Updated from 4:53 p.m. EDT

Federal regulators gave conditional approval Friday for Bell Atlantic ( BEL) to acquire GTE ( GTE - Get Report), clearing the way for the completion of a $65 billion merger that will create the nation's largest local telephone company.

But the companies must meet Government demands that include splitting off GTE's Internet business.

The Federal Communications Commission listed 25 conditions for its approval that it said were "enforceable" and "designed to enhance local phone competition in the markets in which Bell Atlantic or GTE is the incumbent local exchange carrier."

The companies volunteered to spin off GTE's Internet assets into a separate public company to be called Genuity, the FCC said. The move is intended to reassure regulators that the new company will comply with sections of the Telecommunications Act that prohibit a Bell operating company from providing long-distance voice or data services to customers in its service territories before demonstrating that the local telephone market is open to competitors.

Shares of New York-based Bell Atlantic fell 1 1/2, or 3%, to close at 55 1/16, while shares of Irving, Tex.-based GTE shares dropped 2 15/16, or 4%, to close at 66 1/4.

The new local and long-distance phone company, to be called Verizon Communications, will control about 63 million telephone lines in 31 states and the District of Columbia -- about a third of all lines in the United States.

The merged company will provide local phone service in 13 states -- Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Virginia, Vermont, and West Virginia -- as well as in the District of Columbia.

To date, Bell Atlantic has only received authorization to offer long-distance services in New York State. In a conference call late Friday, executives of the two companies said they would start filing for approval to offer long-distance service in Massachusetts and New Jersey by the end of the year and perhaps in Pennsylvania as well. Next would come Virginia and Maryland. The process should be complete in two years, they said.

Section 271 of the Telecommunications Act prohibits an incumbent local exchange carrier such as Bell Atlantic from providing long distance services (voice or data services) before its local telecommunications markets are open to competition.

The spin-off of Genuity complies with the prohibition against an incumbent local phone company from providing long-distance services.

The FCC said the merger conditions are necessary because the merger would otherwise likely remove one of Bell Atlantic's most significant local service competitors, reduce the FCC's ability to open markets and encourage the new company to discriminate against its rivals in providing advanced telecommunications services.

To comply with regulations, the companies also agreed to invest capital outside of their current markets. In the conference call, executives said they would focus on DSL and other advanced telecommunications.

Asked whether AT&T could sue to block the merger, one executive cited the unanimous FCC vote and said, "We think this arrangement is bulletproof."

The executives also said there were about 3,000 "redundancies" in their corporate headquarters.