a recent prescription—which you surely didn't do before deciding to complete the transaction—to get a sense of just how useful the newly-required network management disclosure will be.)

The Nature of Enforcement

But what of the costs of enforcing the rules, or defending against a claim that a broadband Internet provider has violated them?  The Report here is eerily silent.

There are three types of actions that may be taken to enforce the rules.

First, any individual or organization may file an informal complaint, without paying any fee, through the FCC website. (¶ 153.) Though such complaints will not automatically lead to agency action, "the Enforcement Bureau will examine trends or patterns in complaints to identify potential targets for investigation and enforcement action."

Second, under ¶ 160, the agency itself may initiate actions, perhaps based on trends or patterns it notes in the informal complaints.

The third avenue for enforcement, the filing of a formal complaint, is the most worrisome. Under § 8.12 of the Order, "Any person may file a formal complaint alleging a violation of the rules…." (emphasis added) (See also ¶¶ 154-159)

In his greatest work, "The Nature of the Firm" (1937), Coase plainly and clearly laid out his belief that business organizations exist only to the extent that their internal costs are less than the costs of using the market to perform every activity associated with the production and marketing of the firm's products and services. The market in reality is not the magic font of perfect efficiency that theoretical economists assume in their models. Each transaction between a buyer and a seller has certain inefficiencies or costs associated with it, costs Coase referred to as "transaction costs."

I have written in all of my books about the importance of transaction costs in understanding how the Internet—which reduces transaction costs—is putting unique pressures on the structure of firms, and there's no need to repeat that discussion here.

But of the six categories of transaction costs Coase introduced in 1937, one that seems not to have penetrated the FCC's analysis is the one he called "enforcement costs." In the even the terms of a transaction are not met to the satisfaction of buyer or seller or both, various mechanisms—including arbitration, negotiation, regulators and/or the courts—must be invoked to ensure the bargain made is the bargain received.

In many cases these costs can be exorbitant; indeed, far greater than the value of the underlying transaction. A rational consumer won't sue the maker of a rubber band that breaks the first time you use it.

At least not when the consumer has to bear the costs of litigating the claim herself. The loss of value from the broken rubber band is a fraction of a penny. The cost of initiating—let along prosecuting—a lawsuit would exceed that price by several orders of magnitude. And, in most situations, the most the consumer could hope to win would be the fraction of a cent. The cost of enforcing the implied promise of a working rubber band—and the seller's cost of defending itself—are lost.

But what if the consumer can offset nearly all of the enforcement costs on someone else—on the FCC, perhaps, or their broadband ISP provider? If "any person" who believes something is amiss could file an open Internet complaint and pay only a small filing fee to start the machinery of enforcement, why not bring a complaint for any perceived infraction, no matter how small or, indeed, illusory?

And that, unfortunately, is exactly the kind of incentive system created by the Order.

The existence of the new open Internet rules, of course, may operate as a deterrent against the behaviors they prohibit. But it is also likely that the agency will be called upon to enforce the rules against broadband access providers who are accused of violating them. The enforcement costs can be significant—including the costs to the agency itself (that is, to the taxpayers), as well as to the companies accused, rightly or wrongly, of violations.

Bizarrely, the Report makes no mention of the costs of enforcement or their potential impact on the cost-benefit analysis that is dispensed with so quickly. Yet the rules as written are likely to introduce substantial enforcement costs, as evident by looking at the mechanisms for making and resolving complaints. (¶¶ 151-160).

The Danger of a Private Right of Action

In legal terms, the ability of any individual to initiate an enforcement action is known as a private right of action. Federal law grants very few such broadly-written rights. There are, of course, hundreds of millions of American consumers, and giving all of them the right to initiate a formal proceeding that the FCC and the complained-of party must address can generate enormous costs.

But that is precisely what the new rules have done. Regardless of the merits or specifics of a complaint, "the defendant must submit an answer." In cases where the "facts" are disputed, "a thorough analysis of the challenged conduct might require further factual development and briefing." (¶ 156) Moreover, "the broadband provider must answer each claim with particularity and furnish facts, supported by documentation or affidavit, demonstrating reasonableness of the challenged practice." (¶ 157)

In resolving formal complaints, "the Commission will draw on resources from across the agency—including engineering, economic, and legal experts—to resolve open Internet complaints in a timely manner." (¶ 159)

These are the general comments in the Report. Specific "pleading requirements" laid out in the Order provide the procedures for filing complaints, answers and replies, conducting discovery, developing and supporting legal arguments, verifying facts and documents submitted, and the like. (§§ 8.13-8.17) These sections are in fact far longer and more detailed than the rules themselves, and in essence create a system of adjudication that is similar to the most complex cases brought in federal court.

For example, any broadband provider served with a complaint must respond within 20 days, and must respond to each and every fact referenced in the complaint, supported with documentation including affidavits, legal authority, and other evidence. The Commission "may specify other procedures," including hearings and oral arguments, and "may require the parties to submit any additional information it deems appropriate for a full, fair, and expeditious resolution of the proceedings, including copies of all contracts and documents reflecting arrangements and understandings alleged to violate" the rules.

Again, a party filing a formal complaint can be any person or organization so long as they have a good faith belief that the broadband provider has violated the rules. (They need not themselves be a customer of the broadband provider.)

Since the kind of blocking and traffic discrimination the rules prohibit can only be distinguished from "reasonable network management" practices (or indeed, behavior that may appear to involve ISP activity but which may simply be a function of overall network conditions at any given time) by reference to detailed discovery, we can expect a lot of complaints to be filed that will turn out not to reveal violations of the rules.

Since consumers aren't likely to know with any certainty that the behaviors they observe are in fact violations of the rules without extensive and technically complicated discovery, in other words, any slow-down, hiccup, temporary outage or other network artifact that appears to suggest interference will constitute a good faith belief that a violation has occurred, and therefore put the broadband provider (and the FCC) to the cost of demonstrating otherwise.

Is your Internet connection acting up today? Did it take a long time to watch the latest YouTube video? Did you have trouble finding the website you were looking for? Could be that your ISP is blocking or otherwise discriminating against particular content, so perhaps you should submit a formal complaint to the FCC just in case.

All the costs will be borne by others—the provider on the one hand and the FCC on the other.

It's not Just Money that's Being Wasted

Such an open-ended grant of standing to "any person," whether for good or for evil, cannot be squared with the belief that "the costs associated with the open Internet rules adopted here are likely small." Even if no violation of the rules is ever found—even if no broadband provider ever interferes illegally with the open Internet in the future—providers and the agency will find themselves buried under mountains of complaints, all of which must be investigated and responded to…within 20 days of the filing, no less.

It isn't just money that will be wasted. The process of enforcement could undermine basic Constitutional protections as well. If a complaint alleges that a broadband provider is interfering with traffic—perhaps on an on-going basis—in ways that violate the rules, the FCC will of necessity analyze large volumes of traffic to determine if a service is being blocked or unreasonably discriminated against. And that means not just looking at traffic patterns but, of course, at the contents of the packets themselves.

The FCC, in other words, in the name of enforcement, will be looking at the Internet behavior not only of the person making the complaint but perhaps of many other customers of the same provider or other providers for comparison.

Economists were clearly absent from discussions about the cost of the rules. But one would have thought at least that civil libertarians would pause at new rules that, in the name of an open and transparent Internet, give the FCC the ability to observe traffic—to perform deep packet inspection—that in any other context would require federal officers to obtain a search warrant based on probable cause of a crime.

But no.  So far, not a peep.

Next: the final rules and what they "preserve."

A Hundred Years of Coase:  Reading the Net Neutrality Order (Part II)  In my previous post on the FCC's Open Internet Report and Order, I looked at the weak justification given for the new rules the Commission approved on Dec. 21, 2010  In this post, an aside on the likely costs of the rules, and in particular the costs of enforcement.  Last week was the 100th birthday of Nobel prize-winning economist Ronald Coase, a remarkable man I have had the great fortune to know personally.  Among his many contributions to the field, Coase has always advocated for more empirical research and other data collection to help lead the field out of its theoretical quagmire.  To that end, Coase co-founded the International Society for New Institutional Economics, and served as its first President in 1996.  Unfortunately, the FCC, which owes a great debt to Coase for his early championing of auctions for radio spectrum, does not seem to have learned much else from his work.  In a section optimistically captioned, "The Benefits of Protecting the Internet's Openness Exceed the Costs" (¶¶ 38-42), the Commission makes no effort to calculate either with any hint of rigor.  Wishing away serious economic analysis, the Report simply states that "By comparison to the benefits of these prophylactic measures, the costs associated with the open Internet rules adopted here are likely small."  The sole citation for this remarkable claim is to comments filed by Free Press, one of fifty citations to Free Press in the Report.  So far as I know, Free Press does not keep economists on staff, nor did they perform any economic analysis of the benefits or costs of rules that, of course, weren't in any case finalized until months after comments were filed.    So the belief that the costs are likely small, let alone the value of the benefits not of the open Internet but of the rules adopted to salvage it, is simply that—a belief, or, more likely, a mere hope.  The Report goes on to note that openness and no-blocking are already the "norm" and the "status quo" for broadband Internet providers (so, again, why are new rules so urgently required?), and therefore the only significant compliance cost the FCC envisions is for the new transparency rule, which will require disclosure of network management practices that consumers are imagined to use in deciding which broadband provider to choose.   (See ¶¶ 39, 43, and 53-61)  The transparency rule itself, § 8.3, will be discussed in a later post.  But assuming that complying with this rule represents the only significant change to existing practices by broadband Internet providers required by the new rules, it probably won't add enormous new costs.  On the other hand, this is also the rule least likely to deliver much in the way of benefits.  (Just take a look at the Truth in Lending Disclosure on your last mortgage refinance or read the required FDA disclosure for a recent prescription—which you surely didn't do before deciding to complete the transaction—to get a sense of just how useful the newly-required network management disclosure will be.)  The Nature of Enforcement  There are three types of actions that may be taken to enforce the rules.    First, any individual or organization may file an informal complaint, without paying any fee, through the FCC website. (¶ 153.)  Though such complaints will not automatically lead to agency action, "the Enforcement Bureau will examine trends or patterns in complaints to identify potential targets for investigation and enforcement action."   Second, under ¶ 160, the agency itself may initiate actions, perhaps based on trends or patterns it notes in the informal complaints.  The third avenue for enforcement, the filing of a formal complaint, is the most worrisome.   Under § 8.12 of the order, "Any person may file a formal complaint alleging a violation of the rules…."  (See ¶¶ 154-159)    In his greatest work, "The Nature of the Firm" (1937), Coase plainly and clearly laid out his belief that business organizations exist only to the extent that their internal costs are less than the costs of using the market to perform every individual activity associated with the production and marketing of the firm's products and services.  The market in reality is not the magic font of perfect efficiency that theoretical economists assume in their models.  Each transaction between a buyer and a seller has certain inefficiencies or costs associated with it, costs Coase referred to as "transaction costs."    I have written in all of my books about the importance of transaction costs in understanding how the Internet—which reduces transaction costs—is putting unique pressures on the structure of firms, and there's no need to repeat that discussion here.  But of the six categories of transaction costs Coase introduced in 1937, one that seems not to have penetrated the FCC's analysis is the one he called "enforcement costs."  In the even the terms of a transaction are not met to the satisfaction of buyer or seller or both, various mechanisms—including arbitration, negotiation, regulators and/or the courts—must be invoked to ensure the bargain made is the bargain received.  In many cases these costs can be exorbitant; indeed, far greater than the value of the underlying transaction.   A rational consumer won't sue the maker of a rubber band that breaks the first time you use it.  At least not when the consumer has to bear the costs of litigating the claim herself.  The loss of value from the broken rubber band is a fraction of a penny.  The cost of initiating—let along prosecuting—a lawsuit would exceed that price by several orders of magnitude.  And, in most situations, the most the consumer could hope to win would be the fraction of a cent.  The cost of enforcing the implied promise of a working rubber band—and the seller's cost of defending itself—are lost.  But what if the consumer can offset nearly all of the enforcement costs on someone else—on the FCC, perhaps, or their broadband ISP provider?  If "any person" who believes something is amiss could file an open Internet complaint and pay only a small filing fee to start the machinery of enforcement, why not bring a complaint for any perceived infraction, no matter how small or, indeed, illusory?  And that, unfortunately, is exactly the kind of incentive system created by the Order.  The existence of the new open Internet rules, of course, may operate as a deterrent against the behaviors they prohibit.  But it is also likely that the agency will be called upon to enforce the rules against broadband access providers who are accused of violating them.  The enforcement costs can be significant—including the costs to the agency itself (that is, to the taxpayers), as well as to the companies accused, rightly or wrongly, of violations.  Bizarrely, the Report makes no mention of the costs of enforcement or their potential impact on the cost-benefit analysis that is dispensed with so quickly.  Yet the rules as written are likely to introduce substantial enforcement costs, as evident by looking at the mechanisms for making and resolving complaints.  (¶¶ 151-160).    The Danger of a Private Right of Action  In legal terms, the ability of any individual to initiate an enforcement action is known as a private right of action.  Federal law grants very few such broadly-written rights.  There are, of course, hundreds of millions of American consumers, and giving all of them the right to initiate a formal proceeding that the FCC and the complained-of party must address can generate enormous costs.    But that is precisely what the new rules have done.  Regardless of the merits or specifics of a complaint, "the defendant must submit an answer."  In cases where the "facts" are disputed, "a thorough analysis of the challenged conduct might require further factual development and briefing."  (¶ 156)  Moreover, "the broadband provider must answer each claim with particularity and furnish facts, supported by documentation or affidavit, demonstrating reasonableness of the challenged practice."   (¶ 157)  In resolving formal complaints, "the Commission will draw on resources from across the agency—including engineering, economic, and legal experts—to resolve open Internet complaints in a timely manner."  (¶ 159)  These are the general comments in the Report.  Specific "pleading requirements" laid out in the Order provide the procedures for filing complaints, answers and replies, conducting discovery, developing and supporting legal arguments, verifying facts and documents submitted, and the like.  (§§ 8.13-8.17)  These sections are in fact far longer and more detailed than the rules themselves, and in essence create a system of adjudication that is similar to the most complex cases brought in federal court.    For example, any broadband provider served with a complaint must respond within 20 days, and must respond to each and every fact referenced in the complaint, supported with documentation including affidavits, legal authority, and other evidence.   The Commission "may specify other procedures," including hearings and oral arguments, and "may require the parties to submit any additional information it deems appropriate for a full, fair, and expeditious resolution of the proceedings, including copies of all contracts and documents reflecting arrangements and understandings alleged to violate" the rules.    Again, a party filing a formal complaint can be any person or organization so long as they have a good faith belief that the broadband provider has violated the rules.  (They need not themselves be a customer of the broadband provider.)    Since the kind of blocking and traffic discrimination the rules prohibit can only be distinguished from "reasonable network management" practices (or indeed, behavior that may appear to involve ISP activity but which may simply be a function of overall network conditions at any given time) by reference to detailed discovery, we can expect a lot of complaints to be filed that will turn out not to reveal violations of the rules.  Since consumers aren't likely to know with any certainty that the behaviors they observe are in fact violations of the rules without extensive and technically complicated discovery, in other words, any slow-down, hiccup, temporary outage or other network artifact that appears to suggest interference will constitute a good faith belief that a violation has occurred, and therefore put the broadband provider (and the FCC) to the cost of demonstrating otherwise.  Is your Internet connection acting up today?  Did it take a long time to watch the latest YouTube video?   Did you have trouble finding the website you were looking for?  Could be that your ISP is blocking or otherwise discriminating against particular content, so perhaps you should submit a formal complaint to the FCC just in case.    All the costs will be borne by others—the provider on the one hand and the FCC on the other.  Such an open-ended grant of standing to "any person," whether for good or for evil, cannot be squared with the belief that "the costs associated with the open Internet rules adopted here are likely small."  Even if no violation of the rules is ever found—even if no broadband provider ever interferes illegally with the open Internet in the future—providers and the agency will find themselves buried under mountains of complaints, all of which must be investigated and responded to…within 20 days of the filing, no less.  Worse still, the costs of enforcement aren't even the most worrisome feature of the new rules.  The process of enforcement could undermine basic Constitutional as well.  If a complaint alleges that a broadband provider is interfering with traffic—perhaps on an on-going basis—in ways that violate the rules, the FCC will of necessity analyze large volumes of traffic to determine if a service is being blocked or unreasonably discriminated against.  And that means not just looking at traffic patterns but, of course, at the contents of the packets themselves.  The FCC, in other words, in the name of enforcement, will be looking at the Internet behavior not only of the person making the complaint but perhaps of many other customers of the same provider or other providers for comparison.  Economists were clearly absent from discussions about the cost of the rules.  But one would have thought at least that civil libertarians would pause at new rules that, in the name of an open and transparent Internet, give the FCC the ability to observe traffic—to perform deep packet inspection—that in any other context would require federal officers to obtain a search warrant based on probable cause of a crime.  But no, not a peep.  Next:  the final rules and what they "preserve."

Upcoming Internet Policy Books for 2011

Well, even though I just recently put to bed my annual list of the "Most Important Info-Tech Policy Books of 2010," I've already started investigating what new titles we'll need to pay attention to in 2011.  Accordingly, I've started this list and hope that others can suggest other books I may have missed.  Here's what I've got so far:

Evgeny Morozov – The Net Delusion: The Dark Side of Internet Freedom (January)
Sherry Turkle – Alone Together: Why We Expect More from Technology and Less from Each Other (January)
John Brockman (ed.) Is the Internet Changing the Way You Think? The Net's Impact on Our Minds and Future (January)
Berin Szoka (ed.) – The Next Digital Decade: Essays on the Future of the Internet (January)
Siva Vaidhyanathan – The Googlization of Everything, and Why We Should Worry (March)
Daniel Solove - Nothing to Hide: The False Tradeoff between Privacy and Security
Jeff Jarvis – Public Parts
Rebecca MacKinnon – Consent of the Networked (late 2011 / early 2012)

Chairman Genachowski and his Howling Commissioners: Reading the Net Neutrality Order (Part I)

At the last possible moment before the Christmas holiday, the FCC published its Report and Order on "Preserving the Open Internet," capping off years of largely content-free "debate" on the subject of whether or not the agency needed to step in to save the Internet.

In the end, only FCC Chairman Julius Genachowski fully supported the final solution.  His two Democratic colleagues concurred in the vote (one approved in part and concurred in part), and issued separate opinions indicating their belief that stronger measures and a sounder legal foundation were required to withstand likely court challenges.  The two Republican Commissioners vigorously dissented, which is not the norm in this kind of regulatory action.  Independent regulatory agencies, like the U.S. Courts of Appeal, strive for and generally achieve consensus in their decisions.

So for now we have a set of "net neutrality" rules that a bi-partisan majority of the last Congress, along with industry groups and academics, strongly urged the agency not to adopt, and which were deemed unsatisfactory by four of the five Commissioners.  It's hardly a moment of pride for the agency, which has been distracted by the noise around these proceedings since Genachowski was first confirmed by the Senate.  Important work freeing up radio spectrum for wireless Internet, reforming the corrupt Universal Service Fund, and promoting the moribund National Broadband Plan have all been sidelined.

How did we get here?  In October, 2009, the agency first proposed new rules, but their efforts were sidetracked by a May court decision that held the agency lacked authority to regulate broadband Internet.  After flirting with the dangerous (and likely illegal) idea of "reclassifying" broadband to bring it under the old telephone rules, sanity seemed to return.  Speaking to state regulators in mid-November, the Chairman made no mention of net neutrality or reclassification, saying instead that "At the FCC, our primary focus is simple: the economy and jobs."

Just a few days later, at a Silicon Valley event, the Chairman seemed to reverse course, promising that net neutrality rules would be finalized.  He also complimented the "very smart lawyers" in his employ who had figured out a way to do it without the authorization of Congress, which has consistently failed to pass enabling legislation since the idea first surfaced in 2003.  (Most recently, Democratic Congressman Henry Waxman floated a targeted net neutrality bill days before the mid-term elections, but never introduced it.)

From then until the Commission's final meeting before the new Congress comes to town in January, Commissioners and agency watchers lobbied hard and feinted outrage with the most recent version of the rules, which the agency did not make public until after the final vote was taken on Dec. 21.  In oral comments delivered at the December meeting, two commissioners complained that they hadn't seen the version they were to vote on until midnight the night before the vote.  Journalists covering the event didn't have the document all five Commissioners referenced repeatedly in their spoken comments, and had to wait two more days for all the separate opinions to be collated.

Why the Midnight Order?  FCC Commissioners do not serve at the whim of Congress or the President, so the mid-term election results technically had no effect on the chances of agency action.  Chairman Genachowski has had the votes to approve pretty much anything he wants to all along, and will for the remainder of his term.

Even with a Republican House, legislation to block or overturn FCC actions is unlikely.  The Republicans would have to get Democratic support in the Senate, and perhaps overcome a Presidential veto.

But Republicans could use net neutrality as a bargaining chip in future negotiations, and the House can make life difficult for the agency by holding up its budget or by increasing its oversight of the agency, forcing the Chairman to testify and respond to written requests so much as to tie the agency in knots.

So doing something as Congress was nearly adjourned and too busy to do much but bluster was perhaps the best chance the Chairman had for getting something—anything—on the Federal Register.

More likely, the agency was simply punting the problem.  Tired of the rancor and distraction of net neutrality, the new rules—incomplete, awkward, and without a solid legal foundation—move the issue from the offices of the FCC to the courts and Congress.  That will still tie up agency resources and waste even more taxpayer money, of course, but now the pressure of industry and "consumer advocate" groups will change its focus.  Perhaps this was the only chance the Chairman had of getting any real work done.

The Report and Order

Too much ink has already been spilled on both the substance and the process of this order, but there are a few tidbits from the documents that are worth calling out.  In this post, I look at the basis for issuing what the agency itself calls "prophylactic rules."  In subsequent posts, I'll look at the final text of the rules themselves and compare them to the initial draft, as well as to alternatives offered by Verizon and Google and Congressman Waxman.  Another post will review the legal basis on which the rules are being issued, and likely legal challenges to the agency's authority.  I'll also examine the FCC's proposed approach to enforcement of the rules.

"Prophylactic" Rules

Even the FCC acknowledges that the "problem" these new rules solve doesn't actually exist…yet.  The rules are characterized as "prophylactic" rules—a phrase that appears eleven times in the 87-page report.  The report fears that the lack of robust broadband competition in much of the U.S. (how many sets of redundant broadband infrastructure do consumer advocates want companies to build out, anyway?) could lead to ISPs using their market influence to squeeze content providers, consumers, or both.

This hasn't happened in the ten years broadband Internet has been growing in both capability and adoption, of course, but still, there's a chance.  As the report (¶ 21) puts it in challenged grammar, "broadband providers potentially face at least three types of incentives to reduce the current openness of the Internet."

We'll leave to the side for now the undiscussed potential that these new rules will themselves cause unintended negative consequences for the future development or deployment of technologies built on top of the open Internet.  Instead, let's look at the sum total of the FCC's evidence, collected over the course of more than a year with the help of advocates who believe the "Internet as we know it" is at death's door, that broadband providers are lined up to destroy the technology that, ironically, is the source of their revenue.

To prove that these "potential" incentives are neither "speculative or merely theoretical," the FCC cites precisely four examples between 2005 and 2010 where it believes broadband providers have threatened the open Internet (¶ 35).   These are:

1.      A local ISP that was "a subsidiary of a telephone company" settled claims it had interfered with Voice over Internet Telephony (VoIP) applications used by its customers.

2.      Comcast agreed to change its network management techniques when the company was caught slowing or blocking packets using the BitTorrent protocol (the subject of the 2010 court decision holding the agency lacked jurisdiction over broadband Internet).

3.      After a mobile wireless provider contracted with an online payment service, the provider "allegedly" blocked customers' attempts to use competing services to pay for purchases made with mobile devices.

4.      AT&T initially restricted the types of applications—including VoIP and Slingbox—that customers could use on their Apple iPhone.

In the world of regulatory efficiency, this much attention being focused on just four incidents of potential or "alleged" market failures is a remarkable achievement indeed.  (Imagine if the EPA, FDA, or OSHA reacted with such energy to the same level of consumer harm.)

But in legal parlance, regulating on such a microscopically thin basis goes well beyond mere "pretense"—it's downright embarrassing the agency couldn't come up with more to justify its actions.  Of the incidents, (1) and (2) were resolved quickly through existing agency authority, (3) was merely alleged and apparently did not even lead to a complaint filed with the FCC (the footnote here is to comments filed by the ACLU, so it's unclear who is being referenced) and (4) was resolved—as the FCC acknowledges–when customers put pressure on Apple to allow AT&T as the sole iPhone network provider to allow the applications.

Even under the rules adopted, (2) would almost surely still be allowed.  The Comcast case involved use of the BitTorrent protocol.  Academic studies performed since 2008 (when the protocol has been expanded to more legal uses, that is), find that over 99% of BitTorrent traffic still involves unlicensed copyright infringement.  Thus the vast majority of the traffic involved is not "lawful" traffic and, therefore, is not subject to the rules.  The no blocking rule (§8.5) only prohibits blocking of "lawful content, applications, services or non-harmful devices."  (emphasis added)

Indeed, the FCC encourages network providers to move more aggressively to block customers who use the Internet to violate intellectual property law.  In ¶ 111, the Report makes crystal clear that the new rules "do not prohibit broadband providers from making reasonable efforts to address the transfer of unlawful content or unlawful transfers of content…..open Internet rules should not be invoked to protect CR infringement…." (Perhaps the FCC, which continues to refer to BitTorrent as an "application" or believes it to be a website, simply doesn't understand how the BitTorrent protocol actually works.)

Under the more limited wireless rules adopted, (3) and (4) would probably still be allowed as well.  We don't know enough about (3) to really understand what is "alleged" to have happened, but the no-blocking rule (§ 8.5) says only that mobile broadband Internet providers "shall not block consumers from accessing lawful websites, subject to reasonable network management; nor shall such person block applications that compete with the provider's voice or video telephony service, subject to reasonable network management."

A mobile payment application wouldn't seem to be included in that limitation, and in the case of the iPhone, it was Apple, not AT&T, that wanted to limit VoIP.

Even so, the Report makes clear that the wireless rule (¶ 102) doesn't apply to app stores: "The prohibition on blocking applications that compete with a broadband provider's voice or video telephony services does not apply to a broadband provider's operation of application stores or their functional equivalent."  So if the software involved in incidents (3) and (4) involved rejection of proposed apps for the respective mobile devices, there would still be no violation under the new rules.

And the caveat for "reasonable network management" (§8.11(d)) says only that a practice is "reasonable if it is appropriate and tailored to achieving a legitimate network purpose, taking into account the particular network architecture of the broadband Internet access service."  Voice and video apps, depending on how they have been implemented, can put particular strain on a wireless broadband network.  Blocking particular VoIP or apps like Slingbox might be allowed, in other words.

So that's it.  Only four or fewer actual examples of non-open behavior by ISPs in ten years.  And the rules adopted to curb such behavior would probably only apply, at best, to the single case of Madison River (1), a local telephone carrier with six hundred employees, in a case the FCC agreed to drop without a formal finding of any kind nearly six years ago.

But maybe these aren't the real problems.  Maybe the real problem is, as many regulatory advocates argue vaguely, the lack of "competition" for broadband.  Since the first deployment of high-speed Internet, multiple technologies have been used to deliver access to consumers, including DSL (copper), coaxial cable, satellite, cellular (3G and now 4G), wireless (WiFi and WiMax), and broadband over power lines.  According to the National Broadband Plan, 4% of the U.S. population still doesn't have access to any of these alternatives.  In many parts of the country, only two providers are available and in others, the offered speeds of alternatives vary greatly, leaving high-bandwidth users without effective alternatives.

If lack of competition is the problem, though, why not solve that problem?  Well, perhaps the FCC would rather sidestep the issue, since it has demonstrated it is the wrong agency to encourage more competition.  The FCC, for example, has supported legal claims by states that they can prohibit municipalities from offering wireless service, and has dragged its feet on approving trials for broadband over power lines—the best hope for much of the 4% who today have no broadband option, most of whom live in rural areas which already have power line infrastructure.

Indeed, if there are anti-competitive behaviors now or in the future, existing antitrust law, enforceable by either the Department of Justice or the Federal Trade Commission, provide much more powerful tools both to prosecute and remedy activities that genuinely harm consumers.

It's hard, by comparison, to find many examples in the long history of the FCC where it has used its sometimes vast authority to solve a genuine problem.  The Carterfone decision, which Commissioner Copps cites enthusiastically in his concurrence, and (finally) the opening of long distance telephony to competition, certainly helped consumers.  But both (and other examples) could also be seen as undoing harm caused by the agency in the first place.  And both dealt with technologies and applications that were mature.  Why does anyone believe the FCC can "prophylactically" solve a problem dealing with an emerging, rapidly-evolving new technology that has thrived in the last decade in part because it was unregulated?

The new rules, which are aimed at ensuring "edge" providers do not need to get "permission to innovate" from ISPs, may have the unintended effect of requiring ISPS—and edge providers—to get "permission to innovate" from the FCC.  That hardly seems like a risk worth taking for a problem that hasn't presented itself.