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Was AT&T guilty?
Was AT&T guilty? A critique of US v AT&T
Dan Gallagher
Despite the monumental significance of the divestiture of AT&T, little attention hr bsen paid to the antitrust trial. This analysis of the suit, based in part on the premlse that effective regulation should preclude the application of antitrust laws to regulated firms, indicates that AT&T was not guilty of violating the antltrust laws. Regardless of the applic&~ility of the antitrust laws, the overall case against AT&T was weak. Most of the charges were based on highly questlonable theory, or were not supported by evidence. Yet current public policy towards the reglonal holding compmies is dominated by the charges raised in the antitrust trial. The author is a Professor of Economics at St Cloud State University, St Cloud, MN 56301, USA (Tel: 612 255 3051; 612 255 2227). ‘See Paul W. MacAvoy and Kenneth Robinson, ‘Losing by judicial policymaking: the first year of the AT&T divestiture’, Yale Joumal on Regulation, Vol 2, No 2, 1985, pp 225-262, -for an unfavourable view of divestiture. Criticism of aspects of the government’s case can be found in William A. Brock and David S. Evans, ‘Predation: a critique of the Government’s case in US v AT&T’, in David S. Evans, ed, Breaking Up Be//, North Holland, New York, NY, 1963, ~~41-59; and Gerald Faulhaber, Telecommunications in Turmoil, Ballinger, Cambridge, MA, 1967. Favourable reviews of the government’s case can be found in Bruce Owen and Roger Nell, ‘The anticompetitive uses of regulation: United States v AT&T’, in John Kwoka and Lawrence White, eds, The Antitrust Revolution, 1969, pp 290-337; and Timothy Brennan, ‘Why regulated firms should be kept out of unreoulated markets: understanding the divestsure in United States v AT&T’. Antitrust Bulletin. Vol22, No 3, Fall 1967: pp 741-793. continued on page 3 78
0306-5961/92/040317-10
The divestiture of AT&T in 1984, having dramatically restructured the telecommunications industry, is perhaps the most significant antitrust action ever taken. The biggest and one of the apparently most efficient corporations in the USA was dismantled. This dramatic outcome occurred as a result of an antitrust suit that was paid little heed until the settlement, the Modified Final Judgment (MFJ), was announced. Indeed prior to the climatic ending rumours were abundant that the case would be settled with at most a token divestiture. Understandably most attention by analysts has been focused upon the terms of the settlement and its implications for the future. However, perhaps because most public policy experts viewed the outcome favourably, much less attention has been paid to the antitrust trial itse1f.i Given the significance of the antitrust action, a thorough analysis of the case seems to be desirable. The purpose of this study is to critically analyse the merits of the case brought against AT&T by the Justice Department. The extent of AT&T’s guilt will be assessed and compared with Judge Greene’s opinions expressed at mid-trial, when he denied AT&T’s request to dismiss the case.2 In addition, an assessment will be made as to whether divestiture was an appropriate antitrust remedy to the conditions existing in the telecommunications industry at that time. An analysis of both these areas will provide guidance for future antitrust actions and shed light on the appropriate public policy towards the newly created regional holding companies (RHCs).
The formal charges The antitrust suit, filed in 1974, charged that AT&T was guilty of monopolizing segments of the telecommunications industry in violation of Section 2 of the Sherman Act. AT&T was accused of monopolizing the equipment market and the long-distance/intercity market by leveraging its substantial monopoly power in the local exchange market. The complaint charged that AT&T thwarted competition in the terminal equipment market by manipulating the terms of interconnection for non-Bell equipment suppliers as well as implementing a ‘buy Western Electric’ bias that foreclosed the equipment market and resulted in excessive equipment prices .3
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AT&T was viewed as monopolizing the long-distance telephone market by obstructing interconnection with the Specialized Common Carriers (SCCs) that needed to use AT&T’s facilities to connect with their customers. Furthermore, AT&T was charged with predatory pricing with respect to its competitors in the long-distance market. AT&T’s initial defence was to argue that it had immunity from the antitrust laws due to being a regulated common carrier. But following a key Supreme Court ruling in Otter Tail v US, the district court ruled in 1977 that AT&T lacked blanket immunity and was subject to the antitrust laws.4 This fairly recent policy of applying the antitrust laws to regulated firms seems to be based upon the belief that regulation is imperfect and that the regulatory process can be manipulated to allow regulated firms to obtain and maintain monopoly power. However, if regulation is pervasive and reasonably effective at preventing anticompetive behaviour, then antitrust actions should not intrude into the regulatory arena. Yet, ironically, an antitrust trial may be necessary to determine if regulation is sufficiently effective. In that vein, the Justice Department’s case rested largely on the claim that AT&T was not regulatable, and that the Federal Communications Commission (FCC) had failed to prevent AT&T from monopolizing the equipment market and the intercity services market.
Analysis of charges and evidence AT&T was charged with four primary monopolizing actions with respect to the equipment market and the intercity services market: 0 0 0 0
continued from page 3 17 ‘Based upon the arguments and evidence presented up to that point, the judge dismissed one charge, deferred on several others, and found that AT&T was apparently guilty of several charges. See Opinion on Denial of Motion to Dismiss in UnitedStates v AT&T, 524 F Supp 1336, 1348-52 (1981). The Opinion is published in Christopher H. Sterling, Jill F. Kasle and Katherine T. Glakas, eds, Decision to Divest: Major Documents in US v AT&T, 7974-84, Communications Press, Washington, DC, 1986, Vol 2, pp 859-899 (hereinafter cited as Denial of Motion to Dismiss). 3Western Electric was AT&T’s fully owned manufacturing subsidiary. 4Memorandum Opinion and Order on Jurisdictional Issues, 427 F Supp 57 (1977). The precedent-setting case was Otter Tail Power Co v United States, 410 US 366,373-375 (1973).
the denial of interconnection of non-Bell equipment to the AT&T network; the denial of interconnection of the specialized common carriers with the Bell network; a foreclosure of the equipment market via a bias towards Western Electric; predatory pricing, primarily in the intercity service area.
The approach of this article will be to determine if the charges are consistent with the profit-maximization hypothesis and the evidence presented in the case. Denial of interconnection of equipment In the 1968 Carterphone Decision the FCC ordered AT&T to allow non-Bell customer premises equipment (terminal equipment) to be connected to the Bell system. AT&T opposed interconnection of competitive terminal equipment on the grounds that this equipment would threaten the technical integrity of the system. The FCC insisted upon interconnection, but for several years AT&T was allowed to impose the use of an interface device that was ‘designed’ to protect the system. The Justice Department argued that the interface device was simply an unnecessary barrier to entry designed to maintain Western Electric’s monopoly over terminal equipment. AT&T’s defence at the trial was that its actions, which may have had the effect of obstructing competition in terminal equipment, were an effort in good faith to preserve the technical integrity of the telephone system.
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A refusal to allow interconnection of non-Bell equipment can be explained by a profit-maximizing model. A regulated monopolist with untapped monopoly profits would have the incentive to vertically integrate into an unregulated market, such as equipment, in order to earn excess profits that were being denied in the regulated monopoly market. Accordingly, such a regulated monopolist would have the incentive to refuse to interconnect equipment from other suppliers in order to protect those excess profits. AT&T did act to restrict interconnection of non-Bell customer premises equipment such as telephones and switchboards. Ten years elapsed from the time that the FCC ordered interconnection until ‘unencumbered’ attachment of all foreign equipment was a reality. AT&T’s concern for possible harm from interconnecting non-Bell equipment may have been valid, but the Bell approach of requiring an interface device that disadvantaged their competitors is difficult to defend. Thus the evidence seems to show that AT&T was guilty of acting in a deliberately anticompetitive fashion with respect to interconnecting equipment. However, this conclusion is suspect for two reasons. First, no evidence was presented to support the hypothesis that this ‘monopolization’ permitted Western Electric to earn excess profits. Second, the attempted monopolization ultimately failed due to regulatory intervention. Thus, using a ‘no harm, no foul’ approach, no violation of the antitrust laws occurred. Even if AT&T was guilty of this charge, the issue was moot since, three years prior to the trial, the FCC instituted a registration programme for equipment that opened the market up to full competition. By 1981 AT&T’s monopoly over terminal equipment was broken and competition was flourishing.5 Accordingly, bringing AT&T to trial for the ‘interface device’ episode seems to be a misplaced use of antitrust policy by the Justice Department.6 Denial
5Ken Robinson, ‘Maximizing the public benefits of the AT&T break&. Journal of Policy Analysis and Management, Vol 5, No 3, Spring 1988, p 575. ‘%I the other hand, private suits by injured parties seeking damages may be appropriate. AT&T was found guilty with respect to this charge in a suit brought by Litton Systems in 1983. See Litton Systems v AT&T, 700 F 2d 785 (2nd Cir 1983). ‘Faulhaber, op tit, Ref 1, p 123. *Foreign exchange service allowed an MCI customer in city A to call city B and use the AT&T exchange to reach any AT&T subscriber there. Private line service typically provided a dedicated line between two distant points, and did not employ the switching function of any local exchange. g8ell System Tariff Offerings of Local Distribution Facilities for Use by Other Common Carriers, 48 FCC 2d 413 (1974); AT&T, Restrictions on Interconnection of Private Line Services, 80 FCC 2d 939 (1978).
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of interconnection
with the SCCs
AT&T was also charged with denial of interconnection (or equivalent interconnection) to the SCCs, with most of the focus on MCI. MCI was authorized by the FCC to provide private line service in 1969 and the FCC approved a general policy of entry into the private line market in the Specialized Common Carrier Decision of 1971. The SCC Decision ordered AT&T to provide the SCCs with interconnection to the local exchange for private line service. AT&T’s compliance with this order has been described by a former Bell employee as ‘grudging and minimal’.7 Specifically, AT&T resisted interconnection with its local exchanges for a partially switched service known as foreign exchange (FX).8 AT&T also resisted interconnection with its intercity network that would allow the SCCs to provide nationwide service with few intercity facilities of their own, what AT&T termed ‘piece out’. Both of these interconnection difficulties were interpreted by the Justice Department as an attempt by AT&T to maintain a monopoly over private line services in violation of the Sherman Act. New explicit FCC orders were required to get AT&T to interconnect for FX in 1974, and for ‘piece out’ in 1976.9 AT&T maintained that the 1971 SCC Decision, as they interpreted it, did not intend interconnection for a partially switched service like FX or for ‘piece out’. AT&T further defended its resistance to ‘piece out’ by
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“‘United States v Terminal Railroad A&n, 224 US 383 (1912), and Otter Tail Power Co v United States, 410 US 366 (1973).
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arguing that the intercity market was not a natural monopoly with bottleneck facilities like the local market. Thus, under the essential facilities doctrine of antitrust, AT&T only had an obligation to interconnect the SCCs to their local exchanges.” Profit maximization would suggest that a regulated monopolist will have an incentive to leverage its monopoly power into related markets if it is not free to fully exploit its power in the primary market. That is, if prices in the secondary market can be set above cost, then monopolization of this second market would lead to higher economic profits. Accordingly AT&T, denied earning the full monopoly profit in local service, would have a profit incentive to monopolize the intercity services market if it could earn excess profits in the intercity market, Furthermore, denial of interconnection with a bottleneck resource such as the local exchange seems to be a viable way to accomplish this goal. However, the circumstances with AT&T and the intercity private line market were somewhat different than the profit-maximizing model depicted above describes. Intercity private line prices were apparently above cost prior to entry by the SCCs. However, under regulatory direction, long-distance services as a group were cross-subsidizing local service and holding down local telephone rates. Indeed AT&T consistently argued that allowing entry into the long-distance market would jeopardize this cross-subsidy scheme. Thus, despite the fact that private line service may have earned above normal profits, at least prior to entry, there is no evidence that AT&T’s resistance to entry permitted the firm to earn excess profits on the entire range of services. The absence of overall economic profits supports AT&T’s claim that its motive for resisting entry was to protect the cross-subsidy scheme that promoted universal service. AT&T did obstruct interconnection with the SCCs for private line service as the Justice Department charged. AT&T interpreted the SCC Decision narrowly and in a fashion that served AT&T’s self-interest, but it is questionable that such actions were a violation of the antitrust laws. AT&T argued that they had an obligation under the Communications Act to resist interconnection if such cases entailed unresolved public interest considerations. On the other hand, Justice argued that unless the FCC precluded AT&T from interconnecting, AT&T had an obligation to interconnect if failure to do so was anticompetitive. Furthermore Justice argued that the public interest issue about entry into the private line market was settled by the SCC Decision and AT&T was in effect blatantly disobeying the SCC Decision. This paper’s position is that effective FCC regulation of interconnection under the Communications Act should relieve AT&T of antitrust liability. Considering that the FCC was taking a dramatic shift in policy from one of ‘defucto monopoly’ to ‘open entry’ in private line service, the time taken to settle the interconnection disputes was not overly long. The 1971 SCC Decision was made with the idea of allowing the entry of new common carriers which would provide specialized services not currently being offered by AT&T. Only over time did the SCC Decision come to be interpreted as intending more direct competition with AT&T. By 1976, five years before the trial began, all disputes about the type of interconnection for private line services were settled. Regulation was not ineffective during this period of dramatic change in FCC policy. Thus AT&T should have had immunity from the antitrust laws with
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“Denial of Motion to Dismiss, op cif, Ref 2. “ibid, p 1381. “ibid, p 1357.
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regard to the charge of monopolizing private line by resisting interconnection with the SCCs. The FCC forced appropriate interconnection in a reasonable length of time. Given the court’s earlier ruling, AT&T did not argue that pervasive regulation granted AT&T an implied immunity from the antitrust laws. AT&T adopted a rule of reason defence - that its actions, although anticompetitive in effect, were reasonable since it was a regulated firm operating under the public interest standard of the Communications Act. As seen in the Denial of Motion to Dismiss, Judge Greene struggled with this issue of the relationship between the antitrust laws and regulation. l1 Judge Greene had concurred with his predecessor, Judge Waddy, in rejecting a blanket immunity to AT&T because of regulation, but he was uncomfortable with the Justice Department’s position that the antitrust laws imposed obligations beyond the requirements set by FCC under the Communications Act. Justice argued that even if AT&T had the right to deny interconnection under the Communications Act, AT&T had an obligation to interconnect if failure to do so was anticompetitive. At the same time Judge Greene correctly perceived AT&T’s rule of reason defence as granting AT&T the immunity he had denied earlier. Due to his uncertainty on the relationship between the antitrust laws and regulation, at mid-trial Judge Greene deferred any decision on this issue.‘* Despite explicitly deferring on the issue of the relationship between antitrust and regulation, Judge Greene found that, ‘as of now, sufficient evidence has been adduced to dictate the conclusion that AT&T has monopolized the intercity services market by frustrating the efforts of other companies to compete with it in that market on a fair and reasonable basis’. l3 He based his decision on the arguments of the government that the original SCC Decision, despite AT&T’s claims to the contrary, had intended that AT&T should interconnect for both FX service and ‘piece out’. Judge Greene appears to have taken logically inconsistent positions in that, while he does not reject AT&T’s rule of reason defence, he still finds that AT&T is apparently guilty. Judge Greene’s approach to determining guilt or innocence, however, implicitly accepts the possibility of immunity. AT&T would presumably have been immune if AT&T’s behaviour was viewed as consistent with the Federal Communications Commission’s SCC Decision. Thus Judge Greene does not truly defer on the issue of the relationship between antitrust and regulation. His conclusion was effectively based upon the criterion suggested earlier, ie that immunity should be implied if regulation is pervasive and effective. His finding of apparent liability under the antitrust laws was based upon a judgement that regulation was ineffective in controlling AT&T’s anticompetitive behaviour in the intercity market. Even if the judgement that regulation was ineffective were correct, and thus AT&T lacked immunity, Judge Greene seems to be excessively firm in his conviction that AT&T was guilty. There were several extenuating circumstances. For one, the SCC Decision was reasonably subject to varying interpretations. Second, FCC policy was in a state of flux and could very well have been reversed. The FCC did not have a grand design to promote competition in telecommunications in the 1960s and 1970s. Some commissioners and many commission staffers
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had substantial doubts about a policy of introducing competition into telecommunications. As late as 1978 the FCC supported AT&T in its attempt to refuse to interconnect with MCI for Execunet, a public switched service much like AT&T’s long-distance toll service. Finally, AT&T was held up to an unrealistically high standard of behaviour. The court expected AT&T to passively accede to interconnection with rivals who did not have social obligations such as promoting universal service by subsidizing the local loop. Foreclosure of the equipment market The antitrust
suit claimed that AT&T had foreclosed the equipment market through a bias towards its subsidiary, Western Electric (WE). This bias allegedly allowed AT&T to overcharge for Western Electric’s equipment and earn excess profits at the expense of the ratepayer. In an attempt to confirm the bias, the Justice Department presented 16 episodes where the non-Bell suppliers met obstacles in trying to sell to AT&T. In several cases the non-Bell equipment was purported to be ‘better’, yet the Bell operating companies (BOCs) postponed purchase until WE brought the product on the market. The theory presented to explain such a bias is consistent with profit maximization. Overcharging for WE equipment seems like an attractive and viable way for AT&T to earn excess profits. If a bias existed, the social harm would show up in excessive prices and monopoly profits for Western Electric. But the Justice Department did not provide any evidence of excessive Western Electric prices or profits.14 Despite being based upon a solid theoretical argument, the absence of any evidence that Western Electric earned excessive profits undercuts the government’s case. The absence of excess profits is particularly damaging to the government’s case when you consider the fact that Western Electric profits were not subject to government control. The analysis finds AT&T innocent of the procurement charge. In the Denial of Motion to Dismiss, Judge Greene disagreed with this assessment when he held ‘that a showing has been made which, unless it is rebutted, would support the conclusion that defendants have engaged in anticompetitive conduct in their procurement practices, in violation of the law’.l’ However, a year later the judge apparently reversed this position when he noted that the government’s case on procurement bias was not extremely strong.16 Predatory pricing
14The FCC had launched an investigation in the mid-1970s into WE’s pricing with precisely the same concern, but likewise did not uncover any evidence of overpricing. However, the FCC ordered AT&T to present a proposal designed to provide the general trade more opportunity to sell to the Bell System. See AT&T Charges for lnterstafeTelephone Service, 84 FCC 2d 1 (March 1977). “Denial of Motion to Dismiss, op tit, Ref 2, P 1372. ‘61JniredStates v AT&T Co, 552 F Supp 131 (DDC 1982) Modification of Final Judghent (MFJ) ‘Opinion, p 183, n 137. The Opinion is published in Vol 2 of Decision fo Divest, op tit, Ref 2 (hereinafter cited as MFJ Opinion).
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A major allegation made by the government against AT&T was that AT&T monopolized the intercity private line market by predatory pricing. The Justice Department maintained that a regulated monopolist has a greater incentive to practise predatory pricing than an unregulated firm. For this reason the entrance of a regulated monopolist into a competitive market was viewed as untenable, and anticompetitive behaviour was virtually inevitable. The Justice Department did not provide evidence that AT&T priced below cost. Rather they argued that AT&T priced with an intent to exclude competition and without regard to whether these prices covered cost. The government supported its case by providing evidence that AT&T priced intercity services without cost studies to justify their prices or with cost studies the FCC found to be deficient. The argument that a regulated firm has a greater incentive to practise TELECOMMUNICATIONS
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17The lack of consistency with profit maximization was stressed in a critique of the government’s position on predatory pricing bv Brock and Evans, op cit. Ref 1. Brock a;ld Evans concluded that ‘regulated firms are no more likely to engage in predation than unregulated firms under any plausible scenario’: ibid, p 59, n 60. The government’s position that predation is more attractive to a regulated monopolist is also questioned in Faulhaber, op tit, Ref 1, p 116-120. 4 he government’s case did not adopt the AJ model. A subsequent defence of the case by two economists who advised the Justice Department during the prosecution of the suit effectively adopted the model akhouah thev did not mention it by name. See dwen and Nell, op tit, Ref l._ ‘sPaul Joskow and Roger Nell, ‘Theory and practice in public regulation: a critical overview’, in G. Fromm, ed, Studies in public Regulation, MIT Press, Cambridge, MA, 1961. qrennan, op tit, Ref 1, p 750, n 33. 21Richard Posner, ‘Natural monopoly and its regulation’, Stanford Law Review, Vol 21, February 1969, pp 546-643. 22/hid, p 615. *%ince regulation was neither pervasive nor effective in the setting of private line rates, no claim of immunity on this charge is suggested.
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predatory pricing than an unregulated firm depicts a regulated monopolist which also operates in a market where it faces competition. The monopolist prices below cost in the competitive market and shifts costs to the monopoly sector in order to recoup the associated losses. Thus, for a regulated monopolist, predatory pricing may not entail the traditional short-term losses. If predation was costless for a regulated firm, the likelihood of predation would, at first glance, seem to be enhanced. But if the second market is also regulated, as in the case at hand, the predator would not be able to earn excess profits from monopolizing this market. Consequently the government’s model is not consistent with profit maximization. r7 The government’s predation theory can be made consistent with profit maximization if one adopts the Averch Johnson (AJ) hypothesis. The attempt to monopolize the competitive market is thus viewed as building or maintaining the rate base on which the regulated firm is virtually guaranteed an above normal return.l’ However, the validity of the Averch Johnson hypothesis is disputed.” For this reason a former Justice Department economist carefully avoided adopting the AJ model in his analysis of the government’s case.2o Accordingly the argument that a regulated firm has a special incentive to practise predatory pricing is unconvincing because it is either based upon a non-profit-maximizing model, or on a profitmaximizing model with questionable validity. Both the Justice Department and Judge Greene cite an article by Richard Posner in support of this theory of anticompetitive crosssubsidization.21 However, the Posner article has been seriously misrepresented. Posner did note the possibility of costless predation by a regulated monopolist, but he questioned the likelihood of such behaviour for the same reasons just cited - that one has to either abandon the profit-maximization model or explain the behaviour based upon excessive capital build-up.22 Further, somewhat ironically, Posner felt that the antitrust laws would help deter any predatory pricing. As noted earlier, the government did not attempt to demonstrate that AT&T’s prices were below cost. Rather, the government presented a novel theory of predatory pricing. AT&T was charged with pricing with an anticompetitive intent without regard to whether their prices covered cost. As evidence, the government cited a long history of private line rates filed by AT&T but rejected by the FCC as lacking proper cost justification. Much like the government’s argument that regulated firms have special incentives to predate, the pricing without regard to cost theory seems to be either inconsistent with profit maximization or implicitly built upon the AJ model. For this reason the pricing without regard to cost theory is unconvincing. Furthermore, this charge shifts the burden of proof onto the firm to demonstrate that its prices are not below cost and therefore predatory in the conventional sense. Such a standard seems to contradict the presumed-innocent basis of our legal system and could easily lead to convictions where in fact the firm is innocent. The failure of AT&T to satisfy FCC cost standards for its private line rates demonstrates that AT&T failed to meet regulatory standards, not antitrust standards. Since the novel theory of predation is unacceptable on both theoretical and equity grounds, the Justice Department failed to substantiate the charge of predatory pricing in the private line market.23
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In sharp contrast to this analysis, Judge Greene fully accepted the theory that regulated firms have a strong incentive to predate. Yet the judge seemed somewhat sceptical of the novel ‘pricing without regard to cost’ theory, although he did not reject it as a viable antitrust concept. Judge Greene indicated that the pricing without regard to cost charge may be acceptable as part of Justice’s overall case of anticompetitive conduct. Nevertheless, at mid-trial Judge Greene deferred any opinion on the predatory pricing charge.24 Summary
24Denial of Motion to Dismiss, op tit, Ref 2, p 1370. 251bid,p 1381. 26As noted earlier, the judge later appeared to reverse his opinion on the procurement bias charge. See MFJ Opinion, op tit, Ref 2, Vol 2, p 163, n 137. The Justice Department had also charged that AT&T had repeatedly abused and manipulated the regulatory process for the purpose of preventing entry and maintaining its monopoly. Judge Greene ruled that AT&T’s actions to deter entry through the regulatory process were legal in all but one case, the Datran Case. Greene found that AT&T had made sham arguments before the FCC concernina Datran’s aoolication to construct a nationwide system’fbr transmitting digital information. 27US v El Du font de Nemours and Co; also, US v Aluminium Ltd, 268 F Supp 758 (1968). 261f AT&T had successfully monopolized the equipment and intercity services markets as the government’s case alleged, one would have expected a push to split up both Western Electric and AT&T Long Lines. The government, however, was satisfied with divesting the BOCs from AT&T. “Pretrial Brief for the United States at 495, 543 United States v AT&T, Civil Action No 74-1698 (1980). The Pretrial Brief is published in Vol 1 of Decision to Divest, op tit, Ref 2 (hereinafter cited as DOJ Pretrial Brief).
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of evaluation
of charges
The analysis herein indicates that the case brought against AT&T did not ‘prove’ any violation of the antitrust laws. In contrast, at mid-trial Judge Greene shocked virtually everyone when he stated, ‘The testimony and the documentary evidence adduced by the government demonstrates that the Bell System has violated the antitrust laws in a number of ways over a lengthy period of time.‘25 Greene indicated that AT&T appeared guilty of three of the four major charges reviewed, ie the denial to interconnect both equipment and services as well as the procurement bias charge.26 Judge Greene deferred any opinion on the predatory pricing charge, but accepted the government’s argument that regulated monopolists have a special incentive and ability to predate. The theoretical basis of the case presented against AT&T is disquieting since most charges did not even ‘allege’ that AT&T’s monopolizing behaviour was profitable. The lack of monopoly profits, either alleged or in fact, is even more disturbing when it is realized that the heart of the government’s case was that AT&T was not regulatable. How could this all-powerful monopolist who allegedly ran roughshod over the FCC fail to achieve the pre-eminent goal of any corporation, ie high profits? The absence of excess profits testifies that regulation was not ineffectual.
Justification
for divestiture
According to antitrust principles, divestiture is not merely a penalty for violations of the law, but rather a remedy to be applied in situations where workable competition cannot be restored otherwise.27 However, by the time of the settlement, December 1981, competition in terminal equipment was a reality and competition in intercity services was beginning to emerge. AT&T had not succeeded in its ‘monopolization’ attempts due to the visible hand of government regulation. Thus there was no need for a divestiture to restore competition.** Instead the Justice Department justified divestiture as necessary to prevent AT&T from continuing to abuse its monopoly power and thwarting the development of a competitive telecommunications market .29 The government’s position is based upon the following premises: that AT&T, being a regulated monopolist, had a special incentive to predate, that government regulation, ie the FCC, was incapable of restraining AT&T’s anticompetitive impulses, and that the current antitrust suit along with numerous private suits would not act as a significant deterrent to future monopolizing behaviour. None of these premises is valid. This analysis indicates that, under any plausible scenario, regulated monopolists do not have a greater incentive than other firms to practise predatory pricing. Furthermore, even if the government’s theory were correct, the notion that local telephone service constitutes a base to TELECOMMUNICATIONS
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support cross-subsidies and predatory pricing is not supported by the facts. Given the penchant for low local telephone rates, the local exchange business would be a particularly unlikely source of funding for predatory pricing in other markets. Thus, contrary to the government’s position, there was no particular reason to expect AT&T to practise predatory pricing. The heart of the government’s case for divestiture was that the FCC could not adequately regulate AT&T and restrain its anticompetitive actions. Given AT&T’s ultimate lack of success in monopolizing equipment and services, this charge is unsubstantiated. FCC regulation was held up to an unrealistically high standard. Admittedly AT&T temporarily succeeded in forestalling entry. But no market or governmental mechanism exists that ‘instantaneously’ corrects problem areas in a market. Furthermore, any evaluation of the FCC’s performance must recognize that regulation was hampered by a lack of a clear policy direction during the 1960s and 1970s. Relatedly, AT&T’s behaviour was influenced by the belief that the FCC’s procompetitive decisions could be reversed. In contrast, by the time of the trial the FCC had developed a consistent procompetitive policy that AT&T had no chance of reversing. Consequently any future predatory actions by AT&T would be less likely to occur and even less likely to succeed. Ironically, the government’s argument for divestiture totally ignored the deterrent effects of bringing this particular antitrust suit as well as the multiple other private suits underway at that time. Although not providing protection from legal liability, AT&T probably felt immune from the antitrust laws during the period they were charged with anticompetitive behavior. AT&T’s likelihood of illegal conduct would surely be reduced after the court ruled that AT&T lacked immunity from the antitrust laws. If in fact there was a high likelihood of successful predatory behaviour by AT&T in the future, then perhaps divestiture may have been justified. But the theory and evidence provided do not support such a position. In this case divestiture was in effect a legislative action taken under the guise of antitrust policy. The weak basis for divestiture under antitrust principles is demonstrated by the addition of ‘other’ reasons slipped in to bolster the case. For example, in the Competitive Impact Statement with respect to the proposed settlement, the Justice Department justified divestiture as necessary to ‘accelerate’ the development of competition.30 There is little doubt that divestiture of AT&T accelerated the development of competition, but this benefit is not a legitimate basis for divestiture under the antitrust laws.
Public policy implications
%Depatiment of Justice Competitive Impact Statement in Connection with Proposed Modification of Final Judgment, 47 Fed Reg 7178 (February 1982). The Competitive Impact Statement is published in Vol 2 of Decision to Divest, op tit, Ref 2.
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The Modified Final Judgment, based upon the logic of the government’s case against AT&T, prohibited the regional holding companies (RHCs) from providing interexchange services and information services, and from the manufacture of customer premises equipment. This analysis suggests that the restrictions placed upon divested BOCs are not justified since the restrictions have the same faulty basis as the divestiture, ie that regulated monopolists have a high potential for anticompetitive behaviour that neither regulation nor antitrust can deter.
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31The Justice Department proposed eliminating two of the three primary restrictions on RHCs, namely the restrictions on the manufacture of equipment and the provision of information services. Justice originally recommended allowing the provision of interexchange service outside of the BOC’s geographical area, but later dropped the proposal as unworkable. See Department of Justice, Report and Recommendations of the United States Concerning Line of Business Restrictions Imposed on the Bell Operating Companies by the Modification of Final Judgment (21 February 1987). 3?he first triennial review resulted in the lifting of restrictions related to RHC entry into non-telecommunication markets. In addition the court also permitted the RHCs to begin to carry information services provided by other firms, but the RHCs could not produce information services. See United States v Western Electric Co, Inc, No 82-0192 (DDC, 19 September 1987). In 1991 Judge Greene reluctantly allowed the RHCs to provide information services under a standard set down by a federal appeals court: United States v Western Electric Co, 767 F Supp 308 (DDC 1991). 33An unfortunate outcome of ‘the antitrust suit is the usuroation of the FCC’s authority to regulate the industry. Since the settlement Judge Greene has used his authority to oversee the consent decree to regulate significant aspects of the telecommunications industry. “Section VIII (C) of the MFJ states, ‘The restrictions imposed upon the separated BOCs by virtue of section II (D) shall be removed upon a showing by the petitioning BOC that there is no substantial oossibilitv that it could use its monopoly ‘power to impede competition in the market it seeks to enter.’ The MN is published in Vol 2 of Decision to Divest, op tit, Ref 2.
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Regardless, the MFJ provided for a triennial review by the court to evaluate the continuing need for these restrictions on the activities of the RHCs. In the first triennial review of the restrictions in 1987 the Justice Department recommended that most of the MFJ restrictions be lifted.31 In the process of arguing in favour of removing most restrictions on the RHCs the Justice Department effectively abandoned its theoretical basis for divesting AT&T. For example, the Justice Department no longer saw a substantial likelihood of predatory pricing on the part of the regulated monopolists, ie the RHCs. Yet this risk of anticompetitive behaviour was the primary basis for the divestiture. Furthermore, Justice suggests that the FCC can handle the interconnection issue with respect to interexchange cellular service. Judge Greene objected to this suggestion and noted that the FCC’s inability to handle interconnection issues was a major part of the case against AT&T. Judge Greene clearly saw the Justice Department’s arguments as a reversal of its position in the antitrust trial. Even if, as argued in the trial, an intact AT&T had a high probability of predatory behaviour, the newly created market structure and the implementation of equal access should alleviate concerns about potential anticompetitive behaviour. For example, in the intercity service market firms must have a national network to seriously challenge AT&T, MCI and Sprint. The ability of an RHC to leverage its monopoly power in a limited number of local markets to the national intercity market is severely limited. Similarly, any one RHC would not be able to extend its local monopoly power in the equipment market. Furthermore, equal access generated the level playing field that was one of the goals of the antitrust suit. Nevertheless, in 1987 the court maintained the three major restrictions that were the cornerstone of the 1982 settlement: the prohibitions on RHC provision of interexchange and information services, and the manufacture of equipment.32 Unfortunately the erroneous logic of the government’s case in the trial still pervades public policy.33 Judge Greene will apparently only grant the RHCs entry into related areas such as equipment and intercity services when it can be shown that anticompetitive behaviour is virtually impossible. The criterion for maintaining the restrictions set down by the MFJ was a ‘substantial possibility’ of anticompetitive behaviour.34 The judge’s criterion seems much more restrictive and appears to reject the general thrust of public policy towards business in our free-enterprise system. Economic freedom must allow for the possibility of anticompetitive behaviour.
Conclusion Considering that the social harm from AT&T’s monopolizing actions was minimal and the case against AT&T was not particularly strong, it is remarkable that the Justice Department succeeded in achieving such a monumental divestiture. The performance of the regulated telecommunications industry was reasonably good throughout the relevant period, 196&81, particularly when it is recognized that the goal of promoting competition in telecommunications did not gain wide acceptance until the late 1970s. Divestiture may have been a socially desirable form of industrial policy aimed at accelerating the development of an unregulated, competitive telecommunications market, but such an action is the province of the legislative branch of government. TELECOMMUNICATIONS
POLICY May/June 1992
Dan Gallagher
Despite the monumental significance of the divestiture of AT&T, little attention hr bsen paid to the antitrust trial. This analysis of the suit, based in part on the premlse that effective regulation should preclude the application of antitrust laws to regulated firms, indicates that AT&T was not guilty of violating the antltrust laws. Regardless of the applic&~ility of the antitrust laws, the overall case against AT&T was weak. Most of the charges were based on highly questlonable theory, or were not supported by evidence. Yet current public policy towards the reglonal holding compmies is dominated by the charges raised in the antitrust trial. The author is a Professor of Economics at St Cloud State University, St Cloud, MN 56301, USA (Tel: 612 255 3051; 612 255 2227). ‘See Paul W. MacAvoy and Kenneth Robinson, ‘Losing by judicial policymaking: the first year of the AT&T divestiture’, Yale Joumal on Regulation, Vol 2, No 2, 1985, pp 225-262, -for an unfavourable view of divestiture. Criticism of aspects of the government’s case can be found in William A. Brock and David S. Evans, ‘Predation: a critique of the Government’s case in US v AT&T’, in David S. Evans, ed, Breaking Up Be//, North Holland, New York, NY, 1963, ~~41-59; and Gerald Faulhaber, Telecommunications in Turmoil, Ballinger, Cambridge, MA, 1967. Favourable reviews of the government’s case can be found in Bruce Owen and Roger Nell, ‘The anticompetitive uses of regulation: United States v AT&T’, in John Kwoka and Lawrence White, eds, The Antitrust Revolution, 1969, pp 290-337; and Timothy Brennan, ‘Why regulated firms should be kept out of unreoulated markets: understanding the divestsure in United States v AT&T’. Antitrust Bulletin. Vol22, No 3, Fall 1967: pp 741-793. continued on page 3 78
0306-5961/92/040317-10
The divestiture of AT&T in 1984, having dramatically restructured the telecommunications industry, is perhaps the most significant antitrust action ever taken. The biggest and one of the apparently most efficient corporations in the USA was dismantled. This dramatic outcome occurred as a result of an antitrust suit that was paid little heed until the settlement, the Modified Final Judgment (MFJ), was announced. Indeed prior to the climatic ending rumours were abundant that the case would be settled with at most a token divestiture. Understandably most attention by analysts has been focused upon the terms of the settlement and its implications for the future. However, perhaps because most public policy experts viewed the outcome favourably, much less attention has been paid to the antitrust trial itse1f.i Given the significance of the antitrust action, a thorough analysis of the case seems to be desirable. The purpose of this study is to critically analyse the merits of the case brought against AT&T by the Justice Department. The extent of AT&T’s guilt will be assessed and compared with Judge Greene’s opinions expressed at mid-trial, when he denied AT&T’s request to dismiss the case.2 In addition, an assessment will be made as to whether divestiture was an appropriate antitrust remedy to the conditions existing in the telecommunications industry at that time. An analysis of both these areas will provide guidance for future antitrust actions and shed light on the appropriate public policy towards the newly created regional holding companies (RHCs).
The formal charges The antitrust suit, filed in 1974, charged that AT&T was guilty of monopolizing segments of the telecommunications industry in violation of Section 2 of the Sherman Act. AT&T was accused of monopolizing the equipment market and the long-distance/intercity market by leveraging its substantial monopoly power in the local exchange market. The complaint charged that AT&T thwarted competition in the terminal equipment market by manipulating the terms of interconnection for non-Bell equipment suppliers as well as implementing a ‘buy Western Electric’ bias that foreclosed the equipment market and resulted in excessive equipment prices .3
@) 1992 Butterworth-Heinemann
Ltd
317
Was AT&T guilty?
AT&T was viewed as monopolizing the long-distance telephone market by obstructing interconnection with the Specialized Common Carriers (SCCs) that needed to use AT&T’s facilities to connect with their customers. Furthermore, AT&T was charged with predatory pricing with respect to its competitors in the long-distance market. AT&T’s initial defence was to argue that it had immunity from the antitrust laws due to being a regulated common carrier. But following a key Supreme Court ruling in Otter Tail v US, the district court ruled in 1977 that AT&T lacked blanket immunity and was subject to the antitrust laws.4 This fairly recent policy of applying the antitrust laws to regulated firms seems to be based upon the belief that regulation is imperfect and that the regulatory process can be manipulated to allow regulated firms to obtain and maintain monopoly power. However, if regulation is pervasive and reasonably effective at preventing anticompetive behaviour, then antitrust actions should not intrude into the regulatory arena. Yet, ironically, an antitrust trial may be necessary to determine if regulation is sufficiently effective. In that vein, the Justice Department’s case rested largely on the claim that AT&T was not regulatable, and that the Federal Communications Commission (FCC) had failed to prevent AT&T from monopolizing the equipment market and the intercity services market.
Analysis of charges and evidence AT&T was charged with four primary monopolizing actions with respect to the equipment market and the intercity services market: 0 0 0 0
continued from page 3 17 ‘Based upon the arguments and evidence presented up to that point, the judge dismissed one charge, deferred on several others, and found that AT&T was apparently guilty of several charges. See Opinion on Denial of Motion to Dismiss in UnitedStates v AT&T, 524 F Supp 1336, 1348-52 (1981). The Opinion is published in Christopher H. Sterling, Jill F. Kasle and Katherine T. Glakas, eds, Decision to Divest: Major Documents in US v AT&T, 7974-84, Communications Press, Washington, DC, 1986, Vol 2, pp 859-899 (hereinafter cited as Denial of Motion to Dismiss). 3Western Electric was AT&T’s fully owned manufacturing subsidiary. 4Memorandum Opinion and Order on Jurisdictional Issues, 427 F Supp 57 (1977). The precedent-setting case was Otter Tail Power Co v United States, 410 US 366,373-375 (1973).
the denial of interconnection of non-Bell equipment to the AT&T network; the denial of interconnection of the specialized common carriers with the Bell network; a foreclosure of the equipment market via a bias towards Western Electric; predatory pricing, primarily in the intercity service area.
The approach of this article will be to determine if the charges are consistent with the profit-maximization hypothesis and the evidence presented in the case. Denial of interconnection of equipment In the 1968 Carterphone Decision the FCC ordered AT&T to allow non-Bell customer premises equipment (terminal equipment) to be connected to the Bell system. AT&T opposed interconnection of competitive terminal equipment on the grounds that this equipment would threaten the technical integrity of the system. The FCC insisted upon interconnection, but for several years AT&T was allowed to impose the use of an interface device that was ‘designed’ to protect the system. The Justice Department argued that the interface device was simply an unnecessary barrier to entry designed to maintain Western Electric’s monopoly over terminal equipment. AT&T’s defence at the trial was that its actions, which may have had the effect of obstructing competition in terminal equipment, were an effort in good faith to preserve the technical integrity of the telephone system.
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POLICY
May/June 1992
Was AT&T guilty?
A refusal to allow interconnection of non-Bell equipment can be explained by a profit-maximizing model. A regulated monopolist with untapped monopoly profits would have the incentive to vertically integrate into an unregulated market, such as equipment, in order to earn excess profits that were being denied in the regulated monopoly market. Accordingly, such a regulated monopolist would have the incentive to refuse to interconnect equipment from other suppliers in order to protect those excess profits. AT&T did act to restrict interconnection of non-Bell customer premises equipment such as telephones and switchboards. Ten years elapsed from the time that the FCC ordered interconnection until ‘unencumbered’ attachment of all foreign equipment was a reality. AT&T’s concern for possible harm from interconnecting non-Bell equipment may have been valid, but the Bell approach of requiring an interface device that disadvantaged their competitors is difficult to defend. Thus the evidence seems to show that AT&T was guilty of acting in a deliberately anticompetitive fashion with respect to interconnecting equipment. However, this conclusion is suspect for two reasons. First, no evidence was presented to support the hypothesis that this ‘monopolization’ permitted Western Electric to earn excess profits. Second, the attempted monopolization ultimately failed due to regulatory intervention. Thus, using a ‘no harm, no foul’ approach, no violation of the antitrust laws occurred. Even if AT&T was guilty of this charge, the issue was moot since, three years prior to the trial, the FCC instituted a registration programme for equipment that opened the market up to full competition. By 1981 AT&T’s monopoly over terminal equipment was broken and competition was flourishing.5 Accordingly, bringing AT&T to trial for the ‘interface device’ episode seems to be a misplaced use of antitrust policy by the Justice Department.6 Denial
5Ken Robinson, ‘Maximizing the public benefits of the AT&T break&. Journal of Policy Analysis and Management, Vol 5, No 3, Spring 1988, p 575. ‘%I the other hand, private suits by injured parties seeking damages may be appropriate. AT&T was found guilty with respect to this charge in a suit brought by Litton Systems in 1983. See Litton Systems v AT&T, 700 F 2d 785 (2nd Cir 1983). ‘Faulhaber, op tit, Ref 1, p 123. *Foreign exchange service allowed an MCI customer in city A to call city B and use the AT&T exchange to reach any AT&T subscriber there. Private line service typically provided a dedicated line between two distant points, and did not employ the switching function of any local exchange. g8ell System Tariff Offerings of Local Distribution Facilities for Use by Other Common Carriers, 48 FCC 2d 413 (1974); AT&T, Restrictions on Interconnection of Private Line Services, 80 FCC 2d 939 (1978).
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of interconnection
with the SCCs
AT&T was also charged with denial of interconnection (or equivalent interconnection) to the SCCs, with most of the focus on MCI. MCI was authorized by the FCC to provide private line service in 1969 and the FCC approved a general policy of entry into the private line market in the Specialized Common Carrier Decision of 1971. The SCC Decision ordered AT&T to provide the SCCs with interconnection to the local exchange for private line service. AT&T’s compliance with this order has been described by a former Bell employee as ‘grudging and minimal’.7 Specifically, AT&T resisted interconnection with its local exchanges for a partially switched service known as foreign exchange (FX).8 AT&T also resisted interconnection with its intercity network that would allow the SCCs to provide nationwide service with few intercity facilities of their own, what AT&T termed ‘piece out’. Both of these interconnection difficulties were interpreted by the Justice Department as an attempt by AT&T to maintain a monopoly over private line services in violation of the Sherman Act. New explicit FCC orders were required to get AT&T to interconnect for FX in 1974, and for ‘piece out’ in 1976.9 AT&T maintained that the 1971 SCC Decision, as they interpreted it, did not intend interconnection for a partially switched service like FX or for ‘piece out’. AT&T further defended its resistance to ‘piece out’ by
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1992
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Was AT&T
guilty?
“‘United States v Terminal Railroad A&n, 224 US 383 (1912), and Otter Tail Power Co v United States, 410 US 366 (1973).
320
arguing that the intercity market was not a natural monopoly with bottleneck facilities like the local market. Thus, under the essential facilities doctrine of antitrust, AT&T only had an obligation to interconnect the SCCs to their local exchanges.” Profit maximization would suggest that a regulated monopolist will have an incentive to leverage its monopoly power into related markets if it is not free to fully exploit its power in the primary market. That is, if prices in the secondary market can be set above cost, then monopolization of this second market would lead to higher economic profits. Accordingly AT&T, denied earning the full monopoly profit in local service, would have a profit incentive to monopolize the intercity services market if it could earn excess profits in the intercity market, Furthermore, denial of interconnection with a bottleneck resource such as the local exchange seems to be a viable way to accomplish this goal. However, the circumstances with AT&T and the intercity private line market were somewhat different than the profit-maximizing model depicted above describes. Intercity private line prices were apparently above cost prior to entry by the SCCs. However, under regulatory direction, long-distance services as a group were cross-subsidizing local service and holding down local telephone rates. Indeed AT&T consistently argued that allowing entry into the long-distance market would jeopardize this cross-subsidy scheme. Thus, despite the fact that private line service may have earned above normal profits, at least prior to entry, there is no evidence that AT&T’s resistance to entry permitted the firm to earn excess profits on the entire range of services. The absence of overall economic profits supports AT&T’s claim that its motive for resisting entry was to protect the cross-subsidy scheme that promoted universal service. AT&T did obstruct interconnection with the SCCs for private line service as the Justice Department charged. AT&T interpreted the SCC Decision narrowly and in a fashion that served AT&T’s self-interest, but it is questionable that such actions were a violation of the antitrust laws. AT&T argued that they had an obligation under the Communications Act to resist interconnection if such cases entailed unresolved public interest considerations. On the other hand, Justice argued that unless the FCC precluded AT&T from interconnecting, AT&T had an obligation to interconnect if failure to do so was anticompetitive. Furthermore Justice argued that the public interest issue about entry into the private line market was settled by the SCC Decision and AT&T was in effect blatantly disobeying the SCC Decision. This paper’s position is that effective FCC regulation of interconnection under the Communications Act should relieve AT&T of antitrust liability. Considering that the FCC was taking a dramatic shift in policy from one of ‘defucto monopoly’ to ‘open entry’ in private line service, the time taken to settle the interconnection disputes was not overly long. The 1971 SCC Decision was made with the idea of allowing the entry of new common carriers which would provide specialized services not currently being offered by AT&T. Only over time did the SCC Decision come to be interpreted as intending more direct competition with AT&T. By 1976, five years before the trial began, all disputes about the type of interconnection for private line services were settled. Regulation was not ineffective during this period of dramatic change in FCC policy. Thus AT&T should have had immunity from the antitrust laws with
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POLICY
May/June
1992
Was AT&T
“Denial of Motion to Dismiss, op cif, Ref 2. “ibid, p 1381. “ibid, p 1357.
guilty?
regard to the charge of monopolizing private line by resisting interconnection with the SCCs. The FCC forced appropriate interconnection in a reasonable length of time. Given the court’s earlier ruling, AT&T did not argue that pervasive regulation granted AT&T an implied immunity from the antitrust laws. AT&T adopted a rule of reason defence - that its actions, although anticompetitive in effect, were reasonable since it was a regulated firm operating under the public interest standard of the Communications Act. As seen in the Denial of Motion to Dismiss, Judge Greene struggled with this issue of the relationship between the antitrust laws and regulation. l1 Judge Greene had concurred with his predecessor, Judge Waddy, in rejecting a blanket immunity to AT&T because of regulation, but he was uncomfortable with the Justice Department’s position that the antitrust laws imposed obligations beyond the requirements set by FCC under the Communications Act. Justice argued that even if AT&T had the right to deny interconnection under the Communications Act, AT&T had an obligation to interconnect if failure to do so was anticompetitive. At the same time Judge Greene correctly perceived AT&T’s rule of reason defence as granting AT&T the immunity he had denied earlier. Due to his uncertainty on the relationship between the antitrust laws and regulation, at mid-trial Judge Greene deferred any decision on this issue.‘* Despite explicitly deferring on the issue of the relationship between antitrust and regulation, Judge Greene found that, ‘as of now, sufficient evidence has been adduced to dictate the conclusion that AT&T has monopolized the intercity services market by frustrating the efforts of other companies to compete with it in that market on a fair and reasonable basis’. l3 He based his decision on the arguments of the government that the original SCC Decision, despite AT&T’s claims to the contrary, had intended that AT&T should interconnect for both FX service and ‘piece out’. Judge Greene appears to have taken logically inconsistent positions in that, while he does not reject AT&T’s rule of reason defence, he still finds that AT&T is apparently guilty. Judge Greene’s approach to determining guilt or innocence, however, implicitly accepts the possibility of immunity. AT&T would presumably have been immune if AT&T’s behaviour was viewed as consistent with the Federal Communications Commission’s SCC Decision. Thus Judge Greene does not truly defer on the issue of the relationship between antitrust and regulation. His conclusion was effectively based upon the criterion suggested earlier, ie that immunity should be implied if regulation is pervasive and effective. His finding of apparent liability under the antitrust laws was based upon a judgement that regulation was ineffective in controlling AT&T’s anticompetitive behaviour in the intercity market. Even if the judgement that regulation was ineffective were correct, and thus AT&T lacked immunity, Judge Greene seems to be excessively firm in his conviction that AT&T was guilty. There were several extenuating circumstances. For one, the SCC Decision was reasonably subject to varying interpretations. Second, FCC policy was in a state of flux and could very well have been reversed. The FCC did not have a grand design to promote competition in telecommunications in the 1960s and 1970s. Some commissioners and many commission staffers
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321
Was A T&T guilty?
had substantial doubts about a policy of introducing competition into telecommunications. As late as 1978 the FCC supported AT&T in its attempt to refuse to interconnect with MCI for Execunet, a public switched service much like AT&T’s long-distance toll service. Finally, AT&T was held up to an unrealistically high standard of behaviour. The court expected AT&T to passively accede to interconnection with rivals who did not have social obligations such as promoting universal service by subsidizing the local loop. Foreclosure of the equipment market The antitrust
suit claimed that AT&T had foreclosed the equipment market through a bias towards its subsidiary, Western Electric (WE). This bias allegedly allowed AT&T to overcharge for Western Electric’s equipment and earn excess profits at the expense of the ratepayer. In an attempt to confirm the bias, the Justice Department presented 16 episodes where the non-Bell suppliers met obstacles in trying to sell to AT&T. In several cases the non-Bell equipment was purported to be ‘better’, yet the Bell operating companies (BOCs) postponed purchase until WE brought the product on the market. The theory presented to explain such a bias is consistent with profit maximization. Overcharging for WE equipment seems like an attractive and viable way for AT&T to earn excess profits. If a bias existed, the social harm would show up in excessive prices and monopoly profits for Western Electric. But the Justice Department did not provide any evidence of excessive Western Electric prices or profits.14 Despite being based upon a solid theoretical argument, the absence of any evidence that Western Electric earned excessive profits undercuts the government’s case. The absence of excess profits is particularly damaging to the government’s case when you consider the fact that Western Electric profits were not subject to government control. The analysis finds AT&T innocent of the procurement charge. In the Denial of Motion to Dismiss, Judge Greene disagreed with this assessment when he held ‘that a showing has been made which, unless it is rebutted, would support the conclusion that defendants have engaged in anticompetitive conduct in their procurement practices, in violation of the law’.l’ However, a year later the judge apparently reversed this position when he noted that the government’s case on procurement bias was not extremely strong.16 Predatory pricing
14The FCC had launched an investigation in the mid-1970s into WE’s pricing with precisely the same concern, but likewise did not uncover any evidence of overpricing. However, the FCC ordered AT&T to present a proposal designed to provide the general trade more opportunity to sell to the Bell System. See AT&T Charges for lnterstafeTelephone Service, 84 FCC 2d 1 (March 1977). “Denial of Motion to Dismiss, op tit, Ref 2, P 1372. ‘61JniredStates v AT&T Co, 552 F Supp 131 (DDC 1982) Modification of Final Judghent (MFJ) ‘Opinion, p 183, n 137. The Opinion is published in Vol 2 of Decision fo Divest, op tit, Ref 2 (hereinafter cited as MFJ Opinion).
322
A major allegation made by the government against AT&T was that AT&T monopolized the intercity private line market by predatory pricing. The Justice Department maintained that a regulated monopolist has a greater incentive to practise predatory pricing than an unregulated firm. For this reason the entrance of a regulated monopolist into a competitive market was viewed as untenable, and anticompetitive behaviour was virtually inevitable. The Justice Department did not provide evidence that AT&T priced below cost. Rather they argued that AT&T priced with an intent to exclude competition and without regard to whether these prices covered cost. The government supported its case by providing evidence that AT&T priced intercity services without cost studies to justify their prices or with cost studies the FCC found to be deficient. The argument that a regulated firm has a greater incentive to practise TELECOMMUNICATIONS
POLICY May/June
1992
Was AT&T guilty?
17The lack of consistency with profit maximization was stressed in a critique of the government’s position on predatory pricing bv Brock and Evans, op cit. Ref 1. Brock a;ld Evans concluded that ‘regulated firms are no more likely to engage in predation than unregulated firms under any plausible scenario’: ibid, p 59, n 60. The government’s position that predation is more attractive to a regulated monopolist is also questioned in Faulhaber, op tit, Ref 1, p 116-120. 4 he government’s case did not adopt the AJ model. A subsequent defence of the case by two economists who advised the Justice Department during the prosecution of the suit effectively adopted the model akhouah thev did not mention it by name. See dwen and Nell, op tit, Ref l._ ‘sPaul Joskow and Roger Nell, ‘Theory and practice in public regulation: a critical overview’, in G. Fromm, ed, Studies in public Regulation, MIT Press, Cambridge, MA, 1961. qrennan, op tit, Ref 1, p 750, n 33. 21Richard Posner, ‘Natural monopoly and its regulation’, Stanford Law Review, Vol 21, February 1969, pp 546-643. 22/hid, p 615. *%ince regulation was neither pervasive nor effective in the setting of private line rates, no claim of immunity on this charge is suggested.
TELECOMMUNICATIONS
POLICY
predatory pricing than an unregulated firm depicts a regulated monopolist which also operates in a market where it faces competition. The monopolist prices below cost in the competitive market and shifts costs to the monopoly sector in order to recoup the associated losses. Thus, for a regulated monopolist, predatory pricing may not entail the traditional short-term losses. If predation was costless for a regulated firm, the likelihood of predation would, at first glance, seem to be enhanced. But if the second market is also regulated, as in the case at hand, the predator would not be able to earn excess profits from monopolizing this market. Consequently the government’s model is not consistent with profit maximization. r7 The government’s predation theory can be made consistent with profit maximization if one adopts the Averch Johnson (AJ) hypothesis. The attempt to monopolize the competitive market is thus viewed as building or maintaining the rate base on which the regulated firm is virtually guaranteed an above normal return.l’ However, the validity of the Averch Johnson hypothesis is disputed.” For this reason a former Justice Department economist carefully avoided adopting the AJ model in his analysis of the government’s case.2o Accordingly the argument that a regulated firm has a special incentive to practise predatory pricing is unconvincing because it is either based upon a non-profit-maximizing model, or on a profitmaximizing model with questionable validity. Both the Justice Department and Judge Greene cite an article by Richard Posner in support of this theory of anticompetitive crosssubsidization.21 However, the Posner article has been seriously misrepresented. Posner did note the possibility of costless predation by a regulated monopolist, but he questioned the likelihood of such behaviour for the same reasons just cited - that one has to either abandon the profit-maximization model or explain the behaviour based upon excessive capital build-up.22 Further, somewhat ironically, Posner felt that the antitrust laws would help deter any predatory pricing. As noted earlier, the government did not attempt to demonstrate that AT&T’s prices were below cost. Rather, the government presented a novel theory of predatory pricing. AT&T was charged with pricing with an anticompetitive intent without regard to whether their prices covered cost. As evidence, the government cited a long history of private line rates filed by AT&T but rejected by the FCC as lacking proper cost justification. Much like the government’s argument that regulated firms have special incentives to predate, the pricing without regard to cost theory seems to be either inconsistent with profit maximization or implicitly built upon the AJ model. For this reason the pricing without regard to cost theory is unconvincing. Furthermore, this charge shifts the burden of proof onto the firm to demonstrate that its prices are not below cost and therefore predatory in the conventional sense. Such a standard seems to contradict the presumed-innocent basis of our legal system and could easily lead to convictions where in fact the firm is innocent. The failure of AT&T to satisfy FCC cost standards for its private line rates demonstrates that AT&T failed to meet regulatory standards, not antitrust standards. Since the novel theory of predation is unacceptable on both theoretical and equity grounds, the Justice Department failed to substantiate the charge of predatory pricing in the private line market.23
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Was AT&T guilty?
In sharp contrast to this analysis, Judge Greene fully accepted the theory that regulated firms have a strong incentive to predate. Yet the judge seemed somewhat sceptical of the novel ‘pricing without regard to cost’ theory, although he did not reject it as a viable antitrust concept. Judge Greene indicated that the pricing without regard to cost charge may be acceptable as part of Justice’s overall case of anticompetitive conduct. Nevertheless, at mid-trial Judge Greene deferred any opinion on the predatory pricing charge.24 Summary
24Denial of Motion to Dismiss, op tit, Ref 2, p 1370. 251bid,p 1381. 26As noted earlier, the judge later appeared to reverse his opinion on the procurement bias charge. See MFJ Opinion, op tit, Ref 2, Vol 2, p 163, n 137. The Justice Department had also charged that AT&T had repeatedly abused and manipulated the regulatory process for the purpose of preventing entry and maintaining its monopoly. Judge Greene ruled that AT&T’s actions to deter entry through the regulatory process were legal in all but one case, the Datran Case. Greene found that AT&T had made sham arguments before the FCC concernina Datran’s aoolication to construct a nationwide system’fbr transmitting digital information. 27US v El Du font de Nemours and Co; also, US v Aluminium Ltd, 268 F Supp 758 (1968). 261f AT&T had successfully monopolized the equipment and intercity services markets as the government’s case alleged, one would have expected a push to split up both Western Electric and AT&T Long Lines. The government, however, was satisfied with divesting the BOCs from AT&T. “Pretrial Brief for the United States at 495, 543 United States v AT&T, Civil Action No 74-1698 (1980). The Pretrial Brief is published in Vol 1 of Decision to Divest, op tit, Ref 2 (hereinafter cited as DOJ Pretrial Brief).
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of evaluation
of charges
The analysis herein indicates that the case brought against AT&T did not ‘prove’ any violation of the antitrust laws. In contrast, at mid-trial Judge Greene shocked virtually everyone when he stated, ‘The testimony and the documentary evidence adduced by the government demonstrates that the Bell System has violated the antitrust laws in a number of ways over a lengthy period of time.‘25 Greene indicated that AT&T appeared guilty of three of the four major charges reviewed, ie the denial to interconnect both equipment and services as well as the procurement bias charge.26 Judge Greene deferred any opinion on the predatory pricing charge, but accepted the government’s argument that regulated monopolists have a special incentive and ability to predate. The theoretical basis of the case presented against AT&T is disquieting since most charges did not even ‘allege’ that AT&T’s monopolizing behaviour was profitable. The lack of monopoly profits, either alleged or in fact, is even more disturbing when it is realized that the heart of the government’s case was that AT&T was not regulatable. How could this all-powerful monopolist who allegedly ran roughshod over the FCC fail to achieve the pre-eminent goal of any corporation, ie high profits? The absence of excess profits testifies that regulation was not ineffectual.
Justification
for divestiture
According to antitrust principles, divestiture is not merely a penalty for violations of the law, but rather a remedy to be applied in situations where workable competition cannot be restored otherwise.27 However, by the time of the settlement, December 1981, competition in terminal equipment was a reality and competition in intercity services was beginning to emerge. AT&T had not succeeded in its ‘monopolization’ attempts due to the visible hand of government regulation. Thus there was no need for a divestiture to restore competition.** Instead the Justice Department justified divestiture as necessary to prevent AT&T from continuing to abuse its monopoly power and thwarting the development of a competitive telecommunications market .29 The government’s position is based upon the following premises: that AT&T, being a regulated monopolist, had a special incentive to predate, that government regulation, ie the FCC, was incapable of restraining AT&T’s anticompetitive impulses, and that the current antitrust suit along with numerous private suits would not act as a significant deterrent to future monopolizing behaviour. None of these premises is valid. This analysis indicates that, under any plausible scenario, regulated monopolists do not have a greater incentive than other firms to practise predatory pricing. Furthermore, even if the government’s theory were correct, the notion that local telephone service constitutes a base to TELECOMMUNICATIONS
POLICY May/June
1992
Was AT&T guilty?
support cross-subsidies and predatory pricing is not supported by the facts. Given the penchant for low local telephone rates, the local exchange business would be a particularly unlikely source of funding for predatory pricing in other markets. Thus, contrary to the government’s position, there was no particular reason to expect AT&T to practise predatory pricing. The heart of the government’s case for divestiture was that the FCC could not adequately regulate AT&T and restrain its anticompetitive actions. Given AT&T’s ultimate lack of success in monopolizing equipment and services, this charge is unsubstantiated. FCC regulation was held up to an unrealistically high standard. Admittedly AT&T temporarily succeeded in forestalling entry. But no market or governmental mechanism exists that ‘instantaneously’ corrects problem areas in a market. Furthermore, any evaluation of the FCC’s performance must recognize that regulation was hampered by a lack of a clear policy direction during the 1960s and 1970s. Relatedly, AT&T’s behaviour was influenced by the belief that the FCC’s procompetitive decisions could be reversed. In contrast, by the time of the trial the FCC had developed a consistent procompetitive policy that AT&T had no chance of reversing. Consequently any future predatory actions by AT&T would be less likely to occur and even less likely to succeed. Ironically, the government’s argument for divestiture totally ignored the deterrent effects of bringing this particular antitrust suit as well as the multiple other private suits underway at that time. Although not providing protection from legal liability, AT&T probably felt immune from the antitrust laws during the period they were charged with anticompetitive behavior. AT&T’s likelihood of illegal conduct would surely be reduced after the court ruled that AT&T lacked immunity from the antitrust laws. If in fact there was a high likelihood of successful predatory behaviour by AT&T in the future, then perhaps divestiture may have been justified. But the theory and evidence provided do not support such a position. In this case divestiture was in effect a legislative action taken under the guise of antitrust policy. The weak basis for divestiture under antitrust principles is demonstrated by the addition of ‘other’ reasons slipped in to bolster the case. For example, in the Competitive Impact Statement with respect to the proposed settlement, the Justice Department justified divestiture as necessary to ‘accelerate’ the development of competition.30 There is little doubt that divestiture of AT&T accelerated the development of competition, but this benefit is not a legitimate basis for divestiture under the antitrust laws.
Public policy implications
%Depatiment of Justice Competitive Impact Statement in Connection with Proposed Modification of Final Judgment, 47 Fed Reg 7178 (February 1982). The Competitive Impact Statement is published in Vol 2 of Decision to Divest, op tit, Ref 2.
TELECOMMUNICATIONS
The Modified Final Judgment, based upon the logic of the government’s case against AT&T, prohibited the regional holding companies (RHCs) from providing interexchange services and information services, and from the manufacture of customer premises equipment. This analysis suggests that the restrictions placed upon divested BOCs are not justified since the restrictions have the same faulty basis as the divestiture, ie that regulated monopolists have a high potential for anticompetitive behaviour that neither regulation nor antitrust can deter.
POLICY May/June
1992
Was AT&T
guilty?
31The Justice Department proposed eliminating two of the three primary restrictions on RHCs, namely the restrictions on the manufacture of equipment and the provision of information services. Justice originally recommended allowing the provision of interexchange service outside of the BOC’s geographical area, but later dropped the proposal as unworkable. See Department of Justice, Report and Recommendations of the United States Concerning Line of Business Restrictions Imposed on the Bell Operating Companies by the Modification of Final Judgment (21 February 1987). 3?he first triennial review resulted in the lifting of restrictions related to RHC entry into non-telecommunication markets. In addition the court also permitted the RHCs to begin to carry information services provided by other firms, but the RHCs could not produce information services. See United States v Western Electric Co, Inc, No 82-0192 (DDC, 19 September 1987). In 1991 Judge Greene reluctantly allowed the RHCs to provide information services under a standard set down by a federal appeals court: United States v Western Electric Co, 767 F Supp 308 (DDC 1991). 33An unfortunate outcome of ‘the antitrust suit is the usuroation of the FCC’s authority to regulate the industry. Since the settlement Judge Greene has used his authority to oversee the consent decree to regulate significant aspects of the telecommunications industry. “Section VIII (C) of the MFJ states, ‘The restrictions imposed upon the separated BOCs by virtue of section II (D) shall be removed upon a showing by the petitioning BOC that there is no substantial oossibilitv that it could use its monopoly ‘power to impede competition in the market it seeks to enter.’ The MN is published in Vol 2 of Decision to Divest, op tit, Ref 2.
326
Regardless, the MFJ provided for a triennial review by the court to evaluate the continuing need for these restrictions on the activities of the RHCs. In the first triennial review of the restrictions in 1987 the Justice Department recommended that most of the MFJ restrictions be lifted.31 In the process of arguing in favour of removing most restrictions on the RHCs the Justice Department effectively abandoned its theoretical basis for divesting AT&T. For example, the Justice Department no longer saw a substantial likelihood of predatory pricing on the part of the regulated monopolists, ie the RHCs. Yet this risk of anticompetitive behaviour was the primary basis for the divestiture. Furthermore, Justice suggests that the FCC can handle the interconnection issue with respect to interexchange cellular service. Judge Greene objected to this suggestion and noted that the FCC’s inability to handle interconnection issues was a major part of the case against AT&T. Judge Greene clearly saw the Justice Department’s arguments as a reversal of its position in the antitrust trial. Even if, as argued in the trial, an intact AT&T had a high probability of predatory behaviour, the newly created market structure and the implementation of equal access should alleviate concerns about potential anticompetitive behaviour. For example, in the intercity service market firms must have a national network to seriously challenge AT&T, MCI and Sprint. The ability of an RHC to leverage its monopoly power in a limited number of local markets to the national intercity market is severely limited. Similarly, any one RHC would not be able to extend its local monopoly power in the equipment market. Furthermore, equal access generated the level playing field that was one of the goals of the antitrust suit. Nevertheless, in 1987 the court maintained the three major restrictions that were the cornerstone of the 1982 settlement: the prohibitions on RHC provision of interexchange and information services, and the manufacture of equipment.32 Unfortunately the erroneous logic of the government’s case in the trial still pervades public policy.33 Judge Greene will apparently only grant the RHCs entry into related areas such as equipment and intercity services when it can be shown that anticompetitive behaviour is virtually impossible. The criterion for maintaining the restrictions set down by the MFJ was a ‘substantial possibility’ of anticompetitive behaviour.34 The judge’s criterion seems much more restrictive and appears to reject the general thrust of public policy towards business in our free-enterprise system. Economic freedom must allow for the possibility of anticompetitive behaviour.
Conclusion Considering that the social harm from AT&T’s monopolizing actions was minimal and the case against AT&T was not particularly strong, it is remarkable that the Justice Department succeeded in achieving such a monumental divestiture. The performance of the regulated telecommunications industry was reasonably good throughout the relevant period, 196&81, particularly when it is recognized that the goal of promoting competition in telecommunications did not gain wide acceptance until the late 1970s. Divestiture may have been a socially desirable form of industrial policy aimed at accelerating the development of an unregulated, competitive telecommunications market, but such an action is the province of the legislative branch of government. TELECOMMUNICATIONS
POLICY May/June 1992