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Chronicling AT&T’s Divestiture

opening bell picEnd of year greetings from Fraser, CO and Lake Norman, NC.  This has been a week of reflection, not only on the year but also on the decade that was.  Taking some time to contemplate the changes that have occurred over the past ten years is instructive and helpful.  Scheduled broadcasts (except for live sports?) died over the last decade – the term “binge” was most likely preceded by “spending” in 2010, as opposed to referring to online watching today.  Our digital “wait time” expectations shortened (try to pull up a full version of any content-rich website in a poor coverage area).  The quality of our smartphone (video) cameras improved and became the “lead” or replacement for our social media posts.  And many of us now answer messages and calls that appear on our wrist from Bluetooth earbuds using speech recognition.

 

Against this technological whirlwind we evaluate the breakup of AT&T in this week’s TSB, an event that started on November 20, 1974, and culminated on January 1, 1984. Many books have been written on the topic in addition to Steve Coll’s “The Deal of the Century: The Breakup of AT&T” (including “The Fall of the Bell System” by Peter Temin and Louis Galambos and “Network Nation: Inventing American Telecommunications” by Richard John), and when applicable we will draw on them in this review.  Our focus, however, will be on Coll’s chronicle.  As we mentioned in Tim Wu’s The Master Switch (see TSB here), the study of history helps us understand the influences and beliefs that shaped business decisions, many of which parallel those seen in today’s world.

 

Understanding AT&T’s World in the Early 1970s

Against post-WWII prosperity, America came of age in the 1960s, with baby “boomers” going to work, battling communism in Vietnam, or pursuing university degrees.  Science and technology were national interests, and, as a result, subject to increased federal (and sometimes state) attention.  The Cold War embers were still hot, although the fiery and dramatic rhetoric of Kennedy and Johnson had evolved by the end of the 1960s – détente was in, shoe-banging was out.

 

For the two decades following the end of WWII, “systems development” was popular – components working in concert to achieve a particular national or social objective.  In the case of telephony, the system consisted of

  1. terminating equipment
  2. local networks
  3. switching (which was often assisted by personnel called operators)
  4. long-distance networks
  5. interconnection facilities (to complete calls to independent phone companies)
  6. operations support: customer service, billing/ collection, research & development, product management

 

To AT&T executives, the quality of the network was directly correlated to system control.  This was not necessarily, as some back-casting historians presume, a vestige of power-hungry monopolists eager to satisfy increasingly demanding shareholders.  No doubt that there were some malevolent managers at Ma Bell (as discussed below), but there is a fundamental difference between a stalwart belief in operational efficiency (providing telephone service to everyone at affordable rates) and overt anti-competitive monopolism.  Keeping the system together created consistent stability in an increasingly less stable world[1].

 

Equally as important, the system control depended on a delicate mix of businesses and consumers.  Too many consumers, particularly in high-cost rural locations, and profitability would be compromised.  Too many businesses, and capital and service costs would skyrocket.  Customer mix was a Jenga puzzle, and MCI’s focus on enterprise voice and private line services threatened its balance.

 

MCI and AT&T’s Initial Interconnection Discussions

Despite AT&T’s arguments to the contrary, the Federal Communications Commission (FCC) and the capital markets were very interested in MCI’s plans to disintermediate the Bell system.  Coll ends Chapter 1 summarizing MCI’s $100 million equity raise in June 1972 (and follow-on $72 million line of credit later that year) and begins the following chapter with a recap of the roundtable discussion that ensued at MCI.  Rather than a complete overbuild, MCI would negotiate connections to AT&T’s switches in St. Louis and Chicago (it’s hard to imagine the first interconnection negotiation given their commonplace nature today), and AT&T had complete leverage.

 

In March 1973, Jack McGowan, MCI’s Chairman, met with AT&T Chairman John deButts and George Cook, an AT&T attorney, at AT&T’s headquarters in New York City (195 Broadway).  McGowan dictated a memo after the meeting, saying:

 

“On the one hand, they piously state a willingness to be fair and are willing to believe it themselves while at the same time they interpret their mandate to compete hard by actions which they know will result in a denial of their position on fairness… It would be incorrect to be encouraged by the potential impact of antitrust action, although it might receive a very favorable reaction at 195 Broadway simply by having them spend more time being advised by counsel. ”[2]

 

For the next nine years, dozens of attorneys would be employed by each side engulfed in the largest antitrust lawsuit to date.  The system was breaking, and MCI cracked open AT&T at its most vulnerable point – interconnection.

 

The AT&T Chairman Speaks

 

john deButts picCompetition intensified over the summer of 1973, and AT&T Chairman John deButts used the fall meeting of the National Association of Regulatory Commissioners to respond.  Coll spends an entire chapter describing deButts’ speech, which culminates with the following recommendation:

 

“The time has come for a thinking-through of the future of telecommunications in this country, a thinking-through sufficiently objective as to at least admit the possibility that there may be sectors of our economy – and telecommunications [is] one of them – where the nation is better served by modes of cooperation than by modes of competition, by working together rather than by working at odds.

 

“The time has come, then, for a moratorium on further experiments in economics, a moratorium sufficient to permit a systematic evaluation not merely of whether competition might be feasible in this or that sector of telecommunications but of the more basic question of the long-term impact on the public.” [3]

 

The crowd of regulators stomped and cheered.  Bernie Strassburg, the head of the FCC Common Carrier Bureau for the past decade and a 21-year staff lawyer at the Commission prior to that, was in the audience and, according to Coll, took deButts’ comments to mean that AT&T was above the law.

 

Meanwhile, MCI continued to test the regulatory waters, expanding service from private lines (voice calls between two regional offices) to something called Foreign Exchange or FX, which can best be described as a precursor to toll-free 800 service (Coll offers the example of an airline customer calling a local New York City phone number and being serviced by a customer service representative in Chicago).  The challenger had moved from connecting two company locations to connecting customers to company locations.  Both private line and FX were highly profitable services.

 

AT&T took the case to court, and, after losing the first ruling, won on appeal.  Coll describes their activities after that decision:

 

“As soon as the appeals court decision was handed down, it was ordered that all of MCI’s FX lines be disconnected immediately.  AT&T engineers worked an entire weekend unplugging the circuits, inconveniencing MCI’s customers and infuriating McGowan.  John deButts would later say that the decision to disconnect MCI’s customers was one of the few he ever regretted.  The FCC ruled that MCI was, in fact, entitled to sell FX lines, and AT&T was forced to reconnect all of MCI’s customers.  The damage, however, was already done. ”[4]

 

It is tempting to draw some analogies of “above the law” behavior seen today by trillion-dollar market cap companies, but the behavior described above would be akin to Apple removing Google Maps, Netflix or Spotify from the iTunes store.  As we have described in very early TSB editions, there’s always been a delicate balance (Apple’s relationship with Google Maps in 2012-2013, for example) initially, but today’s systems, thanks to the role of applications, has been much more friendly than the early days of telecommunications competition.

 

Attorney General William Saxbe: “I Intend to Bring an Action.”

saxbe picThanks to the administrative turmoil created by Watergate (Nixon resigned in August, 1974), most of the attorneys in the Justice Department thought that the AT&T case would be placed on hold.  Nixon had appointed William Saxbe, an elder senator from Ohio who enjoyed the golf links much more than the office, as Attorney General earlier in 1974.

 

The recommendation to file an antitrust suit against AT&T made its way to General Saxbe’s desk in November, 1974.  After being briefed by two senior DOJ lawyers working on the case, it was AT&T’s turn to make their case.  Coll describes this situation as follows:

 

“John Wood, a Washington lawyer retained by AT&T, stood up to begin AT&T’s presentation.  Mark Garlinghouse, the company’s general counsel, was seated beside him.

 

“Mr. Saxbe,” Wood began, puffing on a pipe, “before we start our presentation, I’d like to know exactly what your state of mind is on this case.  It might help me shape my arguments to you.”

 

Saxbe paused, spit [tobacco juice], looked at Wood, and said, “I intend to bring an action against you.”[5]

 

Within an hour of this statement, the SEC stopped trading in AT&T’s stock.  John deButts, who happened to be the chairman of the United States Savings Bond campaign in 1974, called Treasury Secretary William Simon to let him know the news.  Even President Ford, who was in Japan while all of these actions unfolded, was caught unawares.  According to Coll, “Simon then tried to call Saxbe, but the attorney general had left the office for the day.  He had gone pheasant hunting.”[6]

 

Enter George Saunders

Of all of the characters in the AT&T drama, few rise to the importance of George Saunders, a partner at Chicago-based Sidley & Austin who would devote eight years of his life to defending AT&T from the attacks of MCI and the Justice Department.  Coll describes Saunders as follows:

 

“Saunders was an unabashed fat cat, a smooth, luxuriant attorney who wore expensive suits, drank martinis like they were water, and smoked more than a dozen cigars a day.  He had been born and raised in Birmingham, Alabama, the son of a house painter, and the first member of his family to ever attend college.  He went because even at age fifteen… his extraordinary intellectual gifts were obvious – his mind was like some strange machine.  He had nearly total recall of the most complex and obscure facts, and he could effortlessly organize knowledge in sophisticated, well-developed models.  The lawyers who worked with him later tried to describe this capacity to others by saying that it was like Saunders had a giant flip-chart in his head that he could summon up instantaneously, search for the information he needed, and then flip forward to make his next point without ever skipping a beat.”[7]

 

Saunders scored his first victory after a hearing before Judge Joseph Waddy in February, 1975, when he requested, purely as a tactic, that the federal government be required to preserve every document in its possession that might be relevant in the AT&T case (in the pre-email/ server environment, this is a bold request to say the least.  Saunders backed off the request from all federal agencies to a mere 44).

 

After some vigorous conversation (described by Coll in vivid language), Saunders convinced Judge Waddy that AT&T’s fate should be a decision of the FCC and not the courts.  He convinced Judge Waddy to postpone any discovery until the jurisdictional case was settled.  A mere three months after filing, the case against AT&T was dead and, due to Judge Waddy’s terminal illness, jurisdiction would not be decided for three years.

 

Enter Ken Anderson
One of my favorite characters in Coll’s book is Ken Anderson, chief of the Special Regulated Entities section of the Department of Justice and the owner of the AT&T case when it resumed in late 1977.  Coll describes Anderson as follows:

“Anderson’s approach to life and to the practice of law was somewhat unorthodox.  Though he worked in the heart of the city, he lived on a farm in rural Virginia, and on summer weekends he liked to ride around on his big tractor under the hot sun, and then pull off his shirt and bale some hay…. He was a health food enthusiast, and when he rode into Washington on the train he often carried a large paper sack full of raw vegetables.  He kept the sack on a shelf in his Justice department office, and during important meetings he would wander over, pull out a carrot stick or a piece of cauliflower, and take a large, loud bite.”[8]

 

With the previous DOJ attorney (Phil Verveer) off of the case, AT&T saw an opportunityKen Anderson pic to test the settlement waters as they sized up Anderson.  Hal Levy, an AT&T staff lawyer who was working side-by-side with George Saunders, proposed that the parties discuss injunctive relief with AT&T self-sourcing less equipment, and the government agreeing to keep AT&T intact.  After hearing Levy out, Anderson replies:

 

“I’ll tell you one thing.  This case is going to be a severed limbs case.  We’re going to have severed limbs, AT&T limbs, on the table dripping blood.  That’s the way this case is going to be settled.  We’re not going to settle this thing with injunctive relief.”[9]

 

AT&T was also preparing for a transition as John deButts was preparing for his planned retirement (announced in late 1978).  George Saunders’ boss, Howard Trienens, left his position as the managing partner of Sidley & Austin to become VP and General Counsel of AT&T under new Chairman Charles Brown in early 1979.

Enter Judge Greene

harold greene pic

Of the characters in this multi-act drama, none is as important as Judge Harold H. Greene, who was assigned the case in August, 1978.  Coll describes the influence of politics on Greene in the following manner:

 

“A Jew, Greene was raised in Germany during the 1920s and 1930s.  His father owned a jewelry store, and in 1939, as the terror of Hitler’s Reich reached fever pitch, his family fled to Belgium, where it had relatives.  Greene was just sixteen years old.  When the Germans invaded Belgium, the Greenes fled again, this time to Vichy France.  From there, they made their way to Spain, and later Portugal, before emigrating to the United States in 1943.  Young Harold Greene was immediately drafted into the U.S. Army and sent back to Europe with a military intelligence unit to work against the Nazis.  He saw combat action in his former homeland, but he escaped injury.”[10]

 

Greene grew up in the youthfulness of Attorney General Robert Kennedy and, according to Coll, wrote the Civil Rights Act of 1964 and the Voting Rights Act of 1965.  After leaving the Justice Department in 1967, Greene served as chief judge of the District of Columbia’s Court of General Sessions (municipal court for the District).  He would remain there until Jimmy Carter was elected to the presidency, when he was appointed a federal judge.  In his new role, he inherited the caseload of the late Joseph Waddy, and was thrown into the middle of a nearly four-year dispute.

 

Judge Greene was a strong believer in due process and the strict preservation of constitutional rights.  He also supported a strong judiciary to check the executive and legislative branches (a hot topic on the heels of Watergate).  Unsurprisingly (given his German descent), he was also focused on continuous improvement and courtroom efficiency.  Greene was very different from both Saunders and Anderson – his goal was to run his courtroom like clockwork.

 

The Ending

1981 marked the beginning of the fourth presidency to span the AT&T antitrust trial.  Conventional wisdom indicated that AT&T would finally be vindicated.  That was the case until President Ronald Reagan nominated Bill Baxter to lead the antitrust division of the Justice department.  While a conservative, Baxter strongly supported the Justice department lawsuit because he strongly believed that regulated local telephone divisions were subsidizing their unregulated counterparts.

 

This was not the position of other members of Reagan’s incoming cabinet.  Secretary of Commerce Malcom Baldridge, Secretary of Defense Casper Weinberger, and counselor Ed Meese all had publicly stated their preference to dismiss the lawsuit.  But Attorney General William French Smith was forced to recuse himself form the case due to his previous affiliations with Pacific Telephone.  And James Baker, who managed now Vice President George H.W. Bush’s 1980 campaign, was Reagan’s Chief of Staff.  Assisting Baxter was Jonathan Rose, an assistant attorney general for the DOJ Office of Legal Policy under Nixon.

 

Rose ultimately proved an effective partner to Baxter, carefully running point for Justice within the White House.  Over the July 4th weekend in 1981, after great deliberation, Baker decided to wait to dismiss the case.

 

Meanwhile, in Judge Greene’s courtroom, the prosecution had finished calling their witnesses and AT&T made a bold move to dismiss the case.  Judge Greene’s response denying the dismissal was succinct:

 

“Whatever the substantive merits of the motions and the case generally turn out to be, I don’t believe the government’s evidence justifies such cavalier treatment.  The government has presented a respectable case that the defendants have violated the antitrust laws, … Defenses have been raised, but I certainly could not say that these defenses are self-evident and will prevail…

 

I don’t propose to act on the basis of press reports or someone’s concerns unrelated to this lawsuit. The court has an obligation to deal with this lawsuit under existing antitrust laws, and it will do so irrespective of speculation outside the judicial arena.”[11]

 

The judge would later deny a proposal to continue the case until Congress could pass comprehensive telecommunications legislation (known as bill S. 898).  The defense continued to call witnesses throughout the fall of 1981, and, by a 90-4 vote, the Senate passed comprehensive telecommunications legislation to the House, led by Tim Wirth.  With a new report on competition released in November, it appeared to AT&T Chairman Brown that pursuing a solution other than complete divestiture was going to be difficult if not impossible.

 

On January 8, 1982, AT&T and the Justice department signed a consent decree that separated the local phone companies into independent operating units.  The concept of intra-LATA vs. inter-LATA access was established, and AT&T retained control of its equipment unit (Western Electric).  Over the next two years, AT&T would structurally separate and become independent companies on January 1, 1984.

 

While Coll’s book ends in 1988, we have the benefit of seeing the full effects of the breakup of AT&T:  The rise of multiple fiber-based networks, rapidly decreasing costs to call between states and globally, the rise of wireless spectrum and the rise of the Internet.  Had AT&T controlled the network, it’s unlikely a subsequent Telecommunications Act would have been enacted in 1996, the development of the enhanced services provider would never have occurred, and companies such as AOL would have raised capital to quickly establish early Internet infrastructure.  While it’s difficult to hang too many events on the AT&T tree, it’s important to understand and evaluate the fundamental changes the consent decree and Modified Final Judgement enabled.

 

 

That’s it for this week.  Next week, we’ll preview the 2020 Consumer Electronics Show.  Until then, if you have friends who would like to be on the email distribution, please have them send an email to sundaybrief@gmail.com and we will include them on the list.

 

Also, I’ll be at CES this year on the 7th and 8th.  We have set up a special Sunday Brief table at Gordon Ramsay’s Pub & Grill at 7:30 p.m. on Wednesday January 8 – only three additional slots available, but please reply to sundaybrief@gmail.com if you are interested in attending.

 

Have a great week… and GO CHIEFS!

 

[1] IBM, and to a lesser extent, Apple, shared this belief in systems efficiency.

[2] Coll, p. 26

[3] Coll, p. 43

[4] Coll, p. 52

[5] Coll, p. 68

[6] Coll, p. 71

[7] Coll, pp. 75-76

[8] Coll, p. 115

[9] Coll, p. 120

[10] Coll, p. 125

[11] Coll, p. 234

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