To:From:Date: January 8, 2015Re: Net Neutrality – TMT Industry Impact

Executive Summary and Conclusions

The term “Net Neutrality” was first coined in a 2003 academic paper by Columbia University Law School professor, Tim Wu, who examined the role of regulatory/communications policy in managing the inherent conflict between the private interests of broadband providers and the public’s interest in a competitive innovation environment centered on the Internet. Proponents of open access, the idea that all data on the Internet should be treated equally, see it as a structural remedy to guard against an erosion of the ‘‘neutrality’’ of the network as between competing interests of content/edge providers (i.e. Netflix, Hulu Plus, Skype, Facebook, Spotify, YouTube who all benefit from broadband connections with their customers, utilize such connections significantly but weren’t required to pay for such access under recent Federal Communications Commission (FCC”) rules) and infrastructure owners1. Critics, meanwhile, have taken the stance that open-access regulation is unnecessary, likely to slow the pace of broadband deployment, stifle innovation and would be unfair to the infrastructure companies (if unable to regulate access speeds or charge for high-usage, a toll-road of sorts) who have made the infrastructure investments required to deploy advances that consumers benefit so greatly from.

This memo seeks to explain the history of net neutrality, how it is viewed from a technical/regulatory standpoint and how various scenarios of its implementation could potentially affect a number of TMT industry verticals: telecommunications, cable, data transport and fiber companies.

Following the latest judicial outcome with respect to the FCC’s 2010 Open Internet order (the FCC’s last attempt to address Net Neutrality, see discussion below), there are a confluence of legislative/ rule-making changes afoot which appear to be on the verge of permanently changing the telecom/Internet landscape in the United States:

FCC/Obama Plan: While it was reported that the FCC’s Chairman Tom Wheeler was caught by surprise by Obama’s November Net Neutrality statement2, in more recent press accounts indicate that he

1 Infrastructure owners include “last-mile” cable companies/Internet Service Providers (“ISPs”) such as Comcast, Verizon FIOS, Google Fiber and so-called transit ISPs, the fiber /infrastructure owners such as Level 3 Communications and Cogent, who provide access but don’t necessarily derive significant revenues relative to the significant capacity/bandwidth usage required for delivering such content. Note that the heavy reliance on such so-called transit ISPs by bandwidth intensive content owners has declined in recent years as most content owners have introduced peer to peer connections with each ISP that bypasses the backbone, by using what is known as "content delivery networks" (CDN). CDNs are a network of servers located in different parts of a country (or the globe) that stores files to be used by website visitors/users/content viewers. In the case of Netflix’s CDN, which is known as Open Connect, Netflix places a box with a copy of itself (nearly the entire catalog of its offerings) inside local ISP data centers (to be maintained by the ISP), which reduces the traffic flow to the "last mile," (the last chunk of network between the local data center and subscribers’ homes).2On November 10, 2014, President Obama urged the Federal Communications Commission to expand its authority over broadband providers in setting “the strongest possible rules to protect net neutrality,” including reclassifying ISPs such as Comcast and Verizon FIOS under Title II of the Communications Act, http://www.whitehouse.gov/net-neutrality

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appears inclined to agree to plan wherein the FCC (an independent U.S. government agency overseen by Congress but not reporting to it), would reclassify consumer broadband service under Title II of the Telecommunications Act — while at the same time forbearing from rate regulation and other Title II provisions less relevant to broadband services (a “light-touch” or “hybrid” approach to the regulatory regime enforcement). Once reclassified, a measure which appears likely to survive judicial challenges that have proven nettlesome for the FCC’s recent regulatory measures under Title I, the FCC could ban Internet providers from speeding up internet content that they like and slowing down what they don't. Internet providers oppose the reclassification of broadband under Title II, because it could potentially give the FCC leeway to impose price regulations, conditions on wholesale access and other controls. Such critics also cite the prospect of such FCC Title II regulatory burden as being a driver for reduced infrastructure-related capital expenditures reported in the industry since the January 2014 Verizon v. FCC decision3, an outcome which could have deleterious long-run implications for the consumer and US economy. With the FCC’s commission membership being comprised of three Democrats and two Republicans, Wheeler appears to have a majority he needs to achieve reclassification. Press accounts just prior to the date of this writing indicate that Wheeler will introduce the proposed regulations as early in February of 2015 and will ask the commission to vote on the regulations at their February 26 th

meeting.

Pending GOP Legislative Reform: Following Obama’s November announcement, it has been reported that Wheeler’s plan, which slated to arrive in early 2015, is expected to run into significant republican opposition as was telegraphed by Republican’s such as Sen. John Thune (R-S.D.), who’s set to take the helm of his chamber’s powerful Commerce Committee. Thune has floated the idea of a bill that would pre-empt an FCC move to adopt Obama’s favored approach. One important piece of the proposed legislation would establish a new way for the FCC to regulate broadband providers by creating a new, separate provision of the Communications Act known as "Title X,". Title X would enshrine the key elements of the tough net neutrality principles called for by Obama and as set forth in previous FCC’s previous attempt to address via the 2010 FCC Open Internet Order (which tried to enforce: i) transparency, ii)”no blocking” and iii) no unreasonable discrimination). For example, it would give FCC Chairman Tom Wheeler the authority to prevent broadband companies from blocking or slowing traffic to internet sites, or charging content companies such as Netflix4 for faster access to their subscribers — a tactic known as "paid prioritization." The key benefit of this approach, as opposed to reclassification under Title II, is that it would use legislation to determine the regulatory approach, ensuring a slightly

3 Examples: In April of 2014, AT&T outlined its plan to high-speed fiber optics networks in 100 U.S. cities. However, several days after Obama’s November 10, 2014 Net Neutrality statement, which renewed a push for Internet regulation under Title II, AT&T's CEO, Randall Stephenson stated the following at a analyst conference: "We can't go out and invest that kind of money deploying fiber to 100 cities not knowing under what rules those investments will be governed." Also, during Cisco’s November 2014 conference call, Cisco's (CSCO) CEO, John Chambers also cited the renewed Network Neutrality threat, as the reason CSCO has seen a substantial decline in demand from the largest three U.S. service providers.4 Following the January 2014 Verizon v. FCC decision that eliminated "net neutrality" rules which had previously prohibited Internet providers from prioritizing content, Comcast, Verizon and others cable companies took a more aggressive stance in how content streams through their "pipes” by refusing to add additional interconnection points as they had previously to address Netflix’s ramping traffic. This effectively forcing Netflix to agree to pay Comcast, Verizon and others an access fee to ensure Netflix movies and television shows stream smoothly to their customers. This improved streaming was accomplished by adopting usage of Netflix’s CDN (content delivery network), Open Connect.

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more hands-off approach by the FCC rather than relying on the discretion of the FCC to forbear from regulations it deems to be inapplicable. This legislation would quash reclassification and appears likely to be approved given the Republican majority in both the US House and Senate, though it may need to override (with 66.6% of the vote in both houses) Obama’s potential presidential veto of such legislation, so any solution would need to cater to some portion of the Democrat legislative base or need Obama’s support. Other options available to lawmakers that fall short of legislation include potentially cutting the FCC’s budget or implementation of the seldom-used Congressional Review Act, which allows Congress to void major rules issued by federal agencies (though that would also require Presidential approval or meet the override threshold).

Conclusions:It is difficult to gauge the implications of Net Neutrality on the various TMT industry verticals, since most existing businesses have been living under the broad Net Neutrality guidelines set forth by the FCC under Title I for several years, so the changes aren’t likely to be dramatic. However, if the issue is settled in a manner that’s deemed acceptable - which, in our view, would have to permanently address the specter substantial regulatory oversight, new taxes and provide infrastructure owners with the ability to charge high-usage content providers - to at least a majority of industry participants, it could open up a wave of substantial innovation and telecom spending that had been shelved pending a definitive legislative/judicial/regulatory outcome.

Regulatory uncertainty, without a doubt, is the main reason some ISPs are choosing not to invest or stall on the decision to invest in their infrastructure. The issue is best described by AT&T Chairman and CEO Randall Stephenson, “It is prudent to pause” before making further investments in fiber “not knowing under what rules that investment will be governed.” Even though it is well-reported that the FCC would likely exercise “forbearance” from rate regulation and taxation (USF fees, primarily), as President Obama suggested under his reclassification plan, the threat of regulatory burden sent investors scurrying as was seen in depressed stock prices of the major MSO’s in the days following Obama’s November 2014 Net Neutrality statement. Most industry analysts attributed the decline to the doubt that reclassification cast on cable and telecom companies’ abilities to generate a “sufficient return” on capital investments; nonetheless, since that initial shock, it appears that investors have by-in-large brushed aside such concerns as the stock prices of the largest MSO’s have rebounded and have shot past their pre-announcement highs. As Morgan Stanley cable analyst, Benjamin Swinburne, wrote: ”these specific four asks5 are extremely benign and would have essentially no impact on the outlook for broadband revenue growth. We believe this to be the case because first, #1-3 are already essentially in place, and second, because we have never expected any material revenue lift from charging for prioritization in our outlook for cable.” In addition, Media analyst Craig Moffett said in December of 2014 that investors have "largely shrugged off" the risk of Title II because they think they can live with the risks that come with the change. However, he said he thought the risks were more significant than some investors attribute to the change because the questions around forbearance were more complicated. He also indicated that one of the key questions that remain unanswered is whether transport will be free (as Netflix would prefer), or will it be a paid service

On the other hand, content providers and consumer groups are poised to benefit from the proposed reclassification. Netflix, Google, Amazon and Hulu are some of the companies who will likely gain if FCC reclassified broadband under Title II of the 1934 Communications Act or if Title X legislation eliminates payment requirements for access by content owners. At present, these companies pay special charge to ISPs for speedy transmission of their content. Interestingly, in its role as an ISP via its Google Fiber service, Google

5 President Obama's proposal recap: 1) no blocking as long as the site is legal; 2) no throttling, or intentionally slowing down or speeding up specific content; 3) increased transparency, and 4) no paid prioritization (Netflix or Hulu can't receive either faster or slower service based on whether the company pays a fee to the ISP).

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may also benefit from reclassification in another way since it may gain access to utility poles and other essential utility infrastructure to aid expansion of its broadband service (Section 224 of the 1934 Act/1996 Act Section 224 confers upon cable system operators and telecommunications carriers the right of “nondiscriminatory access to any pole, duct, conduit, or right-of-way owned or controlled” by a utility).

Background

Since the term Net Neutrality revolves around the telecommunication/Internet regulatory framework in the US - past, present and future – it is important to look back before looking forward.

Under the current regulatory regime in the United States, traditional telecommunications providers (or common carriers as they are known in regulatory terms) are regulated by extensive rules set forth by the FCC which were drafted pursuant Title II (Common Carriers) of the Communications Act of 1934 (the “1934 Act”) – the same law that established the FCC and empowered it administer the law and policies stemming from the 1934 Act; while most telecom regulations were originally intended to facilitate the rollout of wireline facilities nationwide at reasonable charges, a significant vestige remains: telecommunication providers that fall under Title II must contribute 16.6% interstate telecommunications revenue to the federal Universal Service (USF) Fund, which is a pool of funds designated to promote universal telecommunication service across the US without regard to the underlying cost. As permitted under the 1934 Act, the FCC has continued to maintain broad and extensive regulations governing “common carriers” written to ensure that they (the common carriers) act “in the public interest” by providing the exact same service, at the same rate, to everyone; however, the Telecommunications Act of 1996 (the “1996 Act”) made a significant distinction between providers of telecommunications services and so-called information services6, which would be subject to a much weaker regulatory framework under Title I (General Provisions).

Since the 1996 Act, the FCC policy position with respect to regulating internet access has gravitated. The official version of the story is that in 2002, the FCC voted to classify cable modem service as an “information service,” which falls under Title I of the 1934 Act (as amended). The justification was that less regulation would “promote investment and innovation,” which would result in “better quality, lower prices, and more choices for consumers.” The FCC followed suit and classified wireless broadband Internet access as an information service in 2007. Since then, notwithstanding the FCC’s policy statements 7 on this issue, the dichotomy of interpretation/regulatory regime (Title I versus Title II) has created significant issues for industry players as there was room for a number of legal interpretations. At the same time, however, the FCC retains the flexibility under the 1934 Act and 1996 Act to either: i) invoke Section 706 of the 1996 Act8 or ii) switch course altogether

6Under the 1996 Act, basic services are now called Title II "telecommunications carriers," which simply transmit information, and enhanced services that offer interactive features are classified as Title I "information service providers." DSL companies are classified as carriers, while AOL-style internet portals fall under information services.7 The FCC’s first attempt to regulate broadband providers consisted of four "open internet" principles adopted in 2005. These principles had little actual effect until they were substantially codified in the Open Internet Order of 2010. However, these regulations were ultimately overturned in January of 2014 when the DC court ruled against the FCC in Verizon v. the FCC, citing the FCC’s inability to impose common carrier rules on information service providers, which are governed under Title I. 8Section 706 of the 1996 Act requires the FCC to determine whether “advanced telecommunications capability [i.e., broadband or high-speed access] is being deployed to all Americans in a reasonable and timely fashion.” If this is not the case, the act directs the FCC to “take immediate action to accelerate deployment of such capability by removing barriers to infrastructure investment and by promoting competition in the telecommunications market.” Some industry analyst believe that Section 706 would give the FCC the authority to regulate ISPs to “promote competition in the local

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and reclassify certain categories of providers under Title II, and then relying on the second subsection 202 (Nondiscrimination) of the 1934 Act which clearly states that common carriers can’t “make any unjust or unreasonable discrimination in charges, practices, classifications, regulations, facilities, or services.” From this language, it’s a bit easier to see how Title II connects to net neutrality, allowing the FCC to achieve their idealized consumer-oriented regulatory goals. With reclassification under Title II, however, come a myriad of potential costs which might be unpalatable by a variety of constituents including: excessive regulation, stifled innovation, politically motivated oversight, potentially higher cost (via the inclusion of USF charges) for consumers and less investment by the owners of telecom infrastructure. It should be noted that a draft proposal from FCC Chairman Tom Wheeler earlier in 2014, he wrote that if it does decide to reclassify ISPs, the FCC would likely forbear from applying all but sections 201, 202, 208, 222, 254, and 255 of Title II (flexibility which is permitted under the 1996 Act).

Following Verizon’s January 2014 appeals court victory challenging the FCC’s authority to implement the 2010 Open Internet order, has been extensive debate about whether net neutrality should be required by law (either through new legislation or through reclassification under Title II). The U.S. Court of Appeals ruled that the FCC overreached their authority in barring broadband providers from slowing or blocking selected Web traffic. This decision has led to a number of discussions between the FCC, ISPs, and large data driven companies like Google, Netflix, and Facebook and also resulted in over 4 million comments from industry participants, including but not limited to Netflix9, Comcast10, Verizon11, Comptel12, the National Cable and Telecommunications Association13, the Computer and Communications Association14, Public Knowledge (a non-profit Washington, D.C.-based public interest group that is involved in advocacy for an open internet) and the general public.

Net Neutrality Overview

What is Net Neutrality?Net Neutrality is the idea that all users of the Internet should have equal access to the same network performance and data speeds, without control or extra expense. The idea relates to the nature of the Internet itself concerning the flow of data across the vast network or wires, servers and ISPs on smartphones, computers, tablets, and TVs.

Those who support net neutrality view the Internet more like a utility (like water or electricity), a service that is a citizen’s basic right, while those who oppose net neutrality believe there should be more control of the Internet’s flow of data, resulting in multiple tiers to the Internet, (commonly known as a fast and a slow lane) and that the those utilizing the fast lane should pay more.

Summary of Net Neutrality History The Net Neutrality concept originated during the age of the telegram, around 1860 or even earlier. Standard telegrams were routed “equally” without discerning their contents and adjusting for one application or another. These networks were considered “end-to-end neutral.”

telecommunications market” and “remove barriers to infrastructure investment,” but it’s not totally clear how that would allow the commission to safeguard net neutrality.9 http://apps.fcc.gov/ecfs/document/view?id=6000100052410 http://apps.fcc.gov/ecfs/document/view?id=6000101112211 http://apps.fcc.gov/ecfs/document/view?id=6000101000612http://www.comptel.org/Files/filings/2014/12-11-13 http://op.bna.com/der.nsf/id/ksas-9rfvef/$File/NCTA%20State%20Tax%20Increase%20Letter.pdf14 http://apps.fcc.gov/ecfs/document/view?id=60001011438

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The Internet had always been categorized under U.S. law as an information service, and thus was not subject to common carrier regulations. In 2004, the FCC announced a set of non-discrimination principles, which was called the principles of “Network Freedom.” The announcement was made to encourage ISPs to offer four freedoms:

1. Freedom to access content. 2. Freedom to run applications.3. Freedom to attach devices.4. Freedom to obtain service plan information.

In 2005, the FCC showed willingness to enforce its network neutrality principles by opening an investigation about Madison River Communications, a local telephone company carrier that was blocking voice over IP service. Although the FCC did not fine Madison River Communications, the FCC’s action established that it would investigate US operators who discriminated against voice over IP traffic.

Historically, broadband services were regulated differently based on the technology by which they were carried. Cable Internet has always been classified as an information service, while DSL was regulated as a telecommunications service. In 2005, the FCC reclassified Internet access across the phone network, including DSL, as “information service” relaxing the common carrier regulations and unbundling requirement. A set of modified principles were created:

1. Consumers are entitled to access the lawful Internet content of their choice;2. Consumers are entitled to run applications and services of their choice, subject to the needs of law

enforcement;3. Consumers are entitled to connect their choice of legal devices that do not harm the network; and

Consumers are entitles to competition among network providers, application and service providers and content providers.

In 2007, the FCC tried to punish Comcast for throttling BitTorrent, a move that demonstrate their stance on preserving the open character of the Internet. However, the U.S. Court of Appeals denied the cease-and-desist order against Comcast because it was deemed that the FCC lacked the authority under Title I of the Communications Act of 1934, to force Internet service providers to keep their networks open, while employing reasonable network management practices, to all forms of legal content.

By 2009, the FCC chair Julius Genachowski announced a series of proposals that would prevent telecommunications, cable and wireless companies from blocking certain information on the Internet, such as Skype applications. The proposal added two rules to its 2005 policy statement: the nondiscrimination principle and the transparency principle. The first stated that ISPs must not discriminate against any content or applications while the latter required that ISPs disclose all their policies to customers. Genachowski argued that wireless should be subject to the same network neutrality as wireline providers. On April 6, 2010, in Comcast Corp. v. FCC, it was ruled that the FCC lacked the authority to force ISPs to keep their networks open to all forms of content.

In December 2010, the FCC approved the FCC Open Internet Order, which banned cable television and telephone service providers from preventing access to competitors or certain web sites such as Netflix. A set of 6 net “neutrality principles” were passed: Transparency, No Blocking, Level Playing Field, Network Management, Mobile, and Vigilance. The net neutrality rule did not keep ISPs from charging more for faster access, however.

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Why the Recent Fuss?

Verizon Communications Inc. vs. FCCOn January 14, 2014, the U.S. Court of Appeals in Washington, DC ruled that the FCC overreached in barring ISPs from slowing or blocking selected Internet traffic. Three judges on the D.C. Circuit of the U.S. Court of Appeals ruled that the previous set of net neutrality standards violated the law and the FCC’s own rules. According to the judges, the problem was that the FCC’s ban on blocking or discriminating against certain Internet traffic resembled rules that would apply to a “telecommunications service,” yet the FCC has classified broadband Internet as an “information service.” While two of the three judges agreed that the FCC had the right to regulate ISP’s relationships with content providers, even if the FCC reclassified broadband as an information service under Title II of the Communications Act (“Title II”), they didn’t think the FCC had done it correctly. As a result, FCC Chairman Tom Wheeler is considering a new set of rules that will govern net neutrality and will likely be announced 1Q2015.

The Difference Between a Telecommunications Service Provider and Information Service Provider

Telecommunications services are common carriers, expected to provide basic service on equal terms to all and to let other businesses make use of their infrastructure to provide information services.

In the early days of the Internet, the hundreds of competing dialup ISPs that utilized existing phone lines to provide their service were categorized as information services companies. However, in 1998, the FCC decided that the broadband DSL connections provided by telecommunication companies were considered a telecommunications service. In 2002, the FCC switched course again and ruled that broadband access provided by cable TV companies was an information service, the reasoning being, that cable broadband had ended the DSL monopoly and created a competitive market once again (including DSL and other broadband services). In 2005, the Supreme Court decided that the FCC was within its rights to make that decision.

Based on the U.S Court of Appeals ruling, President Barack Obama came out in favor of reclassifying broadband providers under Title II as common carriers. Reclassifying broadband providers under Title II will maintain the FCC’s policy prohibiting blocking, traffic discrimination and fast lanes, and including strong transparency mandates, vital to preserving net neutrality.

High-level Arguments Supporting and Opposing Net Neutrality

The pro- and anti- net neutrality players are relatively easy to identify. The supporters of net neutrality are Internet-content and tech-service companies that believe the Internet should be an equal playing field, offering a reliable way for every player to equally distribute content while those who oppose net neutrality are the broadband cable and wireless providers that support deregulation that would allow more “free-market”, profit-driven practices. Please see below for a deeper discussion on the supporting and opposing arguments.

The Supporting ArgumentSupporters of net neutrality argue that the best way to preserve a free and open Internet is to regulate the Internet as a utility, which provides the same access to any website. The overarching argument is that a controlled Internet and an Internet with a fast and a slow lane, would limit both competition and innovation in the following ways:

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1. Internet service providers such as Comcast, Verizon, and Time Warner Cable could potentially control Internet traffic in a way that best suits their own financial interests. For example, cable TV providers that also provide high-speed Internet service might be able to diminish the quality of service to Internet-only services such as Netflix and Hulu that may lure away their customers. An ISP could also affect specific services based on payments by direct rivals. For example, a payment by Skype could see Viber’s VoIP (instant messaging and Voice over IP (“VoIP”) app for smartphones) performance cramped.

2. Only the wealthiest companies will be able to afford the additional costs to ensure their content is accessible through the fast lanes, while the smaller, newer, and less wealthy companies are operating on an inferior service. The concern is how does a new start-up, operating on an inferior service, compete with a more established and wealthy company?

Overall, supporters of net neutrality argue that entrepreneurs would have been discouraged from developing a wide range of online services that have created jobs and wealth, if over the last 20 years, net neutrality hadn’t been in effect.

The Opposing ArgumentThose who oppose net neutrality, support an Internet that is controlled and treated as a “private toll road” with heavy users paying to facilitate the extra demands they are putting on its infrastructure. When taking a look at video streaming service (such as Netflix) in the US, video streaming represents approximately one-third of peak Internet traffic and as such, the argument is that companies like Netflix and Facebook who get the most use from the Internet should pay more to use it. The argument against net neutrality is two-fold:

1. First, businesses need ISPs to continue investing in their broadband networks. It is argued that price regulation often truncates the returns on an investment in a regulated industry, and thereby decreases investment. Based on a December 2014 letter to the FCC15 signed by a number of Telecommunications Industry Association (TIA) members, including Intel, Qualcomm, IBM, Cisco, Juniper Networks and Ciena -- which supply services and equipment for telecommunications networks -- any plans to place the Internet under Title II public utility rules would be harmful for the economy and for the Internet's development and could result in the loss of up to $45.4 billion (~21%) in Internet-related capital investment over the next five years.

2. Second, businesses need the opportunity to innovate. The ability to purchase priority delivery from ISPs would spur innovation among both large and small businesses. Priority delivery (fast lane) would enable certain real-time applications to efficiently operate and generally perform at higher levels. Absent net neutrality restrictions, entrepreneurs in their garages would devote significant energies trying to topple more established companies. But if real-time applications are not permitted to run as they were intended, these creative energies might flow elsewhere.

In some respect, the reality of the fast lane already exists. Companies including Google, Facebook, and Netflix, already benefit from what are essentially Internet fast lanes, and this has been the case for several years. The companies have direct connections to big ISPs like Comcast and Verizon, and they run dedicated computer servers deep inside these ISPs. These are known as “peering connections” and “content delivery servers,” and they are a vital part of the way the Internet works. The illustration below accurately depicts how companies like Google or Netflix directly access the ISPs.

15 http://www.tiaonline.org/sites/default/files/pages/Internet_ecosystem_letter_FINAL_12.10.14.pdfPage 8

These types of peering arrangements are made in response to increasingly slow connection speeds that have occurred due to an uptick in bandwidth usage.

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