oversight

Telecommunications: Process by Which Mergers of Local Telephone Companies Are Reviewed

Published by the Government Accountability Office on 1999-08-20.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                  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
                   United States
GAO                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.


                   Several governmental bodies review mergers between local telephone
Results in Brief   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.


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




                                       US WEST




     Pacific Telesis                                                                       Ameritech
      (Acquired by SBC
      Communications)




                                                                   SBC
                                                             Communications                                          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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                        Federal and state governmental bodies have the authority under different
Governmental Bodies     statutory provisions to review proposed mergers of local telephone
Use Varying Standards   companies. These varied reviews differ with respect to the purposes of the
and Processes to        merger reviews, the reasons mergers can be blocked, the manner in which
                        the governing bodies conduct the reviews, and how any disputes about
Review Local            merger decisions are resolved. Prior to the passage of the 1996
Telephone Company       Telecommunications Act, a provision of the 1934 Communications Act
                        provided the Federal Communications Commission (FCC) with the
Mergers                 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.
10
    However, 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.

11
 Prior 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.
12
 According 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.
13
  In some cases, attorneys general may also challenge mergers under state antimerger laws.
14
  The 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.


                      According to the merging companies, Bell Atlantic and NYNEX merged to
Bell Atlantic-NYNEX   take advantage of a variety of expected benefits both within their local
Merger Went Forward   telephone markets and in markets that the firms hoped to enter (such as
With Conditions       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.


                      15
                        The 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     According to a Bell Atlantic official, the Bell Atlantic-NYNEX merger was
Benefits Motivated Bell   intended to enable the unified company to compete more effectively in the
Atlantic and NYNEX to     delivery of local telephone service within the two companies’ existing
                          service areas. A Bell Atlantic official told us that the merger was expected
Merge                     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       Bell Atlantic and NYNEX announced their intention to merge on April 21,
Merger Required Complex   1996, and the merger was finally completed on August 14, 1997. As figure 2
Competitive Analysis      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.




                          16
                           Specifically, 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                                                         January 23, 1997                          April 24, 1997
  Bell Atlantic & NYNEX                                                     Massachusetts Dept.                     Department of Justice
  Announce Agreement                                                          of Public Utilities                 Issues Antitrust Clearance
         to Merge                                                         Completes Merger Review                       for the Merger
                                                         December 30, 1996                 March 10, 1997
                                                         Maine Public Utilities          Rhode Island Public
                                                        Commission Approves              Utilities Commission
                                                             the Merger                 Decides Not to Review
                                                                                                the Merger




                            November 20, 1996                                                                                           August 14, 1997
                          Connecticut Department              January 6, 1997                 March 20, 1997                         Federal Communications
                           of Public Utility Control        New Hampshire Public              New York Public                         Commission Approves
                            Approves the Merger              Utilities Commission           Service Commission                             the Merger
                                                             Approves the Merger            Approves the Merger
                                                                                                                                    The Merger of Bell Atlantic
                                                                            February 27, 1997                                          & NYNEX Becomes
                                                                              Vermont Public                                               Effective
                                                                          Service Board Approves
                                                                                the Merger



                                                       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

                                                       17
                                                        Courts 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       The Bell Atlantic-NYNEX merger was not challenged in court by DOJ, the
Allowed the Merger to Go   task force of state attorneys general, or any individual state attorneys
Forward, but Some          general. DOJ officials told us that while evidence existed to suggest that
                           Bell Atlantic had contemplated entering the market in the New York City
Imposed Conditions         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



                           Page 14                                 GAO/RCED-99-223 Telephone Merger Review
    B-281828




    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

    18
      FCC 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

    19
      There 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       Bell Atlantic officials told us that the company has enjoyed considerable
Savings From the Merger,          cost savings since the merger. The company originally estimated that the
but Few Market Effects            merger would achieve a cost savings of about $850 million to $900 million
                                  annually within 3 years, but company representatives told us that cost
Are Identifiable                  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




                                  20
                                    An FCC official told us 15 comments were filed in this proceeding.
                                  21
                                   Four 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.


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


                      To obtain information on the merger review process for telephone
Scope and             companies, we reviewed the relevant legislation, current federal and state
Methodology           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

                      22
                        Two 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                                                                                         22

SBC’s Acquisitions of
Pacific Telesis Group
and Southern New
England Telephone
Appendix II                                                                                        26

Comments From the
Federal
Communications
Commission
Appendix III                                                                                       27

Comments From the
Department of Justice
Appendix IV                                                                                        29

GAO Contacts and
Staff
Acknowledgments
Figures                 Figure 1: Service Territories of the Original Seven Regional Bell           5
                          Operating Companies, With Subsequent Mergers Noted
                        Figure 2: Time Line of the Bell Atlantic-NYNEX Merger’s Review             12
                          and Approval by Governmental Bodies



                        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.



               23
                 According 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

24
  FCC’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


25
  The 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.
26
  In 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.
27
  Upon 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




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


                  Judy England-Joseph, (202) 512-7631
GAO Contacts      Stanley Czerwinski, (202) 512-7631
                  Amy Abramowitz, (202) 512-4936


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