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95–461PDF 2004

PROBLEMS WITH THE E-RATE PROGRAM: WASTE,

FRAUD, AND ABUSE CONCERNS IN THE WIRING

OF OUR NATION’S SCHOOLS TO THE INTERNET

Part 2

HEARING

BEFORE THE

SUBCOMMITTEE ON

OVERSIGHT AND INVESTIGATIONS

OF THE

COMMITTEE ON ENERGY AND

COMMERCE

HOUSE OF REPRESENTATIVES

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

JULY 22, 2004

Serial No. 108–103

Printed for the use of the Committee on Energy and Commerce

(

Available via the World Wide Web: http://www.access.gpo.gov/congress/house

2

COMMITTEE ON ENERGY AND COMMERCE

JOE BARTON, Texas, Chairman

W.J. ‘‘BILLY’’ TAUZIN, Louisiana

RALPH M. HALL, Texas

MICHAEL BILIRAKIS, Florida

FRED UPTON, Michigan

CLIFF STEARNS, Florida

PAUL E. GILLMOR, Ohio

JAMES C. GREENWOOD, Pennsylvania

CHRISTOPHER COX, California

NATHAN DEAL, Georgia

RICHARD BURR, North Carolina

ED WHITFIELD, Kentucky

CHARLIE NORWOOD, Georgia

BARBARA CUBIN, Wyoming

JOHN SHIMKUS, Illinois

HEATHER WILSON, New Mexico

JOHN B. SHADEGG, Arizona

CHARLES W. ‘‘CHIP’’ PICKERING,

Mississippi, Vice Chairman

VITO FOSSELLA, New York

STEVE BUYER, Indiana

GEORGE RADANOVICH, California

CHARLES F. BASS, New Hampshire

JOSEPH R. PITTS, Pennsylvania

MARY BONO, California

GREG WALDEN, Oregon

LEE TERRY, Nebraska

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

DARRELL E. ISSA, California

C.L. ‘‘BUTCH’’ OTTER, Idaho

JOHN SULLIVAN, Oklahoma

JOHN D. DINGELL, Michigan

Ranking Member

HENRY A. WAXMAN, California

EDWARD J. MARKEY, Massachusetts

RICK BOUCHER, Virginia

EDOLPHUS TOWNS, New York

FRANK PALLONE, Jr., New Jersey

SHERROD BROWN, Ohio

BART GORDON, Tennessee

PETER DEUTSCH, Florida

BOBBY L. RUSH, Illinois

ANNA G. ESHOO, California

BART STUPAK, Michigan

ELIOT L. ENGEL, New York

ALBERT R. WYNN, Maryland

GENE GREEN, Texas

KAREN MCCARTHY, Missouri

TED STRICKLAND, Ohio

DIANA DEGETTE, Colorado

LOIS CAPPS, California

MICHAEL F. DOYLE, Pennsylvania

CHRISTOPHER JOHN, Louisiana

TOM ALLEN, Maine

JIM DAVIS, Florida

JANICE D. SCHAKOWSKY, Illinois

HILDA L. SOLIS, California

CHARLES A. GONZALEZ, Texas

BUD ALBRIGHT, Staff Director

JAMES D. BARNETTE, General Counsel

REID P.F. STUNTZ, Minority Staff Director and Chief Counsel

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

JAMES C. GREENWOOD, Pennsylvania, Chairman

MICHAEL BILIRAKIS, Florida

CLIFF STEARNS, Florida

RICHARD BURR, North Carolina

CHARLES F. BASS, New Hampshire

GREG WALDEN, Oregon

Vice Chairman

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

JOE BARTON, Texas,

(Ex Officio)

PETER DEUTSCH, Florida

Ranking Member

DIANA DEGETTE, Colorado

TOM ALLEN, Maine

JANICE D. SCHAKOWSKY, Illinois

HENRY A. WAXMAN, California

EDWARD J. MARKEY, Massachusetts

JOHN D. DINGELL, Michigan,

(Ex Officio)

(II)

C O N T E N T S

Page

Testimony of:

Ackerman, Arlene, Superintendent, San Francisco Unified School District ................................................................................................................. 9

Burger, Thomas J., President and CEO, NEC Unified Solutions; Inc;

accompanied by William Holman, former Vice President of Sales for

NEC BNS; George Marchelos, former consultant to and employee of

Video Network Communications; Judy Green, former consultant to and

employee of Video Network Communications, Inc ..................................... 55

Cothran, George M., Investigator, San Francisco City Attorney Office ....... 17

Donovan, Timothy M., former Senior Vice President and General Counsel,

NEC USA, Inc ............................................................................................... 57

Herrera, Dennis J., San Francisco City Attorney .......................................... 14

Maher, William F., Jr., Chief, Wireline Competition Bureau, Federal

Communications Commission ...................................................................... 78

McDonald, George, Vice President, Schools and Libraries Division, Universal Service Administrative Company ..................................................... 83

Renne, Louise H., General Counsel, San Francisco Unified School District ................................................................................................................. 12

(III)

(1)

PROBLEMS WITH THE E-RATE PROGRAM:

WASTE, FRAUD, AND ABUSE CONCERNS IN

THE WIRING OF OUR NATION’S SCHOOLS

TO THE INTERNET

THURSDAY, JULY 22, 2004

HOUSE OF REPRESENTATIVES,

COMMITTEE ON ENERGY AND COMMERCE,

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS,

Washington, DC.

The subcommittee met, pursuant to notice, at 10 a.m., in room

2123, Rayburn House Office Building, Greg Walden (vice chairman), presiding.

Members present: Representatives Walden, Bass, Barton (ex officio), DeGette, and Schakowsky.

Staff present: Mark Paoletta, majority counsel; Peter Spencer,

majority professional staff; Tom Feddo, majority counsel; Jaylyn

Jensen, legislative analyst; Michael Abraham, legislative clerk;

David Nelson, minority investigator and economist; and Jessica

McNiece, minority clerk.

Mr. WALDEN. Good morning. The subcommittee will come to

order.

Last month we opened our hearing on E-Rate with a close look

at the Puerto Rico Department of Education’s experience with the

program. That case, in which a large and needful district and its

vendors literally wasted more than $100 million of E-Rate funds,

shed light on a range of problem areas in the program set-up.

The problems extended from the front to the back of the E-Rate

funding process. The Puerto Rico case illustrated weaknesses in the

competitive bidding process and the requirements that applicants

certify they actually have the resources necessary to make effective

educational use of E-Rate funds.

In Puerto Rico, tens of millions of dollars were being billed, while

few, if any, children actually got connected to the Internet. We saw

problems in implementing the goods and services purchased with

E-Rate funds, as the $20 million—$20 million—of dusty, shrink

wrapped gear in a warehouse highlighted, and we saw weaknesses

in oversight and in the audit process.

This morning we will focus directly on the front end of the ERate process, the application and processing of applications in the

E-Rate program. This is the part of the program where many problems begin and where many problems can be caught, if done right.

This is where the planning and competitive bidding, the keystone

to the program, take place and where E-Rate’s administrators can

2

catch applicants that run afoul of program requirements. Failure

here at the front end assures wasteful spending and opens the way

for fraud and for abuse.

Today we will take a hard look at some of the very troubling actions on the part of vendors and consultants and how these actions

were stopped, at least in one large school district. We will look at

the facts and circumstances surrounding the application for E-Rate

funds by the San Francisco Unified School District in the 2000 ERate funding year.

San Francisco’s experience is a story in which bad actors put the

E-Rate application process to the test. We will learn that the program did not pass that test.

As we will hear today, the E-Rate administrator, USAC, ap- proved more than $58 million in funding, including the District’s

share, based on fraudulent applications. Each procedural safeguard

then set up by USAC failed: Competitive bidding, application certification, application review, and selective review.

Fortunately, a final check, a newly arrived superintendent whom

we will hear from this morning had suspicions that led to uncovering program fraud and abuse not only in San Francisco but also

around this country.

Today’s hearing focuses primarily on the San Francisco Unified

School District’s experience. We are continuing to examine the

broader details of the conspiracy in other States. Questionable activity by the vendors and individuals who exploited the process in

San Francisco has been identified in Arkansas, in Michigan, and in

South Carolina, for example.

One district, with the help of these bad actors, allegedly built a $750,000 television studio with E-Rate funds, something, be assured, that clearly should not have happened, and we will address

these details in due course.

Today’s hearing, nevertheless, will shed light on the integrity of

the E-Rate application process. Equally important, today’s hearing

will also let us focus a bright light on the very troubling behavior

surrounding the bid rigging conspiracy and fraud underlying this

particular school district’s experience.

We have before us today some of the key players in the San

Francisco story. So this light should serve not only to illuminate

where there are problems in program structure, but also to display

clearly the kind of actions that cannot be allowed to occur in the

program or to escape public scrutiny.

The actions we will examine were made public when NEC Business Network Solutions, now doing business as NEC Unified Solutions, pleaded guilty this past May to wire fraud and to a conspiracy to suppress and eliminate competition for E-Rate program

projects.

NEC BNS also confirmed, among other facts, that as part of the

conspiracy it assisted in submitting inflated prices to USAC, $26

million more than vendors had bid on the San Francisco project.

NEC BNS admitted that it had informed USAC that it planed to

‘‘donate’’ ineligible equipment, but in fact intended to buy that

equipment with $10 million in excess E-Rate receipts, and this was

just in San Francisco. As part of the plea deal, NEC BNS agreed

to pay $20.7 million in fines and restitution.

3

At this point, I would note that three of the witnesses before us

this morning are not appearing voluntarily, in large part, they

maintain, due to ongoing criminal and civil cases into the matters

we will be examining. We issued subpoenas last week to command

their presence and their testimony.

Among them today are the President and CEO of NEC BNS, Mr.

Thomas Burger, as well as its former Price President of Sales, Mr.

William Holman. I look forward to learning from Mr. Burger what

he can say about his company’s behavior, especially as he was the

main man in charge at the time of this activity to which this company has pleaded guilty, and Mr. Holman, according to numerous

documents, should have information that will help us understand

how this situation developed.

We also have an individual, Mr. George Marchelos who, San

Francisco investigators suggest, has direct knowledge of what happened in that school district and elsewhere, and I hope he will help

us understand this story.

We also subpoenaed a Ms. Judy Green, another E-Rate consultant who, according to the U.S. Marshal’s Service, has effectively

avoided service for the past week. Given that the committee continues to investigate this conspiracy, let me just note that we will

provide her another opportunity to testify. We will make sure this

committee’s subpoenas are served. She will eventually come before

this committee and testify.

The story of San Francisco is a story of corrupt school employees,

E-Rate consultants controlling the process, and vendors conspiring

to completely undercut competition. We will ask some probing

questions of these people, but I also expect we will ask tough questions of other players.

We have hard questions to ask of USAC, which set up the procedures for policing E-Rate applications for problems and, in the case

of San Francisco, inexplicably neglected several red flags. Of

course, we have the FCC, the agency in charge of the whole program. They have to answer to this story, too, and explain where

they are leading this program now after cases like this.

Let me conclude by extending a welcome to our witnesses, particularly those from San Francisco City Attorney’s Office and from

the San Francisco Unified School District. Superintendent Ackerman, who joins us via videoconference, has been most accommodating to assist us today, and we especially appreciate your willingness and your help.

With that, let me recognize the ranking member for her opening

statement. Good morning.

Ms. DEGETTE. Thank you very much, Mr. Chairman, and I am

pleased to call you Mr. Chairman and welcome you to the chairman’s seat, Mr. Walden.

Mr. WALDEN. I am delighted to be in the seat, but I remain as

vice chairman of the committee.

Ms. DEGETTE. Right. I think you will be there for the foreseeable

future.

I am really pleased to be back here for the second in what I hope

will be a continuing series of hearings on the E-Rate program. I

came out of the last hearing with an understanding that some of

the problems we have seen with this important program can be reVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 95461.TXT HCOM1 PsN: HCOM1
4

solved, but only if oversight is dramatically stepped up, and if there

is a serious crack-down on some of the worst offenders and fraudulent practices.

I want to take a minute again to emphasize why this issue is so

important. Not only have millions of dollars been wasted over the

years, but millions of dollars have not been wasted. Millions of dollars have gone to exactly what the program was intended to do,

and if steps aren’t taken to stop the fraud that has occurred, I am

afraid we run the risk of ending an innovative program that has

done amazing things for students across the country.

I believe that Congress has the very serious responsibility of ensuring that the program runs the way it was intended to, and that

the kids that it is intended to serve do not become the ultimate victims.

I hope today will prove as informative as the last hearing, although I am disheartened that so many of our witnesses are not

here of their own free will to help shed some light on the issue at

hand, and have chosen not to submit testimony.

On the other hand, I believe the first panel will demonstrate how

important oversight at all levels is and how school districts themselves are very important players when it comes to ensuring that

E-Rate funds are properly utilized.

I am extremely impressed with the actions of the San Francisco

Unified School District for sounding the alarm when they got the

word that things were not as they should be.

I think it took great courage and a strong commitment to ethical

standards, something, as we are sadly learning throughout these

hearings, that has been in too short supply. Frankly, it must have

been pretty hard to turn down nearly $50 million that had already

been approved for use, and I greatly admire that decision.

There are a number of questions that come to mind when considering the case of what happened with E-Rate funds and the San

Francisco Unified School District. First, how on earth did the funds

get approved, to begin with, particularly since it seems like the

Universal Service Administrative Company took extra steps to examine the applications that were later found to be fraudulent?

Second, should it really be the responsibility of the recipient

school districts or libraries to make sure that applications aren’t

wrongly approved? Shouldn’t that be the responsibility of those

who run the program and approve the applications?

It seems that, certainly in this case, things were backwards, and

it concerns me there are other cases out there that we are currently unaware of where funds have been wrongly approved, and

recipients have not been diligent about reporting it. This could be

due to ignorance or lax ethics, but either way it would be a huge

problem, and I, for one, would like to see some evidence that San

Francisco and their experience is not being replicated nationwide.

At the last hearing, I laid out what I thought were two of the

most serious problems that need to be addressed in order to ensure

that the E-Rate is actually accomplishing its mission.

First of all, the bad apple vendors and consultants who take advantage of school districts and then essentially take the money and

run—we saw that last week—and also the apparent lack of oversight that has allowed for large amounts of money to go to schools

5

that have no ability to proceed with actually utilizing the funds

and the equipment they receive.

Today, I am looking forward to further exploration of these

issues, and I am pleased that we have a representative from

USAC, Mr. George Mcdonald, to talk about the concerns. I am also

interested in hearing from Mr. McDonald about the current status

of the Puerto Rico case that we talked about in the last hearing.

I want to know what is being done to help them fix the past mistakes so that these students can have the kind of computer programs that they should be having.

Finally, there are a number of other issues we need to address

in this hearing: How can we improve the E-Rate’s competitive bidding process? Exactly what should the responsibilities of school administrators be, and what steps are the USAC taking to make sure

that they never again make the mistake of approving fraudulent

applications for millions of dollars?

Mr. Chairman, I look forward to hearing the testimony, and I

ask unanimous consent that Mr. Dingell and all other members’

opening statements be placed in the record.

Mr. WALDEN. Without objection, so ordered.

[The prepared statement of Hon. John D. Dingell follows:]

PREPARED STATEMENT OF HON. JOHN D. DINGELL, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF MICHIGAN

Mr. Chairman, thank you for continuing this investigation and holding this hearing. Today, this Subcommittee holds the first of its vendor-specific hearings, examining some of the fraudulent activity that a subsidiary of NEC America, Inc. (NEC)

and its co- conspirators engaged in. While this hearing will specifically focus on

NEC’s unsuccessful attempt to defraud the E-rate program in San Francisco, NEC

did succeed in procuring millions of dollars from illegal E-rate program claims that

involved school districts from Michigan to Mississippi.

We will hear from the local public servants who prevented the San Francisco

fraud from going forward and who subsequently uncovered its nationwide scope.

This case study is particularly revealing in that NEC and its vendors were actively

involved in most of the criminal schemes that flourished, in part due to the lax oversight of the E-rate program by the Federal Communications Commission (FCC).

These scams include bid rigging, hiding of ineligible equipment, and goldplating

(specifying equipment acquisition that exceeded the school districts’ needs). Scams

also included the fraudulent inflation of prices, illegal kickbacks, illegal ‘‘in-kind’’

donations, the corruption of local officials, as well as directly or indirectly causing

the filing of a plethora of false statements to the Universal Service Administrative

Corporation (USAC), the non- profit corporation which disburses E-rate program

funds.

Fortunately, a newly hired Superintendent of the San Francisco Unified School

District caught the fraudulent application for almost $50 million in E-rate funds and

stopped the process before the money could be spent, stolen, or wasted. The City

Attorney initiated an investigation that ultimately resulted in prosecution by the

Department of Justice and a guilty plea by NEC. The federal investigation continues

into the roles of various individuals in this sorry saga.

Amazingly, NEC has petitioned the FCC to allow it to continue participating in

the E-rate program, based upon its exceptional ‘‘cooperation’’ with the federal investigations. But NEC’s cooperation did not begin until after they were caught. The

guilty plea probably saved the Government a trial but little else. No important executive has lost his or her job, and employees directly implicated in the wrongdoing

remain on the NEC payroll.

I understand that today the senior executives who oversaw these schemes may

invoke their right to avoid incriminating themselves and refuse to testify. This

strikes me as very curious cooperation. The FCC should not be fooled into thinking

that this company and its employees are now worthy of the taxpayers’ trust.

I support the work of this Subcommittee to expose all the major problems in the

E-rate program, and I look forward to working with my colleagues to address them.

6

Mr. WALDEN. We are now honored to have with us the chairman

of the full committee, Mr. Barton.

Chairman BARTON. Thank you, Mr. Chairman, and before I give

my prepared statement on this hearing, I just want to announce

that we have a new addition to the committee room. We have our

nameplates that have our States on it. I had always wanted to let

people know what State I am from, and Mr. Bass was very happy

when he walked in and noticed that it said he was from New

Hampshire.

Mr. BASS. If the gentleman would yield, I just want to make sure

that—Texas is a long way from here.

Chairman BARTON. So I hope people enjoy the diversity of the

committee, as will be seen as everybody shows up with different locations that we are from.

Mr. Chairman, I appreciate the work that you have shown as

vice chairman of this committee in working on this important

issue. I want to give special commendation to the gentle lady from

San Francisco, Dr. Arlene Ackerman who is joining us by video

conference, for her strong moral stand in turning this issue in to

be investigated. Not too many superintendents, I think, would have

turned $40 million or $50 million down, and she had the moral

courage to make sure that it was on the up and up. Unfortunately,

it turned out that it wasn’t. So I want to thank her long distance

for her strong stand.

It is the intent of this committee’s investigation to ensure that

E-Rate will operate without the waste and abuse that we have

been discovering. Almost every rock that we turn over, it seems

there is a problem under that particular rock.

The E-Rate program deserves vigorous Congressional oversight.

I support this oversight, and I look forward to continuing to work

with this subcommittee as the full committee chairman to get to

the bottom and then, if necessary, provide a legislative reform

package in the next Congress to prevent these kinds of abuses from

continuing to occur.

These hearings are in large measure about accountability, accountability among the applicants and recipients of funding, that

they are following the rules, and accountability among those running the program, that they have set it up to operate effectively

without all the waste and abuse that we are continuously uncovering.

This program is designed to provide recipients and applicants access to other people’s money. When you spend somebody else’s

money, you don’t have the same incentive to spend as carefully as

you would if you were spending your own money.

When tens of millions of dollars are at issue, there is a powerful

incentive to spend wastefully and abuse the program. To address

this powerful incentive, the solution is to ensure accountability of

program participants and managers so that they spend wisely and

manage effectively.

This hearing is about the process put in place to ensure people

act responsibly or with the appropriate authority and understand

the consequence of acting irresponsibly.

Today we are going to look at a fraudulent $50 million application at the San Francisco School District that sailed through the

7

normal process and was approved. The money was eventually rejected, because one person, one person who is going to testify later

this morning, Dr. Arlene Ackerman, had the gumption to look at

this and say that it didn’t look like it was on the up and up. Again,

as I have already said, I want to commend her for her acting responsibly in accountability. I look forward to hearing her testimony

in greater detail this morning.

We also have before us this morning people on the other side, the

company, NEC Unified Solutions, who will answer questions and

actions about their employees. This company recently pleaded

guilty to E-Rate bid rigging in San Francisco and other districts,

and has paid a $20 million fine. I would like to hear how their CEO

answers for the actions of his employees.

We have an E-Rate consultant who was on the ground at the

school districts who can answer to the development of what turned

out to be fraudulent but successful applications for E-Rate funding

and, as you have already pointed out, Mr. Chairman, last week we

issued subpoenas for four witnesses. Three of them are before us

today. One of them, Ms. Judy Green, has successfully ducked service so far.

I take very seriously our oversight function in the House, and I

will not allow people who have information necessary to accomplish

our work to avoid our legitimate inquiries. I have spoken with the

ranking member of the full committee, the Honorable John Dingell

of Michigan, and when we go into recess today or tomorrow, under

the rules of the House of Representatives, as full committee chairman I have the right to issue a recess subpoena, and I will do so.

If Ms. Green’s representatives are in this audience or watching on

television or have access to the record, let them know that there

will be another subpoena issued, and at sometime this fall she will

come before this committee.

The Energy and Commerce Committee, to my knowledge, in the

20 years that I have been in the House, 18 on this committee, has

never had a subpoena that was not successfully served, and we

don’t intend to change that record on this hearing.

So again, in consultation with the ranking member of the full

committee, Mr. Dingell, he is very supportive of my authority as

full committee chairman issuing a recess subpoena to get Ms.

Green to appear at the appropriate time before the committee, and

we will do that.

Finally, we have the Administrator of the program, the E-Rate

program. We have the person who runs the Bureau at the FCC

that is in charge of the E-Rate program. They are responsible for

clear and effective rules and procedures, and we look forward to

hearing from them what they have to say about the larger program, the larger issues before us.

Mr. Chairman, this is a very, very important hearing. I appreciate you holding it. I appreciate the fine bipartisan work that we

have done at the staff level in preparing for it, and I look forward

to a very instructive hearing.

With that, I yield back the balance of my time.

Mr. WALDEN. Thank you, Mr. Chairman, and thanks for your

leadership on this committee.

8

The Chair recognizes the gentleman from New Hampshire, who

I understand does not have an opening statement. Is that correct?

Mr. BASS. I will pass.

Mr. WALDEN. The gentleman passes. The Chair now recognizes

a member of the full committee, Ms. Schakowsky from Chicago, for

an opening statement—from the subcommittee. I’m sorry.

Ms. SCHAKOWSKY. Thank you, Mr. Chairman, for holding this

hearing today. I am glad to have the opportunity to hear about how

the current system’s weaknesses allow vendors to use the E-Rate

program for their own benefit. Once we understand those weaknesses, we can improve the system to make sure it is benefiting our

children.

NEC Business Network Solutions, Inc. entered into bid rigging

schemes in five different school districts in Michigan, Wisconsin,

Arkansas, and South Carolina. The company has also admitted into

entering into a scheme to defraud the E-Rate program in the San

Francisco Unified School District by inflating bids, agreeing to submit false and fraudulent documents to hide the fact that it planned

on installing prohibited items, agreeing to donate so called free

items for which it had planned to bill E-Rate, and submitting false

and fraudulent documents to prevent inquiry into the legitimacy of

the funding requests.

I want to thank those dedicated public servants who are here

today who discovered and helped to uncover these kinds of fraudulent activities. We really appreciate that kind of public service.

NEC generously marked up prices on computer hardware, sometimes as much as 400 percent. On one small Internet switch, for

example, NEC’s bid would have given the firm a profit margin of

$780,000. As shocking as the actions of NEC BNS are, I am sorry

to say that the company is just one of a cast of bad characters profiting at the expense of our Nation’s children.

A price tag cannot be placed on the value of providing Internet

access to the millions of children and teachers in our public schools.

Even in its imperfect condition, the E-Rate program has helped

millions of children gain the kind of technical knowledge that is

crucial in today’s society.

Schools in my district and across the Nation have used E-Rate

funds to provide access to the Internet for kids who might otherwise never have it. Access to the worldwide web can make a world

of difference in our schools. The E-Rate program has helped us

close the information divide, but the disparity in access to computers and online services by race and income still persists.

We cannot afford to abandon the E-Rate program or to have any

of our children left behind on the information superhighway. It is

now our job to reform the E-Rate program to make sure that the

benefits of the program go to those who need them most, our children.

Again, Mr. Chairman, thank you for holding this hearing. I look

forward to hearing the testimony of our witnesses, and I look forward to working to improve the E-Rate program.

Mr. WALDEN. Thank you for your testimony, and we appreciate

your work on this issue.

Now I would like to welcome Panel 1: Dr. Arlene Ackerman, the

Superintendent of the San Francisco Unified School District; Ms.

9

Louise H. Renne, the General Counsel of the San Francisco Unified

School District; Mr. Dennis J. Herrera, City Attorney of San Francisco; and Mr. George Cothran, the investigator for the Office of the

City Attorney.

We appreciate your being here. As you are aware, the committee

is holding an investigative hearing and, when doing so, has had the

practice of taking testimony under oath. Do you have any objection

to testifying under oath? Let the record show the witnesses indicate they have no objection.

The Chair then advises you that, under the rules of the House

and the rules of the committee, you are also entitled to be advised

by counsel. Do you desire to be advised by counsel during your testimony today? The record shows they all indicate no.

In that case, if you would rise and raise your right hand, I will

then swear you in.

[Witnesses sworn.]

Mr. WALDEN. Thank you. They indicate they do.

You are now under oath, and I will call on you to give your 5-

minute summary of your written statement, and we will start with

Dr. Ackerman.

Before I do that, I am going to go ahead and ask unanimous consent to enter into the record the binders that are before us, which

we will reference as we do our questioning. Without objection, they

are now entered into the record. Dr. Ackerman, please go ahead.

TESTIMONY OF ARLENE ACKERMAN, SUPERINTENDENT, SAN

FRANCISCO UNIFIED SCHOOL DISTRICT; LOUISE H. RENNE,

GENERAL COUNSEL, SAN FRANCISCO UNIFIED SCHOOL DISTRICT; DENNIS J. HERRERA, SAN FRANCISCO CITY ATTORNEY; AND GEORGE M. COTHRAN, INVESTIGATOR, SAN FRANCISCO CITY ATTORNEY OFFICE

Ms. ACKERMAN. Thank you. Good morning, Vice Chairman Walden and members of the subcommittee. Thank you for the opportunity to appear before you on the matter of the Federal E-Rate

program and the extremely interesting and revealing experiences

that we have had in San Francisco schools as participants in the

program.

I began my current role as Superintendent of San Francisco Unified School District which serves approximately 59,000 students in

the city and county of San Francisco in July of 2000. Needless to

say, as I went about my work in these first several months, I had

a considerable amount to learn about the detailed context and conditions of San Francisco schools.

In addition to dealing with the core work of a school superintendent, such as evaluating school performance, organizing and

reorganizing the district office and collective bargaining, I was also

hired with a mandate to improve the district’s business practices.

Although I had worked on difficult fiscal and operational issues in

other school districts, I soon learned of activities that, for me, represented a new low in my 30-plus years of public education.

I saw the beginning of a trail of evidence that was ultimately

found to lead to a number of individuals and organizations who

plotted carefully to enrich themselves by depriving our children.

10

In the fall of 2000, two former staff members provided me a copy

of an E-Rate application that had been submitted for $50 million.

As I reviewed the document, several elements of the application

troubled me.

First, it indicated that the district had set aside the approximately $8 million that was necessary to contribute as a matching

requirement. I knew that this was not the case. One of my first priorities had been to become intimately familiar with our financial

condition, and nothing I had studied or heard of indicated that any

district funds had been set aside for this purpose.

Second, the description of the equipment and infrastructure that

was to be funded with the grant proceeds seemed incoherent and

did not reflect a strategy to align technology with instructional objectives. I saw woefully little evidence of sufficient planning, especially for an investment of this size.

Finally and perhaps most obvious, the document materially misstated facts in describing our district. Among other things, the

grant indicated that the district covered 400 square miles, in contrast to the actual figure of 49 square miles.

It also claimed that there is no mass transit system in San Francisco, when we actually have one of the Nation’s largest public

transportation systems. In many respects, the grant seemed to be

describing another district altogether.

As superintendent, I typically require that documents that bind

the district to any funding or other commitments undergo legal review. In this case, my elevated concerns about this grant led me

to contact then City Attorney Louise Renne for assistance in reviewing the document.

As Ms. Renne and then current City Attorney Dennis Herrera

and Investigator George Cothran will describe in detail, so began

an investigation that ultimately led to the extremely disturbing

conclusions that necessitate this morning’s hearing. However, despite the disturbing and cautionary aspects of our experience with

E-Rate, I very much hope that members of this subcommittee and

the public will interpret my comments as supporting reform of the

program, not its elimination.

I fully agree with the goals of the program, to increase all students’ access to technology, paying particular attention to the digital divide that would otherwise place the Internet out of the reach

of many children of low income families.

While our experience in San Francisco and those of several other

school districts have revealed serious problems with the E-Rate

program, I would respectfully ask policymakers to consider that the

program has brought technology to unprecedented numbers of public school students. Nearly all classrooms and school libraries are

now connected to the Internet, and most as a direct result of the

E-Rate program.

The program certainly needs to be reformed, and to that end I

am gratified that San Francisco schools and the extremely capable

attorneys and investigators who have assisted us have helped accelerate discussions about how to increase scrutiny of E-Rate applications and otherwise reduce the possibility of waste, fraud and

abuse in this important program.

11

At this point, I would like to introduce San Francisco’s former

City Attorney and our school district’s former General Counsel,

Louise Renne. Thank you.

[The prepared testimony of Arlene Ackerman follows:]

PREPARED STATEMENT OF ARLENE ACKERMAN, SUPERINTENDENT, SAN FRANCISCO

UNIFIED SCHOOL DISTRICT

Good morning Chairman Greenwood, Ranking member Deutsch, and members of

the subcommittee. Thank you for the opportunity to appear before you on the matter of the federal E-rate program and the extremely interesting and revealing experiences that we have had in San Francisco’s schools as participants in the program.

I began my current role as Superintendent of San Francisco Unified School District, which serves the 59,000 public school students in the City and County of San

Francisco, in July 2000. Needless to say, as I went about my work in these first

several months I had a considerable amount to learn about the detailed context and

conditions of San Francisco’s schools.

In addition to dealing with the core work of a school superintendent, such as evaluating school performance, organizing the district office, and collective bargaining,

I was also hired with a mandate to improve the District’s business practices. Although I had worked on difficult fiscal and operational issues in other school districts, I soon learned of activities that for me represented a new low in my thirtyplus years of public education. I saw the beginning of a trail of evidence that was

ultimately found to lead to a number of individuals and organizations who plotted

carefully to enrich themselves by depriving children.

In the fall of 2000, two former staff members provided me a copy of an E-Rate

application that had been submitted for $50 million. As I reviewed the document,

several elements of the application troubled me.

First, it indicated that the District had set aside the approximately $8 million

that was necessary to contribute as a matching requirement. I knew that this was

not the case. One of my first priorities had been to become intimately familiar with

our financial condition, and nothing I had studied or heard indicated that any District funds had been set aside for this purpose.

Second, the description of the equipment and infrastructure that was to be funded

with the grant proceeds seemed incoherent and did not reflect a strategy to align

technology with instructional objectives. I saw woefully little evidence of sufficient

planning, especially for an investment of this size.

Finally, and perhaps most obvious, the document materially misstated facts in describing the District. Among other things, the grant indicated that the District covered 400 square miles, in contrast to the actual figure of forty-nine (49) square

miles. It also claimed that there is no mass transit system in San Francisco when

we actually have one of the nation’s largest public transportation systems. In many

respects, the grant seemed to be describing another district altogether.

As Superintendent, I typically require that documents that bind the District to

any funding or other commitments undergo legal review. In this case, my elevated

concerns about this grant led me to contact then City Attorney Louise Renne for

assistance in reviewing the document. As Ms. Renne, current City Attorney Dennis

Herrera, and investigator George Cothran will describe in detail, so began an investigation that ultimately led to the extremely disturbing conclusions that necessitate

this morning’s hearing.

However, despite the disturbing and cautionary aspects of our experience with ERate, I very much hope the members of the Subcommittee and the public will interpret my comments as supporting reform of the program, not its elimination. I fully

agree with the goals of the program—to increase all students’ access to technology,

paying particular attention to the digital divide that would otherwise place the

internet out of the reach of many children of low income families.

While our experience and those of several other school districts have revealed serious problems with the E-Rate program, I would respectfully ask policymakers to

consider that the program has brought technology to unprecedented numbers of

public school students. Nearly all classrooms and school libraries are now connected

to the internet, most as a direct result of the E-Rate program. The program certainly needs to be reformed. To that end, I am gratified that San Francisco schools

and the extremely capable attorneys and investigators who have assisted us have

helped accelerate discussion about how to increase scrutiny of E-Rate applications

and otherwise reduce the possibility of waste, fraud, and abuse in this important

program.

12

At this point I would like to introduce San Francisco’s former City Attorney and

our school district’s former General Counsel Louise Renne.

Mr. WALDEN. Thank you for your testimony.

The committee now would like to hear from Ms. Renne. Thank

you for being here. We appreciate your work and your comments.

TESTIMONY OF LOUISE H. RENNE

Ms. RENNE. Thank you. Good morning, Mr. Chairman and members.

As Dr. Ackerman has indicated, the nationwide scheme to defraud the E-Rate program came to our attention shortly after she

became the superintendent of San Francisco schools and at the

time I was the City Attorney. I still very well remember the day

when I got a phone call from Dr. Ackerman saying I think we have

some funny business going on over here, and at her request an investigation was started.

A group of attorneys was assembled, including an investigator,

George Cothran, and as our investigation progressed, the national

scope of the E-Rate problem soon became quite clear.

During the process we called in the FBI and our local United

States Attorney, Kevin Ryan, as well, and as City Attorney, Dennis

Herrera, will describe in more detail, too, we during the course of

the investigation prepared a whistleblower lawsuit which was unprecedented for a school district, was filed in Federal court by my

successor, Dennis Herrera, and that suit resulted in the guilty plea

that has already been described.

During the course of the process, we learned that the matter, not

just in San Francisco, but that there was the same or similar fraud

going on across the country, and that it was part of a well orchestrated effort, it would seem.

In San Francisco, investigator George Cothran will describe in

quite a bit of detail how this process started with the filing basically of a bogus application, how Inter-Tel Technology started the

ball rolling, if you will, by approaching some of our district people,

and then involved, as you have already indicated as well, Judy

Green, George Marchelos in the process.

The proposal, the E-Rate proposal, was drafted in such a way

that it would be prejudiced toward goods and services sold by

VNCI, which was associated with Judy Green and group. They

bundled VNCI equipment inside a bid. The bids were not advertised, as required by law.

So again, as will be described in far more detail by Mr. Cothran,

the companies ensured, as a result of the whole bid rigging process

and their conspiracy, that they would be the primary recipients of

the E-Rate funding.

So what has happened is, in short, the companies involved really

soaked the whole E-Rate process, in San Francisco’s case, of approximately $50 million, who knows how much more in other jurisdictions.

We think, and we know, that for the first time San Francisco’s

lawsuit was the first time, to our knowledge, that a school district

has ever file a whistleblower claim, and it is our hope that, as the

results of the investigation are detailed for this committee by Dennis Herrera and George Cothran, that these actions and some of

13

the corresponding enforcement actions which are undoubtedly

going on around the country will put government agencies and

businesses alike on their guard against the kinds of practices that

will be described this morning, and will help root out the problems

that beset the E-Rate program.

We think at the district that the goals of the program are important for the future. Our children cannot compete in the modern

world without knowledge of computers and technology and, surely

for those companies that have put this program at risk, we hope

that the committee hearings will get to the bottom and root out

this fraud.

My successor in office is my good friend, Dennis Herrera.

[The prepared testimony of Louise H. Renne follows:]

PREPARED STATEMENT OF LOUISE H. RENNE, SPECIAL COUNSEL, SAN FRANCISCO

UNIFIED SCHOOL DISTRICT

Mr. Chairman and Members: The nationwide scheme to defraud the E-Rate program came to our attention in San Francisco soon after Arlene Ackerman, the

former chief of the Washington, D.C. schools, took over as superintendent of the San

Francisco Unified School District.

At the time I was the San Francisco City Attorney.

Ms. Ackerman had grown suspicious of a number of situations at the school district. I still remember very well the day when she called me and said, ‘‘I think

there’s some funny business going on over here.’’

I ordered an investigation, assembling a team of attorneys and investigators, including George Cothran, who will also testify today. As our investigation progressed,

the national scope of the E-Rate problem soon became clear. In the process, we

alerted the FBI and U.S. Attorney Kevin Ryan.

In addition, we prepared a whistleblower lawsuit, unprecedented for a school district, which was filed in federal court by my successor in office, Dennis Herrera.

That suit resulted in a guilty plea last May by one of the companies that perpetrated the San Francisco fraud, NEC Business Network Solutions.

But the matter does not end there. We learned that some of the San Francisco

co-conspirators were likely committing the same or similar fraud across the country.

The misappropriation of E-Rate money from disadvantaged schools and the children they serve was a well orchestrated effort by several corporate players working

in concert with one another.

In San Francisco, the school district’s initial contact with the corporate con game

came when a representative of Inter-Tel Technologies approached the district with

a proposal for the purchase of telecommunications equipment.

The Inter-Tel representative introduced district officials to Judy Green and

George Marchellos, employees of Video Network Communications Inc., or VNCI,

both experts in the E-Rate program. As our chief E-Rate investigator, George

Cothran, will testify in detail, Ms. Green and Mr. Marchellos infiltrated the district’s competitive bidding process to win inflated E-Rate funding for district projects

directly benefiting VNCI, Inter-Tel, and NEC.

Specifically, they wrote the district’s request for proposals so that it would be prejudiced toward goods and services sold by VNCI. Then they bundled VNCI equipment inside a bid submitted by Inter-Tel. As part of the conspiracy, the RFP was

not advertised as required by law.

The investigation suggested that the three companies used the same or similar

schemes elsewhere, with VNCI typically managing the bidding process and hiding

its equipment inside bids submitted either by Inter-Tel, as in San Francisco, or by

NEC.

As a result of their conspiracy, these companies ensured that they would be the

primary recipients of E-Rate funding provided to the San Francisco Unified School

District.

But their fraud didn’t stop with a phony bidding process. They also submitted a

falsified application for E-Rate funding on behalf of the district that inflated their

bid prices by more than $60 million, well above the artificially high rates already

enabled by the rigged bids.

In short, they thoroughly soaked the E-Rate process for millions of dollars with

lies, overcharges, and fraud.

14

San Francisco’s lawsuit marks the first time to our knowledge that a school district has filed a whistleblower claim. It is my hope that our unprecedented action,

along with other enforcement efforts around the country, will put government agencies and businesses alike on their guard against these practices, and will help to

root out the problems that have beset the E-Rate program. The goals of the program

are important for the future. Our children cannot compete in the modern world

without knowledge of computers and technology, which is why a well-run program

is so necessary.

Thank you.

Mr. WALDEN. Thank you for your testimony. We appreciate it.

Mr. Herrera, thank you for being here. Thank you for your work.

We look forward to your testimony.

TESTIMONY OF DENNIS HERRERA

Mr. HERRERA. Chairman Walden, distinguished members of the

subcommittee, I thank you for the opportunity to appear before you

today to discuss San Francisco’s experience with efforts to defraud

the Federal E-Rate program. I am also honored to join San Francisco Unified School District General Counsel, Louise Renne, in testifying today.

As my immediate predecessor as City Attorney, Louise first ordered the investigation that was so capably undertaken and thoroughly investigated by George Cothran of my office, with whom I

am also honored to appear today.

When I took office in January 2002, our office’s investigation into

the E-Rate fraud had been underway for more than a 8 months.

As much or more than any of the cases I inherited or have undertaken since, the E-Rate case represented exactly the kind of public

policy priority that I had talked about extensively during the

course of my campaign for City Attorney.

In establishing a permanent public integrity unit in my office, I

sought to take as aggressive a stand as possible against those who

would seek to defraud our city; because, as I am sure this subcommittee is well aware, the harm government suffers when it is

defrauded cannot be quantified in mere dollar amounts.

Schemes such as these aren’t just greedy. They are a corrosive

influence on the integrity of our public institutions. They are an insult to our citizens’ faith in their government to do the right thing,

and they are an insult to the honest businesses and contractors

who play by the rules and yet lose government contracts to competitors who cheat.

The E-Rate scheme we unmasked in San Francisco represented

all of that, plus one aggravating circumstance for which it deserves

an especially prominent place in the ripoff hall of shame. It targeted funds intended to benefit the poorest, most vulnerable school

children of America.

For disadvantaged kids in San Francisco, growing up in Silicon

Valley’s backyard, in a city that is itself a high tech capital, the

abuse of a program to help them bridge the digital divide represents an all too real theft of future job opportunities and economic advancement.

Indeed, had San Francisco not blown the whistle on the fraud we

uncovered, vendors associated in the scheme in our school system

stood to receive a total of nearly $55 million, and for all that

money, according to their funding applications, San Francisco

15

schools would have been left with an incomplete computer network

that was, by itself, inoperable.

Schools throughout our school district would have been saddled

with millions of dollars in equipment that was functionally equivalent to paperweights, routers, cabling and switches with no servers,

a phone system with no phones, a computer system with no work

stations, videoconferencing equipment that wasn’t even eligible for

E-Rate funding.

When our investigation was completed, the details of which Mr.

Cothran, more than I, is best equipped to discuss, the evidence confirmed that E-Rate applications for San Francisco schools had been

fraudulently conceived and executed in almost every respect. Moreover, the investigation demonstrated that these practices were not

confined to San Francisco.

We discovered fraudulent applications in several other school districts, frequently involving the same co-conspirators. On May 16,

2002, I filed a false claim action under seal on behalf of our school

district and the people of the State of California. In filing the case

as what we call a Qui Tam action, the San Francisco Unified

School District became the whistleblower on a nationwide scam,

and we turned the results of our investigation over to the U.S. Department of Justice with whom we have continued to work.

Under terms of a partial settlement announced in our case several weeks ago, NEC Business Network Solutions paid a total of

nearly $16 million in cash and services to the Federal Government

to settle the lawsuit’s civil claims. As a Qui Tam whistleblower in

the case, the San Francisco Unified School District will receive

nearly $3.4 million.

NEC BNS also pled guilty to felony counts of wire fraud and conspiring to violate Federal anti-trust laws and paid a criminal fine

to the feds of $4.6 million.

Clearly, the settlement represents an excellent outcome for the

San Francisco public schools, but it also is an important vindication

for a brave and controversial decision by our school superintendent,

Arlene Ackerman, to refuse suspect funding from the E-Rate program in the first place. Moreover, it is testimony to the outstanding

work of U.S. Attorney Kevin Ryan of San Francisco, my predecessor, SFUSD General Counsel Louise Renne, and to the investigators and attorneys in my office, particularly George Cothran

whose many months of living, breathing and sleeping the details of

this highly complex case paid off so impressively.

We are, of course, delighted and proud to see justice done in a

manner that realizes such significant benefits for San Francisco’s

school children. We are no less proud to be here today to offer our

assistance to this subcommittee and to this Congress to assure that

no other school district in this country, not one more school kid in

America, suffers for the waste, fraud and abuse of the E-Rate program.

Mr. Chairman and distinguished members of the subcommittee,

in concluding my formal statement I thank you for the opportunity

to appear before you today, and while I am glad to answer any

questions you may have, I will confess that I would likely defer to

our own investigator, the expert on this matter, George Cothran,

from whom you will hear next.

16

[The prepared testimony of Dennis Herrera follows:]

PREPARED STATEMENT OF DENNIS HERRERA, CITY ATTORNEY OF SAN FRANCISCO

Chairman Greenwood, distinguished Members of the Subcommittee: I thank you

for the opportunity to appear before you today to discuss San Francisco’s experience

with efforts to defraud the federal E-Rate Program.

I’m also honored to join San Francisco Unified School District General Counsel

Louise Renne in testifying today. As my immediate predecessor as San Francisco

City Attorney, Louise first ordered the investigation that was so capably undertaken

and thoroughly investigated by George Cothran of my office, with whom I’m also

honored to appear today.

When I took office in January 2002, our office’s investigation into E-Rate fraud

had been underway for more than eight months. As much or more than any of the

cases I inherited or have undertaken since, the E-Rate case represented exactly the

kind of public policy priority I had talked about extensively in my campaign for City

Attorney.

In establishing a permanent Public Integrity Unit in my office, I sought to take

as aggressive a stand as possible against those who would seek to defraud our City.

Because as I’m sure this subcommittee is well aware, the harm government suffers

when it is defrauded cannot be quantified in mere dollar amounts.

Schemes such as these aren’t just greedy.

• They’re a corrosive influence on the integrity of our public institutions. • They’re an assault on our citizens’ faith in their government to do the right

thing. • And they’re an insult to the honest businesses and contractors who play by the

rules—and yet LOSE government contracts to competitors who cheat.

The E-Rate scheme we unmasked in San Francisco represented all of that—plus

one aggravating circumstance for which it deserves an especially prominent place

in the Government Rip-off Hall of Shame: it targeted funds intended to benefit the

poorest, most vulnerable schoolchildren in America.

For disadvantaged kids in San Francisco—growing up in Silicon Valley’s backyard, in a city that is ITSELF a high-tech capital—the abuse of a program to help

them bridge the ‘‘Digital Divide’’ represents an all too real theft of future job opportunities and economic advancement.

Indeed, had San Francisco NOT blown the whistle on the fraud we uncovered,

vendors associated in the scheme in our school system stood to receive a total of

nearly $60 million. And for all that money, according to their funding applications,

San Francisco schools would have been left with an incomplete computer network

that was, by itself, inoperable.

Schools throughout our school district would have been saddled with millions of

dollars in equipment that was functionally equivalent to paperweights.

• Routers, cabling and switches with no servers

• A phone system with no phones

• A computer system with no workstations

• Video-conferencing equipment that wasn’t even eligible for E-Rate funding

When our investigation was completed—the details of which Mr. Cothran more

than I is best equipped to discuss—the evidence confirmed that E-Rate applications

for San Francisco schools had been fraudulently conceived and executed in almost

every respect. Moreover, the investigation demonstrated that these practices were

not confined to San Francisco. We discovered fraudulent applications in several

other school districts, frequently involving the same co-conspirators.

On May 16, 2002, I filed a false claims action under seal on behalf of our School

District and the People of the State of California. In filing the case as what we lawyers call a ‘‘Qui Tam’’ action, the San Francisco Unified School District became the

whistleblower on a nationwide scam. And we turned the results of our investigation

over to the U.S. Department of Justice, with whom we’ve continued to work.

Under terms of a partial settlement announced in our own case several weeks

ago, NEC Business Network Solutions, a subsidiary of NEC Corporation, paid a

total of nearly $16 million in cash and services to the federal government to settle

the lawsuit’s civil claims. As the ‘‘qui tam’’ whistleblower in the case, the San Francisco School District will receive 21 percent—or nearly $3.4 million. NEC/BNS also

pled guilty to felony counts of wire fraud and conspiring to violate federal antitrust

laws, and paid a criminal fine to the feds of $4.6 million.

Clearly, the settlement represents an excellent outcome for San Francisco public

schools. But it was also an important vindication for a brave and controversial decision by our School Superintendent, Arlene Ackerman, to refuse suspect funding

from the E-Rate program in the first place.

17

Moreover, it is testimony to the outstanding work of U.S. Attorney Kevin Ryan

of San Francisco, SFUSD General Counsel Louise Renne and to the investigators

and attorneys of my office—particularly George Cothran, whose many months of living, breathing and sleeping the details of this highly complex case paid off so impressively.

We are, of course, delighted and proud to see justice done in a manner that realizes such significant benefits for San Francisco’s schoolchildren. But we are no less

proud to be here today to offer our assistance to this subcommittee and to this Congress to assure that no other school district in this country—not one more school

kid in America—suffers for the waste, fraud and abuse of the E-Rate program.

Mr. Chairman and distinguished Members of the Subcommittee, in concluding my

formal statement I would like to thank you again for the opportunity to appear before you today.

While I’m glad to answer any questions you may have at this time, I will confess

that I would likely defer to my OWN investigator on the subject, George Cothran,

from whom you’ll hear next.

Mr. WALDEN. Thank you. Thank you for your testimony, and we

appreciate the work of your office.

Mr. Cothran, thank you for being here today. We look forward

to your testimony. Please begin.

TESTIMONY OF GEORGE M. COTHRAN

Mr. COTHRAN. Thank you, Chairman. One of the major findings

of the City Attorney investigation into the attempted E-Rate fraud

in San Francisco in 1999 and 2000 was that every action taken by

defendants in our Qui Tam lawsuit was geared toward one narrow

goal, to put money in their pockets. We found no evidence that defendants once considered the needs of the school district or its student bodies as they went about corrupting a government bid process and submitting fraudulently inflated E-Rate funding applications in January of 2000, seeking to defraud the E-Rate program

of approximately $53 million.

Thank you for the opportunity to allow me to walk you through

conclusions the city attorney’s office reached based on the evidence

that was available to us.

The fraud scheme had its roots in the district declining to do

business with one of our defendants, Inter-Tel Technologies. In

1999 an Inter-Tel representative was rebuffed by the school district

as he tried to make a sale of his employer’s products.

Instead of taking this refusal as the thoughtful and perhaps correct decision by a government agency, the Inter-Tel representative

sought business through the back door. The sales representative

contacted Desmond McQuoid, a friend he knew from having lived

in the same town as McQuoid some years earlier, though McQuoid

had no authority to purchase said equipment. He was merely a custodial supervisor.

To flesh out his product pitch, the Inter-Tel representative then

involved two employees from Video Networks Communications, Incorporated, a small New Hampshire firm that manufactured

videoconferencing equipment. From this point on, the Inter-Tel proposal included VNCI videoconferencing equipment.

At the time, Inter-Tel had an agreement with VNCI that called

for the company to bundle VNCI equipment into its E-Rate bids

and to pay VNCI a so-called marketing fee for identifying E-Rate

opportunities, all despite the fact that VNCI’s equipment was not

eligible for E-Rate funding at the time.

18

Once VNCI was involved, this fraud scheme began, and it only

grew larger and more ambitious as time passed. VNCI employees,

Judy Green and George Marchelos, hijacked the San Francisco procurement process, taking over all of the roles, responsibilities and

obligations of the school district.

At the same time, Green and Marchelos invited another VNCI ERate bidding partner, NEC Business Network Solutions, into the

process. VNCI had the same agreement with NEC that it had with

Inter-Tel, and as Inter-Tel was bundling VNCI equipment in San

Francisco, NEC was bundling VNCI equipment into E-Rate bids in

several school districts’ E-Rate proposals nationwide.

Once Green and Marchelos had control of the San Francisco bid

process, they were in a position to make decisions properly left to

the district in order to benefit themselves, their employer, their

employer’s business partners, and other co-conspirators as it

pleased them.

VNCI, through Green and Marchelos, provided a request for proposal to McQuoid which called for phone switch bidders to include

videoconferencing equipment in their responses. Green and

Marchelos assumed a degree of control over who participated in the

bid, inviting VNCI partners and associates from past E-Rate bids.

At the same time, McQuoid declined to advertise the bid publicly,

as called for in California law.

Marchelos ran the January 3, 2000, pre-bid meeting, according to

witnesses, where he distributed the VNCI RFP. According to witnesses, he told meeting participants he was acting as a consultant

to the school district, which was not true. He did not identify his

affiliation with VNCI, even though many of his co-conspirators in

the room most likely knew where his interests lay.

Green and Marchelos ran a January 14, 2000, bid opening meeting where they selected winners and declared noncompliant the one

bid that stood in the way of VNCI business partner, NEC, and

Sprig Electric, a Green invitee into the San Francisco bid she and

VNCI had done business with in past E-Rate bid situations.

The losing firm, Pacific Bell Network Integration, had been invited to bid by McQuoid as a precautionary measure. Pacific Bell

was conducting extensive work under contract with the district at

various locations, including many affected by the VNCI RFP.

PBNI won McQuoid’s agreement to bid off specification from the

VNCI RFP, because Pac Bell believed the RFP was far too expensive and needlessly complex. Pac Bell offered modest, affordable

bids on data and cabling. The Pac Bell proposal was many millions

of dollars less than the competing bid on data by NEC and the

competing Sprig Electric cabling bid.

Regardless, Green and Marchelos ruled the Pac Bell bid noncompliant with the VNCI RFP, paving the way for NEC and Sprig

Electric to receive E-Rate monies. In the process, they dramatically

increased the cost to the E-Rate program of the project. At the

same meeting Inter-Tel’s bid was approved by Green and

Marchelos.

The City Attorney investigation included NEC, which was concurrently bidding PBX proposals nationwide, and any of VNCI’s ineligible equipment did not make the PBX bid in San Francisco. We

suspect this was by arrangement between the two firms, Inter-Tell

19

and NEC, and VNCI, and we are confident our ongoing litigation

and investigation will confirm the suspicion.

Consequently, Inter-Tel was the only PBX bidder in San Fran- cisco. In approving Inter-Tel’s $20.6 million bid, Green and

Marchelos were awarding a contract on a bid that included more

than $15 million of VNCI equipment and which would presumably

result in sales commissions to the two VNCI employees.

Nearly all parties in the January 14, 2000, meeting had knowledge of VNCI’s conflict of interest or they had ample reason to suspect that Green and Marchelos were improperly ruling on bids.

Immediately following the bid opening meeting, Green and

Marchelos began engineering a process by which NEC assumed

control over two aspects of the project where the company had apparently lost the bid. The two VNCI employees, with McQuoid’s

help, relegated Sprig Electric, which had won the cabling bid, and

U.S. Machinery, a local area firm that had won the server bid, to

subcontractor status and replaced them on the E-Rate funding application or Form 471 with NEC.

The City Attorney’s office suspects VNCI performed this act in

order to ensure that E-Rate monies flowed to a firm that was

bound by agreement to pay a VNCI marketing fee based on its ERate income.

At this point Green and Marchelos, NEC and Inter-Tel, without

including McQuoid in this instance, engaged in their most ambitious attempt at fraud. The parties took the already inflated rigged

bid prices and increased them by more than $50 million when filling out two false and fraudulent Form 471 application forms. The Sprig Electric bid on cabling went from $13.6 million to $39.7 million, once in the hands of NEC. The U.S. Machinery bid

on servers went from $9.2 million to $32.9 million, once it was in

the hands of NEC.

The NEC bid on switchers and routers went from $19.7 million

to $32.9 million, and the Inter-Tel bid on the PBX, which included

the ineligible VNCI equipment, went from $20.6 million to $29.4

million.

After factoring in E-Rate discount rates, the two applications for

funding requested a little over $100 million. The results of the

rigged bid totaled about $52 million. Consequently, the two Form

471s contained a fraud attempt of at least $53 million.

Moreover, one of the two applications would have included 18

schools not involved in the rigged bid process. This application, as

far as we could tell, was not premised on any bid process whatsoever, and the dollar figures included on it were most likely picked

out of thin air.

Once McQuoid learned of the two inflated applications, he had a

decision to make: Call off the deal and blow the whistle or go along

for the ride. He chose the latter, and in the process won NEC

BNS’s agreement to use some of the excess E-Rate award to purchase computer work stations that were not eligible for E-Rate

funds.

After the two fraudulent applications were submitted and E-Rate

administrators at the Universal Service Administrative Company

began their review, Green, Marchelos, McQuoid and representatives of NEC conspired to submit false and forged documentation

20

to the E-Rate program to conceal their wrongdoing and to facilitate

the award of funds they were not properly due. Let me just give

you the highlights.

An altered copy of the RFP was provided to USAC omitting references to the videoconferencing equipment. Names were forged on

a list of attendees at the pre-bid meeting on January 3 in order to

conceal the rigged nature of the process.

A document bearing NEC’s logo purporting to show the size of

seven sample schools in the school district justifying cabling costs

was exaggerated in size by nearly 50 acres and more than 70 rooms

and, most damaging, a counterfeit copy of the San Francisco Unified School District budget was submitted with a fraudulent line

item purporting to show that the district had more than $40 million in E-Rate matching funds, when in reality the district had no

such funds available.

In closing, I would like to point out that this last misrepresentation made to the E-Rate program was perhaps the most egregious.

In responding to written questions, a USAC employee informed the

City Attorney’s office that, had the E-Rate program Administrator

known the school district had no available matching funds, USAC

would have denied the entire funding request.

Thank you for the opportunity to testify today, and I look forward to any questions you might have.

[The prepared testimony of George M. Cothran follows:]

PREPARED STATEMENT OF GEORGE M. COTHRAN, INVESTIGATOR, CITY ATTORNEY’S

OFFICE, CITY AND COUNTY OF SAN FRANCISCO

Beginning in the fall of 1999 and extending into fall of 2000, San Francisco Unified School District (SFUSD) served as the staging ground for an attempted defrauding of the E-Rate program. The fraud scheme was expansive in its ambition.

Involved parties included 1) Desmond McQuoid, a SFUSD custodial supervisor; 2)

NEC Business Network Solutions (NEC BNS), a United States affiliate of the multinational corporation, NEC Corp. of Tokyo, Japan; 3) Inter-Tel Technologies, Inc., a

publicly-traded telecommunications firm; 4) Video Network Communications, Inc.

(VNCI), a publicly traded manufacturer of video-conferencing equipment; 5) US Machinery, a San Francisco Bay Area computer re-seller; and 6) Sprig Electric, a San

Francisco Bay Area electrical contractor.

City Attorney Dennis J. Herrera on behalf of the People of California, and the San

Francisco Unified School District, as whistleblower under the provisions of the False

Claims Act, sued the above parties on May 16, 2002 for their misdeeds in San Francisco and elsewhere in the United States where our investigation uncovered evidence of their likely involvement in similar wrongdoing.

In San Francisco, the parties had varying degrees of culpability. The main wrongdoers were McQuoid, NEC BNS, VNCI, and Inter-Tel Technologies.

VNCI was the ringleader.

Through two grossly inflated and fraudulent SFUSD E-Rate funding applications,

NEC BNS, Inter-Tel, and VNCI sought to defraud the E-Rate program out of

$60,387,081.56.

To accomplish this defendants

• hijacked and rigged a government procurement and competitive bid process, suppressing competition and making the resulting E-Rate proposal vastly more expensive;

• concealed the presence of equipment ineligible for E-Rate funding in the bids and

the funding applications;

• filed fraudulent and inflated funding applications to the E-Rate program;

• conspired to use the fraudulently obtained E-Rate funds for ineligible and improper purposes including the payment of a so-called marketing fee to VNCI

which the City Attorney’s Office contends is little more than a kickback; and

• submitted false and fraudulent documentation to the E-Rate program in order to

conceal their wrongdoing and facilitate the award of E-Rate monies not properly

due to them.

21

THE RIGGED BID:

Though VNCI had a financial interest in the outcome of the bid, two VNCI employees, Judy Green and George Marchelos, controlled nearly every aspect of the

San Francisco bid process, from provision of design specifications to the selection of

winning bidders and the disqualification of a firm not involved in the conspiracy.

a) VNCI, through Green and Marchelos, authored and provided a Request for Proposal (RFP), the equipment specifications mandating the type and amount of equipment bidding firms were required to include in their responses—a job that should

have been left to SFUSD.

The VNCI RFP required firms bidding on the Private Branch Exchange (PBX),

or phone switch, to include a video-conferencing solution, thus tailoring the project,

and the bid responses, in the direction of equipment VNCI manufactured.

The VNCI RFP required a video-conferencing solution even though VNCI and its

co-conspirators knew or should have known that video-conferencing equipment was

not eligible for E-Rate funding at the time.

Inter-Tel, which had an agreement with VNCI whereby it provided VNCI equipment as part of its E-Rate bids, introduced Marchelos and Green to McQuoid and

the SFUSD E-Rate opportunity during the fall of 1999.

From the onset, Inter-Tel included ineligible VNCI equipment as part of the company’s proposal.

And as VNCI, through Marchelos and Green, increasingly took control of the bid

process, Inter-Tel representatives did nothing to interrupt that control even though

they were aware of VNCI’s conflict of interest and stood to profit financially from

it.

By the time of the San Francisco bid, Inter-Tel’s relationship with VNCI was entering its second year. Evidence suggests Inter-Tel had made E-Rate bids including

VNCI equipment in other school districts the year prior to the San Francisco bid.

By late 1999 and early 2000, when the San Francisco bid was corrupted, VNCI

had business agreements with both Inter-Tel and NEC BNS whereby the two firms

included VNCI video-conferencing equipment in their E-Rate bids.

In the case of the San Francisco E-Rate bid, VNCI was planning on selling its

equipment to Inter-Tel in order for Inter-Tel to comply with the PBX specifications

of the VNCI RFP.

But at the same time, VNCI was bundling its ineligible equipment in NEC BNS’s

E-Rate bids in approximately 10 school districts across the United States.

Evidence demonstrates that when Inter-Tel submitted its San Francisco E-Rate

bid on January 14, 2000, nearly three-quarters of the equipment was manufactured

by VNCI.

Consequently, when VNCI representatives Green and Marchelos manipulated the

bid process in favor of the NEC BNS and Inter-Tel bids, they were doing so, for the

most part, to benefit their employer, VNCI.

On January 3, 2000, Marchelos ran a pre-bid meeting where he distributed and

explained the VNCI RFP.

Marchelos introduced himself to the participants of the meeting as a consultant

to the school district, though this was not true. Moreover, witnesses said, he did not

reveal that he was employed by VNCI.

Regardless, evidence suggests that employees or representatives of Inter-Tel, NEC

BNS, and Sprig Electric present at the January 3, 2000 meeting most likely knew

some or all of the following facts: Marchelos’s VNCI affiliation, VNCI’s role as author of the RFP, the RFP’s requirement for a video-conferencing solution, the ineligibility of video-conferencing equipment for E-Rate funding, and VNCI’s role as certain or most likely supplier of the video-conferencing equipment to the winning PBX

bidder.

All three firms were at the time or had been in the recent past involved in ERate bid opportunities elsewhere where Marchelos and Green represented VNCI’s

interests, sometimes influencing school district decisions at the same time as they

were doing in San Francisco.

b) VNCI, through Marchelos and Green, and McQuoid took steps to control who

responded to the San Francisco E-Rate bid opportunity. Green and Marchelos invited bidders they had past or current business arrangements with—NEC and Sprig

Electric (Inter-Tel did not need to be invited as they alerted VNCI to the opportunity in San Francisco).

Desmond McQuoid failed to advertise the existence of the bid in a local newspaper, as required by California law. At the same time he invited US Machinery

with whom he was engaged in a separate criminal fraud conspiracy that would

eventually net him a federal prison sentence.

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The City Attorney’s Office suspects that McQuoid did so at the suggestion or direction of Green and Marchelos and is confident that this suspicion will be confirmed as true through the course of our ongoing litigation and investigation.

c) The bidders, for the most part, did not compete against each other. Sprig Electric bid on cabling, and no other aspect of the RFP. US Machinery bid on servers,

and no other aspect of the RFP. NEC bid on servers and switches and routers, and

no other aspect of the RFP. And Inter-Tel bid on the private branch exchange (PBX),

and no other aspect of the RFP.

The City Attorney’s Office suspects that this failure to compete was by agreement

between the parties and is confident it will be shown to have been so arranged during the course of litigation and further investigation.

One firm, Pacific Bell Network Integration (PBNI), was invited by McQuoid at the

last minute, the day the RFP was distributed to bidders. The City Attorney’s Office

investigation concluded that PBNI was invited only because McQuoid had been

warned by other school district employees that the work prefigured in the VNCI

RFP conflicted with contracts PBNI had with SFUSD. The City Attorney’s Office

concluded that PBNI was not part of the E-Rate fraud conspiracy in San Francisco.

d) VNCI, through Green and Marchelos, ran the meeting where bids were received and ruled on. Green and Marchelos awarded contracts to firms with whom

VNCI had ongoing business relationships and disqualified PBNI, which was in competition with VNCI business partner NEC BNS and Sprig Electric, a Green invitee

into the process.

On January 14, 2000, at approximately 3 p.m. in the afternoon, bidders convened

in McQuoid’s office at 834 Toland St., San Francisco, Calif., the headquarters of the

buildings and grounds division of SFUSD.

Bids were turned in and Marchelos and Green ruled on and announced the winners, according to individuals present at the meeting.

The City Attorney investigation concluded that most of the participants in the

meeting, with the exception of U.S. Machinery and PBNI, knew Green and

Marchelos were VNCI employees, that VNCI had a conflict of interest and that their

decision-making role over the bids was improper.

The Inter-Tel representatives certainly knew VNCI had a conflict of interest;

nearly three-quarters of the bid they were submitting consisted of VNCI equipment.

NEC BNS representatives knew Green and Marchelos were with VNCI, and they

knew VNCI had a conflict of interest as it related to their bid as well. They had

worked with Green and Marchelos to include VNCI equipment in approximately 10

NEC BNS E-Rate bids nationwide during the same funding cycle prior to involving

themselves in the San Francisco bid.

Findings of the City Attorney Office investigation suggests Sprig Electric also was

aware of the VNCI conflict of interest and the office is confident that its ongoing

litigation and investigation will demonstrate conclusively that Sprig Electric was

aware of VNCI’s conflict of interest and Green and Marchelos’ improper control over

the bid process.

The City Attorney investigation concluded that Green and Marchelos assumed a

key role not only in declaring winning bids for their co-conspirators, but also in declaring PBNI’s bid on data (switches and routers) and cabling non-compliant with

the VNCI RFP and disqualifying it.

PBNI sales representative Jim Pillsbury later informed the City Attorney’s Office

during its investigation that he believed the VNCI RFP to be overblown, far too expensive, and much more elaborate than what the district needed.

He felt confident that he knew what the district needed and required in terms

of information technology because PBNI was already under contract with the school

district, laying cable at 30 schools and providing other telecommunications and information technology services. In fact, around the time of the bids, PBNI had been

laying cabling in many of the schools covered by the VNCI RFP.

Pillsbury said he had engaged in discussions with McQuoid about what kind of

technology solutions made the most sense for the district, and he felt he had received McQuoid’s consent to produce a bid response that did not exactly conform to

the VNCI RFP, but which, he believed, was more reasonable, dramatically less expensive, and would work just as well.

Pillsbury recalls that at the January 3, 2000 meeting where Marchelos distributed

the VNCI RFP, McQuoid informed the gathering that the data communications

(switches and routers) solution called for in the VNCI RFP—Asynchronous Transfer

Mode (ATM)—was not necessarily his preferred solution and that he would also entertain other types of data solutions.

Likewise, Pillsbury believed that since PBNI was laying cable at 30 schools for

the district he knew enough about the district’s cabling needs to depart from the

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1 Video-conferencing equipment became eligible for E-Rate funding in Year 4 of the program

(FY 2001-02).

VNCI RFP cabling specifications. Again the PBNI proposal for cabling was less expensive and less grandiose than that called for in the VNCI RFP.

The VNCI RFP called for 30 cable lines into each classroom. The cable jobs PBNI

was working on for the district at the time included 5 to 7 lines into each classroom.

Pillsbury believed this more modest, less expensive cabling scheme was what was

best for the district, especially considering that most of the schools covered by the

VNCI RFP were elementary schools and less computer intensive.

Pillsbury instructed his team to prepare a bid that departed from the VNCI RFP

in these two ways: Instead of the more expensive ATM data solution, PBNI proposed a less expensive alternative; PBNI also offered a less expensive and more

modest cabling scheme.

But according to meeting participants, both Marchelos and Green intervened and

declared the PBNI bids on cabling and data, or switches and routers, non-complaint,

thus paving the way for VNCI business partner NEC BNS to win the data bid and

Sprig Electric, which had been invited into the procurement process by Green, to

win the cabling portion.

Marchelos and Green orchestrated this result even though it produced a much

more costly solution and would have eaten up many millions more E-Rate dollars. PBNI offered a range of data bids costing between $1.2 million and $7.5 million.

After Green and Marchelos eliminated PBNI, they awarded the work to NEC BNS

at a cost of $19.7 million.

PBNI submitted a $6.7 million cabling bid. After Green and Marchelos eliminated the PBNI bid, they awarded the work to Sprig Electric for $13.6 million.

In its guilty plea on May 27, 2004, NEC BNS provided a version of events at the

bid open meeting that supports City Attorney investigative findings regarding Judy

Green’s and George Marchelos’ roles in selecting winning bidders.

THE CONCEALMENT OF VNCI EQUIPMENT IN THE INTER-TEL BID:

Despite the ineligibility of its equipment for E-Rate funding, VNCI had bundled $15,312,435.60 of its equipment into Inter-Tel’s $20,633,732.60 bid, according to

Inter-Tel documents.

When the Form 471 application was prepared by VNCI, Inter-Tel and NEC BNS

representatives, Inter-Tel’s funding request was characterized as being merely for

a PBX, a phone switch, which was eligible for E-Rate funding. The PBX parts list

that accompanied the Form 471 was crafted in such a way as to conceal the fact

that nearly three quarters of the dollar amount of the request was ineligible for ERate funding in Year 3 of the program (FY 2000-01) 1

Based on the findings of its investigation, The City Attorney’s Office suspects

Green and Marchelos and representatives from Inter-Tel of conspiring to falsify

these PBX parts lists and conceal the true nature of the equipment so it could defraud the E-Rate program into funding ineligible equipment. The City Attorney’s Office is confident its ongoing litigation and investigation will confirm this suspicion.

The City Attorney’s Office further believes that VNCI, NEC BNS and Inter-Tel

similarly falsified PBX parts lists and E-Rate applications nationwide in fiscal year

2000-01 to conceal VNCI equipment.

Evidence further suggests that as part of other school district E-Rate applications,

NEC BNS, Inter-Tel and VNCI provided false and misleading answers to the E-Rate

program administrators when asked specifically about the function of the fraudulently-described VNCI equipment.

When it plead guilty on May 27, 2004, information provided by NEC BNS supported City Attorney findings indicating that Inter-Tel and VNCI conspired to falsely describe PBX parts to conceal the ineligible VNCI equipment in the San Francisco E-Rate application.

THE FRAUDULENT INFLATION OF THE SFUSD APPLICATIONS:

As a result of its investigation, the City Attorney’s Office concluded that the

rigged bid process orchestrated by the defendants in San Francisco produced costs

much higher than would have grown out of a legal, competitive bid.

The rejection of the PBNI bid is one example of how the defendants’ corrupt process spiked prices.

Another example lies in the NEC BNS design of the Local Area Networks it

planned to implement in SFUSD, which called for servers and switches in every

classroom, a magnitude of equipment deployment that was entirely unnecessary and

constitutes ‘‘gold plating.’’ (As a point of interest, this same ‘‘gold plating’’ technique

24

of placing servers and switches in every classroom was proposed nationwide by NEC

BNS in fiscal year 2000-01.)

If the San Francisco bid had been open and competitive, it is unlikely a firm

would have submitted a bid calling for servers and switches in every classroom, and

inconceivable that any such bid would have been selected in a truly competitive

process. The conspirators’ gold-plated proposal thus greatly inflated the cost of the

proposed project.

While the rigged bids were fraudulently inflated, a more dramatic financial fraud

attempt occurred when NEC, Inter-Tel and VNCI conspired to submit two grossly

inflated Form 471 applications in January 2000.

One of these applications for funding was premised on no bid process whatsoever.

These three parties, with the acquiescence and later acceptance of McQuoid, took the total of the rigged bid prices—$63,383,768.66—and inflated that total project

cost to $135,142,258.70 when they submitted Form 471 202712 and Form 471

202719 to the Universal Service Administrative Company (USAC) in mid-January

2000.

After factoring in discount rates, Form 471 202719 asked for $75,020,586.05 in E-Rate funds and Form 471 202712 asked for $37,975,023.45 in E-Rate funds for

a total E-Rate funding request of $112,995,609.50.

Had McQuoid, VNCI, Inter-Tel and NEC BNS used the results of the rigged bid process they would have requested $52,608,527.94 in E-Rate money, itself a fraudulent request in that it grew out of a rigged bid process.

But the second layer of fraud—the inflation of the Form 471s—was more ambi- tious by far. It amounted to $60,387,081.56 ($112,995,609.50—$52,608,527.94). But even $52,608,527.94 would have been dramatically more than what was reasonable and ethical.

In 2000, SFUSD had a wide area network affording nearly every classroom and

office a phone system, access to the Internet and all the other benefits of a modern

information technology and telecommunications system including computers for students. It could be argued that the entire VNCI RFP project was not needed nor

wanted by SFUSD. The individuals the City Attorney’s Office spoke to in the

SFUSD Information Technology and Telecommunications division—the proper avenue for E-Rate applications—certainly voiced this point of view.

When inflating project costs on the Form 471s, NEC BNS and VNCI abandoned

the results of the rigged bid process and created a new, even less competitive, and

even more costly scheme, relegating Sprig Electric and US Machinery to subcontractor status and elevating NEC to prime contractor over the server and cabling

portions of the project, areas in which they had lost the bid to Sprig Electric and

US Machinery.

The City Attorney’s Office believes this was done in order to ensure that E-Rate

money flowed to firms with which VNCI had formal business ties.

NEC BNS and Inter-Tel had agreements with VNCI whereby NEC BNS and

Inter-Tel shared with VNCI a percentage of profit from successful E-Rate deals

identified and brought to the attention of NEC and Inter-Tel by VNCI. The agreement also called for NEC BNS and Inter-Tel to bundle VNCI video-conferencing

equipment into its E-Rate bids.

The more E-Rate money VNCI steered toward NEC BNS and Inter-Tel, the more

money these firms would presumably pay VNCI under their arrangements.

The City Attorney’s Office has long believed this ‘‘marketing fee’’ paid to VNCI

constitutes little more than a kickback. These fees were paid to VNCI not only for

identifying and bringing E-Rate funding opportunities to the attention of NEC BNS

and Inter-Tel, but also to compensate VNCI for illegal activity, such as rigging bids

and inflating costs.

Though Sprig Electric had produced the lowest responsive bid on the cabling portion of the RFP, and though US Machinery produced the lowest responsive bid on

the servers portion of the RFP, McQuoid, NEC BNS and VNCI employees Green

and Marchelos orchestrated a process by which US Machinery and Sprig were replaced by NEC BNS when it came time to fill out the Form 471 E-Rate funding application.

According to the City Attorney investigation, Judy Green informed a Sprig Electric consultant at the January 14, 2000 bid opening meeting that NEC would most

likely be the prime contractor for the cabling portion, despite the fact that NEC had

issued a more expensive bid on that section of the RFP. Later, Marchelos convinced

a Sprig Electric official to sign a letter agreeing to become a subcontractor to NEC

BNS for the cabling portion of the project.

Representatives of US Machinery told the City Attorney’s Office that Desmond

McQuoid called them shortly after the January 14, 2000 bid opening meeting and

presented them with a choice. Either fill out the application for E-Rate funding by

25

the following Monday or Tuesday (January 14, 2000 was a Friday) or accept subcontractor status to NEC for the server portion of the project. Since US Machinery did

not have the means nor the expertise to fill out an E-Rate funding application, they

relented to NEC as prime contractor.

The City Attorney’s Office suspects that McQuoid performed this act at the direction of Green, Marchelos, and representatives of NEC BNS and is confident this suspicion will be confirmed through the course of litigation and further investigation.

US Machinery did not strike a subcontracting agreement with NEC BNS until

August 2000. Representatives of US Machinery informed the City Attorney’s Office

during the course of its investigation that the firm felt as if NEC BNS was ignoring

US Machinery’s frequent requests to formalize their subcontractor role. They said

it took many calls to NEC BNS and McQuoid, in addition to hiring a business manager to concentrate his efforts on obtaining the agreement, for the effort to be realized.

It is unclear if Sprig Electric ever signed an actual subcontract with NEC BNS.

What is known is that a NEC BNS representative asked a Sprig Electric manager

to sign a document swearing that Sprig Electric had assessed the capacity of the

SFUSD electrical system and its ability to accommodate the additional information

technology equipment the E-Rate applications was requesting—even though Sprig

had conducted no such analysis. When the Sprig manager declined to do so, he said

he never heard again from NEC BNS on any issue related to the E-Rate project.

Despite the fact that on January 14, 2000 when the bids were opened and VNCI,

through Marchelos and Green, picked the winners, including Sprig Electric and US

Machinery, and despite the fact that US Machinery did not strike an agreement to

subcontract for NEC until August and Sprig may never have signed any such agreement, NEC BNS prepared and signed a purchase agreement with SFUSD on January 14, 2000 which included portions of the bid won by US Machinery and Sprig

Electric.

A signature purporting to be that of Thomas J. Burger, the then-president and

CEO of NEC BNS, is on the signature line of the purchase agreement for NEC BNS.

The City Attorney’s Office has no way of commenting on the authenticity of this signature.

A signature purporting to be that of Desmond McQuoid is on the signature line

for SFUSD, even though he had no such authority. This signature is a forgery.

The City Attorney’s Office suspects that either Green or Marchelos or a NEC BNS

representative committed this forgery.

In pleading guilty to federal criminal charges on May 27, 2004, NEC BNS provided information that supports the City Attorney’s conclusion that Green and

Marchelos were the prime movers behind the decision to relegate Sprig Electric and

US Machinery to subcontractor status in order to benefit VNCI business partner

NEC BNS.

Placing NEC BNS into the prime contractor role, and therefore placing NEC BNS

on the E-Rate funding application as it pertained to cabling and servers, meant

more E-Rate money would potentially flow to NEC BNS and presumably meant

more money would flow to VNCI through their ‘‘marketing fee’’ arrangement with

NEC BNS.

After rigging the bid process and allocating contracts as they saw fit, regardless

of price or merit, representatives of NEC BNS and Inter-Tel, and Green and

Marchelos, on behalf of VNCI, placed NEC and Inter-Tel’s E-Rate identifier number

(called a spin number) on two Form 471 applications (numbers 202712 and 202719)

requesting a total of $112,995,609.50.

Form 471 202712 included an additional 18 schools not included in the bid process

governed by the VNCI RFP. This Form 471 was premised on no bid process whatsoever. The prices on this Form 471 were most likely plucked out of thin air. Only

NEC BNS and Inter-Tel’s spin numbers were included. This entire application was

denied by the Universal Service Administrative Company due to the use of an improper discount rate.

The City Attorney investigation found that McQuoid, Sprig Electric and US Machinery were most likely unaware of the fraudulent inflated nature of Form 471

202719 or even the existence of Form 471 202712 until after they were submitted.

The evidence supports a conclusion that VNCI, through Green and Marchelos, and

representatives of NEC BNS and Inter-Tel joined together in preparing and submitting these fraudulently inflated applications without consulting with or including

anyone from SFUSD, including three of their bid rigging co-conspirators.

When NEC BNS pled guilty to federal criminal charges and settled civil claims

with the City Attorney’s Office and the SFUSD on May 27, 2004, NEC BNS admitted the following:

26

2 In the NEC BNS guilty plea, Consultant One and Consultant Two are identified as sales

representatives working for a ‘‘company that manufactured and installed video-teleconferencing

switches,’’ also described in the plea document as ‘‘VX Company.’’ In its plea, NEC BNS acknowledged entering into an agreement with this VX Company ‘‘under which (NEC BNS) agreed

to pay VX Company a fee for all business opportunities VX Company brought to the (NEC

BNS).’’

On or about January 15-18, 2000 Consultants One and Two 2 and defendants’

employees met to prepare the USAC application Form 471 for the SFUSD and

other school districts. The Form 471 is a school district’s application for E-Rate

funding. It is supposed to set out the selected vendors’ bid amounts, memorialized in contracts, for the equipment and services called for by the district’s Request for Proposal. Consultant One told the defendant’s employees the total

prices she wanted to submit to USAC on the Form 471s and then directed them

to prepare false spreadsheets justifying those prices. With NEC/BNS’s assistance

Consultant One prepared the SFUSD Form 471 with inflated prices. On or about

January 19, 2000, Consultant Two delivered the SFUSD Form 471 to

USAC . . . In addition, Consultants One and Two worked with others to falsely

describe the actual equipment to be supplied to SFUSD, including VX Company

equipment, which is not eligible for funding under the E-Rate program, in order

to have E-Rate pay for that equipment.’’

During the course of its investigation, the City Attorney’s Office discovered that

the business relationship between VNCI and Inter-Tel and VNCI and NEC BNS

reached across the United States.

The City Attorney investigation found that at the same time VNCI and its co-conspirators were rigging the San Francisco bid, concealing VNCI equipment in and inflating the San Francisco applications, VNCI and its employees, including Green

and Marchelos, were most likely conspiring with NEC BNS and others to rig bids,

conceal equipment, and inflate applications in several other school districts, a suspicion supported by NEC BNS when it entered a guilty plea in federal court on May

27, 2004 to anti-trust violations in other states.

In the course of its investigation, the City Attorney’s Office had an opportunity

to speak to Dorothy Travis Johnson, the principal and chief executive officer of the

Ceria M. Travis Academy in Milwaukee, Wisconsin.

She described her experience in dealing with Green and Marchelos and NEC BNS

as, ‘‘This is a little nightmare to me.’’

In the course of interviews conducted in the Spring of 2002, Johnson told the City

Attorney’s Office that in fiscal years 2000-01 and 2001-02, VNCI, through Green

and Marchelos, selected winning bidders and filled out and submitted Form 471s

that included NEC BNS and VNCI equipment.

In fiscal year 2000-01, the Marchelos and Green application netted $1.2 million

for NEC BNS and VNCI.

Johnson said Marchelos took bids submitted to her by local companies back to

California and she never saw them again. ‘‘George has vendors pre-selected,’’ she

said, referring to Marchelos. ‘‘Local people gave me bids. George took that but I

know he’s going to give it to his vendors.’’

Referring to both Marchelos and Green, Johnson said, ‘‘They walked us through

this. They did all the numbers. George did the whole application for me.’’

She said the NEC BNS was one of the main vendors in the fiscal year 2000-01

and fiscal year 2001-02. She told the City Attorney’s Office she believed her name

was forged on several documents including a purchase agreement with a company

providing servers.

The purchase agreement, she said, called for 12 servers to be deployed at her

school. Johnson said she showed the purchase agreement to a friend who was

knowledgeable about information technology and he informed her that she needed

only one server for a school her size.

During the course of its investigation, the City Attorney’s Office came to suspect

that VNCI was conspiring with Inter-Tel and other firms to rig bids, conceal VNCI

equipment, and inflate applications in California (West Fresno School District, Fresno) and Michigan (Highland Park School District, Highland Park) during the same

general time period as the other school district frauds.

In August 2003, Duane Maynard, the former chief estimator for the Fresno-based

Howe Electric, pled guilty to federal criminal bid rigging charges and in the process

pointed toward the involvement of co-conspirators.

Maynard stated in his plea:

On or about February 19, 1999 the defendant, on behalf of his employer, attended a pre-bid meeting at the West Fresno Elementary School District

(WFESD), in the Eastern District of California. The pre-bid meeting related to

27

a project to provide, among other things, equipment and services related to telecommunications, Internet access, and internal connections to the WFESD (‘‘the

WFESD E-Rate Project’’). Those present at the pre-bid meeting understood that

the project was related to the E-Rate program, in which the Universal Service

Administrative Company (‘‘USAC’’) subsidizes the provision of telecommunications, Internet access, and internal connections to underprivileged schools.

Competitive bidding was required for the WFESD E-Rate Project. Nonetheless,

the defendant, together with school district representatives, a consultant, and

others representing potential competitors, combined, conspired, and agreed that:

1) The defendants’ employer would be the successful bidder and have general

responsibility for the WFESD E-Rate Project;

2) No co-conspirator other than the defendant’s employer would submit a general bid for the WFESD E-Rate Project;

3) Other co-conspirator companies would be the defendant’s employer’s subcontractors for the WFESD E-Rate Project; and

4) any bid competing with the defendant’s employer’s bid would be stricken as

nonresponsive.

The defendant, his superiors at his company, and his other co-conspirators did

what they agreed to do to carry out the conspiracy. They further acted in concert

to provide equipment and services related to the WFESD E-Rate Project and receive from USAC payment therefor.

Documents obtained from USAC by the City Attorney’s Office show Inter-Tel subcontracting to Howe as part of Howe’s E-Rate contracts during the same time period. The City Attorney’s Office suspects Inter-Tel to be one of the co-conspirators

Maynard referred to in his guilty plea and is confident its ongoing litigation and

investigation will confirm this suspicion and show Inter-Tel to indeed be one of

Howe Electric’s bid rigging co-conspirators.

Likewise, documents obtained from USAC by the City Attorney’s Office show

VNCI involved in E-Rate applications out of West Fresno Elementary School District during the same funding years in which Howe Electric was the prime contractor.

Sprig management officials and its consultant Bob Waters informed the City Attorney’s Office that the firm was involved in West Fresno E-Rate bids during the

same time period.

The City Attorney’s Office suspects that both VNCI and Sprig were among the

co-conspirators Maynard referred to in his guilty plea and is confident its ongoing

litigation and investigation will confirm this suspicion and show that VNCI and

Sprig were indeed among Howe Electric’s bid rigging co-conspirators in West Fresno.

THE PLAN TO MISUSE E-RATE FUNDS:

In other school districts where Inter-Tel and NEC BNS appear to have acted in

concert with VNCI to rig bids, conceal VNCI equipment in bids and inflate applications, evidence suggests the firms agreed to not charge the school districts their portion of the project costs, which usually came to 10 percent of the total cost.

Based on its evidence, the City Attorney’s Office believes VNCI, Inter-Tel, and

NEC BNS built this cost into their non-competitive bids and later into the inflation

of E-Rate applications.

The City Attorney’s Office believes the inflated costs associated with the two San

Francisco Form 471s were to be used, in part, for this purpose.

Another purpose of the fraudulently inflated project costs in San Francisco would

have gone to fund equipment not eligible for E-Rate monies—in addition to the ineligible VNCI video-conferencing equipment.

The City Attorney investigation found that NEC BNS had agreed to spend more

than $10 million of the inflated project costs to pay for 2250 computer work stations,

which are not eligible for E-Rate funding. When NEC BNS pled guilty and settled

civil claims with our office, they admitted as much, and stated that though NEC

BNS characterized this $10 million expense as an ‘‘in-kind’’ donation, it had indeed

planned on using a portion of its E-Rate award to pay for the workstations.

LYING TO USAC:

On September 22, 2000, USAC issued a Funding Commitment Decision Letter

(FCDL) to McQuoid regarding Form 471 202719.

The FCDL announced a total award to Inter-Tel for the PBX of $14,791,335.38.

Inter-Tel had requested $17,769,776.27 for the PBX.

28

The request had been reduced to remove some of the VNCI equipment as ineligible though it is not clear from USAC documents if the equipment was deemed ineligible because USAC understood it to be video-conferencing equipment.

NEC BNS was awarded $18,156,829. 34 in funding for cabling, the exact amount

they had requested.

NEC BNS was awarded $15,731,613.33 in funding for data equipment (switches and routers). USAC reduced the requested amount of $18,953,751.00 to remove

funding for an extended warranty. NEC BNS was not awarded the $18, 249,395.09 it requested for servers. USAC

denied the entire funding request because more than 30 percent of the use of the

servers would have been for ineligible purposes. It is not clear from USAC documents what ineligible purposes the servers would have been put to.

Likewise NEC BNS was denied its entire service contract request of $1,898,970.78.

The total E-Rate award to SFUSD as a result of the two fraudulently inflated applications was $48,679,778.05

Prior to issuing the award, USAC pursued its normal program integrity review

process. In addition, USAC subjected the McQuoid applications to an Item 25 review, a higher level of scrutiny USAC brings to bear on some but not all applications.

In the course of this two-fold review, USAC asked many questions of McQuoid regarding his applications. Moreover, USAC asked for documents to support

McQuoid’s answers.

Based on the findings of our investigation, the City Attorney’s Office concluded

that VNCI, through Green and Marchelos, controlled this process as well—with

NEC BNS and McQuoid’s knowledge and consent.

We discovered a July 27, 2000 letter from McQuoid to VNCI Chief Financial Officer Bob Emery authorizing VNCI to assist SFUSD in the preparation and submittal

of School’s and Library Division’s (SLD) Item 25 review.

‘‘Under the direction of the District, VNCI will be aggregating the information required to complete the Item 25 review. We authorize VNCI to collect, collate and

prioritize documentation for our intended contractors to facilitate the completion of

the Item 25 review.’’

Likewise the City Attorney’s Office discovered a letter from John Colvin, NEC

BNS Director of Sales, Public Sector, to Judy Green, identified as VNCI Regional

Manager, authorizing her ‘‘to provide documentation on behalf of NEC BNS to facilitate the completion of the Item 25 review.’’

But it also appears from the evidence that Green and Marchelos, on behalf of

VNCI, NEC BNS, and Inter-Tel controlled pre-Item 25 responses to USAC inquiries

as well.

We base this conclusion in part on the fact that McQuoid’s signature was forged

on an initial pre-Item 25 review submittal of information justifying various aspects

of the applications.

Evidence suggests that Green and Marchelos, acting on behalf of VNCI, NEC

BNS, and Inter-Tel either prepared, helped to prepare, directed the preparation of

and transmitted or knew of the preparation of and transmittal of counterfeit, misleading and fraudulent documentation meant to conceal wrongdoing and facilitate

the award of E-Rate money not properly due to NEC BNS, Inter-Tel, and VNCI.

Evidence indicates that as part of the Item 25 review, Green, Marchelos, and

McQuoid caused to be sent to USAC a list of individuals who purportedly attended

the pre-bid meeting on January 3, 2000. Two of the fourteen supposed attendees

listed as having signed in and being present were not actually present.

Both names and signatures are clearly in the handwriting of McQuoid. City Attorney interviews with both individuals indicated that neither was present. In one instance, the individual purported on the sign in sheet to have been present at the

pre-bid meeting had never been to San Francisco.

A third individual who signed in as having attended the pre-bid meeting and

picked up an RFP in order to submit a bid, informed the City Attorney’s Office that

he was a friend of McQuoid’s who was doing some minor alarm repair for McQuoid

at the buildings and grounds division when McQuoid asked him to come to the

meeting where he was asked by another individual believed to be Marchelos to sign

in as having been present as a potential bidder. This individual informed the City

Attorney’s Office that he had no intention of bidding, had no capacity to do so, and

had no real understanding of what transpired in the meeting except that he was

asked to sign in as if he were a potential bidder.

During the review process conducted by USAC, documents bearing the NEC logo

were transmitted to USAC purporting to show the size of seven of the schools to

receive cabling funded by the San Francisco E-Rate proposal.

29

The size of these schools was grossly exaggerated on these documents, increasing

the seven elementary schools by 73 rooms and 58.75 acres. The City Attorney’s Office concluded that the reason for the exaggeration was to better justify the excessive request for cabling funds.

In submitting to USAC proof that SFUSD had the ability to pay its approximately $10 million share of the E-Rate project costs, McQuoid conspired with Judy Green

and others to submit fraudulently altered budget documents.

The key document, a budget summary page, was altered to show that the school district had $41.5 million available under a line item fraudulently titled ‘‘E-Rate

District Match.’’

By the time this falsified document was transmitted to USAC in August 2000, the

SFUSD Board of Education had already approved a fiscal year budget for July 1,

2000 to June 30, 2001 and no such line item was included. In fact, in a separate

portion of the true budget, SFUSD reduced the available E-Rate match fund from

$1.26 million to zero.

Inter-Tel sales representative Jason King informed the City Attorney’s Office that

he attended a meeting where Judy Green of VNCI, Gerard McNulty of NEC BNS,

and he assisted McQuoid in responding to the USAC Item 25 review. During this

meeting, Green asked for and received SFUSD budget information and documentation to submit to USAC.

When USAC asked McQuoid to provide a Technology Plan, a requirement of receiving USAC funding, McQuoid simply obtained one from Green which had been

written by Green and others as part of a Los Angeles Unified School District planning process. The Green-provided plan had not been subject to any discussion or deliberative process by anyone at SFUSD nor had it been submitted and approved by

the SFUSD Board of Education.

As part of the Item 25 review, USAC requested a copy of bid results, the RFP,

and other bid-related documents. Spreadsheets prepared by and transmitted to

USAC by McQuoid and others, most likely VNCI, through Green and Marchelos, on

behalf of NEC BNS and Inter-Tel, contained false information about the bid results.

And the copy of the VNCI RFP sent to USAC had the references to the required

video conferencing solution omitted in order to conceal the fact that PBX bidders

were required to include ineligible equipment in their bids.

Evidence suggests that in justifying the cost of a labor/service agreement with

NEC BNS, Green and Marchelos, on behalf of NEC BNS, submitted a document to

USAC claiming that the costs were at the proposed rates because San Francisco had

‘‘no mass transit’’ system when in fact it has a robust mass transit system, and

some schools were 45 miles apart even though San Francisco is seven miles by

seven miles.

McQuoid’s signature on this document is clearly forged.

CONCLUSION

The City Attorney’s investigation into the E-Rate proposal that was purportedly

submitted on behalf of the San Francisco Unified School District demonstrated that

the proposal was fraudulent in almost every respect. The proposal resulted from a

bid process that was rigged from its inception. The bid process was controlled by

parties who had a direct financial stake in its outcome. After the conspirators prevailed in the rigged process, they included a large amount of ineligible equipment

in their funding requests. They also grossly inflated the prices used in their funding

requests, and made numerous misrepresentations during the funding process.

Fortunately, when Superintendent Arlene Ackerman learned of these proposals,

she suspected they were fraudulent. The San Francisco Unified School District

therefore did not accept any funding from the E-Rate program as a result of these

applications. However, the City Attorney’s investigation demonstrated that these

same conspirators successfully obtaining E-Rate funding for other school districts,

based on similar fraudulent tactics. Investigations into the scope of these improper

activities are on-going.

Mr. WALDEN. Thank you, Mr. Cothran, for your testimony and

for your diligent efforts to expose this fraud and conspiracy and

abuse.

Superintendent Ackerman, again thank you for your diligence in

this matter as well. You touched on this during your testimony, but

can you please explain for us the types of financial and budget

issues and problems that you found when you arrived in San Francisco?

30

Ms. ACKERMAN. Prior to my arriving in San Francisco, there had

been a fiscal audit by the State, called the PCMAT Report, and it

makes clear that there were serious oversight and accountability or

lack of accountability structures in our fiscal house.

We didn’t know how much money we had. There were problems

with—We hadn’t had proper audits. In addition to that, we had

problems getting certified by the State, and then we had problems

with credit. So there were a multitude of fiscal problems when I

arrived.

There was a blueprint for how we could rectify some of our fiscal

problems in this report called the PCMAT report. So I came into

the district understanding that there were serious issues and proper oversight procedures in our fiscal house.

Mr. WALDEN. So how obvious was it to you that there wasn’t

funding there to do the match for the E-Rate program that was

being offered?

Ms. ACKERMAN. Well, as Investigator Cothran said, there was no

line item represented in our budget for the matching funds. That

was one clue. That wasn’t the obvious, though, for me initially. I

mean that was one of the things. There were probably several.

I was initially alerted, though, when I read the E-Rate application, and I saw the misrepresentation of what I knew to be not factual statements describing our city. That started my first red flag

that went up, and then further looking at—Because I was acutely

aware of the problems we had in our fiscal house, our department,

then I began to look at other issues that were raised as a result

of this application.

There were other fraudulent—appearance of other fraudulent

contracts also that I was aware of at the time. So I was already

on high alert.

Mr. WALDEN. But not in the E-Rate program?

Ms. ACKERMAN. No, not initially. Not initially.

Mr. WALDEN. All right. Thank you. Mr. Cothran, so everyone at

the bid rigging—or excuse me—bid meeting on January 14 knew

that Marchelos and Judy Green were affiliated with VNCI the

equipment vendor except Pacific Bell?

Mr. COTHRAN. That is the conclusion of our investigation. NEC,

in our opinion, was definitely aware of their affiliation, because

they had been working with them for sometime at that point to

make E-Rate bids bundling VNCI equipment in about 10 other

school districts.

Inter-Tel, same situation. They were also working—had worked

in previous E-Rate funding years and were working in that current

funding year, bundling VNCI equipment into bids in other school

districts across the country. So when they looked out across the

table at Judy Green and George Marchelos, they knew they were

VNCI employees, and they knew that they were doing business

with their firms.

Sprig Electric, which was present at the meeting in the person

of a consultant to the firm—that consultant had worked with Judy

Green and George Marchelos as VNCI representatives in other

school districts in prior funding years as well.

I believe the only other remaining party at the bid opening meeting during my investigation was Pac Bell, and they did not know,

31

according to their interviews with me, that Judy Green or George

Marchelos were VNCI reps. As a matter of fact, Mr. Marchelos, according to a Pac Bell representative, had identified himself at the

earlier January 3 meeting as a San Francisco consultant. I will

make the point again that he was not a consultant to the school

district. He had no such contract. That was just not true.

Mr. WALDEN. Tab 9, 10, 12 and 86: These appear to indicate that

Judy Green’s influence of the bid process—I’m sorry, Ms. Ackerman, did you want to comment on that? I’m sorry.

Ms. ACKERMAN. Yes. I wanted to add to your prior question

about when was I aware of a problem with E-Rate. It actually happened fairly early in my tenure, not about this particular application but about a new $96 million application that I was asked to

sign and refused to sign it, because—that happened in early fall. So we never actually applied—made an application for the $96

million. So there was——

Mr. WALDEN. Who brought that application forward, the same

cast of characters?

Ms. ACKERMAN. Yes, and at that point with Desmond McQuoid

was our then facilities director, Tim Tronson. So this happened

even before the $50 million application, which had actually already

been approved.

Mr. WALDEN. Okay. Does the $96 million application you were approached to sign come after the fraudulent $58 million one?

Ms. ACKERMAN. No. It came before. We actually—I’m sorry, go

ahead.

Mr. WALDEN. No, you go ahead. That’s fine.

Ms. ACKERMAN. I was asked a new application for $96 million in

the early fall, sometime in September, by Tim Tronson and

Desmond McQuoid. I actually refused to sign that application, and

we never submitted it.

Soon after that came the $50 million application that had already been submitted,and what we were supposed to then do was

to actually have the matching funds of $8 million. So there was at

least attempt to get me to sign off on a $96 million application,

which I initially refused to do.

Mr. WALDEN. All right. Thank you. So let me go to Mr. Cothran

now. These tabs I referenced earlier, 9, 10, 12, 86, appear to indicate Judy Green’s influence in the bid process, Bill Holman as well

as a number of other NEC employees are listed on these e-mails.

If you look at Tab 9, Gerard McNulty, the salesman at NEC who

appears to work most closely with the schools, and Judy Green describes Green’s ‘‘flexibility to award the whole project to NEC.’’ At

first, Holman in particular appears to be questioning Judy’s role.

Can you comment on what we are seeing here?

Mr. COTHRAN. Well, I have never seen this e-mail before, but

what it appears to me to be is sort of an internal admission on the

part of Mr. McNulty and others that Judy Green controlled the bid

process at least. And if I am not mistaken, this is referring to Covert, which is a school district outside of Detroit, I believe.

So at least in this one instance, it appears that there is some

rather frank discussion here about Judy Green’s control over the

process. Mr. Holman raises the issue of a potential conflict of interest, and then Gerard offers an additional explanation, and he uses

32

the term heavy influence in the outcome. Supposedly, I guess that

is enough to soothe the fears of Mr. Holman, and he doesn’t think

that is a conflict of interest—heavy influence as opposed to awarding the contract.

Mr. WALDEN. Do you think there is a conflict there? If you were

Mr. Holman, would you think?

Mr. COTHRAN. Oh, absolutely.

Mr. WALDEN. Okay. Looking at Tab 10, Coleman tells Holman

that Judy Green, ‘‘owns the bid process and seems to be the brains

behind the VNCI operation.’’ Can you comment on that?

Mr. COTHRAN. That is my understanding. As a result of my investigation, I developed the strong opinion that Judy Green was

pretty much the brains of the VNCI operation.

Mr. WALDEN. Okay. Then looking at Tab 12, McNulty tells Holman that he and Judy will lobby the district to award the projects

to NEC. Did Judy Green and George Marchelos rig the bids this

way in other school districts?

Mr. COTHRAN. Could you repeat the question? I’m sorry.

Mr. WALDEN. Did Judy Green and George Marchelos rig the bids

this way in other school districts?

Mr. COTHRAN. Well, as you can refer to in my written testimony,

I interviewed a CEO and principal at Ceria M. Travis Academy in

Milwaukee, Wisconsin, and her comments to me over the course of

two interviews indicated to me that indeed Mr. Marchelos and Ms.

Green rigged the bid and controlled the process in that school district. There are documents we received from USAC that finally indicated to us that that same control was exercised in other school

districts, in Michigan, in Arkansas.

Mr. WALDEN. Have you seen dollar amounts on those? How much

money are we talking about that these two may have been engaged

in?

Mr. COTHRAN. I wouldn’t want to hazard a guess without the

documents in front of me, but to answer your question, yes, I do

have documents relating to those requests and those awards, and

while not as grandiose as the San Francisco application, they did

involve millions of dollars, and in some cases, I believe, tens of millions of dollars.

Mr. WALDEN. In your opinion, how far up the chain of command

do you think the knowledge of the bid rigging and other behavior

went within VNCI? Who knew?

Mr. COTHRAN. I have to apologize. I have no evidence about how

far up the chain of command it went at NEC. My investigation just

didn’t probe that far. I apologize.

Mr. WALDEN. No, but VNCI was my question.

Mr. COTHRAN. Oh, VNCI. Certainly, Judy and George were the

main actors. I have a strong suspicion that Bob Emery, the CFO,

was aware of their activities, although in an interview he denied

it to me. But I have a strong suspicion that that wasn’t an accurate

portrayal. Other than that, I simply don’t know.

Mr. WALDEN. My time has expired. I would now like to recognize

the gentle woman from Colorado.

Ms. DEGETTE. Thank you, Mr. Chairman. Dr. Ackerman, I was

wondering, since having to deal with this E-rate conspiracy that

was initiated by VNCI, NEC BNS, and Inter-Tel, what has been

33

your experience with the E-Rate since these firms were taken out

of the equation?

Ms. ACKERMAN. Well, I would like to say that, as I made the

point in my comments, I believe that the E-Rate program has benefited many young people in our school district. Approximately

20,000 students in 112 of our schools have benefited from the ERate program.

Ms. DEGETTE. And have you applied for E-Rate money since the

scandal happened?

Ms. ACKERMAN. Yes, but much smaller amounts. In the last—in

2001 it was about $800,000, in 2002 about a million, and in 2003

about a million.

Ms. DEGETTE. And how have you been able to use these monies

in the San Francisco School District for the benefit of children? You

keep saying—I’d like to get on the record exactly how this program

benefits kids and what kind of kids it benefits.

Ms. ACKERMAN. It has benefited students especially in some of

our more disadvantaged and challenged neighborhoods, the schools

that are located in those communities, providing Internet connections and infrastructure as well as telecommunication systems with

some of those schools, some of our schools, as well as wiring of our

libraries and bringing our libraries up to the 21st Century.

I would say that it has made, certainly, a difference in this

school district.

Ms. DEGETTE. And these are kids who wouldn’t have those kinds

of services at home. Correct?

Ms. ACKERMAN. Yes. Absolutely.

Ms. DEGETTE. Now I know, Dr. Ackerman, that you have many

years of experience in the education field in other school districts

before you went to San Francisco. My question for you is: As policymakers, how do you think we can improve oversight of the E-Rate

program so that these many hundreds of millions of dollars actually go to benefit kids and we avoid fraud in the future?

Ms. ACKERMAN. Well, I certainly think that there has to be put

in place some checks and balances. The fact that this $50 million

application was submitted—I caught the $96 million application

and refused to sign it, but we actually had applied for two others,

and they were—somehow they went through a process, even after

it left the district, and nobody was able to—and I don’t know the

process after it leaves the district, but certainly there needs to be

some checks and balances in place at the Federal level to ensure

that these applications aren’t fraudulent and that the applications

actually—the processes and procedures that are laid out in the applications have actually taken place.

Ms. DEGETTE. Have you put additional checks and balances in

place within your own school district since this happened?

Ms. ACKERMAN. Absolutely. We have in place not only a review

from our legal department, but we now have an office of risk management that also takes a look at any major applications or grants

that we apply for. We also took our technology department out of

facilities and put it in the technology department where it belonged.

It was really strange to me that a facilities person was bringing

to me—that was a really big clue—that a facilities person was

34

bringing to me a serious E-Rate application. And it has to be vetted

through several layers in our district of overview and oversight, including our risk management department and our Chief Financial

Officer has to check off and sign off of it before it comes to me for

review.

Ms. DEGETTE. And do you think that a review of the school district’s auditing procedures and checks and balances would be an

important component of Federal oversight? In other words, when a

school district submitted an application, part of the review by the

Federal Government would be to make sure that the school district

had appropriate oversight in place as well.

Ms. ACKERMAN. I think that is absolutely appropriate.

Ms. DEGETTE. Okay. I wanted to ask the investigative team, who

I am very proud of, about some of the details of this investigation.

Mr. Cothran, I was wondering. You testified about how VNCI declared PBNI’s bid on data and cabling noncompliant with the RFP,

and subsequently disqualified it from contention. Now if the appropriate officials at the school district knew about the PBNI bid, do

you think they would have still chosen that much more elaborate

system that the NEC bid proposed?

Mr. COTHRAN. I don’t think they would, if this had gone through

the appropriate channel which, to my knowledge, would have been

the information technology and telecommunications division, which

was already doing business with Pac Bell in 30 schools under other

contracts. Pac Bell was a well known contractor to them.

I am confident that their bid would at least been taken a lot

more seriously, and most likely it wouldn’t have been ruled noncompliant with the bid, since it fit the specifications of the projects

they were already working on.

Ms. DEGETTE. Now you also said that, if folks had used the results of the initial rigged bid process instead of the subsequent inflation, that they would have requested almost $53 million in ERate money, and you said this amount would have been dramatically more than was reasonable and ethical.

What figure do you think would have been reasonable and ethical?

Mr. COTHRAN. You know, I don’t think I am qualified to make

that kind of guess, but I would point you to previous E-Rate applications that have been made through the appropriate avenues at

the school district. If memory serves—I haven’t looked at them in

a while—they were in the single—I don’t even think some of them

reached a million dollars.

Ms. DEGETTE. Yes, and I think that is just what Dr. Ackerman

just testified for subsequent proposals.

Mr. COTHRAN. Right. Previous, I believe, I was informed, were

less than a million dollars. So you can take that as a benchmark.

We believe—if I might add, we believe the $52 million figure, even

before it got to the second layer of fraud—we believe that initial

rigged bid was fraud, in and of itself. We see that as a fraudulent

number as well. We see this as two layers of fraud.

Ms. DEGETTE. Right. Now you testified that McQuoid’s signature

on the final purchase agreement was a forgery and that McQuoid

had no such authority to sign off on the agreement. Was the NEC

signature forged as well?

35

Mr. COTHRAN. We have no way of commenting on that. I don’t

have the true exemplar of—I believe it was Thomas Burger’s signature on that document, if memory serves, and I have no true exemplar of that signature to compare it to.

Ms. DEGETTE. Okay. Did you ever see any documents that suggested that an NEC official was having second thoughts about filing the grossly inflated purchase order?

Mr. COTHRAN. No. I mean, until today.

Ms. DEGETTE. Mr. Chairman, I don’t have anymore questions at

this time. I yield back.

Mr. WALDEN. The Chair now recognizes the chairman of the full

committee, Mr. Barton, for questions.

Chairman BARTON. Thank you, Mr. Walden. Dr. Ackerman, can

you hear me?

Ms. ACKERMAN. Yes, I can.

Chairman BARTON. Again, I want to commend you for what you

have done. My first question is just a general question. What was

it that you saw that kind of raised a red flag in your mind that

this particular grant or proposal might not be on the up and up?

Ms. ACKERMAN. As I mentioned before, the first application that

was brought to me in September actually was for $96 million, and

it came to me from staff members from the facilities department.

They actually wanted me to sign it that day. They brought me the

document, and they were standing there waiting for me to sign it.

I actually refused to sign it, said I needed time to look at it, and

that review—the review of that particular application then alerted

me that there were—and I asked some questions about what I believed to be false statements within the document.

At that point, I was told that the contents of the $96 million application was the same as the other two previous applications that

were submitted. So at that point I knew that it was fraudulent.

The other two applications were fraudulent, and I refused to sign

that one, and then alerted Louise Renne, then City Attorney, that

there was a problem.

Chairman BARTON. Where were you before you came to San

Francisco?

Ms. ACKERMAN. I was in Washington, DC.

Chairman BARTON. Were you the superintendent in Washington,

DC?

Ms. ACKERMAN. Yes, I was.

Chairman BARTON. And had you made application for similar

funds for a similar program in Washington, DC?

Ms. ACKERMAN. I don’t remember if there were applications

made when I was there. I was there only 3 years and superintendent 2, but I had been involved in previous school districts,

and even there I knew that that was a lot of money. I knew there

was something wrong with the application, the amount of money.

In addition, in my experiences in DC and in Seattle and other

places where I have actually worked, the application came as a result of a technology plan that was vetted and developed in the technology department. That this application was coming to me from

the facilities department was something I had never seen before.

Chairman BARTON. Now as a consequence of you refusing to sign

that application and all that flowed from that, did the school board

36

in San Francisco pressure you to reconsider or did they give you

the benefit of the doubt or did they actually commend you? What

was the reaction immediately after you refused to sign the application?

Ms. ACKERMAN. Well, it depended upon the school board member. I got a little bit of both. I actually—I think, initially, people

across the city and country thought I was a little bit crazy to turn

down $50 million. There were several news stories, both locally and

nationally, where I felt that there was pressure for me to at least

explain myself in a rational way, why I would turn down $50 million. But at that point, I did know that there were serious investigations going on, and I would just have to wait, and time would

tell the true story.

Chairman BARTON. But today, given the fact that we have had

this plea bargain, the fine that has been paid, the $20 million fine,

what is the attitude now? Are you considered a heroine in San

Francisco or are you still considered that crazy superintendent who

turned down $50 million?

Ms. ACKERMAN. Well, I think I am a heroine. In addition to that,

since this, this actually led to other investigations, and a couple of

weeks ago we actually were awarded another $43 million settlement from an energy company that had defrauded the school district.

So in the last month, we have actually gained another $50 million as a result of the phone call to then City Attorney Louise

Renne. I am feeling pretty good and vindicated.

Chairman BARTON. Okay. Well, your forthrightness is probably

going to save the U.S. taxpayers hundreds of millions of dollars—

hundreds of millions, if not more. So on behalf of the country, I

want to say thank you, and I would hope San Francisco appreciates

you, because everybody thinks it is somebody else’s money and it

is free money, but ultimately it is our money.

Ms. ACKERMAN. Absolutely.

Chairman BARTON. If we don’t have people like you doing the

right thing, the whole system falls apart. You know, we are going

to make structural changes in this program statutorily probably in

the next Congress, if not this Congress. The reason we are going

to be able to do that is because of the stand that you have taken.

So I thank you. I really—I’d love you to come down to my part of

the country and be a school superintendent in one of my school districts, you know.

Ms. ACKERMAN. Well, don’t tell anybody here in San Francisco

you’ve made that offer.

Chairman BARTON. Well, they would probably hoot you out of

town if they thought you were coming to Texas.

I want to ask one substantive question of you. Why was the facilities department, not the technology department, handling this

issue for the schools in your system?

Ms. ACKERMAN. One of the things that I discovered was basically

the facilities department was a separate operation from every other

department in the school district, and much of the fraud that we

have uncovered came as a direct result from the fact that the facilities department was acting as a separate agency. They had their

37

own budget, their own contract compliance manager. They didn’t go

through any vetted process or procedure for oversight.

So a lot of this could happen, because there were no checks and

balances. Now that we have a contract review, a risk management

department, in addition to those two departments, and then now

we separated all of the fiscal procedures and put them back in the

Office of Finance, it has put in place natural checks and balances.

That could never happen again.

By the time it gets to me, it has gone through several layers of

oversight, but this was an unusual practice, and probably one of

the first things that I noticed, that this was very unusual, that this

facilities department acted on its own.

Chairman BARTON. Okay. My staff has indicated that there was

a concerted lobbying campaign undertaken to convince you to

change your mind by Mr. Desmond McQuoid and Mr. Tim Tronson,

the NEC company and VNCI.

Do you want to elaborate a little bit on that, if it is true? Did

they try to convince you to change your mind and, if so, how did

they do that?

Ms. ACKERMAN. I think there were phone calls. There was at

least one meeting with some of the—I believe NEC staffpersons. I

don’t remember who was there. It has been a while back. There

were meetings with the board, some of the board members.

I did call NEC on this and, you know, felt it was really inappropriate that vendors would be talking to board members. But I am

a pretty stubborn person, and you know, all of that pressure—I

didn’t really feel pressure at the time. I had already made up my

mind, and I knew that there was a process, investigative process,

underway. So it was—you know, fell on deaf ears.

Chairman ACKERMAN. When did you think it was time, and what

made you decide that it was time to contact the FBI?

Ms. ACKERMAN. Well, we went through a facilities audit by Arthur Anderson, and there were also some recommendations in the

original PCMAT report, the fiscal management audit that was done

the spring before I actually came to San Francisco, and there were

other contracts that appeared to be fraudulent in other areas, including our energy savings department.

So there was a combination of things. I knew that the district

was strapped for money and, having lived in Washington and understanding clearly that the E-Rate is a Federal grant, I did call

then City Attorney Louise Renne and ask if we could call in the

FBI. I knew, once they came in, that we would have an extensive

investigation that would support what was already happening in

the City Attorney’s office.

Chairman BARTON. Now did anybody try to pressure you not to

contact the FBI? Did anybody say I really wish you wouldn’t do

that; we probably ought not do that, or were you pretty well supported in making that decision?

Ms. ACKERMAN. I was well supported. At that point I was well

supported. After we read the—we submitted the audit and shared

it with the board of education, the facilities audit, I think at that

point everybody knew that something was wrong, and I got no

pressure in terms of my wanting to call the FBI. In fact, I was very

supported, including supported by Louise Renne.

38

Chairman BARTON. Okay. I want to ask Mr. Herrera here in the

hearing room, how often is it that the school district would contact

the City Attorney of San Francisco for assistance? Does that happen a lot, never?

Mr. HERRERA. Yes, it is fairly common. The fact of the matter is

we provide legal counsel to the school district on a variety of matters. So we have a very good interplay. Under my predecessor, Ms.

Renne, there was a very close relationship between the school district and the City Attorney’s office, and that has continued since I

became City Attorney. We work very closely with them on a day

to day basis in terms of providing legal advice.

I have a Deputy City Attorney assigned to the school district to

assist Ms. Renne with general counsel duties at the school district,

and there is a very close interplay also in terms of investigations

of allegations of fraud and mismanagement. So it is not uncommon.

Chairman BARTON. Okay. Ms. Renne, how long have you been

the General Counsel for the school district?

Ms. RENNE. It has been approximately 3 years now, Dennis?

Mr. HERRERA. About that.

Ms. RENNE. Actually, when I decided not to run for City Attorney

again, I actually was going to do something quite different, but Dr.

Ackerman asked me to come over and be general counsel for the

school district, which I have been until June 30. Now I really feel

that all of the things that Dr. Ackerman had asked us to do to basically root out the corruption, take a look at the E-Rate program,

are over.

So as of July 1, I am no longer the general counsel, but I continue to handle special matters for the district.

Chairman BARTON. But in the beginning, you were the City Attorney?

Ms. RENNE. I was. I was the City Attorney.

Chairman BARTON. Superintendent Ackerman contacted you initially in your capacity as City Attorney?

Ms. RENNE. Correct. Correct.

Chairman BARTON. And so she provided the information, and

then you provided the investigative muscle to track this down?

Ms. RENNE. Absolutely, and if I may just say one thing, Mr.

Chairman, I think Dr. Ackerman is being somewhat modest. There

really was quite a lot of criticism against Dr. Ackerman for turning

down these applications. In fact, there were some public hearings

about it, but she was determined that we were going to root out

what was going on.

I would say that she and her board, the board of education, were

supportive in terms of going forward with these investigations.

Chairman BARTON. Now your position as City Attorney was an

elected position.

Ms. RENNE. It is elected, and then when I decided not to run, I

am very happy that the voters of San Francisco had the intelligence and good luck to have Mr. Herrera as City Attorney in San

Francisco now.

Chairman BARTON. That will be a good commercial.

Ms. RENNE. So be it.

Chairman BARTON. Did you get any pressure as City Attorney to

back off the investigation?

39

Ms. RENNE. No. There was some effort, I would say, to try to not

have me become general counsel for the school district, but it was

minor in the scheme of things. No.

Chairman BARTON. I am going to yield back, Mr. Chairman. I

have probably improved the reelection chances of—I don’t know

Mr. Herrera’s political affiliation, but given it is San Francisco, it

is probably not the same as mine.

Ms. DEGETTE. If the chairman will yield, I just have to say: So

rarely do we see such dedicated public servants who are doing the

right thing. It is almost too much of a love fest to bear here, but

we are really glad you all did what you did.

Chairman BARTON. My guess is, though, at the time they were

doing it, it wasn’t a love fest. My guess is there are a lot of people

out there that thought that was what they call easy money and

found money, and to stand up and do what is right at the time they

did it, it was not universally acclaimed. So I again appreciate everybody involved.

With that, Mr. Chairman, I yield back.

Mr. WALDEN. Mr. Chairman, I am sure Mr. Herrera would love

to have you come out and go door to door with him.

Chairman BARTON. I would probably lower his reelection by 20

points.

Mr. WALDEN. The Chair now recognizes the gentle woman from

Illinois.

Ms. SCHAKOWSKY. I thank you, and perhaps the chairman and

Mr. Herrera could pose together for a picture he could use in his

campaign.

I join, though, in the love fest and in thanking all of you for

the—well, really, for doing your job the way it should be done. It

is really a model, I think, for people around the country, and we

thank you for that.

I do understand. I have heard that there was some pretty negative press at the time, too, saying that, you know, you are turning

the money down, etcetera. So withstanding that kind of pressure

is not always easy, and I appreciate it, as we all do. Really, good

work.

I read in your testimony, Dr. Ackerman, that you said, ‘‘Despite

the disturbing and cautionary aspects of our experience with ERate, I very much hope the members of the subcommittee and the

public will interpret my comments as supporting reform of the program, not its elimination.’’ So I wanted to ask you if you had specific recommendations of things that could be built into the program that would reform it, and—Well, let me leave it at that for

now.

Ms. ACKERMAN. Certainly. I believe that—As I have had to put

in certain procedures and processes of oversight and checks and

balances, I think that that has to happen also at the Federal level,

including some kind of oversight even at the district level, making

sure that our procedures and processes are in place so that this

will never happen again.

I am not sure what they would look like at the Federal level. I

just think that these two applications got through, past the district

level was disturbing to me and, you know, not only as a professional but as a taxpayer.

40

Ms. SCHAKOWSKY. Mr. Herrera testified. You said schools

throughout our district would have been saddled with millions of

dollars in equipment that was functionally equivalent to paperweights, and you talked about routers, cabling and switches with

no servers, a phone system with no phones, a computer system

with no work stations, and you add the issue of the video conference, which wasn’t even eligible.

Isn’t that, Dr. Ackerman, a limitation of the program itself? The

program, as I understand the E-Rate program, really ends at the

wall; that is, that the E-Rate program itself just provides the wiring and the equipment to the wall, so that it is the school districts

themselves, if you want to make it function and have the servers,

the phones, the work stations, that that is an expense borne by the

districts. Is that right?

Ms. ACKERMAN. Absolutely. But what we see with the E-Rate

program are discounts, and that is where—you know, of the hardware, as opposed to the infrastructure. Even with the infrastructure, though, we saw evidences of infrastructure that, I would say,

was like a Cadillac and we only needed a Chevrolet is the way I

like to explain it.

So there are problems, I think, on both sides that we have to be

aware of. The infrastructure is one that is needed, not necessarily

an expensive infrastructure, and then the discounts that happen on

the other side. We actually have to be sure that there are no opportunities for people to defraud the school district. So it is actually

on both sides.

Ms. SCHAKOWSKY. So the fraud did occur, Mr. Herrera, also on

the discount part, on the equipment—or Mr. Cothran?

Mr. COTHRAN. I wonder if you could repeat the question.

Ms. SCHAKOWSKY. Well, I am concerned that, even when the infrastructure is done, that school districts can’t get—end up, as Mr.

Herrera described, with equipment functionally equivalent to paperweights, that they can’t complete the program.

I am trying to understand what are the limitations of the program itself, because it does—and then where did the fraud come

in? Was there fraud dealing with servers, phones, work stations,

those things that would complete the system, as well?

Mr. COTHRAN. We can only really guess at what the plan was in

San Francisco once they received—the vendors received the money.

What we do know, because NEC admitted so in their guilty plea,

is that they planned on using $10 million of the excessive request

to fund computer work stations which would have in part help complete the project.

We in the City Attorney’s office strongly suspect that other portions of the inflation, if you will, were going to go to pay for

handsets, phone handsets, voice mail and other things that aren’t

eligible. But as part of making an E-Rate application, a school district has to make sure of two things, if they want to do it properly,

based on my understanding of the program.

They have to make sure that they have the co-pay to pay for the

equipment that E-Rate is going to be paying for. In addition to

that, they have to make sure, and also certify to USAC, that they

also are able to purchase the ineligible equipment that will comVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00048 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
41

plete the program, to complete the IT backbone, if you will, that

the E-Rate program is going to pay for.

At San Francisco in year three of the program when this fraud

occurred, there was no deliberative process on the part of the

school district to ensure that they had the additional equipment

that E-Rate would not pay for, which would complete the program.

We strongly suspect that one of the reasons they inflated it so

grossly was to pay for that equipment with E-Rate money, which

would have been a fraud on the program.

Ms. SCHAKOWSKY. Dr. Ackerman, does the school district now use

the E-Rate program, and do you have—did you have sufficient

funds to do the match and to provide the ineligible equipment?

Ms. ACKERMAN. Yes, we have, but it is a very scaled down application and program now, and so I think over the last year or so

we have barely spent a million dollars each year on the E-Rate program.

We have certainly gone through a fiscal crisis in California, and

this district has been impacted by that crisis, and we now have a

technology plan that drives the E-Rate program as opposed to the

other way around. So I think that was what was missing at that

point also, was a plan, a technology plan that would actually lay

out where we wanted to go, and inclusive of that would be a budget

that would match the needs of the E-Rate program and the needs

of this district, prioritize those needs.

Ms. SCHAKOWSKY. So while I understand that today we are focusing on your wonderful work in rooting out this fraud, I do want to

ask: If the district itself had more of a budget, would your E-Rate

program be more expansive or are you sufficiently providing for the

needs of your kids?

Ms. ACKERMAN. I think that we certainly would do more. As I

think somebody mentioned in the technology, we are in the shadow

of the Silicon Valley, and one of my big disappointments when coming to San Francisco was the fact that I felt our district needed

more technology.

If we want our children to leave the school system technologically

competent, there is a lot of work we have to do in terms of providing more technology resources to our children and into our classrooms. So with more money, we would certainly do more.

Ms. SCHAKOWSKY. Well, it is clear that you not only have your

children but your taxpayers and all of the taxpayers in mind as you

do your job, and so thank you again to all of you for your good

work. I yield back.

Ms. ACKERMAN. You’re welcome.

Mr. WALDEN. Thank you for your questions. We’ve got a few

other questions. Let me kind of outline for the committee and the

panels what we anticipate.

We have been notified that there will be votes on the House floor

sometime between now and 12:15. We would like to do another

round of questions of this panel, but I understand, Ms. Ackerman,

you may—or Dr. Ackerman, you may need to move on, and we understand that. So we won’t keep you in this phase of the hearing.

But we do have some other questions for Mr. Cothran and Herrera

and Ms. Renne.

42

So what we are looking at, we will start into that—Did you want

to say something, Ms. Ackerman?

Ms. ACKERMAN. No, I am okay for about another hour. So if you

would like me to stay, I will stay.

Mr. WALDEN. Okay. I thought it was sooner than that. The problem we are going to face, though, is we are going to break here

when the bells go off in probably 5 or 10 minutes, and then we are

going to recess until 1:30, our time. So it may cause you some problems.

So, anyway, if you need to leave, the point is, feel free to, but

we definitely appreciate what you have testified to today and the

work you have done on this issue.

Ms. ACKERMAN. I just want to say, in case I am not here when

you come back, that I really do appreciate the opportunity to speak

before you today and the fact that this subcommittee is looking at

this issue.

Again, it is unfortunate what happened to our program, E-Rate

program, and the fact that it has hurt our children. But I do firmly

believe in this program and the benefits that it brings to young

people who would not have the access to technology, if it were not

for the E-Rate program.

I just hope that you will bear that in mind in your deliberations

as you hear further testimony. Understand that I hope that this is

not the norm. I always believe that the glass is half full, and I

want to look at the benefits.

So I thank you, Mr. Vice Chair, for inviting me to speak today.

Mr. WALDEN. We want to make sure that that glass doesn’t have

a big hole drilled in the bottom of it, because there are a lot of

schools out there that could benefit greatly by the money rather

than a couple of fraudulent operators putting it in their pockets.

Ms. DeGette and I were talking about how many school districts

could be wired with the amount of money that could have been

loaned in this case, and may have been wrongfully taken out the

of the E-Rate system in other cases. So we appreciate your diligence.

Ms. ACKERMAN. Thank you.

Mr. WALDEN. I am going to go ahead then into the next round.

Again, if you need to leave, feel free to do so. I want to go to Ms.

Renne.

What has happened to Tim Tronson, the former director of operations management of the facilities department?

Ms. RENNE. Well, Tim Tronson is, obviously, not with the school

district anymore. He has been indicted by the Grand Jury in San

Francisco and is awaiting trial in San Francisco on matters not

necessarily related to the E-Rate.

We had some other—As Dr. Ackerman indicated, we did have

some other scandals, for lack of a better word, involving the school

district, and Mr. Tronson has been at the heart of that.

Mr. WALDEN. I understand. Okay. Mr. Cothran, what was the

traveling road show?

Mr. COTHRAN. The traveling road show is a term that I came up

with internally when discussing the case with attorneys. That is

how I described the Judy Green——

Mr. WALDEN. Why? Why do you describe it that way?

43

Mr. COTHRAN. It is just a conversational term I used in private

meetings with attorneys, you know, because they were going all

over the country and doing this.

Mr. WALDEN. I guess that is the question. From what you have

seen so far, you believe they tried to perpetrate this same type of

scam elsewhere in the country?

Mr. COTHRAN. Correct.

Mr. WALDEN. All right.

Mr. COTHRAN. And succeeded in some cases.

Mr. WALDEN. Yes. If you would turn to the chart on Table 133,

Tab 133, I am hoping you can explain a little bit about what this

chart is and where it came from. Is this relating to the 471s?

Mr. COTHRAN. Since we are currently still in the process of litigation with many defendants, I don’t want to get into too great a

specificity, if it is all right with you, about where I got things and

the state of my evidence. All I can say is that I have seen this document before.

It is part of the evidence that is part of the City Attorney investigation, and it is our belief that this was prepared by Mr. McQuoid

or at least with Mr. McQuoid’s knowledge as part of his process

and the process of others of trying to figure out what the heck happened when the 471 applications were filled out, and the type of

inflation that occurred from bid to application.

It is our belief that Mr. McQuoid was unaware at first of this

second layer of fraud where the rigged bid prices were then——

Mr. WALDEN. He was unaware or said he was unaware?

Mr. COTHRAN. I never interviewed Mr. McQuoid, one of my great

disappointments in this investigation.

Mr. WALDEN. Where is he now?

Mr. COTHRAN. He is currently, I believe, in Federal prison doing

21 months for a separate fraud scheme that he was involved in

with one of the E-Rate bidders.

Mr. WALDEN. A different E-Rate bidder than we have heard from

today?

Mr. COTHRAN. An E-Rate bidder that is mentioned in my written

testimony called U.S. Machinery. They were involved in a separate

fraud scheme. I can explain that to you, if you want.

Mr. WALDEN. That’s fine. So you tell me what you can’t answer

because of your investigation, but is this relating to the 471s?

Mr. COTHRAN. It is our strong belief that this was a document

or a spreadsheet, if you will, that was created during the process

that Mr. McQuoid and others engaged in, in trying to figure out

what Judy Green and other parties had done when they went

about filling out the 471s, taking control of that process as well,

and inflating the already rigged bid price.

Mr. WALDEN. Okay. That is what I would like to get. Can you

tell us, as you look at this chart, what is the inflation rate here?

How much was inflated? What are we really looking at?

Mr. COTHRAN. It would take me a while to do that. I really—I

mean, first of all, you have to understand that this is relating to

just one part of the RFP. It is relating to the data portion. You

have your backbone switch, your intermediate switch, your router

and so forth.

44

This would have related to the portion of the bid that was won

by NEC outright in the initial process that Green and Marchelos

ran, and then was inflated even further on the 471. It is just one

of several aspects of the project.

So it looks here like he is trying to figure out how the NEC bid

on data had been inflated when the 471s were filled out.

Mr. WALDEN. I guess that is what we are trying to figure out,

is how did they manipulate this 471 process? How did they basically double the bids?

Mr. COTHRAN. They just filled it out. They just filled out the 471

application.

Mr. WALDEN. And just put in whatever numbers they wanted?

Mr. COTHRAN. I encourage you to read the NEC guilty plea. I

think there is a very articulate explanation of that process in their

guilty plea. They just—A party referred to as Consultant 1 and

later referred to by the feminine pronoun, she, directed NEC representatives what amounts that she wanted on the 471, and then

I believe the NEC guilty plea says that spreadsheets, phony

spreadsheets were created to justify those prices she dictated, and

that was what was submitted as the 471.

Mr. WALDEN. So the elusive Ms. Green, whom we are not able

yet to find to serve the subpoena, but will, is the one who you say

was basically telling NEC people what to put on the 471s for numbers?

Mr. COTHRAN. Based on my investigation, and setting aside for

a second what the NEC guilty plea says—Based on my investigation, the conclusion we reached is that Judy Green, and to some

extent George Marchelos, were the architects of drafting and submitting the 471, and it is also our strong belief that Desmond

McQuoid was not part of that process and didn’t know anything

about it.

So we have a case where, at this stage of the fraud, no one at

the school district, not even school district co-conspirators, were

knowledgeable, it is our investigative conclusion—were knowledgeable about this layer of fraud until later.

When he found out, as I said, he had a choice to make, and he

chose to join the fraud.

Mr. WALDEN. Interesting. So it sounds like you had—From what

you have said, you had two frauds going.

Mr. COTHRAN. Right.

Mr. WALDEN. And you had one group committing a fraud down

here unbeknownst to the other group until they kind of—How did

they tumble on it?

Mr. COTHRAN. I don’t know how Mr. McQuoid found out that the

471——

Mr. WALDEN. But when he did, it is your opinion that he said,

great, let’s up the ante?

Mr. COTHRAN. Well, I think that he might have pitched a fit, but

we do know for certain he didn’t blow the whistle. He didn’t tell

any law enforcement officials. He didn’t tell our office. He didn’t

tell USAC. He didn’t tell anyone and, as a matter of fact, he then

went to NEC and got them to agree to use some of this inflated

portion to pay for ineligible equipment.

45

Mr. WALDEN. If you could please turn to Tab 19, this is an e-mail

that shows an employee of NEC marking up prices and making up

part numbers on VNCI equipment. What do you think this was?

Was he working on the 471’s pricing? Tab 19.

Mr. COTHRAN. Yes, I am getting there. It is a rather convoluted

e-mail, and it has a lot of assumed knowledge embedded in it that

the recipient knows what they are talking about.

My guess would be, my educated guess on this is there is evidence embedded in this e-mail that VNCI equipment, or references

to VNCI equipment on parts lists in other parts of 471 applications

was obscured and changed in order to conceal the nature of the

equipment, since it was ineligible. That would be my educated

guess.

Mr. WALDEN. Okay, Tab 16. This document is an e-mail in which

an NEC employee—hopefully, I will get the pronunciation somewhere correct—Sohail Qasim, expresses concerns about Judy Green

and talks about, ‘‘money and a system that will not work properly.’’

So first, we don’t believe the school district even needed this project

and, second, it would appear from this e-mail that the system

might not even work properly.

Mr. COTHRAN. On the first part of your question, it is certainly

the overwhelming opinion of members of the Information Technology and Telecommunications Division, the proper avenue for ERate funding, that this system was utterly and completely unnecessary.

There was already a wide area network and local area networks

operating in the school district, and nearly all the schools had

Internet access, computers, routers, switches, data, everything, and

that this, in their opinion, not only conflicted with the system that

they already had in place and were in the process of building

through E-Rate applications and other funding avenues, but that

it was entirely unnecessary.

Mr. WALDEN. All right. Turning to Tab 27, this is an e-mail to

Tom Burger, the CEO.

Mr. COTHRAN. Which number? I’m sorry.

Mr. WALDEN. Twenty-seven, which talks about in-kind NABSE

bonus and value added section, NABSE bonus and value added section.

Mr. COTHRAN. Twenty-seven? I apologize.

Mr. WALDEN. Twenty-seven.

Mr. COTHRAN. Twenty-seven is a spreadsheet of prices. It is not

a—It doesn’t refer to NABSE bonus, 27, 2-7. In my binder, it is not

that.

Mr. WALDEN. We will have it brought down.

Mr. COTHRAN. What I can tell you is that my investigation did

not touch on the NABSE arrangement or relationship with any of

the parties involved in our lawsuit. We are interested in learning

more about that, but it did not form part of my investigation.

Mr. WALDEN. All right. So you are then not familiar with the inkind contributions known to NEC, within NEC as the NABSE

bonus?

Mr. COTHRAN. It was not part of my investigation. It did not

touch on that, no.

46

Mr. WALDEN. All right. Could you talk to me about the Inter-Tel

Trojan horse? What is that?

Mr. COTHRAN. Well, that is another term that I made up when

discussing the case internally with attorneys. That, to me, was how

I described Inter-Tel serving as a Trojan horse for VNCI, because

of the percentages of equipment differential that I saw in not only

the San Francisco E-Rate application but in documentation related

to other E-Rate applications for Inter-Tel or NEC that were funneling VNCI equipment.

When talking about the case internally, I explained to attorneys

that in these situations, you know, if the same percentages that we

saw in San Francisco, which was $15 million of a $20 million bid—

of a $20 million Inter-Tel bid being VNCI equipment, it was really

essentially a VNCI bid parading as an Inter-Tel bid, if you follow

me, since the vast majority of the funding would have gone to pay

for VNCI equipment. In that way, I explained to the attorneys in

the office using that term, that at least in the case of San Francisco, Inter-Tel appeared to have been acting as a Trojan horse for

VNCI, because of also the additional acts of concealing the ineligibles.

Mr. WALDEN. And it was hidden on the form.

Mr. COTHRAN. It was hidden. PBX parts lists that were submitted to USAC, according to a witness, purposely obscured the nature of the equipment, and not as it relates to San Francisco but

as it relates to other school districts, documents indicate that,

when USAC asked probing questions about that very equipment

and about its functionality, that the answers that flowed back from

the school district did not reveal that it was videoconferencing

equipment. It is our strong belief and suspicion that those school

district responses were controlled by Judy Green, George

Marchelos, and representatives of Inter-Tel and/or NEC.

Mr. WALDEN. When you say controlled by Judy Green or these

others, is that to say that the school district had no knowledge of

the responses?

Mr. COTHRAN. I think what you are going to find eventually, and

I think what we are going to find in the course of our litigation is

a variety of situations across the country. You will sometimes find

that there was a Desmond McQuoid figure at the school district

who was knowledgeable about parts of the scam but not all of it.

You will find, I would guess, situations where the school district

officials were utterly blind to the fraud that was going on and were

just more than happy to have these people getting them this money

that was so sorely needed by their districts, which is one of the

things that we found rather distasteful about this scam, is that

they preyed on the desperation of poor, underfunded school districts.

Mr. WALDEN. Are there other Judy Greens out there? Have you

stumbled across any?

Mr. COTHRAN. Not in the course of my investigation. I wouldn’t

be surprised.

Mr. WALDEN. All right. We are going to recess now until 1:30.

There are some additional questions we have for this panel, and

then we will reconvene, as I say, at 1:30. So we will stand in reVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00054 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
47

cess. Thank you again for your patience, and we look forward to

reconvening after our votes.

[Brief recess.]

Mr. WALDEN. I am going to call the Subcommittee on Oversight

and Investigations back to order, and I again thank you for your

patience in bearing with our legislative schedules today.

Mr. Cothran, there are a number of documents I would like to

walk through with you, Tabs 51, 53, 58, 62, 124. We will go

through them one at a time.

Could you take us through the Item 25 review and the falsified

documents that were submitted by Judy and George?

Mr. COTHRAN. Well, as I pointed out in my testimony, there were

several documents that flowed from the school district to USAC in

response to USAC inquiries. It is my understanding that those inquiries from USAC existed on two levels: One, the sort of initial

routine review that, I think, is performed on all applications; and

then some applications, but not all applications, are selected for

what is called an Item 25 review, which is an elevated and more

detailed level of review.

All applications flowing out of San Francisco Unified School District that funding year were subjected to an Item 25 review because

of questions USAC had about how unit costs, which are amongst

the highest in the nation, that attended the Desmond McQuoid applications and also the sort of what we in the City Attorney’s office

are terming the gold plating that went on with the proposal, the

most striking example being the proposal to create a Local Area

Network in every classroom which would have meant a server and

switches in every classroom.

So this is my understanding——

Mr. WALDEN. What would a LAN in every classroom serve? Why

would you do that?

Mr. COTHRAN. It is the opinion of the City Attorney’s office that

it would serve no function other than to drive up the cost of the

proposal and put more money in the pockets of the people who perpetrated this fraud.

Mr. WALDEN. All right. Tab 58, Judy Green giving Desmond

McQuoid responses for the SLD. Do you have a comment on that

one?

Mr. COTHRAN. This appears to be—Let me see. Okay, I did not

have an opportunity to review this. So would you mind if I just

read through it?

Mr. WALDEN. That’s fine. Go ahead and take your time.

Mr. COTHRAN. Okay, I have read enough of it to issue my opinion

on this. This is interesting to me. This puts together a piece of the

puzzle I didn’t have before.

Mr. WALDEN. How so?

Mr. COTHRAN. What I did know is that Desmond McQuoid sent

an e-mail to USAC in response to USAC questions about budget

documents that flowed from the school district to USAC purporting

to show that there was more than $40 million in E-Rate matching

funds.

An E-Rate reviewer, I believe, by the name of Tom Schnipp

caught a discrepancy between that document that Mr. McQuoid

and Mr. Tronson under his signature sent to USAC and the actual

48

document that was on the website. I think it is also interesting for

you to know that at this point in time the school district budget—

this was in August of 2000. As you will see, this e-mail was on August 8, 2000.

Mr. WALDEN. Yes.

Mr. COTHRAN. The document that was sent from SFUSD to

USAC purporting to show this E-Rate matching fund line item of

$41-some-odd million was dated August 1. Who knows when it was

actually sent. I think it was actually sent more in the week of August 22, but I won’t bog down with such niggling details.

Desmond McQuoid—It is our belief that Desmond McQuoid, Tim

Tronson conspired—and others, including people of VNCI, conspired to send this fraudulent budget document to USAC showing

that they had the matching funds. As a matter of fact, they had

more than the needed matching funds, $41 million.

Unfortunately, that was a lie. That was just not true. Matter of

fact, the school district had actually decreased their E-Rate matching fund line item elsewhere in the budget from $1.2 million, I believe, to zero. So they had——

Mr. WALDEN. Zeroed out their line item matching.

Mr. COTHRAN. For that year.

Mr. WALDEN. For that year.

Mr. COTHRAN. So this alert USAC reviewer, Tom Schnipp,

caught this. They caught the discrepancy between the budget that

flowed from Tronson, McQuoid and others to USAC and the one

that was on the website. He simply went on the web and found the

real budget.

Then he e-mailed Desmond McQuoid.

Mr. WALDEN. Right.

Mr. COTHRAN. And asked him about this discrepancy. The e-mail

that flowed back from Desmond McQuoid’s e-mail address at San

Francisco Unified School District was a classic example, in my

opinion, of tap dancing around a difficult question where you just

don’t want to answer it, because the answer would put you into

trouble.

This shows me for the first time that my long held suspicions,

and our long held suspicions, that Judy Green directed him to do

that or directed him in some way in answering that question was

indeed confirmed by this e-mail. It shows that Judy Green sent to

Des, which was the prefix of his e-mail address, how to answer the

questions Tom Schnipp had.

As I just read the first two or three items, it comports with my

memory of Desmond McQuoid’s e-mail to Tom Schnipp, this tap

dancing e-mail that I told you about. So it indicates to me in a very

clear way that Judy Green was behind the budget document flowing—the fraudulent budget document flowing to USAC, and also in

attempting to help Mr. McQuoid explain away the discrepancy that

resulted.

Mr. WALDEN. Would you mind turning to Tab 124? I believe that

is the budget, the altered budget, allegedly altered budget.

Mr. COTHRAN. Oh, I got the date right. Good, August 1. I know

that to be Tim Tronson’s signature from other exemplars I have

seen. If you look at Bates USAC Sub 4855 toward the bottom under

the general category of Other Outgo——

49

Mr. WALDEN. Right. The E-Rate District Manager.

Mr. COTHRAN. The E-Rate District Manager. I have in my file received from the CFO of the school district this actual page, and it

includes no such line item.

Mr. WALDEN. And on the next page I think you will see the actual budget line item.

Mr. COTHRAN. Right. Right. I actually have the actual—You are

right, and this shows it, I believe, being zeroed out, if I am not mistaken.

Mr. WALDEN. On 125, I guess.

Mr. COTHRAN. Oh, on 125. I’m sorry. Right. This apparently

looks like what Mr. Schnipp found on the website, which shows

that Other Outgo line item on Bates 4796—there is no such line

item. They simply got into that document and altered it and falsified it and sent it to USAC, and that e-mail indicates to me rather strongly that Judy Green was involved in that conspiracy.

Mr. WALDEN. So you had a USAC reviewer—or not you, but

there was a USAC reviewer who caught this, is what you are saying?

Mr. COTHRAN. Yes. Based on written questions I submitted to ERate—Sorry. I submitted written questions to USAC at their request, and they submitted written answers sometime in the April

timeframe of 2002, shortly before we filed our lawsuit. Amongst

those written answers Mr. Schnipp explained to me his experience

with this document.

Mr. WALDEN. So he spotted it before you raised the questions?

Mr. COTHRAN. I got most of my documents relating to the San

Francisco Unified School District application from USAC. They

were very helpful in that regard.

Mr. WALDEN. But my point is, did you trigger Mr.—Sip, is it?

Mr. COTHRAN. No. Mr. Schnipp did this all on his own.

Mr. WALDEN. He did it all on his own? He spotted it?

Mr. COTHRAN. He spotted it in the year 2000. My investigation

didn’t start until the following year.

Mr. WALDEN. Okay. Then what happened with what he learned?

Mr. COTHRAN. I reviewed his answers to my questions last night

for the first time in a while, and he, in sum, told me that he doubted the accuracy of the document. His answer was not sufficiently—

His questions about the discrepancy between the online document

and the document Mr. McQuoid sent him were not settled by Mr.

McQuoid’s tap dancing e-mail.

Mr. WALDEN. Got it.

Mr. COTHRAN. And he alerted his superior, who at the time was,

I believe, a gentleman named Mark Werner, given other information that flowed from USAC to me, who was then, I believe, the

manager of program integrity assurance select review—I may have

that title a little wrong—and alerted him to the problem.

Mr. WALDEN. Verbally or in writing?

Mr. COTHRAN. I don’t think—Well, I don’t think it specified, but

what I do know is Mr. Schnipp informed in his written replies to

my questions that he alerted his superior to this problem, and

passed the file on up the chain of command, so to speak, with his

concern attached to it, so to speak, and that was the last time he

50

saw that file, and he could not answer my questions about why, despite this, the funding request was approved.

At the time that he answered my questions, which was some 2

years later, he still didn’t know how and why and by whom it had

been approved, according to his written answers to my questions.

Mr. WALDEN. Have you pursued that line of questioning within

USAC?

Mr. COTHRAN. When I got the answers, it was in April of 2002,

and we were busy preparing a lawsuit, and our energies were focused on that. And, no, I did not pick up on that line of inquiry

again.

Mr. WALDEN. I guess the question would be: Is there any backdoor channel going on here between USAC and some of the conspirators and co-conspirators?

Mr. COTHRAN. I think that is a legitimate question to ask.

Mr. WALDEN. All right. Could you turn to Tab 77? This is an email describing how Judy Green at VNCI has a high level contact

within USAC.

Mr. COTHRAN. Yes, I read this earlier today. Seventy-seven, you

said?

Mr. WALDEN. Yes, sir. Do you think that Judy Green had a contact inside USAC?

Mr. COTHRAN. Well, you know, I have always ascribed to Clint

Eastwood’s maxim of a man has to know his limitations, and as it

regards this investigation I will observe that maxim, and I don’t

have any evidence that she did, and I really don’t want to speculate

on that.

Mr. WALDEN. I understand.

Mr. COTHRAN. I just think speculating on that would be irresponsible.

Mr. WALDEN. I understand. But you do think it is a question that

is worth asking of somebody?

Mr. COTHRAN. Yes, I think it is a line of inquiry that is definitely

worth following up, absolutely.

Mr. WALDEN. All right. Looking at Tab 90, Desmond McQuoid email discusses a year four 471 application, so for the fourth year

471 application, that Desmond says was submitted with his name

on it that he knows nothing about.

Mr. COTHRAN. That is my information as well. During the course

of my investigation I uncovered evidence that Mr. Marchelos approached individuals at the school district the following funding

year with an E-Rate application, walking into people’s offices literally and trying to find some official at the school district to sign

the document so that it could be submitted to USAC.

An alert CFO assistant—assistant to the CFO had a conversation

with Mr. McQuoid that she—I mean, sorry, Mr. Marchelos that she

reported to me. Basically, her version—My memory of her version

of events is that he was going into offices, looking for some sort of

official signature to place on what I believe to be a 471 Form for

year four, and I don’t believe that was ever accomplished.

Mr. WALDEN. Okay. That is not the one that Dr. Ackerman refused to sign, is it?

Mr. COTHRAN. I don’t know.

51

Mr. WALDEN. All right. I don’t mean to dwell on this, but I guess

I will for a moment. I want to go back to this Judy Green/USAC

issue. Has anybody told you they thought there might be a contact

going on there?

Mr. COTHRAN. Yes. I had one witness tell me that his belief was

that—or suspicion was that she had someone inside USAC who

helped her out.

Mr. WALDEN. All right. I think we just have one more question

for this panel. Do you have any reason to believe that the schools

and school districts in which NEC BNS was either awarded or subcontracted other questionable E-Rate deals were at all complicit in

the conspiracy to defraud the E-Rate program? So were there

schools or school districts that you are aware of?

Mr. COTHRAN. Where NEC was——

Mr. WALDEN. Yes, in which NEC BNS was either awarded or

subcontracted other questionable E-Rate deals? Were they at all—

Were any of those school district complicit? I am delighted we have

a Dr. Ackerman at San Francisco. Given what we are learning

about all this, it seems like corruption can run rampant in this program.

Mr. COTHRAN. The only information I have on that front is the

information that the CEO and principal of Ceria M. Travis shared

with me in those two interviews I had with her.

It was my impression from those interviews that this individual,

Ms. Johnson, Dorothy Travis Johnson, was uncomfortable with

what was going on around her, was suspicious. Her antennae were

raised by it, but she didn’t understand enough about the process,

either competitive bidding process or the E-Rate process, to follow

through her thinking to the point where she would have been

complicit or have guilty knowledge.

That was my impression of her, but this was only from two brief

phone interviews. So I think the value of that is somewhat limited.

Mr. WALDEN. I think just one more question of each of you. As

we struggle with this issue, do what is right to make sure the program functions as it was intended, that it doesn’t get ripped off by

people for ill gotten gains, what would you do if you were us? What

are the one or two most important things we can do to fix USAC

and fix the oversight?

You know, you have answered everything so far. We will let you

breathe for a second.

Mr. COTHRAN. Thank you.

Mr. WALDEN. Ms. Renne?

Ms. RENNE. Well, I think, first of all, with regard to school districts, as Dr. Ackerman indicated, you need to make sure that internally your procedures are strong. Of course, that is something

only school districts can do, but certainly in the review process that

ought to be looked at.

I think, second, if I were sitting in your shoes, I would be taking

a look at this program in not only San Francisco but in a variety

of school district areas across the country, which I think you are

already.

Mr. WALDEN. Right.

Ms. RENNE. And I would certainly take a look at the organization

that is doing the review. Are they sufficiently distanced from——

52

Mr. WALDEN. Independent?

Ms. RENNE. And independent to be able to take an independent

look at the program, and to be ready to ask the tough questions?

Mr. WALDEN. Mr. Herrera?

Mr. HERRERA. To echo Ms. Renne’s comments, I think that one

thing that we have learned through our office’s investigation, not

just of this matter but other waste, fraud and abuse cases that we

are looking into in our office, is the necessity for strict internal controls to make sure that the administrative agencies have their own

house in order and, to the extent that you have a Federal overlay,

obviously, there is the opportunity for waste, fraud and abuse to

enter into it at another level.

So at least from our perspective, certainly, there is a responsibility that school districts have their own internal house in order,

and that aids investigative agencies immeasurably. But from your

perspective, I think that looking at how the oversight of the program is structured and whether there needs to be more direct government oversight is something that, I think, you need to take a

very serious look at.

Mr. WALDEN. Well, it just really troubles me what I have come

to better understand through this hearing and the data behind the

hearing is that you have a dedicated public servant who within

USAC says this doesn’t look right, these budget numbers don’t add

up—I mean, I would think somebody would put a screeching halt

on the whole application and demand a review to find out—At minimum, ask the question. I guess we will ask USAC that later, but

then to go ahead and move forward when you’ve got an identified

altered budget document.

We are not talking pennies here. What is it, $48 million?

Mr. COTHRAN. $41.5 million.

Mr. WALDEN. 41.5.

Mr. COTHRAN. And this is a document that had—You know, this

is a point on which, I was informed by Mr.Schnipp, that had—they

verified to a certainty further up the chain, I imagine, that they

didn’t have the funds.

Mr. WALDEN. That it had been altered?

Mr. COTHRAN. The decision would have been entirely the opposite, that they would have received no money.

Mr. WALDEN. So they had verified with the school district that

they had no money in their legitimate budget to match against

this? Is that what you are saying?

Mr. COTHRAN. I wouldn’t put it that way. They verified by checking the budget document online that was the true budget document

that was different from the budget document that Mr. McQuoid

sent them, and now apparently with the help of Ms. Green. And

they saw this discrepancy, this rather striking discrepancy.

Mr. WALDEN. Do you know if the folks at USAC then got hold

of the superintendent’s office or the chairman of the school board

or somebody and said, hey, we are seeing this discrepancy, can you

explain it? Did they ever ask for an explanation, that you are

aware of?

Mr. COTHRAN. I don’t know if they ever sought further confirmation through the school district. I think that is a question better

put to USAC.

53

Mr. WALDEN. For USAC? Okay. I really again appreciate not

only your work but your testimony and your patience today with

our process. Thank you very much for being here. We appreciate

it.

Mr. WALDEN. At this time the Chair will call forward the following witnesses: Mr. Thomas Burger, President and CEO of NEC

Unified Solutions, Inc; Mr. William Holman, former Vice President

of Sales for NEC BNS; Mr. George Marchelos, former consultant to

and employee of Video Network Communications, Inc; and Ms.

Judy Green, wherever she may be, former consultant to and employee of Video Network Communications, Inc.

Please come forward and be seated at the table.

Before we proceed any further, I would like to note the absence

of Ms. Judy Green. The committee invited her to testify today, as

I mentioned earlier, but she did not respond to that invitation as

we requested.

Subsequently, the committee issued a subpoena to command her

attendance here. The United States Marshals have attempted for

the past week to serve Ms. Green. They have staked out her home

and have personally spoken to her husband, but she is nowhere to

be seen, apparently shopping for a new home, but her husband

does not expect to hear from her until Friday at the earliest. That

is tomorrow.

We will enter into the record the Marshals’ e-mails regarding

their attempts to serve the subpoena.

[The information referred to follows:]

54

55

Mr. WALDEN. As you know, when conducting an investigative

hearing, this subcommittee follows the practice of taking testimony

under oath. So if you would, please rise and raise your right hand.

[Witnesses sworn.]

Mr. WALDEN. Let the record show they all indicated ‘‘I do.’’

Please be seated. Gentlemen, under the rules of the House and this

committee, you have the right to be advised by counsel as to your

Constitutional rights. Do you have legal counsel here today,Mr.

Burger?

Mr. BURGER. Yes, sir, I do.

Mr. WALDEN. Can you please state for the record the name of the

counsel that is here today to advise you with respect to such matters?

Mr. NIESPOLO. Mr. Chairman, my name is George D. Niespolo,

and I am counsel for Mr. Burger.

Mr. WALDEN. Thank you. The Chair—let’s go on down then. Mr.

Holman?

Mr. HOLMAN. Yes, Mr. Chairman, I am represented by counsel.

It is Mr. Greg Evans.

Mr. WALDEN. Okay. If you could kind of lean toward the microphone, that will be good.

Mr. EVANS. Good afternoon, Mr. Chairman and committee. My

name is Gregory Evans of the law firm of Orrick, Herrington &

Sutcliffe, representing Mr. Holman this afternoon.

Mr. WALDEN. Thank you for being here. Mr. Marchelos?

Mr. MARCHELOS. No, I do not.

Mr. WALDEN. Do not have counsel? Okay. Mr. Donovan?

Mr. DONOVAN. Yes, Mr. Niespolo is counsel for me also.

TESTIMONY OF THOMAS J. BURGER, PRESIDENT AND CEO OF

NEC UNIFIED SOLUTIONS; INC; WILLIAM HOLMAN, FORMER

VICE PRESIDENT OF SALES FOR NEC BNS; GEORGE

MARCHELOS, FORMER CONSULTANT TO AND EMPLOYEE OF

VIDEO NETWORK COMMUNICATIONS; JUDY GREEN, FORMER

CONSULTANT TO AND EMPLOYEE OF VIDEO NETWORK COMMUNICATIONS, INC.; AND TIMOTHY M. DONOVAN, FORMER

SENIOR VICE PRESIDENT AND GENERAL COUNSEL, NEC

USA, INC.

Mr. WALDEN. All right. Thank you. The Chair now recognizes

Mr. Burger for purposes of making an opening statement, if you so

desire. Mr. Burger?

Mr. BURGER. I don’t have an opening statement, no, sir.

Mr. WALDEN. Very well. The Chair now recognizes Mr. Holman

for purposes of making an opening statement, if you desire.

Mr. HOLMAN. Mr. Chairman, I do not have an opening statement. Thank you.

Mr. WALDEN. Very well. The Chair now recognizes Mr. Marchelos

for purpose of making an opening statement if you so desire.

Mr. MARCHELOS. No opening statement, sir.

Mr. WALDEN. Very well. We will be back at you in a moment, Mr.

Donovan.

Mr. Burger, this morning we heard from San Francisco City Attorney’s Office, and this afternoon, about an elaborate conspiracy

between individuals at NEC BNS and VNCI, including Judy Green,

56

George Marchelos and others, in which the co-conspirators eliminated competitive bidding and inflated prices on contracts related

to the E-Rate program.

As you know, NEC BNS pleaded guilty to conspiracy to suppress

and eliminate competition for E-Rate program projects and to wire

fraud.

As the President and CEO of NEC BNS, were you aware of the

conspiracy by NEC BNS, VNCI, Judy Green, George Marchelos and

the others to defraud the E-Rate program by rigging bids, inflating

contract prices, forging the signatures of school district officials,

and lying to USAC during its review process?

Mr. BURGER. Mr. Chairman, as you know from my correspondence and my request to appear at a future hearing, it is my sincere

desire to cooperate with this subcommittee’s investigation. However, due to the ongoing Department of Justice investigation and

on advice of counsel, I respectfully decline to answer the question

on the basis of the privilege afforded me under the 5th and 14th

Amendments of the United States Constitution.

Mr. WALDEN. Mr. Burger, are you then refusing to answer all of

our questions on the right against self-incrimination afforded to

you under the 5th Amendment of the U.S. Constitution?

Mr. BURGER. Yes, Mr. Chairman.

Mr. WALDEN. And is it your intention to assert such right in response to all further questions from the subcommittee today?

Mr. BURGER. Yes, Mr. Chairman.

Mr. WALDEN. Given that, if there are no further questions from

the members, I will dismiss you at this time, subject to the right

of the subcommittee to recall you, if necessary. So at this time, you

are excused.

Mr. BURGER. Thank you, Mr. Chairman.

Mr. WALDEN. Thank you for coming.

Mr. Holman, this morning we heard from the San Francisco City

Attorney’s Office about an elaborate conspiracy between individuals

at NEC BNS and VNCI, including Judy Green, George Marchelos,

and others, in which the co-conspirators eliminated competitive

bidding and inflated prices on contracts related to the E-Rate program.

As you know, NEC BNS pleaded guilty to conspiracy to suppress

and eliminate competition for E-Rate program projects and to wire

fraud. As the former Vice President of Sales for NEC BNS, were

you aware of the conspiracy by NEC BNS, VNCI, Judy Green,

George Marchelos, and others to defraud the E-Rate program by

rigging bids, inflating contract prices, forging the signatures of

school district officials, and lying to USAC during its review process?

Mr. HOLMAN. Mr. Chairman, on advice of counsel, I respectfully

decline to answer the questions on the basis of my 5th Amendment

rights under the United States Constitution, on the basis that any

testimony might be a witness against myself.

Mr. WALDEN. Mr. Holman, are you refusing to answer all these

questions on the right against self-incrimination afforded to you

under the 5th Amendment of the U.S. Constitution?

Mr. HOLMAN. Yes, Mr. Chairman.

57

Mr. WALDEN. And is it your intention to assert such right in response to all further questions from the subcommittee today?

Mr. HOLMAN. Yes, Mr. Chairman.

Mr. WALDEN. Given that, if there are no further questions from

the members, I will dismiss you at this time, subject to the right

of the subcommittee to recall you, if necessary. So at this time, you

are excused.

Mr. HOLMAN. Thank you, sir.

Mr. Marchelos, this morning we heard from the San Francisco

City Attorney’s office about an elaborate conspiracy between individuals at NEC BNS and VNCI, including Judy Green, yourself,

and others in which the co-conspirators eliminated competitive bidding and inflated prices on contracts related to the E-Rate program.

As you know, NEC BNS pleaded guilty to conspiracy to suppress

and eliminate competition for E-Rate program projects and to wire

fraud. As a former employee of VNCI who extensively assisted Mr.

Desmond McQuoid with San Francisco’s E-Rate program, were you

aware of the conspiracy by NEC BNS, VNCI, Judy Green and others to defraud the E-Rate program by rigging bids, inflating contract prices, forging the signatures of school district officials, and

lying to USAC during its review process?

Mr. MARCHELOS. Mr. Chairman, because of the ongoing criminal

and civil investigations, I must invoke my 5th Amendment rights.

Mr. WALDEN. Mr. Marchelos, are you refusing to answer all of

these questions on the right against self-incrimination afforded to

you under the 5th Amendment of the United States Constitution?

Mr. MARCHELOS. Yes, sir.

Mr. WALDEN. And is it your intention to assert such right in response to all further questions from the subcommittee today?

Mr. MARCHELOS. Yes, sir.

Mr. WALDEN. Given that, if there are no further questions from

the subcommittee members, I will dismiss you at this time, subject

to the right of the subcommittee to recall you, if necessary. So at

this time, you are excused.

Mr. MARCHELOS. Thank you, sir.

Mr. WALDEN. At this time, the Chair calls forward our next witness, Mr. Tim Donovan, former General Counsel for NEC-USA. We

appreciate your being at the table.

As you know, in conducting an investigative hearing, the subcommittee has the practice of taking testimony under oath. We

have already sworn you in under oath. So we appreciate your being

here today, and I just remind you, you are under oath, and we

would welcome an opening statement, if you have one, sir.

TESTIMONY OF TIMOTHY M. DONOVAN

Mr. DONOVAN. Thank you, Mr. Chairman. Good afternoon to Mr.

Chairman and the distinguished members of the subcommittee. My

name is Timothy Donovan, and during the time period relevant to

the matters before you today, I was acting as Senior Vice President, General Counsel and Corporate Secretary of NEC-USA, and

I was also Corporate Secretary for NEC Business Network Solutions.

58

Although I left that position at the end of March 2004 after 20

years within the NEC organization, I remain an officer today, Corporate Secretary, of one of the other affiliates, and I am happy to

be able to testify here today.

For some time now, my colleagues and I have been asking ourselves what I am sure members of this distinguished committee are

asking themselves as well: How did a good company with thousands of dedicated and hard working employees and a program

with admirable goals get to the point we are today?

I will do what I can to answer that question, but I think the

more important question for NEC, since we have already admitted

our wrongdoing, and for everyone involved in E-Rate is: How can

we ensure this never, never happens again?

During the time in question, BNS had more than 1,000 employees spread across 36 offices around the United States. This company provided systems and installation maintenance not only to

educational institutions, both under the E-Rate program and many

other programs, but to the financial, health care and many other

industries.

During the time that BNS was actively involved in E-Rate, the

program revenues were only about 3 to 5 percent of BNS total revenues. The company did not have more than five employees out of

the 1,000-plus employees that worked for BNS dedicated to sales

on E-Rate, and BNS’ primary business focus was on the private

sector. It is not typically a government contractor.

BNS’ first serious involvement in the E-Rate program began in

late 1999. As the subcommittee may be aware, it is not unusual for

a company like BNS to team with a consultant that is a specialist

in a particular area, and VNCI held itself out as an E-Rate expert.

In 1999, BNS entered into a teaming arrangement with VNCI,

the consultant in the telecommunications field and the vendor of

certain types of telecommunications products that were going to be

offered. This initial effort involving NEC and VNCI was the project

for San Francisco Unified School District, an opportunity that was

identified for BNS by VNCI.

From the moment NEC learned that DoJ was investigating San

Francisco schools in 2001—and this was before NEC knew that it

was the target of the investigation—and after we learned later that

the company was itself a target in the inquiry, NEC has fully cooperated with the government.

In October 2002 we made a commitment to the Justice Department to accept full and complete responsibility for the conduct of

these employees, and sought to resolve all issues. I believe the committee has received a letter—the staff has received a letter from

the Department of Justice which applauds NEC for its full and continuing cooperation in this investigation. This was not a cover-up

situation.

As part of that resolution announced this past May, BNS has

taken steps to ensure that this conduct is not repeated and that all

of its employees will act responsibly and properly.

Some of these steps include empowering a compliance officer

with broad powers to oversee compliance in government contracting

and elsewhere. It is my understanding that a person with substantial government contracts and internal audit experience has acceptVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00066 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
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ed that position and will shortly start employment with the company Commencing the training of all employees in established ethics and compliance policies and procedures; implementing expanded

services for its anonymous hotline, so that employees can report

suspected wrongdoing or unethical conduct; scheduling regular audits of all government contracts; and BNS is also agreed to provide

periodic reports and permit the FCC to conduct annual audits of

all of its activities in this area.

Our company has learned an expensive lesson, an embarrassing

lesson, but certainly a valuable lesson. The E-Rate program with

effective oversight and management can assist needy schools.

At the same time, please do not lose sight of the fact that there

were many diligent, hard working field engineers and other employees within BNS who were implementing Internet solutions

within schools unaware of the wrongdoing by a few. They believed

they were making a meaningful effort to enhance the success of

students in those schools. Mistakes that were made by a few BNS

employees tarnished this effort and all of our beliefs.

Thank you for allowing me to appear before you today, and I

hope I can answer your questions.

[The prepared testimony of Timothy M. Donovan follows:]

PREPARED STATEMENT OF TIMOTHY DONOVAN FORMER SENIOR VICE-PRESIDENT,

GENERAL COUNSEL AND CORPORATE SECRETARY, NEC USA, INC.

Good morning, Chairman Greenwood, distinguished members of the Subcommittee. My name is Timothy Donovan. During the time period relevant to the

matters before you today, I was acting as Senior Vice-President, General Counsel

and Corporate Secretary of NEC USA, Inc. and Corporate Secretary of NEC Business Network Solutions, Inc. (BNS). Although I left my position at the end of March

2004, having completed almost 20 years within the NEC organization, I remain an

officer today of one of the affiliated companies.

I appreciate the opportunity to appear before the Committee today and address

matters relating to the E-Rate Program, created by the FCC under the Telecommunications Act of 1996. As Secretary of BNS, I had no role in its day-to-day

activities. Other corporate executives of BNS might have more direct knowledge of

the events that are the subject of your questions today, but as you are no doubt

aware, the Department of Justice is conducting an ongoing criminal investigation.

It is expected that this investigation may be concluded in a matter of a month or

so. I am advised that, due to the pendency of that investigation, legal counsel to

other executives you invited to testify advised them that it would be inappropriate

for them to testify today. I understand that counsel for these individuals have asked

that these hearings be postponed until September or October, to give the Justice Department time to complete their ongoing investigation, so that management of BNS

would be able to participate and give substantive testimony after the conclusion of

that process. Since the Committee’s schedule would not allow a postponement, and

consistent with BNS’ commitment to provide full and complete cooperation with all

relevant inquiries into this matter, BNS asked, and I agreed to appear and give testimony for the Committee today. With your understanding of these circumstances,

I will do my best to assist the Committee in its inquiry at this time.

I. BACKGROUND OF BNS INVOLVEMENT IN THE E-RATE PROGRAM IN SAN FRANCISCO AND

ELSEWHERE

BNS was founded in 1989 as a multi-systems integrator and a direct sales and

service organization for NEC America, the NEC America subsidiary that markets

and sells telecommunications equipment and systems in the U.S. BNS designs, sells,

installs and services a broad range of voice, data, and video communication systems

and networks. BNS has in excess of 1000 employees spread across 36 regional sales

and operations offices. A very small proportion of these employees ever had any involvement in the E-Rate Program.

BNS’ first serious involvement in the E-Rate Program began in late 1999. Although BNS was aware of the program, prior to 1999 it had no significant involveVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00067 Fmt 6633 Sfmt 6621 95461.TXT HCOM1 PsN: HCOM1
60

ment in the E-Rate Program, or government contracting in this sector, for all intents and purposes. In 1999, however, BNS entered into a teaming arrangement

with VNCI, a consultant in the telecommunications field and vendor of certain telecommunications (video related) products. The main contact with BNS at VNCI during the early stages of the relationship was Ms. Judy Green. VNCI assisted BNS

in identifying potential school districts and opportunities. Ms. Green and VNCI assisted the schools in their consideration of E-Rate funding. BNS participated in the

E-Rate Program by selling and installing data equipment and telecommunications

equipment to school districts that qualified for funding under the E-Rate Program.

BNS provided systems and installation and maintenance not only to educational

institutions, but to the financial sector, healthcare sector, and many other industries

and customers. During the time that BNS was actively involved in the E-Rate Program the E-Rate Program revenues constituted a little over 3% of the gross revenues of BNS. At the start of its venture into the E-Rate business, BNS had three

sales and marketing employees who were involved full or part time in this sector.

At the conclusion of BNS’ participation, there were about 5. The activities were conducted for the most part in one of the company’s regional offices in the San Francisco Bay Area. These individuals did not have extensive prior experience in government contracting or, for that matter, the E-Rate Program prior to the Year 3 bids

that BNS submitted.

The initial effort involving NEC and VNCI included the project for San Francisco

Unified School District (the ‘‘SFUSD’’), an opportunity identified by Ms. Green and

VNCI. This was a bid effort for what is generally referred to as Year 3 E-Rate Funding. In January 2000, a few weeks after establishing the teaming relationship with

VNCI and Ms. Green, BNS submitted a bid for E-Rate work to the SFUSD. By the

time BNS suspended all activity relating to E-Rate, it had already severed the consulting relationship with VNCI and Ms. Green.

II. THE JUSTICE DEPARTMENT INVESTIGATION, BNS COOPERATION AND THE RESULTING

BNS SETTLEMENT

In the Summer of 2001, BNS learned that there was an investigation into the

SFUSD; and BNS cooperated with the investigation, unaware at that time that the

investigation concerned BNS. By the end of October 2002, it had become apparent

to BNS that some of its employees’ activities were in fact involved in the investigation. At that time, BNS retained independent legal investigators to begin a full scale

internal investigation into BNS’ E-Rate operations. That process continued over

many months and included interviews of witnesses, review of documents, e-mail and

other records. As soon as BNS began to appreciate the nature of the activities by

this small group of individuals engaged in E-Rate Program marketing and sales,

BNS suspended all requests for payment with the Schools and Libraries Division

(′′SLD′′), pending a determination of the outcome of the investigation so as to ensure

that there would be no further injury to the Government or to any other affected

party as a result of continuing this business.

BNS also resolved at that point that it should cooperate fully and completely with

the federal investigators. BNS made a commitment to the Justice Department to accept full and complete responsibility for the conduct of the employees and sought

to resolve all issues. Well along in the inquiry and negotiations, we learned that

there was a civil qui tam complaint that the City and County of San Francisco had

commenced. BNS sought to resolve this matter as well, as part of its overall resolution and commitment to make restitution. In order to make good on its commitment

to resolve the criminal issues and the civil qui tam action, BNS agreed to pay, and

did pay, $15 million in cash fines and restitution, and further agreed to provide

equipment, continuing maintenance and services (valued at an additional $5.7 million) to school districts that are BNS customers under the E-Rate Program. We believe the Government has been made whole with this settlement. BNS sincerely regrets that the conduct by these several employees caused this kind of financial

harm. Some of these individuals are no longer employed by the company. Any further action with regard to the others will be suspended until the DOJ completes its

investigation as to individual culpability.

III. LEGISLATIVE SOLUTIONS TO THE PERCEIVED PROBLEMS IN THE E-RATE PROGRAM

We understand that this Committee is making inquiry into what can be done to

eliminate the factors that led to this disappointing state of events. BNS does not

pretend to have answers to this inquiry from the standpoint of operations of the

SLD and the E-Rate Program. However, from the vendor side, BNS has become

aware that in the E-Rate Program arena, a few employees, improperly supervised,

trained and overseen, can engage in conduct that, in short time, can cause a great

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deal of damage. In the BNS case, BNS is first and foremost a private sector vendor.

There was no substantial line of business and operations dedicated to the government sector for any significant time period. Further, the company did not have the

checks and balances in place to supervise the sales personnel who responded to this

business opportunity. Working with the Justice Department, BNS is taking key

steps to ensure that such conduct is not repeated and that all of its employees will

act responsibly and properly. BNS is taking the following first steps as part of a

long-term process to improve oversight and management:

• Empowering a Chief Compliance Officer with broad powers to oversee compliance

in governmental contracting and elsewhere.

• Commencing the training of all employees in established ethics and compliance

policies and procedures.

• Implementing expanded services for its anonymous hot-line for employees to report suspected wrongdoing or unethical conduct.

• Scheduling regular audits of all government contracts.

BNS has also agreed to permit the FCC Enforcement Bureau and the FCC-OIG,

at BNS’ expense, to conduct an annual audit of BNS’ compliance with applicable

laws and regulations relating to the E-Rate Program and other government sponsored or funded telecommunications programs. BNS will make annual reports to the

FCC Enforcement Bureau and the FCC-OIG concerning its compliance with the established compliance policy.

It would be impossible, from a legislative standpoint, to codify a code of conduct

that might directly address all anticipated problems on the vendor side. However,

from BNS’ experience, it has become clear that any vendor involved in the E-Rate

Program needs to have employees who are properly trained in the requirements of

government contracting and, in particular, the rules and regulations of the E-Rate

Program. To be sure, even in Year 3 of the E-Rate Program, there was still an absence of clear definition as to what products and services were to be funded and a

lack of clarity in other areas as well. Bright line rules are better than leaving matters to subjective judgment. This, however, does not excuse in any way BNS’ conduct, but the ambiguity fostered an environment for mistake, negligence and active

misconduct to occur.

We are also concerned that the present operational parameters under the E-Rate

Program leaves an informational void between the vendor of systems and services

and the school districts. School administrators, especially in the neediest districts,

have little or no expertise in the installation of sophisticated voice, video, and data

networks. The vendors do, but they are in the business of selling equipment and

services that are requested by customers. This information void can be exploited by

opportunistic or dishonest individuals in some cases. Although it would be laudable

if vendors would spend their time and efforts in scaling down a project to save unnecessary expense for the school districts and the E-Rate program, since this would

reduce their revenues, it is unrealistic to think this will often be the case, even in

a competitive response to an RFP. Many of the school districts need to have the assistance and advice of an informed and independent consultant. They should not be

left in a position of either asking the vendor to provide those consulting services or

providing a reference for those services.

The E-Rate Program, with effective oversight and management, can assist needy

schools in acquiring technology that may enhance the education of children in the

urban and rural schools. There were many diligent, hardworking field engineers and

other employees within BNS who were implementing Internet solutions within

schools unaware to the wrongdoing by a few. They believed they were making a

meaningful effort to enhance the success of students in those schools. Mistakes that

were made by a few BNS employees tarnished this effort and their beliefs.

Thank you for the opportunity to appear before the Committee today.

Mr. WALDEN. Mr. Donovan, thank you for appearing today. I noticed in your original draft statement submitted to the committee,

you indicated you thought the Justice Department investigation

would be over in a matter of a month or so. Is that a view you still

hold?

Mr. DONOVAN. That is a little speculative. Counsel for the company that has been cooperating with the Justice Department believes that the investigation, which is still continuing—there is a

Grand Jury proceeding—insofar as NEC employees may be comVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00069 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
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pleted to a point where some of the employees would be able to testify.

Mr. WALDEN. Okay, because I noticed in the press release that

was put out, you indicate—or your press people at least indicate

circumstances may change in the near future which may allow executives to participate subsequently before the subcommittee hearing. But that—the press release doesn’t make any reference to the

investigation being concluded within a month or so. I just wondered.

Your draft release indicates September or October, complete the

investigation. There seems to be a month or so or September or October—It’s kind of an interesting couple of days. something must

have changed.

Mr. DONOVAN. I don’t think so. I think, as you know, that schedule is not up to NEC or to the individuals who are under investigation. So it is a good faith guess.

Mr. WALDEN. Okay. Isn’t NEC’s position about the ratio of ERate revenues to total company revenues a red herring? We have

been told this was like a very small portion of NEC BNS’s revenues

or NEC’s revenues, the E-Rate program itself.

Mr. DONOVAN. Three to 5 percent as a of business, and I think

that is the way the E-Rate program was viewed. It was almost like

a new line of business with some different factors and circumstances that needed to be dealt with. Three to 5 percent would

not be a large business line.

Mr. WALDEN. But wouldn’t that business line have doubled, had

the 471 been approved by USAC for San Francisco? Wouldn’t it

have taken it to $100 million or something?

Mr. DONOVAN. I don’t know.

Mr. WALDEN. Well, I think we have those numbers, don’t we? I

think it would have nearly doubled.

Mr. DONOVAN. This is for the San Francisco school district?

Mr. WALDEN. Well, for your overall revenues, it would have nearly doubled them in this line, business line. I’m a small business

owner. If some chunk of my business that was 3 percent was suddenly going to double, I would probably sit up and take notice, and

I would think the managers down the line would want me to take

notice, if I were CEO, and say, look at what we are doing for you.

Did that happen in your company?

Mr. DONOVAN. Could you rephrase the question? I’m not sure

how to answer that.

Mr. WALDEN. Well, I want to know who knew and what they

knew, bottom line.

Mr. DONOVAN. Yes.

Mr. WALDEN. And I guess, maybe in a big company like NEC, 3

percent of revenue doesn’t matter, but if you are going to add 3

percent—If you are going to basically double this line of business

with this, looked to me like, one contract, I would think somebody

would be saying look at me, look at me, I’m over here in this division of the E-Rate, new line of business, and look at what we are

able to do here. Did that happen?

Mr. DONOVAN. That could be the case, but in my experience as

an attorney for the last 20 years-plus, people who were doing some

of the things that we are hearing about today and that I as a

63

former NEC employee am not proud of, by any means, do not flag

those situations.

So it would not be surprising to me that, if people were engaged,

and we believe they were, in the kinds of things that were happening, they would do everything they could to hide that.

Mr. WALDEN. Right, but somebody is above them. Right?

Mr. DONOVAN. Yes.

Mr. WALDEN. And I assume, aren’t there like monthly revenue

forecasts in your company?

Mr. DONOVAN. There are periodic revenue forecasts.

Mr. WALDEN. Okay, periodic. Is there a look at new contracts

coming in?

Mr. DONOVAN. I’m not sure. There are thousands of contracts

that come in. This one would have been a larger contract, but not

the largest. That is not my belief. But there are many, many——

Mr. WALDEN. There could be a larger contract?

Mr. DONOVAN. I would think so, yes.

Mr. WALDEN. Okay. So you got a couple of folks down here doing

nefarious acts. Somebody above them, though—Who did they report

to?

Mr. DONOVAN. They being who, Congressman?

Mr. WALDEN. The people who have been identified as engaging

and working with your company. I mean, there were people in your

company, obviously, who knew something was wrong. Right?

Mr. DONOVAN. At some point, yes.

Mr. WALDEN. I mean, you have admitted to that in your settlement, haven’t you?

Mr. DONOVAN. Today, yes, we wish we could have done a lot of

things differently, Congressman. The question is this was not a single isolated case. It involved the San Francisco School District.

There were acts which took place over a period of time, and the

question as to when different people realized what was going on is

a difficult question to answer.

Mr. WALDEN. Let’s go to Tab 27, sir, if you would. This is an email from—and I apologize up front—Zahid Masoud to a Mr. Tom

Burger and to you—well, no, to Mr. Holman.

Mr. DONOVAN. Scared me for a moment.

Mr. WALDEN. No, I am sorry. To Glen Means. So Mr. Holman,

Mr. Means, Mr. Burger, and cc’ed to Mr. Rathinson and to Bob

Bliss. It calls VNCI pricing, and it says importance is high. ‘‘Gentlemen, below you will find the pricing summary of the E-Rate

projects as we bid to the individual school districts. I have also included attachments detailing pricing for each of these projects.

Glen, you can find in-kind NABSE bonuses in the value added section. I will be on hand for the 9 a.m. meeting to discuss further.

Zahid.’’

Now who is Mr. Burger? Wasn’t he the gentleman who was just

here?

Mr. DONOVAN. Yes.

Mr. WALDEN. And what would this summary sheet on submitted

bids for the E-Rate projects be?

Mr. DONOVAN. I don’t know. Sorry.

Mr. WALDEN. Well, it is titled ‘‘Summary sheet on submitted bids

for the E-Rate projects.’’

64

Mr. DONOVAN. Yes.

Mr. WALDEN. And what role is Mr. Burger in on February 18,

2000, in the company?

Mr. DONOVAN. He was the Chief Executive Officer of the company.

Mr. WALDEN. All right. So the bids for these E-Rate projects that

amount to 3 percent of your business were being provided to the

CEO of the company. Correct?

Mr. DONOVAN. It looks that way. Yes. Can you point me to——

Mr. WALDEN. I’m sorry, did you not get the tab?

Mr. DONOVAN. I have it, yes. What I would like to know is I am

not sure where the wrongdoing is in this. I am looking at this for

the first time.

Mr. WALDEN. Well, I didn’t say there was wrongdoing in this, but

if you think there is, we can explore that. But my point was who

knew in the company. What I thought I have heard you say is that

this was such a small part of the business, you didn’t know where

it went up in the chain, because I was asking about reporting. You

know, wouldn’t revenue—a new line of business, who knew in the

company?

This e-mail would indicate the CEO at least knew of these ERate projects and the bids that were submitted. If this is that small

a piece of business, does every project where there is a bid go to

the CEO?

Mr. DONOVAN. I don’t know the answer to that.

Mr. WALDEN. This is a $131,249,100 total project bids and accepted for 471.

Chairman. BARTON. Would the chairman yield on that point?

Mr. WALDEN. I certainly would, Mr. Chairman.

Chairman. BARTON. You, Mr. Donovan, at this time were General

Counsel for BNS. Isn’t that right?

Mr. DONOVAN. I was General Counsel for the holding company,

NEC USA, but my staff also provided legal services to this company. That is correct.

Chairman. BARTON. In this year, calendar year 2000, do you

recollect what the total revenues of the company were in the

United States?

Mr. DONOVAN. I don’t know offhand, but I know it was probably

several hundred million dollars.

Chairman. BARTON. Several hundred?

Mr. DONOVAN. Million.

Chairman. BARTON. Million. So $131 million would be a significant portion, if your total revenue were several hundred million.

Mr. DONOVAN. I don’t know if this was a single period. Sometimes when bids are submitted, there is a long period of time between the date that the bid is submitted and a contract is begun,

but I am not sure——

Chairman. BARTON. But, I mean, you would admit that, if you

were CEO of a company and a revenue projection was presented

to you that, let’s say, is 25 to 50 percent of your total revenue, you

would look at it.

Mr. DONOVAN. If I were CEO?

Chairman. BARTON. Yes, sir.

Mr. DONOVAN. Yes, I would look at that.

65

Chairman. BARTON. Okay.

Mr. DONOVAN. I am not sure what detail I would look at it, but

certainly I would be very interested in that.

Chairman. BARTON. Well, I would certainly look at it in great detail. I yield back.

Mr. WALDEN. Well, Mr. Chairman, I would also like to know

from the company who was on hand at the 9 a.m. meeting to discuss this further, since this was sent to Mr. Burger, Mr. Means,

Mr. Holman and cc’ed, obviously, Mr. Bliss and Mr. Rathinson.

Mr. DONOVAN. Rafinson.

Mr. WALDEN. Thank you. And it would imply that perhaps all

these people were going to be at whatever this meeting was at 9

a.m. Do you know if there are minutes of that meeting available?

Mr. DONOVAN. I don’t.

Mr. WALDEN. Do you know who attended that meeting?

Mr. DONOVAN. No, I don’t know. I’m sorry.

Mr. WALDEN. Do you know if at the bottom of this—At the bottom of this same memo, it is marked Confidential. It says, ‘‘The

above districts include 45 NEC PBX systems, almost all of them

NEACs 2000.’’ Then it appears there are Excel spreadsheets for

each district included.

I wonder, are those spreadsheets available in the form that either—the form that they are referenced here?

Mr. DONOVAN. May I speak with counsel?

Mr. WALDEN. Sure. Certainly, sir.

Mr. DONOVAN. Yes, they are.

Mr. WALDEN. And have those been supplied to the committee

yet?

Mr. DONOVAN. Not yet.

Mr. WALDEN. When would it be possible to produce those spreadsheets, gentlemen?

Mr. DONOVAN. As soon as possible, tomorrow or Monday. Yes.

Mr. WALDEN. All right. Thank you. That would be helpful to

know.

My time has expired. I will turn to the gentle woman from Colorado.

Ms. DEGETTE. Thank you, Mr. Chairman. Now, Mr. Donovan, I

guess I have been trying to figure out what you are doing here

today. So I just want to ask you a little bit of question—other than

the fact you are the lawyer. But now Mr. Burger and Mr. Holman

were both employed by the company during this timeframe. Correct?

Mr. DONOVAN. Correct.

Ms. DEGETTE. And they took the 5th today because of the ongoing criminal investigation. Correct?

Mr. DONOVAN. Correct.

Ms. DEGETTE. So you have been sent over to testify, and so I

want to ask you some questions.

Now during this time period, you were the Senior Vice President,

General Counsel, and Corporate Secretary of NEC. Correct?

Mr. DONOVAN. NEC USA. Correct.

Ms. DEGETTE. And you were also the Corporate Secretary of

BNS. Correct?

Mr. DONOVAN. Correct.

66

Ms. DEGETTE. Now as you yourself said in your written testimony, you did not have any role in BNS’s day to day activities.

Correct?

Mr. DONOVAN. Not directly, no.

Ms. DEGETTE. Now you were the legal counsel for—Were you the

legal counsel for BNS and also for NEC USA?

Mr. DONOVAN. The NEC USA Legal Department, which has

about six attorneys, is legal counsel for most of the NEC companies

in the United States.

Ms. DEGETTE. And that would include BNS?

Mr. DONOVAN. Yes, it would.

Ms. DEGETTE. And were you the supervisor of the lawyers in the

legal counsel’s office?

Mr. DONOVAN. Correct.

Ms. DEGETTE. So, basically, they were the ones reviewing contracts and negotiations, and then you were supervising that. Would

that be a fair characterization?

Mr. DONOVAN. Yes, it would.

Ms. DEGETTE. Now in your written testimony and, I think, also

orally, you said in 1999 BNS entered into a teaming arrangement

with VNCI. Correct?

Mr. DONOVAN. That is my understanding.

Ms. DEGETTE. Were you involved in the negotiation of that

teaming arrangement?

Mr. DONOVAN. No, I was not.

Ms. DEGETTE. Were you aware of the arrangement at all?

Mr. DONOVAN. Not at that time, no.

Ms. DEGETTE. Did you review any kind of a contract with VNCI?

Mr. DONOVAN. No, I did not.

Ms. DEGETTE. Did anybody in your office review that agreement?

Mr. DONOVAN. I don’t know if anyone reviewed that agreement,

but to answer your question, typically teaming agreements, which

are very, very common when you are dealing with large systems

with different types of products—they are very common. Assuming

that they are used correctly, they are not illegal.

Ms. DEGETTE. Well, absolutely. I know that. But what you are

saying is maybe a teaming—If it is a routine teaming agreement

done in the course of business, that would not necessarily be reviewed by one of the attorneys. Is that what you are saying?

Mr. DONOVAN. Not by an attorney.

Ms. DEGETTE. Okay. So you don’t know whether this was or

wasn’t, but it wasn’t reviewed by you?

Mr. DONOVAN. Correct.

Ms. DEGETTE. Now do you know how VNCI came to enter into

an agreement with BNS?

Mr. DONOVAN. No, I am sorry. I don’t.

Ms. DEGETTE. Do you know who would know?

Mr. DONOVAN. No, I don’t.

Ms. DEGETTE. So you don’t know what the relationship of the

parties was, whoever was representing BNS and whoever was—

Well, I guess it was probably Judy Green. Right?

Mr. DONOVAN. Of VNCI?

Ms. DEGETTE. Yes.

Mr. DONOVAN. It appears that way.

67

Ms. DEGETTE. Now you say it appears that way. Is that because

of information you have subsequently received?

Mr. DONOVAN. Yes.

Ms. DEGETTE. At the time this transaction was entered into, did

you know Judy Green?

Mr. DONOVAN. No.

Ms. DEGETTE. Okay. Have you ever met Judy Green to this day?

Mr. DONOVAN. No, I have not.

Ms. DEGETTE. And I assume you don’t know where she is, because we are looking for her.

Mr. DONOVAN. I’d rather not have anything to do with Judy

Green.

Ms. DEGETTE. I would believe that.

Mr. DONOVAN. But I wish you much success in finding her.

Ms. DEGETTE. Thank you. Okay. So you basically can’t tell us

about how BNS came to enter into this arrangement.

Mr. DONOVAN. Not this arrangement. Correct.

Ms. DEGETTE. Okay. Well, looking at Tab 27 which is this e-mail

about all the other E-Rate projects, do you know how any of those

arrangements came to be entered into?

Mr. DONOVAN. No.

Ms. DEGETTE. No, because you didn’t have day to day involvement in this?

Mr. DONOVAN. That’s correct.

Ms. DEGETTE. Okay. Now I just ask you again. Have you subsequently learned who at BNS entered into this teaming arrangement? Who was the individual who did it?

Mr. DONOVAN. There should be a signature on the written agreement.

Ms. DEGETTE. Yes, it was Mr. Holman. Have you reviewed any

of that?

Mr. DONOVAN. I probably have seen that during the course of the

investigation.

Ms. DEGETTE. All right. But you didn’t see it sooner?

Mr. DONOVAN. No.

Ms. DEGETTE. Okay. Now you testified about a small group of individuals at NEC BNS who were engaged in E-Rate program deceptions. What are the names of the small group of individuals?

Mr. DONOVAN. I think the names are in the records that have

been provided, but I would like to speak with counsel.

Ms. DEGETTE. Be my guest.

Mr. DONOVAN. The names that I have seen on the correspondence include Mr. McNulty, Mr. Collen, Mr. Holman, Sohail—sorry,

I can’t pronounce his name either. He is in the record before you,

I think, from a previous question. Those are some of the individuals who are involved.

Ms. DEGETTE. All right. And has the company conducted an internal investigation to see whether the individuals involved in deceptions—whether the group is broader than that?

Mr. DONOVAN. The company responded, yes, with an internal investigation before we realized the scope of what was going on,

when we first realized something is wrong. That internal investigation led to the retention of outside legal counsel who were more exVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00075 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
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perienced with this type of investigation, and when they advised us

of what was involved, we worked with the Justice Department.

Ms. DEGETTE. Now Mr. Burger is still the CEO of the company?

Mr. DONOVAN. Yes, he is.

Ms. DEGETTE. Is Mr. Holman still employed with the company?

Mr. DONOVAN. No, he is not.

Ms. DEGETTE. And do you have any evidence that Mr. Burger

was involved with these transactions?

Mr. DONOVAN. Again, I would like to speak to counsel.

I am not aware of any.

Ms. DEGETTE. Has your company instituted any new procedures

designed for this type of activity in the future?

Mr. DONOVAN. Yes.

Ms. DEGETTE. Could you please describe those procedures for us?

Mr. DONOVAN. Yes, I can. Probably the most important is the

hiring of a person who has quite a bit of knowledge about government contracts and, at the same time, internal audit procedures.

One of the reasons this may have occurred is because there were

insufficient checks and balances, not so unlike the school district

that testified earlier today.

The internal audit department has been expanded, and this person will take a very leading role in any type of activity like this

in the future.

We have also started training programs for employees about this

particular type of problem, and we have also instituted an 800

number and provided training and quite a bit of marketing information about that number to encourage employees to use it.

Ms. DEGETTE. Do those audit procedures and also the anti-fraud

procedures you have put in place include having these contracts reviewed by legal counsel?

Mr. DONOVAN. Any government contract will be passed first to

the person with the expertise in that area, and then will involve

Legal. It is my understanding, although I am not directly involved

with the company since April 1, that the General Counsel, who I

know very well, and this new person will work hand in glove to

make sure this does not happen again.

Ms. DEGETTE. When were the procedures instituted?

Mr. DONOVAN. Some of the procedures—it has been ongoing during this process. The anonymous hotline was instituted earlier this

year before I left the company. That would be probably January or

February of this year.

The compliance officer—I am not sure how long a search that

was, but the compliance officer accepted an offer and will start—

this is a person outside the company with substantial experience.

They will be starting soon.

Under the continuing work with the Justice Department, NEC is

going to be filing expanded policies, and some of the training has

already commenced.

Ms. DEGETTE. All right. Let me just say, because everyone else

left, I will communicate to you how seriously this committee obviously takes this investigation, and I appreciate you being willing

to come and testify. Unfortunately, of course, the events we need

to know about are not within your knowledge.

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So, Mr. Chairman, if I may, I think it is going to be critical for

us to try to have the rest of these employees come back, Mr. Burger, Mr. Holman, when we find Judy Green; because Mr. Donovan

doesn’t know a doggone thing about the transactions here. I do appreciate him coming and talking about the company’s investigations and corporate practices, but it doesn’t get to the meat of the

issue. I yield back. Thank you.

Mr. DONOVAN. I’m sorry.

Mr. WALDEN. Thank you for your questions and your comments,

Ms. DeGette. I couldn’t agree more.

The Chair now recognizes the chairman of the full committee,

Mr. Barton.

Chairman. BARTON. Thank you. I have to ask a few just kind of

simplistic questions to make sure I understand the current framework.

Mr. Burger, who is listed as President and CEO of NEC, took the

5th Amendment. He is still the current President. Is that correct?

Mr. DONOVAN. That is correct.

Chairman. BARTON. Mr. Holman is a former Vice President of

NEC. He also took the 5th Amendment. What is his relationship,

if any, with NEC today?

Mr. DONOVAN. He is no longer employed by NEC. His employment was terminated at some point in the past.

Chairman. BARTON. But he is not a current—He has no affiliation?

Mr. DONOVAN. None.

Chairman. BARTON. And his separation from NEC was voluntary

or involuntary?

Mr. DONOVAN. His separation was involuntary.

Chairman. BARTON. And Mr. Marchelos is listed as a former ERate consultant with VNCI, which is not affiliated other than

through a contractual affiliation with NEC.

Mr. DONOVAN. That is correct.

Chairman. BARTON. And, of course, Ms. Green who did not appear is of the same affiliation as Mr. Marchelos. You were listed

as a former Senior Vice President and General Counsel for NEC.

What, if any, is your affiliation with NEC today?

Mr. DONOVAN. I continue to have a consulting agreement with

NEC, but I am not a full time employee.

Chairman. BARTON. You are a consulting?

Mr. DONOVAN. And I am Corporate Secretary for NEC Laboratories America, which is a research institution in Princeton, New

Jersey.

Chairman. BARTON. And what affiliation do they have with

NEC?

Mr. DONOVAN. NEC Laboratories America is a wholly owned subsidiary of the holding company for whom I was employed until recently.

Chairman. BARTON. Now at the time in question in 1999 and

2000, you were General Counsel for NEC USA?

Mr. DONOVAN. Correct.

Chairman. BARTON. And in that capacity, what level of contracts

would you normally personally be appraised of?

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Mr. DONOVAN. The attorneys would be involved with unusual

contracts, and this may be confusing. I hope you will allow me to

explain.

We sometimes have contracts which involve many, many dollars,

but the product itself is very simple. An example would be

cellphones. Those might be sold on the basis of a purchase order.

So even though this might be a $25 million order for cellphones,

the attorney would not need to look at the contract. It is a purchase order basis.

A contract, for example, like a software development contract for

a new product, that is the type of contract that very often might

involve the attorney input, because it is a new contract.

Chairman. BARTON. Okay. Now you are here today as a consultant to NEC, and you are not taking the 5th Amendment, and I

don’t want to lead you. But apparently, your role, your former role

as General Counsel, and your current role as a consultant apparently is not part of the ongoing investigation. Is that correct?

Mr. DONOVAN. That is a broad question.

Chairman. BARTON. It is.

Mr. DONOVAN. I did not take an active role in the investigation

but, certainly, when the company realized that wrongdoing had

taken place, I was advised by the attorney who worked on the investigation of the matters and the seriousness of those matters.

Chairman. BARTON. Well, I am puzzled, because the company

that you were the General Counsel of has entered into a plea bargain, and we’ve got a copy of it, in which you have paid a fine and

given in-kind services, equipment, that is over $20 million.

In that plea bargain, the essence of it is that a few employees

lower in the food chain did something wrong, and as soon as senior

management found out about it, put a stop to it, and you are moving on down the road.

Now if that is the case, there is no reason to take the 5th

Amendment. Now the company has entered into a plea bargain,

and you know, we’ve got it, and you all have good guys or your

former company is doing the right thing. So I don’t understand why

we have to go through the spectacle that we just went through of

standing up and taking the 5th Amendment while sending out

press releases that you are doing everything you can to cooperate.

If you’ve got nothing to hide, there is no reason to take the 5th

Amendment. You are an attorney. You are General Counsel. I

mean you are here.

Mr. DONOVAN. Yes.

Chairman. BARTON. So apparently you believe you have nothing

to hide, and your counsel believes you have nothing to hide. I just

don’t understand that.

Mr. DONOVAN. This is not a simple situation, as you are very

much aware, and in trying to see how I could explain the fact that

some of the people are still employed with NEC, I tried to think

of some way to come up with analogy, and the analogy would be

this.

We all watch television, and some of you may be former prosecutors or law enforcement. The first thing you do at a crime scene,

you touch nothing. The first thing that we did when we spoke with

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the Justice Department was turn over all the evidence we had from

the internal investigation.

We cooperated with them in providing that information, and we

have also, it is my understanding, had discussions with them about

where they are in terms of the individual culpability of the employees.

It is also my understanding that until some of the Grand Jury

investigations which are pending are completed, NEC is not going

to take any further involvement. Specifically, I was asked about

Mr. Burger. Although his name may appear on an e-mail or two,

it is my understanding that there is nothing which shows that he

was involved in these discussions about changing numbers, changing prices and so on.

Chairman. BARTON. And we are not alleging. This committee is

not alleging that he personally was involved. We are just puzzled

that he won’t testify if, as his press release says, he’s got nothing

to hide.

Now we do have documents that are in the record that show that

he is at least aware that VNCI submitted a bid for $37 million on

behalf of VNCI and his company, NEC; and it was rated a high priority that he take a look at it. So I mean, he was at least aware,

if he read the e-mail and attended the meeting, that quite a bit of

business with VNCI was being generated, and a big chunk of that

was coming through the San Francisco Unified School District.

So I think it would be fair for this committee, if he had agreed

to testify, to ask a few questions about what he knew about that.

But the company has admitted in a plea bargain arrangement $20

million worth of compliance or retribution or whatever you want to

call it.

I want to ask some questions about VNCI. What do you know

about VNCI? Do you know anything about their business model?

Mr. DONOVAN. No.

Chairman. BARTON. Do you know what their general revenues

are?

Mr. DONOVAN. No, I don’t.

Chairman. BARTON. Do you know if they are a target of this ongoing investigation by the Justice Department?

Mr. DONOVAN. I think that they are. I know VNCI was a consultant. I know that NEC didn’t know much about E-Rate, and that

was a mistake. I am not trying to justify that.

Chairman. BARTON. Did you, when you were General Counsel,

review the general contract that was signed with VNCI?

Mr. DONOVAN. No, I did to.

Chairman. BARTON. Okay. At what level of the Counsel’s office

would that contract be reviewed?

Mr. DONOVAN. A teaming agreement would probably not be reviewed at all unless——

Chairman. BARTON. Regardless of the amount of dollars involved?

Mr. DONOVAN. As I had mentioned, the amount of dollars is not

always——

Chairman. BARTON. You said it was a special—Here is a company that you all had never done business with in an area you

claim not to have ever attempted to do business in, and this comVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00079 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
72

pany comes in, in the e-mail offering $131 million worth of business. It is a new company. It is a new area, and yet nobody in the

General Counsel’s office would review that contract? I find that

hard to believe.

I am not saying you would review it, but somebody in the General Counsel’s office, I would think, would review that.

Mr. DONOVAN. I wish that someone in the General Counsel’s office had reviewed that, Congressman. The reality is there are six

attorneys, thousands of contracts, and somehow what you have to

do is figure out where you can make the most impact.

I think that part of the mistake that NEC made was exactly

what you are describing, that when this came in, it should have

been flagged as an area of business that this particular business

group was not involved in and, if it really involved $130 million of

business, we should have put people with government contract experience on. If we didn’t have them in the General Counsel’s office

or in the contract administration group, then we should have

brought them in from the outside. We didn’t do that.

Mr. WALDEN. Would the gentleman yield for a moment on this

point?

Chairman. BARTON. Sure, since my time just expired.

Mr. WALDEN. I’ll try and figure out which tab this is, but we do

have an e-mail relative to this that was sent to Mr. John Holman,

a draft of which, I believe—Well, I don’t know who else it went to.

Maybe it did go to—I thought it went to Mr. Burger. One form of

it went to Mr. Burger.

In it, there is a whole paragraph here that talks about risks with

partnering with VNCI where NEC is the prime contractor. I believe

that was one of the questions you were trying to get to the heart

of. I believe it is Tab—Is it 22? Is that right?

It says, ‘‘VNCI is a small company traded publicly at the

NASDAQ. They are not financially sound, but see this opportunity

which can contribute 35 to 40 percent to their this year’s sales

numbers. They expect to do about $17 million this year. I have

checked with the sales engineers, and we can substitute other products to fulfill BNS obligations as a prime in the event VNCI becomes insolvent.’’

So it is the third page of Tab 21. I’m sorry.

Chairman. BARTON. Well, while he is reviewing that document,

my main point is here is a business relationship that has developed

out of whole cloth, and a fair amount of revenue is generated right

off the bat, and nobody at NEC apparently took the time to determine the genesis of where that revenue was coming from. It’s just

manna from heaven. It is just appearing on the balance sheet, and

everybody thinks it is just—Is it, you know, don’t ask, don’t tell,

because you don’t want to know the answer?

I mean, you were general counsel. Surely, there were meetings

in which revenue projections and estimations according to sales

projects from prior years were discussed, and here is this revenue

stream coming up, and to your knowledge, none of the senior management expressed any wonderment about this at all? That just

begs credulity, that there wouldn’t be somebody that said, well,

where is that coming from? How are we getting it? What are the

73

underlying—What is the real product and the real genesis of the

revenue stream?

Apparently, until the San Francisco School District and the city

of San Francisco started asking questions, nobody in the company,

either company, did anything but make sure the checks that might

come in were cashable. Do you have a comment on that?

Mr. DONOVAN. That is a long question, Congressman. Yes, I do

have a comment on it, because this has been an embarrassing

chapter for NEC, and I think that all NEC employees, not just

those people who were involved in the wrongdoing, share some of

the taint from that.

This did not come in as a situation where someone said, listen,

we want to defraud the city of San Francisco out of a whole bunch

of money. It is very typical to have consultants involved in these

kinds of projects.

Very often the school districts hire the consultants. I think, as

one of the people from San Francisco said, when those consultants

are truly independent and doing their job, that is a great check and

balance on the situation.

In this particular case, I am not sure, and I have not seen anything which would have let someone know early on at the high

level in NEC—we are talking about the CEO and the General

Counsel for that company—that there was something amiss. Certainly, people who attended some of the sessions where numbers

were marked should have known something was wrong. They

weren’t telling the General Counsel and the CEO that they were

doing that. That is what I have seen from the record.

Chairman. BARTON. Well, my time has expired. I am going to

read into the record Tab 18 of our binder. It is an e-mail dated January 13, 2000. It is from Bill Holman, who at that time was Vice

President of Sales. He has since been involuntarily separated from

the company, according to your sworn testimony. It was sent to

him from a Mr. Glen Means. The subject is E-Rate/VNCI, and I

quote:

‘‘Bill. I was wondering what guidance you could give me as to

who is really running the show on these deals from a high level.

One of the things that came out as I got into conversations with

the Chief Financial Officer of VNCI is their financial condition,

which is tenuous at best.

‘‘They have a story as to how they are going to tack the company

onto a run, but they have huge cumulative losses and insufficient

sales, less than $10 million a year, to cover their overhead, which

is at least $8 million a year, and they have an accumulated deficit

of $50 million.’’ Then it’s got three exclamation marks. ‘‘Have we

done any background work on how we will deal with long term

warranty? Do we have a workout solution, i.e., product replacement, if they go bust? I am concerned that we are protected.’’

So somebody, this Mr. Glen Means, was asking these questions.

What was his hierarchical position in the company at that time, if

you know?

Mr. DONOVAN. Just to make sure I understand this e-mail, this

sounds like Mr. Means who was a financial person——

Chairman. BARTON. It is not my company. You tell me.

74

Mr. DONOVAN. I’m trying.—was looking at this in terms of what

happens if VNCI goes insolvent. At this particular point in time,

there are a lot of technology companies that were on pretty shaky

ground.

I am not sure how this is relevant to the wrongdoing that took

place, but it appears that Mr. Means, who is something equivalent

to the CFO for the company, was concerned about the financial

health of VNCI.

Chairman. BARTON. Well, here is how it is relevant. NEC, in my

opinion, is a reputable company. I have heard of NEC. I mean, you

have been around. It is not a fly by night dot.com, so to speak.

You enter into a relationship with a company that nobody has

heard of, and right off the bat huge revenues as a percent of your

total revenues are projected, and we have that memo that totals

$131 million.

Now I haven’t run multi-billion dollar companies or even hundred million dollar companies, but I have been a plant manager.

I have worked for corporations with profit and loss responsibility—

that I had profit and loss responsibility. When somebody walked in

the door and offered me a new revenue stream, before I took it at

face value, I investigated the person offering the deal.

You all apparently did nothing, or your former company did

nothing of that. Now you have pled guilty and have paid $20 million. This other company is apparently still under investigation,

and I say apparently because I don’t know that for a fact, and it

is the company that brought this revenue to your former company.

That is why it is relevant.

I have way over-exceeded my time. So I am going to yield back

to the chairman.

Mr. WALDEN. Thank you, Mr. Chairman. I just have one more

question for you, Mr. Donovan, and then I think we will try and

move on.

If you go to Tab 27 again, that is the reference. This is the email that went to, among other people, Mr. Burger. In it, it says,

‘‘Glen, you can find in-kind NABSE bonuses in the value added section.’’

Do you have any knowledge about those terms, in-kind, NABSE,

bonuses, and the value added section? Have you talked to anybody

in the company about what that means?

Mr. DONOVAN. I don’t have a clear understanding of that, no.

Mr. WALDEN. You have no understanding of what your company

was doing on bonuses, in-kind?

Mr. DONOVAN. I don’t have a clear understanding of it and, since

I am under oath, I would like to be accurate.

Mr. WALDEN. Do you have any understanding?

Mr. DONOVAN. No.

Mr. WALDEN. All right. Turn to Tab 82. It is obvious we are

going to have to have additional hearings when we can get somebody here who can answer some of these questions. Tab 82 shows

the NABSE bonus products and services package, and in the center—Section B, it says—it says, ‘‘As a result of agreements with

National Association of Black School Educators, NABSE, NEC and

its partners will be providing the district and its schools the folVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00082 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
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lowing ’in-kind’ bonus products and services, as depicted in the attached memo.’’ You don’t have this one under Tab 82?

Mr. DONOVAN. No, sir.

Mr. WALDEN. Okay, we will get that down to you. Sorry about

that. You do have it then?

Mr. NIESPOLO. It is the second page.

Mr. WALDEN. Yes, it is. I’m sorry. I should have told you that.

Okay. The first page is the Laura-Tom-Mac e-mail, it says.

In the center column there under in-kind bonus products, it lists

student stations complete with Microsoft Office 97, monitors, digital plan, tilt and zoom cameras, inkjet printers, Xerox color network copier or equivalent, higher education training for teachers

and staff, specialized end user technical training, etcetera, etcetera,

and then it talks about the services based on volume of purchase,

any changes in the total volume will result in adjusted bonus package.

Do you know if any of these items are allowable to be paid for

with E-Rate funds?

Mr. DONOVAN. No, I don’t.

Mr. WALDEN. Do any of your counsels know anything about the

E-Rate program and what is allowed and isn’t?

Mr. DONOVAN. I don’t think they are offering testimony today,

Mr. Chairman.

Mr. WALDEN. Thank you. I have no other questions. All right.

You are dismissed. Thank you, sir.

Mr. DONOVAN. Thank you.

Mr. WALDEN. Unless the chairman—did you have another question for Mr. Donovan?

Chairman. BARTON. I have just a few more. I am not going to

take another full 10 minutes.

Mr. WALDEN. All right. Go ahead.

Chairman. BARTON. You may have asked these, and I just didn’t

hear it, but I want to get them on the record.

Do you have any knowledge of how many people at NEC were

involved with this situation, what we are calling a conspiracy?

Your written testimony, I think, said 3 to 5 people.

Mr. DONOVAN. That is based on the records that I have seen

from e-mail. Yes.

Chairman. BARTON. Okay. Do you know how many, if any, of

those people are still employed by NEC?

Mr. DONOVAN. I think two, but I would like to check with counsel. The reason that I am having the discussion, again until the

Grand Jury proceedings are finalized, we are not sure who has

criminal liability. But at this moment it looks like one person may

be still——

Chairman. BARTON. But there are some people still employed

who might have criminal liability, although that is a very small

number?

Mr. DONOVAN. There are some people who are still under investigation.

Chairman. BARTON. Do you know when NEC decided to cooperate? Did they come forward voluntarily or were they caught with

their hand in the cookie jar and decided to cooperate after they

were caught?

76

Mr. DONOVAN. Voluntary.

Chairman. BARTON. If I call the San Francisco people back, they

would say that, too?

Mr. DONOVAN. If you call the law enforcement authorities who

are investigating it, I am sure they will say the same thing. Yes.

Mr. NIESPOLO. Mr. Chairman, may I say something, please?

Chairman. BARTON. As long as you——

Mr. WALDEN. I think we will have to swear him in.

Chairman. BARTON. If you are willing to be sworn in, you may.

Mr. NIESPOLO. I just want to speak with my client.

Chairman. BARTON. Well, you certainly have that right.

Mr. WALDEN. Yes.

Mr. NIESPOLO. Thank you so much.

Mr. DONOVAN. Long-winded lawyers. My apologies.

Chairman. BARTON. It’s all right.

Mr. DONOVAN. Could someone repeat the question for me?

Chairman. BARTON. My question was how many people still employed by NEC were a part of this program, and you said—I think

you said two, one of whom may be criminally liable.

Mr. DONOVAN. I said I think one, and that person is still under

investigation, as are some of the other employees whose names appear on these e-mail.

Chairman. BARTON. My last question—again, this may have been

asked: Under the current E-Rate rules, a company that has been

found either criminally or civilly liable is subject to being debarred

from the program for 3 years. Is NEC still involved in the E-Rate

program, to your knowledge?

Mr. DONOVAN. To my knowledge, all of that activity has been

suspended, and has been for sometime when we realized there was

a problem.

Chairman. BARTON. Okay. If you were working as an attorney at

the FCC and had to make a recommendation whether NEC should

be disbarred, what would that recommendation be, based on the

knowledge of the case as you know it today?

Mr. DONOVAN. I don’t know that I could make a decision without

hearing from all sides. I know that the FCC has posted a notice

and is receiving comments, and certainly, my opinion might be biased.

I think that the difference between some of the cases that we

read about in the news and the NEC situation is that NEC made

a mistake, but we didn’t try to cover it up. We have never lied to

prosecutors. We have never destroyed e-mails. We have made data

bases available, and that has been since the very first day of this

process.

I think, if you—there are provisions in the law which reward——

Chairman. BARTON. So we only disbar companies that destroy emails, lie to prosecutors, and don’t voluntarily cooperate? That is

your standard?

Mr. DONOVAN. That is not my answer, Congressman, no. I think

my answer was——

Chairman. BARTON. It sure sounded like your answer.

Mr. DONOVAN. I’m sorry. My answer was that I would need to

look at all the facts and circumstances. If I were making the decision, I don’t know that I would disbar NEC. NEC has done a lot

77

of good things and, yes, this kind of money—It’s a tremendous

amount of money, to me. It was a lot of money to this company,

but NEC has done some great things with automated fingerprint

identification systems. They are working with various law enforcement on very advanced technologies, some of the other NEC companies, such as face recognition for airport security, and NEC scientists discovered the carbon nanotube, and——

Chairman. BARTON. It is okay that in this case they defrauded

the taxpayers of tens of millions of dollars? All the other good

deeds that they did allow them to do some bad deeds here.

Mr. DONOVAN. No, I think justice can’t be blind, and I think

what justice does—and I think you could agree with this—is to balance the rights and the wrongs. If every time a company makes a

mistake, we destroy that company, I think many good companies

would——

Chairman. BARTON. I didn’t say we are trying to destroy the company. By your own testimony, this was a small percentage of their

total revenues. I just asked the question, if somebody—A company,

in this case NEC, that has already pleaded to wrongdoing, under

the current rules are supposed to be, or at least are allowed to be

disbarred, to send a signal to other companies, we shouldn’t consider disbarring this company.

I mean, I don’t know how many other companies have done what

NEC has done. We’ve got investigations on several other companies, but if we want to get the program right, at sometime you’ve

got to hold accountable the companies that have abused the program.

Mr. DONOVAN. To answer the question, I would look at all the

facts and circumstances that were involved, and I think I would

give quite a bit of credence to the opinion of some of the enforcement agencies, such as the Department of Justice whose letter in

support of NEC, I think, is part of the materials provided to the

committee.

Chairman. BARTON. I have read that. I am going to give you one

more chance. You told me in direct response that NEC voluntarily

came forward. Then you talked to your attorney, and you didn’t answer the question, because I asked, if I called the San Francisco

representatives back, if they would answer it the same way. So I

am going to give you one more chance.

Do you think NEC voluntarily came forward?

Mr. DONOVAN. I think, in my opinion, NEC voluntarily came forward. I can’t tell you what San Francisco would say, Congressman.

Chairman. BARTON. All right. I yield back.

Mr. WALDEN. Thank you, Mr. Chairman. Thank you, Mr. Donovan. You are excused now.

Mr. DONOVAN. Thank you.

Mr. WALDEN. Let’s see here. Now we would like to call up our

third and final panel: Mr. William Maher, Chief, Wireline Competition Bureau, Federal Communications Commission; and Mr.

George McDonald, Vice President, Schools and Libraries Division,

Universal Service Administrative Company, USAC.

Gentlemen, thank you for your patience today. I know it has

been a long one. As you are aware, the committee is holding an investigative hearing and, when doing so, has had the practice of takVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00085 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
78

ing testimony under oath. Do you have any objection to testifying

under oath?

The Chair then advises you that under the rules of the House

and the rules of the committee, you are entitled to be advised by

counsel. Do you desire to be advised by counsel during your testimony today? Both answered no.

In that case, if you could rise and raise your right hands, I will

swear you in.

[Witnesses sworn.]

Mr. WALDEN. Let the record show, they said ‘‘I do.’’ So you are

now under oath, and you may now make a 5-minute summary of

your written statement. We welcome you, and look forward to your

comments. Let’s start with Mr. Maher.

TESTIMONY OF WILLIAM F. MAHER, JR., CHIEF, WIRELINE

COMPETITION BUREAU, FEDERAL COMMUNICATIONS COMMISSION; AND GEORGE McDONALD, VICE PRESIDENT,

SCHOOLS AND LIBRARIES DIVISION, UNIVERSAL SERVICE

ADMINISTRATIVE COMPANY

Mr. MAHER. Thank you and good afternoon, Chairman Walden,

Representative DeGette, and Chairman Barton.

My name is William Maher. I am Chief of the FCC’s Wireline

Competition Bureau, and I have served in this post since August

2002.

I appreciate the opportunity to discuss the FCC’s continuing efforts to improve the E-Rate program and the lessons from the recently concluded criminal and civil case associated with funding

year 2000 involving NEC and the E-Rate service provider. Your attention E-Rate issues, as demonstrated by this and last month’s

hearing, confirms the FCC’s understanding that Congress wants

this program administered efficiently and fairly.

In its first 6 years, the E-Rate program committed over $11 billion to permit an average of about 90,000 schools and libraries each

year to pay more affordable discounted rates. In 1998, the first

year of the program, only 51 percent of classrooms in public schools

were connected to the Internet. That figure reached 92 percent in

2002, and 94 percent of schools now have broadband connections.

In reviewing these numbers, the E-Rate program has been an

overall success, but the program has been the target of some bad

actors and those who have tried to beat the system. The subject of

today’s hearing involving NEC is an object lesson for the FCC, for

USAC, and for all participants in the E-Rate program.

The Commission and its staff work closely with USAC in administering the E-Rate program. As described in detail in the recent

hearing regarding Puerto Rico, we are improving program performance through actions and rulemakings, fact specific adjudications,

and an improved audit program.

Regarding NEC, on May 27 of this year NEC agreed to plead

guilty to two criminal charges, wire fraud and bid rigging for ERate activities, largely in funding year 2000. NEC also agreed to

pay a total of $20.6 million criminal fine, a civil settlement, and

restitution.

NEC was charged with wire fraud for entering a scheme to defraud the E-Rate program in the San Francisco Unified School DisVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00086 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
79

trict, and it was also charged with bid rigging and allocating contracts at five school districts in Michigan, Wisconsin, Arkansas,

and South Carolina.

The monetary amount of the civil settlement makes the E-Rate

program whole. Because NEC has pled guilty to activity related to

the E-Rate program, it is subject to suspension and debarment

under the Commission’s E-Rate debarment rule. On May 27 NEC

petitioned the Commission for waiver of its debarment rule, and

there is a proceeding pending on that petition.

This case illustrates the importance of deterring those who would

seek to defraud or abuse the E-Rate program. Deterrence is an essential and a challenging goal, because as the San Francisco experience shows, defrauders will stop at very little to cover their

tracks. At the same time, the Commission must encourage efficient

participation by the large majority of E-Rate participants who are

law abiding.

The Wireline Competition Bureau has recommended to the Commission rule changes to improve deterrence for action at the August 2004 open meeting. Also in the last 15 months, the Commission has adopted several new rules that address aspects of the

NEC situation.

Moveover, I have directed USAC’s chief executive officer to report

to the Bureau on changes to procedures and rules in light of NEC,

and the staffs of the FCC and USAC are in close communication

to improve USAC’s review process.

An initial step in such deterrence is to require applicants to document thoroughly their participation in the E-Rate program. The

Bureau has recommended expansion of the document retention requirements for applicants, in order to maintain a comprehensive

paper trail for 5 years after service is provided.

The Bureau has also recommended improvements to the certifications that beneficiaries and service providers make regarding

their compliance with substantive program rules. We plan to modify numerous E-Rate forms to expand the required certifications.

Expanded certifications help deter bad actors, because their falsification is a Federal criminal offense.

As an additional deterrent, the Bureau is recommending that

USAC must engage in heightened scrutiny of applications from ERate beneficiaries that have violated the statute or the Commission’s rules in the past. This is consistent with the general framework adopted in the Puerto Rico DOE Order of 2003 for when one

or more parties to an E-Rate application is under investigation for

waste, fraud or abuse.

The Commission’s E-Rate debarment rule is a significant deterrent to fraudulent behavior. Since the rule’s adoption in 2003, the

FCC’s Enforcement Bureau has debarred three individuals in matters not related to NEC, and the Commission has sought comment

on whether to expand the reach of the debarment rule as a further

deterrent.

Encouragement of whistleblowers and early outreach to applicants and service providers regarding the E-Rate program are also

important components of deterrence. Continuing strong review and

auditing programs serve as a long term deterrent to waste, fraud

80

and abuse. We on the Commission staff will continue to work with

our Office of Inspector General to implement such programs.

We at the FCC are proud of the schools and libraries support

program, but we will never be satisfied with the status quo. We are

happy to assist the subcommittee as needed.

Thank you, Mr. Chairman, for the opportunity to participate in

your review of E-Rate, and I look forward to your questions on the

issue.

[The prepared testimony of William F. Maher, Jr. follows:]

PREPARED STATEMENT OF WILLIAM F. MAHER, JR., CHIEF, WIRELINE COMPETITION

BUREAU, FEDERAL COMMUNICATIONS COMMISSION

Good morning, Chairman Greenwood, Representative DeGette, and distinguished

members of the Subcommittee. My name is William Maher. I am chief of the FCC’s

Wireline Competition Bureau, and have served in this post since August 2002. I appreciate the opportunity to discuss the FCC’s continuing efforts to improve the Erate program and the lessons from the recently concluded criminal and civil case

involving NEC Business Network Solutions, Inc. (‘‘NEC-BNS’’), an E-rate service

provider, regarding its activities associated with Funding Year 2000. Your attention

to the issues involved with the E-rate program, as evidenced by this and last

month’s hearings, confirms the FCC’s understanding that Congress wants the program administered efficiently and fairly.

INTRODUCTION

The schools and libraries mechanism of the FCC’s universal service program,

known as the E-rate program, implements the directive of the Telecommunications

Act of 1996 to help schools and libraries gain access to modern telecommunications

and information services for educational purposes. In its first six years, the E-rate

program has committed over $11 billion to permit an average of almost 90,000

schools and libraries each year, including those in the nation’s poorest and most isolated communities, to pay more affordable, discounted rates. While in 1998, the first

year of the program, only 51 percent of classrooms in public schools were connected

to the Internet, the figure reached 92 percent in 2002. Moreover, 94 percent of

schools now have broadband connections.

In reviewing these numbers, the E-rate program has been an overall success. But

from day one, it has been the Commission’s goal to improve operation of the E-rate

program. The FCC seeks to learn from its experience with this program.

The Commission and its staff work closely with the Universal Service Administrative Company (‘‘USAC’’), the not-for-profit company that is responsible for day-today administration of the E-rate program. In particular, whenever we discover examples of potential waste, fraud, or abuse, we seek to address the individual cases

and to improve the relevant program rules or practices.

The Wireline Competition Bureau works to oversee and implement the E-rate program with several other FCC bureaus and offices, including the Office of the Inspector General, the Office of General Counsel, the Office of Managing Director, and the

Enforcement Bureau. As Commission staff described in detail in the recent hearing

regarding Puerto Rico, we are improving program performance through actions in

rulemakings, fact-specific adjudicatory decisions, and an improved audit program.

The FCC also works closely with law enforcement agencies when those agencies

investigate and prosecute possible criminal activity by E-rate participants. The Erate program has been the target of some bad actors and those who have tried to

beat the system. The subject of today’s hearing, involving NEC-BNS, is an example

of such activity. It is an object lesson for the FCC, for USAC, and for all participants

in the E-rate program. The Commission is committed to applying this lesson in

eradicating waste, fraud and abuse in the E-rate program.

THE NEC-BNS CASE

Criminal Plea Agreement and Civil Settlement: On May 27, 2004, NEC-BNS, a

subsidiary of NEC America Inc., agreed to plead guilty to two criminal charges—

wire fraud and bid rigging—and to pay a total $20.6 million dollar criminal fine,

civil settlement, and restitution for its activities related to the E-rate program,

largely in Funding Year 2000. The Justice Department charged NEC-BNS with wire

fraud for entering a scheme to defraud the E-rate program and the San Francisco

Unified School District (‘‘the San Francisco schools’’). The Justice Department also

81

charged NEC-BNS with bid rigging and allocating contracts at five school districts

in Michigan, Wisconsin, Arkansas, and South Carolina. Among other things, the

plea agreement requires NEC-BNS to cooperate with the United States in investigating and prosecuting others involved in criminal violations at E-rate funded

projects, and NEC-BNS agreed to enter into a comprehensive Corporate Compliance

Program as well.

In addition to its criminal plea agreement, NEC-BNS entered a settlement agreement to end a civil lawsuit initially brought by the San Francisco schools, in which

the United States, acting through the Department of Justice, intervened. Among

other things, the monetary portion of the settlement agreement makes the E-rate

program whole.

The settlement agreement notes that the civil claims of the United States and

others against NEC-BNS included (1) engaging in non-competitive bidding practices;

(2) paying fees termed ‘‘marketing fees’’ to at least one entity involved in selecting

vendors to obtain e-rate funds; (3) requesting and receiving E-rate funds for goods

and services that were ineligible for such funding; (4) providing false information

to the United States regarding the goods and services that were be provided to

schools and school districts under the E-rate program; (5) disregarding the requirement that schools and school districts make a co-payment to match a percentage of

their E-rate funding; and (6) inflating prices on invoices and other documents provided to the United States to conceal some or all of these practices.

San Francisco as an Example: I summarize, as a case study of the foregoing practices, the situation with the San Francisco schools, based largely on the description

in the NEC-BNS criminal plea agreement. In December 1999, NEC-BNS agreed

with a switch manufacturing company (‘‘VX Company’’) to pay VX Company a fee

for all business opportunities brought to NEC-BNS, and NEC-BNS agreed to include

VX Company equipment in its E-rate proposals and bids. VX Company employed

two consultants to work as its sales representatives. The consultants specialized in

marketing VX Company products to school districts, and acted as consultants to

school districts in identifying potential government-sponsored funding sources, including E-rate.

On or before December 1999, the consultants began working with the San Francisco schools to obtain E-rate funds. The consultants worked with an official of the

San Francisco schools to put together a request for proposal for equipment and services for E-rate to fund. In January 2000, NEC-BNS submitted its bid on the E-rate

project for the San Francisco schools. One of the consultants managed the opening

of the bids and, together with an official of the San Francisco schools, opened and

reviewed them. That consultant declared that NEC-BNS had submitted the winning

bid for the data equipment portion of the project, and that two other firms had submitted low bids on other portions of the project. The consultants and the official of

the San Francisco schools then decided to make NEC-BNS the prime contractor for

the project and to have other firms act as subcontractors to NEC-BNS.

Still in January 2000, NEC-BNS employees and the consultants met to prepare

the USAC Form 471, which is the application form for E-rate funding. With the assistance of NEC-BNS, one of the consultants prepared the Form 471 with prices inflated over the amounts originally bid, and the other consultant then delivered the

Form 471 to USAC.

In late May or early June 2000, USAC began to review the San Francisco schools’

Form 471 submitted in January 2000. USAC asked the San Francisco schools to

supply information to justify certain parts of the project. One of the consultants, and

others acting under her direction, submitted spreadsheets to USAC that contained

false information regarding the bidding process, the bidding participants, the winning bids, and the bid amounts. USAC subjected the San Francisco schools’ application to a review to determine whether the services requested were supported by adequate resources. The San Francisco schools passed the review. In September 2000,

USAC approved funding for the San Francisco schools in part, but denied E-rate

funding for some requests for ineligible equipment, products, and services.

The Investigation: The NEC-BNS plea agreement and civil settlement resulted

from a two-year investigation conducted by the Department of Justice and the Federal Bureau of Investigation. The FCC’s Office of Inspector General assisted in the

investigation, and various FCC bureaus and offices, including the Wireline Competition Bureau, reviewed the civil settlement agreement earlier in 2004.

The monetary amount of the civil settlement makes the universal service fund

whole. Because NEC-BNS has pled guilty to activity related to the E-rate program,

it is subject to suspension and debarment under the Commission’s E-rate debarment

rule, 47 C.F.R. § 54.521. On May 27, 2004, NEC-BNS petitioned the Commission for

waiver of its suspension and debarment rule. On July 7, 2004, the Commission’s EnVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00089 Fmt 6633 Sfmt 6621 95461.TXT HCOM1 PsN: HCOM1
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forcement Bureau sought public comment on the waiver petition, and the pleading

cycle will close on July 29, 2004.

POLICY AND PROGRAM LESSONS

There are multiple lessons to be learned from the NEC-BNS case. This case illustrates the importance of deterring those who would seek to defraud or abuse the

program. Deterrence is an essential and challenging goal because, as the San Francisco experience shows, defrauders and bad actors will stop at very little to cover

their tracks. At the same time, the Commission must encourage efficient participation by the large majority of E-rate applicants and service providers who are lawabiding.

The Wireline Competition Bureau has already recommended a number of relevant

rule changes, described below, to the Commission for action at its August 2004 Open

Meeting. In the past 15 months, the Commission has adopted several new rules that

address aspects of the NEC-BNS situation. Moreover, I have directed USAC’s chief

executive officer to report to the Bureau on changes to procedures and rules in light

of NEC-BNS, and the staffs of the FCC and USAC are remaining in close communication to improve USAC’s review process. Tightening our rules and USAC’s review

procedures will expose, at the front end, improper or fraudulent activities.

Deterring Bad Actors: To deter bad actors, E-rate applicants must be held accountable for the contents of their applications and other filings.

An initial step in such deterrence is to require applicants to document thoroughly

their participation in the E-rate program. Based on input from our Office of Inspector General, the Wireline Competition Bureau has recommended to the Commission

that it expand the document retention requirements for applicants, in order to

maintain a comprehensive paper trail for five years after receipt of E-rate supported

services. By documenting every step in the E-rate process— from initial application,

through competitive bidding and selection of a service provider, to final service and

equipment delivery and invoicing—such a paper trail aids the initial review of applications as well as later program audits. It places a major obstacle before those who

would consider lying to the federal government for their personal gain.

The Wireline Competition Bureau has also recommended to the Commission improvements in the certifications that beneficiaries make regarding their compliance

with substantive program rules. Upon adoption of the Bureau’s recommendations,

we will modify numerous E-rate forms to expand the required certifications. Expanded certifications help deter bad actors because their falsification is a federal

criminal violation. This reform is the product of discussions among the Bureau, the

FCC’s Office of Inspector General, and the Justice Department.

As an additional deterrent to bad actors, the Bureau is recommending that the

Commission reinforce that USAC should engage in heightened scrutiny of applications from E-rate beneficiaries that have violated the statute or the Commission’s

rules in the past. This is consistent with the general framework adopted in the

Puerto Rico DOE Order of 2003 to deal with situations in which one or more parties

to an E-rate application is under investigation for potential waste, fraud or abuse.

The Commission has already acted in several ways to deter conduct similar to

that of NEC-BNS. In April 2003, the Commission adopted its E-rate debarment

rule, which bars from E-rate participation for a period of three years any individuals

or companies that have been found criminally or civilly liable for activities associated with or related to the E-rate program. We believe the debarment rule to be

a significant deterrent to fraudulent behavior. Since the rule’s adoption in 2003, the

FCC’s Enforcement Bureau has debarred three individuals in matters not related

to NEC-BNS. The Commission also has sought comment on whether to expand the

reach of the debarment rule as a further deterrent to E-rate waste, fraud and abuse.

Encouragement of whistleblowers and early outreach to potential applicants and

service providers regarding the E-rate program are also important components of

deterrence. Timely information from well-informed and honest citizens is one of the

best means of exposing fraudulent activity. Wider understanding of E-rate rules can

help USAC and program participants isolate and identify potential bad actors. For

example, in 2000, roughly the time of the San Francisco situation, the Commission’s

Mastermind Order found a violation of the competitive bidding rules where a service

provider listed in the Form 470 as a contact person for an applicant also participated as a bidder in the applicant’s competitive bidding process. Wider understanding of that ruling in the San Francisco schools could have helped expose the

NEC-BNS case earlier. USAC has announced plans to increase its outreach regarding the E-rate program.

83

Continuing strong review and auditing programs also serve as a long-term deterrent to waste, fraud, and abuse. We on the Commission staff will continue to work

with our Office of Inspector General to implement such programs.

Incentives For Good Actors To Use The Program Efficiently: The Commission

must also encourage efficient use of program funding by those who respect and follow the program rules. In December 2003, the Commission asked for comment on

fundamental E-rate policy issues in this area. The Commission asked whether to adjust the schedule of discount rates so that, for example, applicants would pay for

a greater share of their E-rate services. This would provide greater incentives for

applicants to make only prudent, cost effective purchases. The Commission also

sought comment on possible means of determining whether applicants have made

‘‘cost effective’’ funding requests. We are evaluating the record we have compiled

with the goal of making recommendations to the Commission in this calendar quarter.

CONCLUSION

We at the FCC are proud of the schools and libraries support program, but we

will never be satisfied with the status quo. We will continue to use all tools at our

disposal to help us identify areas of E-rate program administration that are vulnerable to fraud, waste, or abuse. At the same time, we will continue to encourage participation in the program so that those that the program’s true beneficiaries—the

nation’s students, library patrons, and all Americans—receive the support they

need.

We are happy to assist the Subcommittee as it considers these important issues.

Thank you, Mr. Chairman, for the opportunity to participate in your review of the

NEC-BNS matter, and I look forward to your questions on these issues.

Mr. WALDEN. Thank you for being here today, and for your comments.

Mr. McDonald, welcome.

TESTIMONY OF GEORGE McDONALD

Mr. MCDONALD. Thank you, sir. Good afternoon, Congresswoman

DeGette and Chairman Barton. My name is George McDonald. I

am the Vice President of the Universal Service Administrative

Company responsible for the Schools and Libraries Division. It is

my privilege to be here today to speak with you again about USAC

and its administration of the Schools and Libraries Universal Service Support Mechanism, commonly referred to as the E-Rate program.

I appeared before this subcommittee on June 17, 2004, and my

statement at that time provided an overview of USAC and its administration of the E-Rate program. In the interest of time, I won’t

repeat that overview, but I would like to reiterate a few key points.

Before we began making funding commitments in 1998, our internal controls were carefully reviewed by PricewaterhouseCoopers

and staff of GAO. PwC provided an attest opinion about those procedures, and USAC implemented all of the changes recommended

by GAO.

As we have gained experience, we have strengthened some procedures and added others to continue to protect the integrity of the

program and the Universal Service Fund. An early enhancement

was the establishment of a whistleblower hotline, which receives

an average of 100 calls per year. Out Special Investigations Team

investigates every call and ensures that appropriate follow-up action is taken.

Today we have an assortment of tools to help assure compliance

with program rules. These include: Employing detailed application

and invoice review procedures; denying funding commitments when

appropriate; rejecting incorrect invoices; auditing program beneVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00091 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
84

ficiaries and service providers; recovering funds where rule violations are found; investigating whistleblower hotline complaints;

supporting law enforcement investigations; and referring matters

involving suspected program abuse to law enforcement authorities.

As I indicated to the subcommittee last month, it has become

clear to us that we need another tool, a larger oversight presence

in the field. We are now reviewing proposals we have received in

response to a request for proposals soliciting bids to conduct some

1,000 site visits a year.

These visits will allow us to assess even more fully how E-Rate

funds are being used, to learn about and publicize best practices in

education technology and program compliance, and to help ensure

that products and services have, in fact, been delivered and are

being used effectively.

Now let me turn to the participation of the San Francisco Unified

School District in the E-Rate program. San Francisco has received

funding in each year of the program. We have disbursed approximately $6.4 million to various service providers for providing eligible products and services to San Francisco for the past 6 years.

In regard to San Francisco’s application for products and services

to be provided by NEC Business Network Solutions, which is the

focus of this hearing, we committed approximately $48.6 million to

San Francisco, as you have heard here today. San Francisco later

canceled those funding requests and, consequently, we never disbursed any of those funds.

I would like to join the subcommittee in commending Dr. Ackerman for taking responsible action to protect these funds.

Mr. Chairman, I regret to report to you that I believe we made

the wrong decision in response to this funding request and that we

had information that should have provided a clear warning to us.

As you heard today from Mr. Cothran, my review of the files indicates that we had reason to question whether one of the pieces of

documentation that San Francisco provided to us, its budget, had

been improperly altered when it was submitted to us.

We should have done more to assure ourselves that the budget

San Francisco provided to us was accurate, but we did not. If we

had, in light of what we have learned since, I believe we would

have denied this funding request.

We requested San Francisco’s budget and other documentation

as part of our review of whether San Francisco had the funds to

pay the non-discount portion of the cost of eligible services, and

had acquired the goods and services not eligible for discount but

necessary to make effective use of these services, such as computers and software. This particular review had been part of our

application review procedures since the first year of the program,

and we have strengthened this review every year.

For example, in the year in which we reviewed this particular

application, our reviewers’ notes were not entered into the computer system, and our reviewers brought novel issues to the attention of their supervisors orally. In this case, the issue of whether

San Francisco’s budget was accurate was a novel issue, and so the

reviewer would have communicated the concerns orally.

Today, reviewers note their observations in our computer system,

and novel issues such as San Francisco’s budget must be commuVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00092 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
85

nicated in writing and are required to be addressed. The decision

regarding the novel issue must be documented before a final decision is made with respect to the application.

Beyond these changes, we have established an additional layer

of review through our quality assurance function to review the

work of our application reviewers, which further safeguards program funds.

Since August of 2001, we have provided support to the law enforcement investigation of NEC in the form of documentation, answering numerous questions about the program in general and this

application in particular, and meeting with law enforcement officials.

As we provided this support, we coordinated closely with the

Federal Communications Commission, Office of Inspector General,

and through that process strengthened our joint efforts to protect

the fund from waste, fraud and abuse by supporting law enforcement investigations of those who would take advantage of the program.

As a result of our support of this investigation, we learned that

San Francisco officials and NEC had provided us with false information in response to many of our questions about this application.

Mr. Chairman, thank you for providing me with the opportunity

to address the subcommittee. I would be happy to respond to questions.

[The prepared testimony of George McDonald follows:]

PREPARED STATEMENT OF GEORGE MCDONALD, UNIVERSAL SERVICE ADMINISTRATIVE

COMPANY VICE PRESIDENT, SCHOOLS AND LIBRARIES DIVISION

Good morning, Mr. Chairman and Members of the Subcommittee. My name is

George McDonald. I am the Vice President of the Universal Service Administrative

Company (‘‘USAC’’) responsible for the Schools and Libraries Division. It is my

privilege to be here today to speak with you again about USAC and its administration of the Schools and Libraries Universal Service Support Mechanism, commonly

referred to as the ‘‘E-rate’’ program.

Overview

I appeared before this Subcommittee on June 17, 2004, and my statement at that

time provided an overview of USAC and its administration of the E-rate program.

In the interest of time, I will not repeat that overview, but I would like to reiterate

a few key points.

Before we began making funding commitments in 1998, our internal controls were

carefully reviewed by PricewaterhouseCoopers (PwC) and staff of the U.S. General

Accounting Office (GAO). PwC provided an attest opinion about those procedures,

and USAC implemented all of GAO’s recommended changes. As we have gained experience, we have strengthened some procedures and added others to continue to

protect the integrity of the program and the Universal Service Fund. An early enhancement was the establishment of the whistleblower hotline, which receives an

average of 100 calls per year. Our Special Investigations Team investigates every

call and ensures that appropriate follow up action is taken.

Today we have an assortment of tools to help assure compliance with program

rules. These include employing detailed application and invoice review procedures,

denying funding commitments when appropriate, rejecting incorrect invoices, auditing program beneficiaries and service providers, recovering funds where rule violations are found, investigating whistleblower hotline complaints, supporting law enforcement investigations, and referring matters involving suspected program abuse

to law enforcement authorities. But, as I indicated to you last month, it has become

clear to us that we need another tool)—a larger oversight presence in the field. We

are now reviewing proposals we have received in response to a Request for Proposals (RFP) soliciting bids to conduct some 1,000 site visits a year. These visits will

allow us to assess even more fully how E-rate funds are being used, to learn about

and publicize best practices in education technology and program compliance, and

86

to help ensure that products and services have in fact been delivered and are being

used effectively.

Participation of the San Francisco Unified School District in the E-rate Program

Let me now turn to the participation of the San Francisco Unified School District

(SFUSD) in the E-rate program. SFUSD has received funding in each year of the

program. We have disbursed approximately $6.4 million to various service providers

for providing eligible products and services to SFUSD for the past six years. In regard to SFUSD’s application for products and services to be provided by NEC Business Network Solutions, Inc. (NEC), which is the focus of this hearing, we committed approximately $48.6 million to SFUSD. SFUSD later cancelled those funding

requests, and consequently, we never disbursed any of these funds.

Mr. Chairman, I regret to report to you that I believe we made the wrong decision

in response to this funding request and that we had information that should have

provided a clear warning to us. My review of the file indicates that we had reason

to question whether one of the pieces of documentation that SFUSD provided to

us—its budget—had been improperly altered when it was submitted to us. We

should have done more to assure ourselves that the budget SFUSD provided to us

was accurate, but we did not. If we had, in light of what we have learned since,

I believe we would have denied this funding request.

We requested SFUSD’s budget and other documentation as part of our review of

whether SFUSD had the funds to pay the non-discount portion of the cost of eligible

services and had acquired the goods and services not eligible for discount but necessary to make effective use of these services, such as computers and software. This

particular review has been part of our application review procedures since the first

year of the program, and we have strengthened this review every year.

For example, in the year in which we reviewed this particular application, our reviewers’ notes were not entered into our computer system, and our reviewers

brought novel issues to the attention of their supervisors orally. In this case, the

issue of whether SFUSD’s budget was accurate was a novel issue, and so the reviewer would have communicated the concerns orally. Today, reviewers note their

observations in our computer system, and novel issues such as SFUSD’s budget

must be communicated in writing and are required to be addressed. The decision

regarding the novel issue must be documented before a final decision is made with

respect to the application. Beyond these changes, we have established an additional

layer of review through our quality assurance function to review the work of our

application reviewers, which further safeguards program funds.

Since August of 2001, we have provided support to the law enforcement investigation of NEC in the form of documentation, answering numerous questions about the

program in general and this application in particular, and meeting with law enforcement officials. As we provided this support, we coordinated closely with the Federal

Communications Commission Office of Inspector General, and through that process,

strengthened our joint efforts to protect the fund from waste, fraud and abuse by

supporting law enforcement investigations of those who would take advantage of the

program. As a result of our support of this investigation, we learned that SFUSD

officials and NEC had provided us with false information in response to our many

questions about this application.

Conclusion

Mr. Chairman, thank you for providing me with the opportunity to address the

Subcommittee. I would be happy to respond to any questions you may have.

Mr. WALDEN. Mr. McDonald, thank you for being here, and

thank you for your testimony.

I want to go back on San Francisco, because what we have heard

today is that somebody in USAC reviewing the initial application

identified the problem with the budget. It had been falsified, or at

least there was, what, a $41 million discrepancy between what was

on their website and what had been submitted.

We were told that that information was passed up the chain in

USAC. Who got it?

Mr. MCDONALD. That employee’s manager, Mr. Werner whose

name was referred to earlier.

Mr. WALDEN. What did he do with the information?

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Mr. MCDONALD. And let me say, I am relying on the same evidence that Mr. Cothran had, the written answers to the questions

that he posed to us.

Mr. WALDEN. Why?

Mr. MCDONALD. Because there is no written documentation in

the file of this issue. Mr. Schnipp reportedly, by his own report,

raised the issue orally to Mr. Werner, did not document it in the

file, got no guidance from Mr. Werner.

Mr. WALDEN. Is he supposed to do that?

Mr. MCDONALD. He should have documented this in the file so

that everybody would have seen it, and we would have had an open

resolution of it.

Mr. WALDEN. Does his—Is it Mr. Werner, you said, is his supervisor?

Mr. MCDONALD. Was at that time, yes.

Mr. WALDEN. Was? Have you talked to him? Does he admit that

Mr. Schnipp made him aware of this discrepancy?

Mr. MCDONALD. We talked with him last week in preparation for

this hearing. He said that he remembered dealing with that file.

He didn’t remember this issue being raised to him. So there was

a miscommunication at least between these two individuals.

Mr. WALDEN. Is that the first time you had talked to Mr. Werner

about this?

Mr. MCDONALD. This is the first time that we have talked to Mr.

Werner about this. Yes, sir.

Mr. WALDEN. Last week?

Mr. MCDONALD. Yes, sir.

Mr. WALDEN. Maybe I’m missing something here, but I am troubled by that answer, sir. When did you learn of Mr. Schnipp’s—I’m

not saying his name right, I’m sure, but his concern? When did this

letter come out to the City Attorney’s Office saying there is a problem?

Mr. MCDONALD. In 2002.

Mr. WALDEN. And last week was the first time you talked to the

supervisor on this?

Mr. MCDONALD. San Francisco had canceled the funding commitments at that point. There was no issue anymore about these commitments. Mr. Werner left the employment of our contractor in

2000.

Mr. WALDEN. So Mr. Werner didn’t work—Now wait. Mr. Werner

left—What did you say, the employment of your contractor in 2000?

So he has been out of the process?

Mr. MCDONALD. Yes, sir.

Mr. WALDEN. Okay. How do you know this isn’t still going on?

Mr. MCDONALD. Well, we heard this discussion today about

whether there is a contact within USAC with Judy Green. We have

not positively funded any application associated with her since her

name began appearing on any documentation in 2003. So that is

the first I have heard an allegation about that. I did ask whether

Mr. Werner left under adverse situation, and he did not. He chose

to leave.

So we didn’t have any suspicion. Certainly, Mr. Werner took no

other action to try to hide what was going on. This wasn’t docuVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00095 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
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mented in the file. Mr. Schnipp hasn’t said he was directed not to

document this in the file.

So I think it was a human error, is what I believe, and we have

taken——

Mr. WALDEN. Human error by Mr. Schnipp or Mr. Werner?

Mr. MCDONALD. Well, Mr. Schnipp in not documenting it, Mr.

Werner in not following up on it.

Mr. WALDEN. But Mr. Schnipp contends he talked to Mr. Werner

about it, made him aware of it.

Mr. MCDONALD. Yes.

Mr. WALDEN. But he has no documentation to prove that conversation. Is that the issue?

Mr. MCDONALD. Unfortunately, that is correct. And I do applaud

Mr. Schnipp, as Mr. Cothran did, for exercising the initiative to

find this budget.

Mr. WALDEN. What kind of documentation was required by your

rules?

Mr. MCDONALD. There is a worksheet. This is the Item 25 review. Item 25 on the Form 471 is a certification that I have secured

access to all the resources necessary to make effective use of the

discounted services, including the matching share.

Mr. WALDEN. I mean the reviewer documentation.

Mr. MCDONALD. Oh, there is a worksheet that walks through:

Does the applicant have the budget? Does he have hardware? Does

he have software, teacher training, etcetera.

Mr. WALDEN. Got it. And so Mr. Schnipp would review that?

Mr. MCDONALD. Mr. Schnipp would put his conclusions into that

document, and in the budget section of that document ‘‘Pass’’ is circled, and there is no issue raised in the write-up about this budget

discrepancy.

Mr. WALDEN. Oh. So the written document that would have gone

up your chain does not indicate that there was any problem with

the budget?

Mr. MCDONALD. That is correct, and that is very unfortunate, because that would have flagged this to get other reviews subsequent

to Mr. Schnipp’s review, and it would have flagged this for others.

Mr. WALDEN. All right. Are you satisfied with the current document retention policies of the E-Rate program?

Mr. MCDONALD. No, and I think Mr. Maher has addressed that.

The rules don’t require document retention. That has been a problem in audits, and the Commission is addressing that.

Mr. WALDEN. How long has that been an issue?

Mr. MCDONALD. I didn’t realize it was an issue early on. The

forms say that the applicants certify they will retain documents,

but as this became an audit issue, the guidance that we got was

that, since it is not established in the rules, there can’t be recoveries for that.

Mr. WALDEN. And those are rules that would have to be promulgated by the FCC?

Mr. MCDONALD. Yes, sir.

Mr. WALDEN. So have you made recommendations to the FCC

about what you think needs to be done on the records retention

issues?

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Mr. MCDONALD. This has been on the table since at least the first

round of audits when there was documentation—lack of documentation for a program.

Mr. WALDEN. I see. When was that?

Mr. MCDONALD. In 2000 for the funding year 1998.

Mr. WALDEN. So the issue of the lack of retention has been at

the FCC’s door since 2000?

Mr. MCDONALD. It’s been on all of our—All of us have been

aware of it since 2000, and our team wasn’t on the scene in 2000,

but——

Mr. WALDEN. No, but isn’t that one of the issues? There has been

quite a bit of turnover at the FCC level on this program. Correct?

Mr. MCDONALD. Compared to USAC. I’ve been here since 1997.

So more turnover than here.

Mr. WALDEN. And, Mr. Maher, has the FCC known since 2000

that record retention was an issue on an audit trail?

Mr. MAHER. I spoke with the Inspector General about this within

the last year.

Mr. WALDEN. I don’t know what that means. How long has what

he has proposed been before the FCC?

Mr. MAHER. It has not appeared in an open docket before the

FCC, but this issue——

Mr. WALDEN. That is what it would take?

Mr. MAHER. It has been put on the table, and the Bureau has

recommended the rule change for the August meeting.

Mr. WALDEN. Oh, for the August meeting?

Mr. MAHER. Yes.

Mr. WALDEN. So it has been basically 4 years to require record

retention so we can perform audits in a multi-billion dollar program?

Mr. MAHER. The issue so far has been that the current rule, and

there is an FCC rule regarding document retention, is indefinite.

The current rule requires the applicant to retain the same types of

documents as it would for other procurements, for example, within

its school district.

The issue that has been raised is that that is indefinite. It varies

among school districts and libraries. What we are looking for is to

have a clear bright line rule that will aid the audit process and also

aid law enforcement.

So what we are doing is improving an existing rule.

Mr. WALDEN. I know in some of the other FCC rules, it is pretty

clear you have to maintain certain records for, you know, 2 years,

5 years, whatever it is. What am I missing here that is so hard it

takes 4 years to make a decision that these records should be retained for 4 years or 3 years? Did you make a recommendation as

to a length of time?

Mr. MCDONALD. The forms—there was an inconsistency in the

forms. Some said 3 years. Some said 5 years. I think the Commission is moving to 5 years.

Mr. MAHER. So our goal is to clean up these discrepancies. Yes.

Mr. WALDEN. Yes, but why does it take 4 years to make that decision between whether a form is 3 years or 5 years for retention

purposes? I’m not picking on you. I am just——

90

Mr. MAHER. Absolutely. What we have tried to do with many aspects of the program is to look at what is required and move ahead,

and our goal is to improve what we find in place.

Mr. WALDEN. All right. Mr. Maher, you note in your testimony

the importance of certifications on forms. The Department of Justice in December of 2002 made a number of recommendations regarding certification to the FCC. If you don’t mind turning to Tab

130, please, and I’ll give you the chance there to find Tab onethree-zero.

Mr. MAHER. Yes.

Mr. WALDEN. These included requiring a noncollusion certificate,

among others. Why only now is the Bureau recommending certification changes to the forms 18 months after these recommendations and more than 6 years into the program?

Mr. MAHER. We have worked both with the Department of Justice and the Office of Inspector General to go through a variety of

forms, and there’s—I think 8 forms have been brought to our attention, and we are altering roughly 16, 17 of these certifications.

It has been a back and forth process in getting the certifications

right. We have actually submitted the revised forms with certifications to the OMB approval process. it is underway now. These

will be in place for the next funding year.

Mr. WALDEN. Okay. My time has expired. I will turn now to the

ranking member, Ms. DeGette, of Colorado.

Ms. DEGETTE. Thank you, Mr. Chairman. Mr.—Is it Marh?

Mr. MAHER. Maher.

Ms. DEGETTE. Maher. I wanted to follow up on the chairman’s

questions. The Commission is considering rules. Are they considering proposing rules or enacting rules in August?

Mr. MAHER. What was referred to in my testimony is actual

rules, not proposing them in August but to adopt them.

Ms. DEGETTE. But to adopt rules?

Mr. MAHER. Yes.

Ms. DEGETTE. And this document at Tab 130—this is the memorandum, ‘‘Suggestions for E-Rate program’’—has a number of suggestions in it. Have you seen that document before?

Mr. MAHER. I have seen it before, yes.

Ms. DEGETTE. Okay. Do you know if the No. 1 suggestion, requiring a certificate of independent pricing, is among the rules that

will be adopted in August?

Mr. MAHER. Well, there’s a couple of different processes going on.

Many of these certification changes, the Bureau has already proceeded on, that a formal rule isn’t required. What we did, we had

to submit it to OMB for approval. We did that in early June. They

were published in the Federal Register. There’s 60 days notice before they are adopted. So we expect a variety of the certifications

will be in place in September.

Now the specific one that is referenced here I would have to

check on.

Ms. DEGETTE. Okay. Do you think it is a good idea to have a rule

requiring a certificate of independent pricing?

Mr. MAHER. I think, in general, certifications are very important

for three reasons. One, they sort of educate the program participants. The other one is a deterrent effect, because people are certiVerDate 11-MAY-2000 13:56 Oct 07, 2004 Jkt 000000 PO 00000 Frm 00098 Fmt 6633 Sfmt 6602 95461.TXT HCOM1 PsN: HCOM1
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fying to the government. They are saying that they understand the

rule and that they are representing so to the government. Finally,

they are good for evidentiary purposes.

Ms. DEGETTE. Right. So is it your belief that a rule will be promulgated to require certificates of independent pricing, either

through the June rulemaking process that is underway or the August process?

Mr. MAHER. Well, let’s see. That particular one—and I am looking at another chart, but that particular one should be included,

and I think it is a great idea.

Ms. DEGETTE. Thank you. Also, this memorandum at Tab 130

suggests that you require that the process require at least three

bidders and award the contract to the lowest bidder. Do you think

that is a rule that will be promulgated in August?

Mr. MAHER. That will not be promulgated in August, because it

poses a difficult policy issue. This program serves schools and libraries in all parts of the country, very rural isolated ones as well

as large cities. The difficulty there is that in some places there just

aren’t three competing bidders.

The policy issue that we are grappling with is what do you do

to make sure the competitive bidding process—if you don’t have a

rule like that, that the competitive bidding process works, and you

can keep out the cheats.

Ms. DEGETTE. Right. I mean, if you don’t have some kind of a

baseline—I would imagine, especially given the amount of money

that we have heard over the past two hearings is involved in the

contracts, I would think that for the vast majority of projects you

could find at least three bidders who were willing to bid on it.

Wouldn’t you think so, sir?

Mr. MAHER. The experience—Maybe Mr. McDonald could comment, but experience varies among school districts and libraries.

Ms. DEGETTE. Okay. So what kind of rule can be promulgated

that would assure a competitive bidding process, if you are not

going to require a minimum number of bidders?

Mr. MAHER. Actually, the Commission in its Ysletta order—that

is involving the Ysletta, Texas, school district—promulgated

some—made some law which clarified the competitive bidding process.

For example, it made very clear that price—In any bidding circumstance, price has to be the primary factor to be considered in

bidding.

Ms. DEGETTE. Okay, but if you don’t have a competitive bid, then

how do you know if the price is unreasonable or not?

Mr. MAHER. The other side of the equation is something that the

subcommittee discussed in the last hearing, which is looking at

that schedule of discounts that schools are eligible for; because the

notion is that, if a school or a library has to pay more, they will

be more interested in getting an efficient system in place or efficient facilities, and that that, too, will help reinforce the——

Ms. DEGETTE. You mean the percentage of the contract that the

institution has to pay?

Mr. MAHER. Yes.

Ms. DEGETTE. And are you considering then increasing that percentage for all entities?

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Mr. MAHER. Yes. We are looking at that in an ongoing rulemaking.

Ms. DEGETTE. And I understand that might make institutions

pay a little closer attention to the contracts, but wouldn’t that also

eliminate some very poor school districts’ ability to actually make

their share of the E-Rate program? I mean, isn’t it counterproductive for some of the very poorest school districts?

Mr. MAHER. This is the policy debate that has faced the program,

and I will note that in its first 6 years—you have spoken about its

benefits—that many of those school districts, the poorest ones, have

received the up-to-date technology. So what we are trying to do is

to weigh these concerns, both making sure they have the facilities

and making sure that the process can work well.

Ms. DEGETTE. It would seem to me, you could have a rule that

required a certain number of bidders, and then if a school district

couldn’t find those bidders, they could apply for a waiver. Wouldn’t

that make some sense? That way you would have a basic rule, but

that exceptions could be granted in extreme cases.

Mr. MAHER. It is certainly worth considering, ma’am.

Ms. DEGETTE. Okay Do you think you will go back and consider

that?

Mr. MAHER. Yes, ma’am.

Ms. DEGETTE. Now you are leaving at the end of August, I understand. Is that right?

Mr. MAHER. I believe the beginning of September, ma’am.

Ms. DEGETTE. Who is going to be taking over this program when

you leave?

Mr. MAHER. It would be the next Chief of the Wireline Competition Bureau, who hasn’t been designated yet.

Ms. DEGETTE. All right. So are you going to be working with that

person when they come in or are we going to be starting from

Ground Zero with someone new right about the time we come back

into the fall session?

Mr. MAHER. I will be working with that person, and also our professional staff. Our head manager on this is a former State prosecutor and an expert in the schools program. So I think it is in

good hands.

Ms. DEGETTE. Okay. I just want to ask one more question. Then

I know we have a series of votes. The final requirement is to require additional documentation—Oh, the final suggestion in this

memo is to require additional documentation and notice. Are you

familiar with that recommendation?

Mr. MAHER. I’d have to refresh my recollection.

Ms. DEGETTE. It is on page 4 of the memo.

Mr. MAHER. Yes, I see it.

Ms. DEGETTE. Okay. Are you familiar with that, besides just

looking at it today?

Mr. MAHER. Yes.

Ms. DEGETTE. Okay. What kinds of additional—and do you agree

that additional documentation and notice are going to be necessary

to restore the integrity of the program?

Mr. MAHER. I think the best answer to the issue posed by the

suggestion on page 4 is a comprehensive document retention program and effective review of USAC.

93

Ms. DEGETTE. You testified to that before.

Mr. MAHER. Yes, ma’am.

Ms. DEGETTE. And is that going to be put into place?

Mr. MAHER. We have recommended that for Commission consideration at the August meeting.

Ms. DEGETTE. Well, let me just say for the record, and I know

the chairman has a question, I think everybody needs to get on this

fast and enact some very, very stringent rules at every level. I yield

back.

Mr. WALDEN. Thank you. The Chair recognizes the chairman of

the committee.

Chairman. BARTON. And I am going to be very brief, and I hope

your answers are brief, because we are going to have to leave here

in about 4 minutes.

What is the total amount of contracts or grants that are awarded

under the E-Rate program right now?

Mr. MAHER. The program is capped at $2.25 billion a year, and

that——

Chairman. BARTON. $2.25 billion.

Mr. MAHER. Yes, sir, and that is awarded.

Chairman. BARTON. Isn’t it true that the number of requests for

funding is going up almost geometrically? I thought we had requests last year for over $5 billion, $5.6 billion. Is that right, or not

right?

Mr. MAHER. Sir, Mr. McDonald has the number. I believe the actual demand has decreased from 2003 to 2004 by 9 percent, as far

as dollars. But Mr. McDonald perhaps has the best——

Chairman. BARTON. Well, so it has probably gone up.

Mr. MCDONALD. 2002 is the highest level. It has declined in 2003

and 2004. It is still $4.3 billion.

Chairman. BARTON. Okay. When somebody—We have seen, not

just on the issues that are before us that we put on the record,

Puerto Rico and San Francisco, but everywhere across the country

we see instances where requests for funds under this program start

out in what appear to be very reasonable, and then some consultants come in, and the next year the funding levels go up by orders

of magnitude, you know, from like $4 million to $40 million or $20

million to $100 million.

Is there no system in the review process that checks back from

prior years and questions some of these big increases?

Mr. MCDONALD. In 2002, the highest year, we identified a pattern, procurement pattern, that we felt was inconsistent with the

rules, and denied over $500 million. The Commission largely

upheld us on appeal, and I believe that contributed to the reduction

in demand in 2003.

Chairman. BARTON. Well, what it appears to me is that we had

a program that was put in place 5 or 6 years ago, and in the beginning a lot of people didn’t understand it, and a lot of especially the

smaller school districts don’t like dealing with the Federal Government. Then word got out that there was easy money to be had, and

these applications would almost be rubber stamped.

I mean, we have on the record one of these applications where

they built a television studio. Now surely somebody at the regional

and Federal level would look at something like that.

94

I mean, thank God for groups like the San Francisco School District that are kind of self-enforcing, but I don’t see a whole lot of

effort at the Federal level to do anything but kind of manage the

available fund and portion out the amount of money that is allowed

to go out each year. Am I wrong about that?

Mr. MCDONALD. Let me say, sir, that we work really hard to

identify issues in this program. Service providers—we look for patterns across applications. The set of applications that is really the

heart of the issue here today was really the first time we identified

issues like this across applications.

Now we have a special investigations team with certified fraud

examiners on our staff that would dig right into an issue like this.

I am confident we wouldn’t have made the San Francisco commitment if we had seen that now.

I think we have beefed up a lot our ability to identify fraud and

stop it.

Chairman. BARTON. Well, we are going to have to go vote. So I

am going to yield back. But I would like there to be a set of recommendations about how to make changes to the program that

force more automatic compliance, so that we don’t have to depend

on people like the superintendent of the San Francisco School District to be a watchdog for the taxpayers’ money.

With that, Mr. Chairman, I yield back.

Mr. WALDEN. Thank you, Mr. Chairman.

I am going to note that we are going to keep the record open for

members to submit questions in writing to all our witnesses today,

including you two gentlemen, if that is acceptable. Well, yes, without objection.

Mr. MCDONALD. Yes, sir.

Mr. WALDEN. We will keep it open for 30 days to submit questions.

No other business to come before the subcommittee, I appreciate

all the witnesses today, and we stand adjourned.

[Whereupon, at 3:38 p.m., the subcommittee was adjourned.]

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