Connect's fate in hands of PSC: employees reported concerns, unsealed FBI affidavit reveals. (Telecommunications).

TED "DUB" SNIDER JR. MARKETED HIS company, Connect Communications Corp. of Little Rock, as "a radically innovative telecom service provider."

An FBI affidavit suggests that the company's business plan was so radically innovative that even some employees worried that it constituted a fraud against Southwestern Bell Telephone Co.

And Snider's plan was so big that it has been cited as a primary reason that a new area code had to be created for northwest Arkansas.

These days Snider spends his time working with attorneys in an attempt to save what remains of Connect, which shut its doors last year. The company's fate is in the hands of the Arkansas Public Service Commission.

Southwestern Bell filed a complaint with the PSC alleging that Connect used high-tech telephone equipment to defraud Southwestern Bell of millions of dollars by creating artificial interexchange phone traffic. Connect denies the allegation and accuses Southwestern Bell of stiffing Connect for $10 million in legitimate fees.

A hearing on the case was held July 9-10, and the PSC is expected to rule this fall.

Snider blames the fall of his company on Southwestern Bell, which at one time paid Connect more than $1 million a month through a contract agreement.

"It's a big company putting a little company out of business," Snider said. "When you boil it all down, they want a lower rate than the one that we mutually agreed to."

SBC Southwestern Bell spokeswoman Nancy Pollock said Southwestern Bell enjoys competition and didn't want to put Connect out of business. But, she said, Bell is the victim in this dispute and is trying to get reimbursed for $10 million that it paid Connect for artificial telephone traffic.

Connect also blamed Southwestern Bell for an FBI raid in June 2001 on its office at 124 W Capitol Ave. No charges were ever filed. The FBI's affidavit filed in U.S. District Court was unsealed earlier this year and shows that Southwestern Bell did indeed provide information that led to the raid.

But the FBI also relied on the statements of former Connect employees who said they believed Connect was defrauding Southwestern Bell.

In documents filed with the PSC, a Southwestern Bell official said the more than 100,000 new phone numbers necessary for Connect's Internet service contributed to the decision by NeuStat, the national numbering administrator, to recommend adopting the 479 area code for northwest Arkansas.

"Those allegations are completely unsubstantiated," Snider said.

Beginnings

The two companies have been at each other's throats almost since Connect's inception in 1997.

The federal Telecommunications Act of 1996 attempted to end telephone monopolies and make it easier for new companies to enter into the telecommunications market.

The act requires incumbent telephone companies, such as Southwestern Bell, to allow newer ones, such as Connect, to access existing phone lines. The companies would pay each other fees when their customers called each other.

In 1997, Snider, a former nuclear engineering officer with the U.S. Naval Academy, invested $30 million of personal, family and friends' money to start a company that he hoped would become a full-service telecommunications provider.

"We wanted to be the customer s digital gateway to all manner of communication services, whether it be Internet, telecommuting, voice, video," he said. "Our vision was to have a broadband pipe to the customer and then provide them all the services they might want over that pipe.

"We felt like the sky was the limit."

In September 1997, Southwestern Bell met with representatives of Connect.

"Connect's representatives indicated that they were looking for help and support from Southwestern Bell because the Connect team did not have a significant amount of experience or technical expertise in becoming a telephone company," Robert Michael Phillips, an area manager for network interconnection for Southwestern Bell, said in testimony filed with the Public Service Commission.

They signed an interconnection agreement that required Southwestern Bell to pay Connect 1.2 cents a minute every time a Southwestern Bell customer made a local call to a Connect customer and vice versa. That contract eventually resulted in Connect receiving millions of dollars in revenue from Southwestern Bell, but it also led to its eventual closing.

The Dispute

Almost out of the gate, the agreement created problems.

In 1998, Connect filed a complaint with the PSC because Southwestern Bell wouldn't pay for its customers' use of Internet service providers in Connect's network.

Southwestern Bell said it shouldn't have to pay because the Internet calls were long-distance, which wasn't covered by the agreement. The PSC ruled in Connect's favor.

Southwestern Bell then filed suit asking the federal court to overturn the PSC's order. A federal judge dismissed the case in September 1999, saying the court didn't have jurisdiction.

Southwestern Bell waited nearly 15 months before it began complying with the PSC's order, but it did pay Connect $790,000 in March 2000. (It is unclear why Connect's annual report to the PSC claimed less than $16,000 in Arkansas revenue for 2000, when the company had 120 employees.)

That case is now back before the PSC, and a decision is pending.

By March 2000, Connect started taking off. It was receiving about $25,000 a month from Southwestern Bell as a result of its interconnection contract.

During an employee meeting in April or May 2000, according to a former employee's statement to the FBI, Snider talked about how great it was using SBC to create money through reciprocal compensation.

Snider said he doesn't recall making such a statement.

In early 2000, every telecommunication company was trying to figure out a way to offer broadband Internet access, Snider said.

Connect, through its sister company, ZipRamp Inc., unveiled a new service, Megaport, which provided customers with always-on, high-speed Internet access.

With little money to market the service, Connect decided to give it away to nonprofit organizations.

"It was sort of a grass-roots marketing strategy to go out to the nonprofits and provide them this service to get positive word of mouth and referrals," Snider said.

The plan was to then get members of the nonprofits' boards of directors to sign up for the service for their private businesses or to provide references in the community.

"That strategy was really starting to take hold and really work at the point that we had to shut down," Snider said.

In order to get free high-speed Internet service, the customer had to give Connect authority to order the installation of a "super trunk," which gave each customer 48 incoming telephone lines. Connect typically charged no fee for the service and also paid the $2,000 monthly fee for using the trunks.

The problem, according to Southwestern Bell, was Connect attached a call router to the customer's point of connection and programmed the devices to call designated Connect numbers in order to create artificial calls and thus inflate the number of connections for which Bell had to pay the interconnect fee.

Snider has a different explanation. "The purpose for the way they were programmed was to provide high-speed, always-on Internet access for our customers," he said.

Suspicions

Prior to June 2000, Connect never billed Southwestern Bell for more than 3.5 million minutes a month, Stephen G. Collins, executive director of financial operation in Industry Markets, a business unit of SBC Communications Inc., said in his testimony filed with the PSC May 28.

But in June 2000, the bill was for 8 million minutes, he said. By August 2000, it was 32 million, and by January 2001, it was 103 million.

Between July 2000 and January 2001, Southwestern Bell paid Connect $5.6 million for more than 470 million minutes of interconnection use, Collins said.

In Connect's annual report to the PSC, Connect said its revenue for 2001 was $8.65 million, enough to be ranked sixth among local exchange carriers in Arkansas. (See list, Pages 19-20.) According to Snider, Connect was relying on Southwestern Bell for more than 90 percent of its revenue.

SBC employees were suspicious of Connect's business plan, and so were some Connect employees.

On June 30, 2000, John Salsbury of Little Rock called SBC. He identified himself as a former Connect employee and said Connect was fraudulently billing SBC thousands of dollars in reciprocal compensation, according to the FBI's affidavit.

In an interview with the FBI almost a year later, Salsbury, who had worked for Connect as manager of information technologies between August 1999 and June 2000, said he believed Connect was "ripping off" SBC in several ways.

The main one was the Megaport business plan, Salsbury told the FBI.

"I think it's an outrageous characterization," Snider said of Saisbury's comments.

But Salsbury wasn't the only Connect employee who was uncomfortable with the business plan.

According to the FBI's affidavit, Cynthia Lee, who was the manager of regulatory affairs, said she told Snider about her concerns about the Megaport service. Snider told Lee the Megaport service was legal, she said.

Still, Lee contacted Connect's law firm, Swindler Berline Sheriff & Friedman in Washington, D.C., and asked about the legality of the service.

"The Swindler law firm told Lee that it was their opinion that the Megaport service was not legal and that Connect should back away from it," the affidavit said.

"I can't imagine why she would say that," Snider said. Snider wouldn't comment on any advice that attorneys have given him, but he said Lee might have made her statements because she was laid off along with other employees after Southwestern Bell stopped paying.

Lee relayed the attorney's information to a Connect executive, but he told her not to seek any legal opinion about the Megaport service, the affidavit said.

At Southwestern Bell, Karen Carter, a regional sales manager, was the marketing contact for Connect and saw its orders for T-1 super trunk lines explode in the spring of 2000.

Initially, Southwestern Bell could handle Connect's orders for the T-1s, Carter said in direct testimony filed May 28 with the PSC. But Southwestern Bell was concerned about being able to meet Connect's forecasted need for an additional 100 T-1 super trunks per month for the next several months in 2000.

"This forecast was abnormal, requesting many times over the number of T-1 super trunks Southwestern Bell usually sells in a one-year period," Carter said.

Up until that point, Carter said, the typical customer ordering a super trunk was a large business, but Connect was ordering super trunks for residential or light business areas, including house trailers and nonprofit organizations that had few computers.

"Even assuming that some of these customers were using Megaport service to transport data, it is highly unlikely that they generated traffic volumes that required two T-1 super trunks," she said.

And in none of the cases she reviewed did the customers need data. transmission 24 hours a day, seven days a week.

In August 2000, Carter sent an e-mail to a Southwestern Bell executive that said she discovered what Connect was doing. She also said Southwestern Bell was going to gather information on Connect to file a complaint with the PSC.

"Shutting this company down means lost revenue for [Southwestern Bell's] Marketing [department]," she said in the message, apparently referring to the revenue that would be lost from T-1 fees. "Obviously, we will not make our [Internet service] objective with competitors giving it away. However, as a shareholder I was appalled."

Snider said Carter's e-mail is evidence that Southwestern Bell wanted to shut down his company.

Between October and December 2000, Southwestern Bell was paying Connect about $1 million a month, but it wasn't enough. Connect said it was owed about $1.3 million a month. As a result, the company started laying off workers.

By the winter of 2000, orders for T-1 super trunks in Arkansas had slowed down, but Connect actively was marketing the service in Missouri and Oklahoma.

One of the final blows came on April 23, 2001, when Southwestern Bell informed Connect by letter that it would pay only $275,000 of Connect's $1.87 million bill for February 2001. Southwestern Bell said most of the minutes "do not appear to be compensable voice or data communications" or "are not based upon the originated switch recordings required" under the agreement.

Snider said the calls for which Connect billed were legitimate.

Southwestern Bell has put just over $1 million in an interest-bearing account until the PSC rules on whether the calls generated under Connect's plan are subject to payment.

But that offers little relief to Snider.

"We were really growing fast," Snider said.

Eventually he was hoping to sever the Southwestern Bell lifeline and rely on Connect's data services and long-distance programs for revenue.

"But we weren't allowed to get to that point," Snider said.

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