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UNITED STATES v. WESTERN ELEC. CO.

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA


July 26, 1984

UNITED STATES OF AMERICA, Plaintiff,
v.
WESTERN ELECTRIC COMPANY, INC., AND AMERICAN TELEPHONE AND TELEGRAPH COMPANY, Defendants; UNITED STATES OF AMERICA, Plaintiff, v. AMERICAN TELEPHONE AND TELEGRAPH COMPANY, et al., Defendants

The opinion of the court was delivered by: GREENE

The Regional Holding Companies, *fn1" have requested the Court to waive the "line of business" restrictions in section II(D) of the decree so that they may pursue ventures other than the provision of local telephone service. These motions raise the question whether and the extent to which these companies shall be permitted to engage in new business enterprises -- perhaps the most important issue to have arisen since the AT&T Plan of Reorganization was approved last year. *fn2"

 Section II(D) of the decree mandates that

 

After completion of the reorganization . . ., no [Operating Company] shall, directly or through any affiliated enterprise:

 

1. provide interexchange telecommunications services or information services;

 

2. manufacture or provide telecommunications products or customer premises equipment (except for provision of customer premises equipment for emergency services); or

 

3. provide any other product or service, except exchange telecommunications and exchange access service, that is not a natural monopoly service actually regulated by tariff.

 Section VIII(C) provides for the removal of these restrictions under certain circumstances. Motions filed by the Regional Holding Companies or their affiliated Operating Companies request permission to engage in enterprises ranging from real estate investments to foreign business ventures, and the Court is advised that additional motions, for further diversification, will follow. Some of the proposed enterprises are related and some are unrelated to the telecommunications business. *fn3"

  Shortly after the first waiver requests were filed, the Department of Justice suggested that the Court establish a general framework and standards for dealing with these requests. Because of the significance of the issues and because additional requests were certain to follow, the Court agreed that general guidelines might be appropriate in order to achieve substantial uniformity in treatment, to aid the Regional Holding Companies in framing future requests, and to assist the Court in its decisions. A briefing schedule was therefore established and oral argument was had on the general issues. This Opinion describes the standards and procedures the Court will follow in ruling on present and future motions for waivers.

 I

 History of the Restrictions

 In deciding requests for waivers under section VIII(C), the Court must determine whether the petitioning Regional Holding Company has made "a showing" that "there is no substantial possibility that it could use its monopoly power to impede competition in the market it seeks to enter." The parties disagree not only on the factors the Court may consider in making its section VIII(C) determination; they also disagree on the question whether that section establishes the exclusive standard for a removal of the line of business restrictions.

 The Regional Holding Companies argue that such removal is contingent entirely on the anticipated antitrust consequences of their entry into a particular market; that the Court is not free to consider other provisions of the decree; *fn4" and that when the pending waiver requests are considered in light of the proper standard, all of them must be granted without conditions. The Department of Justice and others *fn5" maintain, however, that many, if not all, of the requests should be denied, if only because the Regional Holding Companies have failed to demonstrate that their entry into the markets they seek to penetrate is not likely to impede competition. Beyond that, these parties argue that the Court should refrain from taking a restricted view of its responsibilities but should measure the potential effect of entry on the decree's overall objectives.

 The key remedy adopted in the decree for the elimination of anticompetitive conditions within the telecommunications industry was the divestiture of the Operating Companies from AT&T. As a regulated monopoly, AT&T had both the incentive and ability -- through cross subsidization and various discriminatory actions related to interconnection -- to use its control over the local exchange facilities to foreclose or impede competition in the several competitive or potentially competitive markets. *fn6" The functional separation of the Operating Companies from AT&T was designed to eliminate the potential for such anticompetitive behavior.

 In order to prevent the occurrence or reoccurrence of anticompetitive conduct by the Operating Companies -- each of which retains in its particular area a monopoly over local telecommunications service and thus has the potential for using its monopoly power to discriminate against others -- the decree imposes several restrictions upon their activities. In fact, as originally drafted, the decree flatly prohibited these companies from engaging in any business other than that of supplying local telephone service. *fn7"

 The Court rejected such a blanket restriction, reasoning that the mere theoretical ability to engage in anticompetitive conduct did not constitute a sufficient basis for prohibiting the companies from entering all competitive markets. In the Court's view, the test was to be a pragmatic one. The Operating Companies were different from AT&T -- largely because of their smaller size and relative lack of complexity *fn8" -- and they were therefore to be barred from competitive markets on a less rigid basis.

 After examining the restrictions set forth in section II(D) of the proposed decree in light of that standard, the Court rejected two of these restrictions -- that on marketing of customer premises equipment and that on the publication of the Yellow Pages *fn9" -- and it approved the remainder of the restrictions. In so doing, the Court further noted that

 

It is probable that, over time, the Operating Companies will lose the ability to leverage their monopoly power into the competitive markets from which they must now be barred. This change could occur as a result of technological developments which eliminate the Operating Companies' local exchange monopoly or from changes in the structures of the competitive markets. In either event, the need for the restrictions upheld in Subparts A through C will disappear. . . .

 552 F. Supp. at 194-95.

 Accordingly, the Court required the parties to incorporate into the decree a mechanism by which the line of business restrictions could be removed, and it stated that

 

the removal of the restrictions should be governed by the same standard which the Court has applied in determining whether they are required in the first instance.

 552 F. Supp. at 195.

 The parties accepted the section II(D) *fn10" and section VIII(C) modifications required by the Court. It was also understood that the restrictions would be removed altogether if the rationale therefor became outmoded by technical developments or changes in competitive conditions. *fn11" On that basis, the Department of Justice was required to report to the Court every three years concerning the continuing need for the retention of the restrictions.

 It is in light of this history that the issues now before the Court must be analyzed.

 II

 Cross Subsidization

 In one respect, the risk that a Regional Holding Company will use its monopoly power for anticompetitive purposes becomes more remote as the market it seeks to enter becomes increasingly unrelated to and independent of local exchange service. That is so because products or services in unrelated fields are not dependent upon interconnection to the companies' monopoly bottleneck facilities, and discriminatory access therefore cannot injure the manufacturers or sellers which compete with them. However, competition can be impeded as readily in another way -- by cross subsidization, that is, by a subsidy to a new, competitive line of business with profits earned from or assets held by the existing, regulated monopoly line of business.

 As long as a Regional Holding Company is engaged in both monopoly and competitive activities, it will have the incentive as well as the ability to "milk" the rate-of-return regulated monopoly affiliate to subsidize its competitive ventures and thereby to undersell its rivals in the markets where there is competition. For that reason, caution with respect to "outside" activities is always warranted, particularly in the case of wholesale diversification because the larger the scale and the greater the diversity of a company's activities, the more difficult it is to detect and to remedy cross subsidization between the various affiliates. Compare also note 8 supra. Indeed, widely diversified Regional Holding Companies could enjoy greater opportunities to cross subsidize than did the Bell System which, under the 1956 consent decree, was limited to a relatively narrow range of products and services.

 Cross subsidization may take a variety of forms. One such practice would be the misallocation of common costs. To the extent that a Regional Holding Company used the same facilities, equipment, and personnel to serve both its regulated and its unregulated activities, it would have the ability to overallocate the costs assigned to the former in order to maximize the amount that would be passed on to the ratepayers (who have no choice but to pay). *fn12" Not only would this improper assignment of costs burden the ratepayers; it would also enable the company profitably to charge less for its competitive products and services than do its rivals who enjoy no such subsidy.

  A Regional Holding Company could also subsidize its competitive ventures by transferring assets *fn13" from its regulated affiliates to its unregulated affiliates at less than their cost or below their market value. *fn14" Such a practice would not only adversely affect the ratepayers who ultimately fund the research and development costs of the transferred assets, *fn15" but it would, once again, impede fair and effective competition in the competitive market: this cross subsidization would give the company's unregulated enterprise an obvious and improper advantage over its competitors. Conversely, a regulated affiliate could "purchase" assets from the unregulated affiliate at a price above their market value and pass on the extra costs to the ratepayers. *fn16"

 In addition to cross subsidization, a Regional Holding Company could impede competition in markets unrelated to telecommunications by exploiting the marketing advantages stemming from its local exchange monopoly. The company would have a unique advantage over its competitors if, for example, it "bundled" its regulated monopoly services with its competitive products or services, or if it advertised, and in fact provided to its customers in the competitive market, more timely telecommunications service, preferential access, or both. *fn17"

 In response to these concerns, the Regional Holding Companies argue primarily that cross subsidization is not a competitive issue but a regulatory cost allocation matter for which regulatory sanctions and penalties already exist. In addition, they contend that, even if they did engage in such anticompetitive conduct, the appropriate remedy would be a new antitrust action, not a refusal to grant a waiver. *fn18" These arguments are entirely without merit.

 The cross subsidization of competitive activities with profits earned from a regulated enterprise constitutes precisely the kind of conduct the decree was intended to curb, and for which the decree contains -- in a denial of a section VIII(C) waiver request -- a very precise remedy. There is therefore no reason or basis for turning elsewhere when such practices are threatened by organizations subject to the provisions of the decree.

 That remedy, moreover, is preferable to a regulatory one. Cost misallocation and improper transfer pricing in interaffiliate sales have proved difficult, if not impossible, to detect. *fn19" It is for that reason that regulatory oversight has not been in the past, *fn20" nor is it likely to be in the future, an adequate check against them; it is for that reason that section VIII(C) was incorporated in the decree; and it is for that reason, too, that the burden was placed on the Operating Companies to demonstrate the absence of an anticompetitive effect. By contrast, in a new antitrust action or in a regulatory proceeding the proponent of a restriction would have the burden of proof. In short, the prevention of cross subsidization and other anticompetitive practices is an appropriate and significant ingredient in any decision under section VIII(C).

 It does not follow from what has been said that all waiver requests must or will be denied. As noted below (Part VII infra) some of the problems discussed above can be alleviated by the imposition of conditions or safeguards upon the grant of waivers. It is also apparent, however, that such safeguards or conditions alone are not likely to be adequate to resolve legitimate concerns in this sensitive field, where claims of cross subsidization have contributed to a massive restructuring of the entire telecommunications industry, and where considerable caution is warranted to avoid yet another upheaval.

 Thus, what plainly needs to be done is to avoid a headlong rush by the Regional Holding Companies into diversification programs which, for the reasons stated, would offer them too many opportunities for anticompetitive conduct. *fn21" The Court will therefore require that the entry of these companies into competitive markets proceed at a measured pace (see pp. slip op. 57-58 infra). Additionally, as will now be seen, immediate, widespread diversification of the Regional Holding Companies would be at odds with other fundamental purposes of the decree.

 III

 Public Policy Factors

 The Department of Justice and several of the intervenors *fn22" urge the Court not to take a restricted and isolated view of its responsibilities in passing upon requests for waivers but to consider the effect diversification would have on the overall purposes of the decree. The Regional Holding Companies vigorously disagree, contending that, absent a showing that their entry into a new market will have a specific, directly predictable, adverse effect on competition in that market, they must be granted waivers regardless of the impact on other aspects of the decree. There is thus an issue whether, in addition to the specific standard set forth in section VIII(C), the Court could and appropriately should take into account broader considerations, specifically those articulated in other parts of the decree (e.g., the requirement of equal access) and those which are among the decree's dominant purposes (e.g., the efficient, economical provision of local telephone service). *fn23" It is that issue to which the Court now turns.

 There never was, nor could there ever have been, any doubt that the decree was to be interpreted and enforced not only in accordance with its literal terms but also in conformity with its principal purposes. *fn24" That, in fact, has been the uniform interpretive practice, acquiesced in and even requested at various times by all the parties.

 Before the Court could approve the parties' proposed consent decree, it was required by the Tunney Act (15 U.S.C. ยง 16(e)) to determine whether the decree was "in the public interest." *fn25" In the course of the Tunney Act proceeding, the parties made a number of assurances and undertook to abide by certain principles. *fn26" The Court thereafter approved the decree, but it noted that its public interest determination necessarily rested on the premise that these assurances will be fully carried out and that the other principles included in the decree "will be implemented in the manner most consistent with its purposes." 552 F. Supp. at 214. However, because it was impossible to know whether this premise was well taken, the Court found it necessary to "retain the power to ensure that the parties comply in full with the principles mandated by the decree, both in formulating the plan of reorganization and in their conduct after divestiture." Id.

 A number of times since then, often at the request of the Regional Holding Companies, the Court has had to resort to those principles and purposes in its continuing responsibility to give content to what in relation to the magnitude of the task -- in essence, the restructuring of the nation's telecommunications industry -- are necessarily somewhat sketchy provisions. *fn27"

 For example, even before the proposed decree was approved, the Court required that it be modified to permit the Regional Holding Companies to publish the Yellow Pages and to market customer premises equipment, and it stated that this was being done to ensure the viability of the local companies and to reduce upward pressures on local telephone rates -- both public interest considerations underlying the decree. *fn28" Further, as a condition of approval of the proposed consent decree, the Court required that it be modified to provide that the plan of reorganization shall not be implemented until approved by the Court "as being consistent with the provisions and principles of the decree." Section VIII(J). *fn29"

 Again, when the Court was called upon to clarify how the Operating Companies should treat undesignated interexchange traffic, it looked not only to the language of the decree, but also to its purposes and to "various practical considerations as they affect the public." *fn30" In passing on so-called LATA issues, the Court considered whether the choices made by AT&T and the Department of Justice correctly reflected the principles of the decree, especially in the areas of competition and Operating Company viability. *fn31" And more recently, the Court permitted the Regional Holding Companies to offer mobile radio services beyond their strict boundaries; *fn32" it ruled at the request of a Regional Holding Company that the Federal Communications Commission could not indefinitely delay the approval of effective tariffs; *fn33" it permitted the Operating Companies to provide time and weather services; *fn34" it permitted two Operating Companies to provide FX service across LATA boundaries; *fn35" it precluded a Regional Operating Company from selling to the government its embedded customer premises equipment; *fn36" it granted certain motions for clarification and waivers or modifications of the decree; *fn37" and it approved an interim billing arrangement for intra-LATA 800 service. *fn38" In every one of these rulings, the Court was guided substantially by the decree's purposes.

 Nothing in the decree even hints that the parties intended that the Court should ignore these kinds of considerations when it was called upon to decide line of business waiver requests. To the contrary. The standard which the Court applied in determining whether a particular line of business restriction was to be imposed upon the Regional Holding Companies consisted of three parts, one of which, of relevance here, was "the effect of the restrictions upon other important public policies." 552 F. Supp. at 187-88. And the Court explicitly stated that the removal of the restrictions would be governed by the same standard which it applied in determining whether they were required in the first instance. 552 F. Supp. at 195. *fn39"

 The Regional Holding Companies rely to the contrary upon such cases as United States v. Armour & Co., 402 U.S. 673, 29 L. Ed. 2d 256, 91 S. Ct. 1752 (1971), but that reliance is misplaced. In Armour, the Supreme Court held that a decree which grants only injunctive relief could not subsequently be converted by the unilateral fiat of one party into one effecting a structural separation. This case differs from Armour in at least two critical respects. First, as indicated above, the Court's resort to the decree's purposes, in addition to its literal language, was contemplated and understood -- in fact, provided for -- by the parties from the very outset. *fn40" Second, as to one key factor -- the timing of the entry of the Regional Holding Companies into new markets (see Part IV infra) -- the three entities that were most directly involved in drafting the decree and therefore most aware of its purpose in that regard -- the Court, the Department of Justice, and AT&T -- are all in agreement as to what was intended. See pp. slip op. 22-25 infra.41

 In short, when the Operating Companies argue that, in its consideration of motions for waiver of line of business restrictions, the Court may not consider policies that transcend the narrowest possible competition issues, it is they, rather than their opponents, that seek to transform the standard by which the decree was to be and has been interpreted. Accordingly, in passing upon such motions, the Court will take into account inter alia, the decree's fundamental principles and purposes. *fn42"

 IV

 Equal Access

 Contrary to the claims of some of the Regional Holding Companies, the inclusion of section VIII(C) in the decree is not evidence of a general policy in favor of their diversification. *fn43" That provision was included so that these companies could, at some later time, engage in nonregulated activities on a carefully controlled basis. No one connected with the negotiation, the drafting, or the modification of the decree envisioned that the Regional Holding Companies would seek to enter new competitive markets on a broad scale within a few months, let alone a few weeks, after divestiture -- before the implementation of equal access and before the companies' commitment to an efficient and economical telephone operation could be tested.

 The Department of Justice reported in its Response to Public Comments filed on May 20, 1982 supra (at 55) that

 

there was no suggestion in the comments that the BOCs would have any interest in entering such unrelated competitive businesses or that there would be any significant public benefit from such entry.

 Elsewhere in this Response (at 62) the Department went on to state that:

 

It is quite possible that, as technology evolves, the rationale for the restrictions will erode as the BOCs lose the ability to disadvantage competitors in these markets. As set out in its Competitive Impact Statement, the Department intends to review carefully the continuing need for the restrictions. In order to ensure that the Court is fully apprised of developments in this area, the Department will undertake to make a formal report to the Court on the continuing need for the restrictions on the third anniversary of the date of divestiture, and every third year thereafter so long as the restrictions remain in force. In the event that the Department concludes in its report that the state of competition and technology is such that any or all of the restrictions should be lifted, it will move the Court for a modification of the Judgment to permit such activity by the BOCs.

 Similarly, when Howard Trienens, AT&T's general counsel and a principal negotiator and draftsman of the decree, was asked by the Court whether anyone had in mind that there would be many new Regional Holding Company ventures in such a relatively short time, he replied emphatically in the negative. *fn44" And this Court which, as a result of its authority to require modifications of the decree was directly involved in approving the decree and in defining its meaning, *fn45" -- which, indeed, drafted and required the parties to incorporate section VIII(C) -- did not have the slightest belief or intention that within a very short period of time, *fn46" the Regional Holding Companies would seek to transform themselves from custodians of the nation's local telephone service into conglomerates for which such service was at best a pedestrian sideline. See Part V infra.47

 The line of business restrictions -- like the remainder of the decree -- became effective on January 1, 1984. Those restrictions were necessarily based upon the premise that, as of that time, they constituted an essential ingredient of the decree. Yet none of the requests for waivers is accompanied by a showing or even an allegation of changed circumstances that would justify a departure from the restrictions. The factual assumptions and the rationale underlying the Court's findings that these restrictions are in the public interest therefore remain sound. *fn48"

  Moreover, there are substantial reasons for concluding that a wholesale departure from the status quo at this time would not be in the public interest or consistent with the intended purposes of the decree.

 A principal problem is that the diversion of capital and managerial resources in the pursuit of outside ventures may impede the implementation of equal access, *fn49" and that this development, in turn, will hinder competition in the inter-exchange market. On that basis, some parties (e.g., MCI) urge that the Regional Holding Companies be prohibited from entering new lines of business altogether until they have fully fulfilled their equal access obligations under the decree. The Department of Justice likewise emphasizes that these companies have an incentive to use available financial resources to enter new markets rather than to meet their equal access obligations and that, given such an incentive, they may implement equal access with substantially less vigor and speed. *fn50"

 Some of the Regional Holding Companies argue that, because section VIII(C) itself does not specifically mention equal access, the Court may not even consider the possible effect that their entry into new markets will have on their ability to meet their equal access obligations. This argument necessarily assumes that the parties to the decree -- AT&T and the Department of Justice -- as well as the Court, contemplated that the Operating Companies would embark on a substantial diversification campaign shortly after divestiture and before equal access was implemented. As the Court noted above, nothing could be further from the truth.

 In any event, the narrow approach of the Regional Holding Companies to section VIII(C) waivers is entirely unjustified. The decree's provisions are not independent clauses having no relation to one another but are interrelated components of a plan to reorganize the Bell System and hence -- in effect -- the nation's telecommunications industry. *fn51" The Court would be derelict in its duties if it did not consider the possible effect the Regional Holding Companies' entry into unrelated lines of business will have on other provisions of the decree -- one of which requires the prompt implementation of equal access. *fn52" It was precisely this type of situation that the Court envisioned when it retained the power to ensure that the parties comply in full with the principles mandated by the decree, both in formulating the plan of reorganization and in their conduct after divestiture. *fn53"

  The Regional Holding Companies contend next that ample financial and legal incentives already exist for equal access compliance. *fn54" Yet these companies seem to be already laying the groundwork for blaming their eventual failure to achieve equal access on other factors. Thus, they even now identify the following as potential obstacles to their provision of equal access: (1) the unavailability of switching equipment; (2) the inability of suppliers to provide equipment according to schedule; (3) an inadequate supply of technical experts to engineer equal access; (4) regulatory requirements, including FCC reticence to allow recovery of equal access costs and ambiguity over AT&T's costs guarantees; and (5) the Department of Justice's failure to act on their equal access plans. *fn55" These careful predictions do not instill confidence that the capital and other resources of the Regional Holding Companies will be used to provide equal access and not for the pursuit of the outside ventures now being contemplated by these companies.

 The companies finally claim that, when the Court approved the schedule for implementing equal access, it recognized that it "could not expect equal access to be achieved immediately or to be phased-in on a more expedited basis than is contemplated in the proposed decree." *fn56" That is quite correct. The Court has no intention of requiring the Operating Companies to provide equal access in advance of the deadlines set forth in section A(1) of Appendix B of the decree. But those deadlines stand, and the Court will prevent impediments to the implementation of equal access, including the diversion of needed capital and the distraction of management which would frustrate the scheduled transformation of the local network into an equal access network. Accordingly, the Court will closely scrutinize any waiver request filed before a Regional Holding Company has implemented equal access to ensure that, if granted, it would not interfere with the company's specific obligations under the decree.

 V

 Provision of Local Telephone Service

 Under the decree, the Operating Companies' basic responsibility is to provide local telephone service to the public. The Plan of Reorganization, in turn, established the Regional Holding Companies for the primary purpose of serving the Operating Companies and facilitating their telecommunications functions. This is evident from the description in that plan of the structure and the responsibilities of these companies *fn57" and from section III of the decree itself. *fn58" As will now be seen, the vast and diverse programs the Regional Holding Companies are formulating, and the priorities the companies seem to be assigning to these programs, constitute a serious threat to their obligations under the decree and the implementing documents.

 As evidenced both by the pending waiver requests and by reports of their intentions, *fn59" the Regional Holding Companies are expending significant managerial and other resources to discover and analyze new business opportunities. *fn60" Moreover, some of these companies candidly state that they regard the telephone business as of limited interest to them and the fate of the rate-payers as of little significance in the context of the decree. Thus, US West proclaims that the "Operating Companies owned by US West are in the telephone business rather than US West" and that "US West does not itself intend to be a telephone company." *fn61" Ameritech similarly asserts that, "while protecting ratepayers may be a worthy goal in the abstract, it is one that should be left to the regulators and the legislators to pursue as they see fit." *fn62" And Bell Atlantic argues that its waiver requests must be granted even if diversification into new business will raise the company's cost of capital and divert the attention of its management from providing telephone service, because in its view the effect of diversification on the ratepayers "is extraneous to the Decree" and is therefore not a legitimate criterion for adjudging applications under section VIII(C). *fn63"

 The more the Regional Holding Companies diversify, the less central their telecommunications functions will obviously become to their corporate existence. To the extent that these companies perceive their new, unregulated businesses as more exciting, or more profitable than the provision of local telephone service to the American public -- as they obviously do -- it is inevitable that, should they be permitted to embark upon such business enterprises on a significant scale, their managerial talent and financial resources will be diverted from the business of providing such service. As a consequence, both the quality and the price of that service are bound to suffer. See also, note 122 infra.

 Some parties allege that the attention the Operating Companies are presently giving to outside ventures has already had the effect of diminishing their interest in telephone service, *fn64" impairing the quality of service and increasing telephone rates. Some of the problems with local service reported in the press have been overstated. *fn65" Nevertheless, the Regional Holding Companies themselves concede that complaints over installation, maintenance, and service have increased, *fn66" and that appears plainly to be true.

 One factor contributing to the service problems is inadequate coordination between the Regional Holding Companies and the interexchange carriers, principally AT&T. It should be clear -- and if it is not, the Court is making it clear now -- that the decree does not stand as an obstacle to such coordination (provided, of course, that it is extended to all interexchange carriers without discrimination). Some parties fear that the Regional Holding Companies may not be cooperating with these carriers as fully as they should because they see them as present or potential competitors, not only in those markets where such competition is appropriate, *fn67" but more broadly in the entire field of telecommunications (including interexchange services) and other markets in which these carriers -- and AT&T in particular -- are now beginning to compete. To the extent that the Regional Holding Companies' future business goals are responsible for the current service failures, the present Opinion may assist them in redirecting their focus on their primary role as providers of local telephone service. *fn68"

 Diversification is also believed to have a negative effect on local rates. The Regional Holding Companies must obtain the funds for their new ventures from somewhere, and that source is likely to be the place where, as a consequence of an absence of competition, there is the least risk and the least effective resistance -- the local ratepayers. In recent months, the public has witnessed a number of requests for local rate increases in all parts of the country. These requests are sometimes blamed on divestiture, but in fact they may stem from the need to raise capital for outside ventures, lavish advertising campaigns, and the construction of plants and the hiring of staff suitable for what the Regional Holding Companies consider themselves to be -- diversified conglomerates which are fast outgrowing their modest and relatively pedestrian telephone origins.

 The Regional Holding Companies assert that all these problems and fears are outweighed by the benefits they would derive from diversification, i.e., their ability to attract more capital and to increase revenue. In each of the waiver requests, the moving company argues that diversification will enhance its financial viability by reducing its overall risks. Diversified growth companies, it is said, are more attractive to securities investors and for that reason they are able to sell their stock at a higher price-earnings ratio, lowering their cost of equity capital. It follows, according to that line of reasoning, that a Regional Holding Company which is successful in diversifying could pass on its savings from lower capital costs to the ratepayers. These arguments are erroneous in every respect.

 First. While the cost of capital depends on many different factors, some tangible and others intangible, there is no evidence that the Regional Holding Companies' cost of capital would decrease as a result of diversification. Because regulators are required by law to permit utilities to set rates which recover their cost of service -- including the cost of capital -- utilities have traditionally been less risky *fn69" as investments than competitive ventures and their cost of capital from some sources has therefore tended to be lower. *fn70" Thus, to the extent that a Regional Holding Company raises funds jointly for both its competitive ventures and its regulated services, the cost of capital may be lower for the competitive venture (because it will be averaged with the lower capital costs of the regulated monopoly) but higher for the regulated telephone service. The ratepayers will then, in effect, be subsidizing the activities of the competitive venture by assuming, through higher interest rates, part of its cost. It follows that, if diversification of the Regional Holding Companies into new competitive ventures enhances their financial viability at all, the beneficiaries will more likely than not be these holding companies, their managers, *fn71" and their unregulated affiliates, not the Operating Companies which provide local telephone service. *fn72"

 Second. Despite the representations now made by some of the Regional Holding Companies, it is unlikely that their new business ventures would produce supra-competitive profits which could be used for other purposes. As the Department of Justice correctly observes, if these companies were able to extract supracompetitive prices in these markets, it would indicate that they were abusing their monopoly power in the local exchange market to gain an unfair competitive advantage over their rivals. *fn73" Absent such anticompetitive practices, the companies' profits would probably not exceed those earned by others in the same markets, and little, if anything, would be left over to provide financial assistance to the companies' telephone subsidiaries.

 Third. It may confidently be predicted that, even if the Regional Holding Companies could, somehow, reap significant profits from their outside ventures, they would not use them to benefit their regulated telephone affiliates. In fact, the opposite appears to be true. For example, Nynex candidly concedes, even boasts, that

 

the earnings of the Operating Companies belong to the stockholders of these companies. Those earnings are not automatically invested in any particular enterprise and their use should not be controlled by the Department of Justice. *fn74"

 Similarly, US West has informed the Court that the use of the dividends it receives from the Operating Companies it owns is of concern to no one else. *fn75"

 The Department of Justice cites an October 1982 Report of the Ad Hoc Committee on Utility Diversification of the National Association of Regulatory Utility Commissioners in which the Commissioners concluded that

 

regulators should not divert diversified earnings from shareholders to subsidize rates, except as ratepayers may deserve a share of those earnings to the extent that ratepayers are put at substantial or identifiable additional risk.

 Report at 81 (quoted in Department of Justice Memorandum of February 21, 1984, at 8). *fn76"

 Those predictions are also supported by recent experience. When the Court required AT&T to turn over its Yellow Pages operations to the Operating Companies, *fn77" it assumed that the revenues from directory advertising would continue to be included in the rate base of the Operating Companies, providing a subsidy to local rates. *fn78" Yet, the Regional Holding Companies, or some of them, have breached that understanding. Instead of funnelling Yellow Pages revenues to the Operating Companies, they have created separate subsidiaries to handle their directory publishing operations *fn79" which do not feed the revenues from these operations into the rate base. *fn80"

 In short, it is likely that the competitive ventures of the Regional Holding Companies, which rely in a number of ways on the funds generated by the ratepayers, will not share the profits from these ventures with the ratepayers.

 In further support of their argument that diversification is in the public interest, the Regional Holding Companies contend that an enterprise which is narrowly limited in scope cannot attract the executive and other talent required for quality performance. Thus, Ameritech states that if it is limited to the provision of local telephone service, it will lose its "efficiency and dynamism" and become stagnant and inefficient. *fn81" Bell-South asserts that, if it is unable to respond to the technological changes and evolving market demands of exchange service, it may not only lose potential revenue but it may also forfeit its base of large customers. *fn82" And Pacific Bell has informed the Court that the line of business restrictions are holding back its imagination and "flood of ideas." *fn83"

 There is no reason why the "efficiency and dynamism" of Ameritech, Pacific Bell's "flood of ideas," and the energies of the other Regional Holding Companies could not be directed toward improving local telephone service rather than pursuing extraneous ventures. Much can and should be done through the application of new technology, administrative efficiency, and marketing techniques to reduce the cost of telephone service, to improve its quality, and to make new features available to the public. If the Regional Holding Companies were determined to bring about such developments, they might well reap substantial benefits, and continue to attract the talent they seek.

 One needs only to contemplate the advances made in the customer premises equipment market and the variety of telephone equipment now available on store shelves in the wake of divestiture and hence of competition *fn84" to realize that, where there is a will, there are ample opportunities for technological and other advances in the telecommunications markets themselves. The Regional Holding Companies are only limited in the services they can provide; they are not limited to any particular technology in providing those services.

 The principal substantive purpose of the divestiture was to promote competition and hence to create conditions which will reduce the cost and improve the quality and reliability of the telephone service. For the reasons stated, the diversion of energy, talent, capital, and other resources by the Regional Holding Companies to pursue outside ventures on a substantial scale at this early stage has the potential for threatening that basic objective of the decree. The Court will therefore carefully scrutinize requests for waivers in accordance with the guidelines discussed below, to ensure that, if approved, they will not frustrate the implementation of the decree, the plan of reorganization, or the principles underlying the divestiture.

 This does not mean that the Court will not allow the Regional Holding Companies to engage in other activities, particularly if such activities would tend to increase competition. However, if there is to be a "second phase" restructuring of the telecommunications industry (see note 2 supra), it will evolve only in a deliberate, cautious manner, *fn85" with every step tailored to ensure that the public's telephone service does not suffer, but improves in quality and price.

 The Court will now consider the broad categories of the waiver requests.

 VI

 Interexchange Service

 Considerable concern has been expressed by a number of parties that the Regional Holding Companies plan to enter the interexchange market. These concerns are not without basis. Only one Regional Holding Company has thus far explicitly sought a waiver that would permit it to enter into the interexchange market, *fn86" but several others have expressed a similar desire. See, e.g., statement of Ameritech's Chairman William Weiss that the company wants to enter long-distance market and that the court-ordered restraints against such entry are "artificial" and "over time will fall away." *fn87" Similarly, Pacific Telesis has stated that it expects to connect all major California cities by optics by 1986. *fn88"

 To approve these plans and applications would be to contravene the decree's prohibitions in the most direct and obvious way. *fn89" Indeed, even to leave open the possibility of Regional Holding Company entry into this market would have negative implications, for if the companies perceive themselves as future long distance competitors they will have incentives to spend ratepayer funds for long-distance network construction and to position themselves for successful entry by discriminating against other carriers in interconnection and by delaying their achievement of equal access.

 It is therefore important that the Court state its position clearly. The Court will not even consider the substantive merits of a waiver request seeking permission to provide interexchange services until such time as the Regional Holding Companies lose their bottleneck monopolies and there is substantial competition in local telecommunications service. That is not now. *fn90" The BellSouth motion for a waiver with respect to the NASA contract is therefore denied. *fn91"

  Similar considerations govern the appropriateness of entry of the Regional Holding Companies into the information services and equipment manufacturing markets. No significant technological or structural changes have occurred in these markets to justify a relaxation of these line of business restrictions, and no requests for waivers in these markets will be considered unless and until such changes have taken place.

  VII

  Safeguards and Conditions

  For the reasons stated, the pending waiver requests, and presumably the requests which are bound to follow, present such anticompetitive and other problems that the Court could grant them only with safeguards which would minimize these problems. The Department of Justice has suggested several safeguards of a structural nature which, as noted infra, the Court has carefully considered.

  Before discussing specifics, however, it is necessary to consider first several general objections advanced by the Regional Holding Companies to the principle of conditions or safeguards.

  First. Relying on Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d 263 (2d Cir. 1979), the companies contend that an integrated firm may, without violating the antitrust laws, permit one of its departments to benefit from association with another which possesses a monopoly in its own market, and that structural safeguards are therefore improper. The rule of Berkey, whatever it may be, *fn92" is of no relevance to the issue before the Court. The standard of the decree in this case is not whether the proposed activities would rise to the level of an actionable antitrust violation but merely whether there is a substantial possibility that the Operating Companies "could impede competition." *fn93" The line of business restrictions of section II(D), together with the standard for removal in section VIII(C), are prophylactic measures designed to prevent the Regional Holding Companies from abusing their power over the local telephone monopoly in any way. If the level of the prohibited activity had to rise to that of an antitrust violation, these provisions would have been unnecessary and redundant.

  Moreover, under section VIII(C), the burden is on the petitioning Regional Holding Company, not, as in an antitrust case, on the Department of Justice or a private plaintiff. *fn94" In order to meet this burden, a company must demonstrate that it could not use its local telecommunications monopoly to obtain an unfair competitive advantage in a new market through cross subsidization or other anticompetitive behavior. In the absence of such a showing, the decree presumes that the potential for harm to competition outweighs any of the claimed benefits or efficiencies that may result from diversification. *fn95"

  Second. The Regional Holding Companies claim next that the imposition of any safeguard, beyond those adopted voluntarily by a particular company, constitutes regulation and would, as one of them put it, "thrust this Court into the heart of the regulatory process." *fn96" However, it was because of the shortcomings of the regulatory process that the government brought the AT&T lawsuit and that the Court approved, as in the public interest, the divestiture and other relief. *fn97" There is nothing to indicate that a key assumption underlying the decree -- that state and federal regulation alone cannot eliminate the possibility of anticompetitive abuses by the Operating Companies -- is no longer valid. To the contrary. Those state regulatory commissions which have filed comments with the Court on the pending waiver requests are unanimous in their conclusion that they would be unable to prevent the allocation of competitive costs to the rate base. *fn98"

  In any event, regulators would be concerned with but one facet of cross subsidization -- the Operating Companies' extraction of excess revenues from the rate base -- and not with the use of those revenues to impede competition by subsidizing competitive activities.

  Third. The Regional Holding Companies claim that, by adopting specific safeguards, the Court would be improperly adding new and different provisions to the decree. Part III supra discusses the distinction between the imposition of new provisions and an interpretation of the decree in light of its governing purposes. The guidelines enumerated herein simply implement the Court's responsibility to pass upon waiver applications as required by the decree. *fn99" Because of the variety and complexity of the issues raised by these applications, *fn100" the Court must have the option of conditioning its approval upon the adoption of conditions or safeguards. *fn101"

  The Department of Justice has recommended that the Court impose a number of very specific conditions or safeguards, as follows: (1) establishment by the petitioning Regional Holding Company of a separate subsidiary to conduct competitive activities; (2) separation of the credit underlying the competitive activities from that which supports the Operating Companies; (3) prohibition on the sharing of personnel, equipment, facilities, and services *fn102" between the Operating Companies and the competitive enterprises; (4) prohibition on the transfer of any asset or resource developed by an Operating Company to its affiliate engaged in competitive enterprises; (5) minimization of the number and dollar value of any transactions between the two sets of enterprises; (6) imposition upon the competitive enterprises of the same visitorial and investigative provisions which apply to the Operating Companies; (7) annual certification by the chief executive officer of a Regional Holding Company that the company has conformed to the conditions governing its entry into new line of businesses; and (8) reservation by the Court of the authority to modify or withdraw the waiver at a later date.

  The Court has considered these proposals in light of the objections filed by the Regional Holding Companies, and it has concluded that the following four conditions are adequate and will be required.

  First. It is generally agreed that if the Regional Holding Companies conducted competitive activities through separate subsidiaries, intracompany transactions would become more apparent and thus cross subsidization and other anticompetitive conduct could more easily be prevented or rectified. *fn103" The Regional Holding Companies themselves appear to acknowledge that such structural measures are a necessary safeguard. *fn104" Accordingly, while, as a general matter, the Court is not eager to require the establishment of separate subsidiaries, *fn105" that measure is warranted in this situation, and it will be required.

  Second. The use of the Operating Companies' financial resources or credit to finance new ventures creates an obvious potential for anticompetitive cross subsidization. It also tends to jeopardize the financial soundness of the Operating Companies for purposes unrelated to their own enterprises. The Court will therefore approve waiver applications only if they incorporate provisions which will ensure that subsidiaries of the Regional Holding Companies engaged in competitive enterprises obtain their own debt financing on their own credit and that no entity affiliated with the Regional Holding Company will guarantee the debt in a manner that would permit a creditor, on default, to have recourse to the assets of an Operating Company. *fn106"

  Third. In order to prevent cross subsidization by widely diversified holding companies (see pp. slip op. 8-14 supra), to implement the decree's equal access provisions (see pp. slip op. 22-29 supra), and to protect the nation's telephone service from injury due to lack of attention or the absence of a sound financial base (see pp. slip op. 30-41 supra), the Court will require that the bulk of the investments of the Regional Holding Companies remain in decree-related activities. Accordingly, the Court will not, for the present, *fn107" grant line of business waivers for activities the total estimated net revenues of which exceed ten percent of a Regional Holding Company's total estimated net revenues. *fn108"

  Fourth. Each Regional Holding Company seeking a waiver will be required to agree in its application that the monitoring and visitorial provisions of section VI of the decree apply to its proposed competitive activities. This will enable the Department of Justice to monitor compliance with the order granting the waiver and to report to the Court in the event that there are violations. *fn109"

  In the view of the Court, these safeguards are adequate to protect the integrity of the decree in the respects discussed in this Opinion. Some of the additional conditions proposed by the Department of Justice would involve the Court too deeply in the internal operations of the Regional Holding Companies; others would not be readily enforceable; *fn110" and still others are unnecessary in view of the unambiguous requirements of the decree. *fn111"

   VIII

  Procedures

  The Court has received a number of suggestions concerning procedures for dealing with present and future requests for waivers of the line of business restrictions. *fn112" In order to encourage informal negotiation and resolution, to avoid inundation of the Court with requests, and to make use of the expertise of the Department of Justice, *fn113" all such requests will be initially referred to the Department of Justice, as follows. *fn114"

  A Regional Holding Company seeking a waiver of the line of business restrictions of the decree shall submit its request to the Department of Justice, together with a detailed proposal which should include the products or services to be offered, the means by which they would be offered, and the conditions proposed for avoiding the problems discussed in this Opinion. *fn115" The Department of Justice, guided by the principles expressed in this Opinion, will consider the requests formally or informally with the requesting Regional Holding Company and all other interested parties. *fn116"

  If the Department concludes that the Regional Holding Company has met its burden as explained herein and concurs in the requested waiver, it shall submit to the Court a proposal for an appropriate order. That order will be entered as the order of the Court unless an interested party files an objection or the Court sua sponte expresses reservations. If the Department does not concur in the request, it shall submit the proposed waiver request to the Court for its decision, together with its own comments, and any supporting and opposing materials it may have received. The Court will at that juncture establish a procedure for further briefing, and possibly oral argument, to consider the views of all interested parties.

  All currently pending waiver requests are herewith transmitted to the Department of Justice for its analysis and report to the Court in accordance with the procedure set forth above. *fn117" In view of the length of time these requests have been pending, the Department should endeavor to return these requests to the Court with its views within thirty days hereof.

  IX

  Conclusion

  The decree was entered under the Sherman Act to eliminate anticompetitive conditions in the telecommunications industry. Within that legal framework, the bedrock purpose of the decree is to create conditions that will reduce the cost and improve the quality of telecommunications products and services. *fn118" Under the decree, the Regional Holding Companies play an essential role -- they are to provide efficient, economical, and, if possible, technologically advanced local telephone service. Their role is not to provide a source of ratepayer funds, credit, and other assets to finance competitive ventures, nor were they meant to be vast conglomerates in which telephone service is relegated to a subordinate place. Yet that is what is threatened by the broad diversification efforts presently under way. This conclusion is reinforced by the lack of restraint some of the Regional Holding Companies have shown in their desire to transform themselves rapidly from local telecommunications organizations into seven diversified "Bell Systems." *fn119"

  The decree contemplates that AT&T, as a company now engaged in competitive business, could enter various new fields as it sees fit; it did not contemplate such entry for the Regional Holding Companies except on a limited and slowly-evolving basis. The reason is simple: these companies, unlike AT&T, retain what is in law and in reality a monopoly over a critical aspect of the nation's telephone service.

  The Court embraced diversification as it applies to AT&T, *fn120" reasoning that, should that company squander its resources on unprofitable non-telecommunications ventures, raise its rates, or fail to render quality service, its customers could easily take their business to one of its long distance or equipment competitors. *fn121" That is not so, however, with respect to the customers of the Operating Companies. These companies are at present the only entities with the license and the capacity to provide local telephone service to the general public. Thus, if they neglect their responsibilities in that regard in order to pursue what they may consider more interesting ventures, or if they are diverted from those responsibilities by unrelated or speculative business objectives, *fn122" the public, unable to go elsewhere, will suffer in higher rates, deteriorating service, or both. Such a result would be entirely inconsistent with the basic purposes of the decree, *fn123" and the Court will not approve requests which would help to bring it about. *fn124"

  Beyond these considerations, there is the overriding principle that the Court is obligated under the decree to make certain that the Regional Holding Companies do not impede competition in the non-telecommunications markets they seek to enter. Here again, wide diversification presents a serious threat in terms of cross subsidization and other anticompetitive practices.

  The decree assumes, as does the Court, that the Regional Holding Companies may diversify on a significant scale only as they demonstrate the centrality to their corporate life of the responsibilities imposed upon them by the decree, their firm commitment to low-cost, high-quality telephone service, and the improbability of their involvement in anticompetitive conduct based upon their monopoly status. The rules established herein are designed to achieve these objectives while also permitting the Regional Holding Companies to enter into new business ventures to the extent that this will not be a threat to the fundamental purposes of the decree.


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