AT&T TELLS COURT IT PLANS TO BRING CHARGES AGAINST MCI

AT&T urged the U.S. Bankruptcy Court, N.Y., Mon. not to approve MCI/WorldCom’s bankruptcy reorganization plan in light of the charges that emerged this weekend of alleged access charge fraud by MCI. AT&T told the court that MCI’s reorganization plan, if approved, would deprive AT&T of the ability to file racketeering and fraud charges against MCI, which it planned to do.

MCI “should not have the ability pursuant to their Plan of Reorganization to restrict AT&T’s and other creditors’ rights to pursue [action] in other appropriate nonbankruptcy forums,” AT&T said. It said the reorganization plan would enjoin entities with postbankruptcy petition claims from taking any action against MCI and would give the bankruptcy court “exclusive jurisdiction over objections to post- petition claims.”

At issue are allegations that MCI rerouted some of its higher cost domestic long distance calls through Canada and onto AT&T’s lines, thus shifting hundreds of millions of dollars of access charge costs to AT&T. MCI also has been accused of rerouting local calls in a way that avoided paying access charges to Verizon and SBC and perhaps others. That alleged scheme involved routing long distance calls through 3rd-party phone companies so the calls would arrive on the Bell company networks as local, instead of long distance, calls. Generally only long distance calls require the payment of access charges. One Bell company spokesman said his company “suspected” something was amiss after customers complained that their long distance calls were showing up as local calls on their caller IDs.

The Justice Dept. is investigating the allegations and MCI confirmed it was served with a subpoena last week by DoJ investigators. The Wall St. Journal reported Mon. that Onvoy, a Minn.-based wholesale telecom transport service, was among those receiving requests for information from Justice. An Onvoy official said the company transported long distance companies’ traffic in and out of Minn., including Canadian calls. The allegations reportedly surfaced within the last 2 months when a former MCI executive called law enforcement officials and disclosed the schemes, including the “Canadian Gateway Project” involving the alleged diversion of calls to AT&T and “Project Invader” involving avoidance of Bell company access charges.

MCI officials said over the weekend that “access charge disputes between local and long distance carriers have existed for decades and are routine in the industry.” It said it nonetheless took such inquiries “very seriously” and would cooperate. MCI sources also questioned the timing of the disclosures because it coincided with 2 important activities for MCI -- final action on its plan of reorganization and a GSA investigation into calls for its suspension from govt. contracting.

AT&T told the court that “less than 2 months ago” it “first received indications from law enforcement and other sources outside the company” that MCI had been rerouting the calls. “Only within the past 2 weeks has AT&T confirmed the veracity of this information” through “significant testing of the calls coming onto its network from Canada,” it said. After gaining “preliminary indications” of the scheme from law enforcement officials, AT&T said it began placing test calls from domestic locations over MCI’s network. “In many cases such calls in fact appeared on AT&T’s network for termination after being handed off by Canadian carriers to AT&T international gateways,” the company told the court. AT&T then tested a sample of that traffic to ascertain whether there was any pattern to what type of traffic generally was diverted and said it learned it tended to be calls made to areas with particularly high access charges, such as rural ILECs: “It was destined primarily for areas of the United States where it was disproportionately expensive to terminate calls.” In the last 2 weeks, using a prepaid MCI calling card, AT&T made more test calls to areas where access charges were high and said it found that 8 of 15 calls “were diverted to Canada and routed back to the U.S. for termination via AT&T.” Test calls using telephone service of an MCI subscriber, “with full permission to do so,” revealed 9 of 10 test calls were diverted, AT&T said.

AT&T charged that such actions enabled MCI to “unfairly generate and maintain business… by offering artificially lower rates to customers.” The “fraudulent diversion of costly calls” to AT&T enabled MCI to offer lower rates and thus “lure major customers… from AT&T,” AT&T charged. It said “perhaps most alarmingly,” some of the diverted calls were placed by U.S. govt. personnel. AT&T said “a substantial number of domestic calls from the offices of various U.S. Government agencies in Washington, D.C., and other locations were received by AT&T from Canada for call termination” including calls from the State Dept., “at least one” member of Congress, the U.S. Agency for International Development, National Traffic & Safety Bureau and U.S. Postal Service.

AT&T told the court this wasn’t the first time it had been “the victim” of such practices by MCI, including instances in 1995-1995, 1997 and 2001: “In earlier iterations, [MCI’s] schemes shunted the high-cost calls onto AT&T’s network by sending the calls first to small telephone companies and thereafter causing the calls to be sent to AT&T via large AT&T corporate customers… Each time AT&T has discovered and taken steps to shut down [MCI’s] prior schemes, [MCI has] reinstituted it again in another form… The [current scheme] represents the first time of which AT&T is aware that [MCI has] attempted to shift costs via the use of international traffic.”

Also Mon., Verizon urged the General Services Administration to suspend MCI from participating in federal contracting. “Recent disclosures compel prompt action,” Verizon said in a letter. According to revelations in the news media over the weekend, “MCI is the subject of an ongoing criminal fraud investigation,” Verizon said. “MCI’s competitors have informally complained for a long time that the prices MCI was giving the government appeared to be below cost,” it said. “The practices being investigated by the DoJ would explain how MCI has been able to provide those prices by defrauding other carriers.”

House Commerce Committee spokesman Ken Johnson said both Chmn. Tauzin (R-La.) and Telecom Subcommittee Chmn. Upton (R- Mich.) were “deeply troubled” by the allegations against MCI. Johnson said there would be an early Sept. hearing that would generally address access charges issues. The House is in recess until Sept. 3. Tauzin and Upton are sending a letter to the FCC today (Tues.) about the allegations and access charge issues. Tauzin in the past has expressed concerns about access charges and in 2001 conducted a committee inquiry into reciprocal compensation between CLECs and ISPs.

It was unclear whether the allegations would cause MCI to lose some federal contracts, but Congress could have several opportunities in coming months to directly address the carrier’s nearly $800 million in federal contracts. Last week, House appropriators backed off an amendment that would have barred the General Services Administration (GSA) from contracting with MCI (CD July 25 p1). The House Appropriations Committee instead required reports from both the GSA and General Accounting Office (GAO) on federal MCI contracts. GSA’s report is due to House appropriators Aug. 30. A spokesman for Rep. Sweeney (R-N.Y.), who proposed the amendment to prohibit MCI from getting GSA contracts, said if House appropriators were unsatisfied with the GSA’s report, they still could push for an amendment when the full House considered the Transportation & Treasury appropriations bill once Congress returned. Sweeney’s amendment would have banned GSA contracts only with MCI, leaving the Defense Dept. free to continue to contract with the company.

The Senate Govt. Affairs Committee also is looking at MCI’s federal contracts, and Chmn. Collins (R-Me.) said Mon. that the latest allegations, if true, would “undermine MCI WorldCom’s claims that the fraud was limited to just a few ‘bad apples,'” and that the company had been thoroughly reformed. Collins said the law prohibited federal agencies from contracting with companies that didn’t have adequate “integrity and ethics.” “I am particularly concerned about the possibility that MCI WorldCom has engaged in fraud in its provision of government services. Some allegations even suggest that this activity may have compromised secure information. To the extent that these allegations prove true, they raise additional questions about MCI WorldCom’s business practices and ethics,” Collins said. The Senate Govt. Affairs Committee is looking for information from the GSA on how it concluded that MCI/WorldCom still was an appropriate recipient of federal contracts.

An FCC spokesman said the agency didn’t confirm or deny pending investigations. “The Commission will review the allegations, and appropriate action, if any, will be taken,” the spokesman said. In answer to a question, he said there wasn’t a specific FCC rule barring a company from making a long distance call into a local call, but there was a prohibition on stripping information from a call, for example caller ID or billing information.

A BellSouth spokesman said his company was using new technology manufactured by Agilent “to see if we were similarly victimized, and if so we will act accordingly.” BellSouth has been using the Agilent “black box” technology for a few months as a billing enhancement, he said: “Now we will be using it to more closely track local and long distance calls.”

The allegations come a month before a scheduled hearing before U.S. Bankruptcy Judge Arthur Gonzalez in N.Y. to confirm the reorganization plan. The revelations about the fraud allegations could throw the confirmation into disarray, although one industry source said it was too early to tell what the impact might be. WorldCom, which filed for Chapter 11 protection in July 2002, has been planning to emerge from bankruptcy this fall. Gonzalez on his own motion could seek more time in light of the questions raised by the allegations, or he could rule on a request filed by a 3rd party, the source said: “All of this is thrown into question.” The news of the Justice Dept. investigation caused WorldCom bond prices to dive Mon. Among the questions raised by industry observers were the timing of publicizing the charges. One source said they didn’t surface at a Senate Judiciary Committee hearing last week on the policy implications of the company’s Chapter 11 filing (CD July 23 p1). Verizon had reached an agreement just days before that hearing to not oppose WorldCom’s reorganization plan as part of a proposed $60 million settlement agreement that would put an end to disputes over how much the 2 companies owed one another. Verizon was expected at that time to maintain a public campaign highlighting what it believed was a lack of govt. enforcement action against WorldCom’s past actions.

UBS analyst John Hodulik in a Mon. note to investors said it was difficult to evaluate the veracity of the claims against WorldCom given the “constant wrangling” between carriers on interconnection fees. “The potential liability is substantial as is the risk that the company could lose its largest customer, the U.S. government,” he wrote. Anything that slowed the bankruptcy process of WorldCom or barred it from emerging from Chapter 11 would be a victory for AT&T and, “to a lesser extent,” Bell companies, Hodulik said. “Not only may this entitle the Bells to some substantial remuneration, it could help rationalize the hypercompetitive market for business voice and data services,” he wrote. AT&T shares were up 8.77% to $22.20 on the N.Y. Stock Exchange Mon. and Verizon rose 2.68% to $35.98. Edie Herman, Mary Greczyn, Terry Lane