[Federal Register Volume 69, Number 27 (Tuesday, February 10, 2004)]
[Rules and Regulations]
[Pages 6181-6192]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-2732]


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FEDERAL COMMUNICATIONS COMMISSION

47 CFR Part 54

[CC Docket No. 02-6; FCC 03-323]


Schools and Libraries Universal Service Support Mechanism

AGENCY: Federal Communications Commission.

ACTION: Final rule.

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SUMMARY: In this document, the Commission addresses several matters 
related to the administration of the schools and libraries universal 
service mechanism (also known as the e-rate program). The adopted rules 
will advance the goals of the schools and libraries program by making 
support for internal connections regularly available to a larger number 
of applicants and by discouraging waste, fraud, and abuse. The 
Commission also adopts rules that provides additional certainty to 
applicants by clarifying existing rules and procedures.

DATES: Effective March 11, 2004 except for Sec. 54.513(c) which 
contains information collection requirements that have not been 
approved by the Office of Management Budget (OMB). The Commission will 
publish a document in the Federal Register announcing the effective 
date of that paragraph.

FOR FURTHER INFORMATION CONTACT: Kathy Tofigh, Attorney, at (202) 418-
1553, Karen Franklin, Attorney, at (202) 418-7706, or Jennifer 
Schneider, Attorney, at (202) 418-0425 in the Telecommunications Access 
Policy Division, Wireline Competition Bureau.

SUPPLEMENTARY INFORMATION: This is a summary of the Commission's Third 
Report and Order in CC Docket No. 02-6; FCC 03-323, released on 
December 23, 2003. There was also a Companion Second Further Notice of 
Proposed Rulemaking released in CC Docket No. 02-6; FCC 03-323, on 
December 23, 2003. The full text of this document is available for 
public inspection during regular business hours in the FCC Reference 
Center, Room CY-A257, 445 Twelfth Street, SW., Washington, DC 20554.

I. Introduction and Summary

    1. In this Third Report and Order, we address several matters 
related to the administration of the schools and libraries universal 
service mechanism (also known as the e-rate program). First, we adopt 
rules that will limit the ability of schools and libraries to engage in 
wasteful or fraudulent practices when obtaining internal connections. 
Specifically, we conclude that eligible entities should be precluded 
from upgrading or replacing internal connections on a yearly basis. 
Instead, our rules will permit a particular eligible entity to receive 
support for discounted internal connections services no more than twice 
in every five years. We will permit, however, entities to receive 
discounts on basic maintenance associated with internal connections on 
a yearly basis, but clarify our rules regarding permissible maintenance 
costs to ensure that such discounts are appropriately narrow. We also 
prohibit a school or library from transferring equipment purchased with 
universal service discounts, as part of eligible internal connections 
services, for a period of three years except in limited circumstances. 
These rules will advance the goals of the schools and libraries program 
by making support for internal connections regularly available to a 
larger number of applicants and by discouraging waste, fraud, and 
abuse. We also adopt a rule creating a more formal process for updating 
annually the list of services eligible for support. In addition, we 
codify the Universal Service Administrative Company's (USAC or the 
Administrator) current

[[Page 6182]]

practices for allocating costs of services between eligible and 
ineligible components consistent with Commission rules and 
requirements, codify a prohibition on the provision of free services to 
entities receiving discounts, and codify with one modification 
procedures for service substitutions. We also clarify existing 
requirements for eligibility of certain equipment and services. 
Finally, we adopt rules to implement our prior decision to carry 
forward unused funds from the schools and libraries mechanism for use 
in subsequent funding years. All rule changes and clarifications shall 
be implemented upon the effective date of this Order, unless specified 
otherwise.
    2. This Order is one of a series of orders designed to simplify 
program administration, ensure equitable distribution of funds, and 
protect against waste, fraud, and abuse. In taking these additional 
steps today, we draw on information from a number of sources, including 
issues raised in a public forum held in May 2003 on ways to improve the 
schools and libraries support mechanism, the Office of the Inspector 
General's semi-annual reports, beneficiary audit reports, and the 
recommendations of USAC's Waste, Fraud, and Abuse Task Force. We remain 
committed to making ongoing changes to ensure that this program 
continues to benefit school children and library patrons across 
America.

II. Third Report and Order

A. Limits on Use of Internal Connections

    3. In this Order, we adopt a rule limiting each eligible entity's 
receipt of discounts on internal connections to twice every five 
funding years. We exempt basic maintenance services from this 
restriction. We also clarify the types of maintenance services that are 
eligible for discounts. In addition, we adopt a rule that limits an 
entity's ability to transfer equipment purchased with universal service 
funds.
    4. Frequency of Discounts. We conclude that each eligible entity 
may receive commitments for discounts on Priority Two services, except 
as discussed further, no more than twice every five funding years. The 
practical effect of this rule will be to permit applicants to receive 
funding once every three years for internal connections, as supported 
by the record, but will allow applicants to obtain internal connections 
in two consecutive years as part of a staged implementation of internal 
connections. In order to give applicants sufficient planning time, we 
conclude that this rule will become effective beginning with support 
received in Funding Year 2005. Commitments for Priority Two services 
received in years prior to Funding Year 2005 will not be considered in 
determining an applicant's eligibility to receive support for Priority 
Two services.
    5. For the purpose of determining whether an applicant is eligible 
to receive a funding commitment for Priority Two services under this 
rule, the five-year period begins in any year, starting with Funding 
Year 2005, in which the entity receives discounted Priority Two 
services. The rule is applicable to discounts for services that are 
site-specific to the entity and for services that are shared by the 
entity with other entities. Thus, if an entity receives support only 
for shared services in a particular funding year, that funding will be 
counted as one of the two years out of five that it may receive 
support. The restriction does not apply to consortium members who do 
not actually receive Priority Two funding when other members of the 
consortium receive discounts in specific funding periods.
    6. We find that, by limiting the frequency in which applicants may 
receive Priority Two discounts, funds will be made available to more 
eligible schools and libraries on a regular basis. Specifically, we 
find that the twice-every-five-years rule we adopt balances this goal 
with the need to ensure that the most disadvantaged schools and 
libraries are able to maintain functioning internal connections 
networks. Permitting applicants to receive support more often than 
twice every five years would not make funds available to significantly 
more eligible schools and libraries, while limiting applicants to 
support less frequently than twice every five years could prevent 
applicants from updating their internal connections as necessary.
    7. We are not persuaded by those commenters that assert that the 
most disadvantaged applicants will suffer from a policy restricting 
receipt of internal connections discounts. The Commission remains 
committed to ensuring that discounts continue to flow to schools and 
libraries that are economically disadvantaged. Indeed, program rules 
continue to provide greater discounts for the most economically 
disadvantaged schools and libraries. We recognize, however, that many 
applicants below the very highest discount levels are also economically 
disadvantaged and also unable to acquire internal connections without 
universal service support. We also recognize that demand for universal 
service discounts will likely continue to exceed the annual funding 
cap. Thus, we agree with commenters that without revising our existing 
policies, some economically disadvantaged applicants will continue to 
be denied Priority Two funding. We find that the twice-every-five-years 
restriction is appropriate and necessary to make advanced technologies 
more accessible to all schools and libraries. We further find that the 
twice-every-five-years policy will increase the mechanism's funding 
reach to a greater number of economically disadvantaged schools and 
libraries.
    8. It is important to note that even with this revised policy on 
the funding of internal connections, funding commitments will continue 
to be made in accordance with the annual funding cap. Thus, it is 
conceivable that an applicant may be eligible to apply for discounts on 
Priority Two services and still be denied funding because demand for 
discounts exceeds available funding. In this instance, we encourage 
applicants to reapply for discounts during the following funding year. 
We further note that it is the receipt of support for Priority Two 
services, rather than the application for support, that counts toward 
the limitation that an entity may receive in only two out of five 
years.
    9. Furthermore, we conclude that, by precluding a particular entity 
from receiving support for Priority Two discounts every year, our 
modified rule strengthens incentives for applicants to fully use 
equipment purchased with universal service funds. Our current rules 
permit applicants in the highest discount bands to upgrade their 
equipment on a yearly basis, even when existing equipment continues to 
have a useful life. By limiting each eligible entity's ability to 
receive support for internal connections, recipients will have greater 
incentive not to waste program resources by replacing or upgrading 
equipment on an annual basis.
    10. A few commenters maintain that limiting funding of internal 
connections will disrupt applicants' planning and budgets. We recognize 
that our modified rule will limit applicant flexibility to some extent, 
particularly for those applicants that wish to make modest 
infrastructure investments on a yearly basis. But, we conclude that the 
benefits of the rule--namely, making support available to more 
applicants on a regular basis and preventing wasteful and abusive 
practices--outweigh the potential impact on such applicants. We find 
that the twice-every-five-years restriction provides sufficient 
flexibility

[[Page 6183]]

for applicants to make efficient use of Priority Two funding, and thus 
is reasonable. In particular, we recognize that for a variety of 
different reasons, an applicant may not be able to make efficient use 
of program discounts in a single year. For example, an applicant's 
annual resources may require the applicant to extend its costs over a 
period of years. Our modified rule allows an applicant to seek internal 
connections discounts in two consecutive years, thus, enabling an 
entity to spread its costs over two funding years. We conclude that 
providing applicants the flexibility to implement internal connections 
over two consecutive years is sufficient to accommodate the differing 
planning and budgetary needs of most applicants. We expect applicants 
to assume the responsibility of adequately planning and budgeting to 
make the most effective use of discounts available to them.
    11. USAC also suggests that in an effort to counter funding 
limitations, some applicants may request more funding than they will be 
able to use in a given funding year. We emphasize that existing program 
rules require applicants to examine their technology needs and 
budgetary resources before making funding requests to ensure that 
applicants make effective use of any discounted services that they 
receive. Failure to have an approved technology plan is a violation of 
our current rules. We expect funding requests to be based on an 
applicant's technology plan, not based on a scheme to maximize funding. 
A funding request that is not reasonably based on a technology plan 
does not constitute a bona fide request for services. Further, the 
Administrator's review and enforcement of the necessary resources 
certification must and will continue to serve as a safeguard against 
unreasonable funding requests.
    12. Maintenance Costs. We agree with commenters that maintenance 
costs should be exempt from the twice-every-five-years restriction. The 
Universal Service Order, 62 FR 32862, June 17, 1997, provides that 
support for internal connections includes ``basic maintenance.'' 
Maintenance costs associated with internal connections services are 
currently eligible for discounts as a Priority Two service. Proper 
maintenance of internal connections products ensures that equipment 
functions properly, thereby limiting uneconomical replacement of 
equipment. We therefore continue to allow applicants to apply for 
discounts for maintenance of equipment each funding year.
    13. We instruct USAC to revise Block 5 of the FCC Form 471 to 
include a separate category of service for maintenance requests, with 
this form change to take effect for Funding Year 2005. Maintenance 
requests will continue to be funded as Priority Two funding. However, 
maintenance requests will be considered for funding separately from 
other requests for Priority Two funding and, therefore, will not be 
subject to the twice-every-five years funding rule we adopt in this 
Order. The revision of the FCC Form 471 will allow efficient review of 
the Priority Two funding requests.
    14. In response to allegations of waste, fraud, and abuse, we 
prospectively clarify the services eligible for Priority Two support as 
basic maintenance costs for internal connections. Although the 
Universal Service Order allows support for those internal connections 
services that are ``necessary to transport information all the way to 
individual classrooms'' and public areas of a library, and specifically 
authorizes support for ``basic maintenance services'' that are 
``necessary to the operation of the internal connections network,'' our 
rules do not expressly specify the types of maintenance costs that are 
eligible for support. In light of our concerns about allegations of 
waste, fraud, and abuse in this area and our changes, we conclude that 
we should provide further clarity on what maintenance services are 
``necessary'' under the terms of the Universal Service Order, and thus 
eligible for support and exempt from the twice-every-five-years rule.
    15. Basic maintenance services are ``necessary'' if, but for the 
maintenance at issue, the connection would not function and serve its 
intended purpose with the degree of reliability ordinarily provided in 
the marketplace to entities receiving such services without e-rate 
discounts. Basic maintenance services do not include services that 
maintain equipment that is not supported or that enhance the utility of 
equipment beyond the transport of information, or diagnostic services 
in excess of those necessary to maintain the equipment's ability to 
transport information. For example, basic maintenance will include 
repair and upkeep of previously purchased eligible hardware, wire and 
cable maintenance, and basic technical support, including configuration 
changes. On-site technical support is not necessary to the operation of 
the internal connection network when off-site technical support can 
provide basic maintenance on an as-needed basis. Services such as 24-
hour network monitoring and management also do not constitute basic 
maintenance. Such services are therefore ineligible for discounts under 
the schools and libraries universal service mechanism.
    16. We also provide greater clarity as to how USAC should address 
requests for discounts on technical support for internal connections. 
When confronted with products or services that contain both eligible 
and ineligible functions, USAC, in the past, has utilized cost 
allocation to determine what portion of the product price may receive 
discounts. We generally endorse this practice as a reasonable means of 
addressing mixed use products and services. At the same time, however, 
we are concerned that it is administratively difficult and burdensome 
to derive reasonable cost allocations for the eligible portions of 
services provided under a technical support contract. In a rapidly-
changing marketplace, with vendors supplying complex packages of 
services, it simply is not administratively feasible to determine what 
portion of a technical support contract is directed to basic 
maintenance. Therefore, we hereby clarify prospectively that technical 
support, including on-site Help Desks, is not eligible under our rules 
if it provides any ineligible features or functions. A Help Desk system 
typically goes beyond the level of support authorized by the Commission 
in the Universal Service Order, which stated that ``[s]upport should be 
available to fund discounts on such items as routers, hubs, network 
file services, and wireless LANs and their installation and basic 
maintenance * * *.'' There is no language in the Universal Service 
Order that contemplates the provision of discounts for the 
comprehensive level of support typically provided by a Help Desk. On 
the contrary, the Universal Service Order indicates that support will 
be provided for a product or service ``only if it is necessary to 
transport information all the way to individual classrooms. That is, if 
the service is an essential element in the transmission of information 
within the school or library * * *.'' We conclude that if a technical 
support contract provides more than basic maintenance, it shall be 
ineligible for discounts under our modified rules. We instruct USAC to 
review and fund requests for discounts on maintenance services in 
accordance with this clarification, as of the effective date of this 
Order.
    17. Equipment Transfers. We also find it appropriate to amend our 
rules expressly to prohibit, except as provided below, the transfer of 
equipment purchased with discounts from the schools and libraries 
universal

[[Page 6184]]

service support mechanism. The Act prohibits the sale or transfer of 
equipment purchased with discounts from the universal service program 
in consideration of money or anything else of value. Here, in order to 
promote the goal of preventing waste, fraud, and abuse, we extend that 
prohibition to all transfers, without regard to whether money or 
anything of value has been received in return for a period of three 
years after purchase.
    18. Recipients of support are expected to use all equipment 
purchased with universal service discounts at the particular location, 
for the specified purpose for a reasonable period of time. Purchasing 
equipment with universal service discounts and then replacing or 
upgrading that equipment annually or almost annually is unnecessary and 
not economically rational. Unnecessary replacement of equipment 
suggests that entities are not fully utilizing the equipment purchased 
with universal service discounts. We agree with commenters that such 
practices deprive other eligible entities of the full benefits of the 
schools and libraries universal services program. Moreover, the 
practice of purchasing equipment with universal service funds, then 
transferring that equipment to other schools and libraries with lower 
discount rates would undermine the intent of the Commission's priority 
rules, and is therefore prohibited. We find, however, that it would be 
wasteful to prevent recipients from transferring equipment that, after 
a reasonable period of time, has been replaced or upgraded. We 
therefore permit recipients freely to transfer equipment to other 
eligible entities three years or more after the purchase of such 
equipment. Consistent with the Act, however, such transfers must not be 
in consideration of money or anything else of value.
    19. We agree also with commenters that argue that applicants may 
have legitimate reasons to transfer internal connections equipment due 
to the closing of a school or other eligible facilities. For example, 
due to a natural disaster, a school district may conclude that its 
needs are best served by temporarily or permanently closing a 
particular school and transferring its students, as well as any 
valuable equipment purchased with supported discounts, to other 
locations. Similarly, a school district may choose to close, remodel, 
or consolidate a particular school to meet changing demographic needs 
or fiscal realities, and thereby transfer the students and useable 
school property to a nearby school. Likewise, a county or municipality 
may choose to close a library branch for financial reasons. Under these 
circumstances, we find that it would be economically rational and 
consistent with the goals of the schools and libraries program for the 
support recipient to transfer any equipment it has purchased with 
universal service discounts to another eligible location where the 
equipment may be used effectively. We therefore conclude that a 
recipient may transfer equipment purchased with universal service 
discounts to other eligible entities if the particular location where 
the equipment was originally installed is permanently or temporarily 
closed. In these limited circumstances, we note that it is not 
necessary for the transferring and receiving entities to have 
comparable discount levels, as long as each is eligible under the 
schools and libraries program.
    20. In the event that a recipient is permanently or temporarily 
closed and equipment is transferred, the transferring entity must 
notify the Administrator of the transfer, and both the transferring and 
receiving entities must maintain detailed records documenting the 
transfer and the reason for the transfer for a period of five years. We 
instruct the Administrator to verify compliance with this requirement 
as part of its beneficiary audit reviews. In order to enable the 
Administrator to verify compliance with this transfer prohibition, we 
require all recipients of internal connections support to maintain 
asset and inventory records for a period of five years sufficient to 
verify the actual location of such equipment.
    21. This rule change shall be implemented upon the effective date 
of this Order. To facilitate enforcement of this rule, we will amend 
the FCC Form 471 for Funding Year 2005 to include a reasonable use 
certification. In order to receive discounts, applicants must certify 
that they will use all equipment purchased with universal service 
discounts at the particular location for the specified purpose. 
Applicants will thereafter be held accountable for their compliance 
with the reasonable use certification.
    22. We decline to institute useful life criteria for equipment 
purchased with universal service funds. Useful life criteria could 
provide a more equitable distribution of Priority Two funding and 
ensure that more applicants receive the full benefit of the program by 
ensuring that applicants did not replace equipment components of 
internal connections services more frequently than necessary. We 
believe, however, that measures adopted, including the restriction of 
transfers and our revised policy governing the funding of Priority Two 
equipment, will provide similar results in achieving these goals. We 
also conclude that developing and enforcing useful life criteria would 
add a significant degree of complexity to the program, which would 
result in increased administrative costs and burden for both recipients 
and USAC.

B. Eligible Services

    23. Although the current cost allocation approach used by the 
Administrator reasonably implements the Commission's rules and 
requirement regarding eligible and ineligible services, we conclude 
that administration of the schools and libraries support mechanism 
would benefit from an explicit rule regarding the cost allocation for 
services with mixed eligibility. We also conclude that the eligibility 
process would be improved by adopting a rule for the yearly updating of 
the eligible services list. Additionally, we codify rules prohibiting 
the provision of ``free'' services to recipient schools and libraries 
by service providers that also provide supported services to those 
schools and libraries and codify procedures for applicants to modify 
funding requests that have been granted but not yet funded. Finally, we 
provide additional guidance on the provision of discounts on services 
that include the lease of on-premises equipment.
    24. Cost Allocation. We specifically amend our rules to make clear 
how applicants and service providers should allocate costs of a service 
or product that, although generally eligible for universal service 
support, contains both eligible and ineligible components. In the 
Universal Service Order, the Commission concluded that, when a school 
or library signs a contract for both eligible and ineligible services, 
the contract must break out the price of eligible services separately 
from ineligible services. Since that time, the marketplace has seen an 
evolution of products and services that contain both eligible and 
ineligible features but which are not commercially available on an 
unbundled basis. Thus, the issue has evolved from merely separately 
listing eligible services and products from ineligible services and 
products to one of determining what components or features of an 
otherwise eligible service or product may be ineligible when the 
service or product is not commercially available on an unbundled basis. 
Consistent with the Commission's directive to separate these costs, the 
Administrator has generally required schools, libraries, or the service 
provider to separate the costs of an ineligible component from what 
generally would be an eligible service or

[[Page 6185]]

product. As explained, the Administrator has provided reasonable 
guidance, consistent with Commission rules and requirements, to 
schools, libraries, and service providers in determining the allocation 
approach.
    25. As part of our efforts to improve the operation of the 
eligibility determination process, we explicitly amend our rules to 
include cost allocation rules for services and products that contain 
mixed eligible and ineligible components, features, or functions to 
provide greater clarity in this area. Under these rules, if a product 
or service contains ineligible components, costs should be allocated to 
the extent that a clear delineation can be made between the eligible 
and ineligible components. The clear delineation must have a tangible 
basis and the price for the eligible portion must be the most cost-
effective means of receiving the eligible service. If the ineligible 
functionality is ancillary, the costs need not be allocated to the 
ineligible functionality. An ineligible functionality may be considered 
``ancillary'' if (1) a price for the ineligible component that is 
separate and independent from the price of the eligible components 
cannot be determined, and (2) the specific package remains the most 
cost-effective means of receiving the eligible services, without regard 
to the value of the ineligible functionality.
    26. These cost allocation rules address the widespread availability 
of products and services with mixed eligibility and are fully 
consistent with the overriding requirement that support be provided for 
eligible services, while preventing support for ineligible services. By 
providing service providers and applicants a means of allocating costs 
between eligible and ineligible components, features or functions of 
what would otherwise be an eligible service, the cost allocation method 
increases the variety of service options available to schools and 
libraries, improving each school or library's ability to purchase the 
most useful and cost-effective service possible. Without this cost 
allocation approach, applicants may fail to pursue the purchase of 
certain advanced telecommunications and information services, contrary 
to the intent of section 254. Our E-rate rules should not drive the 
development of communications services and technologies, but rather 
should permit the marketplace to flourish and innovate in ways that 
meet consumer needs and facilitate access to these innovations. Schools 
and libraries should continue to allocate eligible and ineligible costs 
in their contracts with service providers. In the interests of ensuring 
that support be provided only for eligible services, the Administrator 
also should continue to employ the use of the cost allocation method 
when necessary.
    27. The Commission recently addressed those circumstances where an 
applicant erroneously identifies certain costs as eligible for support 
by adopting the 30 percent rule. Specifically, we concluded in the 
Second Report and Order, 68 FR 36931, June 20, 2003, that where less 
than 30 percent of a request for support is ineligible, the 
Administrator is permitted to grant support, reduced by the amount of 
ineligible services. We clarify that the Administrator may rely on the 
cost allocation methods we adopt today in applying the 30 percent rule 
and performing any resulting adjustments.
    28. Eligible Services List. We now adopt a more formalized process 
for updating the eligible services list, beginning with Funding Year 
2005. Under the new rule, USAC will be required to submit by June 30 of 
each year a draft of its updated eligible services list for the 
following funding year. The Commission will issue a Public Notice 
seeking comment on USAC's proposed eligible services list. At least 
sixty days prior to the opening of the window for the following funding 
year, the Commission will then issue a public notice attaching the 
final eligible services list for the upcoming funding year. The 
Commission anticipates that this public notice will be released on or 
before September 15 of each year. This process will provide greater 
transparency to the development of the eligible services list. The 
yearly updated list will interpret what may be funded under current 
rules, and will represent a safe harbor that all applicants can rely on 
in preparing their applications for the coming funding year. It will 
provide interested parties, both recipients and service providers, an 
opportunity to bring to the Commission's attention areas of ambiguity 
in the application of current rules in a rapidly changing marketplace. 
Currently, the only way an applicant can determine whether a particular 
service or product is eligible under our current rules is to seek 
funding for that service or product, and then seek review of the 
Administrator's decision to deny discounts. The rule we adopt today 
will simplify program administration and facilitate the ability of both 
vendors and applicants to determine what services are eligible for 
discounts.
    29. Prohibition of ``Free'' Services. We also take this opportunity 
to clarify and amend our rules to codify a prohibition on the provision 
of free services to an eligible entity by a service provider that is 
also providing discounted services to the entity. The Commission 
requires that an entity must pay the entire undiscounted portion of the 
cost of any services it receives through the schools and libraries 
program. For the purpose of this program, the provision of unrelated 
free services by the service provider to the entity constitutes a 
rebate of the undiscounted portion of the costs, a violation of the 
Commission's rules. Codifying this existing restriction will clarify 
the obligations of schools and libraries that receive discounted 
services under the schools and libraries program and improve the 
ability of the Commission to take appropriate enforcement action.
    30. Service Substitution. Again, as part of our efforts to improve 
the operation of the schools and libraries support mechanism, we also 
formally adopt and codify the Administrator's current procedures 
relating to requests for service or equipment changes. These procedures 
provide flexibility to applicants where it has become necessary to make 
a minor modification to their original funding request. We find that 
the Administrator's service substitution procedures are consistent with 
the Commission's goal of affording schools and libraries maximum 
flexibility to choose the offering that meets their needs most 
effectively and efficiently. We conclude that codifying these existing 
procedures in our rules will facilitate USAC's administration of the 
schools and libraries support mechanism. In codifying USAC's procedures 
in our rules, we make one modification, however. USAC's current 
procedures permit a service substitution only if the substitution does 
not result in an increase in the pre-discount price of the eligible 
service. We will permit applicants to substitute an eligible service 
with a higher pre-discount price, but will provide support based on the 
lower, original price, rather than the higher price for the substituted 
service. We agree with commenters that this will further maximize 
flexibility for schools and libraries to meet their needs effectively 
and efficiently, without additional cost to the E-rate program.
    31. Accordingly, we amend our rules to specify that service change 
requests will be granted for a substitute service or product where (1) 
that service or product has the same functionality; (2) the 
substitution does not violate any contract provisions or state or local 
procurement laws; (3) the substitution does not result in an increase 
in the percentage of ineligible services or functions, but (4) support 
shall be provided based on the lesser of the pre-

[[Page 6186]]

discount price of the original service or the substitute service. In 
order to ensure the integrity of the competitive bidding process, we 
require the applicant's request for a service change to include a 
certification that the requested change in service is within the scope 
of the controlling Form 470, including any associated Requests for 
Proposal (RFP), for the original services. We also require that support 
not be provided in excess of the amount for which the applicant 
originally would have been eligible. By adopting these procedures as 
rules, we recognize that events may occur between the time of the 
original funding request and the time when commitments are made that 
make the original funding request impractical or even impossible to 
fulfill.
    32. Eligibility of On-Premises Equipment as Part of Priority One 
Service. In the Schools and Libraries NPRM, 67 FR 7327, February 19, 
2002, the Commission sought comment on whether to modify its policies 
regarding the funding of Priority One services (telecommunications 
service and Internet access) that include service provider charges for 
capital investments for wide area networks. Those policies were 
established in the 1999 Tennessee Order and the Brooklyn Order.
    33. We decline at this time to modify our existing policies in this 
area, and in the companion Further Notice of Proposed Rulemaking seek 
more focused comment on specific rule changes that would limit the 
availability of discounts for service provider charges that recoup the 
cost of significant infrastructure investment. We do, however, clarify 
the scope of the existing requirements in this area to facilitate 
USAC's processing of applications.
    34. In the 1999 Tennessee Order, the Commission addressed the issue 
of whether certain facilities located on the applicant's premises 
(namely, routers and hubs) are part of an end-to-end Internet access 
service or part of internal connections. The Commission determined that 
facilities located on an applicant's premises should be presumed to be 
internal connections, but that an applicant may rebut that presumption. 
In analyzing the facts presented in the 1999 Tennessee Order, the 
Commission concluded that this presumption had been rebutted. In 
support of the rebuttal, the Commission noted that the hub sites at 
issue constituted the Internet access provider's points of presence and 
that the applicant's internal connections networks would continue to 
function without the hub sites, indicating that the hub sites were not 
necessary to transport information within the schools' instructional 
buildings on a single campus. Further, the Commission found that other 
indicia--the ownership of the facility, the lack of a lease-purchase 
arrangement, the lack of an exclusivity arrangement, and the fact that 
the service provider was responsible for its maintenance--supported its 
conclusion that, on balance, the facilities should be deemed part of an 
end-to-end service. The Commission found that these factors weighed 
against a finding of internal connections, even though the cost of 
leasing those facilities represented nearly 67 percent of the total 
funding request. The decision was based on the facts presented; the 
Commission did not establish a per se requirement that an applicant 
must meet all factors in order to receive discounts on service provider 
charges for the cost of leasing on-premises equipment.
    35. We conclude it is administratively efficient for USAC to use 
the factors relied upon in the 1999 Tennessee Order as a processing 
standard. USAC has posted an advisory on its website providing guidance 
to help applicants and service providers understand how it has 
implemented the 1999 Tennessee Order. Specifically, USAC has provided 
guidance that a private branch exchange (PBX) that routes calls within 
a school or library is not eligible for support as Priority One on-
premises equipment. This guidance is consistent with our 1999 Tennessee 
Order because a PBX, like most on-premises equipment, is presumed to be 
Priority Two internal connections. Moreover, it is unlikely that an 
applicant would be able to establish a rebuttal to that presumption, 
because the PBX functions to transmit information from and between 
multiple locations within a local network. If the PBX were removed from 
a school, the school would lose its ability to route phone calls within 
the building or campus, but could maintain its access to the public 
switched telephone network. In other words, the PBX is necessary to 
maintain the internal communications network, but not its end-to-end 
access to telecommunications services.
    36. We now clarify that the 1999 Tennessee Order does not preclude 
the provision of support for on-premises equipment that constitutes 
basic termination equipment. Accordingly, an applicant may receive a 
discount for the lease of a cable modem as part of Priority One 
Internet access. A cable modem is a type of basic terminating 
component. It is analogous to a channel service unit/data service unit 
(CSU/DSU) or a network interface device (NID) in that it functions as 
the termination point for a Priority One service. The language in the 
1999 Tennessee Order stating that facilities located on the school 
premises are presumed to be internal connections was enunciated in the 
context of considering the status of network hubs and routers, and 
should not be read to encompass basic termination equipment. A basic 
terminating component, though normally located on a customer's 
premises, is necessary to receive the end-to-end Internet access 
service because it provides translation of the digital transmission 
using the appropriate protocols. In the case of a cable modem, it would 
not be possible to receive the Internet access service in question 
without the cable modem on the customer's premises. Conversely, the 
internal connections on the site would continue to function without the 
cable modem. Moreover, while customers may obtain cable modems from 
other sources, providers of cable modem service typically offer 
customers the opportunity to lease a cable modem in conjunction with 
the provision of cable modem service. We also note that the cost of 
leasing a cable modem is a relatively low proportion of the yearly cost 
of the service. The fact that technical limitations would, as a 
practical matter, preclude the service provider from using the cable 
modem to deliver service to other customers, creating a de facto 
exclusivity arrangement, in our view does not support a finding that 
such equipment must be viewed as internal connections. Rather, we 
conclude that it is appropriate to provide discounts on the lease of a 
single basic terminating component used at a site as a Priority One 
service.
    37. We also clarify that it is appropriate to provide Priority One 
discounts on service provider charges to recoup the cost of leasing 
optical equipment to light fiber, when that optical equipment is the 
single basic terminating component of an end-to-end network and it is 
necessary to provide an end-to-end telecommunications or Internet 
access service. We reach that conclusion even though the optical 
equipment on the customer's end, as a technical matter, is dedicated to 
the customer's sole use.

C. Carryover of Funds

    38. We adopt the procedures for carrying forward unused funds for 
the schools and libraries program proposed in the Schools and Libraries 
Further Notice, 68 FR 36961, June 20, 2003. Specifically, we amend our 
rules to require the Administrator to provide quarterly estimates to 
the Commission

[[Page 6187]]

regarding the amount of unused funds that will be available for 
carryover in the subsequent full funding year. We further amend our 
rules so that the Commission will carry forward available unused funds 
from prior years on an annual basis. We find that, in light of the high 
demand for discounts, such action is consistent with section 254 and 
the public interest, as well as the framework established in the 
Schools and Libraries Order, 67 FR 41862, June 20, 2002. Accordingly, 
we amend Sec. 54.507(a) of our rules.
    39. The Administrator shall continue to estimate unused funds as 
the difference between the amount of funds collected, or made available 
for that particular funding year, and the amount of funds disbursed or 
to be disbursed. We note that the Administrator already considers the 
remaining appeals for a funding year when identifying unused funds. 
Therefore, we do not believe that the carryover of unused funds will 
detract from the funding of outstanding appeals.
    40. Consistent with the proposed rules in the Schools and Libraries 
Further Notice, we also amend the rules to require the Administrator to 
file with the Commission quarterly estimates of unused funds from prior 
years of the schools and libraries support mechanism when it submits 
its projection of schools and libraries program demand for the upcoming 
quarter. This amendment codifies the Administrator's existing reporting 
practice and reporting cycle. The quarterly estimate serves to prepare 
the Administrator for the annual release of carryover funds and 
provides schools and libraries with general notice regarding the amount 
of unused funds that may be made available in the subsequent year. We 
disagree with the National Association of Independent Schools (NAIS) 
that the quarterly reporting procedure would become too cumbersome and 
hinder the ``overall integrity of the program.'' We do not believe that 
the Administrator will be overburdened by this requirement because it 
has been reporting quarterly estimates of unused funds for six quarters 
without a problem.
    41. We further amend the rules to make unused funds available 
annually in the second quarter of each calendar year for use in the 
next full funding year of the schools and libraries mechanism. Based on 
the estimates provided by the Administrator, the Commission will 
announce a specific amount of unused funds from prior funding years to 
be carried forward in accordance with the public interest to increase 
funds for the next full funding year in excess of the annual funding 
cap. For example, the Commission will carry forward the unused funds as 
of second quarter 2004 for use in the Schools and Libraries Funding 
Year 2004, thereby increasing the available funds in Funding Year 2004 
above the annual funding cap of $2.25 billion. The Wireline Competition 
Bureau will announce the availability of carryover funds during the 
second quarter of the calendar year, when it announces the universal 
service contribution factor for the third quarter of each year. The 
amount of unused funds to be carried forward will be deemed approved by 
the Commission if it takes no action within 14 days of release of the 
public notice announcing the contribution factor and the amount of 
unused funds.
    42. We determine that it is in the public interest to carry forward 
unused funds for disbursement on an annual basis in the second quarter 
of the calendar year. Distribution of unused funds on an annual basis 
allows the Administrator to refine its calculation of available funds 
over four reporting quarters as the funding year progresses starting 
with the third quarter of the calendar year. The annual carryover of 
funds during the second quarter of the calendar year also coincides 
with the time of year the Administrator begins making funding 
commitment decisions for the upcoming funding year. We believe that the 
timing of this process provides certainty regarding when unused funds 
will be carried forward for use in the schools and libraries program 
with minimal disruption to the administration of the program.
    43. In order to implement the Commission's prior decision to carry 
over funds beginning April 1, 2003, we modify the schedule for this 
year only in order to implement the process for Funding Year 2003. We 
direct the Administrator to carry forward unused funds as projected for 
the first quarter of 2004 for use during the remainder of Funding Year 
2003. While there will be an increase in the amount of funds available 
in Funding Year 2003, we note that no decisions previously made by USAC 
concerning the distribution of funds for Funding Year 2003 will be 
reversed or revisited. Only funding requests that are currently pending 
will be considered for the Funding Year 2003 carryover funding. 
Henceforth, starting with the second quarter of 2004, funds will be 
carried over on an annual basis as described in the previous paragraph.
    44. Finally, we take this opportunity to revise Sec. 54.509(b) of 
the Commission's rules to conform to the Fifth Order on 
Reconsideration, 63 FR 43088, August 12, 1998. Section 54.509(b) 
provides that, if the estimates of future funding needs of schools and 
libraries lead to a prediction by the Administrator that total funding 
requests will exceed available funding for a funding year, the 
Administrator shall adjust the discount matrix by calculating a 
percentage reduction of support to all schools and libraries, except 
those in the two most disadvantaged categories, in order to permit all 
requests in the next funding year to be fully funded. The technical 
correction we make to Sec. 54.509(b) clarifies that the reduction in 
percentage discounts explained in Sec. 54.509(b) does not apply within 
a filing window or period, as described in Sec. 54.507(c). Priority 
within a filing window is determined in accordance with Sec. 
54.507(g)(1) of the rules. Thus, Sec. 54.509(b) applies only during a 
funding year in which the Administrator is acting in accordance with 
Sec. 54.507(g)(2). We find that the rule change is exempt from the 
notice and comment requirements of the Administrative Procedure Act 
because it concerns a non-substantive technical change to the existing 
rules.

III. Procedural Matters

A. Paperwork Reduction Act Analysis

    45. The action contained herein has been analyzed with respect to 
the Paperwork Reduction Act of 1995 (PRA) and found to impose new or 
modified reporting and/or recordkeeping requirements or burdens on the 
public. Implementation of these new or modified reporting and/or 
recordkeeping requirements will be subject to approval by the Office of 
Management and Budget (OMB) as prescribed by the PRA. Specifically, 
Sec. 54.513(c) will go into effect upon announcement in the Federal 
Register of OMB approval, to the extent OMB approval is required.

B. Final Regulatory Flexibility Analysis

    46. As required by the Regulatory Flexibility Act of 1980, as 
amended (RFA), an Initial Regulatory Flexibility Analysis (IRFA) was 
incorporated in the Schools and Libraries NPRM. The Commission sought 
written public comment on the proposals in the Schools and Libraries 
NPRM, including comment on the IRFA. This present Final Regulatory 
Flexibility Analysis (FRFA) conforms to the RFA.
1. Need for, and Objectives of, the Third Report and Order
    47. In this Third Report and Order, we adopt rules whereby eligible 
entities

[[Page 6188]]

may receive discount rates for internal connections services, except 
for certain basic maintenance services, twice every five years and that 
prohibit a school or library from transferring equipment purchased with 
universal service discounts, except in limited circumstances. These 
rules will advance the goals of the schools and libraries program by 
making support for internal connections regularly available to a larger 
number of applicants and by reducing the likelihood of waste, fraud, 
and abuse.
2. Summary of Significant Issues Raised by Public Comments in Response 
to the IRFA
    48. There were no comments filed specifically in response to the 
IRFA. Nevertheless, the agency has considered the potential impact of 
the rules proposed in the IRFA on small entities. Based on analysis of 
the relevant data, the Commission concludes the new rules limit the 
burdens on small entities and result in a de minimis recordkeeping 
requirement. The Commission also concludes that the new rules will 
positively impact schools and libraries, including small ones, seeking 
universal service support.
3. Description and Estimate of the Number of Small Entities to Which 
Rules Will Apply
    49. The RFA directs agencies to provide a description of and, where 
feasible, an estimate of the number of small entities that may be 
affected by the proposed rules, if adopted. The RFA generally defines 
the term ``small entity'' as having the same meaning as the terms 
``small business,'' ``small organization,'' and ``small governmental 
jurisdiction.'' In addition, the term ``small business'' has the same 
meaning as the term ``small business concern'' under the Small Business 
Act. A small business concern is one which: (1) Is independently owned 
and operated; (2) is not dominant in its field of operation; and (3) 
satisfies any additional criteria established by the SBA. A small 
organization is generally ``any not-for-profit enterprise which is 
independently owned and operated and is not dominant in its field.'' 
Nationwide, as of 1992, there were approximately 275,801 small 
organizations. The term ``small governmental jurisdiction'' is defined 
as ``governments of cities, towns, townships, villages, school 
districts, or special districts, with a population of less than fifty 
thousand.'' As of 1997, there were about 87,453 governmental 
jurisdictions in the United States. This number includes 39,044 county 
governments, municipalities, and townships, of which 37,546 
(approximately 96.2%) have populations of fewer than 50,000, and of 
which 1,498 have populations of 50,000 or more. Thus we estimate the 
number of small governmental jurisdictions overall to be 84,098 or 
fewer.
    50. The Commission has determined that the group of small entities 
directly affected by the rules herein includes eligible schools and 
libraries and the eligible service providers offering them discounted 
services, including telecommunications service providers, Internet 
Service Providers (ISPs) and vendors of internal connections. Further 
descriptions of these entities are provided. In addition, the Universal 
Service Administrative Company is a small organization (non-profit) 
under the RFA, and we believe that circumstances triggering the new 
reporting requirement will be limited and does not constitute a 
significant economic impact on that entity.
a. Schools and Libraries
    51. As noted, ``small entity'' includes non-profit and small 
government entities. Under the schools and libraries universal service 
support mechanism, which provides support for elementary and secondary 
schools and libraries, an elementary school is generally ``a non-profit 
institutional day or residential school that provides elementary 
education, as determined under state law.'' A secondary school is 
generally defined as ``a non-profit institutional day or residential 
school that provides secondary education, as determined under state 
law,'' and not offering education beyond grade 12. For-profit schools 
and libraries, and schools and libraries with endowments in excess of 
$50,000,000, are not eligible to receive discounts under the program, 
nor are libraries whose budgets are not completely separate from any 
schools. Certain other statutory definitions apply as well. The SBA has 
defined for-profit, elementary and secondary schools and libraries 
having $6 million or less in annual receipts as small entities. In 
Funding Year 2 (July 1, 1999 to June 20, 2000) approximately 83,700 
schools and 9,000 libraries received funding under the schools and 
libraries universal service mechanism. Although we are unable to 
estimate with precision the number of these entities that would qualify 
as small entities under SBA's size standard, we estimate that fewer 
than 83,700 schools and 9,000 libraries might be affected annually by 
our action, under current operation of the program.
b. Telecommunications Service Providers
    52. We have included small incumbent local exchange carriers in 
this RFA analysis. A ``small business'' under the RFA is one that, 
inter alia, meets the pertinent small business size standard (e.g., a 
telephone communications business having 1,500 or fewer employees), and 
``is not dominant in its field of operation.'' The SBA's Office of 
Advocacy contends that, for RFA purposes, small incumbent local 
exchange carriers are not dominant in their field of operation because 
any such dominance is not ``national'' in scope. We have therefore 
included small incumbent carriers in this RFA analysis, although we 
emphasize that this RFA action has no effect on the Commission's 
analyses and determinations in other, non-RFA contexts.
    53. Incumbent Local Exchange Carriers (LECs). Neither the 
Commission nor the SBA has developed a size standard for small 
incumbent local exchange services. The closest size standard under SBA 
rules is for Wired Telecommunications Carriers. Under that size 
standard, such a business is small if it has 1,500 or fewer employees. 
According to Commission data, 1,337 incumbent carriers reported that 
they were engaged in the provision of local exchange services. Of these 
1,337 carriers, an estimated 1,032 have 1,500 or fewer employees and 
305 have more than 1,500 employees. Consequently, the Commission 
estimates that most providers of incumbent local exchange service are 
small businesses that may be affected by the rules and policies adopted 
herein.
    54. Competitive Local Exchange Carriers (CLECs), Competitive Access 
Providers (CAPs) and ``Other Local Exchange Carriers.'' Neither the 
Commission nor the SBA has developed a size standard for small 
businesses specifically applicable to providers of competitive exchange 
services or to competitive access providers or to ``Other Local 
Exchange Carriers.'' The closest applicable size standard under SBA 
rules is for Wired Telecommunications Carriers. Under that size 
standard, such a business is small if it has 1,500 or fewer employees. 
According to Commission data, 609 companies reported that they were 
engaged in the provision of either competitive access provider services 
or competitive local exchange carrier services. Of these 609 companies, 
an estimated 458 have 1,500 or fewer employees and 151 have more than 
1,500 employees. In addition, 35

[[Page 6189]]

carriers reported that they were ``Other Local Exchange Carriers.'' Of 
the 35 ``Other Local Exchange Carriers,'' an estimated 34 have 1,500 or 
fewer employees and one has more than 1,500 employees. Consequently, 
the Commission estimates that most providers of competitive local 
exchange service, competitive access providers, and ``Other Local 
Exchange Carriers'' are small entities that may be affected by the 
rules and policies adopted herein.
    55. Interexchange Carriers (IXCs). Neither the Commission nor the 
SBA has developed a size standard for small businesses specifically 
applicable to interexchange services. The closest applicable size 
standard under SBA rules is for Wired Telecommunications Carriers. 
Under that size standard, such a business is small if it has 1,500 or 
fewer employees. According to the Commission's most recent data, 261 
companies reported that their primary telecommunications service 
activity was the provision of payphone services. Of these 261 
companies, an estimated 223 have 1,500 or fewer employees and 48 have 
more than 1,500 employees. Consequently, the Commission estimates that 
the majority of payphone service providers are small entities that may 
be affected by the rules and policies adopted herein.
    56. Wireless Service Providers. The SBA has developed a small 
business size standard for wireless small businesses within the two 
separate categories of Paging and Cellular and Other Wireless 
Telecommunications. Under both SBA categories, a wireless business is 
small if it has 1,500 or fewer employees. According to the Commission's 
most recent data, 1,761 companies reported that they were engaged in 
the provision of wireless service. Of these 1,761 companies, an 
estimated 1,175 have 1,500 or fewer employees and 586 have more than 
1,500 employees. Consequently, the Commission estimates that most 
wireless service providers are small entities that may be affected by 
the rules and policies adopted herein.
    57. Private and Common Carrier Paging. In the Paging Third Report 
and Order, 62 FR 16004, April 3, 1997, we developed a small business 
size standard for ``small businesses'' and ``very small businesses'' 
for purposes of determining their eligibility for special provisions 
such as bidding credits and installment payments. A ``small business'' 
is an entity that, together with its affiliates and controlling 
principals, has average gross revenues not exceeding $15 million for 
the preceding three years. Additionally, a ``very small business'' is 
an entity that, together with its affiliates and controlling 
principals, has average gross revenues that are not more than $3 
million for the preceding three years. An auction of Metropolitan 
Economic Area licenses commenced on February 24, 2000, and closed on 
March 2, 2000. Of the 985 licenses auctioned, 440 were sold. Fifty-
seven companies claiming small business status won. At present, there 
are approximately 24,000 Private-Paging site-specific licenses and 
74,000 Common Carrier Paging licenses. According to Commission data, 
474 carriers reported that they were engaged in the provision of either 
paging and messaging services or other mobile services. Of those, the 
Commission estimates that 457 are small, under the SBA approved small 
business size standard.
c. Internet Service Providers
    58. Internet Service Providers. The SBA has developed a small 
business size standard for ``On-Line Information Services,'' North 
American Industry Classification System (NAICS) code 514191. This 
category comprises establishments ``primarily engaged in providing 
direct access through telecommunications networks to computer-held 
information compiled or published by others.'' Under this small 
business size standard, a small business is one having annual receipts 
of $18 million or less. Based on firm size data provided by the Bureau 
of the Census, 3,123 firms are small under SBA's $18 million size 
standard for this category code. Although some of these Internet 
Service Providers (ISPs) might not be independently owned and operated, 
we are unable at this time to estimate with greater precision the 
number of ISPs that would qualify as small business concerns under 
SBA's small business size standard. Consequently, we estimate that 
there are 3,123 or fewer small entity ISPs that may be affected by this 
analysis.
d. Vendors of Internal Connections
    59. The Commission has not developed a small business size standard 
specifically directed toward manufacturers of internal network 
connections. The closest applicable definitions of a small entity are 
the size standards under the SBA rules applicable to manufacturers of 
``Radio and Television Broadcasting and Communications Equipment'' 
(RTB) and ``Other Communications Equipment.'' According to the SBA's 
regulations, manufacturers of RTB or other communications equipment 
must have 750 or fewer employees in order to qualify as a small 
business. The most recent available Census Bureau data indicates that 
there are 1,187 establishments with fewer than 1,000 employees in the 
United States that manufacture radio and television broadcasting and 
communications equipment, and 271 companies with less than 1,000 
employees that manufacture other communications equipment. Some of 
these manufacturers might not be independently owned and operated. 
Consequently, we estimate that the majority of the 1,458 internal 
connections manufacturers are small.
e. Miscellaneous Entities
    60. Wireless Communications Equipment Manufacturers. The SBA has 
established a small business size standard for radio and television 
broadcasting and wireless communications equipment manufacturing. Under 
this standard, firms are considered small if they have 750 or fewer 
employees. Census Bureau data for 1997 indicate that, for that year, 
there were a total of 1,215 establishments in this category. Of those, 
there were 1,150 that had employment under 500, and an additional 37 
that had employment of 500 to 999. The percentage of wireless equipment 
manufacturers in this category is approximately 61.35%, so the 
Commission estimates that the number of wireless equipment 
manufacturers with employment under 500 was actually closer to 706, 
with an additional 23 establishments having employment of between 500 
and 999. The Commission estimates that the majority of wireless 
communications equipment manufacturers are small businesses.
4. Description of Projected Reporting, Recordkeeping, and Other 
Compliance Requirements for Small Entities
    61. In this Third Report and Order, we adopt a rule that prohibits 
the transfer of equipment purchased with universal service discount, 
except in limited circumstances. Further, we provide that the excepted, 
limited circumstances consist of a discount recipient temporarily or 
permanently closing its operations where the original equipment was 
installed. In that instance, we require a recipient, who closes 
permanently or temporarily and transfers equipment to another eligible 
entity, to notify the Administrator of a transfer and require the 
transferring and receiving entities to maintain detailed records of the 
transfer consistent with the Commission's recordkeeping requirements 
for five years. We do not believe that these reporting and

[[Page 6190]]

recordkeeping requirements will result in a significant economic 
impact.
    62. The rule adopted today, limiting the frequency of receiving 
discount rates for internal connections, does not involve additional 
reporting, recordkeeping, or compliance requirements for small 
entities. Similarly, the rule adopted in this Third Report and Order, 
creating a more formal process for annually updating the list of 
services eligible for support, does not involve additional reporting, 
recordkeeping, or compliance requirements for small entities. The rules 
adopted governing cost allocation between eligible and ineligible 
services, provision of free services, and service substitution do not 
impose additional reporting, recordkeeping, or compliance requirements 
for small entities. Finally, the rules regarding carryover of unused 
funds do not require additional reporting or recordkeeping for small 
entities participating in the schools and libraries universal support 
mechanism.
5. Steps Taken To Minimize the Significant Economic Impact on Small 
Entities, and Significant Alternatives Considered
    63. The RFA requires an agency to describe any significant 
alternatives that it has considered in developing its approach, which 
may include the following four alternatives (among others): ``(1) 
establishment of differing compliance or reporting requirements or 
timetables that take into account the resources available to small 
entities; (2) the clarification, consolidation, or simplification of 
compliance and reporting requirements under the rule for such small 
entities; (3) the use of performance rather than design standards; and 
(4) an exemption from coverage of the rule, or any part thereof, for 
such small entities.''
    64. Although we received no IRFA comments, we considered 
alternatives to the proposed recordkeeping requirements for small 
entities. In creating the narrow exception to the equipment transfer 
policy adopted in this Third Report and Order, we recognize the 
Commission's need to protect the integrity of the schools and libraries 
support mechanism by curbing waste, fraud, and abuse while 
acknowledging circumstances that justify permitting the transfer of 
discounted equipment received by a program beneficiary, small or large. 
We recognize that we must require certain recordkeeping to verify the 
appropriate use of universal service funds. Consideration was afforded 
to having the recipient file equipment transfer records with USAC and 
having USAC maintain the records. However, we conclude that requiring a 
filing with USAC would be more burdensome for the recipient than having 
the recipient collect and maintain its equipment transfer records. 
Complying with the processes promulgated by USAC would be more 
burdensome than requiring each beneficiary to retain its own files 
because the beneficiary would have to do more than send the documents 
to USAC. The beneficiary would have to comply with the procedural 
scheme devised by USAC for compiling, and mailing or delivering the 
records, and quality control measures for assuring that the records 
submitted were properly identified with the correct beneficiary. In the 
RFA, an exemption of small entities from the recordkeeping requirements 
is listed as a possible alternative. In this instance, exemption from 
the recordkeeping requirement would impede the Commission's ability to 
account for funds distributed through the schools and libraries program 
and would undermine the Commission's efforts to prevent waste, fraud, 
and abuse.
    65. Report to Congress: The Commission will send a copy of the 
Order, including this FRFA, in a report to be sent to Congress pursuant 
to the Congressional Review Act, see 5 U.S.C. 801(a)(1)(A). In 
addition, the Commission will send a copy of the Order, including the 
FRFA, to the Chief Counsel for Advocacy of the Small Business 
Administration. A copy of the Order and FRFA (or summaries thereof) 
will also be published in the Federal Register.

IV. Ordering Clauses

    66. Pursuant to the authority contained in sections 1, 4(i), 4(j), 
201-205, 214, 254, and 403 of the Communications Act of 1934, as 
amended, this Third Report and Order is adopted.
    67. Part 54 of the Commission's rules, is amended as set forth, 
effective March 11, 2004 except for Sec. 54.513(c) which contains 
information collection requirements that have not been approved by the 
Office of Management Budget (OMB). The Commission will publish a 
document in the Federal Register announcing the effective date of that 
section.
    68. The Commission's Consumer and Governmental Affairs Bureau, 
Reference Information Center, shall send a copy of this Third Report 
and Order, including the Final Regulatory Flexibility Analysis, to the 
Chief Counsel for Advocacy of the Small Business Administration.

List of Subjects in 47 CFR Part 54

    Reporting and recordkeeping requirements, Telecommunications, 
Telephone.

Federal Communications Commission.
Marlene H. Dortch,
Secretary.

Final Rules

0
For the reasons discussed in the preamble, the Federal Communications 
Commission amends 47 CFR part 54 as follows:

PART 54--UNIVERSAL SERVICE

0
1. The authority citation continues to read as follows:

    Authority: 47 U.S.C. 1, 4(i), 201, 205, 214, and 254 unless 
otherwise noted.

0
2. Amend Sec. 54.504 by revising paragraph (b)(2)(iii) and by adding 
paragraphs (f) and (g) to read as follows:


Sec. 54.504  Requests for services.

* * * * *
    (b) * * *
    (2) * * *
    (iii) The services will not be sold, resold, or transferred in 
consideration for money or any other thing of value, and will not be 
transferred, with or without consideration for money or any other thing 
of value, except as permitted by the Commission's rules;
* * * * *
    (f) Service substitution. (1) The Administrator shall grant a 
request by an applicant to substitute a service or product for one 
identified on its FCC Form 471 where:
    (i) The service or product has the same functionality;
    (ii) The substitution does not violate any contract provisions or 
state or local procurement laws;
    (iii) The substitution does not result in an increase in the 
percentage of ineligible services or functions; and
    (iv) The applicant certifies that the requested change is within 
the scope of the controlling FCC Form 470, including any associated 
Requests for Proposal, for the original services.
    (2) In the event that a service substitution results in a change in 
the pre-discount price for the supported service, support shall be 
based on the lower of either the pre-discount price of the service for 
which support was originally requested or the pre-discount price of the 
new, substituted service.
    (3) For purposes of this rule, the broad categories of eligible 
services (telecommunications service, Internet access, and internal 
connections) are not deemed to have the same functionality with one 
another.

[[Page 6191]]

    (g) Mixed eligibility services. A request for discounts for a 
product or service that includes both eligible and ineligible 
components must allocate the cost of the contract to eligible and 
ineligible components.
    (1) Ineligible components. If a product or service contains 
ineligible components, costs must be allocated to the extent that a 
clear delineation can be made between the eligible and ineligible 
components. The delineation must have a tangible basis, and the price 
for the eligible portion must be the most cost-effective means of 
receiving the eligible service.
    (2) Ancillary ineligible components. If a product or service 
contains ineligible components that are ancillary to the eligible 
components, and the product or service is the most cost-effective means 
of receiving the eligible component functionality, without regard to 
the value of the ineligible component, costs need not be allocated 
between the eligible and ineligible components. Discounts shall be 
provided on the full cost of the product or service. An ineligible 
component is ``ancillary'' if a price for the ineligible component 
cannot be determined separately and independently from the price of the 
eligible components, and the specific package remains the most cost-
effective means of receiving the eligible services, without regard to 
the value of the ineligible functionality.
    (3) The Administrator shall utilize the cost allocation 
requirements of this subparagraph in evaluating mixed eligibility 
requests under Sec. 54.504(d)(1).

0
3. Section Sec. 54.506 is revised to read as follows:


Sec. 54.506  Internal connections.

    (a) A service is eligible for support as a component of an 
institution's internal connections if such service is necessary to 
transport information within one or more instructional buildings of a 
single school campus or within one or more non-administrative buildings 
that comprise a single library branch. Discounts are not available for 
internal connections in non-instructional buildings of a school or 
school district, or in administrative buildings of a library, to the 
extent that a library system has separate administrative buildings, 
unless those internal connections are essential for the effective 
transport of information to an instructional building of a school or to 
a non-administrative building of a library. Internal connections do not 
include connections that extend beyond a single school campus or single 
library branch. There is a rebuttable presumption that a connection 
does not constitute an internal connection if it crosses a public 
right-of-way.
    (b) Basic maintenance services. Basic maintenance services shall be 
eligible as an internal connections service if, but for the maintenance 
at issue, the internal connection would not function and serve its 
intended purpose with the degree of reliability ordinarily provided in 
the marketplace to entities receiving such services. Basic maintenance 
services do not include services that maintain equipment that is not 
supported or that enhance the utility of equipment beyond the transport 
of information, or diagnostic services in excess of those necessary to 
maintain the equipment's ability to transport information.
    (c) Frequency of discounts for internal connections services. Each 
eligible school or library shall be eligible for support for internal 
connections services, except basic maintenance services, no more than 
twice every five funding years. For the purpose of determining 
eligibility, the five-year period begins in any funding year, starting 
with Funding Year 2005, in which the school or library receives 
discounted internal connections services other than basic maintenance 
services. If a school or library receives internal connections services 
other than basic maintenance services that are shared with other 
schools or libraries (for example, as part of a consortium), the shared 
services will be attributed the school or library in determining 
whether it is eligible for support.

0
4. Amend Sec. 54.507 by adding paragraphs (a)(1) and (a)(2) to read as 
follows:


Sec. 54.507  Cap.

    (a) * * *
    (1) Amount of unused funds. The Administrator shall report to the 
Commission, on a quarterly basis, funding that is unused from prior 
years of the schools and libraries support mechanism.
    (2) Application of unused funds. On an annual basis, in the second 
quarter of each calendar year, all funds that are collected and that 
are unused from prior years shall be available for use in the next full 
funding year of the schools and libraries mechanism in accordance with 
the public interest and notwithstanding the annual cap, as described in 
paragraph (a) of this section.
* * * * *

0
5. Amend Sec. 54.509 by revising paragraph (b) to read as follows:


Sec. 54.509  Adjustments to the discount matrix.

* * * * *
    (b) Reduction in percentage discounts. At all times other than 
within a filing period described in Sec. 54.507(c), if the estimates 
schools and libraries make of their future funding needs lead the 
Administrator to predict that total funding request for a funding year 
will exceed the available funding, the Administrator shall calculate 
the percentage reduction to all schools and libraries, except those in 
the two most disadvantaged categories, necessary to permit all requests 
in the next funding year to be fully funded.
* * * * *

0
6. In Sec. 54.513, revise the section heading and add paragraph (c) to 
read as follows:


Sec. 54.513  Resale and transfer of services.

* * * * *
    (c) Eligible services and equipment components of eligible services 
purchased at a discount under this subpart shall not be transferred, 
with or without consideration of money or any other thing of value, for 
a period of three years after purchase, except that eligible services 
and equipment components of eligible services may be transferred to 
another eligible school or library in the event that the particular 
location where the service originally was received is permanently or 
temporarily closed. If an eligible service or equipment component of a 
service is transferred due to the permanent or temporary closure of a 
school or library, the transferor must notify the Administrator of the 
transfer, and both the transferor and recipient must maintain detailed 
records documenting the transfer and the reason for the transfer for a 
period of five years.

0
7. Amend Sec. 54.516 by adding a second sentence to paragraph (a) to 
read as follows:


Sec. 54.516  Auditing.

    (a) * * * Schools and libraries shall be required to maintain asset 
and inventory records of equipment purchased as components of supported 
internal connections services sufficient to verify the actual location 
of such equipment for a period of five years after purchase.
* * * * *

0
8. Add Sec. 54.522 to subpart F to read as follows:


Sec. 54.522  Eligible services list.

    The Administrator shall submit by June 30 of each year a draft list 
of services eligible for support, based on the Commission's rules, in 
the following funding year. The Commission will issue a Public Notice 
seeking comment on the Administrator's proposed eligible

[[Page 6192]]

services list. At least 60 days prior to the opening of the window for 
the following funding year, the Commission shall release a Public 
Notice attaching the final eligible services list for the upcoming 
funding year.

0
9. Add Sec. 54.523 to subpart F to read as follows:


Sec. 54.523  Payment for the non-discount portion of supported 
services.

    An eligible school, library, or consortium must pay the non-
discount portion of services or products purchased with universal 
service discounts. An eligible school, library, or consortium may not 
receive rebates for services or products purchased with universal 
service discounts. For the purpose of this rule, the provision, by the 
provider of a supported service, of free services or products unrelated 
to the supported service or product constitutes a rebate of the non-
discount portion of the supported services.

[FR Doc. 04-2732 Filed 2-9-04; 8:45 am]
BILLING CODE 6712-01-P