**Draft #1 3-31-04**

# WHITE PAPER ON DIVERSITY CREDITS

**David Honig**

**Member, Transactional**

**Transparency Subcommittee,**

**FCC Advisory Committee on**

**Diversity for the Digital Age**

**202-332-7005**

> **dhonig@crosslink.net**

**March 31, 2004**

Presented here is a draft proposal for FCC consideration of "Diversity
Credits." The proposal was developed at the request of the Transactional
Transparency Subcommittee of the FCC Advisory Committee on Diversity in
the Digital Age.

**I. [Diversity Credits As An Incentive For Access to Capital And
Opportunity]{.underline}**

Based on its interviews with broadcast industry experts, the
Subcommittee members are generally agreed that the single best incentive
for minority access to deal flow was the 1978-1995 Tax Certificate
Policy. While it was in operation, the Tax Certificate Policy was
responsible for about 2/3 of all minority-owned broadcast stations. The
Policy was effective because it gave sellers an economic incentive to
consider selling properties to minorities.

Access to capital remains a significant impediment to minority
ownership. [See]{.underline} NTIA, "Changes, Challenges, and Charting
New Courses: Minority Commercial Broadcast Ownership in the United
States" (December, 2000) at 45-46. The Tax Certificate Policy provided
minorities with a source of access to capital, since they could use
their ability to deliver tax relief to the seller as a means of securing
price concessions in transactions.

Unfortunately, it appears unlikely that Congress will enact a
replacement for the Tax Certificate Policy in the foreseeable future.
Consequently, the Diversity Credits proposal is offered as a means by
which the Commission could achieve the transaction-stimulating
objectives of the Tax Certificate Policy without the need for
authorizing legislation.

**II. [The EPA's Market-Trading Paradigm Translatable To Diversity
Credits]{.underline}**

The Diversity Credits concept is modeled after the EPA's private market
approach to greenhouse gas emissions. Under the EPA's model, an
aggregate level of clean air is established, subject to the trading by
individual companies of pollution credits in a private market that
resembles a commodities exchange. Through this market-based approach,
aggregate pollution levels have steadily declined without the need for
substantial EPA case-by-case oversight.

There is a rich literature on the subject of how market forces can be
harnessed to secure social policy objectives otherwise obtainable only
through command-and-control regulation. Professor Robert N. Stavins,
Director of the Environmental Economics Program at Harvard's Kennedy
School of Government, is the leading exponent of this approach. One of
Professor Stavins' articles, "Market-Based Environmental Policies," in
Public Policies for Environmental Protection (1998), comprehensively
explains the concept and related paradigms. [See also]{.underline}
Robert N. Stavins, "What Can We Learn from the Grand Policy Experiment?
Lessons from SO2 Allowance Trading," 12 [J. of Economic
Perspectives]{.underline} 69 (1998).

An example of the successful use of emissions trading is the Chicago
Climate Exchange, patterned after commodity exchanges and created by
major corporations for "trades of credits earned by firms that exceed
emission-reduction goals." Peter Behr and Eric Pianin, "Firms Start
Trading Program for Greenhouse-Gas Emissions," [Washington
Post]{.underline}, January 17, 2003, p. A14. Among the 14 initial
members of the Exchange are DuPont Co., Ford Motor Co., Motorola Inc.
and the City of Chicago. Each Exchange member agreed to reduce average
greenhouse gas levels from 1998 to 2001 by four percent over the next
four years, and "\[c\]ompanies that exceed reduction goals could sell
excess reductions to their members that were falling behind their
targets. The price would be set by bids on the exchange. Members that
failed to meet the 4 percent target would be disciplined at that time by
the exchange" and would face sanctions. [Id.]{.underline}

The EPA model has been proffered in the broadcast context by University
of Chicago law professor Cass Sunstein. His article, "Television and the
Public Interest", 88 [Calif. L. Rev.]{.underline} 499 (2000), explores
how the environmental market-based paradigm could be applied to
television programming. The Diversity Credits paradigm would apply a
similar market-based approach to television and radio ownership.

**III. [How Diversity Credits Would Operate]{.underline}**

Through rulemaking, the Commission would create Diversity Credits and
initially attach them to broadcast licenses. The number of Diversity
Credits attached to each license would be commensurate with the extent
to which the licensee is a socially and economically disadvantaged
business ("SDBs").

When a transaction occurs that would promote diversity --
[e.g.]{.underline}, the breakup of a local radio ownership cluster, a
crossownership or a duopoly, or the sale to an SDB \-- the FCC would
give the seller additional Diversity Credits, commensurate with the
extent to which the transaction promotes diversity. Diversity Credits
could also be issued to reward other diversity-promoting initiatives,
such as the creation of media incubators. In this way, the seller would
be provided a direct incentive to undertake market-diversifying
transactions, and particularly to sell stations to SDBs. This procedure
would parallel the use tax certificates, under Section 1071 of the
Internal Revenue Code, to incentivize structural diversity
([e.g.]{.underline}, xx) and to incentive minority ownership
([see]{.underline} [Statement of Policy on Minority Ownership of
Broadcast Facilities]{.underline}, 68 FCC2d 979, 983 (1978)).

In like manner, when a transaction would reduce diversity --
[e.g.]{.underline}, the creation or expansion of a cluster,
crossownership or duopoly (but not the sale to non-SDBs) the FCC would
reclaim Diversity Credits from the buyer, commensurate with the extent
to which the transaction reduces diversity. Thus, the buyer would be
disincentivized to undertake market-consolidating transactions.

Finally, the occasion will arise when the number of Diversity Credits
held by a company is insufficient to permit the company to complete a
particular market-consolidating transaction. In that event, the buyer
could purchase Diversity Credits from companies having more Diversity
Credits than they need. The price for Diversity Credits would be
established in the private marketplace -- much as the market price for
the EPA's "pollution credits" is established in the private marketplace.
For the most part, the sellers of Diversity Credits in the private
marketplace will be SDBs, as well as companies that formerly sold
stations in pro-diversifying transactions. In this way, a private market
for Diversity Credits would provide SDBs with much-needed access to
capital. Further, those with the greatest need for access to capital
will have the greatest number of Diversity Credits and therefore will
have the greatest ability to raise capital by selling excess Diversity
Credits. In this way, Diversity Credits would be a self-regulating,
market-driven mechanism providing both access to opportunity and access
to capital.

Minority status could be a factor in qualifying as an SDB if the
Commission finds, through rulemaking, that minorities, under certain
conditions, are socially and economically disadvantaged in the
broadcasting industry because of their race. Not all minorities would be
considered socially and economically disadvantaged, and some
nonminorities would be considered socially and economically
disadvantaged. The paradigm for SDB qualification could be borrowed from
the Department of Transportation's contracting program, which was upheld
in [Adarand Constructors, Inc. v. Slater]{.underline}, 228 F.3d 1147
(10^th^ Cir. 2000), [cert. dismissed as improvidently granted sub
nom.]{.underline} [Adarand Constructors, Inc. v. Mineta]{.underline},
534 U.S. 103 (2001).

**IV. [The Advantages Of Diversity Credits]{.underline}**

Diversity Credits would have these advantages:

1.  They would incentivize diversity and competition, and discourage
    consolidation, by harnessing market forces rather by than requiring
    more Commission regulation or oversight in specific cases.

2.  Diversity Credits would give SDBs an asset convertible into capital,
    thereby helping cure the single greatest barrier to entry faced by
    SDBs. Further, the capital available to SDBs through this mechanism
    would be roughly commensurate with SDBs' need for capital.

3.  Diversity Credits would incentivize sales of stations to SDBs,
    thereby partly replacing the transaction-stimulating impact of the
    former Tax Certificate Policy.

Finally, the benefits of Diversity Credits flow directly to the
broadcasters who promote diversity through the transactions in which
they engage.

**V. [The FCC Has Authority To Create Bidding Credits]{.underline}**

The Commission's authority to attach Diversity Credits to licenses flows
from its power under Section 303(r) of the Communications Act, 47 U.S.C.
§303(r), authorizing the Commission to "\[m\]ake such rules and
regulations and prescribe such [restrictions and
conditions]{.underline}, not inconsistent with law, as may be necessary
to carry out the provisions of this Act...." (emphasis supplied). These
"restrictions and conditions," including those necessary to avoid
interference, are typically attached to broadcast licenses. The
"provisions of this Act" the Commission would "carry out" by awarding
Diversity Credits are Section 151 (banning discrimination) and Section
257 (requiring Commission to report on steps taken to reduce market
entry barriers). Authority to issue Diversity Credits may also be found
in Section 303(i) of the Communications Act, 47 U.S.C. §303(i), which
authorizes the Commission to "make special regulations applicable to
radio stations engaged in chain broadcasting\[.\]"

A rough analogy to Diversity Credits is bidding credits for new entrants
in auctions. [See, e.g.]{.underline}, [Implementation of Section 309(j)
of the Communications Act -- Competitive Bidding for Commercial
Broadcast and Instructional Television Fixed Services Licenses,
Reexamination of the Policy Statement on Comparative Broadcast Hearings,
Proposals to Reform the Commission's Comparative Hearing Process to
Expedite the Resolution of Cases (First R&O)]{.underline}, 13 FCC Rcd
15920, 15993-96 ¶¶186-90 (1998). However, unlike auction bidding
credits, Diversity Credits would require no legislative grant of
authority.

**VI. [How Diversity Credits Would Fit Into Structural Ownership
Regulation]{.underline}**

The Diversity Credits concept was created in February 2003 by the
Minority Media and Telecommunications Council (MMTC) as a potential
successor to the system of voice tests that has governed broadcast
multiple ownership regulation for decades. Because the FCC has had so
much difficulty articulating and justifying particular voice tests, MMTC
designed a Diversity Credits system that could take the place of voice
tests if voice tests were invalidated by the courts.

Under MMTC's proposal, Diversity Credits would be applicable to all
transactions not prohibited by antitrust limitations. Such limitations
would be needed to cure the well known problem that has arisen in the
implementation of Pollution Credits -- "hot spots" or geographic areas
receiving more pollution as a result of Pollution Credit trading that
reduced pollution in another location; in the broadcast context, these
"hot spots" would be certain local markets subject to unacceptable
levels of concentration attendant to the reduction of concentration
elsewhere.

However, Diversity Credits could also be used in tandem with voice
tests. A voice test establishes a floor for diversity, or a ceiling for
concentration. On the other hand, Diversity Credits operate to keep
diversity from that floor and to keep concentration from that ceiling.
Thus, Diversity Credits could be used either as a substitute for, or as
a supplement to, any regulatory paradigm that undertakes to stimulate
diversity, discourage concentration, and promote ownership by
disadvantaged companies.

**VI. [How The FCC Could Develop The Diversity Credits
Concept]{.underline}**

Diversity Credits are a promising new paradigm that could do much to
provide opportunity and access to capital.

Unavoidably, Diversity Credits would contain some element of
subjectivity. The Commission would have to determine the right size for
a Diversity Credit, how many Diversity Credits each company would
receive, and the conditions under which the Commission could reclaim
Diversity Credits attendant to consolidation-promoting transactions.
Still, the prospect of some subjectivity is not a reason to reject the
concept out of hand. Some measure of subjectivity is inherently present
in any system of market regulation. Even the application of the HHI is
premised on DOJ concentration guidelines, which at bottom are subjective
impressions of where, on a concentration continuum, a market is "highly
concentrated" as opposed to "moderately concentrated."

Consequently, the Subcommittee recommends that the Commission delegate,
to a team of economists, the task of performing a modeling study on the
appropriate quantitative attributes of a system of Diversity Credits,
including the value of a Diversity Credit and the number of Diversity
Credits that could be applied to or derived from particular types of
transactions. The Commission would call in experts to validate that
study through traditional peer review, and then offer the fruits of the
study for public comment in the rulemaking on minority ownership that
the Commission has promised to undertake. [See]{.underline} [2002
Biennial Regulatory Review \-- Review of the Commission's Broadcast
Ownership Rules and Other Rules Adopted Pursuant to Section 202 of the
Telecommunications Act of 1996, MB Docket No. 02-277 (Report and Order
and Notice of Proposed Rulemaking)]{.underline}, 18 FCC Rcd 13620, 13636
¶50 and n. 78 (2003) (promising to issue further NPRM on minority
ownership).

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