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Waltz of the Cannibals

1. FORGET THE PAST

They laid Ma Bell to rest in Denver last month, on the last day of the second quarter of the fiscal year. She was a sick old gal, but nobody could agree on the cause of death. Rot and parasites had been eating away at her for years, and she'd endured several amputations, bouts of dementia and fits of hubris -- not to mention some peculiar doctoring by high-priced specialists.

Mourners gathered at the Colorado Convention Center to pay their respects. They called it the 120th annual shareholders' meeting of AT&T, but it was really an embalming, presided over by men clad in black suits and undertaker pallors. Security was tight and the program highly scripted, with scarcely a nod to the long and illustrious history of the American Telephone and Telegraph Company. The corporate greeters didn't even recognize one elderly gentleman waiting patiently for admission, who was asked if he was somebody's guest.

The man -- Robert K. Timothy, president of Mountain Bell from 1970 until 1982 -- seemed puzzled. "No, I'm a shareholder," he said.

Standing under the company's Death Star logo -- the wavy-lined sphere that replaced the famous Bell symbol in 1984, when AT&T was forced to relinquish control of Mountain Bell and 21 other local phone companies -- the morticians prepped the corpse with astonishing speed. It took titans like J.P. Morgan decades to make AT&T the biggest corporation on the planet. It took current CEO David Dorman ninety minutes to hustle through the formalities of obtaining shareholder approval of the company's acquisition by SBC Communications, one of the "Baby Bells" created by the 1984 divestiture. Subject to regulatory approval, SBC will soon devour the battered husk of its parent for a mere $16 billion, logo and all.

"Clearly, our company has endured a range of significant challenges in recent years," Dorman told the shareholders, racing through a PowerPoint pitch that teetered between prim understatement and brawny hyperbole. The challenges, he explained, stemmed from the "telecom nuclear winter" that has gripped the industry in recent years, triggered by over-investment, shifting regulations, fraud and scandal. The freaky economic climate vaporized half a million jobs and $2 trillion in market value, chalked up $165 billion in defaulted debt, bankrupted several heavy players and pummeled the survivors.

But, hey, the good news is that since 2002, AT&T has boosted dividends, cut its debt by 60 percent and trimmed operating costs by a third, largely by spinning off ungainly pieces of itself. Slimming down made the company prime merger bait for on-again, off-again suitor SBC, even if the dowry was a bit on the chintzy side. AT&T's stable of high-end business customers and global phone and Internet networks, joined with SBC's extensive local, broadband and wireless services, will produce a company with $70 billion in 2004 combined revenues and the potential for some hot and heavy synergies.

When it was their turn to comment, several shareholders let Dorman know they were unmoved by his brisk depiction of dazzling synergies and enhanced value. Although they support the merger as the best path out of a bad jam, union representatives took turns at the microphone blasting current management over pension cutbacks, downsizing and bloated executive-compensation packages. Dorman stood stone-faced through most of the two-minute harangues, declining to respond.

The CEO's uncanny imitation of a wax dummy prompted Gerald Armstrong to hop to the microphone more often than usual. At one point Armstrong, a Denver shareholder activist who's been interrogating bank and utility executives at annual meetings for decades, tried to extract a response from Dorman to the remarks of the previous speaker, Laura Unger, president of Communications Workers of America Local 1150, who'd urged shareholders to oppose the re-election of the current board of directors.

"I have no response," Dorman said.

"I feel shortchanged, frankly," Armstrong replied. "You know, Denver is more familiar with AT&T than you imagine. This great board of directors sent us someone named Joe Nacchio, and they forgot to put a 'hazardous materials' label on him."

The crowd roared. Dorman managed a tight grimace. "I certainly have no comment on that," he said.

Armstrong's jab provided the only moment of levity in a grim affair, but it was no idle quip. The spirit of Joe Nacchio -- the much-reviled former AT&T exec who oversaw Qwest's acquisition of US West, one of the seven Baby Bells formed out of the 1984 crackup -- hung over the convention center like a shroud.

Ousted as Qwest's chief executive in 2002, these days Nacchio is battling SEC charges that he made more than $200 million through a fraudulent scheme to inflate the company's stock. His successors are toiling under a mountain of debt and hungrily seeking merger partners. Spurned by MCI recently in favor of a lower bid from Verizon, Qwest is now the weak sister among the four surviving regional telecom giants -- and, like AT&T, possibly a ripe target for bargain-basement acquisition itself.  

Although the local Bell companies and the mother ship parted ways a generation ago, the self-devouring world of the telecom business has made them cozier bedfellows than ever, their miseries closely linked. Two companies, SBC and Verizon, now control the largest wireless services in the country as well as two-thirds of the local phone service, prompting Qwest chief executive Richard Notebaert to warn of an impending "duopoly" in the business. Strategic blunders, technological upheaval, regulatory confusion and economic reversals have made a shambles of the industry -- particularly in places like Denver, once a proud hub of cable and communications empires. But perhaps the greatest devastation has been wreaked by the towering greed and arrogance of top shamans, who've provided a primer in how to ignore the lessons of the past and submarine your own stock.

AT&T may have been the phone company for more than a century, but there's no monopoly on foolishness. They buried Ma Bell last month, but her legacy lives on.


2. FIGHT CHANGE

Some analysts blame the telecom nuclear winter on the government. The regulators should have done a better job, they say. The court-ordered breakup of AT&T and subsequent tinkerings with the rules of the game were supposed to foster robust competition, but many of the moves also hurt local phone customers and played hell with established ways of doing business.

True enough. Yet such arguments tend to be infused with nostalgia for the good old days of a single phone company -- days that were never that good to begin with.

Regulation crept into the industry in the first place because of its own inequities and inefficiencies. Alexander Graham Bell's patents on his marvelous device began to expire as early as 1893, prompting competing phone companies to enter the fray. There were price wars and wasteful duplication of services, with some customers forced to sign up with multiple companies in order to phone friends and family in rival territories. Even after a shakeout that led to increasing consolidation of the phone networks under the umbrella of American Telephone and Telegraph, there was no way to enforce uniformity of service and price -- not until the Communications Act of 1934, which created the FCC and gave it authority to regulate interstate rates.

The primary benefit of having a regulated monopoly such as AT&T was its ability to pursue the goal of universal service. Although it cost considerably more to wire up rural customers, the effort was subsidized by hefty long-distance rates and other costs passed on to high-usage areas. But being the only game in town also encouraged hidebound complacency: With no danger of customers going elsewhere for their service, where was the incentive to innovate? Bell Laboratories employed Nobel-caliber geniuses, who gave the world its first transistor in 1948 -- yet at the time, the company was still in the process of rolling out the rotary phone, which had been developed thirty years earlier.

The drawbacks of monopoly were apparent in Colorado and other Rocky Mountain states, where vast distances and sparse population presented a range of service problems. Herb Hackenburg, who transferred to Mountain Bell from a public-relations job at Ohio Bell in 1972, was surprised to discover that many of Colorado's rural customers were still dependent on party lines. "In Ohio, the most I'd seen was two to a line," says Hackenburg, author of Muttering Machines to Laser Beams: A History of Mountain Bell. "Out here, it went as high as eighteen."

Challenged repeatedly for its stranglehold over the manufacturing (Western Electric), research (Bell Labs) and distribution components of the business, AT&T stubbornly refused to be pried loose from any of its toys. But by the 1970s, court decisions were nibbling away at the empire. Consumers won the right to buy their phones rather than lease them, and competitors began to vie with AT&T for long-distance customers. These were minor setbacks, though; the real damage came in an antitrust brawl with the Justice Department, which was finally resolved by the court-ordered divestiture of AT&T's local phone companies.

The heads of the various Bell operating companies were summoned to a secret meeting in Phoenix to hear the bad news. According to Larry DeMuth, former general counsel for Mountain Bell and US West, even top staffers in the Bell companies didn't learn of the breakup until it was publicly announced.

"Everybody had thought of divestiture in terms of getting rid of Bell Labs or Western Electric," DeMuth recalls. "Nobody had thought about separating the companies that provide the service. That was not part of the original antitrust action. It was a complete change of approach."  

AT&T reported revenues of $50 billion in 1980, about 2 percent of the gross national product. It had more than one million people on its payroll; only the federal government employed more. That was simply too big, concluded Harold Greene, the federal judge who approved the divestiture agreement.

Breaking up Ma Bell "will be an enormous undertaking, fraught not only with many problems and difficulties, but also with a potential for substantial private advantage at the expense of the public interest," Greene wrote. "[But] it is antithetical to our political and economic system for this key industry to be within the control of one company."

By failing to make concessions in any phase of its business, the giant had lost the whole package. Local phone service was handed over to seven regional Baby Bells, including US West, an amalgam of Mountain Bell, Northwestern Bell and Pacific Northwest Bell. The regulators predicted that long-distance rates would become more affordable, while operating the regional monopolies without the long-distance subsidy would push the cost of local phone service upward. They were right.

The babies immediately began to squabble with the parent over who was going to retain control of the lucrative directory business and take the lead in emerging "information services" and the wireless market -- which in those days was regarded as an exotic, limited-range luxury for top business clients. The brats won many of the court battles, hampering AT&T in the brutal new world to follow.

"AT&T failed to recognize that long distance wasn't a separate business, it was a commodity," DeMuth notes. "Now AT&T is no more."

But both sides were still primarily focused on each other, on how the bounty was going to be divvied up, rather than the opportunities the breakup presented for new companies and new products. "There was no real contemplation of the technological changes that were under way," DeMuth says. "The company had this huge investment in copper wire, and it was hard to imagine where the competition was going to come in."


3. PUT YOUR CUSTOMERS ON HOLD

It takes time to turn battleships around in the middle of the ocean, and hulking monopolies don't become spry dancers overnight. The Death Star and its babies had more than a year to prepare for divestiture. It didn't help.

Mired in its own smugness and the glacial pace of the regulatory process, AT&T was hopelessly behind the curve when it came to adapting rates and products to the new marketplace. The company made a half-assed move into the personal-computer market that quickly fizzled. Meanwhile, the barbarians were buzzing at the gates; by the end of 1984, nearly 400 rivals had entered the long-distance business, and AT&T's share had slipped to below 60 percent.

Over at US West, the primary emphasis wasn't on getting competitive, but on avoiding further antitrust actions. That meant crafting an unbeatable firewall that would divide the heavily regulated local phone service from any other areas of endeavor the company might enter on its own or spin off to arm's-length subsidiaries.

"The real question was what was local exchange service and what were the other services," says DeMuth. "We wanted to make sure we did exactly what the law purported to require. We wanted to separate the local exchange from any competitive business we got into."

Fear of breaching the firewall may have made company management a mite slow to tackle new opportunities in cable, cellular and data services. But it's also true that the dominant culture within the Bell companies was most comfortable with the reliable old business of transmitting voices over wires. There was an innate skepticism of fancy-pants stuff like digitalization -- why digitalize voice communication when you're just going to have to convert it to analog at the other end? -- and computers.

DeMuth remembers trying to get baffled corporate types to approve a plan to network the legal department's computers in the mid-1980s. "I had a very hard time convincing anyone that the lawyers in fourteen states needed to communicate with their computers," he sighs. "The management of the company simply did not correlate computers with communication."

More than the other Baby Bells, perhaps, US West was ill-suited for the post-divestiture world. The company launched a wireless business called New Vector, only to sell it after concluding that the Rocky Mountain states didn't have the customer base to support it. A second wireless effort became a joint venture with Pacific Telesis. Meanwhile, local users began to wax nostalgic about Mountain Bell, calling the new company "US Worst" because of its mounting service problems and fee hikes; poor service made customers eager to jump ship when competitors did arise. After a century of being one gear in a vast machine, it was tough to be on your own, in a world of regulatory snarls, accelerating technology and fast-talking rivals.  

"They stuck to the old model for way too long," says Ron Binz, a veteran telecom consultant and former director of the Colorado Office of Consumer Counsel, which represents consumers in utility-rate cases. "When you look back at it, the regulators were very kind to the Bell companies. They got to continue collecting a lot of charges and legacy costs that should have been competed away."

The industry's foot-dragging was one of the reasons behind the Telecommunications Act of 1996, which was supposed to inject competition in the sluggish local phone market by blurring the distinctions between local and long-distance companies that had been established twelve years earlier. Now the Baby Bells were allowed to expand beyond their regional territories, so they could offer long-distance and cable services on a national scale, while the long-distance and cable companies could begin competing for local phone customers. The result was a cacophony of court cases, regulatory flip-flops, start-ups that quickly crashed, and mergers that seemed to be slowly reassembling the monster that Judge Greene had dismembered.

Southwestern Bell, now known as SBC, swallowed Pacific Telesis, then Ameritech. AT&T leaped into the cable business, shelling out a jaw-dropping $100 billion for Denver-based TCI, Liberty Media and other cable ventures in a bold effort to deliver phone and Internet service over cable lines -- only to abandon the effort a few years later, selling its cable operations to Comcast for half of what it had paid for them. And Qwest, the fiber-optic whiz kid on the block, snapped up stumbling US West.

"The FCC provided a lot of false starts through all of this," Binz acknowledges. "The whipsaw federal policies made life harder for customers and for the companies. Everybody thought in March of 2000 that this industry was finally tipping into a competitive mode. But what we got was a lot of competition that turned out not to be sustainable. There was a certain amount of exuberance about how easy it was to be a telecom, and that turned out not to be true."


4. BLOW OFF YOUR SHAREHOLDERS

Gerald Armstrong attended his first shareholders' meeting in 1967. At the time, he worked in the retail credit office of JC Penney and had a little stock in the Public Service Company of Colorado. He wanted to find out how the state's largest power company treated its investors.

He was appalled at what he saw. "Nobody asked any questions," he recalls. "So the next year I returned with questions, and they were very upset."

At first his pointed questions about management shocked the button-down types in the audience; some even hissed when he got up to speak. But his evident preparation and research started inspiring others to take a closer look at their own proxy statements. Armstrong began attending other annual meetings, including those of Mountain Bell, one of the few Bell companies that actually had stockholders other than AT&T (the minority investors were bought out in 1980).

Mountain Bell meetings tended to be staid affairs, run by men in gray flannel suits. "Many people in the audience were Mountain Bell retirees or retired investors," Armstrong says. "They were just there for the event of the day. They were not going to rock the boat. It used to be that wealthy people would buy enough stock in Mountain Bell so that the dividends would pay the phone bill, and enough stock in Public Service to pay the light bill."

Armstrong soon became acquainted with other prominent shareholder activists around the country, including crusading feminist Wilma Soss and the legendary Gilbert brothers, John and Lewis, who began sending him their proxies. Now he travels to places like San Francisco and Minneapolis to confront the mega-corporations that have taken over many local banks and utilities, but Denver continues to be his base of operation. The fortunes of Mountain Bell and its successors, US West and Qwest, remain a principal obsession, even as the corporate stewards have become less and less responsive to shareholders.

Mountain Bell's board was often paternalistic in its dealings with investors, but that wasn't always a bad thing. Armstrong recalls getting letters signed by Bob Timothy, the company's president, following up on his inquiries. In the 1970s, Soss and others pressured large corporations to place women and minorities on their boards. Armstrong joined in that effort, nominating a protest slate of directors for Mountain Bell to replace a board dominated by bankers from back East. One of his candidates was a director of the First National Bank of Arizona named Sandra Day O'Connor.  

"She was summarily rejected," he says. "When we pressed the issue, Bob Timothy said he'd have the corporate secretary look into her qualifications. They came back and described her as a housewife lawyer."

When President Ronald Reagan appointed O'Connor to the Supreme Court, many corporate boards -- including General Electric, RCA and AT&T -- were left fretting that their dismissal of her might have ramifications in future court cases involving their companies.

Yet however inflexible the old Mountain Bell leadership might have seemed, it was far more accessible to shareholders than subsequent regimes. With the advent of US West came a crew of investor-relations professionals keen on micromanaging the annual meetings, which had become a vehicle for showcasing the company's achievements. Gadflies like Armstrong were supposed to be anticipated, screened, managed and ultimately neutralized.

"Their investor-relations people would call us to make sure we were happy," Armstrong recalls with a faint smile. "They'd ask about your likely topics at the upcoming meeting and say, 'Why would you want to talk about that?' They were very defensive."

Like Timothy, who'd once collected change from pay phones, US West CEO Sol Trujillo had worked his way up through the ranks of Mountain Bell, starting as a lineman. But the resemblance ended there. Armstrong discovered an inverse ratio between corporate accountability and the soaring egos of the new breed of telecom executives, whose generous opinion of their own value is reflected in their lavish compensation packages: outrageous salaries and stock options, golden parachutes, fat retirement bonuses.

"We used to think it was bad when Bob Timothy got a hundred thousand a year," Armstrong says. "Now there's this whole degree of arrogance. They get country-club memberships; what benefit is that to the company? Where would they all be, lined up in the soup kitchen if we didn't pay them that much? Warren Buffett has shown there can be reason brought to this front with the compensation he offers -- but it isn't happening in these companies."

With the arrival of Qwest's Nacchio, who denounced US West employees as "clowns" and exercised a small emirate's worth of stock options before departing in a huff, the compensation-versus-accountability metrics shot off the scale. Armstrong and others have tried repeatedly to introduce shareholder proposals reining in executive pay, to no avail. Even when the proposals pass, the boards often drag their feet about implementing them. (One measure that Armstrong carried at a Wells Fargo meeting two years ago still hasn't been adopted by the board. "The only way to make them adopt it is to start a proxy fight and oust the board of directors," he says. "I can't afford that.")

Shareholders have had even less success trying to get the telecom industry's most engorged fat cats to explain their most disastrous moves or take any responsibility for the evaporation of jobs and share value over the past few years. In the worst cases, such as Dorman's performance at the AT&T meeting, the hunkered-down CEOs don't even see why they should bother with a response. They know that individual shareholders' opinions are as inconsequential as dust mites, so why bother coddling them?

"Any corporation can make a mistake in timing or judgment," Armstrong says. "But these people have never made a mistake."

Despite the executives' indifference to him, Armstrong keeps taking his turn at the microphone. "The shareholders of utilities and banks don't speak up enough," he says. "People have told me my lights aren't going to be on when I get home or my account is going to be closed. They have this idea that if you speak up, you'll be penalized. The shareholders are intimidated by management, and that's wrong."


5. LIE. CHEAT. STEAL

Tucked away in an obscure corner of the Qwest building on 17th Street is one of the largest privately held telecom archives in the country. The non-profit Telecommunications History Group has collected more than 80,000 photographs; telephone directories from across the West dating back to the nineteenth century; stock certificates and other papers from more than 500 long-gone phone companies; oral histories; antique phones and artifacts; and endless clippings, correspondence and other documents -- all tracing the evolution of an industry, from electronic novelty to an essential organ of contemporary life and commerce.

Staffed largely by volunteers, the THG is a noble bid to provide some historical perspective on a business that reinvents itself every few months or so. With study, it also yields some stunning contrasts in means and ends, between the way the phone hucksters used to do business and the way they operate today.  

Take, for example, the case of the One Millionth Telephone. A few years after World War II, Mountain Bell was rapidly approaching its one-millionth installation job. A surviving file from the public-relations department documents the debate that percolated within the company about how to handle this milestone event -- that is, how to best exploit it.

Caught in a post-war boom, Mountain Bell was struggling with a backlog of phone orders that were taking months to fill. The flacks knew that well-orchestrated hoopla around installing a millionth phone could send the message that the company was making progress overcoming the backlog. The problem was that the company had no way of knowing which phone order would actually represent the magic number; it could be any one of 10,000 phones being installed across the region in a given month.

So what do you do? Do you simply announce you've hit the million mark, without zeroing in on a particular location? Or do you pick a suitable lucky family and pretend they hit the jackpot, in order to milk the maximum attention out of the deal?

There were heated meetings. The boys in Phoenix, where the back orders were staggering, wanted the millionth phone put in their city. The suits in Utah made a case for their state. According to the minutes of one confab, somebody else pushed for Denver, the media capital of the region, "since interstate jealousies and hometown loyalties would probably result in a studied lack of interest in some sections of the territory, regardless of the location chosen."

A scrupulous PR man named Shaw argued for not picking any place in particular, "on the grounds that such a selection would be admittedly arbitrary and reek of fake." He was quickly overruled.

In the end, the honor went to the family of a war vet who was trying to start a farm on a godforsaken sagebrush reclamation project fourteen miles north of Riverton, Wyoming. On September 15, 1948, Wyoming governor L.C. Hunt and a slew of Mountain Bell executives drove out to the farm, made a few speeches, then stood beaming as flashbulbs popped and Mrs. Carroll Riggs made the first call on the new phone, a howdy-do to her invalid mother in Oklahoma. There was a big lunch and more speeches in Riverton, with plenty of reporters chowing down. Nobody asked if the device in question was really the One Millionth Telephone.

The whole affair was a pretty typical exercise in old-style public relations. You could call it hype; you could even call it corporate puffery. But it was not a complete fraud. The company really had installed one million phones, even if nobody could prove which one was the millionth one.

In the current telecom chaos, hype has been replaced by outright mendacity -- but they're still calling it hype. In court filings responding to SEC claims that Joe Nacchio's rake-off of Qwest was ill-gotten, Nacchio's lawyers claim he was guilty of nothing more than "puffery" and "expressions of corporate optimism." The government maintains that Joe's sunny-side economics included elaborate machinations to pump up Qwest's stock in order to make the US West merger happen, then further inflate revenues while cashing in his stock options.

The same day the SEC filed its civil suit against Nacchio, a criminal jury convicted WorldCom founder Bernie Ebbers of fraud. Ebbers's corporate optimism was of a different order than Nacchio's; his finance chief testified that Ebbers essentially ordered him to cook the books, to the tune of $11 billion. Last week, a federal judge sentenced Ebbers to 25 years in prison.

The case against Nacchio relies heavily on alleged omissions, distortions and accounting tricks rather than evidence of criminal fraud. Still, former Qwest CFO Robin Szeliga pleaded guilty to insider-trading charges last week and agreed to cooperate with prosecutors, possibly laying the groundwork for similar charges against Nacchio, her ex-boss. And last fall, Qwest settled its own problems with the SEC by paying a fine of $250 million for overstating revenues, while declining to admit any wrongdoing.

The havoc wreaked by such creative accounting extends far beyond the companies involved. It put the squeeze on other companies to match their outrageous scores. A major factor in AT&T's decline, several analysts have suggested, is the pressure brought to bear by Wall Street firms lusting for the same kind of profits WorldCom was claiming -- profits that turned out to be illusory.

Qwest has revised its books and, under CEO Notebaert, is seeking to distance itself from its tainted past. Yet it failed in its bid to acquire WorldCom, now known as MCI, despite MCI's own tangled history of fraud and bankruptcy. Now the company is looking eagerly for other dance partners and seeking to throw off the remaining shackles of regulation.  

Last month, Colorado became the ninth of fourteen states in Qwest's region to grant some degree of deregulation for the company in its efforts to be more competitive in business and long-distance services. Ron Binz, who served as a consultant to the Office of Consumer Counsel in the negotiations, says the deal that was hammered out protects the basic rates for residential phone service while giving the company more room to maneuver in markets where competition for local service is emerging.

"There's no consumer interest in making it difficult for Qwest to respond to competitors," Binz says. "They got substantial flexibility for their business services, but they still have to behave themselves in the marketplace."

The deal is not as generous as the ones Qwest has obtained from regulators in Nebraska and South Dakota, and less than what the company had sought. Binz doesn't expect it will dramatically hike rates or broaden services.

"Colorado is around the national average in residential rates," he notes. "What we don't truly have is a choice of local competitors for the small business and residential markets, which could push the price down. Most of the country is in the same boat."


6. WHEN ALL ELSE FAILS, STICK TO THE SCRIPT

The services for Ma Bell are winding down. The men in black have declared that the meeting will adjourn promptly at 11 a.m., even if they have to shut off the microphones to do it.

Shareholder approval of the proposed merger between AT&T and SBC is announced at 10:51 a.m.: 70.7 percent for, 4.7 percent against. To no one's surprise, the current board of directors is re-elected.

Gerald Armstrong heads for the mike one last time, to question the figures CEO Dorman has just rattled off regarding the vote count on the directors. Dorman gives up the numbers, even though he's disinclined to answer Armstrong's central question concerning the board's compensation: "How much is enough, and how much is too much?"

Eleven arrives. Dorman bids a hearty farewell. T-shirted union reps heckle the departing board. Somebody cues the exit music. Not a dirge, but Muzak suitable for boarding a flight to Aruba.

The mourners ride the escalators to the street, whipping out their cell phones as they go down.


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