Interesting People mailing list archives
IP: Prudential Securities report on FBI and NTT purchase of Verio
From: Dave Farber <farber () cis upenn edu>
Date: Wed, 19 Jul 2000 06:41:53 -0400
Date: Fri, 14 Jul 2000 11:29:04 -0400
To: politech () vorlon mit edu
From: Declan McCullagh <declan () well com>
[Jim asks me to send this out in hopes of starting a dialogue on politech.
I'm happy to forward thoughtful responses. --Declan]
*********
From: "James Lucier" <James.Lucier () att net>
To: <declan () well com>
Date: Wed, 12 Jul 2000 13:55:14 -0400
JAPANESE CONSTITUTION MAY POSE HIDDEN BARRIERS TO NTT'S VERIO ACQUISITION,
MAKING THIS DEAL, FUTURE ONES MORE COMPLICATED THAN THEY LOOK (PART 1 of 2)
R E S E A R C H N O T E S July 11,2000
Subject: Telecommunications and Internet Regulation
NTT (NTT--72 1/2, not rated)
VERIO (VRIO--52 7/8, not rated)
JLUCIER
Analysts: James Lucier (703) 358-2987
=======================================================================
o NTT's bid to acquire VRIO has been complicated by FBI concerns over
wiretapping capabilities.
o We think the FBI will eventually sign off on the deal, but perhaps not
until the Exon-Florio review period expires in early August or even later.
o In Japan, constitutional and political sensitivities have made the legal
environment for wiretapping murkier than elsewhere.
o But the FBI is not sure what it wants either, except more access than it
has already, so talks drag on.
o Globalization and digitalization of telecoms, challenging FBI, drive
hardball tactics in case-by-case negotiations.
Shares in Englewood, Colorado-based ISP Verio (VRIO--52 7/8, not rated) took
a beating last week when officials of NTT (NTT--72 1/2, not rated) confirmed
on July 7 that the U.S. FBI had raised national security concerns about the
Japanese domestic telephone giant's bid to acquire the portion of Verio
shares it does not already own. We suspect that the FBI's concerns may
derive in part from the politically and constitutionally problematic legal
regime that applies to wiretapping in Japan.
Both ongoing and trade issues and the FBI concerns over the national
security and law enforcement aspects of this deal have been cited as reasons
why U.S. government approval of the deal may be delayed. In our opinion,
the trade and national security issues are completely separate. We believe
the trade issues are likely to be solved by the upcoming July 21-23 meeting
of the G-8 to be hosted by Japan in Okinawa.
However, we also believe that discussions between the FBI and NTT could
carry on for some time yet, perhaps a period of weeks pushing up to and even
slightly beyond the timetable allotted to a formal review process that would
normally end in mid-August. We believe nvestors should not interpret this
as a signal the NTT-Verio deal might ultimately fail to win approval.
Indeed, we consider approval to be much more likely than not in the end.
However for both legal and practical reasons, including the FBI's normal
operating procedure in such matters, we tend to think the approval process
could take longer than most investors would like.
The globalization and digitalization of world telecommunications
infrastructure are twin forces challenging the FBI's current surveillance
capabilities. Driven by fear of losing capabilities, the FBI has undertaken
a multifaceted campaign to enhance and extend its capabilities instead.
Proceeding somewhat opportunistically, the FBI has used its ability to block
important transactions as a way of both learning what new capabilities exist
and forcing telecommunications companies to provide them. The process is one
of exploration. On occasion it can be time consuming. We believe that may
be the situation.
Background. FBI officials were concerned about their ability to serve
subpoenas and obtain wiretaps, according to published reports. The FBI
concerns have triggered an investigation by the Committee on Foreign
Investment in the United States (CFIUS) that could last as long as 45 days
from June 30, the date NTT received notice of the investigation. CFIUS is
an interagency group of federal officials chaired by the Secretary of the
Treasury, which implements the Exon-Florio national security review process
required for certain transactions. (For a detailed discussion of
Exon-Florio, which is beyond the scope of this note, we refer investors to a
July 10 note by Prudential Securities Senior Telecom Policy Analyst Susan
Lynner.*) The basic concern among investors is that a protracted approval
process could raise the costs to NTT acquiring Verio and lower the quality
of acquisition.
The NTT bid for Verio occurs in the context of a trade dispute over
interconnection fees NTT charges competitive carriers to connect calls
through its local network. The U.S. wants these fees cut by 41 percent
immediately. Japan has offered to cut rates of the majority
government-owned telecommunications carrier by 22.5 percent over four years.
In negotiations set for this week, Japan will reportedly offer a three-year
schedule. In our opinion, the pieces seem to be coming together for
resolution of this problem before U.S. President Bill Clinton meets Prime
Minister Yoshiro Mori in Okinawa.
Investors have asked to what extent the FBI's red flare signals unalloyed
national security concerns, and to what extent it may also be a tactic in
tandem with the trade negotiations. If both national security and trade
concerns are at issue, investors wish to know which may be predominant. In
fact, we believe the trade and national security negotiations are not linked
and are proceeding on entirely separate tracks.
Constitutional Barriers to Wiretapping In Japan. We have not been following
the ins and outs of the trade dispute, but we do have certain insights
gained from our experience in the debate over encryption controls and
implementation of the 1994 Communications Assistance for Law Enforcement Act
(CALEA) that may cast light on the FBI's concerns. We suspect but cannot
confirm that the national security and law enforcement issues involved in
the NTT-Verio deal are more complicated than generally realized.
o Article 21 of the Japanese constitution was long held to forbid
wiretapping. Specifically, section two of the article reads: "No
censorship shall be maintained, nor shall the secrecy of any means of
communication be violated..."" Though wiretapping was understood to occur
on some scale, transcripts of intercepts could not be introduced as evidence
in Japanese courts.
o In July 1999, the upper house of the Japanese Diet adopted a wiretapping
statute but only after overcoming unusual Japanese-style filibusters known
as ox-walks and bitter dissents from the opposition parties. The new
statute goes into effect in August 2000. The law specifically addresses
only four categories of crimes involving weapons, drugs, illegal aliens and
organized crime. It is widely believed the law could be applied more widely,
but the precise mechanics are unclear. There is little guiding precedent to
ease matters.
o The law entitled, as we translate it, "Wiretapping for Investigations in
Criminal Cases," does allow for the interception of both telephone and
Internet communications. However, during the Parliamentary debate, wireline
and cellular telephony providers argued that the bill did not adequately
consider the costs and technical difficulties of tracing and monitoring
calls. Internet service providers complained even more bitterly that the
requirements placed on switched-circuit telephony providers were even more
difficult to implement in the packet switched world, and the technical
differences of their environment were not considered at all.
o The law was adopted at the insistence of the Japanese Ministry of Justice,
which had pressed for the proposal since 1996. Critics claimed that the
bill was forced through Parliament under the under pressure from the United
States, and this claim is at least in part correct. Encryption and
wiretapping had been a flashpoint in U.S. Japanese technical discussions
since 1995-96, when NTT, to the great consternation of U.S. policymakers,
attempted to market a two-piece chipset that that implemented virtually
uncrackable triple DES at a cost of pennies per unit.
[Continued in Part 2 of 2]
* "We Think A Deutsche Telekom Purchase of a Major U.S. Carrier Would Be
More Than A Legal And Regulatory Exercise," Parts 1 and 2, Susan Lynner,
First Call, July 10, 2000.
Prudential Securities (or one of its affiliates or subsidiaries) or its
officers, directors, analysts, employees, agents, independent contractors,
or consultants may have positions in securities or commodities referred to
herein and may, as principal or agent, buy and sell such securities and
commodities.
JAPANESE CONSTITUTION MAY POSE HIDDEN BARRIERS TO NTT'S VERIO ACQUISITION,
MAKING THIS DEAL, FUTURE ONES MORE COMPLICATED THAN THEY LOOK (PART 2 of 2)
R E S E A R C H N O T E S July 11,2000
Subject: Telecommunications and Internet Regulation
NTT (NTT--72 1/2, not rated)
VERIO (VRIO--52 7/8, not rated)
JLUCIER
Analysts: James Lucier (703) 358-2987
=======================================================================
[Continued from Part 1]
Other Complicating Factors. We see three immediate problems which are
likely
to be the substantative focus of the ongoing CFIUS review of the
transaction:
o First, according to published reports, the FBI is insisting that
(1) it
have physical access to Verio's network and (2) surveillance be undertaken
by a U.S. citizen or citizens. These are reasonable enough conditions in
our view, but the issue of back traffic through Japan complicates matters.
In addition, the Japanese are just as likely to insist that key functions
at facilities in Japan be performed by Japanese officials and that
warrants for accessing these facilities be issues by Japanese judges.
o Second, the FBI may want explicit commitments that would be
difficult for
NTT to give or the Japanese government to sanction, especially given the
June 25 election results which reduced the coalition's lower house
majority from 366 to 271 seats, which is only two seats over the threshold
to maintain nominal control. These commitments might be especially
difficult for Japan to offer in the broad range of international security
issues that are important to the United States but may run counter to the
tenor of the peace clauses in the Japanese Constitution.
o Third, most importantly, we believe the FBI does not itself have a
clear
understanding of what its requirements are. Rather, the talks are likely
to be characterized by iterative discussions in which the FBI seeks to
glean every possible bit of information it can obtain about NTT and
Verio's networking business, ranging from the types of equipment and
technologies used to the names and professional backgrounds of actual
personnel who may be on call to meet to answer FBI subpoenas for
existence. Based on what we know of other such negotiations, the FBI will
continuously expand and refine its lists of requirements until the agency
is satisfied it has nothing more to gain in the way of potentially useful
surveillance capabilities. In any situation, such talks would take time.
However, in this case, we believe that patience is likely to be tried on
both sides. First and foremost, we believe the FBI's negotiating style
and insistence on detailed, explicit agreements runs counter to Japanese
negotiating styles. Second, the comparative lack of case law and pre-
defined standards for required telecommunication provider assistance to
law enforcement in Japan may require more lawyering than usual if both
sides are to perform what amounts to "due diligence" on the law
enforcement side of the deal. It is our opinion, based on both U.S. and
Japanese legal sources, that the legal issues can be worked out and could
even already be worked out in principle. But a good number of details are
likely to remain.
In addition to foreground concerns, we see an assortment of background
issues
that may additionally cast a shadow over the CFIUS proceedings:
o CALEA has been a factor before in reviews of foreign acquisitions
of U.S.
telecommunication companies before, most notably in Vodafone's acquisition
of Airtouch. To describe matters from the perspective of U.S.
telecommunications providers and equipment makers, the FBI's standard
practice is to take the most expansive possible reading of CALEA (which
statute theoretically guarantees law enforcers the same level of access to
communications in digital networks that they enjoyed in earlier, less
sophisticated analog networks.) Not infrequently this reading may be far
beyond what industry and civil libertarians consider to have been the
Congressional intent. Grousing industry contacts complain that the FBI
gets maximum leverage for its demands by routinely holding important
transactions and standards-setting processes hostage and negotiating
behind closed doors with hardball tactics designed to get, through
whatever means necessary, wiretapping capabilities Congress will not
expressly grant them in law. Without endorsing these attitudes ourselves,
we do note that the FBI has incurred considerable ill will and resentment
in the telecommunications and technology communities, along with a slowly
festering image problem on Capitol Hill. (To show only one instance of
this problem, House Majority Leader Dick Armey, with the full support of
his colleagues, now systematically kills or questions every critical
infrastructure protection proposal to emerge from the U.S. Department of
Justice, even when these would appear justified in the light of growing
foreign information warfare capabilities. In our opinion, a change of
control in Congress would result only in Democrats who are even more
skeptical of the FBI than is Armey coming to power.) One difference
between NTT-Verio and other foreign acquisitions of U.S.
telecommunications and information services providers, though, is that
countries such as Germany, France, and the U.K. appear already to have or
to be adopting requirements for assistant to law enforcement that are more
explicit and detailed than those in Japan.
o On another front, the European Union has begun the using the antitrust
lever in part to break up as what the Europeans perceive as American
hegemony on the Internet's infrastructure. Aggravating such concerns is
the growing furor over a U.S., British, and Australian jointly-managed
signals intelligence collection system reportedly code-named Echelon.
Reports presented to the European Parliament suggest that Echelon is
capable of intercepting all telephone calls, faxes, and emails transmitted
in Europe. Elaborate keyword dictionaries then filter the communications.
In our opinion, these reports are somewhat exaggerated (and promoted in
part by governments trying to do much the same thing themselves).
However, last week, at roughly the same time the CFIUS proceedings began
in the United States, the French government appointed a special prosecutor
to examine whether the civil rights of French citizens were infringed by
Echelon, and the European Parliament began a formal inquiry that is
anticipated to result in public hearings in the fall.
o The Europeans allege that the United States uses Echelon for
commercial
espionage, which is denied by the U.S. intelligence community and seems
unlikely to us. But a series of high profile incidents in which U.S.
eavesdropping appears to have played a role in trade negotiations
beginning with the heavy-handed U.S. surveillance of the 1993 APEC meeting
in Seattle and continuing through treaty negotiations with both European
partners and Japan have perhaps justifiably irritated America's trans-
Atlantic and trans-Pacific allies. These worries by Japan and Europe will
not lie far beneath the surface in any talks over who controls sensitive
Internet information flows in the future.
Conclusion. In sum, the NTT-Verio deal occurs in the context of many
interesting but little known developments. Japan has moved toward the
United
States in adopting a less restrictive policy on judicial wiretapping, but
Japan may also be reluctant to acknowledge explicitly how far the policy
goes. In France and the rest of Continental Europe, age-old paranoia about
Anglo-Saxon hegemony has taken a new, high tech turn. In the future, we
believe, negotiations over who controls the checkpoints, tollgates, and
traffic monitoring stations of the information highway will become more
complicated, not less. Investors will have to get used to it, we suggest.
--------------------------------------------------------------------------
POLITECH -- the moderated mailing list of politics and technology
To subscribe, visit http://www.politechbot.com/info/subscribe.html
This message is archived at http://www.politechbot.com/
--------------------------------------------------------------------------
Current thread:
- IP: Prudential Securities report on FBI and NTT purchase of Verio Dave Farber (Jul 19)