Auction Give & Take

There is both good news and bad news with the FCC's auction rules. The good news is that the FCC finally is moving away from service-by-service auction rules toward packaged, generic auction rules, which should make the application process easier. The bad news is that many of the proposed rule changes seem to depart from Congress' intent of auctions. These new rules could hinder auction participation.

Originally, the FCC adopted auction rules on a service-by-service basis. In other words, if the FCC wanted to auction broadband PCS licenses, it held a rulemaking to adopt auction rules. Then it held another rulemaking to auction narrowband PCS licenses. The same applied to 900MHz SMR, IVDS and other licenses.

This process worked, but entailed several months of rulemak-ings before each new auction could take place. In the end, virtually all of the auction rulemakings produced fundamentally the same result: multiround auctions with simultaneous electronic bidding. Only a few details varied between auctions.

Recognizing the inefficiencies in this process, the FCC has adopted some generic auction rules and proposed some additional rules. These rules could apply, cookie-cutter style, to all future auctions, and the Wireless Telecommunications Bureau (WTB) would have authority to vary the details.

SMALL BUSINESS In modifying the Communications Act to permit auctions, Congress instructed the FCC to adopt rules that give "small businesses" an opportunity to participate in the auctions. This means the FCC has to define what constitutes a small business. As before, the FCC proposes to measure the size of business by average gross revenues for the last three years of the applicant and its affiliates.

However, the WTB would define the small-business threshold amount on a service-specific basis. This corresponds with prior FCC practice, which uses various thresholds between $3 million (SMR very small businesses) and $125 million (broadband PCS entrepreneurs).

Traditionally, determining who the applicant's affiliates are has been a difficult part of making the gross revenue determination. The FCC's new rules help this process by adopting a single definition of affiliate, instead of earlier definitions that varied from one auction to another.INSTALLMENT PAYMENTS The new rules giveth and they taketh away. The biggest "take" could be the official elimination of installment payments for small-business auction winners.

Originally, the FCC adopted installment payments as a way to provide risk capital to smaller businesses that weren't able to raise enough debt or equity capital to participate in the auctions. This decision was, and is, correct. But once the FCC accepted installment payments for auctioned licenses, there were problems: Auction winners could default on their installment payments. This problem compounded when the perceived value of wireless dropped, and C-block PCS bidders wildly overbid their licenses. The problem compounded further when former Chairman Reed Hundt touted the PCS auction proceeds in Washington political circles.

As a result, the FCC faced an extremely public multibillion-dollar default among its PCS auction winners. The FCC magnified the impact of this default when it failed to secure the debt by having the debtor sign a standard UCC-1 form perfecting the FCC's security interest in the license. As a result, the FCC's legal authority to reclaim and re-auction defaulted licenses became hopelessly tangled with bankruptcy law.

Faced with a difficult situation, the FCC reacted by dropping installment payments in future auctions, at least for the foreseeable future. This is one of several decisions by which the FCC is dampening demand for its auctioned licenses.

The FCC's flexibility here is hindered by a Congressional requirement that all auction installment payments be deposited in the U.S. Treasury by Sept. 30, 2002. This requirement permits Congressional budgeting calculations to claim future auction revenues with certainty. On the other hand, it appears to limit the FCC's flexibility to institute future installment-payment plans.

The answer to this paradox is for the FCC to use auctions to generate installment-payment obligations, and then for the U.S. Treasury to sell packages of those obligations on the financial markets. This would be similar to the process used for FHA-backed mortgage loans. It would permit the Treasury to obtain immediate revenue from installment-plan auctions. It also would remove the FCC from the conflict of being both the regulator and banker to its licenses.

The FCC also is addressing the problem of late payments in installment financing. Under the new rules, licensees will receive one 90-day, non-delinquency period for their installment payments, followed by a further 90-day automatic grace period. Those two periods will be accompanied by 5% late fees in the first period, and 10% late fees in the second. If, at the end of the second period, the licensee has not brought its payments current (late fees, accrued interest and unpaid principal if any), the FCC will declare the licensee in default and reclaim its license.

The FCC did give licensees with installment payments one important break. It decided not to "cross-default" licensees, which means that it will not declare all of a licensee's installment-payment licenses in default if it defaults one of them. This gives auction-winning licensees the flexibility to make difficult business decisions if money is tight.

MINIMUM BIDS After the disastrous Wireless Communications Service auction ($6 for San Francisco), Congress told the FCC to adopt minimum bids for its auctions. The FCC started with the 800MHz SMR auction. The initial minimum bid for each license was the up-front payment for that license. Although this decision likely will preclude regulatory embarrassment, it has some problems.

Before minimum bids, it was possible for a small business to participate in the auction with a reasonable up-front payment, knowing that it might be able to bid on any of several undervalued markets in the initial stages of the auction. Minimum bids eliminate that bidding flexibility and dampen auction demand.

They also create uncertainty. The FCC might not be able to auction a license when the minimum bid exceeds the marketplace's value of the license. The FCC has the power to reduce the minimum bid for an inactive license during the course of an auction. However, that power will not be helpful in practice. More than likely, inactive bidders will be declared ineligible under the FCC's auction activity rules before the FCC decides to cut prices.

CLICK-BOX BIDDING Collusion between bidders during auctions is an ongoing FCC concern. Recently, the FCC considered allegations that one PCS bidder signaled its intentions during the auction ("colluded") by placing its desired market number in the cents field of its bids. Some observers think this controversy was blown out of proportion. After all, the whole point of public bidding is to signal intentions in bidding. And collusion suggests secrecy -- public bidding by definition is not secret. Regardless, the alleged collusion didn't work; the alleged colludee reported its concerns to the FCC.

Nevertheless, the FCC took the problem seriously. It investigated these allegations and adopted click-box bidding. Under click-box bidding, the FCC specifies the next round's bid for each license, and the bidders merely accept or reject the bid. This departs from the key concept of auctions that the varying bid levels indicate the bidder's desire for each item. Although it solves the collusive-bid-amount problem, it makes bidding in FCC auctions akin to playing the piano with mittens on.

But click-box bidding did eliminate another auction problem, caused in part by deficiencies in the FCC's bidding software: Bidders would accidentally mistype bids, typically by adding one or two zeros to their bids. The early versions of the FCC's software did not detect wildly high overbids, and the earliest versions actually supplied the extra zeros for bidders in some circumstances.

Once detected, bidders withdrew these overly high bids but then became liable for the bid-withdrawal penalty. Originally, the penalty was the difference between the withdrawn bid and the winning bid. With one or two erroneous zeros, such penalties could run into millions of dollars.