******************************************************** NOTICE ******************************************************** This document was converted from WordPerfect to ASCII Text format. Content from the original version of the document such as headers, footers, footnotes, endnotes, graphics, and page numbers will not show up in this text version. All text attributes such as bold, italic, underlining, etc. from the original document will not show up in this text version. Features of the original document layout such as columns, tables, line and letter spacing, pagination, and margins will not be preserved in the text version. If you need the complete document, download the WordPerfect version or Adobe Acrobat version, if available. ***************************************************************** Before the Federal Communications Commission Washington, D.C. 20554 In the Matter of: ) CUID Nos. NY0335, NY0336, NY0337, ) NY0338, NY0339, NY0340, NY0670, TIME WARNER CABLE ) NY1172, NY1566, NY1567, NY1586, ) NY0796, NY0996, NY0836, NY0837, Petition for Special Relief to Revoke) NY1167, NY1168, NY1534, NY0352, the Certification of Various New York) NY0582, NY0509, NY0588, NY0589, State Franchising Authorities to ) NY0596, NY0643, NY0668, NY0742 Regulate Basic Cable Service Rates ) MEMORANDUM OPINION AND ORDER Adopted: June 3, 1997 Released: June 5, 1997 By the Chief, Cable Services Bureau: I. Introduction 1. In the captioned proceeding, Time Warner Cable ("Time Warner") has filed a Petition for Special Relief asserting that it faces effective competition in 27 New York State franchise areas served by the Time Warner Albany-Troy, New York head-end (collectively, the "Affected Communities") from CAI Wireless, Inc. d/b/a Capital Choice Television ("CAI"). Time Warner further alleges that CAI is affiliated with Bell Atlantic Corporation ("Bell Atlantic") and NYNEX Corporation ("NYNEX"). 2. The Commission gave public notice seeking comment on Time Warner's petition. No comments were filed. Pursuant to a request by Commission Staff, Time Warner submitted certain financial statements filed by CAI with the Securities and Exchange Commission ("SEC") pertinent to Time Warner's petition. In addition, CAI filed a copy of an agreement affecting this proceeding. On January 30, 1997, Time Warner filed a pleading updating certain aspects of its petition. 3. Section 623 of the Communications Act of 1934, as amended ("Communications Act"), provides that subscriber rates of cable television systems are subject to either local or federal regulation only where effective competition is absent. Section 623(l)(1)(D) of the Communications Act, added as part of the Telecommunications Act of 1996, provides that a cable operator is subject to effective competition where: a local exchange carrier or its affiliate (or any multichannel video programming distributor using the facilities of such carrier or its affiliate) offers video programming services directly to subscribers by any means (other than direct-to-home satellite services) in the franchise area of an unaffiliated cable operator which is providing cable service in that franchise area, but only if the video programming services so offered in that area are comparable to the video programming services provided by the unaffiliated cable operator in that area. Section 623(a)(4) of the Communications Act allows franchising authorities to become certified to regulate basic cable service rates of cable operators which are not subject to effective competition. For purposes of the initial request for certification, local franchising authorities may rely on a presumption that cable operators within their jurisdiction are not subject to effective competition unless they have actual knowledge to the contrary. Certification becomes effective 30 days from the date of filing, unless the Commission finds that the authority does not meet the statutory certification requirements. In Implementation of Cable Act Reform Provisions of the Telecommunications Act of 1996, Order and Notice of Proposed Rulemaking ("Cable Act Reform Order"), the Commission instructed cable operators believing themselves subject to local exchange carrier ("LEC") effective competition under Section 623(l)(1)(D) of the Communications Act to file a petition for determination of effective competition pursuant to Section 76.7 of the Commission's rules. II. The Pleadings 4. Time Warner states that it is subject to LEC effective competition in the Affected Communities from CAI. With regard to the LEC affiliation requirement, Time Warner asserts that CAI, a multichannel video programming distributor ("MVPD"), is affiliated with two LECs, Bell Atlantic and NYNEX. According to Time Warner, in 1995, Bell Atlantic and NYNEX made a $100 million cash investment in CAI (the "CAI Investment"). Time Warner states that, in return for this investment, Bell Atlantic and NYNEX (directly and through a general partnership known as BANX Partnership ("BANX")) hold the following interests in CAI. 1. 7,000 shares of CAI Senior Preferred Stock, which are unilaterally convertible into shares of CAI Voting Preferred Stock, which are then unilaterally convertible into shares of CAI Common Stock. 2. 14% Term Notes of CAI, unilaterally convertible into shares of CAI Senior Preferred Stock at the option of BANX, which shares are unilaterally convertible into shares of CAI Voting Preferred Stock, which are then unilaterally convertible into shares of CAI Common Stock. 3. A warrant to purchase either shares of CAI Common Stock, or shares of CAI Voting Preferred Stock, which shares are unilaterally convertible into shares of CAI Common Stock. Time Warner asserts that the issue raised by the Commission in the Notice of Proposed Rulemaking contained in the Cable Act Reform Order of whether to aggregate the separate interests of LECs in the same MVPD for purposes of determining affiliation is immaterial to this proceeding because Bell Atlantic and NYNEX hold the bulk of their interest in CAI through BANX. Thus, argues Time Warner, the LECs themselves have already chosen to aggregate their interest in CAI. Furthermore, Time Warner asserts that Bell Atlantic and NYNEX are actively pursuing plans to merge. Time Warner states that, taken together, these facts demonstrate that "Bell Atlantic and NYNEX are clearly acting in concert with respect to their CAI activities." 5. Time Warner argues that the 7,000 shares of CAI Senior Preferred Stock currently held by Bell Atlantic and NYNEX, standing alone, constitute an equity interest in CAI in excess of the 10% threshold established by the Commission's interim rules. Thus, argues Time Warner, the LEC affiliation requirement is satisfied merely by reference to Bell Atlantic and NYNEX's Senior Preferred Stock interest in CAI. To further support its argument, Time Warner states that Bell Atlantic's and NYNEX's remaining interests in CAI (in 14% Term Notes and a warrant to purchase shares of stock), standing alone, are again sufficient to satisfy the affiliation requirement because they "constitute a beneficial interest which should be deemed the 'equivalent' of equity within the meaning of the 'affiliate' definition adopted in the [1996] Act." As support for this assertion, Time Warner states that, in their October 12, 1995 Amendment No. 2 to Schedule 13D filed with the SEC, Bell Atlantic and NYNEX reported that their affiliates hold a collective beneficial interest in CAI equivalent to 49.4% (if only the conversion and warrant rights were exercised) of the shares of CAI Common Stock (or 45.3% on a fully diluted basis). Finally, Time Warner asserts, under a Business Relationship Agreement between Bell Atlantic and NYNEX and CAI, CAI has granted to Bell Atlantic and NYNEX the ability, on a market-by-market basis (including the Albany, New York area), to elect to become the marketer and provider of wireless cable services using CAI's transmission systems. Where Bell Atlantic or NYNEX elect to provide service in a market, CAI will receive contractual monthly service revenues based on the number of serviceable households and subscribers in each market. Therefore, argues Time Warner, if it so elects, NYNEX would be a LEC actually providing video service to subscribers in Time Warner's Albany-Troy, New York franchise areas, instantaneously satisfying the affiliation requirement of the LEC effective competition test. 6. In addition, Time Warner asserts that CAI offers comparable video programming service in the 27 Affected Communities, thus satisfying the remaining requirements of the LEC effective competition test. 7. Neither CAI, Bell Atlantic, nor NYNEX filed comments in this proceeding. However, CAI filed comments and Bell Atlantic filed reply comments in a companion LEC effective competition case involving a cable system owned by Cox Communications, Inc. To the extent these comments discuss the CAI Investment, we take notice of these comments and incorporate them in the record of this proceeding. In its comments, CAI states that, because Bell Atlantic and NYNEX currently have no voting equity in CAI, have not exercised their warrants, and have not offered a LEC-related video service to one subscriber as a result of its investment in CAI, Bell Atlantic and NYNEX should not be treated as affiliates of CAI for purposes of the LEC effective competition test. 8. In its Reply Comments in the Cox Communications proceeding, Bell Atlantic generally supports CAI's comments. According to Bell Atlantic, $30 million of the $100 million CAI Investment is in the form of a loan which must be repaid, and the remaining $70 million is in the form of a "nonvoting preferred instrument which also must be repaid." Bell Atlantic stresses that, while convertible into voting stock, Bell Atlantic and NYNEX's interests in CAI are not yet equity interests "[b]ecause no conversion to voting stock in CAI has been effected. . . ." Bell Atlantic cites the Commission's regulations regarding MMDS/cable cross-ownership as the appropriate guidance in this context and argues that "'debt and instruments such as warrants, convertible debentures, options or other non-voting interests with rights of conversion to voting interests' are not attributable 'unless and until conversion is effected.'" Finally, with regard to the Business Relationship Agreement, Bell Atlantic asserts that the agreement merely gives Bell Atlantic and NYNEX an option to lease transmission capacity from CAI -- a right that neither Bell Atlantic nor NYNEX has exercised. 9. On January 30, 1997, in response to a request by Commission Staff, CAI submitted a redacted version of the December 12, 1996 Modification Agreement (the "Modification Agreement") executed by CAI, BANX, and the BANX partners which modifies the Business Relationship Agreement. The Modification Agreement provides CAI, or its designee, a one-year option to purchase all (but not less than all) of the $100 million CAI Investment in CAI. In the event that CAI, or its designee, does not purchase the CAI Investment within the first 270 days, Bell Atlantic and NYNEX have the right to sell the CAI Investment to any party, free and clear of the option granted to CAI. If CAI, or its designee, exercise CAI's option to purchase the CAI Investment within the one-year period, the Business Relationship Agreement concurrently terminates. The Modification Agreement requires CAI to make commercially reasonable efforts during the option period to secure the funds required to exercise the option, or to otherwise find a purchaser for the CAI Investment. If CAI obtains sufficient funds to acquire the CAI Investment, the Modification Agreement further requires CAI to use commercially reasonable efforts to obtain any consents or other authorizations necessary to permit it to exercise such option. 10. The Modification Agreement also suspends the Business Relationship Agreement for one year. During the suspension period, Bell Atlantic and NYNEX give up their right to elect to become the video programming marketer of wireless cable service using CAI's wireless delivery platform. All deadlines for construction and other obligations set forth in the Business Relationship Agreement are tolled for one year and will be reinstated in the event that the Business Relationship Agreement is not terminated pursuant to the terms of the Modification Agreement. The Modification Agreement also permits CAI to use its MMDS spectrum in markets subject to the Business Relationship Agreement during the one-year suspension period for businesses other than video transmission, and to enter into strategic relationships with third parties. 11. At the request of Commission Staff, Time Warner filed comments updating its petition based on the effect of the Modification Agreement. Time Warner stated that it was aware of the Modification Agreement through filings with the SEC and press reports, but has no independent knowledge regarding CAI and its financing that would alter the claims contained in Time Warner's petition. Time Warner asserts that, based on its limited knowledge, the Modification Agreement does not affect its petition, and "the facts regarding CAI's structure and financing are the same as they were when [Time Warner's petition was] filed." 12. On April 30, 1997, CAI announced that it had renegotiated its option to repurchase the CAI Investment. The amendment provides CAI the option through February 28, 1998 to repurchase the CAI Investment for $40 million and 100,000 shares of convertible junior preferred stock. The junior preferred stock is non-voting, carries no coupon, has no maturity, and is convertible into 250,000 shares of CAI common stock "in the hands of a subsequent purchaser unrelated to [Bell Atlantic and NYNEX]." As part of the amendment, Bell Atlantic and NYNEX released CAI from its obligation under the Business Relationship Agreement to make its wireless MMDS spectrum available to Bell Atlantic and NYNEX in Boston, Pittsburgh, Albany, Syracuse and Buffalo. If CAI purchases the CAI Investment, the Business Relationship Agreement will terminate releasing CAI's obligations to provide wireless MMDS spectrum to Bell Atlantic and NYNEX in CAI's other markets. Finally, Bell Atlantic and NYNEX also suspended or released CAI from a number of covenant restrictions and governance rights and provided CAI with a blanket proxy relating to Bell Atlantic and NYNEX's approximately 10% interest in CS Wireless Systems, Inc. III. Analysis 13. In the absence of a demonstration to the contrary, cable systems are presumed not to be subject to effective competition as defined in the Communications Act. The cable operator bears the burden of rebutting the presumption that effective competition does not exist and so must provide evidence sufficient to demonstrate that effective competition, as defined by Section 76.905 of the Commission's rules, is present in the franchise area. Time Warner has failed to meet this burden. 14. We note that Bell Atlantic and NYNEX are unquestionably LECs as defined by the Communications Act, and CAI meets the Commission's definition of the term MVPD. We therefore address the issue of whether CAI is an affiliate of Bell Atlantic and/or NYNEX. 15. When the Commission adopted interim rules regarding the affiliation requirement of the LEC effective competition test, it concluded that it would use the definition of affiliate set forth in Section 3 of the 1996 Act which states that: The term "affiliate" means a person that (directly or indirectly) owns or controls, is owned or controlled by, or is under common ownership or control with another person. For purposes of this paragraph, the term "own" means to own an equity interest (or the equivalent thereof) of more than 10 percent. In addition, affiliation can also be demonstrated through de facto control regardless of the actual ownership interest. 16. In arguing that there exists sufficient affiliation between CAI, Bell Atlantic, and NYNEX for purposes of the LEC effective competition test, Time Warner relies on the CAI Investment and the Business Relationship Agreement. We will examine each in light of the changes effected by the Modification Agreement, as amended. 17. Bell Atlantic and NYNEX have invested in CAI through a number of different financial interests. Through wholly-owned subsidiary corporations, both Bell Atlantic and NYNEX each owns Term Notes in the principal amount of $15 million and each holds 3,500 shares of convertible Senior Preferred Stock, having an aggregate par value of $35 million. In addition, the BANX Partnership owns a warrant permitting it to acquire CAI stock in the future. The parties had also entered into the Business Relationship Agreement pursuant to which Bell Atlantic and NYNEX (or their affiliates) would provide and market video services over certain of CAI's facilities. Pursuant to the Business Relationship Agreement, CAI was to receive revenue in certain markets without incurring the usual capital expenditures required for subscriber equipment and installation by virtue of Bell Atlantic/NYNEX affiliates electing to become the marketer and provider of service using CAI's MMDS transmission systems. However, the Business Relationship Agreement has now been suspended and is no longer relevant to this decision. The issue here is whether separately or in combination, these interests involve "an equity interest (or the equivalent thereof) of more than 10 percent." In this regard, we note that Time Warner argues that the investment contribution made in connection with the Senior Preferred Stock is equity. Time Warner further argues that the investment contribution made in connection with the Term Notes and warrant is an equity equivalent. 18. We first examine the Senior Preferred Stock and its status as equity. Without attempting to resolve here definitional issues that remain somewhat ambiguous in terms of accounting standards and securities law more generally, we conclude, bearing in mind the underlying purposes of the present review, that CAI should not be treated as a LEC affiliate based upon the Senior Preferred Stock component of the CAI Investment. In support of this conclusion, we note that for financial accounting purposes "preferred stock that by its terms must be redeemed by the issuing enterprise or is redeemable at the option of the investor" is generally excluded from the definition of "equity security." The Securities and Exchange Commission has also recognized that mandatorily redeemable preferred securities may properly be characterized as similar to debt for some purposes and that it is, from an economic point of view, substantially different than capital stock that is not redeemable. Thus, for SEC reporting purposes mandatorily redeemable preferred stock must not be presented under a stockholder's equity caption. The balance sheet CAI filed with the SEC lists Bell Atlantic and NYNEX's Senior Preferred Stock not as "shareholder's equity" but in a separate "mandatorily redeemable preferred stock" account. As these SEC and accounting guidelines reflect, investments of this type are definitionally ambiguous in nature, holding some attributes of debt securities and some attributes of common stock. 19. In the context of our LEC effective competition analysis, the nature of our review is necessarily fact specific. Our mandate does not permit us to merely observe that the Senior Preferred Stock has attributes of both debt and equity, we must find one way or the other. Courts and the Commission have considered numerous factors in analyzing debt/equity definitional issues for a variety of other ownership attribution and tax purposes. Given the unique circumstances of this proceeding, we believe the most significant factor here is the intent of the parties as reflected in the Modification Agreement, as amended. We first observe that neither CAI, Bell Atlantic, nor NYNEX characterize the CAI Investment as creating an affiliate relationship. Even more compelling is the conduct between the parties as evidenced by the Modification Agreement and the amendment thereto. The entire CAI Investment is now subject to the obligation of CAI to purchase, or find a purchaser for, all of the CAI Investment. CAI has indicated in public filings that is actively seeking financing "to replace the BANX Partnership." These facts persuade us that the nature of this investment and the ongoing business relationship is such that the Bell Atlantic and NYNEX interest in CAI should be not be viewed here as an equity or equivalent interest for purposes Section 76.1401(b). 20. In evaluating whether the entire CAI Investment (Senior Preferred Stock, Term Notes and warrant) constitutes an equity equivalent, it is clear, even after execution of the Modification Agreement, as amended, that Bell Atlantic and NYNEX have a continuing interest in CAI. However, it also seems that this interest is inconsistent with the apparent goal of the LEC affiliation requirement. With regard to the CAI Investment, the Modification Agreement, as amended, affirmatively requires CAI to use commercially reasonable efforts to purchase, or find a purchaser for, Bell Atlantic and NYNEX's entire interest in CAI. Moreover, after 270 days, the Modification Agreement affords Bell Atlantic and NYNEX the opportunity to market their CAI interest to any party. The Modification Agreement, as amended, indicates that Bell Atlantic and NYNEX are no longer interested in continuing their business relationship with CAI. Therefore, we find that the CAI Investment, as amended by the Modification Agreement, is not an equity equivalent sufficient to satisfy the affiliation requirement of the LEC effective competition test. 21. The Modification Agreement, as amended, also suspends all obligations for a one- year period under the Business Relationship Agreement, which defines Bell Atlantic, NYNEX, and CAI's cooperative effort to provide wireless video programming. In addition, the Modification Agreement, as amended, provides that the Business Relationship Agreement will terminate upon the purchase of the CAI Investment in accordance with the option granted to CAI. The Modification Agreement also releases CAI's obligations to make wireless MMDS spectrum available to Bell Atlantic and NYNEX in Boston, Pittsburgh, Albany, Syracuse, and Buffalo, frees CAI of the obligation to reserve the use of its MMDS spectrum in the remaining markets subject to the Business Relationship Agreement for Bell Atlantic and NYNEX's use, and permits CAI to contract with third parties during the suspension period to use its spectrum in such markets for businesses in addition to video transmission. In addition, neither the CAI Investment, the Business Relationship Agreement, or the two in combination, as amended by the Modification Agreement, establish that Bell Atlantic and NYNEX have de facto control of CAI's operations. We therefore conclude that CAI is not currently an affiliate of either Bell Atlantic or NYNEX for purposes of the LEC effective competition test. We cannot relieve Time Warner of cable rate regulation based on the possibility that CAI will not be able to purchase, or find a purchaser for, the CAI Investment, and that Bell Atlantic and NYNEX might contractually be required to resume its business relationship with CAI at the end of the one-year suspension period. We cannot conclude that Congress intended that cable operators should be deregulated based upon such uncertain and tenuous grounds. 22. Because we find that Time Warner has failed to satisfy its burden of proving that Bell Atlantic and NYNEX are affiliates of CAI for purposes of the LEC effective competition test, we need not address, and expressly reserve judgement on, the aggregation of Bell Atlantic and NYNEX's interest in CAI, and whether CAI is offering comparable programming to subscribers in each of the Affected Communities. As Time Warner has not submitted sufficient evidence demonstrating that its cable systems serving the Affected Communities are subject to LEC effective competition from CAI, its petition is denied. IV. Ordering Clauses 23. Accordingly, IT IS ORDERED that the Petition for Special Relief filed by Time Warner Cable IS DENIED. 24. This action is taken pursuant to the interim rules adopted in Implementation of Cable Act Reform Provisions of the Telecommunications Act of 1996, and is without prejudice to any further action taken by the Commission in adopting final rules pursuant to the Notice of Proposed Rulemaking contained therein. 25. This action is taken pursuant to delegate authority under Section 0.321 of the Commission's rules, as amended. FEDERAL COMMUNICATIONS COMMISSION Meredith J. Jones Chief, Cable Services Bureau