Why is modifying a web site in this way not copyright infringement? Is not AT&T creating an unauthorized derivative work?
It is! I used to run an Anon Service and had a lengthy discussion with my attorney about doing something like what they are doing.
My idea was to capture the banner ad's and replace them with my own as the proxy processed the web page. I was not going to add to it or inject scripts. Just replace the banner ad's with ones my sponsors were paying for.
The final decision was to go with a set of frames and tag the banner ad in the top frame as being a sponsor of the anon-service while displaying the requested page in the bottom frame.
The attorney assured me that replacing content in a page as it went through the proxy was violating the craters copyright.