113 January 2008

New Barriers toU.S. Market Entry by Undersea Cable Operators and International Carriers

Kent Bressie

213 January 2008

Recent regulatory developments in the United States have made it increasingly burdensome to construct and operate undersea telecommunications infrastructure:

• Expanded scope and depth for TeamTelecom security reviews

• More expansive, politicized CFIUS reviewsfor mergers and acquisitions

• Unworkable new FCC environmentalrules for cable landing licenses

• Continuing failure of FCC to reform IBCfees

313 January 2008

1. Expanded Scope and Depth for “Team Telecom” Security Reviews

• Team Telecom agencies have expanded their use of security agreements and other assurances, and seek to impose ever more burdensome obligations on facilities owners and service providers over the course of time-consuming negotiations.

413 January 2008

What Is “Team Telecom”?• Team Telecom is the nickname for the Executive

Branch agencies that scrutinize national security and law enforcement aspects of applications filed with the Federal Communications Commission (“FCC”):

• Departments of Justice, Homeland Security, and Defense

• Federal Bureau of Investigation (though not recently)

• Team Telecom seeks to protect government communications, preserve government wiretapping and surveillance capabilities, prevent terrorist acts, and deter money laundering and drug trafficking

• Team Telecom does not act pursuant to any particular law, has adopted no formal regulations, and retains substantial power and discretion

Team Telecom2

513 January 2008

What Does Team Telecom Review?• Team Telecom scrutinizes both applications for new

FCC authorizations (including international Section 214 authorizations, cable landing licenses, and mobile and satellite licenses) and for FCC consent to acquisitions of existing telecommunications infrastructure

• Examples: new cable landing license for Trans-Pacific Express; VSNL acquisition of Tyco Global Network

• Foreign Ownership Threshold: Team Telecom automatically reviews an application for a new license or transaction approval if applicant or acquirer has direct or indirect foreign ownership of 10 percent or more

• An application will receive even greater scrutiny if the applicant is foreign-controlled or if there is foreign-government ownership (including ownership through a sovereign wealth fund)

Team Telecom3

613 January 2008

How Does Team Telecom Work with the FCC?• In typical case (e.g., resale authorization), Team

Telecom requires an applicant to answer questionnaire about its existing and planned business and its ownership structure before Team Telecom will allow FCC to process application

• Provision of foreign ownership details and law enforcement point of contact may suffice

• In sensitive cases (e.g., new infrastructure), Team Telecom formally asks FCC to defer action pending resolution of security concerns

• Team Telecom petitions FCC to condition any license or transaction approval on compliance with negotiated assurances or security agreement

• Team Telecom retains right to ask FCC to revoke a license or transaction approval if the applicant fails to comply with negotiated assurances or the security agreement

Team Telecom4

713 January 2008

What’s in a Security Agreement?The content of the security agreement varies by transaction/investment, but typically:

• Restricts the location of infrastructure and routingfor U.S. communications;

• Requires the storage of customer and call data in the United States;

• Requires compliance with lawful surveillance requests by U.S. law enforcement agents;

• Prohibits foreign surveillance using U.S. infrastructure;

• Imposes U.S. citizenship requirements for principal contacts and security officers, and other screening procedures for other employees and even visitors to certain facilities; and

• Imposes auditing and reporting obligations.

Team Telecom5

813 January 2008

Recent Changes in Team Telecom Reviews

• Scope expanded to cover resellers, even though underlying facilities owners may be U.S.-owned or have separately entered into assurances or security agreement.

• Increasing concern about sovereign wealth funds and offshore private equity funds.

• Where CFIUS foreign ownership review also required under Exon-Florio statute, CFIUS and Team Telecom reviews are integrated.

• Team Telecom has, however, shown new flexibility with consortium-owned infrastructure; required only Verizon, and not Asian carrier-owners, to sign security agreement for Trans-Pacific Express.

Team Telecom6

913 January 2008

2. More Expansive, Politicized Foreign Ownership Reviews for Mergers and Acquisitions

Reviews significantly altered by 2007 amendments to Exon-Florio law:

• Expanded scope, covering a broader range of transactions, including those involving critical infrastructure and homeland security.

• Further politicized, with greater congressional oversight

• Increased risks of delay and denial for covered transactions

• Significant new ongoing complianceobligations.

1013 January 2008

FINSA Amends Exon-Florio Statute

• Following Dubai Ports World’s acquisition of P&O Ports in 2006 (later unwound) and China National Overseas Oil Corporation’s proposed acquisition of Unocal (never consummated), the U.S. Congress passed the Foreign Investment and National Security Act of 2007 (“FINSA”), which the President signed into law.

• FINSA amends the Exon-Florio statute and makes significant changes to the transaction review process administered by the Committee on Foreign Investment in the United States (“CFIUS”).

• FINSA amendments took effect on October 24, 2007.• CFIUS must publish new implementing regulations

by January 22, 2008.

CFIUS / FINSA2

1113 January 2008

Expanded Focus on Homeland Security and Critical Infrastructure

Specifically defines “national security” to include “homeland security” and protection of:

• “critical infrastructure,” which includes “systems or assets, whether physical or virtual, so vital to the United States that the incapacity or destruction of such systems or assets would have a debilitating impact on national security,” and

• “critical technologies,” which include (rather tautologically) “critical technology, critical components, or critical technology items essential to national defense.”

CFIUS / FINSA3

1213 January 2008

Extended Reviews in Many Cases

Requires a 45-day investigation (beyond the initial 30-day review) where:

(1) a foreign government or a foreign-government-controlled entity is a party to the proposed transaction, unless Treasury Secretary (or his deputy) and head of lead agency (selected based on subject-matter expertise) jointly determine that the transaction will not impair national security;

(2) national security threat has not been mitigated during initial review;

(3) foreign control of any critical infrastructure could impair U.S. national security, unless alleged impairment has been mitigated during the initial review; or

(4) the lead agency and CFIUS concur that an investigation should occur.

CFIUS / FINSA4

1313 January 2008

“Evergreen” Provision

• CFIUS or President may reopen an investigation at future date if a party (1) submits false or misleading material information to CFIUS or (2) materially breaches a negotiated mitigation agreement.

• CFIUS or President may order a divestiture if “there are no other remedies or enforcement tools available to address such breach.”

CFIUS / FINSA5

1413 January 2008

3. Unworkable New FCC Environmental Rules for Undersea Cables

• FCC has adopted new coastal management rules that could greatly delay the issuance of cable landing licenses for new undersea cables—of critical importance for Asia-Pacific connectivity.

1513 January 2008

What is the Coastal Zone Management Act (“CZMA”)?

• CZMA is a federal statute allowing states to require that federal permitting and licensing actions affect state coastal zone be “consistent”with state coastal management program

• States may listed federal activities subject to consistency reviews, and also review “unlisted activities”

• No state has listed cable landing licenses, though states could review them as “unlisted activities”

• States don’t need special FCC rule to conduct consistency reviews; in fact, states and FCC operated without such a rule for 35 years

• NOAA opposed FCC’s recent rule proposals

FCC / CZMA2

1613 January 2008

New Note to Section 1.767(a)(10) of FCC Rules

• Operator must determine whether it is required to certify to the state(s) where the cable lands that its proposed activities will comply with the enforceable policies of the coastal management programs of the relevant state(s)

• If state(s) require consistency certification, certification must be included as part of FCC application

• Rule took effect on October 25, 2007

FCC / CZMA3

1713 January 2008

New Certification in Section 1.767(k) of FCC Rules

• Applicant must certify that “the submarine cable system will not be located in any states where the cable landing licenses may be subject to the consistency certification requirements of the Coastal Zone Management Act, 16 U.S.C. 1456.”

• Rule will take effect in early 2008• Workaround: As certification requirement

not yet effective, applicants have stated that they are “aware of and will comply with the requirements of the Coastal Zone Management Act of 1972, as amended (“CZMA”), and the National Oceanic and Atmospheric Administration’s CZMA implementing rules, codified at 15 C.F.R. Part 930 Subpart D.”

FCC / CZMA4

1813 January 2008

Harms Posed by FCC’s New CZMA Rules• Uncertainty: state authority to review unlisted

activities means that an operator cannot know if a state will take issue with a particular cable

• Delay: rules could easily delay grant of cable landing license by 6 months or more

• Deprives operators of ability to signal to investors and lenders that a submarine cable project is consistent with U.S. foreign policy, national security, telecommunications connectivity, and competition objectives

• Allows any one state to hold an entire cable project hostage

• Could re-order entire permitting process for cables

FCC / CZMA5

1913 January 2008

Example: the Florida Paradox

• Florida treats the issuance of state cable permits as its consistency determination.

• To obtain state cable permits, Florida law requires that a cable operator have a cable landing license.

• But under the FCC’s new CZMA rules, a cable operator can’t get a cable landing license without first obtaining the state cable permits.

FCC / CZMA6

2013 January 2008

Legal and Policy Challenges by North American Submarine Cable Association (“NASCA”)

• NASCA has petitioned FCC to defer implementation of new certification requirement and to reconsider and rescind all new CZMA rules.

• NASCA has also challenged the FCC’s compliance with the Paperwork Reduction Act and the White House Office of Management and Budget.

• Comments on NASCA petition due January 17, 2008; replies due January 28, 2008.

FCC / CZMA7

2113 January 2008

4. Continuing Failure of FCC to ReformInternational Bearer Circuit (“IBC”) Fees

• Current fee methodology creates significant economic distortions and confusion in international capacity markets.

2213 January 2008

What are IBC fees?• FCC assesses annual regulatory fees on

active international capacity; in 2007, the rate was $1.05 per 64 KB circuit or circuit-equivalent.

• Fees due each September for capacity sold in previous calendar year (so fees for capacity sold in 2006 were due in September 2007).

• A cable operator must pay IBC fees for capacity sold to all customers except those holding international Section 214 authority (as 214 holders must themselves pay—FCC seeks to avoid double-payment).

FCC / IBC Fees2

2313 January 2008

When must an undersea cable operator pay fees?Obligation of a non-common-carrier undersea cable operator to pay IBC fees applies regardless of:

• “country of incorporation or organization of either the entity holding a cable landing license issued by the Commission, or of that licensee entity’s ultimate corporate parent.”

• whether the licensed operator sells capacity directly or “through an through an affiliated sales or marketing subsidiary,” even if the affiliate is organized in a foreign country or has no commercial presence in the United States

• “whether the operator sells the capacity on a lease or IRU basis”

• “the nature of the services its customers provide using such capacity,” whether voice or data.

Facilities-based international Section 214 holders must also pay.

Source: FCC Public Notice, DA 04-2027 (July 6, 2004)

FCC / IBC Fees3

2413 January 2008

Why Capacity-Based Fees Make No Legal or Economic Sense

• Contrary to Section 9 of Communications Act, capacity-based fees bear no relation to FCC efforts to regulate undersea cables, which in fact is characterized by deregulation

• In last 10 years, capacity prices have dropped 90 percent while capacity has increased 2000 percent; because fee decreases haven’t kept pace, fees threaten to exceed total revenues for certain capacity offerings

• Fees for 10 GB wavelength = 78 percent of revenues

• By comparison, cable TV operators and wireless providers pay 0.10 percent of revenues for FCC regulatory fees

• Concept of “active capacity” problematic

• Active capacity does not always generate revenue (e.g., ring configuration, backbone traffic from peering arrangements)

• Methodology encourages strategic behavior (e.g., turning down circuits on December 30th)

• Operators unable to price capacity to recover the cost of IBC fees, as fees as assessed in arrears and customers object

• IBC fee levels have led some carriers to route traffic outside the United States in order to avoid fees

FCC / IBC Fees4

2513 January 2008

Reform Proposals• Reform proposals—based on legal, economic,

and administrative arguments—have sought to move from capacity-based fees to license-based fees

• First proposed by Tyco Telecom in 2002

• FCC came close to adopting new methodology in 2004 and 2005, but declined in part out of concern that it was a “one company” issue

• VSNL petitioned the FCC for new methodology in early 2006

• In August 2007, FCC deferred action on VSNL petition; 2 out of 5 commissioners supported concept of rulemaking to address methodology

FCC / IBC Fees5

2613 January 2008

Why Hasn’t the FCC Acted?

• Apathy: reform unlikely so long as FCC recoups sufficient fee revenues and operators invent extra-legal workarounds

• Fear of a zero-sum game with winners and losers among current IBC fee payers

• Fear of encouraging challenges to methodologies for other FCC fee categories

• FCC may assume that no operator will take the FCC to court, or that it would win any court challenge

• Lack of a uniform industry position, including criticism of or opposition to reform proposals from cable operators who derive most of their revenues outside the undersea cable industry

• Politics

FCC / IBC Fees6

2713 January 2008

Kent D. Bressie

HARRIS, WILTSHIRE & GRANNIS LLP1200 18th Street, N.W., Suite 1200Washington, D.C. 20036-2516U.S.A.+1 202 730 1337 office+1 202 460 1337 mobile+1 202 730 1301 faxkbressie@harriswiltshire.comwww.harriswiltshire.com