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MCI's White Knight Comes Out Swinging

In the cutthroat field of telecom, MCI has always been a scrapper. So it struck many as strange when the second-largest carrier's new CEO, Michael D. Capellas, kept silent for a week after AT&T (T) accused his company of fraud. No longer.

Capellas first acquired a reputation as a corporate white knight at Compaq, where he was CEO and chairman, and then at Hewlett-Packard (HPQ), where he was president. Now he's charging into the fray, sword in hand. He has hired a Washington law firm to lead an internal investigation of AT&T's charge that MCI (MCWEQ) -- formerly knows as WorldCom -- illegally disguised long-distance calls as local ones to avoid access charges.

And he has mounted a legal challenge in the courts, filing a counterclaim on Aug. 4 in which it derides AT&T's accusations of wrongful call-routing as "frivolous to the core." He also has set out to personally contact MCI's biggest 100 customers and reassure them that it's innocent of any wrongdoing. Says supporter Mark Neporent, co-chairman of the unsecured creditors committee overseeing MCI's reorganization: "This guy is a rock under pressure. That's why we picked him."

"AN ADMISSION"? Capellas' rivals show no sign of backing down, however. On Aug. 6, AT&T filed a massive new counterclaim in bankruptcy court. And Verizon (VZ) and other phone companies may soon join the fight, insiders tell BusinessWeek Online. Rivals say they find MCI's legal response unconvincing. They contend that it confirmed routing traffic internationally but maintained the practice was legal.

"MCI's response was an admission it was routing traffic into Canada in order to insinuate it onto AT&T's network," says Verizon General Counsel William P. Barr, a former Attorney General during the Reagan Administration (see BW Online, 7/29/03, "Under WorldCom's Latest Cloud").

Federal prosecutors in New York are conducting a criminal investigation into that charge. And the federal government, unsatisfied with MCI's progress in beefing up internal controls and ethics programs, has barred MCI from winning new contracts. Its customer base continues to erode while some creditors grow skeptical. Both Capellas and other MCI officials declined to comment for this article.

IN-HOUSE INQUIRY. For all his public silence in the early days of the phone-routing flap, behind the scenes Capellas was anything but cool, according to company insiders. AT&T's charges caught him off guard, prompting him to rage at subordinates. At one point, the CEO told some he might resign if AT&T's accusations proved true under his watch. Says a creditor close to Capellas: "He wants to be as clean as the wind-driven snow."

That might help to explain why Capellas launched a massive internal investigation, hiring the Washington law firm of Gibson, Dunn & Crutcher to test the network and track how calls were routed. Investigators have interviewed scores of employees and reviewed contracts with third-party phone companies that were used to route calls.

The probers' initial finding: No evidence that MCI had done anything other than use standard industry practices to reduce access charges, they told Capellas. The findings form the backbone of the aggressive legal counterattack MCI mounted on Aug. 4, in which it branded AT&T's charges as a "cynical" attempt to manipulate the court in order to hurt a competitor.

"SHOCK AND AWE." Capellas & Co. aren't alone in their skepticism. Some industry observers see AT&T's charges as a last-ditch attempt to block MCI from emerging from bankruptcy. Says Blair Levin, managing director at Legg Mason: "It's the best shock and awe campaign I've seen in the industry."

Still, Capellas is waging a difficult fight. AT&T and the other phone companies contend they have mountains of evidence showing that MCI systematically disguised long-distance calls on their networks as local ones. "I don't have indications that any other carrier has done anything of the magnitude of what we saw in connection with our studies of MCI," says James D. Ellis, SBC Communication's (SBC) senior executive vice-president and general counsel.

For MCI and Capellas, this fight couldn't come at a worse time. The outfilt finally closed the page on its WorldCom accounting scandal on Aug. 6, when a U.S. bankruptcy court judge approved its $2.25 billion settlement with the Securities & Exchange Commission. But as bankruptcy court proceedings slog on amid new charges by AT&T, MCI continues to see its business erode, with ever more customers unwilling to renew contracts with a company that can't seem to shake scandal.

And as business declines, so does some creditors' confidence. Capellas, who has always relished the role of the white knight, may be involved in the biggest joust of his career. By Charles Haddad in Atlanta

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