AT&T is trying to change cable TV forever. Starting sometime this month, AT&T will offer an internet-only subscription TV package, with upwards of 100 channels for $35 per month. If the channel selection and pricing are as good as the company promises, it will be a hit.

But AT&T was banking on one other thing to really sell DirecTV Now: integration with AT&T’s cell network, which would let you stream TV channels on your smartphone without using up your data plan. It’s the kind of deal that only AT&T could pull off, as the owner of a national cell and cable network. But according to a letter from the Federal Communications Commission, doing so could be illegal.

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In the letter, the FCC says it “believes that the terms and conditions under which Sponsored Data is offered to content providers unaffihiated with AT&T, combined with s current practice of zero-rating DIRECTV video applications for AT&T Mobility subscribers, may obstruct competition and harm consumers by constraining their ability to access existing and future mobile video services not affiliated with AT&T.”

The problem isn’t with all zero-rating: the FCC allows some data zero-rating, provided that it’s fair and equitable across all different content providers. That’s why T-Mobile’s Binge On program, which zero-rates data for free from any content provider that chooses to participate, is allowed to continue.

But in the case of AT&T and DirecTV, the FCC is worried about fairness. AT&T says that its program is legal because it allows any competitor to pay the same rate as DirecTV to zero-rate the data. So, if Netflix wanted AT&T subscribers to watch shows without using data, AT&T says it can pay the same low, wholesale rate as DirecTV to do so.

The crucial difference, according to the FCC, is that Netflix would be paying AT&T cash up-front, while DirecTV (an AT&T subsidiary) provides an internal transfer payment. The FCC explains it:

The position that the participation of DIRECTV in Sponsored Data is the same as that of third parties, however, fails to take account of the notably different financial impact on unaffiliated providers. For example, while there is no cash cost on a consolidated basis for AT&T to zero-rate its own affiliate’s mobile video service (since DIRECTV’s “cost” of Sponsored Data is equal to AT&T Mobility’s Sponsored Data “revenue”), an unaffiliated provider’s Sponsored Data payment to AT&T Mobility is a true cash cost. Moreover, based on the information you have provided,7 it appears that, at foreseeable usage levels of zero-rated mobile video services, the Sponsored Data charge to a third-party video competitor could be significant. Indeed, it is not difficult to calculate usage scenarios in which an unaffiliated provider’s Sponsored Data charges alone could render infeasible any third-party competitor’s attempt to compete with the $35 per month retail price that AT&T has announced for DIRECTV Now.

AT&T has already responded to the letter in a statement, saying “With our Data Free TV offer, DIRECTV picks up the tab for our Mobility customers’ data use when they’re streaming content…We welcome any video provider that wishes to sponsor its content in the same “data free” way for AT&T Mobility customers and we’ll do so on equal terms at our lowest wholesale rates. Saving consumers money is something we all should support.”

The FCC will examine AT&T’s response, but this is unlikely to be the last we hear of the issue.

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