This error can occur if:
The modem is actually in use - make sure you don't have other applications that are using the modem. Applications that can use the modem include fax software, terminal software (like HyperTerminal), as well as voice software including software that can make your modem an answering machine or speakerphone.
One way of seeing all running applications is to press CTRL+ALT+DEL and look at the Task List or Task Manager. This will display the actual program names - it may be difficult to pinpoint which, if any, programs are accessing the modem. Terminating tasks are about the only way - however, if you terminate certain tasks, your system may crash or become unstable.
The telephone.ini file is missing or damaged - If the telephone.ini file is missing or damaged, you can create a new one by running Tapiini.exe - this file is in the \windows\system folder. Before you run this, rename the telephone.ini file and reboot your PC if it already exists. Then, run the tapiini.exe file. This program will run very quickly and may not appear to do anything. You can verify the program created the telephone.ini file by searching for it.
The telephone.ini file is a Microsoft Windows file that stores settings for all TAPI-enabled applications including DUNS.
Make sure the modem named in the DUNS entry matches the name of your installed modem - You can check the name of your modem in ControlPanel->Modems.
Windows 95/98 - Can occur if the Unimodem TAPI file (unimdm.tsp) is missing or damaged. See MS KB Q150619
Windows XP - Can occur if another device's driver has a conflict with the modem driver. MS KB 324760 indicates this can occur with older Palm Desktop HotSynch Software.
Also see these Microsoft KB articles:
The Modem is Not Installed... (Win98 & ME)
Troubleshooting Modem Problems in Win98