United States General Accounting Office

GAO Report to Congressional Requesters

August 1999 TELECOMMUNICATIONS

Process by Which Mergers

of Local Telephone

Companies Are Reviewed

GAO/RCED-99-223

GAO United States

General Accounting Office

Washington, D.C. 20548

Resources, Community, and

Economic Development Division

B-281828 

August 20, 1999

The Honorable Mike DeWine

Chairman

The Honorable Herb Kohl

Ranking Minority Member

Subcommittee on Antitrust, Business Rights,

 and Competition

Committee on the Judiciary

United States Senate

The Honorable Luis Gutierrez

House of Representatives

One of the primary purposes of the Telecommunications Act of 1996 was

to promote competition within telecommunications markets. Since the law

was enacted, some large local telephone companies have merged, and

other mergers are pending. As a result of your concern that the industry

has become more consolidated, you asked us to provide information on

(1) the standards and processes under which mergers between local

telephone companies are evaluated and approved by governmental bodies

and (2) the implementation of this process in the Bell Atlantic-NYNEX

merger—the largest local telephone merger completed when we began our

work in early 1999—and the effects of the merger that can currently be

observed.

Results in Brief Several governmental bodies review mergers between local telephone

companies using varied standards and processes in their analyses. At the

federal level, these mergers are reviewed by the Department of Justice and

the Federal Communications Commission. Using guidelines that have been

developed to evaluate the likely effects of a merger on market

concentration and other competitive factors, the Department of Justice,

acting as the enforcement agency to review mergers under federal

antitrust law, assesses whether a merger may “substantially lessen

competition” within the industry. If the Department determines that a

merger will substantially harm competition and therefore violates antitrust

laws, it can bring a court action—in which it bears the burden of proof—to

stop the merger. In contrast, the Federal Communications Commission,

the federal agency that regulates the telecommunications industry,

primarily examines whether the transfer of licenses and lines from one

company to another in a merger is in the “public interest.” To determine

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if a merger is in the public interest, the Commission considers several

factors, such as the effects of a merger on (1) competition in the industry,

(2) the Commission’s ability to enforce its obligations under the

Communications Act, and (3) the deployment of advanced

telecommunications services. If the Commission cannot determine that a

merger is in the public interest and accordingly declines to approve a

license transfer, merging parties can file a lawsuit—in which they bear the

burden of proof—challenging the Commission’s decision. State attorneys

general and some state public utility commissions also have the authority

to review mergers between local telephone companies. Like the

Department of Justice, state attorneys general review the potential impact

of a merger on competition. Most state utility commissions tend, like the

Federal Communications Commission, to focus their reviews on whether a

merger is in the public interest.

The Bell Atlantic-NYNEX merger took place in August 1997 after review by

several governmental bodies. The merging companies’ prior status as

regulated monopolies complicated the merger review process. After

conducting antitrust reviews, the Department of Justice, a task force of

state attorneys general, and individual state attorneys general did not

challenge the merger under antitrust law. While the Federal

Communications Commission and all the reviewing state utility

commissions allowed the merger to go forward, the Federal

Communications Commission and four of the five reviewing state

commissions imposed conditions on the merged company. Many of these

conditions—which, for example, required Bell Atlantic to provide a

uniform way for competitors to place orders for services—were aimed at

inducing Bell Atlantic to rapidly open its local telephone markets to

competitors. While few market effects of the merger are identifiable, Bell

Atlantic officials told us that the company has realized the cost savings it

expected to gain from the merger.

Background Much of the nation’s telephone infrastructure was built and owned by

American Telephone & Telegraph Company (AT&T) from the time the

company was formed in 1885 through most of the next century. For most

of that time, AT&T was the parent company of many subsidiary companies

that provided local and long-distance telephone service throughout the

United States and also manufactured telephone equipment. By the early

1980s, AT&T carried roughly 80 percent of the nation’s local telephone

traffic through its 22 subsidiary Bell Operating Companies, and the

remaining 20 percent of local telephone traffic (much of which was

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concentrated in rural areas) was carried by a myriad of independent

telephone companies unaffiliated with AT&T. Because the Bell Operating

Companies and the independent companies held franchises giving them

the right to serve geographically distinct areas that did not overlap, very

few consumers had a choice of providers for local telephone service.

As technology advanced and regulatory changes opened up

telecommunications markets to new entrants, competition began to

emerge in the long-distance telephone market. In 1974, the Department of

Justice (DOJ) brought an antitrust suit against AT&T alleging that the

company was engaging in anticompetitive behavior to the detriment of

new competitors in the long-distance and telephone equipment markets.

The resolution of that case unfolded in the early 1980s and brought an end

to AT&T’s domination of the nation’s local telephone markets on January 1,

1984—16 months after a court approved the consent decree, known as the

Modification of Final Judgment, that the Department of Justice and AT&T

had entered into. Under the consent decree, AT&T was required to divest its

ownership of the 22 Bell Operating Companies to ensure that AT&T would

not have an advantage in the long-distance telephone market through its

ownership of the local telephone networks and facilities where all

telephone calls originate and terminate.

The 22 Bell Operating Companies were reorganized into seven regional

entities—Ameritech Corporation, Bell Atlantic Corporation, BellSouth

Corporation, NYNEX Corporation, Pacific Telesis Group (PacTel),

Southwestern Bell Corporation (now called SBC Communications Inc.),

and US WEST, Inc.—that became known as the “Baby Bells” (see fig. 1).

The service territories of the newly formed Baby Bells were, and continue

to be, geographically distinct; however, the recent mergers between Bell

Atlantic and NYNEX, as well as between SBC and PacTel, have reduced the

number of Baby Bells to five.1

 The AT&T consent decree also imposed

restrictions on the lines of business that Bell Operating Companies were

allowed to enter. For example, these companies were not allowed to enter

the long-distance market or to manufacture telephone equipment. The

AT&T consent decree did not affect the independent local telephone

1

A merger between SBC and Ameritech, announced in May 1998, is currently pending before federal

and state regulatory bodies. In addition, Bell Atlantic announced its intention in July 1998 to merge

with GTE Corporation, a non-Bell company that provides local telephone service in 28 states and also

provides long-distance, wireless, and Internet access services. In both of these cases, DOJ has

tentatively approved consent decrees, and FCC is still reviewing the mergers, although, according to

FCC, Bell Atlantic and GTE asked the Commission to defer processing their merger application until

those companies make a further submission to the Commission on long-distance issues. In addition, a

merger between US WEST and Qwest, a non-Bell communications provider of broadband data and

voice services, was announced on July 18, 1999. Ten percent of Qwest’s current ownership is held by

another Baby Bell company, BellSouth.

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companies that had not been part of AT&T, and their service areas are still

distinct and do not overlap Bell service areas.2

Since the AT&T consent decree was issued, advanced technologies have

altered the telecommunications market. Recognizing the dramatic changes

in the industry, the Congress enacted the Telecommunications Act of 1996.

This act was a major modification to the Communications Act of 1934 and

set out a framework for the development of competition in local telephone

and other telecommunications markets.

At the time Bell Atlantic and NYNEX announced their intention to merge in

April 1996, each of the companies controlled approximately 98 percent of

the local telephone market in its respective area. Bell Atlantic operated in

Delaware, Maryland, New Jersey, Pennsylvania, Virginia, West Virginia,

and the District of Columbia, and NYNEX operated in Maine, Massachusetts,

New Hampshire, New York, Rhode Island, Vermont, and a portion of

Connecticut. The wireless cellular subsidiaries of the two companies had

merged in 1994, and discussions on a corporatewide merger between Bell

Atlantic and NYNEX were initiated prior to the enactment of the

Telecommunications Act of 1996.

2

In all 48 states of the continental United States, local telephone service is provided by either a Baby

Bell company or an independent local telephone company. Hawaii and Alaska are served only by

independent companies.

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Figure 1: Service Territories of the Original Seven Regional Bell Operating Companies, With Subsequent Mergers Noted

NYNEX

(Acquired by

Bell Atlantic)

Pacific Telesis Ameritech

(Acquired by SBC

Communications)

SBC

Communications

US WEST

Bell Atlantic

BellSouth

Note: SNET (a non-Bell company prior to its acquisition by SBC Communications) is the primary

local telephone company for most of Connecticut. However, NYNEX (now Bell Atlantic) operated

in a small portion of that state.

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Governmental Bodies

Use Varying Standards

and Processes to

Review Local

Telephone Company

Mergers

Federal and state governmental bodies have the authority under different

statutory provisions to review proposed mergers of local telephone

companies. These varied reviews differ with respect to the purposes of the

merger reviews, the reasons mergers can be blocked, the manner in which

the governing bodies conduct the reviews, and how any disputes about

merger decisions are resolved. Prior to the passage of the 1996

Telecommunications Act, a provision of the 1934 Communications Act

provided the Federal Communications Commission (FCC) with the

authority to review local telephone company mergers, and FCC could

authorize such mergers to go through without review by federal antitrust

agencies. This provision was repealed by the 1996 act and, while FCC

maintains the authority to review the transfers of licenses that occur with

mergers based on other provisions of the Communications Act, DOJ now

also reviews mergers between local telephone companies.3

 Mergers of

telephone companies announced since the 1996 act, such as the Bell

Atlantic-NYNEX merger and the SBC-Pacific Telesis merger, have been

reviewed by FCC and DOJ at the federal level. State attorneys general and

some state utility commissions also have the authority to review proposed

mergers of local telephone companies.

Department of Justice. DOJ’s Antitrust Division derives its merger review

authority from both the Sherman Act of 1890 and the Clayton Act of

1914—the primary federal antitrust laws. These laws are generally

designed to preserve competition in an industry sector. Section 7 of the

Clayton Act incorporates the policies underlying relevant sections of the

Sherman Act and prohibits a merger if the resulting effect “may be to

substantially lessen competition.” The Hart-Scott-Rodino Antitrust

Improvement Act of 1976, an amendment to the Clayton Act, requires that

merging companies, in certain cases,4

 notify DOJ of their intent to merge

and expands DOJ’s authority to conduct premerger investigations.

3

Generally, federal antitrust reviews are performed by either DOJ or the Federal Trade Commission

(FTC) under a cooperative system that will eliminate duplicative merger reviews. In the case of

telephone company mergers, DOJ is usually the reviewing agency because a merger of two common

carriers—which local telephone companies are—is outside the statutory jurisdiction of FTC, 15 U.S.C.

18, 21, 45(a)(2). Since telephone company mergers are reviewed by DOJ and FCC at the federal level,

this report will focus on those agencies.

4

For example, if the merging parties or the transaction are of sufficient size, a merger will pass certain

“thresholds” that require Hart-Scott-Rodino filings to be made.

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Operating under specific time frames in conducting its review, DOJ can

request further information from the companies that have filed premerger

notifications if the Department determines that a more extensive analysis

is appropriate. As mandated by law, information that is gathered by DOJ is

confidential and protected from public dissemination. To determine

whether a merger violates antitrust laws, DOJ uses well-established

economic and legal principles that are reflected in the Department’s

merger guidelines.5

 The merger guidelines provide methods for several

key elements of an antitrust review: defining the relevant markets,

measuring concentration, evaluating whether firms are likely to enter a

market,6

 determining competitive effects, and evaluating the efficiencies of

a proposed merger. If DOJ determines that a merger will substantially harm

competition and therefore violates antitrust laws, it can bring a court

action to stop the merger. The burden of proof in such a case is on the

government to show that the merger will be substantially anticompetitive.

When DOJ concludes that a merger will violate antitrust laws, it may, in

some cases, negotiate a “consent decree” with the merging companies.

Under a consent decree—which is filed with a court and is thus legally

enforceable—the merging companies agree to undertake activities that

would eliminate the competitive harm of the merger, such as divesting

certain properties. If DOJ does not go to court to block a merger, or if it

does not end its investigation with a consent decree or otherwise resolve

5

DOJ and the FTC’s merger guidelines are periodically updated. The most recent update was in 1997.

6

The evaluation of likely entry includes determining whether one of the merging parties is likely to

enter a relevant market.

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competitive issues,7 the Department will close its investigation.8 DOJ

generally provides little or no public information about its analyses of a

merger’s impact on competition.

Federal Communications Commission. FCC’s authority to review the

transfer of control of licenses in connection with a proposed merger

derives from sections 214 and 310 of the 1934 Communications Act.9

Because mergers involve a change in the ownership or control of

companies holding licenses or lines needed to offer telecommunications

services in the United States, merging firms must apply to FCC for approval

of the transfer of those licenses or lines. The purpose of FCC’s review is to

determine that the license transfers are in the “public interest,” and this

review may consider many factors, such as the competitive effects of the

license transfers, the effects on FCC’s ability to enforce its obligations

under the Communications Act, and the effects on the deployment of

advanced telecommunications services. While FCC follows, in part, DOJ’s

merger guidelines in its competitive analysis of mergers, the Commission’s

merger review is generally viewed as broader than DOJ’s because the public

interest standard can take into account a more diverse set of issues and

therefore may cause FCC to reach a conclusion that differs from DOJ’s.

Since a primary purpose of the Telecommunications Act of 1996 was to

promote competition in the industry, the Commission’s more recent public

interest reviews of telephone companies’ license transfers have focused

closely on competitive effects.

FCC’s review of telephone mergers takes place under an open process. All

of the documents that companies file with the Commission become part of

the public record,10 parties get a chance to respond to the comments filed

by others, and the Commission issues a final order in which it provides a

detailed account of its rationale for a decision. When FCC finds a merger to

be in the public interest, it will approve the transfers of licenses and lines

necessary to allow the merger to go forward. Alternatively, if FCC cannot

determine that a merger is in the public interest, it will accordingly decline

7

In some cases, the Department may agree, informally, to a restructuring of the transaction to

eliminate competitive concerns. Also, in some cases, the parties may abandon their intent to merge.

8

DOJ’s decision to not block a merger cannot be challenged in court.

9

FCC also has the authority under the Clayton Act to review mergers. However, we were told that FCC

does not generally exercise its Clayton Act authority. Recently, a number of bills have been introduced

to modify FCC’s authority to review the transfers of licenses occurring through mergers.

10However, part of the public record may include confidential materials to which access is limited.

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to approve a license transfer.11 If FCC finds the public interest harm

outweighs the public interest benefit of a transaction, it may enter into

discussions with the merging parties, and ultimately, adopt

conditions—that is, specific activities that the merged company would

have to perform—that will change the balance of the public interest effects

and thus enable the Commission to find the license transfers to be in the

public interest.12 Whatever FCC actions are taken in a particular case,

interested parties (including, but not limited to, the merging companies)

can file a lawsuit challenging FCC’s decision. Any party filing such a lawsuit

against a Commission decision bears the burden of proof in showing that

the decision was “arbitrary and capricious” or beyond the Commission’s

authority.

State Attorneys General. State attorneys general also have the authority to

block mergers under federal antitrust law.13 Because few mergers will

affect only one state, the attorneys general have formed a task force

through the National Association of Attorneys General to coordinate

merger reviews by multiple attorneys general. Typically, one state will take

the lead role to coordinate the merger review. Additionally, if the merging

parties consent, filings submitted to DOJ are shared with participating state

attorneys general for their review.14 The National Association of Attorneys

General and DOJ have developed a protocol for how the state attorneys

general and the Department will conduct a joint investigation on the

antitrust implications of a proposed merger.

The National Association of Attorneys General has also developed merger

guidelines—which have some similarities to DOJ’s merger guidelines—to

analyze how a merger will affect competition. If a single state attorney

general or a group of attorneys general determines that a merger will

substantially harm competition—which is the standard for a merger to be

illegal under the Clayton Act—a state or a combination of states can file an

action in court to stop the merger. They can also file comments in hearings

before state utility commissions or join in a proceeding with DOJ.

11Prior to a final finding that it cannot find a merger to be in the public interest, the Commission will

send the case for a hearing before an administrative law judge. If that judge also cannot find the

merger to be in the public interest, the case goes back to FCC for a final ruling.

12According to FCC documents, the Commission has the authority to attach conditions to its approvals

of license transfers under sections 214(c) and 303(r) of the Communications Act.

13In some cases, attorneys general may also challenge mergers under state antimerger laws.

14The Voluntary Pre-Merger Disclosure Compact, sponsored under the auspices of the National

Association of Attorneys General, creates a contractual understanding between the compact’s

signatory states and the parties concerning the sharing of information filed with DOJ and the

coordination of the investigation by the state attorneys general. As part of the compact, participating

states agree to refrain from filing subpoenas for additional information from the parties.

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State Public Utility Commissions. State statutes that provide the authority

to public utility commissions (sometimes called public service or

commerce commissions) vary a great deal with regard to their merger

review authority. According to a representative of the National

Association of Regulatory Utility Commissioners, some state utility

commissions have the authority to review mergers of the companies that

they regulate, other state utility commissions have the authority to review

only transfers of regulated companies’ assets, and still others have no role

at all in reviewing or approving mergers between telephone companies.

While most commissions’ reviews focus on whether mergers are in the

public interest, some commissions also specifically examine competition

issues.

Bell Atlantic-NYNEX

Merger Went Forward

With Conditions

According to the merging companies, Bell Atlantic and NYNEX merged to

take advantage of a variety of expected benefits both within their local

telephone markets and in markets that the firms hoped to enter (such as

the long-distance market). The merger review process, which began in

April 1996 when Bell Atlantic and NYNEX announced their intention to

merge, was completed when the last of all federal and state governmental

reviewing bodies approved the merger in August 1997. The review process

was lengthy in part because of the complexity of the analyses conducted

by these bodies. At the federal level, the merger was reviewed by DOJ

under federal antitrust statutes and by FCC under the Communications Act

of 1934. Five state utility commissions conducted formal merger review

proceedings, and a task force of state attorneys general also reviewed the

merger.15 Neither DOJ nor any of the state attorneys general sought to

block the merger on the basis that it would violate antitrust laws. In

addition, the merger was approved by FCC and the five state utility

commissions that formally reviewed the merger. However, FCC and four of

the states placed specific conditions on the merging parties, many of

which were designed to help foster greater competition in the local

telephone market. While Bell Atlantic officials told us that the company

has realized significant cost savings since the merger, no other significant

measurable market effects can be definitively attributed to the merger at

this time.

15The merging companies filed notices of the planned merger with all 14 utility commissions in the

jurisdictions in which the companies operated. However, license transfers took place only within the

NYNEX states, and five of these state utility commissions issued formal orders approving the merger.

One of the state utility commissions in the original Bell Atlantic region, the New Jersey Public Utility

Commission, also issued an order approving the merger, although no control of licenses was

transferred in the state. Massachusetts also issued an order, even though it had no specific statutory

authority to review or approve mergers of telephone companies.

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A Variety of Expected

Benefits Motivated Bell

Atlantic and NYNEX to

Merge

According to a Bell Atlantic official, the Bell Atlantic-NYNEX merger was

intended to enable the unified company to compete more effectively in the

delivery of local telephone service within the two companies’ existing

service areas. A Bell Atlantic official told us that the merger was expected

to result in cost savings from the greater efficiencies gained by their

combined operations.16 In addition, Bell Atlantic and NYNEX’s merger

application outlined the companies’ plans to adopt each other’s best

practices to attain operational improvements. Cost savings and improved

business procedures were considered by both companies to be necessary

to retain their most valued customers in the face of new entrants into the

local telephone market. In addition, Bell Atlantic stated in its merger

applications that the merged company would be in a better position to

enter the domestic long-distance market—which Bell Atlantic hoped to do

soon after the merger’s completion—as well as the global

telecommunications market.

Bell Atlantic-NYNEX

Merger Required Complex

Competitive Analysis

Bell Atlantic and NYNEX announced their intention to merge on April 21,

1996, and the merger was finally completed on August 14, 1997. As figure 2

shows, over the course of those 16 months, various jurisdictions approved

the merger. FCC officials told us that the merger review process was

protracted partly because of the review’s complexity. Besides the large

size of the merging companies and the multiple reviewing bodies, the

merger review was especially complicated because the merging parties

were formerly monopolistic companies and because FCC’s framework for

applying its public interest standard was evolving as a result of the passage

of the Telecommunications Act of 1996.

16Specifically, the anticipated cost savings resulted from greater economies of scale and scope.

Economies of scale occur when larger production output is associated with lower per unit cost of

production, and economies of scope occur when producing two or more similar products reduces the

average costs of production of those products.

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Figure 2: Time Line of the Bell Atlantic-NYNEX Merger’s Review and Approval by Governmental Bodies

April 22, 1996

Bell Atlantic & NYNEX

Announce Agreement

to Merge

December 30, 1996

Maine Public Utilities

Commission Approves

the Merger

January 23, 1997

Massachusetts Dept.

of Public Utilities

Completes Merger Review

March 10, 1997

Rhode Island Public

Utilities Commission

Decides Not to Review

the Merger

April 24, 1997

Department of Justice

Issues Antitrust Clearance

for the Merger

November 20, 1996

Connecticut Department

of Public Utility Control

Approves the Merger

February 27, 1997

Vermont Public

Service Board Approves

the Merger

August 14, 1997

Federal Communications

Commission Approves

the Merger

January 6, 1997

New Hampshire Public

Utilities Commission

Approves the Merger

March 20, 1997

New York Public

Service Commission

Approves the Merger

The Merger of Bell Atlantic

& NYNEX Becomes

Effective

Note: The Bell Atlantic-NYNEX merger application was filed with FCC on July 2, 1996.

The history of Bell Atlantic and NYNEX as regulated monopolies, and the

associated lack of a “market history,” made determining the competitive

effects of this merger difficult. In most antitrust merger cases, companies’

previous market behaviors and strategies are central to the review, but

such information in this case was less available and was of less use

because both companies had been constrained in many ways by previous

regulation. Despite the fact that these companies did not compete against

each other, the competitive effects of their merger can be evaluated under

the “actual potential competition doctrine” of DOJ’s merger guidelines.

The actual potential competition doctrine focuses on whether, in the

absence of the merger, one of the merging companies is likely to

successfully enter the other’s market, and on whether competition in the

market will be substantially lessened by the elimination of such entry. To

show that a firm is a potential competitor, however, it is important to have

evidence that the firm was actually planning or at least considered

entering the market in question.17 The fact that a firm did not actually

enter a market can make it difficult to prove that entry was likely.

Additionally, while DOJ generally would not find that a merger between a

17Courts are split on the standard of evidence required to prove that a company was likely to enter a

market.

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current competitor and a potential competitor substantially lessened

competition if at least three other viable competitors—current or

potential—would remain after the merger, Department officials told us that

in this case, the merger required careful scrutiny despite the existence of

other potential competitors.

Officials at both DOJ and FCC told us that the actual potential competition

standard was more difficult to apply to nearly monopolized markets

where, until very recently, laws, regulations, and related requirements

precluded the merging parties—in this case, Bell Atlantic and

NYNEX—from entering each other’s market areas. Because of the

complexity of applying the potential competition doctrine in what FCC

called “transitional markets”—that is, markets that are in the process of

changing from a regulated monopoly to a more competitive

environment—the Commission developed a new framework: the

“precluded competitor” analysis. FCC officials told us that the

Commission developed this framework in order to protect the interest

defined by the Communications Act. Under this framework, which is

based on the same economic principles as those underlying antitrust

doctrines, FCC could evaluate the likelihood that one of the merging parties

(as well as others that had been precluded) would successfully enter

markets where it had been precluded prior to the enactment and

implementation of the procompetitive aspects of the 1996

Telecommunications Act. FCC’s framework characterizes some precluded

competitors as “most-significant market participants.” In particular,

Commission officials noted that a most-significant market participant

would (1) have an incentive to enter a market from which it had been

previously—but was no longer—precluded; (2) have the resources,

experience, and ability to succeed in that market; and (3) would, upon

entering, have a significant competitive impact in that market. Moreover,

FCC stated that for precluded competitors that are most-significant market

participants, the lack of actual entry or clear evidence of intent to enter a

market should not be a decisive factor in evaluating a firm’s likelihood of

entry because entry only recently became a possible market strategy for

the firm. Thus, in contrast to the potential competition doctrine, harm to

competition can be found from a merger between a current and a

precluded competitor under FCC’s precluded competitor framework, even

if little definitive evidence exists to show that the precluded competitor

was about to enter the market.

In addition to the development of this new framework, FCC’s application of

its public interest standard was also evolving in other ways during its

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review of the Bell Atlantic-NYNEX merger. FCC officials told us that their

merger analysis was incorporating the competitive focus of the

Telecommunications Act of 1996. For example, in the order approving

SBC’s merger with Pacific Telesis, which occurred 11 months after the

passage of the 1996 act, FCC stated that it was not necessary for the

merging parties to demonstrate that, in the absence of any harms, this

merger would create competitive benefits (see app. I). Seven months later

in the Bell Atlantic-NYNEX order, however, FCC stated that any potential

competitive harm related to a merger must be offset by competitive

benefits so that the merger will be procompetitive and, therefore, in the

public interest. Thus, FCC’s application of the public interest standard

focused more closely on competitive issues in the later merger. FCC

officials confirmed to us that competitive issues within the public interest

standard were more heavily weighted in the Commission’s review of the

Bell Atlantic-NYNEX merger, in part because of the focus of the 1996 act, in

part because the specifics of the Bell Atlantic-NYNEX merger raised more

competitive issues and in part because subsequent mergers among

Regional Bell Operating Companies and/or other large incumbent local

telephone companies will raise increasingly greater competitive concerns.

All Reviewing Bodies

Allowed the Merger to Go

Forward, but Some

Imposed Conditions

The Bell Atlantic-NYNEX merger was not challenged in court by DOJ, the

task force of state attorneys general, or any individual state attorneys

general. DOJ officials told us that while evidence existed to suggest that

Bell Atlantic had contemplated entering the market in the New York City

metropolitan area, other information suggested that Bell Atlantic might not

enter that market. Moreover, other potential entrants—such as the large

long-distance companies—existed that also had the resources and ability

to succeed in providing local telephone service in the New York market.

Consequently, DOJ believed that there was too much uncertainty to

determine that Bell Atlantic was uniquely situated to improve competition

in this market. Although the task force of attorneys general had some

concerns about the competitive effects of the merger, only the New York

state attorney general, while not attempting to block the merger, formally

stated opposition to the merger in a brief submitted to the New York

Public Service Commission.

Using its newly derived precluded competitor framework, FCC concluded

that Bell Atlantic was likely to enter the market for small business and

residential telephone service in and around New York City and that Bell

Atlantic was likely to be successful in that market. Thus, in FCC’s view, the

evidence showed that the merger would substantially retard or delay the

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achievement of the Communication Act’s competitive goals in the region.

FCC noted that for the merger to be in the public interest, the potential

harms of the merger would need to be outweighed by potential benefits.

Bell Atlantic and NYNEX were able to demonstrate to the satisfaction of FCC

that commitments made by Bell Atlantic in a letter to FCC on July 19, 1997

(and later modified on Aug. 13, 1997), were sufficient to outweigh any

potential harm related to the merger. FCC’s approval of the merger was

conditioned on Bell Atlantic’s meeting these commitments—now defined

as conditions under the merger approval—throughout its entire service

region. One of the conditions stated that all of the conditions would expire

after 4 years.18

FCC’s merger conditions included several items designed to promote

greater competition in the provision of local telephone service and to

achieve the goals of the Telecommunications Act of 1996. It appears that

three of the conditions were most important to FCC’s determination that

the potential harms of the proposed Bell Atlantic-NYNEX merger would be

outweighed by the expected benefits that would result from implementing

the conditions. Under these three conditions, Bell Atlantic agreed to do the

following:

• Provide uniform “interfaces” for obtaining access to the basic

“operations system support” functions—such as placing an order, billing,

and scheduling maintenance—which would help competing carriers

efficiently access and purchase services from Bell Atlantic’s network.

• Set the rates for “unbundled network elements”—piece parts of Bell

Atlantic’s network that competitors need to purchase in order to provide

local service—based on “forward-looking economic costs.” An FCC official

told us that under a forward-looking economic costing method, the prices

of the unbundled network elements are based on the costs associated with

the most efficient commercially available technologies, rather than on

average historical costs of the telephone company’s existing plant.

Because technology has advanced so rapidly in this industry, the price of

network elements based on forward-looking, rather than historical, costs

will be lower.

• Provide detailed “performance monitoring reports” to FCC, state

commissions, and competitive carriers. These reports provide data

depicting the quality of service Bell Atlantic provides, both to competitive

18FCC provided for the Bell Atlantic-NYNEX Merger Conditions to sunset 48 months after the

Commission approved the merger. In an FCC proceeding on Bell Atlantic’s compliance with the

merger conditions, a number of competitive carriers submitted comments arguing that because FCC

intended the benefits of the conditions to last 4 years, the conditions should not sunset until 4 years

after Bell Atlantic demonstrates full compliance. FCC officials told us that the sunset provision is

among the matters currently being reviewed in this compliance proceeding.

Page 15 GAO/RCED-99-223 Telephone Merger Review
B-281828 

carriers and to its own retail operations, thus conveying information on

the network access Bell Atlantic affords to competing companies. These

data could help detect any problems that may exist in Bell Atlantic’s

supply of unbundled network elements or bundled services to be resold by

the competitors. In particular, these data could help determine whether

Bell Atlantic is meetings its obligation to provide nondiscriminatory

service to its competitors.

Five state utility commissions in the NYNEX region held formal proceedings

and issued orders approving the Bell Atlantic-NYNEX merger. Four of these

states imposed conditions on Bell Atlantic that pertained to Bell Atlantic’s

activities within their individual jurisdictions:

• The New York commission required that the new company establish its

headquarters in New York City. The New York commission also required

Bell Atlantic to (1) provide additional quality of service measurements;

(2) hire an additional 750 to 1,000 employees by December 31, 1997, to

address problems with service quality; and (3) improve service by making

an additional $1 billion investment in infrastructure improvements over

the next 5 years.

• The Maine commission required that by September 30, 1997, Bell Atlantic

meet the “competitive checklist” enacted as part of the

Telecommunications Act of 1996.19 This checklist sets forth several

requirements—such as allowing competitors to interconnect to the Bell

network and to purchase unbundled network elements—that any Bell

Operating Company must meet to be allowed to enter the long-distance

telephone market. The state also required the merged company to

maintain an investment in the state at a level similar to NYNEX’s investment

in recent years.

• Following Maine’s lead, the Vermont commission required that Bell

Atlantic meet the competitive checklist contained in the

Telecommunications Act of 1996 by September 30, 1997. In addition,

Vermont required so-called intrastate long-distance dialing parity, under

which users would be able to dial the same number of digits regardless of

whether they used Bell Atlantic or any other competitive provider for

long-distance calls within the state of Vermont. The Vermont commission

also required the merged company to maintain an investment level in the

state equivalent to those of previous years.

• To ensure that service quality did not decline after the merger, the New

Hampshire commission required Bell Atlantic to adopt the service

standards of the National Association of Regulatory Utility Commissioners

19There are 14 points on the competitive checklist in section 271(c)(2)(B) of the Communications Act.

Page 16 GAO/RCED-99-223 Telephone Merger Review
B-281828 

in the state. New Hampshire also required that the role of the key Bell

Atlantic representative working in New Hampshire not significantly

change or diminish after the merger and that the responsibility for

construction, engineering, installation, and repair within the state rest with

the company’s representative assigned to the state rather than with Bell

Atlantic executives elsewhere.

FCC opened a proceeding on February 5, 1999, on Bell Atlantic’s progress

in implementing FCC’s merger conditions. In a report filed by Bell Atlantic

in this proceeding20 and in our discussions with company officials, Bell

Atlantic stated that it has met FCC’s merger conditions. However, some of

the companies that compete with Bell Atlantic have filed complaints with

FCC21 and have filed comments in this proceeding stating that Bell Atlantic

has failed to meet some of the conditions. This disagreement appears to

stem largely from varying interpretations of the meaning of specific

language in FCC’s merger order.

Bell Atlantic Realizes Cost

Savings From the Merger,

but Few Market Effects

Are Identifiable

Bell Atlantic officials told us that the company has enjoyed considerable

cost savings since the merger. The company originally estimated that the

merger would achieve a cost savings of about $850 million to $900 million

annually within 3 years, but company representatives told us that cost

savings have surpassed that level. Beyond these cost savings, few effects

can be directly attributed to the merger at this time, as illustrated by the

following:

• Service quality in New York improved at about the time of the merger, but

regulators attribute the improvement to the Performance Regulatory Plan

that the state of New York had negotiated with NYNEX in 1995. Under the

plan, NYNEX had agreed to pay substantial fines if it did not improve service

quality in a number of areas. In Massachusetts, regulators noted that

service had declined before the merger and had improved somewhat since

that time. Massachusetts officials told us that the decline in service quality

prior to the merger was most likely the result of a “reengineering” by

NYNEX, which had led to excessive losses of knowledgeable service staff.

The increase in quality at about the time of the merger was likely related to

20An FCC official told us 15 comments were filed in this proceeding.

21Four complaints filed with FCC by two companies (one of which was filed jointly by the two

companies) assert that Bell Atlantic has not complied with the merger conditions. The Commission is

currently considering all of these complaints.

Page 17 GAO/RCED-99-223 Telephone Merger Review
B-281828 

restaffing. In many of the other Bell Atlantic and NYNEX states, state

regulators said they could not identify changes in service quality.22

• Some state officials also told us that it is difficult to determine whether the

prices that consumers are paying for local telephone service have been

affected in any way by the merger. For example, some states pointed to

some recent decreases in the prices of local telephone service, but

attributed those changes to price cap regulations adopted in several states.

• While Bell Atlantic officials told us that the company has increased

employment and investment levels since the merger, these changes are

also difficult to attribute solely to the merger. Two state regulators also

expressed concern that Bell Atlantic would redirect its capital investment

away from smaller states to the larger states that were more likely to see

the entry of new competitors. There is no evidence, however, that Bell

Atlantic has undertaken such a strategy.

Agency Comments We provided a draft of this report to the Federal Communications

Commission and the Department of Justice for review and comment. FCC

stated that the staff who reviewed the report were in general agreement

with its conclusions (see app. II). FCC staff also provided us with technical

comments, which we incorporated as appropriate. The Department of

Justice provided some technical comments (see app. III), which we have

addressed. We also provided excerpts of the draft to Bell Atlantic and SBC

Communications officials. Both companies provided some corrections and

modifications, which we incorporated as appropriate.

Scope and

Methodology

To obtain information on the merger review process for telephone

companies, we reviewed the relevant legislation, current federal and state

merger guidelines, and federal and state orders approving the mergers of

Bell Atlantic and NYNEX and of other telephone companies. We also

interviewed officials at FCC, DOJ, the office of the New York Attorney

General, the National Association of Attorneys General, and all the state

public utility commissions in the Bell Atlantic and NYNEX states.

To obtain information on how the merger review process was applied in

the Bell Atlantic-NYNEX merger and the extent of measurable effects of the

merger to date, we reviewed Bell Atlantic’s merger application and FCC’s

order approving the merger. We also examined state utility commission

orders regarding the merger. We interviewed officials at FCC, DOJ, the

22Two states’ officials told us that since the merger, Bell Atlantic has been less responsive to state

regulators than the premerger companies were. The view of these and some other state officials was

that decision-making authority was being concentrated at Bell Atlantic headquarters in New York City.

Page 18 GAO/RCED-99-223 Telephone Merger Review
B-281828 

Office of the New York State Attorney General, the National Association of

Attorneys General, and the 14 public utility commissions in the Bell

Atlantic and NYNEX service territories. We reviewed documents related to

Bell Atlantic’s compliance with FCC’s merger conditions, including

complaints filed by competitors with FCC alleging noncompliance. Finally,

we interviewed officials at Bell Atlantic and at two national companies

that have begun to compete in the local telephone market.

We conducted our review from December 1998 through August 1999 in

accordance with generally accepted government auditing standards.

As agreed with your offices, unless you publicly release its contents

earlier, we plan no further distribution of this report until 14 days after the

date of this letter. At that time, we will provide copies to William E.

Kennard, Chairman, Federal Communications Commission; Joel Klein,

Assistant Attorney General, Antitrust, the Department of Justice; and other

interested parties. We will also make copies available to others on request.

If you or your staffs have any questions about this report, please contact

me at (202) 512-7631. Key contributors to this report are listed in appendix

IV.

Judy A. England-Joseph

Director, Telecommunications Issues

Page 19 GAO/RCED-99-223 Telephone Merger Review
Contents

Letter 1

Appendix I 

SBC’s Acquisitions of

Pacific Telesis Group

and Southern New

England Telephone

22

Appendix II 

Comments From the

Federal

Communications

Commission

26

Appendix III 

Comments From the

Department of Justice

27

Appendix IV 

GAO Contacts and

Staff

Acknowledgments

29

Figures Figure 1: Service Territories of the Original Seven Regional Bell

Operating Companies, With Subsequent Mergers Noted

5

Figure 2: Time Line of the Bell Atlantic-NYNEX Merger’s Review

and Approval by Governmental Bodies

12

Abbreviations

AT&T American Telephone & Telegraph

DOJ Department of Justice

FCC Federal Communications Commission

FTC Federal Trade Commission

SNET Southern New England Telephone

Page 20 GAO/RCED-99-223 Telephone Merger Review
Page 21 GAO/RCED-99-223 Telephone Merger Review
Appendix I 

SBC’s Acquisitions of Pacific Telesis Group

and Southern New England Telephone

In addition to the Bell Atlantic-NYNEX merger, two other large local

telephone company mergers have occurred since the Telecommunications

Act of 1996 was passed. In April 1997, SBC Communications Inc., the parent

company of Southwestern Bell Telephone Company, which provides local

telephone service in Arkansas, Kansas, Missouri, Oklahoma, and Texas,

acquired Pacific Telesis Group (PacTel), which provided local and

wireless service through Pacific Bell and Nevada Bell in substantial parts

of California and Nevada (see fig. 1). SBC and PacTel were two of the

smallest Baby Bells.23 In addition, in October 1998, SBC acquired Southern

New England Telephone (SNET), an independent telephone company, far

smaller than the Baby Bells, that provides local, wireless and long-distance

telephone services in Connecticut.

SBC officials described the acquisitions of PacTel and SNET as a response to

increasing and changing customer demands for telecommunications

services (particularly business customers with multistate operations) and

said that through these mergers, SBC hoped to better serve its customers,

become a more effective competitor, and enhance its potential to compete

in other domestic and international markets. SBC officials told us that the

acquisition of PacTel was also motivated by the ending of its local

telephone franchise and the opening of the local market, with the

enactment of the 1996 act and by the inroads being made by competitive

providers in large and medium-sized cities in SBC’s service areas. In

addition, SBC’s and PacTel’s management teams were concerned about

improving their companies’ earnings to satisfy shareholders and the

investment community at a time when growth in their local telephone

market shares was expected to be static. Like the Bell Atlantic-NYNEX

merger, the SBC-PacTel merger was viewed by officials of the companies as

providing new and improved services, cost savings from increased

economies of scale and scope, and the application of best practices across

the combined company.

The acquisition of SNET by SBC was also viewed as a means to grow SBC’s

local telephone business and, for SNET, to improve its attractiveness to

investors in a changing local telephone market. Because SBC was already

providing cellular telephone services in New England, the acquisition of

SNET was viewed as complementing SBC’s existing business and as enabling

the company to better compete in other areas of the northeast region.

23According to 1995 and 1996 data from the Federal Communications Commission, SBC and PacTel

were among the smallest of the Baby Bells in terms of number of employees, revenues, and customer

lines.

Page 22 GAO/RCED-99-223 Telephone Merger Review
Appendix I 

SBC’s Acquisitions of Pacific Telesis Group

and Southern New England Telephone

The federal and state reviews of SBC’s acquisitions of PacTel and SNET

appear to have been similar to those described in the Bell Atlantic-NYNEX

case. These acquisitions, like the Bell Atlantic-NYNEX merger, were

reviewed by the Federal Communications Commission (FCC) and the

Department of Justice (DOJ) and by all of the public utility commissions

and attorneys general in the relevant states in which the transfer of

licenses would occur.

The SBC-PacTel merger was approved by all relevant federal and state

governmental bodies. At the federal level, the merger was not challenged

under the federal antitrust laws by DOJ. FCC issued an order approving the

transfer of licenses from PacTel to SBC on January 31, 1997, 9 months after

the companies announced their intention to merge. The Commission did

not need to apply formally the standard that it used later in its August 1997

order approving the Bell Atlantic-NYNEX merger: that the benefits of the

merger must, on balance, outweigh the potential harm. Instead, FCC

concluded that the SBC-PacTel merger would not lead to a reduction of

competition and that it might result in some modest improvements to the

competitiveness and performance of some markets; hence, there was no

need to engage in a balancing process.24

At the state level, the California Attorney General issued an advisory

opinion after review stating that the SBC-PacTel merger would not

adversely affect competition. However, to ensure approval of the merger,

SBC made certain commitments to both the California and Nevada state

commissions. In December 1996, the Nevada Public Service Commission

approved the merger. However, the Nevada commission required SBC to

provide at least $4 million in credits to Nevada Bell customers, in part,

because SBC had offered to provide credits to California customers and

had made a promise to establish four new headquarters in California. In an

order issued in March 1997, the California commission concluded that the

merger would benefit shareholders, the financial condition and

management of PacTel, and the California economy and was unlikely to

adversely affect competition. However, the California commission

imposed conditions requiring SBC to provide credits to ratepayers of more

than $200 million over 5 years to reflect the short- and long-term economic

benefits of the merger; implement a 10-year program to fund $50 million in

consumer education efforts and $32 million for other activities to ensure

service to underserved communities; show compliance with certain

service quality standards; and, in the event that SBC proposed to acquire

24FCC’s order approving the SBC-PacTel merger states that a demonstration that benefits will arise from

the merger is not a prerequisite for approval, provided that no foreseeable adverse consequences will

result.

Page 23 GAO/RCED-99-223 Telephone Merger Review
Appendix I 

SBC’s Acquisitions of Pacific Telesis Group

and Southern New England Telephone

another local telephone company within 5 years after the merger, to notify

the commission and explain how it would affect the SBC-PacTel merger

and the company’s response to the state’s imposed conditions.

SBC’s acquisition of SNET was also approved by all relevant federal and state

reviewing authorities. The acquisition was not challenged as a violation of

antitrust laws by either DOJ or Connecticut’s Attorney General.25 The

Connecticut Department of Public Utility Control approved the merger

and accepted a set of commitments by SBC that included maintaining SNET’s

headquarters in Connecticut, continuing SNET’s charitable contributions

and contributing $1 million to institutions of higher learning in the state,

conducting a trial of high-speed data service over SNET’s existing

infrastructure, and planning operations support systems to be used by

competitors to order facilities and services. The department also

conditioned its approval on SBC’s continued compliance with the terms and

conditions of SNET’s cable television subsidiary for 2 years. The SBC-SNET

merger was reviewed by FCC under the framework first developed in the

Bell Atlantic-NYNEX merger review. FCC found that SBC’s acquisition of SNET

was not likely to harm the public interest and was likely to produce some

tangible benefits.26 Among other conditions for approval, FCC required the

companies to complete and continue fulfilling measures designed to

ensure the merger does not result in SBC providing long-distance services

in its region in violation of the Communications Act and to continue the

restructuring of local telephone operations in Connecticut in accordance

with requirements of the state commission.27

According to SBC, since the merger of SBC-PacTel closed in April 1997,

approximately 4,500 new jobs have been created in California as of

June 1999, including positions for technicians to build network facilities

and install and maintain telephone lines and for service representatives.

SBC also claims that the total capital budget for Pacific Bell, PacTel’s local

25The Connecticut Office of the Attorney General did raise concerns in the proceeding of the

Connecticut Department of Public Utility Control on the merger regarding SBC’s marketing practices

in California and the suitability of SBC as the owner of SNET’s statewide cable television subsidiary.

26In its order approving the merger, FCC described its duty to weigh the potential harm to the public

interest against the potential benefits to ensure that, on balance, the merger served the public interest,

which, at a minimum, requires that it does not interfere with the objectives of the Communications

Act.

27Upon closing an investigation into whether, after the merger with SNET, SBC may have been in

violation of the law in the provision of long-distance information services (secs. 271-272 of the

Communications Act) and related FCC regulations, FCC entered into a consent decree with SBC in

June 1999 to ensure future compliance. Although no wrongdoing was admitted by SBC, the company

agreed to change its internal operations to ensure compliance and to make a voluntary $1.3 million

payment to the U.S. Treasury.

Page 24 GAO/RCED-99-223 Telephone Merger Review
Appendix I 

SBC’s Acquisitions of Pacific Telesis Group

and Southern New England Telephone

telephone subsidiary in California, has increased 11 percent since the

merger closed, with 20 percent more being spent to expand the Pacific

Bell network, improve service quality, and make new lines available to

consumers. Service orders for telephone installations are processed more

quickly, customer trouble reports have declined, and the speed of repairs

for service disruptions has accelerated. Finally, SBC states that the price of

Pacific Bell’s basic local telephone service has not changed since the

completion of the merger.

Page 25 GAO/RCED-99-223 Telephone Merger Review
Appendix II 

Comments From the Federal

Communications Commission

Page 26 GAO/RCED-99-223 Telephone Merger Review
Appendix III 

Comments From the Department of Justice

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

Now on p. 12.

See comment 1.

Now on p. 14.

See comment 2.

Page 27 GAO/RCED-99-223 Telephone Merger Review
Appendix III 

Comments From the Department of Justice

GAO Comments 1. We made the Department of Justice’s suggested wording change.

2. We deleted the phrase “a different conclusion from that of DOJ.”

Page 28 GAO/RCED-99-223 Telephone Merger Review
Appendix IV 

GAO Contacts and Staff Acknowledgments

GAO Contacts Judy England-Joseph, (202) 512-7631

Stanley Czerwinski, (202) 512-7631

Amy Abramowitz, (202) 512-4936

Acknowledgments In addition to those named above, Dennis Amari, Nancy Barry, Thomas

Farrell, Fran Featherston, and Mindi Weisenbloom made key contributions

to this report.

(385776) Page 29 GAO/RCED-99-223 Telephone Merger Review
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