Who Rules the Internet?

From its beginnings, the Net has elicited emotional responses from technologists, futurists, consumers, investors and policymakers alike. Now, as the initial frenzy of the online gold rush subsides, debate heats up over the regulatory vacuum that has nursed this massive expansion. Whereas state and federal lawmakers have until now fairly consistently adopted a hands-off approach, growing alarm at the increase of cybercrimes and public worries over privacy infringements have begun to prod them into action. The difficulty for both government bodies and the Internet industry is that neither faction seems certain what action should be taken or what the proper role of government should be in an industry characterized by such a unique combination of volatility and innovation.

Not only has the debate pitted lawmakers against industry leaders, who insist that unconditional freedom must be maintained lest the so-called new economy (politically, a sacred cow) crumble, but state and federal regulators also find themselves at odds with one another on issues like taxation (see sidebar). The din of conflicting opinion only increases as issues close in on every front: New privacy, taxation, security, intellectual property and antitrust questions emerge every day.

Communication Gap

"There's definitely a void between government and e-commerce leaders," notes Ray Everett Church, vice president of public policy and chief privacy officer of AllAdvantage.com, an online marketing "infomediary" based in San Francisco. "The regulators and legislators understand very little of what goes on in the start-up world--in this atmosphere of creating new lines of business on a daily basis. As thoughtful as many members of Congress and their staffs are, as keenly aware of the rapid pace of growth within this industry as they are, Silicon Valley is still quite a mystery to them."

At the same time, Washington remains a mystery to Silicon Valley, says Church. "There are very, very few companies that even know that they ought to be talking to lawmakers," he observes. "It's something that really doesn't cross the mind of a lot of start-up firms or even larger high-tech companies." Church cites the Department of Justice's prosecution of Microsoft for unfair practices as an example. "They didn't even have a lobbying presence in Washington, D.C., until just about four or five years ago," he says. "That was the single worst thing they could have done. When you ignore Washington, you're not aware of concerns until in some respects it's too late."

Lack of industry participation in the political process can lead to reactionary legislation based on fear or an imperfect understanding of what's at stake. This is especially true in states, such as California, where issues are frequently taken directly to the voters through referenda. These initiatives are generally drafted by groups of like-minded people who share a common cause. For this reason, pro-business lobbying groups, such as the Institute for Government Affairs and Public Policy (www.igapp.com), advocate that industry leaders sit down at the table with lawmakers to participate in developing balanced regulation. "Once the [regulatory] momentum has built, it has a life of its own," explains Mike Pinkerton, director of IGAPP. "The laws that we'll have in a legislative environment that is hyper-heated will be unreasonable and will impede e-commerce just as much as the reverse, where you have chaos and everybody [in the industry] doing their own thing."

Let the Market Decide

Some believe that the rules of engagement for e-commerce will be determined by market forces, rather than dialogue between lawmakers and industry leaders. Because of the distributed structure of most e-commerce enterprises--where staff, servers, data storage and the like often exist in different jurisdictions--Internet companies enjoy a level of flexibility that enables them to relocate in states or countries that offer the most business-friendly operating conditions. According to Douglas Graham, a senior analyst for KPMG, this free-market approach to regulation would favor "agile" nations whose legislative systems enable them to draft and pass laws in a relatively short timeframe.

From a global point of view, this theory would disfavor the larger, more cumbersome G-8 nations, such as the United states, where red tape abounds and lawmakers persist in their schizophrenic view of e-commerce. These governments recognize the enormous growth potential inherent in e-commerce but worry about the long-term implications of crime, taxation and defining virtual borders. In fact, the threat that jurisdictional competition poses to these governments' revenues has sparked debate over definitions of an e-business "nexus" or actual location.

"It's not clear what will prevail for determining nexus," explains KPMG's Graham. "There are almost as many criteria as taxing jurisdictions. You've got the location of the servers, the location of the company, the location of the company headquarters, the location of staff, where the data's stored, where the financial transaction occurs, where the settlement occurs, where the customer is and so on. The trouble with using destination as the determining factor, which worked for shipping physical containers, is that we're moving toward products that are being made available electronically--music, movies, entertainment, content, information, publishing. Here, the old model starts to break down a little bit."

Adherents to the free-market approach to regulation contend that, while fiscal issues, such as taxation, will be decided by lawmakers within each jurisdiction, issues affecting nexus and cybercrime prevention will be resolved by treaty or, possibly, by a voluntary commercial code.

"There needs to be some kind of international body of law or code that prevails," says Graham, who has been consulted by heads of state, as well as by advocacy groups, on various aspects of global regulation. "A Global Commercial Code could serve as a kind of umbrella of trust. This code could consist of what the global community considers to be fair and legitimate practices, and you would track those people who voluntarily agree to be bound by these kinds of regulations and provisions." Companies that comply with this Global Commercial Code would receive a seal of approval, if you will, whereas those that do not comply would operate under a cloud of suspicion.

Although it's possible that such a commercial code could emerge as the result of a formal dialogue among e-businesses and government representatives, free-market advocates suggest that it's equally likely an "agile" nation will develop a workable code that could be widely adopted by the industry--beginning with those companies that relocate to its jurisdiction. "Free market forces will prevail," suggests Graham. "The first country that comes up with a very pragmatic code, just as Delaware was the first state in the United states to come up with favorable business laws, will take the lead."

Delaware hosts 47 percent of the Fortune 500, thanks to a very favorable body of jurisdictional laws. These opportunities now exist on a global basis for companies. According to Graham, KPMG has received calls from governments interested in repositioning themselves as havens for electronic commerce. Because these Delawares of the world, whose traditional businesses consist largely of very discreet capital storage, are coming under pressure from multilateral statutes against money laundering, they seek new opportunities in providing a favorable regulatory environment for e-commerce companies.

The Trouble with Self-Regulation

The free-market approach to regulation finds some support in successful efforts at self-regulation, such as the motion-picture industry's rating system. AllAdvantage.com's Church believes the e-commerce industry can follow a similar path. "If companies were really serious about regulating themselves, limiting what can be done with consumer information in the absence of permission, I think they could certainly stop what's looking more and more like an inexorable march toward government regulation on privacy," he observes. "I have long been advocating that the industry work with Congress to come up with some baseline regulation."

Like Church, IGAPP's Pinkerton believes that self-regulation can only occur with legislative involvement. "I think [the industry] is capable of making some efforts in the direction of self-regulation, but if you look at the literature and the actions of the various players, what you've got are folks who are fundamentally highly individualistic. So they would never be able to come together and self-regulate. Even if you did get a group that would want to self-regulate in a really sincere way, it would be insufficient, because the policy makers in the various jurisdictions have very different notions about what kind of standards are sufficient than the industry does."

Pinkerton encourages industry leaders to think about regulation strategically, rather than tactically, on a global basis. This means taking an active role with government representatives in charting the course of the future--which inevitably holds some measure of restrictions on e-commerce. It also holds greater opportunities. Successful e-commerce, after all, depends on customer confidence--both consumer and business. Companies whose practices give rise to concern harm the entire industry--particularly where privacy is involved. Whether or not privacy guidelines, tax issues or jurisdiction matters are resolved through free-market forces and careful self-regulation by the industry, or whether change comes about as a result of state, federal and international legislation, the Internet industry must accept that the lawless days of e-commerce are fast coming to an end. And there can be no confusion about that.