Three years after the breakup of American Telephone & Telegraph, many phone users are getting far less than they bargained for. In some instances, customers with small, new phone companies find their long-distance services jammed. And some people have seen their investment in small phone companies go bust.
Clearly, not all phone companies are fraudulent or poorly managed. But the ones that are have benefited from confusion about selecting long distance and have slipped through legal cracks. The Federal Trade Commission does not monitor them, and states govern them haphazardly, often failing to share information with one another.
``Because every state is wholly or partially deregulated, there's a lot of opportunity for companies to enter and leave,'' says Patty Van Slyke, a spokeswoman with the Kansas Corporation Commission, which has been among the most aggressive of the state regulators.
The number of new phone companies has surged, especially in the West and Southwest. Many thousands of people are believed to have lost money - and the number is growing rapidly. State prosecutors and public-utility commissions warn consumers to look carefully before signing up for phone services.
``We operate under the theory that if it looks too good to be true, it probably is,'' says Steve Gardner, assistant attorney general of Texas. Caveat emptor
The common thread among these companies is that they use a ``multilevel marketing'' plan - a structure similar to pyramid schemes, which are illegal in most states.
In these schemes, customers are lured by promises of huge commissions - $280,000 a month in the case of one long-distance reseller that is now bankrupt and being investigated by the Secret Service (which is authorized to investigate ``access-device fraud''). The commissions induce customers to sell the product to new recruits. The recruits find other recruits, and so on, down several layers.
A key difference is that these companies offer something tangible (long distance service), whereas pyramids generally don't sell a viable product and eventually collapse, leaving the last investors out of money.
These telephone services present another risk to subscribers: that they will rarely, if ever, be able to use the service they pay $100 or more for each month. Since the company leases a limited number of telephone lines from AT&T, US Sprint, MCI, or other carriers, the lines can get blocked as more people try to use them.
Ken Wegorowski of Los Angeles subscribed to Z-Tel, an Everett, Wash., subsidiary of Ideal, a multi-level marketer of food supplements. He was attracted by the prospect of flat-rate long-distance service (either $100 or $120 a month), and large commissions ($20 a month for each subscriber he brought on line directly, and $5 a month for each person signed up on subsequent layers). One customer's story
When he first began to use Z-Tel in November, the service was ``semi-usable,'' he says, with some of his calls getting through. But after Dec. 1, he says, ``there was nothing but trouble, because Z-Tel got a whole new group of people on line.''
After getting constant busy signals, he finally canceled the service. He has written for a refund but has not yet received a response.
Engineers at the Washington Utilities and Transportation Commission claimed that Z-Tel's blockage rate - the chance of a call's not getting through because of traffic - was ``upwards of 60 percent,'' says commission spokeswoman Maria Peeler. (AT&T, Sprint, and MCI have less than 1 percent blockage.)
In late December, the state ordered Z-Tel to stop selling phone services unless it made an escrow account by which dissatisfied customers could get their money back. A week ago the company increased its access to long-distance service by 20 percent by supplementing its WATS lines with US Sprint service. It concedes that a customer may have to redial six times to get through to the line.
Z-Tel is not unique. The most troubled company, which is being prosecuted in North Dakota, Wisconsin, and Wyoming, is Independent Communications Network (ICN) of Cody, Wyo., formerly of Wautoma, Wis.
Last year, Wisconsin brought suit against ICN for misrepresenting its service of unlimited long distance for $100 a month. Wisconsin claimed that the service was very limited, since only about 5 percent of the calls got through because of heavy traffic. (ICN claimed 38 percent got through.) To get down to a reasonable level of blockage, ICN would need at least 99 WATS lines, but it had only 9, although that was later increased to 24.
Last month, the court ruled ICN must stop soliciting customers with promises of large commissions and must disclose the 95 percent blockage rate in its marketing pitches. Repeated calls to ICN spokesmen about this and other cases and ICN's service were not returned. `The computer stopped dialing'
Even if the service is usable, there is a danger that these companies will disappear or go bankrupt. That presents a major inconvenience, sometimes on a large scale.
The government offices of Lawrence, Kan., subscribed to Telecom Management International Inc. (TMI), which offered a discount (not flat-rate) on long-distance service. One day in the summer of 1985, says Michael Wildgen, a public relations officer at the city offices, ``The computer suddenly stopped dialing, and that's the last we heard of them.''
Apparently, TMI had failed to pay its bills for access to the local switch, and the local phone company cut off TMI's service. The company declared bankruptcy that summer. Its officers are being sued for alleged securities fraud by some 1,000 investors who put up $7 million to buy shares in TMI, which was set up as a limited partnership. They claim management diverted money from operations, leaving the company bankrupt.
Mismanagement of funds is common to the pyramid setup, and regulators suspect it could be inherent in many of these telephone services. They warn customers that they could lose their up-front investment, often $100 to $250 in hookup fees and marketing materials.
``We take them [the company] to court and get an injunction,'' says Marjorie Leeper, an investigator at the Iowa attorney general's office, ``but then we turn around and the company has folded, the principals are nowhere to be found.''
Mr. Gardner at the Texas attorney general's office figures customers ``lost $300,000 to $400,000 in Texas alone'' when Starcom Inc., a long-distance reseller in Fort Worth, went under. Customers had been encouraged to deposit $150 to become ``independent distributors'' and sell the service for large commissions.
``Starcom proves the problem,'' he says. ``These companies are undercapitalized, take in a lot of money, and go belly up.'' Some services look OK
Consumers need not shun every multilevel marketing service that comes along. US Sprint, for example, has a contract with Network 2000, a multilevel marketer which Missouri regulators have investigated but found not to be in violation of the state's pyramid laws. MCI is distributed by Amway of Ada, Mich.
Network 2000 and Amway serve as marketing arms, not resellers, so the customer does not experience blockage problems. (The customer also does not pay more, since commissions for Network 2000 and Amway salespeople replace commissions that Sprint and MCI salespeople would have obtained.)
A consumer can beat these rates by 10 to 15 percent - safely - through a local company that has its own switching equipment, says Lawrence Humphrey, president of American Telecommunications Inc. in Lees Summit, Mo. That's because the expense for a local company is only the outgoing call (not incoming and outgoing, as with a national carrier). One company's story
American Telecom started as a local carrier in June. In an attempt to expand the company, Mr. Humphrey says, he had the ``poor judgment'' to begin marketing through a multilevel plan in September.
``Then it got out of control,'' he says. He claims about 200 of the 1,200 customers began selling or giving away access code numbers, and the company suddenly found itself with 2,000 users. This jammed the lines, people complained, and the requests for refunds began rolling in.
Such illicit distribution is widespread under multilevel marketing services, he says, causing risk not only to an unsuspecting consumer, but to the company. American Telecom is now $300,000 in the hole, is being investigated by the Missouri attorney general, and has received letters from Wisconsin, Ohio, Indiana, Washington, and Kansas since it stopped service on Dec. 1. Humphrey doubts he will begin service again. Problems facing regulators
Regulators say that before signing up with a telephone reseller, a consumer should always check with the state attorney general's office, public-utility commission, or Better Business Bureau to see if any complaints have been filed against the company. Even that precaution may not protect the consumer, however, since states have only haphazard ways of monitoring such companies.
Because these companies are too small to control market prices, they do not have to file their schedule of charges or practices with the Federal Communications Commission, nor obtain certificates to operate. States can require companies to register for intrastate service - if they can find them.
Often, the only way states know a company exists is if the utility commission starts getting complaints about it from consumers. Other signals: advertisements in local newspapers and tip-offs from consumer columnists. Locating the company and getting information from it is often difficult. Many companies are not listed in the phone book, so regulators must reach them by registered mail.
The problem worsens if investigators in one state want information about a company based in another. When Washington State was investigating ICN, ``We had to ship a summons to the sheriff'' in Wautoma, Wis., says Steve King at the utility commission, ``and they had to deliver it to ICN.
``You get farther and farther away, and it gets very clumsy, cumbersome, and expensive. We don't have the tools to go after them,'' he says.
Many states have been taken by surprise by the upsurge in these companies and have not channeled the resources into investigating them.
Another problem is the law. Generally, states go after such companies under their pyramid statutes. ``But it's not fraud in the traditional sense of the word,'' says Harry Newton, publisher of Teleconnect magazine. ``There's a product at the end of the line,'' which renders many pyramid statutes inapplicable, or tenuous at best.''
Consumers should rely on their own homework as much as on the state regulators to protect them from fraudulent companies. Notes Mr. King at the Washington Utilities Commission: ``Ultimately we get them, but it takes a long time.''