How the Justice Department Helped Birth a Multibillion Dollar Phone Scam

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Recently, the Federal Communications Commission, the Federal Trade Commission and the Senate have all taken aim at "cramming," a multibillion dollar industry that cheats phone customers by adding bogus fees to their bills. But the groundwork for this massive swindle -- which affects an estimated 17% of all households -- began with the much-ballyhooed breakup of AT&T (T). Now, almost 30 years after the Justice Department unwittingly opened the floodgates to a tidal wave of fraudsters, several other government organizations are trying to close them.

Cramming: A Quiet Con

The FCC defines cramming as "the illegal placement of an unauthorized fee onto a consumer's monthly phone bill." Averaging roughly $6, these small surcharges are designed to be overlooked by consumers. In fact, up to 95% of affected phone users pay these fraudulent fees for years without realizing that they represent services that are unnecessary, unrequested, unwanted and unused.

According to a recent report issued by the Senate, telephone companies cram more than 300 million such charges -- totaling over $2 billion -- onto phone bills every year. In addition to victimizing an estimated 20 million American households, these crammed charges also hit small businesses, big corporations, and even the government itself. They have showed up on Internet data accounts, fire alarm lines, security systems and even 911 phone lines, and their victims range from small doughnut companies to the city of Los Angeles.

These little levies add up: The Senate report cites the case of one California phone customer who found that bogus fees on his phone bills totaled more than $1,000, and the FCC recently highlighted the case of a Texas doctor whose crammed charges added up to more than $430. For some corporate and government victims, the toll is even higher: Recently, the U.S. Post Office announced that it had hired consultants to hunt down and dispute at least $110,000 in crammed charges since 2006. Had each of these crammed bills gone unchallenged for a year, they would have added up to more than $550,000.

How Did Cramming Start?

The cramming problem is a classic example of unintended consequences. In 1982, when AT&T broke into seven regional "Baby Bells," it looked like the company's stranglehold on American telecommunications was broken. Soon, numerous companies -- including AT&T, Sprint (S), and MCI -- were competing for the long-distance market. In order to simplify phone bills and encourage competition, the FCC ruled that the Baby Bells had to place third-party long distance charges on their bills. In other words, companies like Bell Atlantic had to adjust their billing so customers could pay for both their local phone service and their MCI long distance with a single check.

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Soon afterward, the FCC relaxed its rules, permitting the Baby Bells to reject third-party charges if they so desired. However, rather than refusing third-party billings, these regional phone companies actually expanded them, allowing a variety of companies -- many completely unrelated to telephony -- to attach charges to their bills. Before long, according to a Senate report, "telephone numbers worked much like credit card numbers. Consumers could purchase services with their telephone numbers, and the charges ... would later appear on their telephone bills."

By the 1990s, third-party billing was attracting a motley crew of schemers and scammers, leading many consumers to complain to the FCC, the FTC, and other government agencies. Reviewing the problem in 1999, the FTC noted that "con artists have found the telephone billing and collection system to be a fertile area to defraud consumers ... these stealth 'operators' are arranging to put charges on a consumer's phone bill for services that were never ordered, authorized, received, or used."

A big part of the problem lay with the Baby Bells, which, according to the FTC, hadn't developed "the kind of effective mechanisms for risk assessment and fraud prevention that characterize other billing and collection systems." In other words, the phone companies had created a situation in which phone numbers functioned as credit cards, but didn't provide the protection that credit card companies were legally obligated to deliver.

Ask Not for Whom the Baby Bell Tolls ...

In 1999, the FTC prophesied that cramming "may undermine confidence in the integrity of the phone system." Since then, this has proven to be a major understatement, and many customers have asked why respectable, mainstream phone companies like Verizon (VZ), AT&T, and Comcast (CMCSA) would willingly allow shady third parties to stick charges on their bills.

The answer is obvious, if a bit depressing: money. For each charge that gets included on a bill, telephone companies receive a small fee -- generally a dollar or two. Given that at least 300 million of these charges are added to bills every year, it isn't hard to see how selling out has become a very profitable sideline for AT&T, Verizon, and other phone service providers. A recent Senate investigation discovered that AT&T, Verizon and Qwest earned more than $650 million from third-party charges between 2006 and 2011.

In the late 1990s, Congress began searching for ways to rein in cramming. The phone companies responded by promising to handle the problem themselves. Their solution was to develop a list of "best-practices" guidelines that were designed to clarify phone bills and make it harder for scammers to enroll unwitting phone customers. Unfortunately, adoption of the guidelines was voluntary and -- as Joel Gurin, chief of the FCC's Consumer and Governmental Affairs Bureau notes, "these efforts did not stem the tide" of crammed charges.

Instead, crammers became more sophisticated. In addition to basic scammers, other types of companies developed to further divvy up the cramming pie. On the billing end of the equation, "aggregators" helped connect third-party vendors to phone companies, making it easier for scammers to get charges placed on phone bills. On the other end, "lead generators" gathered together lists of phone customers that third-party vendors could sign up for various unwanted services. And, in the middle, "hub companies" gathered together several third-party vendors under one roof, making it almost impossible for phone customers to escape the spider's web of crammers. If a customer complains about one vendor, a hub company can close the account, then shift the customer's name over to another third-party scam that it controls.

What Is the Government Doing?

Cramming schemes rely on confusion: Phone customers who understand their bills are often quick to identify illegitimate charges. Consequently, the FCC has focused on clarifying phone bills and making it easier for customers to seek help for dealing with phone scams. The commission's Truth-in-Billing rules, for example, require that phone companies use "clear, non-misleading, plain language" to explain the services for which they charge their users. Bills must explicitly identify the companies that provide each service, and must clearly display toll-free numbers that customers can use to ask about or dispute charges on their bills.

Another tool in the scammers' arsenal is fear. Many customers worry that failure to pay some part of their phone bill will result in disconnection. This isn't entirely true: While charges for basic telephone services -- which the FCC calls "deniable charges" -- must be paid, a refusal to pay other charges will not result in disconnection. To clarify this differentiation, the FCC's Truth-in-Billing rules require that phone companies tell their customers which charges are connected to basic services and which are not. Additionally, the FCC is working on rule changes that will require phone companies to clearly separate phone company charges from those of third-party service providers.

Some states have moved even further against crammers. Virginia and Vermont, for example, have banned almost all third-party charges from landline phone bills. The FCC, however, is proceeding more carefully: As Gurin notes, the commission "must balance the benefit to consumers with the burden on industry." While it has asked for public comment about the possibility of a total ban on third-party charges, its current focus is on making it easier for customers to understand and redress problems with their bills.

What Can You Do?

When it comes to protecting yourself against cramming, Gurin recommends vigilance: "You should carefully review your phone bill every month ... review it the way you would review your credit card bill." If there are any confusing charges, if it seems like you are being charged multiple times for the same service, or you find charges for services that you don't use, the next step is to call the phone company and the third-party vendor who placed the charges.

Unfortunately, many customers have found that their phone service providers tend to give them the runaround. Gurin stresses that, "If customers feel like they are being shuttled back and forth between the phone provider and the third party," they need to seek outside help. He suggests that they call the FCC. In addition to pursuing rules to protect consumers, the commission can also offer more direct help: "Mediating on behalf of consumers is part of our job," he says.

Bruce Watson is a senior features writer for DailyFinance. You can reach him by e-mail at, or follow him on Twitter at @bruce1971.

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