The Information Technology Association of America (ITAA) opposes Bell Atlantic and GTE’s further revised proposal regarding the disposition of GTE’s inter-LATA Internet backbone operations (Genuity). While styled as a contingent option arrangement, the proposal is nothing more than an elaborate artifice to evade compliance with the inter-LATA restrictions contained in Section 271 of the Communications Act.

As demonstrated below, there can be no reasonable doubt that the post-merger Bell Atlantic/GTE (Verizon) ultimately would convert its 9.5 percent equity interest into an 80 percent interest in Genuity, and would thereby derive 80 percent of the benefit of Genuity’s appreciation during the time in which Verizon was prohibited from providing in-region, inter-LATA services. Thus, it is indisputable that the proposal would give Verizon an immediate economic interest in Genuity substantially in excess of 10 percent. The end-result would be precisely the same as if Verizon had a conventional equity interest in excess of ten percent: it would reduce Verizon’s incentives to open its local markets to competition and would give Verizon an incentive to discriminate in favor of Genuity.

The Commission has gone to great lengths to ensure that the BOCs are not allowed to provide in-region, inter-LATA services before they have opened their local markets to competition. The Commission must be wary of sanctioning any arrangement that the BOCs could use to circumvent the Section 271 regime. The Commission, therefore, should hold that: the revised proposal would give Verizon "the equivalent" of an equity interest in excess of 10 percent in Genuity; this would cause Genuity to be an "affiliate" of Verizon; and, therefore, the proposal would violate Section 271 of the Communications Act.

The Information Technology Association of America is the principal trade association of the nation’s information technology industries. Together with its forty-one regional technology councils, ITAA represents more than 26,000 companies throughout the United States. ITAA’s members provide the public with a wide variety of information products, software, and services. Many of ITAA’s member companies provide Internet access and other information services.

ITAA has a long-standing interest in the BOC inter-LATA restriction. ITAA’s predecessor association – the Association of Data Processing Services Organizations (ADAPSO) – participated actively in the proceedings involving the adoption and implementation of the Modification of Final Judgment (MFJ). ITAA also played an active role in the congressional enactment, and Commission implementation, of Sections 271 and 272 of the Communications Act. Finally, ITAA previously participated in this proceeding, through its opposition to Bell Atlantic and GTE’s ill-conceived and unlawful request that the Commission allow Bell Atlantic to acquire GTE’s inter-LATA Internet backbone operations by creating a "single LATA" for this operation.

In adopting the Telecommunications Act of 1996, Congress correctly recognized that allowing a BOC to have a direct equity interest in excess of ten percent in an entity that provides in-region inter-LATA services would undermine the twin goals of Section 271: it would eliminate the BOC’s incentive to open its local markets to competition, while providing the BOC with the incentive to use its monopoly power to distort competition in the inter-LATA market. Congress therefore prohibited a BOC from having such an interest until it opens its local markets to competition.

Congress also recognized that allowing a BOC to enter into certain arrangements that might not technically qualify as equity interests would eliminate the BOC’s incentive to open its local markets to competition, and would provide the BOC with the incentive to use its monopoly power to distort competition in the inter-LATA market, in precisely the same manner as would allowing the BOC to have a direct equity interest in an entity that provides inter-LATA services. Consequently, the Act proscribes arrangements that give a BOC "the equivalent" of an equity interest in excess of ten percent in such entities.

This proceeding requires the Commission to adopt a standard to determine whether a given arrangement constitutes the "equivalent" of an equity interest, and to apply that standard to the proposed arrangement. In seeking to establish a standard, the Commission should look beyond the question of whether a particular arrangement would create an equity interest for accounting, tax, or securities law purposes. Rather, the Commission should develop a standard that will promote the dual policy objectives that underlie Section 271 – opening the local market and preventing BOC anti-competitive abuse in the inter-LATA market. The standard should proscribe any arrangement between a BOC and an in-region, inter-LATA service provider that would cause a BOC, acting rationally, to conduct its affairs as if it had an equity interest in excess of ten percent in the service provider.

A BOC’s incentives to open its local markets, and to discriminate in favor of a particular inter-LATA service provider, will be based on the economic reality of the particular arrangement that the BOC has with the inter-LATA service provider – not on whether the arrangement meets the technical classification of an equity interest. Thus, consistent with the language of the statute, and the dual objectives of Section 271, the Commission should hold that:

Bell Atlantic and GTE have carefully structured the proposed arrangement to conceal its economic impact. The proposed arrangement appears to be an option agreement, appears to turn on the occurrence of a genuine contingency, and appears to subject Verizon to a degree of risk if it does not promptly open its local markets to competition. Under the proposed arrangement, Verizon would "spin off" Genuity into a separate company in return for a 9.5 percent equity interest and an "option" to convert this interest to 80 percent ownership of Genuity. In order for the option to be effective, however, Verizon would need to obtain Section 271 approval to provide inter-LATA services in States accounting for fifty percent of its access lines within five years. If Verizon failed to meet this condition, it could incur a financial loss. Verizon could exercise the option when the Commission grants it Section 271 authorization in States accounting for 95 percent of its access lines.

In order to assess the economic consequences of the proposed agreement, however, the Commission must look beyond its form to its substance. There can be no reasonable dispute regarding any of the following four facts:

1. Verizon would satisfy the contingency necessary to exercise the option. Bell Atlantic and GTE have set the bar shamelessly low. Bell Atlantic currently has Section 271 authority in New York, which accounts for nearly thirty percent of Bell Atlantic’s access lines, Verizon would need to obtain Commission approval in just two additional States to meet the fifty-percent threshold. There is no reasonable chance that Verizon would not meet this extremely modest goal within five years from the date the option agreement becomes effective – a date nearly ten years after the adoption of the Telecommunications Act. But, if it doesn’t, Verizon could ask the Commission for a further extension. Consequently, there is no realistic possibility that Verizon would incur any financial losses.

2. Verizon would exercise the option. Nor can there be any reasonable doubt that Verizon would exercise the option. The option would allow Verizon to convert its 9.5 percent equity interest into an 80 percent equity interest at no additional cost. In that circumstance, failure to exercise the option would be economically unthinkable. Indeed, failure to do so almost certainly would give rise to a stockholders’ action.

1. Verizon would derive the same economic benefit that it would have obtained if it held a direct 80 percent equity interest in Genuity during the period in which Verizon was not allowed to fully participate in the inter-LATA market. Once Verizon exercised its option, it would acquire an 80 percent equity interest in Genuity. Because Genuity would not be allowed to make significant dividend payments prior to that time, upon exercise of the option, Verizon would own 80 percent of the increase in the value of Genuity that occurred during the period in which Verizon was not permitted to participate in the inter-LATA market. Economically, Verizon would be placed in the same position as if it had owned an 80 percent interest in Genuity from Day One.

2. Financial markets would value Verizon’s interest in Genuity as if Verizon had an 80 percent equity interest. Bell Atlantic and GTE have conceded that, under the previous version of their proposal, the capital markets would have placed a value on Verizon’s 9.5 percent stock interest plus the option equal to 80 percent of the value of Genuity. Nothing in the current proposal changes this. The risk that Verizon would not be able to get Section 271 approval in two more States within five years is so small that the rational response of the market would be to place no value on it. Thus, whatever the legal status of Verizon’s interest in Genuity, Verizon clearly would have an immediate economic interest equal to 80 percent of the value of Verizon.

Given these indisputable market realities, the proposed arrangement plainly would cause Verizon to conduct its affairs, from the outset, in precisely the same way as if it had an 80 percent equity interest in Genuity.

The proposed arrangement would undermine both of the objectives of Section 271: Verizon’s incentive promptly to open its local market would be reduced, while it would have a substantial incentive to discriminate in favor of Genuity.

Verizon’s Incentives to Promptly Open Its Local Markets to Competition. Incumbent monopolists have no incentive to open their markets to competition. Section 271 seeks to provide the BOCs with a significant incentive – the ability to enter the in-region, inter-LATA market. Indeed, the Commission has observed that, without this incentive, "it would be highly unlikely that the competition would develop expeditiously in the local exchange and exchange access markets."

In the present case, the proposed arrangement would not create an incentive for Verizon to open its local markets to competition. The need for Verizon to obtain Section 271 authorization in just three States within ten years of the enactment of the Telecommunications Act is hardly an incentive to open its markets "expeditiously." To the contrary, because Verizon would be able to reap the benefits of current participation in the inter-LATA market – especially obtaining the economic value of the Verizon’s appreciation – allowing it to enter into the proposed arrangement would decrease its incentive to open its local markets.

Verizon’s Incentive to Discriminate in Favor or Genuity. Until Verizon fully opens its local markets to competition, it will retain the ability to discriminate against Genuity’s competitors in the Internet backbone market. There are numerous ways in which Verizon will be able to do so. For example, Verizon will be able to provide technically superior interconnection, advanced access to network information, or preferential support services to its ISP customers that connect to the Genuity backbone. Individually, instances of discrimination may be difficult to detect. Collectively, they could significantly undermine competition in the Internet backbone market.

The proposed arrangement would give Verizon concrete economic incentives to engage in such discrimination. As a rational market participant, Verizon would conduct its business based on two assumptions: Genuity ultimately will be "re-absorbed" into Verizon and, once it is, Verizon will obtain the benefit of the appreciation in Genuity’s value. Consequently, Verizon would have every incentive to strengthen Genuity by discriminating in its favor. The Commission should not sanction an arrangement – no matter how artfully drafted – that would have this result.

For the foregoing reasons, the Commission should find that the revised proposal would give Verizon "the equivalent" of an equity interest in excess of 10 percent in Verizon; that this would cause Genuity to be an "affiliate" of Verizon; and, therefore, that the proposal would violate Section 271.