A federal appeals court Tuesday sided with broadband access providers like Verizon and Comcast in striking down Federal Communications Commission (FCC) regulations on these providers pertaining to network neutrality – the idea that telecommunications companies should be required to treat all Internet traffic, whether a bandwidth-hogging video or a brief email message, the same.

But the decision has been described as only a partial victory for Verizon, which brought the suit, in that the ruling affirmed the FCC’s overall right to regulate broadband.

Who wins and who loses as a result of this ruling? What are the longer-term implications for the Internet, and does the FCC have other options for ensuring fair treatment for all parties concerned? Knowledge at Wharton interviewed Wharton legal studies and business ethics professor Kevin Werbach, who formerly worked at the FCC and, in 2008-2009, advised the Obama administration transition team on telecommunications issues.

Knowledge at Wharton: Can you briefly explain the decision by the three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit?

Kevin Werbach: The FCC, the federal agency that oversees telecommunications and media, adopted a set of rules in 2010 on network neutrality in which it prohibited broadband access providers – like Verizon, Comcast and AT&T – from blocking or discriminating against traffic on their broadband networks. Verizon challenged this rule in court.

The court decision yesterday overturned the FCC rules, saying the FCC had enough legal authority to act, but that the specific rules they adopted violated the restrictions of the Communications Act.

Knowledge at Wharton: Is this regulation going to be bad news for consumers?

Werbach: It’s largely bad news for consumers, although not quite as bad as most of the consumer advocates are suggesting. Network neutrality is designed to promote and protect the openness of the Internet. A big reason why it has been such a catalyst for innovation is that the Internet is open to anyone and any company, and is not controlled by a small number of gatekeepers, like other traditional communications platforms. If the outcome from this court decision overturning the FCC rules is that the Internet increasingly looks less like an open innovative marketplace and more like a controlled walled garden where a few large companies decide what happens, that would be a huge loss for consumers and for the rest of the U.S. economy.

Knowledge at Wharton: Can you give us some examples of how this might happen?

It’s largely bad news for consumers, although not quite as bad as most of the consumer advocates are suggesting.

Werbach: The FCC dealt with two kinds of behaviors. One is blocking. So the concern is that Comcast, for example — which might be your Internet Service Provider (ISP) but is also a cable company – is unhappy that you are watching your movies over the Internet connection on Netflix as opposed to paying Comcast for its cable service. Comcast might have an incentive to not allow you to go to that service over the Internet. Comcast hasn’t done that and has said it won’t, but the argument is that they could.

That’s one concern. The second is discrimination. The FCC rules said that broadband providers couldn’t unreasonably discriminate against certain content. The concern there is that those providers will have a fast lane and a slow lane. Only the companies that are their partners or are willing to pay them will have effective access to customers, while everyone else will be stuck in a slow lane that will make their services not as valuable.

Knowledge at Wharton: What about the ISPs? Is this good or bad for them?

Werbach: The surprising thing about this decision is that I actually think it’s not great for the ISP industry. First, what Verizon was really in this fight to win was the argument that the FCC doesn’t have the authority to regulate broadband. And they lost on that. Before this court decision, it had never been clear legally whether the FCC could adopt any rules of this type. The court clearly said they could; they just couldn’t impose the rules they chose. This hardly makes the issue go away. The court provided a number of other legal avenues the FCC might pursue instead. The court said the FCC couldn’t regulate broadband ISPs as common carriers, but it could impose rules as long as those companies still have some degree of flexibility to cut individual deals on a commercial basis.

So one thing the FCC could do is adopt a more limited set of rules, which would have continuing oversight over behavior. The second thing the FCC could do is adopt similar policies on a case by case process. So if the broadband companies are free to do as they please, but the FCC retains the right to bring a complaint when there are abuses, that probably would survive this court decision.

And finally, the whole legal challenge is based on the fact that the FCC, going back to the period between 2002 and 2005, decided broadband is not a regulated common carrier service. But the court said the FCC didn’t have to reach that result. So the FCC could go back and reclassify broadband. It could say that the pure transportation part of broadband is just like telephone service, and we can regulate that without regulating all the services and content that go across.

I’m skeptical the FCC could actually do that, or would do that, but it is an option. Frankly, it’s the worst option from the perspective of the broadband providers. That’s what they were so violently fighting against. By limiting the FCC’s flexibility with other legal approaches in this case, the broadband providers might actually get the approach they feared all along.

Knowledge at Wharton: Are Verizon and similar broadband carriers “information services” or “common-carriers,” and why does the distinction matter?

Werbach: The Communications Act has a set of rules that apply to telecommunications services – i.e., common-carriers — and does not specify any obligations for information service providers. It’s confusing, but what it means is that the set of rules that are enumerated for common carriers apply only to them and not to other companies. Essentially, the FCC’s argument was that broadband is an information service, but it should still be subject to some of the kinds of rules that traditionally applied to common carriers.

Network neutrality, implemented appropriately, does not mean no one can differentiate anything. That’s not the way things work on the Internet.

Knowledge at Wharton: Shouldn’t service providers be allowed to charge differentially for the bandwidth used – as long as it’s content blind and doesn’t discriminate on the type of data being carried?

Werbach: They should and they are. Network neutrality, implemented appropriately, does not mean no one can differentiate anything. That’s not the way things work on the Internet. What it says is that companies can’t unreasonably discriminate. If you pay more for your broadband connection because you use more bandwidth, that’s reasonable and economically justified. The issue is if companies act in anti-competitive ways or in ways that suck the life and vitality out of the innovative ecosystem on top of the Internet.

Knowledge at Wharton: Which raises the question: Will this ruling stifle innovation in any way?

Werbach: Again, it depends on what happens now. There are two concerns. One is that the broadband operators will, in fact, engage in the sorts of practices people are concerned about. The other is that the Internet industry will be afraid they are going to, and will be more reluctant to invest and innovate because it doesn’t think it will be able to capture the benefits in light of the power of the network operators. So there is the potential for a chilling effect. We saw this in the wireless industry, before the growth of smart phones. Venture capitalists were very reluctant to invest in wireless data services because everyone had to go get permission from the wireless carriers to put anything on a phone. So it stifled innovation in the marketplace. Once that opened up on wireless devices, there was a tremendous flowering of investment in that marketplace.

Knowledge at Wharton: Will the FCC appeal this decision?

Werbach: There is a reasonable likelihood they will appeal. There are arguments on both sides. The decision gives the FCC more running room than would have been expected. This is a legal battle that has been going on for four to five years, and as an overall battle for more than a decade. From the FCC’s perspective, they may just want to move forward, because if this is going to go up to the U.S. Supreme Court, even if the FCC wins and has to go back and start implementing these rules, we are almost getting to the end of the Obama administration. So that will be part of the consideration. Does the FCC want to allow this to keep dragging on in the courts?

Knowledge at Wharton: Are you optimistic or pessimistic about the eventual outcome?

By limiting the FCC’s flexibility with other legal approaches, the broadband providers might actually get the approach they feared all along.

Werbach: I have mixed feelings because this depends on a number of factors, largely involving how the FCC acts. I think this whole process has been such a mess and so confused and dragged on for so long that it is hard to imagine it coming to a clean resolution any time soon. But I think I’m more optimistic than not, because after all this time, the notion that companies would engage in broad scale blocking and discrimination across the board seems harder for me to imagine, given all the attention that gets paid to this and the degree of consumer mobilization. It doesn’t mean it’s not going to happen. There are a number of gray areas, but I think that companies like Comcast, Verizon and AT&T have to have this on their minds even if they may be legally justified. They are going to have to worry about the response to certain business practices.

One more thing: The big picture of this is that ultimately, the only answer is more broadband competition because network neutrality is kind of a second best solution to market forces. If we all have five or 10 good choices for our broadband providers, there would be much less reason to worry if one happened to block certain content, because people would have choice. We do have some choice but not at the same level as other countries. That is really the big question. The outcome of this net neutrality ruling doesn’t affect that except to the extent that it pushes the FCC and Congress to remove barriers to competition.

Knowledge at Wharton: In what way do you see this competition coming?

Werbach: It’s hard to have multiple competing platforms across the U.S. But to have significantly more competition, especially for high speed broadband, is certainly possible in lots of the country. This could come from entrants like Google, from cities themselves, which in many cases are blocked by state laws from doing municipal broadband, or from upgraded operators. The other piece, which is not a complete substitute, is wireless technology, which is getting better all the time, especially wifi technology. So that can become a competitive force as well.