# Appendix — American Telephone & Telegraph Co. v. MCI Communications Corp.

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 1983
- **Citation:** 464 U.S. 891

## Text

No. 82- —

In The

Supreme Court of the United States

October Term, 1982

AMERICAN TELEPHONE AND TELEGRAPH
COMPANY,
Petitioner,

\

MCI COMMUNICATIONS CORPORATION and
MCI TELECOMMUNICATIONS CORPORATION,
Respondents

ON PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES
COURT OF APPEALS FOR THE SEVENTH CIRCUIT

APPENDIX TO PETITION FOR WRIT OF CERTIORARI

HOWARD J. TRIENENS*
GEORGE L. SAUNDERS, JR.

Of Counsel THEODORE No MILLER

Jim G. KiLPatRee
RAYMOND BRENNER One First National Plaza
Siptky & AUSTIN Chicago, Illinois 60603

(312) 83-7000

alte K. 1983
Dated July d Counsel for Petitioner

*Counsel of Record

TABLE OF CONTENTS
PAGE
Appendix A Opinion of Court of Appeals for the
Seventh Circuit ..c.cccecssceceseser la

Appendix B Order of Court of Appeals Denying Pet-
tions for Rehearing, With Suggestions for
Rehearing En Banc ..... cece eeeeeees 239a

la

APPENDIX A

OPjinion of Court of Appeals
for the Seventh Circuit

2a

iu the
United States Court of Appeals

For the Seventh Cirenit

Nos. 80-2171 and 80-2288

MCI COMMUNICATIONS CORPORATION and
MCI TELECOMMUNICATIONS CORPORATION,

Plaintiffs-A ppellees,
Uv.
AMERICAN TELEPHONE AND TELEGRAPH COMPANY,
Defendant-A ppellant.

Appeal from the United States District Court for the
Northern District of Illinois, Eastern Division
No. 74-C-633—John F. Grady, Judge.

ARGUED APRIL 19, 1982%*—DECIDED JANUARY 12, 1983

* This case was originally argued on April 30, 1981, before a
panel consisting of Circuit Judge Harlington Wood, Jr., Senior
Circuit Judge Thomas FE. Fairchild, and Senior District Judge
Inzer B. Wyatt, of the United States District Court for the
Southern District of New York. Judge Wyatt subsequently was
forced to withdraw from the case on his physician's orders, and
Circuit Judge Richard D. Cudahy was selected by lot from the
judges of this court not disqualified from hearing this case to
replace him. The case was then reargued on April 19, 1982,
before Judges Wood, Cudahy and Fairchild.

3a
TABLE OF CONTENTS

OPINION OF THE COURT

4

II.

III.

IV.

PRI ITEE sett sincakvbdsadohvhanlohatsekeusiininndeceyesrsaviaamvanees

A. Background and Initial Entry of MCI ...
B. The Interconnection Disputes ................
C. The Execunet Decision ............00. one
D. The Pricing Controversies Between
I a sted
E. MCI’s Damage Evidence ...........ccccccee

Rig TTE ils cicsintannitsosensesvaryseestteonsistéusltanctesiaveye>

A. The Federal Regulatory Scheme for
TelecomMmMunications .....cccccccccccceceeseeeees

Be, WUENE BUMMIINNIIIIED sciceeconcccvsnsvesesoseascivcsssses

C. The Impact of Regulation ...........0..00

PREDATORY PRICING .......ccccccsssssscsessseens

ii sis ecient bcssnsnaseias
I SA UII vcocsccsesscissvvesscssssssvecsese
Defining Measures of Cost ..........6ccc0008
The Proper Cost Standard ................06
CKOSS-BUDBIGIZACION .....0..ccccccrescssscsccccecceeeess
Insufficiency of the Evidence ................
Pre-ANNOUNCEMENT ...........cccccccsssssersssserseees

LOMB OOMD>

INTERCONNECTIONS. .......csccssssssesssesseesess

A. FX-CCSA Interconnections ..............060:
1. The Essential Facilities Doctrine .......
2. The Meaning of the Specialized
Common Carrier Decision ............
3. “Retroactive” Application of
| Br is ECT

4a
ii

4. Instructions on Regulatory Policy ......
5. Insufficient Evidence ............cccccceeeeee
6. Evidentiary Rulings ............cccccccceeeee
7. Substantial Impact ..........ccoccccccssssscsess
TSI cinceicindninictsiaemesaneieseeaniadinieale
SII, sscicicensnnscasncasacbeaiaones
Denial of Interconnections for Service
Outside of Local Distribution Areas ...
Multipoint Service ........c.cccccscoccrsecsssesssees
Inappropriate or Inefficient Inter-
CURD | uicecnccsocacntntamacamenaens

=m DOW

V. BAD FAITH NEGOTIATIONS AND
NOERR-PENNINGTO! | eisasakececniaemniaaal

A. The State Tariff Filings ..............cceee
B. Bad Faith Negotiations ...........cccccccceeeees
Oi. RI SIS: scsccncsisscensevenccsoicnecciadenasin

Vi. CARTERS eicniieinsinenicnannniaian

A. MCI’s Proof of Damages ..............6.0000008
B. Causation of Damages .............cccccceceeeeeees
C. The Flawed Assumptions of the Lost
FUER TN =. ccsistscrcionnaicemenaccnuanena
D. Remand for a Partial New Trial ..........

VII. THE CONDUCT OF THE TRIAL ...........

Be. OR BOE vcicccntsnnceitnutiadinnnaenne
ee. OU BS Cer ees

WEEE. CARP INT ccissistrsrmeinenninaameae

iii
D AEROS ORAS Rene er cape arEr TEEN eN rae 164
I. HI-LO AND PREDATORY PRICING ...... 166
A. The Inappropriateness of Exclusively
Cost-Based Standards ...........ccccccceees 166
1. The History and Goals of the
IID TINIE od ncsiertadnenbepuennenveassinns 170
2. LRIC and Consumer Welfare in the
Monopoly Context .......cccccceccsceeeseceees 176
B. Evidence of AT&T’s Predatory
3 ne en a UE en 183
II]. PRE-ANNOUNCEMENT OF HI-LO ........ 187
BE, RPMS IIE veccesecniciscsnssreressunsesnesenenbeis 189
ic I a sank pacesalanmebeusanes 190
is + III 1:2 sieentesa guestebecasibiaiiiasemmersionane 199
1. The Revenue Assumption. ...............0. 200
hs HERETO i ea CN OPE 205
Be. SUEY TRAP UCEIOIG vevccvvevscsscccceeiecsesciivesesnses 207
Ss SEE. SUE III --osrasnsncnetinsiesecnbvccsevteiaoeantaee 230

NOTE

Throughout the opinion the following abbreviations are
used: Trial Transcript — Tr., Plaintiff's Exhibit — PX,
Defendant’s Exhibit — DX, and Appendix of this Opin-
ion — App.

Nos. 80-2171 & 80-2288 1

Before Woop and CUDAHY, Circuit Judges, and FAIR-
CHILD, Senior Circuit Judge.

CUDAHY, Circuit Judge. In this extraordinary anti-
trust case,! defendant American Telephone and Tele-
graph Company (“AT&T”) appeals from a judgment in
the amount of $1.8 billion, entered on a jury verdict, ina
treble damage suit brought by plaintiffs MCI Communij-
cations Corporation and MCI Telecommunications Cor-
poration (collectively “MCI”) under section 4 of the
Clayton Act, 15 U.S.C. § 15 (1976)?

I. FACTS
MCI’s original complaint, filed March 6, 1974, con-
tained four separate counts: monopolization, attempt to

monopolize, and conspiracy to monopolize—all under sec-
tion 2 of the Sherman Act'—and conspiracy in restraint

' The author of this opinion recognizes his debt and expresses
his appreciation to Judge Wood, whose draft of this opinion
me ot important ground and formed a basis for what has
become the majority opinion. Although Judge Wood and the
author disagree on some of the points at issue here, we agree
fully about the Herculean joint efforts required to produce
such a “weighty” finished product. Further, we both recognize
the important contributions of Judge Fairchild to this product.

Section 4 of the Clayton Act, 15 U.S.C. § 15 (1976), provides
as follows:

Any person who shall be injured in his business or
roperty by reason of anything forbidden in the antitrust
aws may sue therefor in any district court of the United
States in the district in which the defendant resides or is
found or has an agent, without respect to the amount in
controversy, and shall recover threefold the damages by
him sustained, and the cost of suit, including a reasonable
attorney's fee.

* Section 2 of the Sherman Act, 15 U.S.C. § 2 (1976), provides
in relevant part: “Every person who shall monopolize, or
attempt to monopolize or combine or conspire with any other
person or persons, to monopolize any part of the trade or com-
— among the severa! States .. . shall be deemed guilty of a
elony... .”

2 Nos. 80-2171 & 80-2288

of trade—under section 1 of the Sherman Act. MCI al-
leged that AT&T had committed twenty-two types of
misconduct, classifiable into several categories includ-
ing predatory pricing, denial of interconnections, negoti-
ation in bad faith and unlawful tying. MCI claimed at
trial, on the basis of a lost profits study originally pre-
pared in part for financing purposes, that it had suffered
damages of approximately $900 million as a result of
AT&T's allegedly unlawful! actions.‘

The case was tried to a jury between February 6 and
June 13, 1980. After completion of MCI’s case in chief,
the district court directed a verdict in favor of AT&T on
seven of the twenty-two alleged acts of misconduct.’ The
remaining fifteen charges—all based on section 2 of the
Sherman Act—were submitted to the jury. A special
verdict form required the jury to make a separate find-
ing of liability as to each of the fifteen charges, but per-
mitted the jury to award damages in a single lump sum,
without apportioning MCI’s claimed financial losses

4 AT&T also filed a counterclaim against MCI alleging that
MCI attempted and conspired to monopolize the om Baer
market and actually monopolized the St. Louis-Chicago seg-
ment, conspired to restrain trade in the relevant market, and
wrongfully acquired stock or share capital of other cor-
porations, which substantially lessened competition. The dis-
trict court did not permit any of these allegations to go to the
jury, and AT&T does not challenge the propriety of that action
on appeal.

5 The district court directed a verdict in favor of AT&T on the
following seven allegations: (1) inducing Western Union to file
a tariff which mirrored the St. Louis-Chicago charges of MCI;
(2) increasing AT&T's capacity to conduct business in data
communications for the purpose of destroying competition; (3)
introducing experimental service to discourage tential
customers from dealing with MCI; (4) disparaging MCI; (5)
bringing sham proceedings before certain administrative and
judicial bodies; (6) participating in a massive public propa-
ganda campaign conducted against MC]; and (7) refusing to
provide Joint Telpak (a special tariff) to MCI. MCI does not
challenge the propriety of the district court's directed verdict
on any of these issues.

8a
Nos. 80-2171 & 80-2288 3

among AT&T’s various lawful and unlawful acts. The
jury found in favor of MCI on ten of the fifteen charges
submitted, and awarded damages of $600 million—a sum
equal to two thirds the total damage figure claimed in
MCI’s aggregated lost profits study.* The district court
trebled this damage award, as required by section 4 of
the Clayton Act, resulting in a judgment of $1.8 billion,
exclusive of costs and attorneys’ fees.

AT&T filed motions for judgment notwithstanding the
verdict or, in the alternative, for a new trial on June 23,
1980. These motions were denied without opinion on July
29, 1980. On August 25, 1980, AT&T filed its notice of
appeal. On September 8, 1980, MCI filed a notice of
cross-appeal.’ In this opinion, we reject challenges to
certain jury findings upon which AT&T's liability was
based, sustain other challenges, and remand for a new
trial on the issue of damages.

A. Background and Initial Entry of MCI

Prior to 1969, the telecommunications industry was
regulated as a lawful monopoly. Local exchange service
was and still is provided exclusively by one of the twenty-
three Bell System operating companies or by one of some
1600 independent telephone companies, depending upon
the geographical area involved.* Long distance service

6 i” Special Verdict is reprinted in the Appendix. See infra,
p.

’ Because we hold that Judge Grady did not err in refusing to
admit evidence alleging destruction of documents by ATT.
we do not reach a motion filed by AT&T to strike a portion of
MCI’s reply brief on this issue.

* Local exchange telephone service is the ordinary service
provided in nearly all homes and businesses. From a technical
standpoint, it involves a wire connection between the telephone
set and a switching machine in a nearby telephone company
central office which is connected by transmission trunks to the
switching machines in other central offices within the ex-
change area. When the telephone is taken off the hook—or in
the case of multiple telephones behind a private branch ex-

(Footnote continued on following page)

9a
4 Nos. 80-2171 & 80-2288

was provided by the Long Lines Department of AT&T in
partnership with these operating companies.’ The net-
work of long distance transmission facilities was owned
in substantial part by Long Lines; however, the inter-
exchange facilities of the local telephone companies, in-
cluding both transmission and switching facilities, were
used in conjunction with Long Lines facilities whenever
efficiency required. The local exchange facilities and
switching machines belonging to the local companies
were also used at each end of a regular long distance call.

This same nationwide network was used as well by
AT&T to provide other intercity telephone services, in-
cluding point-to-point private lines, foreign exchange
lines (“FX”), and common control switching arrange-
ments (“CCSA”). Point-to-point private lines (also called
tie lines) are connections between two locations that do
not require the use of local switching machines because
the lines are available to the customer on a continuing
and exclusive basis. FX and CCSA, although classified
for tariff purposes as private line services, do require
interconnection with local switching machines.'®

* continued

change, when a designated access code such as “9” is dialed—a
signal is sent to the central office. The switching machine in
the central office responds to this signal by sending a dial tone
that enables the calling party to dial any telephone connected
yg switched network within that exchange area. See DX

* Long distance service operates in a manner similar to local
exchange service but typically involves a two-step process in
which the user first gains access to the local switching machine
through a dial tone and then a access to the long dis-
tance toll switching machine < ialing an area code plus the
number of the telephone the calling — wishes to reach. If a
circuit is available to handle the call, it is routed through the
calling party’s central office to a toll office nearby, over an in-
tercity circuit to a toll office in the city that is being called, and
finally through the central office that serves the called
telephone to that telephone. Wade, Tr. 3903-04; Marshall, Tr.
4893; DX 1828, 1833.

0 From a technical standpoint, FX and CCSA services are
similar to local exchange service in that they provide a connec-
(Footnote continued on following page)

10a
Nos. 80-2171 & 80-2288 5

In 1963, Microwave Communications, Inc., the prede-
cessor corporation to MCI,'! requested permission from
the Federal Communications Commission (“FCC”) to con-
struct and operate a long distance telephone system be-
tween Chicago and St. Louis. The proposed system con-
sisted of a terminal in each city and microwave radio
relay towers connecting the terminals. Through this sys-
tem, MCI intended to provide long distance, private line
telephone service to business and industria! subscribers
whose needs justified the exclusive or semi-exclusive use
of a long distance telephone line. MCI also sought inter-
connections from its terminals to ordinary local telephone
facilities, principally telephone wires running in conduits
beneath the street. These interconnections were essential
to MCI’s ability to do business, since they provided the
telephone or computer linkage between MCI’s terminals
and its individual customers in each city.

In 1969, after lengthy administrative proceedings in
which AT&T and the other general service carriers op-

1° continued

tion into a switching machine in a telephone company central
office which responds to requests for network access by send-
ing a dial tone. The distinguishing aspect of FX service is that
the switching machine to which the telephone is connected is
not located in the nearby telephone company central office but
is in a distant office, as, for example, where a telephone located
in Chicago is connected to a switching machine in New York
City. Such an arrangement permits the user to make and
receive calls in the distant city as though they were local calls,
i.e., aS if the subscriber had a local telephone in the distant
city. For this reason, FX service is frequently used by such
businesses as airlines and hotel reservation agents.

CCSA service offers a similar advantage to large subscribers
who wish to link far flung branches or offices to each other via
private telephone lines connected through switches in the local
telephone company office. In essence, CCSA service allows a
large subscriber to obtain a personal mini version of the
nationwide telephone network. The FTS line that connects
federal government offices is one example of a CCSA-type ser-
vice.

‘In this opinion, Microwave Communications, Inc., as well as
its successor corporations, are collectively referred to as MCI.

lla

6 Nos. 80-2171 & 80-2288

posed MCI’s application, the FCC approved MCI’s pro-
posal. Microwave Communications, Inc., 18 F.C.C.2d 953,
966 (1969); 21 F.C.C.2d 190 (1970).'* The FCC's decision
specifically authorized MCI to provide only point-to-point
private line service not requiring connection to the nation-
wide switched network—that is, tie lines that would
connect two or more locations without the use of switch-
ing machines. 18 F.C.C.2d at 953-54. The FCC also
retained jurisdiction to order appropriate local inter-
connections.

The MCI decision resulted in a deluge of new appli-
cations to the FCC for authority to construct and oper-
ate facilities for specialized common carrier services.
MCI filed applications for authority to provide special-
ized services among more than 100 cities. Other com-
panies filed similar applications, creating a situation in
which, in many instances, more than one carrier was seek-
ing to provide specialized services over the same route.
To deal with this situation, the FCC instituted a broad
rulemaking inquiry designed to permit consideration in
one proceeding of the policy questions raised by these
numerous applications. Specialized Common Carriers, 24
F.C.C.2d 318 (1970) (Notice of Inquiry).

In June 1971, the FCC handed down its Specialized
Common Carriers decision, approving in principle the
entry of specialized carriers into the long distance tele-
communications field, and declaring as a matter of policy
that there should be open competition in the specialized

The general service carriers argued that the entry of
specialized common carriers into the telecommunications in-
dustry would be contrary to the public interest because
telecommunications services could provided more eco-
nomically by a oe 7 because additional micro-
wave systems would be duplicative and wasteful; and be-
cause specialized carriers without general service respon-
sibilities would “cream-skim” the existing averaged rate struc-
ture by selectively competing only along the most profitable
long distance routes, thus imposing a heavier rate burden on
low density and local telephone users.

Nos. 80-2171 & 80-2288 7

services to which the decision applied. 29 F.C.C.2d 870
(1970). Because AT&T, reversing its earlier position,
agreed to negotiate with MCI and other new entrants for
local interconnections, the FCC elected to defer consider-
ation of MCI’s claim that AT&T was misusing its power
over local telephone service to gain a competitive advan-
tage over potential specialized competitors.

The FCC’s Specialized Common Carriers decision was
hardly a model of clarity.'* The decision did not define
the specialized services to which it referred, nor did it
define the corresponding obligations that the FCC ex-
pected the general carriers (primarily AT&T) to assume
in order to assist the new carriers. AT&T contended, both
at the time of the FCC decision and throughout the
pendency of this lawsuit, that the Specialized Common
Carriers decision authorized only point-to-point private
line services not requiring switched network connections,
and that the obligations of the Bell System extended only
to providing local distribution facilities for these point-to-
point private line services. MCI, by contrast, has con-
sistently taken the position that the Specialized Common
Carriers decision authorized it to provide FX and CCSA
type services, as well as point-to-point private lines, and
that AT&T had a corresponding obligation to provide it
with the switched network connections required for these
services. MCI also contended, both before and after the
Specialized Common Carriers decision, that AT&T was
obligated to provide it with loca! distribution facilities at
the same rate at which AT&T provided such facilities to
Western Union, under a longstanding contract between
those two carriers. AT&T disagreed, claiming that the
contract then in effect with Western Union did not re-
flect AT&T's current costs, and that the price charged to
MCI for local! distribution facilities should be set so as to
recover AT&T's costs on a current basis.

‘Indeed, the district judge in this case characterized the
decision as an “abomination” and “one of the worst examples of
legal draftsmanship | have ever seen.” Tr 2785

}3a
8 Nos. 80-2171 & 80-2288

In September 1971, AT&T entered into interim con-
tracts with MCI defining the kinds of interconnections
that AT&T would provide for MCI’s initial Chicago-St.
Louis route and establishing the price for those inter-
connections. These contracts did not permit switched net-
work connections for FX or CCSA type services, nor was
the price set by the contracts for local distribution
facilities comparable to that charged to Western Union.

During this same time period, the original MCI in-
vestors joined forces with William McGowan, an experi-
enced business executive and engineer, to form a venture
that envisioned the eventual construction and operation
of a nationwide long distance telephone system. After
scrutiny of the market it believed had been opened by the
Specialized Common Carriers decision, MCI created a
plan contemplating sales of 74,000 circuits (leased tele-
phone lines) having an average length of 500 miles per
circuit, or approximately 37 million circuit miles’ by
the end of 1975. According to this plan, MCI expected its
revenues to average $1.00 per circuit mile excluding
AT&T's local connection charges, which MCI intended to
pass on to its customers. Projected annual revenues for
1975 were approximately $350 million. Armed with these
projections, MCI proceeded to raise $110 million by June
1972, making it one of the largest start-up ventures in the
history of Wall Street. The funds were raised after re-
view and analysis by leading lenders and large equip-
ment suppliers who were either lending the funds or
underwriting or guaranteeing the financing.

MCI commenced operations over its Chicago-St. Louis
route on January 1, 1972. In the fall of 1972, MCI began
construction of the first segment of its nationwide sys-
tem, extending east and south from the original Chicago-
St. Louis route. MCI initially expected to complete
the first portion of its national network and commence
customer service over major parts of the system by

“ Circuit miles measure the total distance covered by all lines
leased by customers in a given month. Mctiowan, Tr. 355-56

Ida
Nos. 80-2171 & 80-2288 9

late summer 1973. Expansion to a second and a third
group of smaller cities was to follow over the next three
years. MCI planned to fund these capital expenditures
from its initial $110 million capitalization, from substan-
tial additional anticipated financing, and from operating
revenues.

B. The Interconnection Disputes

During late 1972, while construction was progressing,
MCI entered into negotiations with AT&T over the pro-
vision by AT&T of interconnections and local distribu-
tion facilities on the expanded MCI system. Because MCI
had previously experienced difficulty obtaining satis-
factory interconnections for its Chicago-St. Louis seg-
ment, MCI hired an experienced lawyer-negotiator to
secure a national interconnection agreement with AT&T
that would permit MCI to serve the entire market it
believed the FCC had opened. These negotiations began
in September 1972, and continued with little progress for
the next nine months.

During this same period, MCI appealed to the FCC for
help in breaking down what it viewed as AT&T's unrea-
sonable negotiating stance. Through a series of informal
complaints and conferences with FCC staff, MCI charged
that AT&T was treating it unfairly, on the question of
interconnections, in at least three respects:

(1) MCI claimed that AT&T was unlawfully deny-
ing it interconnections to the switched network for
FX and CCSA services and for point-to-point service
to customers located outside a local distribution
area,’® including multipoint service;'*

The dispute over local distribution areas related to the
geographic boundaries within which AT&T was obhgated to
provide ocal facilities to MCL See infra. pp. 107-110

Multipoint service involves a situation in which a customer
has an AT&T private line between Cities A and B, and an MCI
private line between Cities 2 and © MCI claimed that it was
entitled to an interconnection between tts terminal and the

tnot ntinued following page)

15a

10 Nos. 80-2171 & 80-2288

(2) MCI claimed that it was being charged exces-
sive and discriminatory prices for the local distri-
bution facilities provided by the Bell System; and

(3) MCI claimed that it was being harassed by Bell
System employees in the provision of local distribu-
tion facilities through delays, improper installation,
improper maintenance and other similar practices.

AT&T denied each of these charges. Both in its direct
dealings with MCI and in its responses to FCC staff
members, AT&T adhered to the position that the Special-
ized Common Carriers decision authorized only private
line service not requiring switched network connections.
AT&T also contended that it was providing MCI with all
the interconnections to which MCI was entitled and that
the prices it was charging for those interconnections
were not excessive or unfair.

In August 1973, with negotiations still pending, and
without informing MCI, AT&T decided to file with forty-
nine of the state utility commissions interconnection tar-
iffs that would be equally applicable to all carriers—in-
cluding MCI and Western Union. By filing interconnec-
tion tariffs with the state commissions rather than with the
FCC, AT&T made it more difficult for MCI to oppose the
tariffs, since, in the words of one AT&T official, the inter-
connection “controversy would spread to 49 jurisdictions.”
PX 2148 at 2031. Even after making this unilateral tariff
decision, AT&T continued to “negotiate” with MCI. After
MCI accidentally learned of the state tariff plan, how-
ever, AT&T formally broke off all contract negotiations.

In early October 1973, several top MCI officials met
with Bernard Strassburg, Chief of the FCC Common
(arnier Bureau, to discuss a plan designed to resolve the
interconnection controversies between MC'l and AT&T.

‘6 continued

AT&T terminal in City B so that the customer could obtain
direct, MC] provided service between City A and City ©
Revenues for the City A to City B segment would, of course,
redound to AT&T. See infra, pp. 111-116

l6a

Nos. 80-2171 & 80-2288 1

Pursuant to this plan, FCC Chairman Burch, on October
4, 1973, issued a letter on behalf of the Commission,
rejecting AT&T's resort to state regulatory agencies as
unlawful and asserting exclusive F.C.C. jurisdiction over
the interconnection dispute. Shortly thereafter, MCI
wrote to Mr. Strassburg, inquiring as to the nature and
scope of the services that MCI was authorized to pro-
vide and for which AT&T was obliged to supply inter-
connections under the Specialized Common Carriers
decision. Mr. Strassburg replied by letter dated October
19, 1973, that these services included FX and CCSA, as
well as services outside local distribution areas and
multipoint services. On November 2, 1973, MCI filed a
complaint in federal district court under section 406 of
the Communications Act asking that AT&T be ordered to
provide interconnections for these services.

On December 31, 1973, the United States District Court
for the Eastern District of Pennsylvania issued a prelimi-
nary injunction ordering AT&T to provide all of the in-
terconnections sought by MCI, on the theory that such
interconnections were contemplated and required by the
FCC's Specialized Common Carriers decision. MCI Com-
munications Corp. v. AT&T, 369 F. Supp. 1004 (E.D. Pa.
1973). AT&T provided the required interconnections, but
immediately appealed the district court’s injunction.
Meanwhile, the FCC, on December 13, 1973, issued its
own order requiring AT&T to show cause why it should
not be held to have violated the Specialized Common
Carriers decision by refusing to provide the intercon-
nections requested by MCI.

On April 15, 1974, the Third Circuit reversed the pre-
liminary injunction issued against AT&T. MCI Com-
munications Corp. v. AT&T, 496 F.2d 214 (3d Cir. 1974).
On April 16, 1974, despite assurances that the FCC's
“show cause” decision was expected “any day now,” and
despite FCC warnings that disconnection of MCI’s cus-
tomers would violate the Communications Act, AT&T
ordered its local operating companies to disconnect MCI’s
customers on twenty-four hours notice. MCI alleged that
the resulting disconnections caused turmoil among its

17a
12 Nos. 80-2171 & 80-2288

customers and seriously damaged its reputation for re-
liable service. On April 23, 1974—eight days after the
Third Circuit had vacated the injunction obtained by
MCI—the FCC issued a decision ordering AT&T to pro-
vide the disputed interconnections. Bell System Tariff
Offerings of Local Distribution Facilities for Use by Other
Common Carriers, 46 F.C.C.2d 4138, affd sub nom. Bell
Telephone Co. v. FCC, 503 F.2d 1250 (3d Cir. 1974), cert.
denied, 422 U.S. 1026 (1975). The FCC held that it had
intended to include both FX and CCSA services within
the terms “specialized” or “private line” services as those
terms were used in the Specialized Common Carriers
decision. 46 F.C.C.2d at 425-27. AT&T provided the re-
quested interconnections within ten days of the FCC's
order.

C. The Execunet Decision

In October 1974, MCI filed a tariff with the FCC for
what the tariff referred to as metered use private line
services, principally a service called “Execunet.” Al-
though the FCC did not immediately perceive it as such,
this tariff was apparently designed to permit MCI to
provide ordinary switched long distance service to users
in any city to which its microwave system extended. See
MCI Telecommunications Corp., 60 F.C.C.2d 25, 40-43
(1976) (the “Exrecunet decision”). When the FCC dis-
covered the nature and purpose of the new tariff, it
declared the tariff unlawful and ordered MCI to dis-
continue providing ordinary long distance message serv-
ice on the ground that the Specialized Common Carriers
decision limited MCI’s authorization to the provision of
private line services. 60 F.C.C.2d at 35-44, 58.

MCI appealed the FCC’s E-recunet decision to the Court
of Appeals for the District of Columbia Circuit and, in
July 1977, the Court of Appeals set the decision aside.
MCI Telecommunications Corp. v. FCC, 561 F.2d 365
(D.C. Cir. 1977), cert. denied, 434 U.S. 1040 (1978). In its
opinion, the Court of Appeals assumed, without deciding,
that “a service like Execunet was not within the contem-
plation of the [FCC] when it made the Specialized Com-

l8a
Nos. 80-2171 & 80-2288 13

mon Carriers decision,” 561 F.2d at 378, but held that the
FCC had not conducted a sufficient hearing—either dur-
ing the Specialized Common Carriers proceeding or at
any subsequent time—to justify any limitation on the
operating authority of MCI and the other new special-
ized carriers. Jd. at 378-80.

This decision by the District of Columbia Circuit—
handed down long after the events involved in the in-
stant case occurred—rendered virtually meaningless the
debate between MCI and AT&T over the proper inter-
pretation and definition of the specialized private line
services to which the Specialized Common Carriers de-
cision applied. AT&T also claims that it was only by
virtue of this Court of Appeals decision that MCI was
able to achieve profitability since, according to AT&T,
MCI’s costs for private line services (including FX and
CCSA) substantially exceeded the rates AT&T was then
charging its large users under the Telpak tariff. See
infra, pp. 15-17.

D. The Pricing Controversies Between MCI and AT&T

From the time of MCI’s entry into the telecommunica-
tions field, AT&T's prices for specialized long distance
services had been a significant source of controversy.
Initially the principal controversy centered on AT&T's
Telpak tariff. The Telpak tariff, which accounted for
most of AT&T's private line circuits at the time MCI
commenced operations, offered private line service to
large users under two schedules: (1) the user could obtain
the right to up to 60 circuits between any two points for
$30 per mile per month, or an average of $.50 per circuit
mile per month if all circuits were being used; or (2) the
user could obtain the right to up to 240 circuits between
any two points for $85 per mile per month, or an average
of $.35 per circuit mile per month if all 240 circuits were
being used. PX 821.

AT&T originally instituted its Telpak tariff in 1961 as
a competitive response to the FCC's decision to permit
large telephone users to construct and operate their own

19a
14 Nos. 80-2171 & 80-2288

private microwave systems.'’ At the time MCI entered
the industry, in 1969, a number of microwave manu-
facturers were contending in proceedings before the FCC
that Telpak rates were too low and unfairly hindered
efforts to interest large users in building their own
microwave systems. At the same time, however, a num-
ber of large users, including the federal government,
were resisting any efforts to increase the Telpak tariff
and, indeed, were contending that Telpak rates were
already too high.

In 1968, shortly before MCI obtained its first author-
ization to enter the telecommunications industry, AT&T
was permitted to increase its Telpak rates on an interim
basis. During the period 1969-1972, AT&T was able—
over the strenuous objections of some Telpak users—to
obtain FCC approval for two additional rate increases.
Although MCI contended strongly before the FCC that
AT&T's Telpak tariff did not cover its fully distributed
costs and was therefore predatory, the FCC, in 1977,
ae rejected all of the attacks upon the Telpak
tariff.'*

Concurrent with MCI’s entry into the telecommuni-
cations field, AT&T also initiated studies to consider
nationwide deaveraging of its rates for individual private
line service. Pursuant to these studies, AT&T formu-
lated a plan known as the Hi-Lo tariff, which provided
for the deaveraging of AT&T’s individual private line

'' For a detailed description of Telpak and how it works, see
American Trucking Ass'ns, v. FCC, 377 F.2d 121, 124-27 (D.C.
Cir. 1966), cert. denied, 386 U.S. 943 (1967).

'* AT&T, Revisions ef Taryff F.C.C. No. 260 Private Line Ser-
vices, Series 5000 (TELPAK), 64 F.C.C.2d 971, 983-89 (1977).
This holding was affirmed by the Court of Appeals for the Dis-
trict of Columbia Circuit after the completion of the trial in the
instant case. Aeronautical Radio, Inc. v. FCC, 642 F.2d 1221,
1223 (D.C. Cir. 1980), cert. denied, 541 U.S. 920 (1981).

Nos. 80-2171 & 80-2288 15

service into two principal rate categories.'* Under Hi-Lo,
AT&T would lower its rates on certain “high density”
long distance routes, many of which MCI planned to
serve. At the same time, AT&T would increase its rates
between so-called “low-density” cities, most of which MCI
was not planning to serve. In February 1973, the month
after MCI had announced its plans and prices for nation-
wide service, AT&T announced Hi-Lo to the public and
sought permission from the FCC to file the new tariff.
AT&T did not actually receive permission to file its Hi-
Lo tariff until November 15, 1973, and the new tariff
finally became effective on June 13, 1974.

E. MCI’s Damage Evidence

Faced with unproductive negotiations, a “chilled” mar-
ket caused by AT&T's early announcement of Hi-Lo, and
curtailed sales commitments stemming in part from
customer awareness of MCI’s interconnection difficulties,
MCI in mid-1973 began to pare down its construction
program. Because the company’s revenues were sub-
stantially lower than originally anticipated, MCI de-
cided to defer construction on fifteen of the thirty-four
routes contained in its original plan. In addition, MCI
terminated almost one-third of its employees and re-
negotiated its bank loans to secure permission to use loan
proceeds for working capital rather than for additional
construction. Although MCI survived and eventually
prospered, it alleges in the instant lawsuit that by the

'* AT&T had initiated studies to consider a deaveraged rate
structure as early as 1970. shortly after the FCC's approval of
MCIl's Chicago-St. Louis line. The initial proposal resultin
from those studies was a so-called “exception tariff” which
would have matched M(l's rate over the Chicago-St. Louis
route as soon as MC! commenced operations. Warned by its
economic advisors that such an exception tariff oad be
perceived as violative of the antitrust laws, AT&T decided

inst this approach and opted, instead, for the development
of a broadly deaveraged national rate structure. deButts, Tr
4038-39

2la
16 Nos. 80-2171 & 80-2288

time the interconnection dispute was finally resolved, in
May 1975, it had a far smaller system, slower growth
rate and related lower net cash flows and profits than it
would have had absent AT&T’s unlawful interference.

At trial, MCI’s proof of damages was based almost
entirely on a lost profits study authored by MCI’s former
controller, Mr. Uhl. This study compared the profits that
a hypothetical MCI—undamaged by AT&T’s allegedly
unlawful actions—would have enjoyed with MCI’s actual
and projected profit figures for the years 1973-1984.”
The revenues posited for the “undamaged” MCI were
based upon projections made by MCI in 1971-1972 and
previously used for financing purposes. Among other pre-
sumptions, these revenue projections assumed that
AT&T’s Telpak service—which the jury in this case
found to be lawfully priced and marketed—would not be
in existence during the relevant time period. Costs for the
“undamaged” MCI were derived from MCI’s actual oper-
ating experience. These revenue and cost projections
were then used to compute MCI’s “lost profits,” measured
in net cash flow, for each of the years 1973-1994.2'! These
computations resulted in an aggregated before-tax dam-
age claim of $900,468,000.

AT&T, at trial, sharply disputed the accuracy of MCI’s
revenue projections. AT&T argued that MCI’s own lost
profits study demonstrated that MCI could never have
achieved profitability in the private line business, even
including FX and CCSA services, since MCI’s costs for
such services substantially exceeded the rates AT&T was
then charging its large business users under the Telpak
tariff. According to AT&T, MCI’s lost profits study
showed MC I's costs to be $.63 per circuit mile per month

2% =6The revenue projections for the “undamaged” MCI were ad-
justed Paced to account for some delays and uncertainties
that MC1 officials felt were not fairly attributable to AT&T
See Uhl, Tr. 3228-37; PX 12038

“) MCI assumed that the effects of AT&T's allegedly unlawful
conduct would be completely eliminated as of 1995

ty
ty

Nos. 80-2171 & 80-2288 17

assuming that it could obtain local distribution facilities
at the Western Union contract rates and $.74 per circuit
mile per month, if it had to pay for those facilities on the
basis of the current prices charged by AT&T. On either
basis, AT&T argued that MCI’s costs were substantially
in excess of the Telpak rates and, hence, that MCI could
not have undercut these rates and still have covered its
costs.22 AT&T also argued that because its ordinary long
distance rates are averaged on a nationwide basis, and
because state and federal regulatory policy has tradi-
tionally required AT&T to set its long distance rates high
enough to subsidize its less profitable local telephone
service, MCI and other specialized carriers, by com-
peting exclusively in the most lucrative long distance
markets, could easily undercut AT&T's artificially ele-
vated long distance rates.

Il. REGULATION AND THE ANTITRUST LAWS

A. The Federal Regulatory Scheme for
Telecommunications

The first venture of the federal government into the
regulation of telecommunications was section 7 of the
Mann-Elkins Act of 1910,*° which added telephone and
telegraph companies to the list of common carriers regu-
lated by the Interstate Commerce Commission (“ICC”).
The Mann-Elkins Act imposed upon the newly designated
common carriers the obligation to provide service upon
request at just and reasonable rates, without unjust
discrimination or undue preference“ The Act did not,

# MCI countered this contention by arguing. inter alia, that
AT&T's Telpak rate computations did not include applicable
termination charges and that they failed to account for the
percentage of base capacity actually used by a customer (the
“fill factor”). See infra, pp. 146.147

= Mann-Elkins Act of 1910, ch 309. § 7. 46 Stat 580 544
(1910)

* See Mann-Elkins Act of 1910. ch. 309 §§ 7. 12. 86 Stat 539,
544, 551 (1910)

18 Nos. 80-2171 & 80-2288

however, subject the telecommunications industry to the
broad tariff and regulatory jurisdiction enjoyed by the
ICC over railroads. See Essential Communications Sys-
tems v. AT&T, 610 F.2d 1114, 1117-19 (8d Cir. 1979)
(detailing early regulation of telecommunication and rail-
road industries).

Competition among telephone services in the same geo-
graphic area was, in the early part of the century, a fact
of life. Thus, the enactment, in 1914, of the Clayton Act's
antimerger provisions™ presented a serious obstacle to
the development of an integrated national telephone net-
work. The Willis-Graham Act addressed this problem by
authorizing the ICC to approve the consolidation of tele-
phone company properties into single companies if such
consolidation was “of advantage to the persons to whom
service is to be rendered and in the public interest.”
WillisGraham Act of 1921, ch. 20, 42 Stat. 27 (1921)
(current version at 47 U.S.C. § 221(a)(1976)). The statute
granted express immunity from the antitrust laws for
such consolidations. /d.

Thus, as of 1921, federal law recognized the telecom-
munications industry as a common carrier, subject to the
consumer protection and non-discrimination provisions of
the Mann-Elkins Act and exempt from antitrust liability
for consolidations of competing local service systems. In
other respects, however, the industry was subject to the
antitrust laws. Indeed, in 1914, a government antitrust
suit produced a consent decree against AT&T. See Es-
sential Communications, 610 F.2d at 1119 & n.19. Aside
from the ICC’s jurisdiction to enforce AT&T's common
carrier obligations, AT&T was free to determine its own
rates, return on investment and service obligations. Fed-
eral law did not even impose upon AT&T an obligation
to interconnect with other communications common
carriers, although AT&T's local subsidiaries were sub-
ject to regulation at the state level. /d. at 1119.

% Clayton Act, ch. 323, § 7, 38 Stat. 731 (1914) (current ver-
sion at 15 U.S.C. § 18 (1976).

24a
Nos. 80-2171 & 80-2288 19

In 1934, Congress enacted the Federal Communications
Act, 47 U.S.C. § 151 et seg. (1976), which constitutes the
primary federal regulatory mechanism for the telecom-
munications industry today. The 1934 Act severed regu-
lation of the telephone, telegraph and radio industries
from the ICC, and vested regulatory jurisdiction over
those industries in the newly created Federal Communi-
cations Commission. The Act carried forward, almost
verbatim, many provisions of the Mann-Elkins Act of
1910—for example, the just and reasonable tariff require-
ment and the prohibition against unjust or unreasonable
discrimination. The 1934 Act also imposed certain
new obligations on the telecommunications industry—for
example, the requirement that regulated carriers inter-
connect or establish through routes with other common
carriers. See 47 U.S.C. § 201(a) (1976).

With respect to tariffs, the 1934 Act continued the
prior practice that tariffs be generated, at least in the
first instance, by the carriers themselves. Under section
20% a) of the Act, these tariffs must be filed with the
FCC, and carriers must give the FCC and the public
ninety days notice of any proposed changes. 47 U.S.C.
§ 20%a) (1976); 47 U.S.C.A. § 203(b) (West Supp. 1982).
No charge may be demanded or collected, or any service
rendered, except in accordance with a filed tariff. Jd.

20%c). Section 204 of the Act further authorizes the

CC, either sua sponte or upon request, to conduct a
hearing concerning the lawfulness of the rates embodied
in a proposed tariff and to suspend operation of the tariff
for up to five months. /d. § 204. If the Commission deter-
mines that the new tariff does not meet the requirements
of the Act, it may prescribe a “just and reasonable” sub-
stitute, or set maximum and/or minimum charges to be
observed. /d. § 205; see American Broadcasting Com-
panies v. FCC, 643 F.2d 818, 822 (D.C. Cir. 1980). Any

* Compare Mann-Elkins Act of 1910, ch. 309, §§ 7, 12, 36
Stat. 539, 554, 551 (1910) uith Communications Act of 1934, ch.
652, §§ 201, 202, 43 Stat. 1064, 1070 (1934) (current version at
47 U.S.C. §§ 201(b), 202(a) (1976)).

20 Nos. 80-2171 & 80-2288

carrier which knowingly fails to obey an FCC order
issued under this section is liable for a fine of $1000 per
violation per day. In addition, any common carrier which
does or causes to be done any act prohibited or declared
unlawful by the Communications Act shall be liable “to
the person or persons so injured thereby for the full
amount of damages,” plus attorneys’ fees. 47 U.S.C. § 206
(1976).

B. Implied Immunity

AT&T contends that the district court should have dis-
missed this suit on its motion because the FCC's regu-
latory control over AT&T's conduct renders AT&T im-
mune from antitrust liability.*’ The trial court denied the
motion in a well-reasoned memorandum opinion. MC]
Communications Corp. v. AT&T, 462 F. Supp. 1072 (N.D.
Ill. 1978). Judge Grady traced the legislative history of
the Federal Communications Act, and concluded that
while AT&T is subject to considerable regulatory con-
trol and supervision, there is no indication that the Act
was meant to immunize a carrier such as AT&T from the
antitrust laws. 462 F. Supp. at 1086-87. Moreover, he
concluded, the regulatory scheme to which AT&T is sub-
ject is not so wholly inconsistent with the antitrust laws
as to require immunity. AT&T is not subject to conflict-
ing requirements, nor would it be held liable for deci-
sions which were not its own business judgment. The
district court noted that the FCC did not sanction AT&T's
conduct with regard to interconnections nor dictate its
tariffs. Thus, while certain actions might ultimately have
been subject to agency review, the initial decisions were
the product of AT&T's private business judgment, and
were not so heavily regulated as to remove them from
AT&T's control.

On appeal, AT&T contends that the district court's
decision incorrectly focused on blanket immunity rather

“We acknowledge the brief on this issue of the United States
as amicus curiae,

26a

Nos. 80-2171 & 80-2288 21

than immunity for the particular actions of which MCI
complained. Thus, AT&T argues that the critical ques-
tion left unconsidered by the district court is “whether
the charges in this case do in fact relate to matters basic
to the pervasive regulatory scheme to which AT&T is
subject.” Appellant’s Br. at 188. Our reading of the dis-
trict court’s opinion, however, convinces us that it did not,
as AT&T insists, miss the point now raised on appeal.
While the district court did address the question of
“blanket immunity” (7.e., whether regulation by the FCC
under the public interest standard contained in the Com-
munications Act is wholly inconsistent with the antitrust
laws), 462 F. Supp. at 1074, 1080-82, it also fully con-
sidered AT&T's “fall back position. . . that even though
all of AT&T’s conduct may not be immunized, the FCC,
in its pervasive regulation, has approved each of the
allegedly anticompetitive activities of which MCI com-
plains and that therefore AT&T should obtain at least ad
hoc immunity from antitrust laws.” Jd. at 1078, 1082-
1102. For the reasons largely set forth in the district
court’s memorandum opinion denying AT&T’s motion to
dismiss, we reject AT&T's assertion of implied immunity.

As the district court recognized, the Communications
Act of 1934 does not expressly grant AT&T immunity
from the antitrust laws for the conduct challenged in the
instant case. Nor does the legislative history of the Com-
munications Act indicate how Congress intended that the
Act and the antitrust laws were to be reconciled. See
United States v. AT&T, 461 F. Supp. 1314, 1321 (D.D.C.
1978); Comment, AT&T and the Antitrust Laws: A Strict
Test for Implied Immunity, 85 Yale L. J. 254, 269 (1975).
It is well established, however, that regulated industries
“are not per se exempt from the Sherman Act.” Georgia
v. Pennsylvania R.R., 324 U.S. 439, 456 (1945). “Repeal
of the antitrust laws by implication is not favored and not
casually to be allowed. Only where there is a ‘plain
repugnancy between the antitrust and regulatory pro-
visions’ will repeal be implied.” Gordon v. New York
Stock Exchange, 422 U.S. 659, 682 (1975) (quoting United
States v. Philadelphia National Bank, 374 U.S. 321, 350-
51 (1963)). As a further limitation, repeal is to be re-

22 Nos. 80-2171 & 80-2288

garded as implied only where necessary to make the

regulatory scheme work, and even then, only to the mini-

mum extent necessary. Silver v. New York Stock Ex-

change, 373 U.S. 341, 357 (1963); see National Gerimedi-

polars dg & Gerontology Center v. Blue Cross, 452 U.S.
(1981).

Application of these general principles to a particular
claim of implied immunity requires an evaluation of the
specific regulatory scheme involved and the administra-
tive authority exercised pursuant to that scheme. North-
eastern Telephone Co. v. AT&T, 651 F.2d 76, 83 (2d Cir.
1981), cert. denied, 102 S.Ct. 1438 (1982); see National
Gerimedical Hospital! & Gerontology Center v. Blue Cross.
Thus, in our case, the inquiry must focus upon (1) whether
the activities that are the subject of MCI’s complaint were
required or approved by the Federal Communications
Commission, pursuant to its statutory authority, in a way
that is incompatible with antitrust enforcement, see, e.g.,
Goraon v. New York Stock Exchange, 422 U.S. 659 (1975);
Pan American World Airways, Inc. v. United States, 371
U.S. 296 (1963), or (2) whether these activities are so per-
vasively regulated “that Congress must be assumed to
have forsworn the paradigm of competition.” Northeastern
Telephone, 651 F.2d at 82; see United States v. AT&T, 461
F. Supp. 1314, 1324 (D.D.C. 1978).

With respect to interconnections, we conclude, as did
the district court, that the FCC’s regulatory authority
under the Communications Act does not preclude appli-
cation of the Sherman Act. See 462 F. Supp. at 1089-
96. The mere pervasiveness of a regulatory scheme
does not immunize an industry from antitrust liability
for conduct that is voluntarily initiated. Otter Tail Power
Co. v. United States, 410 U.S. 366, 374 (1973); see Com-
ment, The Application of Antitrust Law to Telecommunt-
cations, 69 Calif. L. Rev. 497, 509 (1981). Although the
FCC has authority to compel interconnection under sec-
tion 201(a) of the Act, the initial decision whether to in-
terconnect rests with the utility, and the record shows
that the FCC did not control or approve of AT&T's ac-

Nos. 80-2171 & 80-2288 23

tions here. Nor has the FCC supervised AT&T's inter-
connection practices so closely that the FCC’s approval
could be inferred. Cf. Gordon v. New York Stock Ex-
change, 422 U.S. 659 (1975)

Other circuits that have considered AT&T's implied
immunity in interconnection-type disputes have uniform-
ly rejected arguments the same as or similar to those
made by AT&T in the instant case. See, e.g., North-
eastern Telephone Co. v. AT&T, 651 F.2d 76 (2d Cir.
1981), cert. denied, 102 S.Ct. 1438 (1982); Phonetele, Inc. v.
AT&T, 664 F.2d 716 (9th Cir. 1981), cert. denied, 51
U.S.L.W. 3533 (1983); Mid-Texas Communications Sys-
tems v. AT&T, 615 F.2d 1372, 1377-82 (5th Cir.), cert.
denied, 449 U.S. 912 (1980); Sound, Inc. v. AT&T, 631
F.2d 1324, 1327-31 (8th Cir. 1980) (citing with approval
Judge Grady’s memorandum opinion); Essential Com-
munications Systems v. AT&T, 610 F.2d 1114 (3d Cir.
1979); see also United States v. AT&T, 461 F. Supp. at
1320-30. But see Southern Pacific Communications Co. v.
AT&T, No. 78-0545 (D.D.C. Dec. 21, 1982). We agree with
the reasoning of these decisions and are not persuaded
that a contrary result is warranted here.

AT&T relies heavily on Hughes Tool Co. v. Trans World
Airlines, Inc., 409 U.S. 363 (1973), and Pan American
World Airways, Inc. v. United States, 371 U.S. 296 (1963),
to support its claim that “matters at the heart of a per-
vasive scheme of common carrier, or public utility, regu-
lation [here, presumably, AT&T's interconnection and
pricing policies] are immune from antitrust liability.”
Appellant’s Br. at 183. In both of these cases, however,
the Supreme Court found that the transactions chal-
lenged as violative of the antitrust laws fell precisely
within the detailed scheme of administrative oversight
established by Congress. Thus, in Hughes Tool, the Court
held that where the Civil Aeronautics Board (CAB) had
specifically authorized certain transactions between a
parent and its subsidiary, those transactions were im-
munized from antitrust liability by section 414 of the
Federal Aviation Act, 49 U.S.C. § 1378 (1976). Similarly,

29a
24 Nos. 80-2171 & 80-2288

in Pan American Airways, the Court held that section
411 of the Federal Aviation Act granted to the CAB the
very jurisdiction over the division of territories and allo-
cation of air carrier r utes that was the subject of the
government’s antitrust complaint. In the instant case, by
contrast, neither AT&T’s interconnection decisions nor
its price structure policies are dictated, in the first in-
stance, by the FCC (although, of course, AT&T's overall
rate of return is subject to continuing surveillance).
Moreover, to the extent that any FCC decisions are rele-
vant to AT&T's claim of implied immunity, those deci-
sions disapprove of, rather than condone, AT&T's actions.
Thus, this is not a case like Hughes Tool or Pan Ameri-
can Airways, where the refusal to grant antitrust im-
munity could subject AT&T to conflicting and potentially
irreconcilable liability standards. See also Phonetele, Inc.,
664 F.2d at 732-34.

AT&T also cites the case of FCC v. RCA Communica-
tions, Inc., 346 U.S. 86 (1953), for the proposition that the
public interest standard embodied in the Communica-
tions Act is inconsistent and thus presumably irreconcil-
able with the policy of the antitrust laws favoring com-
petition. However, the Third Circuit, in Sound, Ine. v.
AT&T, 631 F.2d 1324 (3d Cir. 1980), recently rejected
precisely this irreconcilability argument. In Sound, /nc.,
AT&T argued that it was exempt, by virtue, inter alia, of
the public interest standard contained in the Communi-
cations Act, from antitrust liability arising out of its rate
structure and marketing practices for terminal telephone
equipment. In rejecting AT&T's assertion that the public
interest standard of the Communications Act was neces-
sarily inconsistent with the pro-competition standard of
the antitrust laws, the Third Circuit noted that the FCC
had exercised its supervisory authority so as to encourage
rather than discourage competition in the terminal equip-
ment market. In light of this policy, the court concluded
that “the maintenance of an antitrust suit will not conflict
with the operation of the regulatory scheme authorized
by Congress but will supplement that scheme.” 631 F.2d
at 1330. Similarly, in the instant case, the interconnec-
tion policies adopted by the FCC during the time period

30a
Nos. 80-2171 & 80-2288 25

relevant to this litigation appear designed to promote
rather than inhibit competition in the specialized tele-
communications field. Thus, the allowance of antitrust
liability is likely to complement rather than undermine
the applicable statutory scheme.

AT&T's assertion of implied immunity with respect to
MCI’s predatory pricing allegations presents a closer
question. Because section 201(b) of the Communications
Act requires that AT&T’s rates be “just and reasonable,”
and because both AT&T’s rates and rate making method-
ology are subject to continuing supervision by the FCC, it
is probable that AT&T enjoys less flexibility in setting
rates than it does, for example, in making initial inter-
connection decisions. Moreover, it can be argued that the
hearing and enforcement provisions of the Communica-
tions Act itself afford competitors such as MCI an adequate
opportunity to contest and seek relief from tariffs they
consider unreasonable or unfair. Although these argu-
ments are not entirely without merit, we believe that,
under the particular circumstances of this case, AT&T is
not entitled to antitrust immunity for the competitive
rate filings which form the basis of MCI’s predatory
pricing claims.

Although the Communications Act grants the FCC
potentially broad authority over interstate and foreign
telephone rates, in practice, this authority is consider-
ably more circumscribed. First, as the district court in
this case noted, the Act gives the carrier sole responsi-
bility for filing a tariff, and a carrier may file a new or
revised tariff at any time. See 47 U.S.C. § 204 (1976).
Thus, it is AT&T, not the FCC, that has the primary re-
sponsibility for initiating and setting both regular and
private line telephone rates. See Sound, Inc., 631 F.2d at
1330. “When [such decisions] are governed in the first
instance by business judgment and not regulatory

* But see Essential Communications, 610 F.2d at 1120 (Com
munications Act intended for the benefit of customers, not
com petitors ).

3la
26 Nos. 80-2171 & 80-2288

coercion, courts must be hesitant to conclude that

Congress intended to override the fundamental national
licies embodied in the antitrust laws.” Otter Tail, 410
S. at 374.79

Moreover, although the Communications Act gives the
FCC the right to conduct hearings on proposed tariffs, a
new tariff automatically goes into effect after 90 days
unless acted upon by the FCC in its discretion. See 47
U.S.C. § 203(bX1) (Supp. 1981). Thus, the FCC does not
expressly approve or adopt as agency policy every tariff
it permits to become effective. “By permitting a tariff to
go into effect, the FCC does not assert that it has
examined the content of the tariff and found it necessary
or appropriate to effectuate the regulatory program, nor
does it have an obligation under the Act to make such a
finding.” Phonetele, 644 F.2d at 733; see Essential Com-
munications, 610 F.2d at 1124; MCT Telecommunications
Corp. v. FCC, 561 F.2d 365, 374 (D.C. Cir. 1977), cert.
denied, 434 U.S. 1040 (1978).

The less than comprehensive nature of the FCC's au-
thority over tariffs is further reinforced by the huge
volume of tariff filings received by the Commission.
During the twelve month period between September
1974 and August 1975, for example, the FCC received
1,371 tariff filings, totaling 11,491 pages. Because of this
volume, it was able to investigate only a small percentage
of the tariffs filed. See United States v. AT&T, 461 F.
Supp. at 1326. Recognizing these practical limitations on
its regulatory jurisdiction, the FCC has acknowledged, in
an antitrust case involving implied immunity questions
similar to those at issue here, that “rate filings generally
proceed from the carrier's independent judgment... .”
Id. at 1326 (quoting Memorandum of FCC, filed Decem-
ber 30, 1975, pp. 19-20). Moreover, the FCC has consis-

“

But we believe that FCC regulation of AT&T's rates may
be more pervasive than Federal Power Commission (now
Federal Energy Regulation Commission) regulation of the
wholesale rates of electric utilities Cf Otter Tail Power Co. v.
l'mted States, 410 US. 366 (1973)

Nos. 80-2171 & 80-2288 27

tently maintained—in contrast to the SEC in the stock
exchange cases relied upon by AT&T—that antitrust en-
forcement is not precluded in this area.*® United States v.
AT&T, 461 F. Supp. at 1326. Finally, as is the case in the
interconnection context, the actual FCC decisions rele-
vant to the pricing policies challenged as predatory in the
instant case have tended to disapprove of, rather than
support, those policies.*! We thus conclude that where, as
here, the — decisions complained of are more the
result of business judgment than regulatory coercion,
and the FCC has neither dictated nor approved of those
decisons, the challenged rate filings are not immune from
antitrust scrutiny.®? See City of Kirkwood v. Union Elec-
tric Co., 671 F.2d 1173, 1176-79 (8th Cir. 1982), petition
for cert. filed, 51 U.S.L.W. 3141 (U.S. June 11, 1982) (No.
81-2278) (no immunity for rate filing under similar pro-
visions of Federal Power Act); City of Mishawaka v.
Indiana & Michigan Electric Co., 560 F.2d 1314, 1318-21
(7th Cir. 1977), cert. denied, 436 U.S. 922 (1978) (denying

” The FCC maintains, however, that when it has prescribed
or specifically approved a tariff, its judgment must control. See
United States v. AT&T, 461 F. Supp. at 1327 n.39; ef. Jeffrey v.
Southwestern Bell Tel. Co., 518 F.2d 1129 (5th Cir. 1975) (state
action immunity from antitrust laws granted where challenged
rate had been approved by municipality after thorough
hearings).

See, e.g. AT&T, Charges, Regulations, Classifications and
Practices For Voie Grade/Private Line Service (High Density -
Low Density), 55 F.C.C.2d 224, 244 (1975) (Interim Decision);
58 F.C.C.2d 362, 364, 370 (1976) (Final Decision) (finding
Hi-Lo tariff “unlawful” because AT&T had not submitted suf-
ficient cost data to justify the tariff); AT&T, Revisions of Tari
FCC No. 260 Private Line Services, Series 5000 (TELPA kK),
61 F.C.C.2d 587, 651-62 (1976) (overall rate levels for AT&T's
private line telephone service unlawful because not set in ac-
cordance with fully distributed cost methodology), affd in
part, rev'd in part sub nom. Aeronautical Radw, Inc. v. FCC,
642 F.2d 1221 (D.C. Cir. 1980), cert. denied, 451 U.S. 920
(1981).

* AT&T's claim that its tariff filings with state commis-
sions are immune from antitrust liability under the Noerr-
Pennington doctrine is analyzed separately infra, at pp. 122-133.

33a
28 Nos. 80-2171 & 80-2288

immunity for price squeeze claim arising out of relation-
ship between electric utility’s filed wholesale and retail
rates); cf. Cantor v. Detroit Edison Co., 428 U.S. 579
(1976) (denying state action immunity for light-bulb-
exchange program contained in tariff approved by state
public utility commission).

C. The Impact of Regulation

Our conclusion that AT&T is not entitled to antitrust
immunity in the instant case does not mean that AT&T's
status as a regulated common carrier is irrelevant to our
evaluation of AT&T’s conduct. On the contrary, an in-
dustry’s regulated status is an important “fact of market
life,” the impact of which on pricing and other competi-
tive decisions “is too obvious to be ignored.” JTT v.
General Telephone and Electronics Corp., 518 F.2d 913,
935-36 (9th Cir. 1975) (footnote omitted). For this reason,
the Supremie Court has repeatedly recognized that con-
sideration of federal and state regulation may be proper
even after the issue of antitrust immunity has been re-
solved. United States v. Marine Bancorporation, 418 U.S.
602, 627 (1975) (application of antitrust doctrine to bank
mergers “must take into account the unique federal and
state restraints on [defendant's conduct]. Failure to do so
would produce misconceptions that go to the heart of the
doctrine itself.”); see Silver v. New York Stock Exchange,
373 U.S. 341, 360-61 (1963) (although applicable stat-
utory scheme not sufficiently pervasive to create anti-
trust immunity, particular acts of self regulation—even if
in restraint of trade—may be justified with reference to
that scheme); Otter Tail, 410 U.S. at 381 (court, in fashion-
ing antitrust remedy, “should [not] be impervious to
[regulated utility’s] assertion that compulsory intercon-
nection or wheeling will erode its integrated system and
threaten its capacity to serve adequately the public”).

Similarly, several recent decisions of the courts of ap-
peals involving regulated industries have emphasized the
“continuing significance of regulation” in evaluating al-
leged antitrust violations. Mid-Teras Communications
Systems v. AT&T, 615 F.2d 1372, 1385 (5th Cir. 1980),

34a
Nos. 80-2171 & 80-2288 29

cert. denied, 449 U.S. 912 (1980) (antitrust laws “are not
so inflexible as to deny consideration of government regu-
lation.”); Almeda Mall, Inc. v. Houston Lighting & Power
Co., 615 F.2d 343, 354 (5th Cir.), cert. denied, 449 U.S.
870 (1980) (“Monopolization cases involving .. . regu-
lated industries are special in nature and require close
scrutiny.”); Jacobi v. Bache & Co., 520 F.2d 1231, 1237-39
(2d Cir. 1975), cert. denied, 423 U.S. 1053 (1976) (reject-
ing application of per se liability rule in light of regula-
tion of stock exchange); TT, 518 F.2d at 935-36 (impact
of regulations must be assessed as fact of market life). As
Professors Areeda and Turner have stated:

[A]ntitrust courts can and do consider the particular
circumstances of an industry and therefore adjust
their usual rules to the existence, extent, and nature
of regulation. Just as the administrative agency
must consider the competitive premises of the anti-
trust laws, the antitrust court must consider the
peculiarities of an industry as recognized in a regu-
latory statute.

1 P. Areeda & D. Turner, Antitrust Law 223d (1978).

Whether in a regulated context or not, the broad out-
line of the offense of monopolization is well understood.
Most recently, the Supreme Court has stated:

The offense of monopoly under § 2 of the Sherman
Act has two elements: (1) the possession of monopoly
power in the relevant market and (2) the willful
acquisition or maintenance of that power as distin-
guished from growth or development as a conse-
quence of a superior product, business acumen, or
historic accident.

United States v. Grinnell, 384 U.S. 563, 570-71 (1966); see
Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d 263,
274-76 (2d Cir. 1979), cert. denied, 444 U.S. 1093 (1980).
Cases dealing with non-regulated industries have de-
veloped a number of analytic tools designed to aid courts
in identifying each of these elements. In many instances,
however, these tools are of only limited value in resolving
monopolization charges against regulated monopolies.

30 Nos. 80-2171 & 80-2288

See Watson & Brunner, Monopolization by Regulated
“Monopolies”: The Search for Substantive Standards, 22
Antitrust Bull. 559, 563 (1977). In particular, the
presence of a substantial degree of regulation, although
not sufficient to confer antitrust immunity, may affect
both the shape of “monopoly power” and the precise
dimensions of the “willful acquisition or maintenance” of
that power. Jd.

According to the Supreme Court, monopoly power
may be defined as “the power to control prices or exclude
competition” in a relevant market. United States v. E. I.
duPont de Nemours & Co., 361 U.S. 377, 391 (1956). In
many cases involving unregulated industries, however,
courts have eschewed examination of the ostensible
monopolist’s actual degree of control over prices or com-
petition, and have relied solely on statistical data con-
cerning the accused firm’s share of the market. Where
that data reveals a market share of more than seventy to
eighty percent, the courts have inferred the existence of
monopoly power. See, e.g., United States v. Grinnell, 384
U.S. at 571, American Tobacco Co. v. United States, 328
U.S. 781, 797 (1946); Standard Oil Co. v. United States,
221 US. 1, 33 (1911).

Such a heavy reliance on market share statistics is
likely to be an inaccurate or misleading indicator of
“monopoly power” in a regulated setting. In many regu-
lated industries, each purveyor of service, regardless of
absolute size, is in a monopoly position with regard to its
customers. Indeed, while a regulated firm's dominant
share of the market typically explains why it is subject to
regulation, the firm’s statistical dominance may also be
the result of regulation. See United States v. Marine
Bancor poration, 418 U.S. at 633. For these reasons, the
size of a regulated company’s market share should con-
stitute, at most, a point of departure in assessing the
existence of monopoly power. Ultimately, that analysis
must focus directly on the ability of the regulated com-
pany to control prices or exclude competition—an assess-

36a
Nos. 80-2171 & 80-2288 31

ment which, in turn, requires close scrutiny of the regu-
latory scheme in question.”

In the instant case, the district court properly instructed
the jury that, in determining whether AT&T possessed
monopoly power in the relevant market,

you may consider the effect of the FCC's exercise of
regulatory authority over prices and entry, includ-
ing interconnection. Similarly, you may consider the
effect of the exercise by state regulatory agencies of
regulatory authority over prices and entry in connec-
tion with the provision of local services and facilities.
That AT&T may have had the largest share or the
entire share of the telephone business in certain
areas would not be sufficient to establish that AT&T
possessed monopoly power if in fact regulation by
regulatory agencies prevented AT&T from having
the power to restrict entry or control prices.

App. 215.

Although the district court’s instructions in this area
might have been more helpful if they had described, in
more detail, the specific regulatory scheme to which
AT&T was subject, see Mid-Teras, 615 F.2d at 1386-87,
we believe the instructions, taken as a whole, adequately
apprised the jury of its duty “to take into account the
unique federal and state regulatory restraints” to which
AT&T was subject. /d. at 1387. We, therefore, reject

% See, eg., Travelers Insurance Co. v. Blue Cross, 361 F.
Supp. 774, 780 (W.D. Pa. 1972), affd, 481 F.2d 80 (3d Cir.),
cert. denied, 414 US. 1093 (1973) (company was not a monopoly
since it lacked control over rate-making mechanism), Nankin
Hospital v. Michigan Hospital Service, 361 F. Supp. 1199,
1209-10 & n.33 (B.D. Mich. 1973) (company did not
monopoly power since rates were controlled and actively
reviewed by state insurance commission). Cf /nternatwnal
Railways of Central America v. United Brands Co., 532 F.2d
231, 240 (2d Cir.), cert. denied, 429 U.S. 835 (1976) (consent
decree which fixed freight rates removed ability of banana
grower to coerce lower freight rates from rai!road and thus
negated finding of monopoly power).

37a
32 Nos. 80-2171 & 80-2288

AT&T's contention that the trial court’s instructions on
this issue left the jury without any meaningful way to
assess the impact of regulation on the existence or non-
existence of AT&T’s monopoly power (and constituted
reversible error).

AT&T's status as a regulated public utility also bears
on the second element of a monopolization offense: the
willful acquisition or maintenance of monopoly power.
The precise dimensions of the “willfulness” standard have
been the subject of considerable litigation and varying
formulations even in cases involving unregulated indus-
tries. Some courts, building upon Judge Learned Hand’s
noted opinion in United States v. Aluminum Co. of
America, 148 F.2d 416 (2d Cir. 1945), have concluded
that monopolistic conduct can be presumed from the
possession of monopoly power unless the accused firm
affirmatively demonstrates that its monopoly position has
been “thrust upon it.” /d. at 432; see American Tobacco
Co. v. United States, 328 U.S. at 813-14. Under this
analysis, if the ordinary business conduct of a dominant
firm leads to the acquisition or maintenance of monopoly
power, that conduct is presumed to reflect the requisite
willful monopolistic intent. Whatever merit this pre-
sumption may have in other contexts,"4 we believe it is a

“ Although many cases make reference to Alcoa's innovative
presumption, in the more than three decades since that case
was decided, courts have consistently found monopolization
only in circumstances where predatory or exclusionary conduct
was proven. Watson & Brunner, supra, at 590 n.83; see Hanover
Shoe, Ine. v. United Shoe Machine Corp., 392 U.S. 481, 485-86
(1968); United States v. L'nited Shoe Machine Corp., 110 F.
Supp. 295, 343-44 (D. Mass. 1953), affd per curiam, 347 US.
521 (1954). In most successfully prosecuted section 2 monopoli-
zation cases, predatory or exclusionary practices held to consti-
tute a violation of section | of the Sherman Act have also been

resent. See, ¢.g., United States » Grinnell, 384 US. 563 (1966):

‘nited States » Griffith, 334 US. 100, 106-07 (1948), Amerwean
Tobacco Co. United States, 328 US. 781 (1946), United States
1. Reading Co, 258 U.S. 26 (1920), ef Berkey Photo Inc». East
man Kodak Co. 608 F.2d 263, 278-76 (2d Cir. 1979), cert

(Footnote continued on following page)

38a

Nos, 80-2171 & 80-2288 33

particularly inappropriate means of identifying monopo-
listic conduct by a regulated utility or common carrier.
For these industries, anticipating and meeting all rea-
sonable demands for service is often an explicit statu-
tory obligation. See, e.g., 47 U.S.C. § 201(a) (1976) (“It
shall be the duty of every common carrier. . . to furnish
such communication service upon reasonable request
therefor.”). To apply the Alcoa presumption to such con-
duct would be tantamount to holding that adherence to a
firm's regulatory obligation could, by itself, constitute
improper willfulness in a section 2 monopolization case.

This circuit has already declined to endorse such an
anomalous result. In City of Mishawaka v. American
Electric Power Co., 616 F.2d 976, 985 (7th Cir. 1980), cert.
denied, 449 U.S. 1096 (1981), we specifically held that
“{iJn the particular circumstances of a regulated utility

. , entitled to recover its cost of services and provide its
investors with a reasonable rate of return, we believe that
something more than general intent should be required
to establish a Sherman Act violation.” See also Watson &
Brunner, supra, at 574-79 (willfulness by a regulated
monopoly should be demonstrable only by evidence of
predatory conduct or other exclusionary acts contrary to
public policy). We reaffirm our holding in Mishawaka
and, therefore, reject MCI's contention on cross-appeal
that the trial court erred in requiring MCI to prove that
each allegedly anticompetitive act or practice attributed
to AT&T was done with the intent to maintain a monopoly
in the relevant market.”

4“ continued

denied, 444 US. 1098 (1980) (integrated monopolist’'s failure to
predisclose innovations and its ability to sell monopolized and
competitive products as a system are not unlawful uses of
monopoly power, but legitimate advantages of size and integra-
twn), Teles Corp. + 1AM 510 F 2d 894, 927-28 (10th Cir ), cert
dismissed, 424 US 802 (1975) (reversing finding of section 2
lability in the absence of predatory conduct)

* We reject MC I's suggestion that our holding in Mushawaka
is limited to the unique situation of an alleged price squeeze by
an electric utility subject to both federal and state rate regula
tion

394
34 Nos. 80-2171 & 80-2288

The impact of regulation was also an important ele-
ment of AT&T's defense in the instant case. Particularly
with regard to the interconnection controversy, AT&T
argued that its dealings with MCI were reasonable and
that they represented a good faith attempt to comply with
AT&T's regulatory obligations under section 201 of the
Communications Act. AT&T claims that the trial court's
instructions improperly prevented the jury from con-
sidering this defense, in that the instructions were fatally
“silent concerning the overall structure of the Communi-
cations Act, the public interest standards under which
the provisions of that Act are administered by the FCC
and to which common carriers are required to conform
their conduct, and the requirements set forth in the Act
relating to the particular interconnection and pricing
controversies presented to the jury for resolution.” Ap-
pellant’s Br. at 138.

MCI, by contrast, argues in its cross-appeal that the
district court gave too much credence to AT&T's regu-
latory defense. In particular, MCI claims that the district
court improperly held it to an “over-rigorous burden of
proof” by instructing the jury that, if AT&T believed in
good faith that interconnection with MCI would have
violated established regulatory policies, then AT&T's
refusal to interconnect could not be considered anticom-
petitive conduct. We reject both parties’ contentions. The
district court in this case properly allowed AT&T to
assert a defense based on good faith adherence to its
regulatory obligations. See Mid-Teras, 615 F.2d at 1388-
90. The district court also properly articulated this de-
fense in its instructions to the jury. Thus the district
court instructed the jury that

MCI must prove more, however, than the fact that
AT&T refused to provide the interconnections. As
you know, AT&T contends that it refused to provide
the connections because it believed that it had not
been ordered to do so, that MCI was not authorized
to provide the service, and that it would have vio-
lated established regulatory policies for MCI to re-
ceive the connections. If AT&T refused the inter-

40a
Nos. 80-2171 & 80-2288 35

connections because of such reasons, believing in
good faith that they justified the refusal, then the
refusal to provide the interconnections was not anti-
competitive conduct and cannot be considered con-
duct engaged in for the purpose of maintaining a
monopoly.

MCI has the burden of proving that in refusing the
FX and CCSA interconnections AT&T acted with
anti-competitive intent, for the purpose of maintain-
ing a monopoly, rather than for what it in good faith
regarded as legitimate reasons.

App. 217-18.

Similarly, with respect to the charge that AT&T un-
lawfully pre-announced its Hi-Lo tariff, the jury was told
to consider AT&T’s contention that the time interval
involved was reasonable and required by applicable
regulations. In addition, the district court instructed the
jury that:

With respect to those facilities and interconnections
which AT&T did not provide, its position is that its
failure to do so was based upon a good faith belief
that it would have violated established regulatory
policies and therefore that it acted reasonably in all
the circumstances.”

App. 216.

We believe these instructions adequately conveyed to
the jury the substance of AT&T's regulatory defense and,

% Moreover, the trial court assured the jury that

the Sherman Act allows a regulated firm with monopoly
power to compete vigorously whenever it may be faced
with competition. So long as the defendant's competitive
responses to plaintiffs were based on legitimate business
decisions and on the merits of defendant's services, defen-
dant cannot be found to have unlawfully maintained a
monopoly. This is so even if plaintiffs were hurt by the
competition and defendant sought to retain as much of its
business as possible.

App. 214.

4la
36 Nos. 80-2171 & 80-2288

thus, allowed the jury to “consider the effect of regula-
tion in ascertaining whether Bell misused its monopoly
power.” Mid-Teras, 615 F.2d at 1389. We reject AT&T’s
contention that the trial court’s failure to provide a more
detailed exposition of the standards contained in the
Communications Act constituts reversible error. We also
reject MCI’s counter-argument that the district court’s
instructions in this area improperly placed upon MCI the
burden of disproving AT&T’s subjective good faith. See
California Computer Products, Inc. v. IBM Corp., 613
F.2d 727, 736 (9th Cir. 1979) (holding that a verdict must
be directed in favor of defendant when plaintiff's evi-
dence is insufficient to establish that defendant acted
unreasonably). In the particular context of an industry
subject to extensive and rapidly changing regulatory
demands, we believe that an antitrust defendant is en-
titled both to raise and to have the jury consider its good
faith adherence to regulatory obligations as a legitimate
antitrust defense. See Mid-Teras, 615 F.2d at 1389-90;
City of Mishawaka, 616 F.2d at 985.

Finally, we believe the fact of FCC regulation is rele-
vant to our analysis of antitrust principles in another,
more subtle way. AT&T, as the dominant firm in a regu-
lated industry recently opened in part to competition, is
subject to dual, and sometimes conflicting, principles of
regulatory and antitrust law. As already indicated, we
believe the trial court properly reconciled these bodies of
law by allowing AT&T to present evidence as to its good
faith belief in its compliance with regulatory require-
ments. In addition, the fact of FCC regulation to some
extent affects our view of the appropriate purposes and
proper scope of antitrust law in the present context—
specifically, whether we should focus our examination on
economic efficiency and consumer benefit or whether we
should more expansively consider the political and social
consequences of bigness or concentration of economic
power. Compare R. Bork, The Antitrust Paradoz (1978)
and R. Posner, Antitrust Law (1976) with L. Sullivan,
Handbook of the Law of Antitrust § 2 (1977) and Pitofsky,
The Political Content of Antitrust, 127 U. Pa. L. Rev. 1051

42a
Nos. 80-2171 & 80-2288 37

(1979) and Schwartz, “Justice” and Other Non-Economic
Goals of Antitrust, 127 U. Pa. L. Rev. 1076 (1979).

Certain factors may tend to distinguish this from ordi-
nary monopolization cases. AT&T is a public utility sub-
ject to public regulation, occupying a unique place in the
American industrial scene. To the extent that it may
have enjoyed economies of scale and significant techno-
logical resources, the political and regulatory judgment,
until recently, has been to tolerate the political and social
consequences of its size in the ostensible interest of reli-
able, effective and economic telecommunications service.
Now this regulatory judgment has been drastically modi-
fied, and competiton—with all its economic, political and
social consequences—is transforming the telecommuni-
cations industry.

Certainly this transformation, carried out at the behest
of regulatory authorities, is meeting the broadest objec-
tives of the antitrust laws at least as effectively as they
might be pursued by this court in this case. The FCC has
exercised its powers under the Communications Act and
has instituted sweeping pro-competitive changes in the
telecommunications industry to accommodate the broad
demands of national communications policy. We also note
the role of the Justice Department, AT&T itself, and the
federal district court in the consent decree entered re-
cently between AT&T and the government in the District
Court for the District of Columbia. See United States v.
AT&T, 43 Antitrust & Trade Reg. Rep. (BNA) No. 1077
(Spec. Supp. Aug. 12, 1982). The massive restructuring of
AT&T accomplished in that decree is an additional ave-
nue through which the issues of the concentration of
economic power in the Bell System, as well as its political
power, are being addressed.

We acknowledge with approval the populist origins of
the antitrust laws as well as the preeminent role of the
Sherman Act as a charter of economic freedom.” But we

"See Northern Pacific Ry. Co. v. United States 9356 U.S. 1,4
(1958).

43a
38 Nos. 80-2171 & 80-2288

also believe that, as we have pointed out, larger concerns
about broad pro-competitive policy, economic concentra-
tion and political power have been, and are being at this
very moment, effectively addressed by the regulators,
and possibly by the Congress. Hence, we have tended
to believe it appropriate to focus at this time and in
this case upon the specific issues of economic efficien-
cy and consumer benefit which are directly presented.
Thus, our resolution of the allegations of predatory
pricing and unlawful failure to interconnect MCI to
Bell’s local distribution facilities has centered on the
questions whether prices cover costs and whether the
denied facilities are essential. We are, of course, not in-
sensitive to broader social and political issues, but as in-
dicated, we think that our principal task is to deal in
depth with the specific questions presented.

Ill. PREDATORY PRICING

At trial MCI alleged that AT&T had engaged in preda-
tory pricing of both its Telpak and Hi-Lo services for
long distance business communications. The jury found
that Telpak was lawfully priced, but that Hi-Lo was
priced below its fully distributed costs and was preda-
tory. We disapprove this finding with 4 pe to Hi-Lo
because of erroneous instructions, the use of an improper
cost standard and insufficiency of the evidence. We also
disapprove the jury’s finding that AT&T unlawfully pre-
announced its Hi-Lo tariff. Further, we reject MCI’s
cross-appeal on Telpak’s marketing plan and sustain the
jury’s finding that Telpak was lawfully priced and
marketed.

A. Jury Instructions

One of the crucial issues presented at trial concerned
the proper standard for determining predatory pricing.
Both parties presented expert testimony on this issue.
AT&T argued that unless its prices for a particular
service failed to cover that service's long-run incremental
costs the price could not be found predatory. MCI con-

44a
Nos. 80-2171 & 80-2288 39

tended that proof of price below fully distributed cost
was sufficient to establish predation.

At trial Judge Grady refused to instruct the jury as to
which cost measure was the correct legal standard to
determine predatory pricing. Instead, he left the choice
of a cost-based standard for predation —in this case fully
distributed costs (“FDC”) or long-run incremental costs
(“LRIC”)—for the jury to decide as a question of fact.
Judge Grady instructed the jury:

{[Y]Jou’re going to have to decide whether it should
be fully distributed costs on the one hand, or incre-
mental costs on the other hand; and in doing that
you'll have to look at all the evidence and decide
which is the cost that truly reflects the actual cost
of producing the service.

The test for determining whether Hi-Lo was pred-
atory is the same as for Telpak. Again, it is a ques-
tion of whether the price covered what you con-
sider the applicable cost. If it did, you may not
infer predatory intent. If it did not, you may infer
predatory intent.

Tr. 11486-87.* As a result, the special verdict required

the jury to check which cost standard it felt was appro-
riate and then decide whether AT&T's prices were
low that measure of cost: either LRIC or FDC.

This we hold to be error. The choice of a cost-based
standard for evaluating claims of predatory pricing is a
question of law to be decided by the trial judge. Thus,
while several courts have stated that the appropriate
cost-based standard for predation may differ depending

“ In the course of instructing the jury, Judge Grady noted
that the term “average costs” had also been referred to at
trial as “fully distributed costs” or “embedded costs,” and the
term “marginal costs” had also been used neers
with “incremental” or “long-run incremental costs.” Tr. 11485.
This arguably imprecise terminology, see infra, was repeated
in the special verdict. App 230-33.

45a
40 Nos. 80-2171 & 80-2288

on the facts of the case, see, e.g., Chillicothe Sand &
Gravel Co. v. Martin Marietta Corp., 615 F.2d 427 (7th
Cir. 1980), both courts and commentators are united in
regarding the selection of that standard as a question of
law. Indeed, the entire judicial and academic struggle
to enunciate an appropriate definition of predatory pric-
ing reflects the legal rather than factual nature of the
question. Since a finding of below-cost pricing permits
the jury to infer, or even presume, anticompetitive
intent, it is imperative thet the judge instruct the jury
on the relevant cost standard to compare with defend-
met prices. See 2 P. Areeda & D. Turner, supra, at
315.

MCI relies on Greenville Publishing Co. v. Daily Re-
flector, Inc., 496 F.2d 391 (4th Cir. 1974), to support the
proposition that the jury may select the appropriate cost
standard to evaluate a predatory pricing claim. MCI’s
reliance here reflects an overly broad interpretation of
that case. In Greenville Publishing the Fourth Circuit
reversed a grant of summary judgment for the defend-
ant in a case charging monopolization and attempted
monopolization. On the issue of predatory pricing the
court took note of affidavits by the defendant purport-
ing to show that the operation of the advertising guide
in question was profitable and that prices covered aver-
age variable costs. Plaintiffs challenged both the actual
calculation of these costs and the failure of the defend-
ant to include in its cost calculations “any portion of the
—" fixed expenses or personnel costs.” /d. at 397

n.10.

The court in Greenville Publishing reversed the grant
of summary judgment in favor of the defendant stating
“(t]he sum of this evidence presents an issue of disputed
fact.” /d. at 398. It is misleading, however, in the con-
text of the instant case, to place much reliance on this
sentence. The court in Greenville Publishing was not
concerned with which entity—judge or jury—is em-
powered to select the proper cost-based standard for
determining predation. Rather, the Greenville Publish-
ing court was addressing the much more general issue
of the propriety of summary judgment in a complex

46a
Nos. 80-2171 & 80-2288 41

antitrust case. At the summary judgment stage, the
plaintiffs in Greenville Publishing had presented no evi-
dence on the issue of anticompetitive intent other than
the pricing policies of the defendant. Hence, the propri-
ety of summary judgment on plaintiffs’ monopolization
and attempted monopolization claims turned entirely on
whether any inferences of intent could be drawn from
the relationship between the defendant’s prices and
costs. The Fourth Circuit's refusal to uphold the grant
of summary judgment in Greenville Publishing merely
represents the traditional view that summary judgment
is generally inappropriate in complex antitrust cases
where intent may be difficult to discern. /d. at 398 (cit-
ing Poller v. Columbia Broadcasting System, 368 U.S.
464 (1962)).

There is no support in the cases for the proposition
that a jury may simply choose the cost-based standard it
feels is most appropriate. Indeed, the only other pur-
portedly apposite case cited by MCI in its brief, the dis-
trict court’s opinion in Northeastern Telephone Co. v.
AT&T, 497 F. Supp. 230 (D.Conn. 1980), has been re-
versed on this very point, with the Second Circuit stating
that the cost standard used to determine whether a
monopolist’s prices were predatory was a legal question.
651 F.2d 76, 87 (2d Cir. 1981), cert. denied, 102 S.Ct.
1438 (1982), rev'g in part 497 F. Supp. 230, 240-41
(D. Conn. 1980). Judge Grady himself acknowledged
that it is inappropriate for the jury to consider all possi-
ble economic theories of predation in ruling that MCI’s
originally proffered profit-maximizing theory was in-
adequate as a matter of law.

B. Below Cost Pricing

Liability for predatory pricing represents an excep-
tion to the general antitrust regime which contemplates
that no limits on price competition shall be imposed.
Predatory pricing is prohibited because of the fear that
a monopoly or dominant firm will deliberately sacrifice
present revenues for the purpose of driving rivals from
the market and then recoup its losses through higher
profits earned in the absence of competition. See North-

47a
42 Nos. 80-2171 & 80-2288

eastern Telephone Co. v. AT&T, 651 F.2d 76, 86 (2d Cir.
1981), cert. denied, 102 S.Ct. 1438 (1982); Areeda &
Turner, Predatory Pricing and Related Practices Under
Section 2 of the Sherman Act, 88 Harv. L. Rev. 697, 698
(1975) [hereinafter cited as Areeda & Turner, Predatory
Pricing].

There is at present, in cases such as the one before us,
no reliable way to determine whether predatory pricing
has occurred without some comparison between the
prices charged and a properly defined measure of the
cost of production. A subjective test based wholly upon
intent is almost incapable of distinguishing between
pro- and anticompetitive price cuts by a monopolist.
Areeda, Predatory Pricing (1980), 49 Antitrust L. J.
897, 899 (1980); R. Posner, supra, at 188. Nor is a sub-
jective test capable of identifying whi . pricing strate-
gies represent rational business decisions and which
have no legitimate business purpose and are designed
only to injure competition.

In addition, a test based wholly on intent is unwork-
able.” Even if it were possible to identify those persons
within a firm whose intentions are relevant, the mean-
ing of the evidence will usually be obscure. After all,
competition consists of winning business from rivals.
The intent to preserve or expand one’s market share is
presumptively lawful. To encourage judges and juries to
rely overly on nonprobative data allegedly bearing on a
firm's “state of mind” invites the twin mischiefs of (1)
burdening litigation with thousands of documents about
the firm's motives and calculations; and (2) encouraging
inconsistent and quixotic results. Areeda, Predatory
Pricing (1980), 49 Antitrust L. J. 897, 899 (1980); see R.
Posner, supra, at 189-90.”

*” We do not mean to imply that direct probative evidence of
a defendant's intent is inadmissible. See infra, note 58.

“” Early antitrust cases could define predatory pricing only
in vague verbal formulations relating to predatory intent and
ruinous competition. See Moore v. Mead’s Fine Bread Co., 348
U.S. 115, 118 (1954); Forster Mfg. Co. v. FTC, 335 F.2d 47,
52-53 (Ist Cir. 1964), cert. denied, 380 U.S. 906 (1965); Porto

(Footnote continued on follewing page)

48a
Nos. 80-2171 & 80-2288 43

In the absence of an objective standard, firms making
ahage decisions in the presence of competition would
unable to ascertain what price reductions rnay be
legally undertaken. Because the antitrust laws are de-
signed to encourage vigorous competition, as well as to
promote economic efficiency and maximize consumer
welfare, such uncertainty seriously undermines the goals
of antitrust enforcement. As one commentator has re-
cently emphasized:

It is imperative that courts timely establish objec-
tive and understandable pricing standards which
bring into sharp focus the line which separates
commendable price reductions from predatory pric-
ing practices. Such standards are necessary for the
guidance of businessmen . . . . Businessmen should
not be put into the position where they must either
forego competitive price decreases or risk treble
damages in Sherman Act suits.

Sherer, Predatory Pricing: An Evaluation of its Poten-
tial for Abuse Under Government Procurement Contracts,
6 J. Corp. L. 531, 539 (1981).

Within the past decade, both economists and lawyers
have recognized the need for an objective standard to
evaluate predatory pricing claims.*' Advocates of an
objective test agree that price cuts by a dominant firm
or monopolist are nothing more than lawful competition

© continued

Rico Am. Tobacco Co. ». American Tobacco Co., 30 F.2d 234,
236 (2d Cir.), cert. denied, 279 U.S. 858 (1929). Such -
definitions resulted in erratic application of the law as we
lengthy and complex inferences of intent, which were of litele
predictive or precedential value, See Brodley & Hay, Preda-
tory Pricing: Com mpeting Economic Theories and the Evalua-
tion of Legal Standards, 66 Cornell L. Rev. 738, 765-67 (1981)
{hereinafter cited as Brodley & Hay, Predatory Pricing}
Areeda & Turner, Predatory Pricing at 699.

‘| See, “a5 3 P. Areeda & D. Turner, supra, at 1711-15
1978); R. Posner, supra, at 189; Areeda & Turner, oe ay 4
icing at 709-13; Joskow & Klevorick, A Framework

Analyzing Predatory Pricing Policy, 89 Yale L. J. 213 (1 9).

49a
44 Nos. 80-2171 & 80-2288

on the merits if prices remain above costs. Since such
price cuts benefit consumers by providing greater out-
put of desired goods at lower prices, they are pro-com-
petitive and cannot result in the elimination of equally
efficient competitors.

Similarly, the courts have nearly unanimously adopted
some form of a cost-based standard in deciding ques-
tions of predation. afi Northeastern Telephone Co. v.
AT&T, 651 F.2d 76 (2d Cir. 1981), cert. denied, 102 S.Ct.
1438 (1982); Chillicothe Sand & Gravel Co. v. Martin
Marietta Corp., 615 F.2d 427, 430-32 (7th Cir. 1980);
California Computer Products, Inc. v. IBM Corp., 613
F.2d 727, 742-43 (9th Cir. 1979); Janich Bros. v. Ameri-
can Distilling Co., 570 F.2d 848, 857 (9th Cir. 1977),
cert, denied, 439 U.S. 829 (1978); Pacific Engineering &
Production Co. v. Kerr-MceGee Corp., 551 F.2d 790, 797
(10th Cir.), cert. denied, 434 U.S. 879 (1977); National
Association of Regulatory Utility Commissioners v. FCC,
525 F.2d 630, 637-38 & n.34 (D.C. Cir.), cert. denied, 425
U.S. 992 (1976).

MCI nonetheless argues in its cross-appeal that the
district court erred in requiring it to prove that AT&T
priced its Hi-Lo service below any measure of cost. MCI
contends that, if AT&T knowingly sacrificed revenue
(i.e, failed to maximize its profits) with the intent to
injure competition, this court should hold that behavior
to constitute unlawful predatory pricing. In support of
this “profit maximization” theory, MCI cites a trio of
cases. Hanson v. Shell Oil Co., 541 F.2d 1352, 1358 n.5
(9th Cir. 1976), cert. denied, 429 U.S. 1074 (1977); Jnter-
national Air Industries, Inc. v. American Excelsior Co.,
517 F.2d 714, 724 (5th Cir. 1975), cert. denied, 424 U.S.
943 (1976); JLC Peripherals Leasing Corp. v. IBM Corp.,
458 F. Supp. 423, 432 (N.D. Cal. 1978), affd per curiam
sub nom. Memorex Corp. v. IBM Corp., 636 F.2d 1188
(9th Cir. 1980), cert. denied, 452 U.S. 972 (1981).

Each of these cases contains language to the effect
that a price may be predatory if it is below the short-
run profit-maximizing price and barriers to new entry
are great. Assuming, arguendo, that these statements
are more than mere dicta, we must reject such a “profit

SOa

Nos, 80-2171 & 80-2288 45

maximization” theory as incompatible with the basic
principles of antitrust. The ultimate danger of monopoly
power is that prices will be too high, not too low. A rule
of predation based on the failure to maximize profits
would rob consumers of the benefits of any price reduc-
tions by dominant firms facing new competition. Such
a rule would tend to freeze the prices of dominant firms
at their monopoly levels and would prevent many pro-
competitive price cuts beneficial to consumers and
other purchasers. In addition a “profit maximization”
rule would require extensive knowledge of demand
characteristics—thus adding to its complexity and un-
certainty. Another, and related, effect of adopting the
“profit maximization” theory advocated by MCI would
be to thrust the courts into the unseemly role of moni-
toring industrial prices to detect, on a long term basis,
an elusive absence of “profit maximization.” Such super-
vision is incompatible with the functioning of private
markets. It is in the interests of competition to permit
dominant firms to engage in vigorous competition, in-
cluding price competition. See Berkey Photo, Inc. v.
Eastman Kodak Co., 603 F.2d 263, 273 (2d Cir. 1979),
cert. denied, 444 U.S. 1093 (1980). We therefore reject
MCI’s “profit maximization” theory, and reaffirm this
Circuit’s holding that liability for predatory pricing
must be based upon proof of pricing below cost. Chillt-
cothe Sand & Gravel Co. v. Martin Marietta Corp., 615
F.2d 427 (7th Cir. 1980).

C. Defining Measures of Cost

The first commentators to propose a specific cost-
based standard for predatory pricing were Professors
Areeda and Turner, who argued that pricing below a
firm's short-run marginal cost should be deemed unlaw-
ful, and that prices above that level should be deemed
lawful. Areeda & Turner, Predatory Pricing at 709-13.

*# It should also be noted that AT&T is a regulated public
utility. A dominant purpose of public utility regulation is to
deny AT&T profits attributable to its monopoly power. It
would be anomalous indeed in this context to require AT&T,
as a matter of antitrust law, to maximize its profits.

Sla

46 Nos. 80-2171 & 80-2288

See also 3 P. Areeda & D. Turner, supra, at 711-15.
In economic terms, short-run marginal cost represents
the increment to total cost that results from producing an
additional unit of output, where some inputs of produc-
tion are variable and others are fixed. 3 P. Areeda & D.
Turner, supra, at 712 at 155. Because short-run margi-
nal cost is an economic concept that cannot be derived
by conventional accounting methods, Areeda and Turner
advocate the use of “average variable cost” (“AVC”) as a
proxy in predatory pricing cases. Variable costs, as the
name implies, are costs that vary with changes in out-
put. They typically include such items as materials,
fuel, maintenance, and labor directly used to produce
the product. /d. A product’s average variable cost is the
sum of all its variable costs divided by the number of
units of output.

The Areeda-Turner rule has engendered much discus-
sion about whether short-run marginal (or, its proxy,
average variable) cost represents the proper cost stand-
ard for evaluating predatory pricing claims.** Much of
the economic literature, as well as the case law, has
examined whether average variable cost or some meas-
ure of average total cost (which includes “fixed” as well
as variable costs) represents the better cost standard for
measuring predatory pricing.

It is unfortunate that in the course of trial the case
before us was characterized as a contest between the

“3 See Scherer, Predatory Pricing and the Sherman Act: A
Comment, 89 Harv. L. Rev. 868 (1976); Areeda & Turner,
Scherer on Predatory Pricing: A Reply, 89 Harv. L. Rev. 891
(1976); Scherer, Some Last Words on Predatory Pricing, 89

arv. L. Rev. 901 (1976); Williamson, Predatory Pricing: A
Strategic and Welfare Analysis, 87 Yale L. J. 284 (1977);
Areeda & Turner, Williamson on Predatory Pricing, 87 Yale
L. J. 1337 (1978); Williamson, A Preliminary Res , 87
Yale L. J. 1353 (1978); Williamson, Williamson on Predatory
Pricing I], 88 Yale L. J. 1183 (1979); Greer, A Critique of
Areeda and Turner's Standard for Predatory Practices, 24
Antitrust Bull. 233 (1979); Koller, When is Pricing Preda-
et Ne aaa Bull. 283 (1979). See also R. Posner, supra,
at -196.

Nos. 80-2171 & 80-2288 47

supporters and opponents of the Areeda-Turner rule. At
trial long-run incremental cost was incorrectly equated
with average variable cost while fully distributed cost
was incorrectly equated with average total cost. In fact,
the validity of the Areeda-Turner rule, based on short-
run marginal costs, is not at issue in this case because
neither party ever argued for a short-run cost standard.
Rather, AT&T introduced evidence, unrefuted by MCI,
showing that its prices for both Telpak and Hi-Lo were
above those services’ long-run incremental costs.

There are important economic differences between
long-run incremental cost and short-run marginal cost.
First, incremental costs (LRIC) represent the average
cost of adding an entire new service or product rather
than merely the last unit of production. Professor Al-
fred Kahn has highlighted this distinction by stating:

bed orice cost, strictly speaking, refers to the
additional cost of supplying a single, infinitesimally
small additional unit, while “incremental”. . . re-
fer({s] to the average additional cost of a finite and
possibly a large change in production or sales.

1 A. Kahn, The Economics of Regulation 66 (1970)
(emphasis in original).

Second, and more important, long-run incremental
cost differs from average variable cost in that it is a
long-run rather than a short-run cost measure. Because
variable costs, by definition, are associated with the
limited time period in which a firm cannot replace or
increase its plant or equipment, the cost of plant and
equipment is regarded as fixed and is not included in
the calculation of a product's short-run marginal, or
average variable, cost. Long-run incremental cost, by
contrast, measures all the costs of adding a new product
or service—“fixed” as well as variable costs (and “capi-
tal” as well as “operating” items). Essentially, the

“ Professor William Baumol! has defined long-run incre-

mental costs of product X as “total — cost minus what

the total cost of the company would be in the absence of pro-
(Footnote continued on following page)

S3a
48 Nos. 80-2171 & 80-2288

LRIC approach assumes that all costs become variable
in the long run. Hence, a number of the criticisms that
have been leveled against the choice of a short-run mar-
ginal cost standard are not applicable to the use of long-
run incremental cost. The use of long-run cost analysis
may be particularly appropriate to capital-intensive
processes where growth of plant and equipment is
marked.

In addition to incorrectly equating long-run incremen-
tal cost with short-run marginal (or average variable)
cost, the district court (without adequate guidance from
the parties) incorrectly equated fully distributed cost
(“FDC”) with average tota tal cost. Both these notions are
= because LRIC and FDC can be viewed as

different ways of defining the average total cost
("A are) of a particular product or service for a firm that
produces multiple products or services.”

For a single product firm, average total cost can be
easily defined as the sum of all costs, both fixed and
variable, divided by the total units of output produced
by the firm. Such simple concepts of average total cost,
however, lose their meaning when one considers a multi-
service firm such as AT&T. Joint and non-joint common
costs shared among products of the same firm render it
impossible to calculate ATC simply by adding up costs
and dividing by the number of units of output. This is
possible only in a firm which produces a single product.
One cannot proceed in this fashion for multiproduct

“continued

duction of X, all divided by the quantity of X being pro-

5 om Baumol, Quasi-Permanence of Price Reductions: A
a cy for, Prevention of Predatory Pricing, 89 Yale L. J. 1, 9

n.

** “Average total cost” as we use it here refers to average
total economic cost, as the term is employed by economists in
predatory erie ng analysis, See steerer rodley & Hay, Pred-
atory Prieci e term “average total costs” is also some-
times wed ¢ in utility ratemaking to refer to the revenue
required to meet al] the accounting costs of an entire utility
enterprise. See infra, note 51.

54a
Nos. 80-2171 & 80-2288 49

firms because the total number of units produced in-
clude many different products each with different costs
and different price and sales data. It is therefore neces-
sary, in the multiproduct context, to determine what
costs are «7used by which products and services, and
this requ some sort of differential (e.g., incremental)
methodolo,,y.

In an antitrust context, fully distributed cost is not an
economically relevant definition of average total cost
and must be rejected as determinative.” First, FDC is a
quite arbitrary allocation of costs among different classes
of service. There are countless FDC methods, each allo-
cating costs by a different mathematical formula.” De-

“No objection has been made in the instant case to the
introduction of fully distributed cost evidence. Thus, nothin
in this opinion should be construed as reflecting on the
missibility of fully distributed cost evidence. Under some cir-
cumstances—for example, the operation of a single product
enterprise in a stable economy —average balance sheet costs
may provide an acceptable proxy for LRIC. See R. Posner,
supra, at 190. The use of C, as a proxy, in various con-
texts, is always open to examination.

Thus, various FDC methods will normally produce quite
different calculations of the cost of a product or service. In
one electric utility rate case one witness testified to the exist-
ence of at least 29 different methods of apportioning costs
among services. J. Bonbright, Principles of Public Utility
Rates 351 (1961). The FCC itself has required AT&T to sub-
mit at least seven different FDC cost studies. In the instant
case, cost studies — these seven different FDC methods
were introduced at trial. Not surprisingly, each method yielded
a significantly different cost profile.

A simple example helps to highlight the arbitrariness of
FDC methodology. Imagine a railroad line that simultane-
ously transports three different products: gold, lead and
feathers. If the railroad attempted to calculate, on a fully dis-
tributed cost basis, the cost of shipping each of these prod-
ucts, it would reach radically different results depending on
whether it allocated joint and common costs on the basis of
the value, weight, or bulk of the respective commodities

shipped.

5Sa
50 Nos. 80-2171 & 80-2288

spite trenchant criticism on economic grounds,** FDC
continues to be widely used for reguiatory purposes, inter
alia, because of its ease of application in dividing an
authorized total revenue requirement among individual
Cg oe or services—much as a pie is divided into slices.

ut FDC cannot purport to identify those costs which
are caused by a product or service, and this is funda-
mental to economic cost determination.

FDC also fails as an economically relevant measure of
cost for antitrust purposes because it relies on historical
or embedded costs. For it is current and anticipated
cost, rather than historical cost that is relevant to busi-
ness decisions to enter markets and price products. The
business manager makes a decision to enter a new
market by comparing anticipated additional revenues
(at a particular price) with anticipated additional costs.
If the expected revenues cover all the costs caused by
the new product, then a rational business manager has
sound business reasons to enter the new market. The
historical costs associated with the plant already in
place are essentially irrelevant to this decision since
those costs are “sunk” and unavoidable and are unaf-
fected by the new production decision. This factor may
be particularly significant in industries such as telecom-
munications which depend heavily on technological in-
novation, and in which a firm’s accounting, or sunk,
costs may have little relation to current pricing deci-
sions.*9

In particular, FDC fails as a relevant measure of cost
in a competitive market. FDC is, at best, a rough indi-

“ See erally 1 A. Kahn, supra, at 150; J. Bonbright,
supra; Aeronautical Radio, Inc. v. FCC, 642 F.2d 1221, 1236-
47 (D.C. Cir. 1980) (Wilkey, J., dissenting), cert. denied, 451
U.S. 920 (1981).

* This decision path illustrates that LRIC analysis is not, as
the dissent suggests, a solely theoretical view of the question,
but is, in fact, a meaningful representation of the implicit
issues considered in the making of business decisions in the
real world.

56a
Nos. 80-2171 & 80-2288 51

cator of an appropriate rate ceiling for regulatory pur-
poses and should not be used as a measure of the
minimum price permissible in a competitive market.
The justifiable fear of monopoly, and the basis of section
2 of the Sherman Act, is that a firm enjoying monopol
power will not be constrained by market forces; it will
raise prices and decrease output in such a manner that
its own profit will be maximized but that consumers
will be subject to higher prices and a less efficient allo-
cation of resources than would be the case in a competi-
tive market. A standard making predatory pricing il-
legal and subject to treble damages must be carefully
structured to fit the needs of the Sherman Act and its
encouragement of competition on the merits. See Janich
Bros. v. American Drilling Co., 570 F.2d 848, 855 (9th
Cir. 1977), cert. denied, 439 U.S. 829 (1978). When a
price floor is set substantially above marginal or incre-
mental cost a price “umbrella” is created which allows
less efficient rivals to remain in the market sheltered
from full price competition. A fully distributed price
floor may thus misallocate resources and force con-
sumers to pay more for less production than competition
would dictate.

The economic literature that has considered the prob-
lem of predatory pricing has rejected almost entirely
the notion that fully distributed costs are a relevant
measure of ATC.” To the contrary, long-run incremen-
tal cost has been approved as an economically relevant

5% MCI has cited no economic authority beyond the testimony
of its own expert, Dr. Melody, which supports fully distrib-
uted cost as a measure of average total cost. Similarly, MCI
has cited no economic authority supporting the use of fully
distributed cost in an antitrust context. But cf. Noll & Rivlin,
Regulating Pricea in Competitive Markets, 82 Yale L. J. 1426
(1973) (use of incremental cost methods in — oe
prices may invite predatory ma, See ly ae
lic Utility Pricing

Comment, in New Dimensions in

(H. Trebing ed. 1976) (discussing the problems of —
cost information in regulatory contexts); rage fi The wi 1
nal Utility of Marginal Analysis in Public cy Formula-
tion, 8 J. Econ. Issues 287 (1974).

57a
52 Nos. 80-2171 & 80-2288

measure of average total cost for one product produced
by a multiproduct firm. Professor Baumol has stated in
reply to the sloppy use of the term “average total cost”:

By average total cost, [one] surely does not mean
fully allocated cost, which is a mare’s nest of arbi-
trary calculations parading as substantive informa-
tion . . . . Consequently, I assume that when [one]
requires the price of a good in the long-run to ex-
ceed its “average total cost,” [one] defines the latter
to mean the average incremental cost of the prod-
uct including any fixed cost outlays required by
the item.

Baumol, Quasi-Permanence of Price Reductions: A Pol-
icy for Prevention of Predatory Pricing, 89 Yale L. J. 1,
9 n.26 (1979). Professors Joskow and Klevorick agree
with this critique of fully distributed cost as a measure
of average total cost:

For a single-product firm, average total cost is
easily defined. In the more likely multiproduct con-
text, we are using “average total cost” to signify the
average incremental cost of the commodity of con-
cern and not any arbitrary “fully allocated cost
measure.”

Joskow & Klevorick, A Framework for Analyzing Pred-
atory Pricing Policy, 89 Yale L. J. 213, 252 n.79 (1979).
Since all costs are variable in the long run it is long-run
incremental costs (including return on investment) which
most closely measure anticipated average total cost. 3 P.
Areeda & D. Turner, supra, at 7712 at 156. Cf R.
Posner, supra, at 190.°!

51 Unfortunately the terms “average total cost” or “average
total costs” have been used ambiguously. As we use “average
total cost” in this ee. we mean average total economic
cost, i.¢., costs on a forward-looking basis. See generally 1 A.
Kahn, supra, at 73-74, 130-33. For a particular product or
service of a multiproduct business “average total cost” is de-
fined differentially as the average long-run incremental! cost
of the product or service in question. The term “average total
costs” has also been used in quite a different sense in a utility
(Footnote continued on following page)

58a
Nos. 80-2171 & 80-2288 53

A simplified example of some of these cost relation-
ships can be found in Judge Wilkey’s dissenting opinion
in Aeronautical Radio, Inc. v. FCC, 642 F.2d 1221, 1236
(D.C. Cir. 1980), cert. denied, 451 U.S. 920 (1981) (Wil-
key, J., dissenting).6* In Judge Wilkey’s example, a
judge accepts an invitation to participate in a law school
moot court, with the school paying for his hotel room
costing $125 per night. He later decides to bring his
wife along even though the school’s moot court represent-
ative cannot assure him that his wife’s expenses will
also be paid. Judge and Mrs. X attend the moot court,
and their hotel bill for two is $150 per night. Upon his
return, Judge X sends the moot court board his item-
ized expenses, noting that if the board has decided to
pay for his wife’s => he should be reimbursed at $150
a day; if not, he should receive $125 a day, the amount it
would have cost him had he attended the moot court
alone. The moot court board sends back a check for $75,
noting that it is unable to absorb the expenses of Mrs.
X, and explaining that, using a fully distributed cost
methodology, it has allocated one half of the couple’s
daily $150 hotel bill to Judge X and the other half to his
wife. Judge X is understandably both annoyed and con-
fused; he knows that if he had attended the moot court
alone, he would have been reimbursed at $125 a day, be-

5! continued

ratemaking setting to refer to the revenues required to meet
all the accounting, historical or embedded costs of the entire
utility enterprise. See Bonbright, supra, at 300. This latter
usage of “average total costs” is not ——— here since we
are concerned with the economic cost of a particular service of
a multiservice business. Such a cost must be one which is
caused by the particular service in seers. * Brodley and

} an

Hay, Predat Pricing at 780-86; Cudah Malko, Elec-
tric Peak- Pricing: Madison Gas and Beyond, 1976 Wis.
L. Rev. 47, 62.

%? In Aeronautical Radio, the District of Columbia Circuit
held that the FCC did not act arbitrarily and copermenty in
adopting a form of fully distributed cost methodo for pur-
poses of evaluating propessd telephone rates. Judge Wilkey
dissented, arguing that FDC was irrational, arbitrary and
capricious even as applied to regulatory ratemaking.

59a
54 Nos. 80-2171 & 80-2288

cause this is what his actual hotel charge would have
been, and because the moot court board's original invi-
tation had been extended on this basis. Judge X is also
angry because, had he known that the moot court board
was going to penalize him in this manner, he would not
have asked Mrs. X to accompany him, but would have
come by himself at the agreed all-expenses paid rate of
$125 a day. Thus, both practical considerations and eco-
nomic theory dictate that the relevant cost of Mrs. X’s
stay is $25 and that a marginal cost methodology should
be used to analyze the judge’s travel expenses and other
real world problems.™

53 Judge wd eh Base on to draw the parallel between this
example and AT&T's pricing decisions:

The parallel with the AT&T situation is obvious. The cost
for monopoly services is fixed, and will be the same
whether the competitive services are added by AT&T or
not. The cost for the monopoly services is the equivalent of
the $125 which would have been the hotel charge for
Judge X; the cost for the competitive services would be
the additional $25 which would be added if Mrs. X
enjoyed the use of the same services. From the hotel's
point of view, the additional cost for Mrs. X's presence is
only the additional li

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385011_0024%3A2. Public record. Not legal advice.