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" ! COMMITTEE PRINT 109TH CONGRESS

1st Session

COMMITTEE

2005

PRINT 109-E

WASTE, FRAUD, AND ABUSE CONCERNS WITH THE E-RATE PROGRAM

A STAFF REPORT

ADOPTED BY THE

SUBCOMMITTEE ON OVERSIGHT AND

INVESTIGATIONS

OF THE

COMMITTEE ON ENERGY AND

COMMERCE

U.S. HOUSE OF REPRESENTATIVES

109TH CONGRESS

NOVEMBER 2005

COMMITTEE ON ENERGY AND COMMERCE

JOE BARTON, Texas, Chairman

RALPH M. HALL, Texas

MICHAEL BILIRAKIS, Florida

Vice Chairman

FRED UPTON, Michigan

CLIFF STEARNS, Florida

PAUL E. GILLMOR, Ohio

NATHAN DEAL, Georgia

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

ROY BLUNT, Missouri

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

C.L. ‘‘BUTCH’’ OTTER, Idaho

SUE MYRICK, North Carolina

JOHN SULLIVAN, Oklahoma

TIM MURPHY, Pennsylvania

MICHAEL C. BURGESS, Texas

MARSHA BLACKBURN, Tennessee

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

BOBBY L. RUSH, Illinois

ANNA G. ESHOO, California

BART STUPAK, Michigan

ELIOT L. ENGEL, New York

ALBERT R. WYNN, Maryland

GENE GREEN, Texas

TED STRICKLAND, Ohio

DIANA DEGETTE, Colorado

LOIS CAPPS, California

MIKE DOYLE, Pennsylvania

TOM ALLEN, Maine

JIM DAVIS, Florida

JAN SCHAKOWSKY, Illinois

HILDA L. SOLIS, California

CHARLES A. GONZALEZ, Texas

JAY INSLEE, Washington

TAMMY BALDWIN, Wisconsin

MIKE ROSS, Arkansas

BUD ALBRIGHT, Staff Director

DAVID CAVICKE, Deputy Staff Director and General Counsel

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

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

ED WHITFIELD, Kentucky, Chairman

CLIFF STEARNS, Florida

CHARLES W. ‘‘CHIP’’ PICKERING,

Mississippi

CHARLES F. BASS, New Hampshire

GREG WALDEN, Oregon

MIKE FERGUSON, New Jersey

MICHAEL C. BURGESS, Texas

MARSHA BLACKBURN, Tennessee

JOE BARTON, Texas,

(Ex Officio)

BART STUPAK, Michigan

Ranking Member

DIANA DEGETTE, Colorado

JAN SCHAKOWSKY, Illinois

JAY INSLEE, Washington

TAMMY BALDWIN, Wisconsin

HENRY A. WAXMAN, California

JOHN D. DINGELL, Michigan,

(Ex Officio)

(II)

LETTER OF TRANSMITTAL

U.S. HOUSE OF REPRESENTATIVES

COMMITTEE ON ENERGY AND COMMERCE

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

November 2, 2005

To the Members of the Committee on Energy and Commerce:

It is our pleasure to forward to you for your information the bipartisan report entitled ‘‘Waste, Fraud, and Abuse Concerns in the

E-rate Program,’’ unanimously adopted by the Subcommittee on

Oversight and Investigations on October 18, 2005. This report details the Subcommittee’s two-year investigation of the E-rate program, which is the Universal Service funding mechanism that subsidizes the provision of advanced telecommunications services for

schools and libraries.

The Subcommittee’s investigation revealed a well-intentioned

program that nevertheless has suffered from poor implementation

from the very start. These structural weaknesses made it particularly susceptible to waste, fraud, and abuse—specific cases of which

were examined during four Subcommittee hearings on the E-rate

program. To be sure, Congress shares some responsibility for the

program’s flaws because the program is founded on a very general

statutory basis. Looking forward, more time should be devoted to

crafting the legislative framework of this program to ensure it

achieves the goals that we want it to achieve.

It is clear to us, as we consider the work laid out in this report,

that many E-rate program weaknesses must be addressed legislatively to avoid waste and misuse. In light of this, we are transmitting this report to the full Energy and Commerce Committee, and

commend it particularly to our colleagues on the Telecommunications and Internet Subcommittee, so that our work can assist the

Committee in crafting the appropriate legislative proposals. The report provides a bipartisan list of findings, and a set of eleven principles that should help guide our deliberations over program reform. We appreciate your giving it your careful consideration.

Sincerely,

ED WHITFIELD, Chairman

BART STUPAK, Ranking Member

Subcommittee on Oversight and Investigations

(III)

C O N T E N T S

Page

I. Introduction and Overview .......................................................................... 1

Key Findings ..................................................................................................... 1

Recommendations ............................................................................................. 3

II. Background .................................................................................................. 5

The E-rate Program ......................................................................................... 5

The Subcommittee Investigation ..................................................................... 8

III. Case Studies and other work of the Investigation .................................. 10

A. E-rate and the Puerto Rico Department of Education ............................. 10

Findings from PRDOE-focused hearing and related investigation .............. 13

B. San Francisco Unified School District’s E-rate Experience, and NEC

BNS ................................................................................................................ 19

Findings from NEC-focused hearings and related investigation .................. 22

C. The Denial of $500 million in applicant requests associated with

IBM ................................................................................................................ 24

Findings from IBM-focused hearing and related investigation .................... 26

D. E-rate related investigation of Chicago Public Schools ............................ 31

Findings from Chicago Public Schools related investigation ........................ 34

E. E-rate related investigation of Atlanta Public Schools ............................. 38

F. GAO Work Requested by the Committee ................................................... 41

GAO Recommendations ................................................................................... 46

(IV)

(1)

WASTE, FRAUD, AND ABUSE CONCERNS WITH

THE E-RATE PROGRAM

BIPARTISAN STAFF REPORT FOR THE USE OF

THE COMMITTEE ON ENERGY AND COMMERCE

October 18, 2005

I. INTRODUCTION AND OVERVIEW

In 1996, Congress mandated that schools and libraries receive

discounted telecommunications services through the newly codified

Universal Service Fund. In turn, the Federal Communications

Commission (FCC) proceeded to implement that mandate, commonly known today as the E-rate program, through a private nonprofit corporation known as the Universal Service Administrative

Company (USAC). Within USAC, the Schools and Libraries Division (SLD) is responsible for the daily administration of the E-rate

program. Between 1998 and the present time, USAC has ‘‘committed’’ over $15 billion and disbursed over $10 billion, to discount

the costs of eligible telecommunications projects for schools and libraries throughout the country.

While E-rate has arguably benefited the nation’s children, the

program falls far short as an example of efficiency, effectiveness, or

integrity. In fact, the Subcommittee on Oversight and Investigations’ in-depth examination of the E-rate program uncovered serious instances of waste, fraud, and abuse. This work highlighted instances in which all program participants—the FCC, USAC,

schools, and vendors—have neglected their respective obligations

and responsibilities under the program’s rules.

Key Findings

The Subcommittee’s investigation developed along several directions, culminating in three public ‘‘case study’’ style hearings and

the compilation of significant additional information regarding the

E-rate programs at Chicago Public Schools and Atlanta Public

Schools. Further information was developed, at the direction of the

Subcommittee, through a comprehensive review by the Government

Accountability Office (GAO), which was reviewed in a fourth public

hearing on the E-rate program. Key findings from the Subcommittee investigation include:

• The FCC crafted an ambitious multi-billion-dollar funding program, utilizing an ‘‘unusual’’ organizational structure, and then

never conducted a comprehensive assessment to determine

which federal requirements, policies, and practices apply to the

E-rate program, to USAC, or to the Universal Service Fund

itself. • Although more than $15 billion has been ‘‘committed’’ by the Erate program during the past 8 years, the FCC did not develop

performance goals and measures that could be utilized to asVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
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sess the specific impact of the funds and to improve the management of the program. • The FCC’s three key oversight mechanisms for the E-rate program—rulemaking procedures, beneficiary audits, and reviews

of USAC decisions (i.e., appeals decisions)—are not sufficient to

manage the program. • Over the course of three program years, more than $100 million

in E-rate funds were provided to one large school district after

it certified that its E-rate funded network would be operational

and put to educational use, when, in fact, it was never made

operational or put to any significant educational use. • The FCC’s failure to help resolve the above school district’s enormous mismanagement and planning problems contributed to

the waste of E-rate funds, and reflects the underlying deficiencies of the FCC’s program management and oversight. • Currently, the E-rate program does not require beneficiaries of

large sums of E-rate funds to comply with standard federal

oversight and accounting requirements, such as the Single

Audit Act. • Some school districts have acquired goods and services through

the E-rate program without using a formal bidding process,

contrary to both the program’s rules and local regulations,

even though those districts might have otherwise followed the

E-rate Form 470 application process. • A fundamental weakness in the program involves technology

planning. Some school districts have received E-rate related

goods and services without an adequate technology plan. More

broadly, E-rate’s current technology plan requirements provide

no meaningful protection from ‘‘gold-plating’’ (procurement of

technology goods and services far beyond reasonable school district needs and resources). • The FCC Inspector General (IG) cannot provide adequate assurance that the program is sufficiently protected against waste,

fraud, and abuse. Furthermore, the FCC Wireline Competition

Bureau (WCB) does not know the magnitude of potential fraud.

• The FCC IG faces several obstacles in implementing effective

independent oversight of the program, including insufficient resources to conduct audits and provide audit support to law enforcement investigations.

• The certifications contained on E-rate program application documents apparently have little effect in deterring some school officials and some vendors from taking advantage of the program’s weaknesses. In one case examined by the Subcommittee, school officials and several employees of service

providers forged documents and signatures as part of a conspiracy to defraud the E-rate program.

• Weak E-rate program competition requirements and inadequate

oversight allowed a group of vendors to completely manipulate

the competitive process for E-rate program goods and services,

without USAC detecting the fraud.

• Weaknesses in the E-rate program application process and related certifications permitted non-competitive procurement of

E-rate program goods and services around the country in

Funding Years 2001 and 2002. The flawed application process

3

resulted in the waste of millions of dollars in one school district

in Funding Year 2001, and almost led to the waste of tens of

millions more among 21 other large school districts in Funding

Year 2002. Today, the FCC continues to allow anti-competitive

or insufficiently competitive procurement practices, due to remaining weaknesses in the application process.

• The FCC only recently established guidelines for debarment of

vendors and applicants, but set standards of program abuse too

high, requiring first a civil judgment or criminal conviction

against the participant before a suspension may occur and debarment can be considered.

• The E-rate program’s ambiguous rules and procedures, and extensive delay in the distribution of funding, create significant

confusion among applicants and vendors. This confusion and

delay tends to increase program waste.

• E-rate program fund disbursements generally go directly to vendors, rather than being disbursed through the program applicants (the schools and libraries), which lessens applicants’ control over work performed and diffuses responsibility and accountability for program integrity; although this structure

stems from the FCC’s interpretation of the underlying statutory language, it nevertheless makes oversight and enforcement more difficult.

In sum, the Subcommittee’s investigative work reveals a well-intentioned program that nonetheless is extremely vulnerable to

waste, fraud, and abuse, is poorly managed by the FCC, and completely lacks tangible measures of either effectiveness or impact.

This bipartisan staff report recommends certain principles that

should guide any effort to improve the E-rate program. These principles are substantially based upon the results of the Subcommittee’s investigation and staff opinion that effective improvements

may likely require significant legislative reform.

Recommendations:

Based upon the results of the E-rate program investigation, staff

identified several overarching principles that should guide program

reform:

1) The FCC and USAC must conduct more rigorous oversight. To

accomplish the necessary rigorous oversight and strong program auditing, the FCC and USAC require adequate personnel

resources.

2) The E-rate program must have concrete and achievable goals

and measures of effectiveness, so that Congress can assess the

specific impact and value of program spending. Among a number of key issues, Congress should consider: (a) whether the

FCC is the proper agency to manage and oversee the E-rate

program; (b) whether the largely arbitrary $2.25 billion annual

price tag is appropriately set; (c) whether control and management of this large sum is appropriately delegated to a non-governmental entity; and, (d) the extent to which E-rate program

discounts should cover technological infrastructure and related

services, i.e., whether the program covers too much, or should

expand to subsidize key technology components that are not

4

currently eligible, such as computers, software, and teacher

training.

3) In the interest of ensuring the maximum return on E-rate program funds, the E-rate program must have a mechanism to ensure that ‘‘gold-plating’’ is minimized. That is, schools should

request and receive only what they genuinely will put to effective use, and technology plans should not be an empty exercise.

The FCC and USAC should develop a mechanism to verify that

applicants’ requests match legitimate education-technology

needs; this will require revising the technology planning process and requirements.

Among other things, complete and approved E-rate program

technology planning documents should be the required first

step before posting a Form 470. These planning documents cannot be broad-brush, but rather need to: (a) account for the current state of the supporting physical infrastructure at each

school for which funding is requested; (b) specify exactly how

the technology will be implemented in support of the curriculum, including details of the necessary level of teacher

training and the school district’s plan for providing such training; and (c) include the district’s specific budget commitments

for infrastructure, training, and maintenance, as well as the

computers and other complementary equipment required to

make use of the E-rate program funded internal connections

being requested.

4) Reform should incorporate the GAO’s recent recommendations

for the FCC, including that the FCC: (a) comprehensively determine which federal accountability requirements apply to Erate; (b) establish meaningful E-rate program performance

goals and measures; and (c) take steps to reduce its backlog of

appeals. The FCC must take these necessary and reasonable

actions in order to begin to address the problems identified by

this Subcommittee, the FCC IG, and the GAO. In addition,

Congress should consider directing the GAO to continue its examination of the E-rate program, focusing on the issues relating to the complexities posed by the FCC’s organizational relationship with USAC and provide guidance to Congress and the

FCC on the questions that flow from this organizational structure.

5) The E-rate program requires an organizational structure that

encourages greater accountability of all program participants—

including vendors, consultants, schools, USAC, and the FCC

Wireline Competition Bureau.

6) The FCC must acquire, and promptly provide to Congress, some

tangible measure of the extent and scope of program waste,

fraud, and abuse, i.e., statistically significant auditing must be

undertaken immediately and accomplished before the end of

this Congress. The necessary resources should be made available to ensure an appropriate number of beneficiary audits can

be performed to make an accurate assessment of program

waste, fraud, and abuse.

7) School districts should hold a greater ‘‘stake’’ in their applications for E-rate program discounts. This may be accomplished

in a number of ways, including several possibilities that were

5

1See Telecommunications Act of 1996, Conference Report, U.S. House of Representatives (Report 104-458) at 132-33.

suggested during the Subcommittee’s hearings, such as: (a) requiring higher co-payments by the school districts; (b) drafting

certifications for vendors and school officials that include

tougher criminal penalties; (c) restructuring the program into

a reimbursement paradigm (i.e., direct reimbursement to

schools and libraries); or (d) conducting verification and inspection of E-rate program related work before discounts are paid

out. There are likely other creative options to achieve this goal,

as well.

8) The E-rate program requires stronger ‘‘built-in’’ disincentives to

waste, fraud, and abuse (as opposed to the external disincentives of FCC IG auditing or Justice Department criminal prosecution), including such options as mandatory audits, civil penalties for rule violations, and more flexible provisions for program debarment.

9) The program needs a much more robust competitive bidding

structure than it currently possesses, in order to ensure that

E-rate program funds support the highest per-dollar value possible. Achieving this goal is not simply a matter of mandating

that price should be considered the primary factor. Congress

should consider whether an adequate competitive bidding environment could be better assured by incorporating relevant portions of the Federal Acquisition Regulations (FAR) to the Erate program’s rules and regulations.

10) The FCC and USAC should act immediately to specify that, for

all ‘‘Priority II’’ (internal connections) applications exceeding a

reasonable threshold, a portion of the district’s approved funding must be set aside for an independent audit of the total

funds committed. Further, USAC must be provided with a copy

of all audit results within 30 days of audit completion and

within one year of the expenditure.

11) The GAO should examine the potential for (and scope of any)

waste, fraud, and abuse in the E-rate program’s funding of

‘‘Priority I’’ services (telecommunications and Internet access

fees).

II. BACKGROUND

The E-rate Program. Under the Telecommunications Act of

1996 (P.L. 104-104) (the Act), Congress codified a longstanding policy commitment to ensure ‘‘universal service’’ in the provision of

telecommunications services, and expanded that policy to cover

schools and libraries. Specifically, to ‘‘assure that no one is barred

from benefiting from the power of the information age,’’ 1 Congress

mandated that elementary and secondary schools, and libraries, be

offered discounted access to telecommunications services for educational purposes, including ‘‘advanced’’ telecommunications services.

Consequently, the FCC, which is responsible for implementing

universal service policy, established the Schools and Libraries Universal Support Mechanism—more popularly known as the E-rate

program. In late 1997, the program began preparations for proVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
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2 An E-rate program fiscal year is referred to herein as a ‘‘Funding Year.’’ Generally, a given

E-rate Funding Year runs from July 1st of one calendar year to June 30th or September 30th

of the next calendar year, depending on the category of goods or services funded. 3 At the time of this report, the fee assessed on rate-payers’ phone bill amounts to 10% of the

total long distance calling costs. 4The genesis of the organizational structure and relationship of USAC, NECA, and the FCC,

and the resulting concerns, are explained in more detail infra, pages 46-47, and also in the GAO

Report prepared for the Committee. 5See Code of Federal Regulations (CFR), Title 47, Part 54, §§1 et. seq.

viding discounts to eligible schools and libraries for fiscal year 2

1998. The E-rate program is funded through the Universal Service

Fund (USF, or, the Fund), which is supported by a ‘‘Universal

Service Fee’’ charged to telecommunications providers—and which

is usually passed on to consumers’ phone bills.3 USAC administers

the Fund under the direction of the FCC. USAC is a non-profit corporation and wholly-owned subsidiary of the National Exchange

Carrier Association (NECA), whose members are comprised of

about 900 ‘‘local’’ telephone companies.4 In 2004, USAC disbursed

approximately $5.7 billion in support of four ‘‘universal support

mechanisms’’: $3.5 billion for the ‘‘high cost’’ program, $760 million

for the ‘‘low-income’’ program, $21.7 million for the ‘‘rural health

care’’ program, and $1.4 billion for the E-rate program.

The E-rate program provides funding to service providers (telecommunications vendors) to support discounts for schools and libraries in three service categories: telecommunications, Internet access, and ‘‘internal connections’’ (i.e., the cabling and network infrastructure necessary for multiple users within schools to access the

Internet). The discounts range from 20% to 90% of the costs of eligible products and services, depending on both the rate of participation in the National School Lunch Program and the urban/rural

status of the school or school district. USAC publishes a comprehensive and annually updated list of goods and services that are

eligible for E-rate program discounts.

As of October 2005, USAC collected and approved for disburse- ment roughly $15 billion since the program’s start. Approximately

$10 billion of that amount has actually been disbursed to E-rate

program service providers. The amount of funding available each

year for the E-rate program is capped at $2.25 billion. However,

current rules permit unused fund balances to be rolled over to following years. Thus, $2.4 billion was available for funding commitments in 2004. Each year, requests from nearly 40,000 applicants

for E-rate program funds far exceed the available funding. (Approximately $4.3 billion in requests were submitted in 2004.) Because of the limited funds, program rules prioritize discount commitments first by type of service and then by discount level of the

applicant. Under program rules, all eligible applicants receive support for so-called ‘‘Priority I’’ services—that is, telecommunications

and Internet access fees. Only applicants qualifying for very high

discounts (typically at 80% and higher) receive the remaining support for internal connections, or ‘‘Priority II’’ services, which account for the largest amount of applicant funding requests.

USAC develops and implements procedures, under the supervision of the FCC, to administer the E-rate program in accordance

with the program rules.5 Essentially, for an eligible applicant to receive funding it must choose services that it intends to use effectively for educational purposes, and must do so through a competiVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
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6This report’s references to schools and school systems apply to libraries as well.

7See Federal-State Board on Universal Service, CC Docket No. 96-45, Report and Order, FCC

97-157, ¶ 570.

tive bidding process (to ensure cost effectiveness). Applicants must

also certify that they have the resources—including a budget, computers, teacher training, and infrastructure—necessary to make effective use of the products and services for which they request discounts. Put another way, applicants are required to ‘‘do their homework’’ before applying for funds. Schools accomplish this by developing technology plans, which are meant to set forth in detail how

the applicant intends to use the technologies and how it plans to

integrate technology into its curriculum.— Applicants also must

bear the costs for any necessary initial planning for the implementation of E-rate program products and services, such as design of

technology architecture, determination of project scope, and evaluation of the products and services needed.

After determining the products and services for which they will

seek E-rate program discounts, the applicants file—for posting on

USAC’s Web site—an FCC ‘‘Form 470.’’ Applicants must supply information on this basic form with sufficient specificity for potential

bidders to formulate bids for eligible E-rate program products and

services. According to the statute, E-rate program discounts must

be provided to eligible applicants who make a ‘‘bona fide request’’

for products and services for educational purposes. Through its

May 8, 1997 Universal Service Order, the FCC attempted to implement this requirement by mandating that applicants (i.e., the

school or school district): 6 ‘‘(1) conduct internal assessments of the

components necessary to use effectively the discounted services

they order, (2) submit a complete description of the services they

seek so that it may be posted for competing service providers to

evaluate, and (3) certify to [sic] certain criteria under penalty of

perjury.’’ 7

Since the program’s inception, the integrity of this E-rate program application process has relied (almost exclusively) upon applicants to (1) certify that they possess the necessary resources and

plans to use the products and services for which they request Erate program subsidies, and (2) choose the most cost-effective products and services through a competitive bidding process for those

products and services. When applicants subsequently select the

most cost-effective bid or bids, price must be the primary factor

considered. After winning vendors are chosen from the pool of bidders, the—applicant requests funding from USAC for specific products and services on an FCC ‘‘Form 471.’’

After the applicant files a Form 471, having its own set of mandatory certifications, USAC evaluates the request and then makes

a funding commitment to the applicant, adjusting the request if

necessary or rejecting the request outright if it fails to conform to

the program’s rules. E-rate program funds are disbursed by

USAC’s Schools and Libraries Division (SLD) directly to service

providers, based upon invoices submitted by the service provider

and a certification submitted by the applicant that installation of

the products and services has or is about to commence, or has been

completed. Applicants submit their ‘‘co-payment’’ for the E-rate program goods and services directly to the service providers.

8

While disbursing funds, USAC also conducts invoice review, special investigations, and site visits when circumstances warrant. Finally, USAC draws on both its internal audit staff and independent

auditors (in consultation with the FCC and the FCC IG) to gather

further information regarding program integrity and to identify

waste, fraud, or abuse of the disbursed funds.

Since the program’s inception, however, serious questions concerning the ability of these administrative processes to effectively

tackle the risks of waste, fraud, and abuse have been repeatedly

raised—despite some continuing efforts to improve program oversight and management by both the FCC and USAC. These questions highlight fundamental weaknesses in the program’s application and review processes, as well as in the overall structure and

direction of the program.

The Subcommittee Investigation. In January 2003, the Subcommittee on Oversight and Investigations initiated its investigation of the E-rate program to examine the potential for waste,

fraud, and abuse in the program. The investigation was in part

prompted by news reports of incidents in December 2002 that suggested serious problems of program waste, fraud, and abuse. In

particular, a New York City E-rate program vendor was indicted on

federal charges for defrauding the E-rate program. Additionally,

the FCC IG’s October 31, 2002, semi-annual report to Congress described a number of concerns with the program, as well as the rise

in law enforcement activity, including the creation of a special Department of Justice (DOJ) E-rate program task force. Further, the

FCC IG criticized the insufficient funding devoted to oversight and

concluded that, ‘‘until such time as resources and funding are available to provide adequate oversight for the USF program, we are

unable to give the Chairman, Congress and the public an appropriate level of assurance that the program is protected from fraud,

waste and abuse.’’

At the outset, Committee staff interviewed FCC and USAC officials, GAO staff, as well as some E-rate program vendors, to identify the scope and nature of the issues affecting the E-rate program. That initial work revealed that problems of waste, fraud, and

abuse have followed the E-rate program from the beginning. For

example, Committee staff learned that the relatively small number

of targeted audits of funding beneficiaries over the first two years

identified more than $10 million in inappropriate funding disbursements.

Also at this time, there were approximately 30 active Federal

and state investigations of either vendors or recipients of E-rate

program funds around the United States—involving, in aggregate,

more than $200 million of questionable funding. Moreover, ongoing

and ensuing work by the FCC IG, and concerns raised by both the

IG and the GAO, revealed an inadequate system of E-rate program

oversight. The IG had estimated that the E-rate program, given the

magnitude of its yearly funding, may face up to $180 million in improper and fraudulent disbursements annually, based upon a GAO

analysis of similar-sized programs. This also suggested that the

emerging evidence of fraud and abuse around the country might

just be the tip of an iceberg. Committee concerns on this front were

underscored by the absence of a statistically representative audit

9

8The requests to USAC, which fully cooperated in the document production, were augmented

by a subpoena on April 29, 2003 for certain records that USAC could not initially provide due

to confidentiality concerns. 9The investigation focused on waste, fraud, and abuse in provision of Priority II funding; it

did not examine the provision of Priority I services to determine the extent, if any, of problems

under that category of funding. The FCC IG testified that his office has not conducted enough

work to draw a conclusion about problems in that funding category, and acknowledged that

waste, fraud, and abuse may exist there as well.

of the full program. As a result, the Committee had little reassurance that the efforts made by the FCC and USAC to administer the

E-rate program and to improve program oversight and auditing

were actually addressing the full extent of the problems.

In light of this information, then-Chairman Tauzin and thenSubcommittee Chairman Greenwood wrote the FCC and USAC on

March 13, 2003, requesting records relating to implementation,

oversight, and management of the E-rate program.8 Further review

of preliminary information from vendors and applicants participating in the program prompted the Committee to seek information

on the implementation of E-rate program products and services at

the school level. Data showed that the largest potential for waste,

fraud, and abuse resided with the provision of ‘‘internal connections’’ (Priority II) products and services. Accordingly, staff identified several internal connections service providers whose participation in the program was particularly large and active.9 On July 14,

2003, then-Chairman Tauzin and then-Subcommittee Chairman

Greenwood wrote to the five largest internal connections vendors

over the duration of the E-rate program (by funding receipts), including the companies SBC Telecommunications and IBM. Additionally, the Committee wrote to seven other vendors that ranked

among those with the largest rate of increase in internal connections funding requests (over $30 million for any given year), which

included the company NEC Business Network Solutions, among

others.

Subsequent document productions and related interviews focused

the inquiry on certain topics that illuminated some of the main

problems plaguing the E-rate program. The staff pursued several

case studies that resulted in four public hearings by the Oversight

and Investigations Subcommittee, as well as additional work that,

while not directly addressed during the hearings, provided further

information that has proven helpful in identifying major program

issues.

In the course of this work, it is important to note, the Committee

staff observed instances of the E-rate program working effectively.

Such cases helped to underscore the importance of identifying Erate program weaknesses and vulnerabilities, and of developing

meaningful fixes to the program.

An example of the E-rate program’s potential can be found on the

southwest side of the City of Chicago, at the Nathaniel Greene Elementary School (Greene School). Of the 803 students in kindergarten through fifth grade at Greene, 88% are Hispanic. For many,

if not most, English is a second language. Roughly 94% of the students are enrolled in the free or reduced lunch program. Nonetheless, the combination of technology, determined administrators, and

a well-trained and dedicated faculty is transforming the educational experience to a level comparable with the best that suburVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
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10The Greene School’s Web site can be found at http://www.greene.cps.k12.il.us/

ban schools have to offer. Not only are computers used effectively

in the lab and the library, but in each classroom as well. Even a

brief visit found kindergarten students spelling out words on their

computers, third grade students preparing PowerPoint  presentations, fifth grade students forecasting the weather, and a science

fair that would impress any elementary school teacher. Most important, the children were truly engaged in the learning process

and appeared to delight in their assignments. The E-rate program

has played a big role in providing the opportunity for learning in

this inner-city community.10

The School District of Philadelphia presents another positive example of the E-rate program’s impact. When that district began to

participate in the E-rate program, much of the school district’s

physical infrastructure was obsolete and it had already completed

a five-year plan to modernize education-related technology. Instead

of falling for vendor temptation to ‘‘gold-plate’’ problem schools,

Philadelphia chose a slower and economically reasonable path to

maximize the efficient use of technology. The school district applied

for E-rate program funds only as the technology plan dictated, and

it never requested more than could be effectively integrated in any

given year.

School district officials used the E-rate program as a complement, not as a crutch. Local funding sources were used to upgrade the schools’ electrical systems, buy computers, develop software, and, in part, to install wireless networks and construct a

fiber-optic network. Philadelphia’s plan emphasized and funded

training for teachers and students. School district officials tied the

installation of technology in each of the schools to both professional

development and specific curriculum needs—hence, assuring productive and efficient use. The school district refrained from installing expensive technology simply because E-rate program funds

were available.

Philadelphia’s completion of an integrated and comprehensive

technology plan, effective teacher training, and resistance to overstating its needs or procuring unnecessary goods and services, all

demonstrate the proper use of the E-rate program.

III. CASE STUDIES AND OTHER WORK OF THE INVESTIGATION

The following section details the key facts of specific case studies

and their related hearings, followed by additional information relating to those parts of the investigation concerning E-rate program

participation by Chicago Public Schools and Atlanta Public Schools,

and finally, a discussion regarding the GAO’s recent E-rate program report that was requested by the Subcommittee.

A. E-rate and the Puerto Rico Department of Education

(PRDOE)

In the case of Puerto Rico’s experience with seeking E-rate program discounts for its public schools, the situation involved: (1)

questionable planning and a clear failure by administrators of the

school district to make any use of E-rate program funded infrastructure and ensure the integrity of the investment of E-rate proVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
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gram funds; (2) questionable implementation of and billing for Erate program products and services by the vendors, Puerto Rico

Telephone Company (PRTC) and Data Research Corporation

(DRC); and, (3) a critical failure on the part of USAC and especially

the FCC to respond effectively to the severity of a situation in

which more than $100 million of E-rate program funds had been

spent, with nothing significant to show for it. Thus, 50,000 students have been graduating each year from the largest school system in the country without having any of the broadband Internet

access (IA) that the program is intended to support.

PRDOE operates the entire public school system for the Commonwealth of Puerto Rico, overseeing approximately 610,000 students and 1,540 schools. By number of school facilities, the system

is the largest in the United States (by comparison, the New York

City Board of Education administers 1,200 schools but one million

students, and ranks second). Additionally, Puerto Rico is among

the poorest school districts in the United States, eligible for 90%

E-rate program discounts district-wide.

PRDOE applied for funding in each of the first six years of the

E-rate program—from 1998 to 2003—and has not applied for funding since. In the first three years of the program—1998, 1999, and

2000—USAC committed and disbursed funds on behalf of PRDOE

to two service providers, PRTC and DRC. All told, USAC disbursed

$101.2 million during this period—with PRTC receiving a total of

$31.6 million for the supply of Internet access and broadband (T1)

service, and DRC receiving a total of $69.6 million for a combination of internal connections (totaling $58.6 million), Internet access,

and T1 service fees. PRDOE’s E-rate program applications stated

that the funding was intended to support broadband service and

the underlying infrastructure to enable Internet access for all 1,540

schools.

A new governor of Puerto Rico, elected in November 2000, appointed a new Secretary of Education, who assumed leadership of

PRDOE in January 2001. After assuming office, the new administration continued the Funding Year’s E-rate program application

process started by the departing administration. Over the course of

2001, the new PRDOE administration progressively learned

through vendors, school personnel, and site visits of chronic problems within the schools—in terms of electrical infrastructure, security, inadequate teacher training, and other facility problems. Most

important, the fact emerged that very few schools—and virtually

no students—actually had access to computers connected to the

Internet.

In the spring of 2001 the Office of the Comptroller of Puerto Rico

reported its preliminary findings of an audit of PRDOE’s E-rate

program to the FCC IG, noting concerns about competitive bidding

irregularities. The IG collected information on PRDOE from USAC

and proceeded to make a referral to the U.S. Department of Justice

(DOJ). (At the same time, the DOJ was investigating broader corruption by the former Secretary of Education, who later was indicted and convicted, and is serving 12 years in federal prison.) In

October 2001, an Arthur Andersen audit conducted during the

summer of 2000 was released. The audit showed that PRDOE had

failed to acquire some 100,000 computers to be used by students

12

to connect to the E-rate program funded infrastructure. On December 5, 2001, USAC wrote PRDOE requesting a report on questions

generated by the audit, stating that PRDOE’s outstanding E-rate

program applications would not be processed or any more funds

disbursed until USAC received and evaluated the information. To

date, $102 million in requests (for Funding Years 2001, 2002, and

2003) still await USAC decisions.

PRDOE responded to USAC’s inquiries on January 15, 2002,

with additional information about problems it had identified in the

management and planning of E-rate program related work done by

the previous administration, and also identified steps it was taking

to rectify the situation. Over the course of the next year, PRDOE

made presentations to USAC and FCC staff, describing efforts to

ensure resources were available and to rectify problems identified

in the workings of the network. By January 30, 2003, PRDOE had

petitioned the FCC to direct USAC to process its applications.

In May 2003, the FCC issued a request for public comment on

PRDOE’s petition for the continued processing of the outstanding

E-rate program funding requests. On November 14, 2003—two

years after E-rate program funding was halted—the FCC issued an

order directing USAC to (1) process applications for 2001 and 2002,

except for DRC-related funding, but only subsequent to an audit;

and (2) investigate the use of E-rate program funds during Funding

Years 1998, 1999, and 2000, after which the FCC would evaluate

the results and determine appropriate action. DRC-related funding

was held due to allegations of on-going investigations of DRC by

authorities in Puerto Rico and the United States.

In February 2003, following interviews with relevant parties at

PRDOE, PRTC, DRC, USAC, and the FCC, Committee staff visited

Puerto Rico to examine the infrastructure and high-speed network

that the E-rate program had funded, and to determine the extent

of the efforts by the current PRDOE administration to put the system to effective use. During the visit, Committee staff discovered

nearly $23.5 million in E-rate program funded equipment in a

PRDOE warehouse, in violation of program rules. The gear included about 73,000 ‘‘wireless cards’’ that were to be used in

PRDOE computers for the wireless portion of PRDOE’s network.

The Committee staff found the equipment shrink-wrapped and sitting on storage pallets. Committee staff also observed that, in the

schools that they visited, there were very few, if any, computers

dedicated to utilizing the E-rate program funded network, and especially the wireless half of the network. Staff also observed substandard equipment installation, placement of servers and switches

near open windows, and little security for protecting equipment

from vandalism. Due in part to a grossly inadequate number of

computers available for utilization of the system, a roughly $58

million high-speed computer network remained virtually unused.

Further, USAC paid $43 million for T1 service and Internet access fees, but because of the very small number of computers and

the inadequate training of teachers very few school children ever

benefited educationally from the learning resources broadband

Internet access made available by paying these fees. At the time

of the staff visit, Puerto Rico’s school children who could access the

Internet did so via 56K dial-up modems—staff learned that

13

broadband service had been terminated after July 2003 because,

according to school district officials, USAC had not yet released

more funding or processed outstanding E-rate program applications

for such services.

On June 17, 2004, the Subcommittee on Oversight and Investigations held the first of three hearings entitled: ‘‘Problems with the

E-rate Program: Waste, Fraud, and Abuse Concerns in the Wiring

of Our Nation’s Schools to the Internet.’’ The hearing examined: (1)

the factors surrounding the evident failure of PRDOE to make effective use of more than $100 million of E-rate program funding

from 1998 through 2001; (2) the role played by the school district’s

two principal E-rate program service providers, PRTC and DRC;

and (3) the actions taken by USAC and the FCC to identify and

resolve the school district’s problems, and what such actions demonstrated regarding oversight of the E-rate program generally.

The hearing provided a case study of the E-rate program and the substantial waste of more than $100 million in one large school district, and highlighted programmatic weaknesses—in the application process, the certification process, technology planning, auditing, implementation of goods and services, resolution of problems

by USAC and the FCC, and overall program guidance by the FCC.

Findings from the PRDOE-focused hearing and related investigation:

• Over the course of three years, more than $100 million in

funds were provided after PRDOE certified that its E-rate program

funded network would be operational and put to educational use,

when, in fact, it was never made operational or put to any significant educational use.

In the most egregious sign of this waste, funds were paid to vendors when the school district certified that key wireless components

of the network infrastructure were installed and operational, when

installation of those components had actually never occurred. The Committee staff discovery of $23.5 million of unused and unopened wireless cards in a PRDOE warehouse, which had been

invoiced as delivered and installed, represents one of the most flagrant examples of the failure to deliver or make use of goods and

services purchased through the E-rate program. (The investigation

identified similar patterns of failure in other school districts as

well, some of which are discussed below.) This failure signals an

underlying weakness of the E-rate program; that is, the difficulty

to ensure that E-rate program funded goods and services are put

to effective educational use. It also underscores a weakness in

USAC’s reliance on certifications in lieu of independent verification.

Until staff made the discovery, neither the FCC nor USAC knew

of the warehoused equipment, although school district officials

were fully aware of the circumstances. Moreover, these officials

seemed unaware that the situation amounted to a major program

rule violation.

Puerto Rico’s Comptroller testified that insufficient planning and

oversight by PRDOE contributed to the nonfunctional network.

Limited inspections by both the Comptroller and an outside consultant for the school district revealed inadequate facilities and security for equipment. Documents also revealed extensive problems,

14

either due to equipment malfunctions or the lack of technical training, for the school district to maintain consistent connectivity to the

Internet. The District neglected to provide training resources for

teachers during the time of funding, further limiting the ability to

make effective educational use of the E-rate program funds.

Puerto Rico’s deficiencies in resources, training, infrastructure

maintenance, and equipment installation also underscore the weakness in applicant certifications. Puerto Rico had certified, as required by the E-rate program on every application, that it possessed the resources necessary to make effective use of the goods

and services it was seeking. Yet this was clearly not the case, and

the program’s money was wasted. Given the annual number of Erate program applications, independent verification of all requests

may be prohibitively expensive; however, the situation in Puerto

Rico underscores the critical need to ensure the penalties behind

false certifications are sufficiently strong to effectively deter wasteful or fraudulent requests. • Over two years, and for more than 700 schools, a monthly fee of up to $1,500 per school was charged for T1 lines that were essentially not being utilized.

The failure to provide adequate internal connections infrastructure, sufficient computers for student access, and teacher training

did not stop the E-rate program from paying for broadband service

and Internet access. Hearing testimony and documents indicate

that approximately $43 million was disbursed for either T1 lines or

Internet access fees before the district’s follow-on applications were

placed on hold in December 2001. PRTC continued to provide

broadband service for the portion of the district’s schools under its

contract (760 schools at a monthly rate of $1,500 per school), irrespective of whether any schools were actively using the lines or had

fully functioning internal networks. In the vast majority of cases,

according to documents, testimony, and staff interviews, the networks were not utilized, but PRTC maintained that it was contractually obligated to provide the service. In the meantime, PRDOE

neglected to alert USAC that E-rate program funds were supporting unused services. The E-rate program cannot mandate how

often or how much a beneficiary actually uses the delivered goods

and services; but the circumstances in Puerto Rico nonetheless reveal a weakness with regard to ensuring that the delivered goods

and services are in fact used by students.

• The FCC did not help resolve PRDOE’s enormous funding

management and planning problems, and therefore contributed to

both the waste of E-rate program funds and the failure of the program there. This shows one symptom of the underlying problem of

the FCC’s poor program management and oversight.

The FCC and USAC squandered valuable time by delaying any

intervention in Puerto Rico, thus effectively prolonging the school

district’s E-rate program problems. Throughout 2002, according to

documents in the record, PRDOE continued infrastructure upgrades and informed the FCC and USAC regarding its progress, to

ensure that resources would be available to put the E-rate funded

internal connections to effective use. PRDOE reported spending approximately $136 million in facility upgrades, computer and infrastructure purchases, and training. In the course of meetings with

15

USAC, the district stressed the urgent need for releasing the Erate program funds in order to continue development of the network. During its October 1, 2002 presentation, Puerto Rico requested that USAC act upon its Funding Year 2001 and 2002 requests—again citing its work to ensure resources would be available, and the urgency of making the E-rate program funded internal connections available to the school system.

At the same time, according to the record and staff interviews,

USAC and the FCC’s Office of General Counsel, in coordination

with staff at the FCC’s Wireline Competition Bureau (WCB), prepared a plan to allow USAC to resume processing Puerto Rico’s

2001 and 2002 applications, provided that the district made certain

certifications. The FCC examined the U.S. Department of Education’s prior work in Puerto Rico when developing the plan. The

FCC’s General Counsel outlined to the DOJ its intentions to process Puerto Rico’s funding requests, and asked the DOJ to respond

with objections within fourteen days. The FCC letter explained that

absent any objections, it would ‘‘go forward with the process of reviewing and granting, subject to conditions, PRDOE’s application

for funding years 3 and 4 [sic, years 4 and 5 were at issue].’’ The

FCC’s self-described ‘‘work-out’’ conditions required PRDOE to

enter a binding agreement to take various steps to establish compliance and demonstrate the ability to use the funds, including hiring an independent auditor at PRDOE’s expense. The DOJ did not

respond to the FCC. Subsequently, however, the FCC requested on

January 30, 2003, that Puerto Rico submit a petition for the release of the funds. Initially, the FCC planned to process the district’s petition as a unique case, without public notice. Puerto Rico’s

attorney told Committee staff that the FCC made no indication

that the petition would be posted for public comment.

In May 2003, however, the FCC decided that Puerto Rico’s request should obtain public comment. According to Committee staff

interviews with the FCC, the WCB decided that the district’s funding request provided an opportunity for the agency to develop a

broader policy concerning waste, fraud, and abuse in the E-rate

program. Thus, the FCC abandoned its ‘‘work-out plan,’’ and instead noticed the Puerto Rico petition on May 16, 2003 for public

comment. On November 25, 2003—two years after USAC initially

postponed further funding for Puerto Rico—the FCC issued an

order instructing USAC to: (1) process funds for 2001 and 2002 (excluding any funding related to the vendor DRC), but only after

USAC conducted an audit; and (2) investigate Puerto Rico’s use of

E-rate funds during Funding Years 1998, 1999, and 2000, following

which the FCC would evaluate the results and determine any appropriate action.

Notably, the FCC order did not contain the procedures detailed

in the fall 2002 ‘‘work-out plan.’’ Much of the lengthy consultation

and negotiation between the FCC and the district was abandoned

in favor of a more arms-length approach. By contrast, with regard

to Puerto Rico’s use of fiscally unrelated federal education funds,

the U.S. Department of Education (USDOE) has worked actively

and closely with the district to resolve major financial control

issues that arose under the Single Audit Act. The FCC’s decision

16

11 Currently, the threshold is set at $500,000, as determined biannually by the Office of Management and Budget. This sum is the aggregate of all Federal awards in a given fiscal year. 12See E-rate Hearing, June 17, 2004, Committee on Energy and Commerce, Serial No. 108-

92 (hereinafter referred to as Hearing, Part 1) at 160. According to the FCC IG and USAC, current E-rate beneficiary audits require that auditors examine Single Audit findings, if they exist,

to see if the findings affect E-rate program funding management; this requirement was not instituted until 2002. In May 2002, the USDOE had designated Puerto Rico a ‘‘high risk grantee.’’

The USDOE made this determination based upon information gathered through the Single

Audit Act—the USDOE tabulated literally 300 findings that were unresolved and extended as

far back as the mid-1990s. (The USDOE disburses roughly $1 billion annually to Puerto Rico

through various programs.) As a result, the USDOE requested periodic progress reports from

Puerto Rico as a precondition to receiving further education funding. While the findings did not

directly address the E-rate program, they questioned financial controls and oversight by the

school district that clearly might also impact the management and use of E-rate program resources. Based upon continued accountability concerns, the USDOE established ‘‘special conditions’’ in August 2002, and began its own ‘‘work-out’’ plan with PRDOE.

regarding Puerto Rico will likely delay resolution until well into

2005. • The E-rate program does not presently require compliance with

standard federal oversight requirements, such as the Single Audit

Act.

Important information regarding a given school district’s management and use of federal funds is not collected as a matter of

practice. From the program’s inception, there has been much confusion surrounding the legal status of E-rate program funds, and the

consequent statutory financial oversight and accounting activities

that should result from that legal status. One example of this is

the Single Audit Act of 1984, 31 U.S.C. §§7501 et. seq., which sets

forth certain auditing requirements for ‘‘non-Federal entities’’ that

‘‘expend’’ federal funds exceeding a specified amount 11 in a given

fiscal year. The single audit of all federal funds received by a nonFederal entity must be conducted by an independent auditor, in accordance with generally accepted government auditing standards.

The single audit is then submitted to the OMB’s Federal Audit

Clearinghouse, from which the OMB prepares and submits an annual report to Congress regarding all such audits.

In Puerto Rico, the Arthur Anderson ‘‘beneficiary’’ audit of the

school district’s E-rate program projects—commissioned by USAC—

did not identify the fiscal situation described by USDOE documents

contained in the record. The documents, not directly related to the

E-rate program, noted that ‘‘large scale fiscal and accountability

problems’ in the district had existed for a number of years ‘‘and appear to be continuing.’’ 12

• The Puerto Rico Department of Education acquired goods and

services through the E-rate program without using a formal bidding process, contrary to both the program’s rules and the Commonwealth’s regulations, and even though the district otherwise

followed the E-rate program’s Form 470 application process.

According to Puerto Rico’s Comptroller, the district did not adhere to formal bid procurement procedures in awarding E-rate program contracts during Funding Years 1998 and 1999. Further, the

Commonwealth’s Office of Management and Budget failed to approve the E-rate program contracts in accordance with established

rules. E-rate program rules require applicants to follow state and

local bidding requirements, as well as the E-rate program’s competitive bidding requirements. The Comptroller’s audit findings

showed that Puerto Rico had not done so. In contrast, USAC’s outside auditor, Arthur Andersen, did not identify the irregular proceVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
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13See Hearing, Part 1 at 233. 14 Arthur Andersen’s failure on this front raises questions of the quality of the auditors’ work.

The FCC IG expressed such concerns in a memo to the FCC Chairman, criticizing both Andersen’s work and USAC’s acceptance of this work. See Hearing, Part 1 at 184 et. seq. 15See 47 CFR 54.508(d). 16See FCC Order 97-157, ¶ 573-74. 17See Hearing, Part 1 at 108-09. However, the Arthur Andersen audit reported reviewing a

technology plan.

dures. For example, Arthur Andersen reported that the Form 470

was filed properly and noted ‘‘we ascertained through discussion

with PRDOE management that they had established appropriate

procedures to evaluate and select the most cost-effective bidder

based on the responses to their 470 posting. PRDOE management

also indicated that all bids received were appropriately evaluated

in accordance with state and local requirements.’’ 13 Arthur Anderson evidently did not verify the district’s assertions. Puerto Rico’s

broader problems, as identified by the Comptroller and the

USDOE, show the limited utility of the Form 470 and Form 471

as the basis for competitive procurement and obtaining E-rate program funds.14

• PRDOE acquired E-rate program related goods and services

without an adequate technology plan. More broadly, the E-rate program’s current technology plan requirements provide no meaningful protection from gold-plating (over-procurement of goods and

services, beyond the needs and resources of the school district).

Under E-rate program rules, an applicant must certify that it

has a technology plan that has been endorsed by its state, USAC,

or an ‘‘independent entity’’ approved by the FCC.15 According to the

FCC, this requirement ensures: (1) that schools and libraries prepare ‘‘specific plans for using [E-rate program funded] technologies,

both over the near term and into the future, and how they plan to

integrate the use of these technologies into their curriculum’’ and

(2) that the technology plans ‘‘are based on the reasonable needs

and resources of the applicant and are consistent with the goals of

the program.’’ 16

Puerto Rico’s then-Secretary of Education testified that no E-rate

program related documentation, including the required technology

plan, was located when his administration assumed office, suggesting that the prior administration, which was largely responsible for ordering the E-rate program goods and services, did not

have an approved plan. USAC relied on Puerto Rico’s certifications

on the program’s forms and did not review a technology plan, according to testimony.17 Moreover, whether or not a technology plan

existed and was approved, testimony, documents, and staff interviews all indicate that the E-rate program’s technology-plan requirements have no real effect on what applicants actually request

from the program. In short, the technology planning requirements,

as shown by the excessive purchases in Puerto Rico and in other

districts, are not effective and do not serve the intended purpose.

Although USAC implementing procedures specify criteria that

applicants must include in their technology plans, these criteria are

not enforceable or necessarily effective in guarding against goldplating. As the hearing showed, plan ‘‘approvers’’ have no incentive

to carefully monitor the substance and specificity of a technology

plan, and USAC does not regularly refer to the plans when assessVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
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18See ‘‘Hearing on Problems with the E-rate Program: GAO Review of FCC Management and

Oversight,’’ March 16, 2005, Committee on Energy and Commerce, Serial No. 109-7, at 30.

ing applications. Moreover, the FCC did not codify the criteria that

technology plans should cover until its August 2004 Fifth Report

and Order, and even so, other weaknesses in technology planning

still remain (infra, pages 31-32).

• The FCC IG cannot provide adequate assurance that the program is sufficiently protected against waste, fraud, and abuse. Furthermore, the FCC’s Wireline Competition Bureau does not know

the magnitude of potential fraud.

According to hearing testimony and staff interviews, to date no

statistically representative audit of the E-rate program has been

completed to determine the extent of waste, fraud, and abuse.

Without this critical information, the IG testified that he could not

assure that the program could be protected against waste, fraud,

and abuse. The deputy chief of the WCB also testified that the

magnitude of potential fraud was unknown. (See GAO discussion

below.)

Further, the FCC IG testified that those audits that have been

conducted and reviewed by his office raise several questions about

the program’s weaknesses. For example, according to an IG review

of 135 E-rate program ‘‘beneficiary audits,’’ only 65 beneficiaries

(schools and school districts) were determined to be compliant with

program rules, 22 were determined to be ‘‘generally’’ compliant but

with some problems identified, and 48 were not compliant and evidenced significant problems.18 Moreover, compliance with the rules

does not necessarily mean the absence of audit ‘‘findings’’ questioning the integrity of the application process. In short, the type

and magnitude of the problems found by this small number of audits suggests the need for a more thorough and systemic review of

the universe of applicants.

• The FCC IG faces several obstacles in implementing effective

independent oversight of the program. The IG testified that he

lacks sufficient resources to conduct audits and provide audit support to law enforcement investigations.

The FCC IG testified that his office would need approximately

$12 million to hire the contractors to conduct approximately 240

audits, as well as to hire additional FCC staff to review the work.

This would provide, according to the testimony, a statistically valid

sample to enable the FCC IG to draw conclusions concerning the

scope and nature of problems in the program.

Under the program’s current structure, the FCC cannot use

funds from the USF to accomplish this oversight work. Congress

would need to provide express statutory language authorizing the

FCC or FCC IG to use E-rate program funds for audits and oversight of the E-rate program, or otherwise appropriate money for

this purpose.

It should be noted that at the time of this report’s completion,

the FCC IG and USAC are in the final stages of signing three-way

contracts with outside audit firms to conduct statistically valid audits of all USF funding mechanisms. This would amount to an estimated 700 audits across the funding mechanisms and would likely

provide sufficient statistical confidence to make determinations

19

19See Request for Proposals for Audit Services in Support of Oversight Program for the Universal Service Fund, USAC.

about the scope of waste, fraud, and abuse both in the E-rate program and Universal Service funding in general.19

B. San Francisco Unified School District’s E-rate Experience, and NEC BNS

On July 22, 2004, the Subcommittee held the second of three

hearings entitled ‘‘Problems with the E-rate Program: Waste,

Fraud, and Abuse Concerns in the Wiring of Our Nation’s Schools

to the Internet.’’ The Subcommittee considered the circumstances

surrounding bid-rigging, inflated pricing, and the filing of false

statements during the application process for E-rate program funding by San Francisco Unified School District (SFUSD). During

Funding Year 2000, the competitive bidding process for SFUSD’s

E-rate program projects was completely corrupted, and the self-certification process failed. The Subcommittee also examined why

USAC approved more than $48 million for a plainly fraudulent application, and how the school district superintendent, Dr. Arlene

Ackerman, and others thwarted the scheme.

SFUSD has about 60,000 students enrolled in approximately 116

schools. During the first two years of the E-rate program, Funding

Years 1998 and 1999, SFUSD applied for $3.5 million and $6.8 million respectively. By contrast, in Funding Year 2000, SFUSD submitted several E-rate program applications totaling $112 million.

Of that total amount, two of the applications sought $106 million

in internal connections discounts through two vendors—InterTel,

Inc. ($23 million) and NEC BNS ($83 million).

During the applications’ processing, USAC conducted its routine

program integrity assurance (PIA) review. USAC also performed a

‘‘selective review’’ of the applications because of the magnitude of

funds being requested. Subsequently, in September 2000, USAC

committed $48.68 million to SFUSD for the products and services

to be provided by NEC BNS and InterTel. While USAC approved

this funding commitment, it neglected to perform the requisite due

diligence despite finding certain irregularities in the SFUSD application, such as altered district budget documents.

Shortly after Dr. Ackerman assumed leadership of SFUSD in August of 2000, she determined that there was something unusual

about the school district’s pending E-rate program applications,

turned down the funding, and alerted the FBI. In April, 2001 Ms.

Ackerman also requested that the San Francisco City Attorney investigate certain SFUSD employees, including Mr. Desmond

McQuoid, who were involved with the suspect E-rate program applications. The City Attorney ultimately uncovered a nation-wide

scheme to defraud the E-rate program, and filed a lawsuit under

the False Claims Act against NEC BNS, VNCI, InterTel, and other

parties involved with SFUSD’s E-rate program application.

On May 27, 2004, NEC BNS pleaded guilty to federal antitrust

violations under Section 1 of the Sherman Act, and to wire fraud.

As part of the plea agreement, NEC BNS agreed to pay $20.7 million in fines and restitution. According to both the plea agreement

and the testimony provided by San Francisco officials before the

20

20On April 7, 2005, VNCI, Judy Green, Allan Green, George Marchelos, and others were

charged in a 22-count indictment with wire fraud, conspiracy, and various federal antitrust violations related to E-rate programs in more than 20 schools or school districts throughout the

country. See United States v. Video Network Communications, Inc. (N.D. Cal.).

Subcommittee, NEC BNS, VNCI, and InterTel established an

agreement to circumvent competition for E-rate program projects

by rigging the bidding process, submitting fraudulent bids, and predetermining who would win. Afterwards, the co-conspirators would

submit Form 471s that grossly inflated the cost of the work (for example, SFUSD’s Form 471 was inflated by roughly $26 million),

forging signatures and falsifying documents when necessary. Between December 1999 and March 2001, the co-conspirators used

the bid-rigging scheme at several schools across the country. On

December 8, 2004, the Justice Department announced that InterTel

also pleaded guilty to similar federal antitrust violations under

Section 1 of the Sherman Act, and to wire fraud. InterTel’s agreement included fines and restitution totaling $8.7 million.20

For the July 22nd hearing, the Subcommittee subpoenaed four

witnesses who had been invited but declined to voluntarily attend

and testify. The individuals included: Mr. Thomas J. Burger, the

President and CEO of NEC BNS; Mr. William Holman, the former

Senior Vice President of Sales for NEC BNS; Mr. George

Marchelos, a former E-rate consultant and VNCI employee; and

Ms. Judy Green, also a former E-rate consultant and VNCI employee. While Ms. Green successfully evaded service by U.S. Marshals, the other subpoenaed witnesses appeared at the hearing and

all of them invoked their Fifth Amendment rights against self-incrimination.

On September 22, 2004, the first part of the Subcommittee’s

third E-rate hearing continued the examination of the NEC BNSrelated bid-rigging conspiracy. Testimony focused on other school

districts that, unlike San Francisco, actually received E-rate program funded products and services through the conspiracy. The

Subcommittee considered issues including: E-rate program funding

of ineligible goods and services; vendors’ inappropriate use of ‘‘inkind’’ donations to schools; school districts’ obligations and responsibilities under program rules, including the mandatory requirement that schools contribute a co-payment to the cost of E-rate program projects; and, the role played by certain consultants in the

conspiracy, as well as the role played by consultants in the E-rate

program more broadly.

Again, four witnesses who were invited to the hearing declined

to attend and testify voluntarily, and the Subcommittee subsequently compelled their appearance through subpoenas. The individuals included: Ms. Judy Green, former E-rate consultant and

VNCI employee; Dr. Emma Epps, Superintendent of Ecorse Public

School District; Dr. Douglas Benit, the former facilities director for

Ecorse Public School District; and Mr. Quentin Lawson, the Executive Director of the National Alliance of Black School Educators

(NABSE). At the hearing, Ms. Green and Mr. Lawson invoked their

Fifth Amendment rights and declined to testify. Additionally, Mr.

Carl Muscari, the President and CEO of VNCI, appeared voluntarily, but also chose to invoke the Fifth Amendment at the hearing.

21

21For a complete accounting of Ecorse’s allocation of E-rate funds, see E-rate Hearing, September 22, 2004, Committee on Energy and Commerce, Serial No. 108-124 (hereinafter referred

to as Hearing, Part 3) at 54-77. See also id. at 67 (Dr. Benit was not able to locate documents

that supported his assertion that Ecorse School District paid NEC BNS its co-payment for the

E-rate project). 22The NABSE video also refers to IBM as a member of the NABSE E-rate ‘‘team,’’ but the

investigation did not find evidence of IBM actually receiving business from NABSE efforts, and

IBM officials testified that they had no knowledge of any such relationship.

Testimony at the September 22nd hearing showed that both the

Ecorse Public School District, in Michigan, and the Jasper County

School District, in South Carolina, failed to pay their required copayment to NEC BNS for the cost of their respective projects. NEC

BNS and VNCI ‘‘waived’’ the school districts’ co-payments, despite

clear FCC and USAC guidance that this was prohibited. Instead,

the inflated funding requests on the Form 471s were used to cover

the schools’ obligations. Additionally, both school districts’ superintendents admitted that their schools received substantial in-kind

donations of clearly ineligible goods and services. In the case of

Ecorse, the Subcommittee examined documents and received testimony from an NEC BNS project manager that revealed that E-rate

program funds paid for the construction of an $800,000 ‘‘TV production studio’’ at the district’s high school. Testimony provided by

USAC’s Schools and Libraries Division Vice President, George

McDonald, made clear that the TV studio and other in-kind donations were ineligible for E-rate program discounts and violated program rules. Neither the Ecorse nor Jasper County school officials

were able to explain or justify the violation of the program’s rules.

Furthermore, in Ecorse, neither Dr. Epps nor Dr. Benit provided

credible testimony about the funding of the TV studio or the

school’s failure to pay its co-payment. Specifically, under questioning, neither school official could credibly explain several documents that showed Dr. Benit directing NEC BNS to allocate E-rate

program funds to pay for the studio, other ineligible goods and

services, and, implicitly, the school’s mandatory co-payment.21

Finally, the September 22nd hearing examined the involvement

of NABSE in the E-rate program, and its association with NEC

BNS, VNCI, and other parties. For example, testimony showed that

NABSE had an apparent contractual arrangement to provide potential E-rate program project leads to NEC BNS and VNCI

through its large membership of school superintendents. Further,

for every funded E-rate program project resulting from a NABSE

lead, NABSE was slated to receive what amounted to a 1.5% revenue return on all business related to the E-rate program. Despite

Mr. Lawson’s refusal to testify, a ten-minute NABSE E-rate program marketing video and documents entered into the record

showed very active participation by NABSE officials in attempting

to steer E-rate program related business to NEC BNS and VNCI.22

In fact, statements in the video and documents claim that NABSE’s

E-rate ‘‘team’’ had helped nine school districts receive a total of

roughly $81 million in program discounts. The hearing showed that

while NABSE held itself out to its members as simply being interested in ensuring that poor school districts were able to take full

advantage of E-rate program funding, the organization actually

held a financial stake in the process. USAC’s George McDonald testified that any E-rate program funds that USAC determines actuVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
22

23See Hearing, Part 2, Tab 130.

ally went to NABSE inappropriately are subject to recovery actions.

(To date, no attempts at recovery have been undertaken.)

Findings from the NEC-focused hearings and related investigation:

• USAC failed to reject the fraudulent SFUSD E-rate program

applications, despite the fact that its employees identified several

red flags and discrepancies, perhaps most notably among them an

altered school district budget document.

During the hearing, USAC Vice President George McDonald

could not adequately explain why the forged budget document did

not halt the program’s application approval process for San Francisco. Mr. McDonald did note that the application reviewer’s notes

were not placed into a computer system, and that, at the time,

‘‘novel’’ issues were passed on to supervisors orally. Mr. McDonald

did say that USAC has improved its review process since that time,

compiling reviewers’ observations in a database, and conducting

quality assurance reviews of the reviewers. Mr. McDonald stated

that he believed that today’s reviewers would have been more diligent in investigating the budget forgery and notifying supervisors,

and that USAC’s approval would have been withheld. However, the

hearing showed that Members remain concerned about ‘‘rubberstamping’’ of applications and inadequate scrutiny of the details

and reasonableness of very large funding requests.

• The certifications contained on E-rate program application documents had little effect in deterring certain San Francisco school

officials or the employees of NEC BNS, InterTel, or VNCI from

forging documents and signatures and attempting to defraud the Erate program.

The certifications contained in E-rate program forms have failed

to deter abuse by predatory vendors or irresponsible school officials. In December 2002, the FCC IG, in consultation with the Justice Department, provided the WCB with a series of recommendations to strengthen certifications, but, according to testimony and

staff interviews with the Inspector General, the recommendations

were largely ignored for more than 18 months. Only in 2004—six

years into the program—did the FCC begin to propose changes in

the certifications. Further, the FCC has not been comprehensive in

its approach to strengthening the certifications. For example, the

FCC’s Chief of the WCB, Mr. William Maher, testified that the

FCC was not considering requiring ‘‘certificates of independent

pricing,’’ even though the Justice Department had suggested it, and

Mr. Maher testified that he thought such a certificate would be a

‘‘great idea.’’ In the end, the hearing illustrated the weakness of

certifications, to date, and the reticence of the FCC to promulgate

certifications containing stronger criminal sanctions for acts of

fraud and abuse, and greater deterrents to program predators—despite the sound advice provided by the Justice Department and endorsed by the FCC’s IG.23

• Employees of NEC BNS and VNCI completely manipulated the

competitive process for E-rate program goods and services, and

USAC did not discover the fraud.

23

24 Id.

The hearing also illustrated some of the weaknesses contained in

the E-rate program’s competitive bidding requirements. The program’s competitive bidding requirements should ensure the maximum value received by the applicant for the price paid, and reduce

the risk of fraud and abuse. The Justice Department’s certification

memorandum also made suggestions regarding improving the competitive bidding environment.24 In answering questions at the hearing regarding those suggestions, Mr. Maher testified that establishing competitive bidding standards to ensure reasonable pricing,

such as requiring a minimum number of bidders, posed ‘‘a difficult

policy issue’’ with which the FCC was ‘‘grappling.’’ However, the

WCB Chief could not answer how he thought an adequate competitive bidding process could be assured. Currently, one of the primary rules regarding competition simply requires a waiting period

of 28 days between posting a Form 470 and entering into a contract. Program rules provide little guidance regarding exactly how

E-rate program applicants should ensure competition, except to the

extent that state and local procurement standards must be followed. • The E-rate program recently gained the option of debarring

abusive vendors and applicants, but the rule established by the

FCC is very limited in scope.

Only since April 2003 has the program had access to the tool of

debarment for purposes of deterring waste, fraud, and abuse, but

the thresholds of conduct that trigger the ‘‘suspension and debarment’’ process are set too high. According to the E-rate program’s

rules, an E-rate program participant may be barred from participating in the program for three years, but only upon a finding of

criminal or civil liability. Debarment could be an effective tool for

both holding program abusers accountable, and for deterring future

abuse. However, the current rule does not address abusive or

wasteful behavior that falls short of criminal or civil liability. For

debarment to have a legitimate deterrent effect, and given that

criminal or civil litigation may take several years to reach a judgment, the FCC’s debarment standards should be more flexible, so

that when an E-rate program participant considers abusing the

program or intentionally exploiting program loopholes, it must also

consider that the FCC has the power to address the participant’s

abusive actions.

• According to testimony, staff interviews, and criminal plea

agreements to date, USAC and the FCC have dedicated insufficient

attention and oversight to the activities of program consultants

such as Judy Green, George Marchelos, VNCI, and NABSE.

USAC and the FCC have not done enough to ensure that consultants play a fair and independent role in school districts’ E-rate programs, that they have no financial stake in the outcome of the competitive bidding process, and that the E-rate program is not billed

for those consulting services that are ineligible for E-rate funding.

Testimony and documents from the NEC BNS-related hearings

demonstrate how these ‘‘consultants’’ either worked with willing

and cooperative school officials to defraud the program, or used

their greater knowledge of the program (or, in the case of NABSE,

24

25Documents in the record only show payments made by VNCI to NABSE. While the letter

purporting to establish an E-rate program partnership agreement was also signed by an IBM

employee—Mr. Don Parker, a Customer Services Executive for IBM Global Services—who also

appears in the NABSE E-rate program marketing video, the Subcommittee has no other evidence showing IBM’s actual involvement with NABSE’s E-rate ‘‘Team.’’ IBM representatives testified, and a subsequent IBM letter submitted for the record declares (Hearing, Part 3, at 761-

62), that Mr. Parker was not authorized to enter into any E-rate program teaming agreement

with NABSE, and that IBM was not aware of the NABSE E-rate program video that suggests

IBM’s partnership with NABSE. Further, IBM’s letter states that it has never made payments

to NABSE in exchange for E-rate business referrals. 26See the FCC ‘‘Ysleta’’ Order, FCC Order 03-313, December 8, 2003.

used its position of trust) to take advantage of overly-reliant school

district personnel. According to testimony, documents, and the

NABSE marketing video, employees of NEC BNS and VNCI in

many cases had broad authority over decisions that should have

been made by school officials. In other instances, such as in San

Francisco, school district officials were extensively involved in the

fraudulent procurements; in Ecorse, Michigan, school district officials were directly involved in highly questionable procurements.

Further, the hearings examined documents showing a financial arrangement that NABSE had established with preferred vendors,

such as NEC BNS and VNCI.25 However, staff found no information indicating that either the vendors or NABSE ever disclosed

these contractual arrangements to NABSE’s member school districts.

C. The Denial of $500 million in applicant requests associated with IBM

During E-rate program Funding Year 2002, USAC rejected program funding requests from 21 school districts totaling approximately $517 million, due to a distinct pattern of program rule violations. In particular, USAC identified a pattern of procurement

that violated the program’s competitive bidding requirements. With

minor variations, each school district engaged in a type of procurement that, according to the FCC, in affirming USAC’s decision, ‘‘effectively eliminates competitive bidding for the products and services eligible for discounts under the [E-rate] support mechanism.’’

Notwithstanding the FCC’s decision that the school districts violated E-rate program rules, the FCC permitted the rejected applicants who submitted appeals to resubmit their E-rate program applications for 2002 in accordance with proper procedures. The FCC

reasoned that allowing reapplications would be in ‘‘the public interest.’’ 26

Although the Funding Year 2002 ‘‘boilerplate’’ applications were

noticed and denied by USAC, the identical bidding procedure had

actually succeeded during the prior E-rate program Funding Year

2001, in El Paso Independent School District (EPISD), Texas. This

urban school district—the 7th largest district in Texas, with 86

schools and approximately 62,000 students—had participated in

every year of the E-rate program. During the first three years,

USAC approved $2.6 million, $6.4 million, and $1.4 million, respectively, in program funding for El Paso. However, in Funding Year

2001, after EPISD selected IBM as a ‘‘Strategic Technology Solutions Provider’’ to integrate technology (including E-rate program

funded technology) throughout the District, El Paso’s E-rate program funding request swelled to more than $65 million.

25

27See Hearing, Part 3, at 136.

IBM has participated as an E-rate program vendor since the very

start in 1998, and is the largest single recipient of the program’s

‘‘internal connections’’ funding. Over the course of the program,

IBM has received more than $832 million for E-rate related work.

In Funding Year 2002, IBM was associated with more than $1 billion of E-rate program funding requests—almost double the value

from the previous year.

In El Paso, after the school district approved IBM as its ‘‘technology integrator,’’ IBM provided El Paso with E-rate program

‘‘statements of work’’ for particular products and services, as well

as the associated documents for the district’s E-rate program application. These materials were prepared through Alpha Telecommunications (Alpha), IBM’s E-rate program consultant. Without adequate analysis 27 or price competition for the products and

services, El Paso submitted the documents provided by IBM as the

basis of its E-rate program application. With IBM serving as El

Paso’s primary program vendor, USAC approved $65.7 million in

E-rate program funds in October 2001 for 52 schools. EPISD eventually spent $57 million of this amount, and also paid its $6 million

co-payment.

After USAC approved El Paso’s E-rate program request, IBM aggressively marketed its ‘‘systems integrator’’ concept and promoted

its work in El Paso as an example of how IBM could maximize Erate program funds for other districts across the country, focusing

primarily on IBM’s ‘‘West’’ sales region. Documents in the record

show that IBM supplied templates for school districts to use in

making their requests for proposals, both for a strategic technology

partner and for the E-rate program related services. IBM’s marketing and the boilerplate E-rate program documents ultimately

led to 21 school districts selecting IBM to coordinate their E-rate

projects. Those 21 contracts involved the previously mentioned

$517 million in funding requests for Funding Year 2002, which

USAC began to review in the spring of 2002.

Meanwhile, in January 2002, USAC received an anonymous

whistleblower letter that complained about IBM’s role in El Paso

and which prompted USAC to scrutinize the procurement process

more closely. At that time, there was no indication on EPISD’s

funding request that it had engaged IBM as a strategic partner.

USAC’s investigation expanded to several other districts in 2002,

and directly led to the denials for funding. USAC’s investigation

also determined that funds had been disbursed for ineligible services performed by IBM and its subcontractors.

Of the 21 districts that were denied funding by USAC, nine districts (totaling $268 million in funds), appealed to the FCC. Additionally, IBM submitted its own appeals on behalf of eight of the

districts. In December 2003, the FCC upheld USAC’s decision regarding eight of the nine districts, but allowed them to re-submit

applications for the funding year. The FCC sided with the remaining appellant—Winston-Salem School District, involving $16.7 million—determining that Winston-Salem did not exhibit the same

pattern that had triggered the other rejections.

26

In light of the numerous applicants and the magnitude of E-rate

program funds involved, the Committee staff focused extensively on

the facts and circumstances surrounding these IBM-related applications. Staff conducted interviews with school officials at districts

that were denied funding, and particularly focused on the circumstances at the El Paso Independent School District. Committee

staff conducted a site visit to EPISD in August 2003.

On September 22, 2004, the Subcommittee’s third hearing addressed information regarding the roles of the FCC, USAC, IBM,

Alpha Telecommunications, and several school districts that

worked with IBM in 2001 and 2002. The hearing examined the integrity of the E-rate program application process generally, and in

particular, in the context of the IBM-related applications. The

hearing also considered the specific circumstances leading up to

and surrounding the denial of the Funding Year 2002 applications.

The hearing presented a case study regarding the roles of vendors and of school districts in the E-rate program application process, and the propensity of schools and vendors to ‘‘gold-plate’’ the

technology of the schools, far exceeding any reasonable educational

technology needs. The hearing considered: 1) how IBM ‘‘captured’’

the E-rate program planning and procurement process at the

schools by encouraging school districts to adopt the concept of a

‘‘strategic integrator,’’ and how this placed IBM in a conflicted advisor/vendor situation; 2) how vendors can ‘‘bundle’’ millions of dollars of ineligible goods and services, in effect removing them from

USAC scrutiny; and 3) how weaknesses in the program were exploited by a large technology industry icon—as well as by school

districts that were encouraged by the prospect of essentially paying

only ten cents on the dollar for technology goods and services and

of avoiding the difficult task of adequately planning for the integration of infrastructure, peripheral equipment, and teacher training

with the technology purchased by E-rate program dollars.

Findings from the IBM-focused hearing and related investigation:

• Weaknesses in the E-rate program application process, including applicant certifications, allowed non-competitive procurement of

E-rate related goods and services. The flawed application process

resulted in the extravagant and wasteful E-rate program funding

in EPISD in Funding Year 2001, and nearly resulted in the waste

of at least tens of millions of dollars more, among 21 other large

school districts in Funding Year 2002. Today, the FCC still allows

anti-competitive or insufficiently competitive procurement practices. The program remains plagued with weaknesses in the application process, including vague or ambiguous rules regarding the

requirements for competition.

Competitive bidding for particular products and services sought

by the applicants is fundamental to cost-effective procurement of

goods and services. The program’s minimal competition requirements and weak certifications do not ensure such price competition. Consequently, the program is highly susceptible to funding expensive, ineligible, and inappropriate products and services.

The case in point is the El Paso Independent School District (and

the attempts to mimic that paradigm around the country). Essentially, El Paso lacked any meaningful price competition for the

27

28See Hearing, Part 3, at 135. 29 In a truly competitive bidding process, this additional 7% ‘‘fee’’ would have likely made IBM

less competitive in each of its bids.

goods and services requested by the District through the program.

IBM was selected by the applicant in a two-step process that enabled the company to be the only service provider ‘‘at the table’’

when details of the goods and services were placed on the E-rate

program application. In this instance, IBM made the most significant decisions regarding what services to request. As school district

officials testified, district personnel had little time to review the application before it was submitted to USAC and relied ‘‘too heavily’’

upon IBM.28 In fact, IBM crafted portions of the E-rate project

‘‘statements of work’’ without even consulting with EPISD staff.

Whatever oversight the El Paso school district exerted before the

E-rate program forms were signed and certified, the documents and

testimony (as well as the templates used by IBM around the country) show that the service provider was guiding decision-making.

This raises questions about the integrity of certifications that

school officials must make. IBM and its consultant Alpha were able

to bundle ineligible goods and services at excessive rates. For example, IBM did not specify in its invoices ineligible consulting services (i.e., Alpha’s assistance in determining school discount eligibility and in preparing application forms and subsequent responses

to USAC queries), which cost the E-rate program more than $4

million for El Paso alone. Alpha charged 7% for each E-rate program funded statement of work that it helped to prepare. This fee

was actually rolled into the statements of work’s final price tags.29

USAC explained that these services were ineligible for E-rate program funding. That is, if the school district had sought the services

provided by Alpha separately, the E-rate program would not have

covered the cost. Had similar IBM-associated applications for

Funding Year 2002 been approved, the program would have paid

out an even larger sum for these ineligible consulting services. Further, the consulting fees amount to just one part of more than $20

million in wasteful E-rate program spending in El Paso.

Fortunately, USAC was able to identify the anti-competitive

practices and deny the ‘‘technology integrator’’ pattern of applications in 2002. Subsequently, the FCC and USAC did clarify rules

and procedures regarding price competition in the aftermath of

these denials. However, underlying problems in the process still remain. The FCC IG testified that IBM-related applications highlight

the IG’s concern about weaknesses in the rules governing competition for E-rate projects. One fundamental weakness in this regard

is the reliance on the Form 470 as the basis of competition. The

FCC IG testified that the current E-rate program competitive process is based upon the faulty assumption that by posting a Form

470 on USAC’s Web site for 28 days—as the current rules require—healthy and rigorous competition will occur. The FCC IG

further testified that its audits indicate that this ‘‘frequently does

not happen.’’ Simply put, the Form 470 is too general for vendors

to discern project parameters and build robust, highly competitive

bids that meet the schools’ needs, and therefore frequently fails to

generate the level of competition envisioned for the program. The

hearing testimony demonstrated that school officials often fail to

28

30See Hearing, Part 3, at155-57. 31 Id. 32 Id. at 46. 33 Id. 34 Id. at 246.

carry out their obligations to the competitive process—for example,

neglecting to provide interested vendors with answers to questions

about a given RFP.30

Additional testimony illustrated that school districts often already have vendors in mind when they post the Form 470s, or otherwise fail to respond to legitimate vendor inquiries. This weakness

provides some vendors with an opportunity to insert themselves,

inappropriately, into a school’s planning process. As one witness

testified, service providers ‘‘prey upon applicants that have no

knowledge of the program but are told this service provider can get

them money for computers.’’ 31 Testimony and documents suggest

that vendors have improperly sought advance commitments from

school officials. For example, documents in the record showed IBM

seeking ‘‘verbal commits’’ during the posting of RFPs and the Form

470. USAC testified that if the verbal commit occurred before the

posting of the Form 470, that it would violate E-rate program

rules.32

Additionally, certifications made by school officials on applications may not be sufficiently strong to deter false claims and statements, and ultimately prevent waste, fraud, or abuse. The FCC IG

testified that reliance on beneficiary ‘‘self-certification’’ is a serious

vulnerability because the program uses these signatures as a primary bulwark against improper funding requests. Without an ability to police these certifications and punish false statements, this

flaw opens an avenue for waste and abuse. There have been no

false statement charges asserted in the criminal indictments, to

date, or that are being pursued by ongoing federal investigations,

as reported by the FCC IG.33 The FCC IG testified that the FCC

waited until September 2004 to begin to address some of the Justice Department’s December 2002 recommendations regarding the

certifications.

• El Paso and other school districts involved in the IBM-related

‘‘strategic integrator’’ applications demonstrate that the current Erate program application approval process cannot either prevent

‘‘gold-plating,’’ which far exceeds the reasonable needs of a school

district, or ensure the cost-effective delivery of E-rate program

goods and services. In fact, the program’s current structure may actually encourage gold-plating.

The Subcommittee’s work unearthed a number of vivid examples

of wasteful and excessive spending. For example, the El Paso application persuaded USAC to fund a $27 million, state-of-the-art network maintenance support center for 53 of the district’s poorest

schools to keep the network ‘‘up and running.’’ 34 As troubling, the $27 million maintenance center only operated for three months before the funding year ended. Even though IBM billed USAC and

the district for the full $27 million, most of the funds were dedicated to the design and set up of the maintenance center. Further,

the set-up costs involved included ineligible inventory surveys,

high-level design and planning, and leasing and construction of an

29

35Documents in hearing record reveal funding for maintenance support covered more than

‘‘basic maintenance.’’ See Id. at 478-79, 556-57, 561-65. 36 Email subject line ‘‘TSO Support Multiple ISD,’’ from Milota to Diaz et. al, of IBM, July

18, 2002. (This document is stored at the Committee on Energy and Commerce.) 37See Hearing, Part 3 at 560, 570. 38 IBM testified that its maintenance costs were high because the District was moving from

essentially no maintenance infrastructure to the set up of ‘‘a large, complex system.’’ Actual

maintenance and ‘‘help desk’’ support represented only a portion of the total costs. See Id. at

260, 261. 39 Id. at 617.

off-site call center.35 In the end, the help desk possessed so much

capacity that IBM sales staff considered using it to support other

school districts.36

At the hearing, EPISD’s superintendent testified that the district

did not get its money’s worth from the partnership with IBM.

Moreover, documents show that the maintenance system placed an

enormous burden on the district’s resources, prompting El Paso to

redirect some of its staff to assist with the help desk. For all the

2001 E-rate project’s promise, the district technology director became concerned that the district had ‘‘bit off more than it could

chew,’’ and documents and testimony show that he had difficulty

articulating the value of the maintenance center to the school

board.37 When USAC rejected the district’s E-rate program application for Funding Year 2002, IBM removed the associated-equipment and closed the center—to the surprise of the school district—

and left the school to manage on its own, on roughly a $2 million

annual technical maintenance budget—or about 7% of the IBM

maintenance support funding.38 It should be noted that no technical assistance relating to the problems with computers, printers,

or other non-E-rate program equipment were eligible under this

maintenance support. Most technical problems with E-rate program eligible equipment should have been provided for under the

standard warranties that IBM and other equipment vendors provide purchasers. It is no exaggeration to claim that virtually the

entire $27 million maintenance operation was ineligible.

Another example of waste may be found in the failure to prevent

excessive and redundant acquisition of E-rate program goods and

services. In El Paso, the scope of work was drafted by IBM to include all 86 schools in the district, not the 53 that were eligible for

funding. Yet the district made no change in the scope of work applied for, and thus received funding for an additional 33 schools.

In the Dallas Independent School District (DISD), IBM planned

and priced the E-rate program related work for all of the district’s

245 schools.39 Documents and testimony indicate that, as a result,

the initial request to USAC for $216 million for the district’s 155

eligible schools was excessive. The Dallas School District official responsible for the project testified that when he reviewed the application, he was able to cut about $86 million in duplicative products,

services, and support. Overly duplicative applications were also

part of the broader pattern of applications associated with IBM in

Funding Year 2002. Documents in the record indicate that IBM

recommended (and drafted into its statements of work for each applicant) ‘‘stand-alone’’ E-rate projects that had maintenance and

other installation services actually built into the cost, in the event

30

40See USAC technology plan guidelines at www.sl.universalservice.org 41See FCC Fifth Report and Order and Order, August 2004, ¶¶ 56, 62.

that other maintenance projects were rejected. This approach led to

large, redundant requests that inflated the cost.

• E-rate program technology plan requirements and resource requirements for school districts insufficiently guard against waste,

fraud, and abuse.

EPISD maintained that the $27 million maintenance operation

and $30 million worth of other E-rate program related work was

consistent with the district’s technology plan. However, that technology plan—as is generally the case for E-rate program technology

plans—was insufficient to prevent waste, fraud, and abuse. In fact,

the initial $70 million in funding requests was made under the

technology plan used by the EPISD the previous three years, when

the school district received E-rate program funds averaging $3.4

million per year. The plan provided no meaningful measures to ensure that the goods and services purchased were reasonably connected to the school district’s needs and abilities. Significantly,

USAC’s guidance on technology plans notes that ‘‘it is only necessary that the approved plan include a sufficient level of information to justify and validate the purpose of a Universal Service Program request. However, it does not have to include the specific details and information called for on FCC Forms 470, 471, and 486

[request to commence invoicing].’’ 40 Moreover, USAC does not review plans as part of its normal application review process. The

FCC in its August 2004 Fifth Report and Order declined recommendations to require such review, ‘‘for administrative efficiency.’’ Given weaknesses in content and timing of plan preparation—the FCC only ‘‘expects,’’ not requires, that plans are prepared

prior to posting a Form 470. 41

• The program does not ensure that schools and teachers have

chosen goods and services they actually need.

Despite spending more than $60 million in E-rate program funds,

as well as its own money, for services and upgrades to its telecommunications infrastructure, El Paso was actually reducing its

focus on integrating technology into the classroom. In the first

three years of the program, the District’s head of instructional

technology, Ms. Sharon Foster, coordinated E-rate program applications. When Ms. Foster departed, E-rate program management was

completely shifted to the technology department, which, by all

available information to the Subcommittee, neglected to coordinate

with the instructional needs of teachers. Indeed, during an August

2003 site visit, Subcommittee staff learned that in the year leading

up to and following installation of the Funding Year 2001 project,

El Paso effectively eliminated eight to ten ‘‘Campus Technology Coordinators.’’ In short, the district eliminated a key element for coordinating training and curricula needs with the E-rate program

application for goods and services. Consequently, high-quality gear

and services were not being fully utilized more than a year after

the systems were installed.

Hearing testimony by Ms. Foster also provided a broader perspective to the issue. That is, absent a direct link to the instructional needs of the students, school districts that have been driven

31

42See Hearing, Part 3 at 154. 43 Id.

by vendor influence have ‘‘asked for too much too quickly and were

not in the best position to fully support technology projects for

which funding was awarded.’’ 42 ‘‘In short,’’ she said, ‘‘staff development, like the funding for network and technology projects, must

be on a consistent, realistic, multi-year basis.’’ 43 With these weaknesses in technology planning and application certifications the Erate program lacks an effective and reliable mechanism for ensuring that E-rate program funding requests are driven by instructional need.

• Unclear rules and program procedures and delays in program

funding generate confusion among applicants and vendors, and are

a source of waste.

Testimony by E-rate program vendors and school district officials

provided an important perspective regarding the E-rate program’s

rules and operation. First, substantial confusion regarding goods

and services eligibility and the interpretation of vague rules and

procedures contributes to waste and abuse. Notably, the FCC essentially acknowledged this confusion in its ‘‘Ysleta’’ Order regarding Funding Year 2002. Furthermore, the ambiguity of program

rules also provides an incentive to vendors and consultants to take

advantage of school districts that have either not necessarily

planned for the E-rate program adequately, or that are not

equipped with ‘‘technology-savvy’’ staff.

Second, the structure of the E-rate program funding cycle, with

its very large time span between when an application is submitted

and when it is funded, does not efficiently fit into the typical school

district’s budget and planning cycles—an issue the Committee staff

observed in many school districts. This disconnect between typical

school operations and the program’s funding process generates

waste, because districts must either scramble to spend the funds

before the program’s implementation deadlines, or apply for E-rate

program funds before other resources have been budgeted and secured. According to testimony, school districts that are burdened by

limited planning in the first place may struggle to manage the

overlapping phases of three E-rate program funding years that may

be occurring at any one time. This inherent program confusion and

delay contributes even more complexity to the effective implementation, management, and oversight of the program, from the perspective of the applicants, USAC or the FCC.

D. E-rate Related Investigation of Chicago Public Schools

The Subcommittee’s E-rate program oversight hearings were

largely focused on the programmatic flaws and concerns with the

program’s ‘‘front end’’ application process. Significantly, our work

has determined that the E-rate program also encountered problems

during the ‘‘implementation’’ stage of the funding process—that is,

the period of time when E-rate program goods and services are provided, and the funds actually are spent.

Subcommittee oversight of Chicago Public Schools’ (CPS) participation in the E-rate program, and CPS’ relationship with the

school district’s program manager, SBC Telecommunications

32

44See Investigation Report by Mayer, Brown, Rowe & Maw LLP, dated January 14, 2004

(Mayer Brown Report) at 21. (The Report is stored at the Committee on Energy and Commerce). 45 Id. at 2 and 35. 46See Investigation Report by Hogan & Hartson LLP, dated August 16, 2004 (Hogan Report)

at 1. (The Report is stored at the Committee on Energy and Commerce.) 47See Mayer Brown Report.

(SBC) 44, helped to illuminate some of the major pitfalls of E-rate

program implementation. In Chicago, the school district created an

environment that encouraged program fund mismanagement by

both the school and the primary E-rate program contractor, SBC,

and led to the improper stockpiling of $8.5 million in internal connections equipment, much of which included expensive electronic

switches that never left distribution warehouses.45

CPS is one of the largest school districts in the country, with

nearly 600 schools and 435,000 students. CPS has received over

$236 million in E-rate program discounts since the program’s inception, and according to the district has spent over $600 million

of non-E-rate funds on infrastructure improvements necessary to

prepare the schools for the internal connections funded by the Erate program.46 Chicago became one focal point of the investigation

as a result of Committee letters sent during July 2003 to 14 E-rate

program vendors, including several SBC operating units.

During the course of the Committee’s work, staff visited school

districts across the country to observe first-hand how the E-rate

program was actually being implemented. Among the site visits

were two trips to Chicago, one in early December 2003 and the

other in late August 2004, during both of which staff conducted

interviews of the relevant employees of SBC and CPS. Staff had

scheduled a December 11, 2003 site visit to Chicago, and on December 9, 2003, SBC’s Washington, D.C. office contacted staff to

alert the Committee regarding a then-current stockpile of $5 million worth of E-rate program related inventory sitting unused in

three Chicago warehouses. Committee staff later ascertained that

SBC officials in Chicago had knowledge of the stockpiled equipment at least since early 2001, when more than $8 million sat in

inventory. There is no evidence indicating that SBC’s knowledge

extended beyond the Chicago office. Staff also determined that

school district officials were aware of the inventory at least as early

as April 2002. Staff further learned that SBC had been reimbursed

by USAC for this unused equipment.

Also in December 2003, SBC tasked the law firm Mayer, Brown,

Rowe & Maw LLP (‘‘Mayer Brown’’) to conduct an internal investigation regarding the improper stockpiling and billing of USAC for

the equipment. On January 14, 2004, the Committee issued a second letter to SBC requesting further details and documentation of

the E-rate program in Chicago, and particularly the circumstances

surrounding the equipment stockpiling. In mid-January 2004,

Mayer Brown completed its investigation, and SBC provided a copy

of the firm’s report to the Committee.47 The Mayer Brown Report

concluded that SBC had violated program rules and that the company was required to return $8.8 million to the E-rate program. On

January 16, 2004, SBC submitted a payment of $8.8 million to

USAC. Subsequently, in late January 2004 the Committee requested further documents and information from the school district

regarding its participation in the E-rate program, and specifically

33

48See Hogan Report. 49See Mayer Brown Report at 27. 50See Hogan Report at 23. See also Mayer Brown Report at 21. 51 Id. at 27-32. See also Hogan Report at 31-38. 52 A LAN is generally defined as: ‘‘A system that links together electronic office equipment,

such as computers, and forms a network within an office or a building.’’ (Webster’s II New College Dictionary, 3rd Ed., Houghton Mifflin Co., 2005). An ‘‘Ethernet’’ is one example of a LAN. 53See Mayer Brown Report at 32-33. 54 Id. at 35-38. 55 Id. at 39. In general, after a school certifies to USAC on an E-rate Form 486 that the applicant ‘‘is receiving, is scheduled to receive, or has received service’’ from the vendor, USAC will

reimburse the vendor upon receipt of the vendor’s invoices. Subsequently, the vendor may submit a Form 474 (‘‘service provider invoice’’), informing USAC the amount of E-rate program

funds owed to the vendor for the work performed. While the vendor indicates either the date

it billed the school district for the work or the date that it completed the E-rate program related

work, there is no requirement for the vendor to provide detailed billing information or supporting documentation. 56See Mayer Brown Report at 44. According to staff interviews of Cisco employees, however,

the switches were far from obsolete, either in terms of their usefulness or the last date for which

service support would be available. 57 Id. at 45. 58 Id.

regarding the inappropriate stockpiling. CPS hired outside counsel,

the law firm Hogan & Hartson LLP (‘‘Hogan’’), which conducted an

investigation and prepared a report of its own. CPS provided the

Committee a copy of the report on August 16, 2004.48

During Funding Year 1999, USAC approved CPS’ request for $66

million for internal connections projects in July 1999.49 CPS awarded a contract for management of the E-rate program project to

SBC, which had specifically held itself out to CPS as having an expertise in project management.50 Due to a number of issues, including inconsistent decisions by CPS administrators and poor planning, as well as lengthy USAC funding-decision delays, CPS faced

a severe time crunch for fully implementing the $66 million project

before the funding year’s deadline of September 2000.51 Consequently, CPS instituted a ‘‘Fast Track’’ plan between June and

September of 2000 to accomplish basic Local Area Network

(LAN) 52 construction in as many schools as possible before the

deadline.53 That decision ultimately led SBC and its subcontractors

to bulk purchase and stockpile large quantities of internal connections equipment, including several hundred Cisco switches.54 SBC

submitted invoices and was reimbursed for this equipment, much

of which had not been installed, violating E-rate program rules.55

In April 2002, SBC and its major equipment supplier, Cisco, prepared an E-rate program related work proposal for marketing to

Chicago Public Schools a ‘‘refresh’’ of the uninstalled switches. SBC

and Cisco described the warehoused switches to CPS as being ‘‘obsolete.’’ 56 The SBC/Cisco switch refresh required that the school

district return the ‘‘old’’ unused switches for a minimal discount

against the cost of the new switches.57 Thus, CPS and the E-rate

program would essentially pay twice for equipment that had never

been installed into the school district’s networks.58 Under E-rate

program rules and procedures, USAC would have simply approved

the funding request for the new switches from CPS—as long as the

request form was correctly filled out, submitted, and certified. At

the time, USAC had no safeguards to prevent this sort of ‘‘refreshing’’ of otherwise usable equipment, or for detecting duplicative

equipment requests.

In sum, the Chicago Public Schools case study highlights management and implementation problems that may be encountered

34

59See Letter from SBC to the Committee on Energy and Commerce, dated August 6, 2004.

(The document is stored at the Committee on Energy and Commerce.) 60See FCC/SBC Consent Decree, adopted December 14, 2004. 61 Id. 62 It is not necessarily the case that CPS or any other school district that did not spend the

entire committed amount in a given Funding Year would lose those funds. In the first instance,

applicants have the opportunity to submit a request for an extension of time to complete the

E-rate related project. Furthermore, USAC would likely approve a new application, for the following Funding Year, to complete the work that it had previously authorized.

when carrying out a very large and expensive E-rate program internal connections project over multiple years. The extended delay

by USAC in making a funding commitment to Chicago Public

Schools led the school district to make key project decisions that

further compounded implementation issues. Furthermore, the case

study highlights the limitations of USAC to effectively oversee the

implementation of such complex projects.

Additionally, then-Chairman Tauzin and then-Subcommittee

Chairman Greenwood requested further documents and information from SBC regarding its participation in the E-rate program in

other regions of the country. SBC responded to the Committee’s request, providing information to the Committee regarding: (1) an

SBC Connecticut sales employee who discussed with school officials

the possibility of inflating SBC’s bid costs, so that sufficient margin

would be available to cover Bridgeport Public School’s co-payment;

(2) SBC Ohio personnel who offered to provide Cleveland Municipal

Public School District an interest-free loan to cover its co-payment,

which the school rejected after its attorneys determined that such

a transaction would violate E-rate program rules; and (3) an SBC

refund to SLD of $1.4 million in E-rate program funds from Funding Year 2003 that had been spent on ineligible services in New

London, Connecticut.59 In the Connecticut instance, SBC later entered into a consent decree with the FCC in which SBC made ‘‘a

voluntary contribution to the United States Treasury in the

amount of five hundred thousand dollars’’ in addition to the $1.4

million that it had refunded to the SLD.60 SBC also agreed to implement an extensive E-rate training and compliance program for

its employees, designate regional E-rate program coordinators

throughout the company, and create its own internal E-rate program oversight structure.61

Findings from the Chicago Public Schools related investigation:

• The timing of the E-rate program application, review, and approval process makes implementation of large internal connections

projects, such as at Chicago Public Schools, particularly vulnerable

to waste, fraud, and abuse.

Because of the very long delays in funding decisions by USAC, CPS faced the dilemma of spending $66 million for Funding Year

2000 in only a matter of months. (In fact, during the course of the

investigation, the Subcommittee frequently came upon instances in

which school officials and their vendors found themselves with

large sums of E-rate program funds being approved late in the program funding cycle and very little time to utilize those funds before

the deadlines.) In late July 2000, the CPS Board and CEO directed

Ms. Elaine Williams (the head of the school district’s Office of

Technology Services), against her recommendation to return

unspent funds to USAC 62, to spend $54 million by September 30,

35

63See Mayer Brown Report at 34. 64 Id. at 35. 65 Id. at 36. 66 Id. 67 Id. 68 Id. 69 Id. at 37. 70 Id. at 32. 71 Id. 72SBC is one of Cisco’s industry ‘‘channel partners,’’ and as such Cisco extends a substantial

discount to SBC on its equipment purchases. 73See Hogan Report at 40.

2000.63 This gave rise to the decision to implement the Fast Track

program, setting off a chain of events that led to advance purchases of large amounts of equipment by SBC’s distributors, and

ultimately to the stockpiled surplus. Indeed, the SBC project management team in Chicago believed that the lynch pin to completing

the work and utilizing the funds by the program deadline was materials procurement.64

SBC and CPS agreed that bulk purchase of key materials, including ‘‘long-lead-time’’ components, was indeed the solution, and

on July 20, 2000 CPS authorized SBC to make the bulk purchases.65 Among other steps, SBC placed a purchase order with each of its three distributors for a total of $24.5 million, based upon

a generic ‘‘template design’’ for wiring all of the schools.66 SBC also

placed a $3 million open purchase order with each distributor ‘‘to

cover the materials needed for the Fast Track installations for both

E-rate Year 2 and Year 3 which... had an identical scope of work

and an overlapping three-month period.’’ 67 According to one SBC

program manager, contractors may have deliberately ordered excess materials to prevent any delays.68 Ultimately, the Mayer

Brown investigation determined that the initial Fast Track invoices

were not based on actual shipments to schools, but rather were

‘‘ ‘pre-bills’ for materials that were not yet shipped, but merely ordered or to be ordered by the distributors.’’ 69

Further procurement confusion grew from a three-month overlap

in E-rate program Funding Years 1999 and 2000, as well as from

the fact that the ‘‘scope of work’’ for CPS’ LAN project was identical

for each year.70 According to the Mayer Brown Report, this may

have fostered ‘‘a lack of rigor among project personnel in failing to

assure that all work funded with E-rate Year 2 SLD dollars was

completed by the Year 2 implementation deadline, rather than

being allowed to spill over into E-rate Year 3, and beyond.’’ 71

Building upon the unintended consequences, SBC’s three distributors purchased directly from the switch vendor, Cisco, rather

than through the program manager, SBC.72 Thus, ‘‘SBC had to pay

the standard, non-discounted prices for the Cisco network equipment that its distributors had purchased, rather than the 35%

bulk-rate discounts that would have been available on Cisco equipment had SBC ordered the equipment directly from Cisco.’’ 73 Indeed, at a June, 2003 ‘‘Inventory Issues Meeting’’ between CPS and

SBC, the meeting minutes state:

when CPS questioned why the amount paid for the original

Cisco equipment (switches) was so large (approximately $4 million), SBC stated that they paid full price for the Cisco materials. SBC could not obtain a discount, as is customary, because they ordered the Cisco Equipment from distributors. The

36

74See Mayer Brown Report at Tab 30, at 9. 75 Id. at 3. 76 Id. at 26. 77 Id. 78 Id. 79 Id. at 54. 80 Id. at 55.

discount can only be obtained if the order is placed directly

through Cisco (material ordered directly from Cisco is discounted at 35%). SBC stated that there was not enough time

to place the order directly with Cisco because of the time constraint imposed by the September 30 deadline.74

Finally, with regard to the implementation phase of very large

E-rate program projects, there is no commensurate oversight by the

FCC or USAC after applications for funds are approved for disbursement. As a case in point, USAC’s Arthur Anderson beneficiary audit of Funding Years 1999 and 2000 at Chicago Public

Schools completely failed to identify the $8.5 million in uninstalled

inventory that USAC had funded. Instead, the audit identified

some other billing and invoice discrepancies, which ultimately

prompted CPS to hire its own auditor, KPMG. KPMG resolved

many of the problems identified by Anderson, but also identified

the deeper problems of program management detailed above.

• SBC and CPS failed to effectively plan, manage, and keep accurate records, and failed to resolve problems in a timely manner,

which led to considerable waste.

The SBC project management team in Chicago failed to understand the E-rate program’s rules. According to the Mayer Brown

Report, ‘‘[e]mployees involved with the CPS E-rate Program had

not received adequate training with respect to contractor obligations in a federally-funded program. This lack of training with respect to the unique obligations imposed under such a program resulted in the employees inappropriately relying on exchanges of emails with a federal agency for interpretation of federal regulatory

requirements . . .’’ 75

SBC’s account team lacked training regarding the issues surrounding the receipt of federal funds.76 The SBC ‘‘management

team received no formal E-rate training, nor training on regulatory

compliance . . .’’ and the individuals in charge of that team ‘‘had no

prior experience in managing E-rate projects or contracts involving

federal funds.’’ 77 For example, SBC’s ‘‘program executive’’ for the

Chicago E-rate project lacked any experience on federal government contracts or E-rate program projects prior to her leadership

of the CPS LAN project.78

The Mayer Brown investigation found that ‘‘at least by the end

of 2000, SBC personnel were aware of the general requirement that

materials be ‘delivered and installed’ in the E-rate year in which

the materials were purchased.’’ 79 SBC’s subcontractor, TeamWerks,

when told in writing by the SLD that it was against the rules to

bill for ‘‘work’’ not installed by September 30, 2000, characterized

that guidance as ‘‘quite ambiguous’’ because the SLD had made no

reference to ‘‘materials.’’ 80 Ultimately, SBC decided to roll forward

the Funding Year 2000 inventory to Funding Year 2001—despite

its knowledge of the rules requiring delivery and installation—

based upon a tenuous distinction between ‘‘returned’’ excess invenVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
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81 Id. at 56. 82 Id. at 1-2. When KPMG first learned of the April 2001 e-mail to the SLD, it described the

question as ‘‘misleading’’—‘‘apparently because it used the words ‘some inventory’ instead of disclosing the amount.’’ Id. at 48. 83 Id. at 28. 84 Id. 85 Id. 86The Mayer Brown Report points out that because these combined bids were screened for

the lowest lump sum price, the district had no guarantee that the E-rate program portion of

a particular subcontract was being awarded to the lowest bidder for those services. Id. at 29.

tory and excess materials that had never left warehouses.81 Further, SBC project leaders were willing to rely on an old and vague

e-mail message from April 2001 to support their actions.82

The school district also was responsible for the spate of program

management problems. In order to ensure sufficient electrical

power support for the LAN project, CPS undertook an electrical

service upgrade at the same time as the LAN implementation.83

CPS chose to execute both projects simultaneously, through a single contractor leading both efforts—even though the electrical infrastructure upgrades were not E-rate program eligible. As a result, ‘‘the LAN installation and power upgrade work contributed to

a convoluted organizational structure for the overall project.’’ 84

Furthermore, SBC did not report directly to the school district. Instead, a consulting firm named Chicago School Associates (CSA)

was hired by the district to manage the LAN installation and

power upgrade general contractors, including SBC, so SBC’s project

team reported to the Director of Program Management at CSA.85

The school district made several other decisions that hampered

project planning and efficiency, including, among others: 1) CPS

had 250 schools that had separately applied for Funding Year 1999

E-rate funds, and which were outside the scope of the CPS-SBC

agreement, but which still required E-rate program work to be accomplished; 2) the LAN project was initially supervised by the district’s Capital Improvements Department, not by the Office of

Technology Services where the knowledge of the E-rate program

and the LAN project actually resided; 3) the Capital Improvements

Department generated its own LAN designs for the schools, despite

the lack of necessary technical expertise, resulting in the majority

of the designs being rejected by SBC and its network architect; 4)

CPS required SBC to seek combined LAN/power upgrade bids from

subcontractors 86; 5) CPS failed to promptly issue SBC a ‘‘notice to

proceed,’’ further constraining the time available to fully utilize Erate program funds before the funding deadline; 6) CPS delayed

providing SBC specific school assignments for E-rate program LAN

work; and 7) CPS frequently made revisions to the list of schools

at which SBC needed to do E-rate program work. These sorts of

choices ultimately end up costing a school district countless dollars

in E-rate program resources.

• The E-rate program offers vendors a powerful incentive to sell

unnecessary or excessive gear, and to upgrade equipment quickly.

According to the Mayer Brown Report, under the SBC-CPS LAN

Agreement, SBC agreed to contract directly with contractors to perform the construction, installation and related services and to be

responsible for paying such subcontractors on a timely basis. Generally, ‘‘SBC would be compensated by adding a 9.5% project manVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
38

87See Mayer Brown Report at 21-22. 88 Id. at 22. 89 Id. at 45. While the full refresh plan was never carried out, a smaller variation of the refresh went forward. Importantly, however, SBC maintains that the SLD had not been billed for

the purchase of the new switches because CPS never approved the relevant invoices. Id. at 47. 90See Committee Letter to Dr. Beverly L. Hall, Atlanta Public Schools, dated June 8, 2004. 91The Subcommittee concluded its investigation without determining who was responsible for

the decisions regarding the installation of these expensive Cisco switches or other gold-plating

in Atlanta that wasted E-rate program funds. In Chicago, where Staff conducted an extensive

investigation of CPS’ participation in the program, Cisco was a prime motivator in the school

district’s decision to install unnecessary switches, as explained, supra, at 35-36.

agement fee to the amounts it paid out to its contractors.’’ 87 Further, explains the Mayer Brown Report, ‘‘given the costly infrastructure that SBC had to put in place to manage the project, SBC

faced the risk of losing money on the contract if CPS failed to authorize a level of work sufficient to generate project management

fees in excess of SBC’s costs. The structure of the contract’s payment terms created an economic incentive for SBC to encourage

CPS to spend the full amount of any Universal Service Fund award

it received from SLD.’’ 88

One additional result of this economic incentive was the problematic ‘‘refresh’’ proposal, described above, involving warehoused, new

switches that Cisco and SBC described as ‘‘obsolete.’’ While the

switches that CPS had purchased only months before were no

longer ‘‘top of the line’’ due to technological advances, they were

more than adequate for the district’s governing technology plan at

the time. The ‘‘obsolescence’’ to which the vendors referred actually

described the fact that the equipment possessed a finite date beyond which it would not be eligible for vendor maintenance. Yet,

the switches at issue in Chicago would not reach that service life

end date for another five years.

In the end, CPS bought new switches to replace ones that had

never been installed and which had only been purchased mere

months before vendors were proposing to replace them. This replacement of uninstalled equipment ultimately led to unnecessary

costs for both the school district and for the E-rate program. While

the proposal included a small trade-in rebate on the old switches,

CPS would essentially be wasting nearly $3.6 million.89

E. E-rate Related Investigation of Atlanta Public Schools

In May 2004, a series of investigative reports by the Atlanta

Journal-Constitution (AJC) newspaper alleged widespread waste,

abuse, and mismanagement of more than $60 million in E-rate program funds by officials at Atlanta Public Schools (APS). Subsequently, in June 2004, the Committee began an investigation and

issued several letters to the district and its primary vendors, requesting documents and information regarding APS’ E-rate program.90 The Committee’s letters focused on serious allegations that

included the improper stockpiling of more than $4.5 million in Erate program funded equipment, non-competitive bidding for E-rate

program work, installation of multiple $100,000 Cisco switches in

a single school, and other examples of ‘‘gold-plating.’’ 91

The Committee also sought details regarding BellSouth’s installation of an expensive high-capacity network ‘‘backbone’’ into the

district’s elementary schools, despite warnings to the school board

by APS’ technology director at the time, that the project expansion

39

92 As staff commenced work regarding Atlanta, attempts were made to interview several

former school officials who were key decision-makers in APS’ E-rate program. Two former leaders of the school district’s technology department during the relevant time period declined,

through their respective attorneys, to be interviewed regarding APS’ participation in the E-rate

program. Significantly, the respective attorneys for the two technology department officials each

stated that, unless granted immunity, his client was likely to invoke his Fifth Amendment

rights if invited to testify at a Committee hearing. 93See Atlanta Public Schools E-rate Program Interim Report by Greenberg Traurig, LLP,

dated September 23, 2004 (Greenberg Interim Report). (The Report is stored at the Committee

on Energy and Commerce.) 94 Id. at 1.

was unnecessary and proceeding too rapidly. On December 19,

2004, a follow-on article by the AJC reported that school district officials diverted about $5 million in E-rate program funds, between

2000 and 2002, to cover the cost of unauthorized or ineligible goods

and services, including consulting fees, plasma television monitors,

cell phone bills, and wireless Internet access for two of the district’s

football stadiums.

APS is comprised of 95 schools and approximately 57,000 students, with 80 of those schools at the E-rate program’s 90% discount level. During the first four years of the E-rate program, $81

million was committed to APS, of which approximately $59 million

has been disbursed. Additionally, a state educational consortium

(known as the Metropolitan Regional Educational Service Agency,

or MRESA) supplied an estimated $8 million in E-rate program

funded equipment to the district during Funding Year 1999. Thus,

the district has received roughly $68 million in E-rate program

funded products and services. In Funding Year 2002, APS requested $71 million from E-rate, but USAC denied that application

because APS submitted an E-rate program application that was associated with the anti-competitive ‘‘strategic technology partner’’

application process involving IBM, as described earlier in this report.

A case study of Atlanta Public Schools therefore provided an opportunity to examine various dimensions of the implementation of

E-rate program funded goods and services. Subcommittee staff recognized issues relating to competitive bidding procedures and the

awarding of E-rate program contracts, ‘‘gold plating’’ schools with

unnecessary technology, ordering equipment that might never have

been installed, and funding of equipment that was not ordered. In

response to the Committee’s letter, the school district committed

itself to providing answers to all of the Committee’s questions by

conducting an internal investigation and submitting a comprehensive report on its findings.92 As a preliminary answer to the requests for documents and information, on September 23, 2004, APS

provided an ‘‘interim’’ report 93 to the Committee, prepared by its

outside counsel, Greenberg Traurig, LLP (‘‘Greenberg’’).

Greenberg submitted an ‘‘interim’’ report because the school district continued ‘‘to review documents including electronic data recovered during the investigation. Also, the information contained in

this report was not based upon a complete audit.’’ 94 Further, the

interim report was submitted without the benefit of adequate interviews of several key school officials, and did not answer the Subcommittee’s Question No. 6, regarding the school district’s competitive bidding procedures, and Question No. 7(a), regarding any circumstances in which ‘‘the school did not receive the products and

40

95 Id. at 6. See also id. at 116-17. 96See http://www.atlanta.k12.ga.us/news/goodnews/doc/022505SoutheastInvestigationOver.pdf 97On May 6, 2005, the Atlanta Journal-Constitution reported that in late April the Justice

Department subpoenaed E-rate related records from Atlanta Public Schools, for delivery to a

federal grand jury by May 24, 2005. 98The report states that investigators could not locate any documentary evidence supporting

an allegation that an IBM representative established a close relationship with Mr. Robert

Beman, the school district’s former Chief Information Officer, and that IBM used that relationship to ensure that it had a major role in preparing APS’ Funding Year 2002 E-rate application

through its consultant Alpha Telecommunications (‘‘Alpha’’). Specifically, an APS employee believed that IBM and Alpha had persuaded Mr. Beman to permit Alpha to prepare the E-rate

forms, to ‘‘assure that IBM received [follow-on] E-rate funded contracts . . . in direct response to

IBM’s alleged dissatisfaction about not being awarded APS E-rate funded contracts during

Funding Year [2001].’’ See Greenberg Interim Report at 71-72. According to the employee, Mr.

Beman ‘‘developed a close relationship with IBM, and in particular with IBM’s Atlanta representative, Portia Lemons.’’ Id. at 72. The employee believed that Mr. Beman was urged to

services as specified on E-rate applications or invoices.’’ 95 Thus, the

interim report failed to answer critical questions about waste,

fraud, and abuse in the district’s E-rate program.

In fact, Greenberg informed Subcommittee staff that APS could

not produce a complete report without further document retrieval

and review and that it would cost approximately $80,000 to do so.

Given the breadth and scope of E-rate program waste, fraud, and

abuse that the Subcommittee had already uncovered and examined

elsewhere, it was decided that requiring the public school system

to incur these additional costs was not essential for the Subcommittee to complete its work. Thus, before APS submitted a final

and complete report, the Subcommittee finished its two-year investigation and began the work of assembling its findings to assist in

laying the groundwork for legislation to improve the program. In

the meantime, APS decided not to proceed with the additional work

and expense of its internal investigation in connection with the

Subcommittee’s request.

Moreover, because the Subcommittee ended its E-rate program

investigation, having accumulated sufficient information regarding

the program and its weaknesses, staff did not continue to further

develop information regarding the respective roles of the school district and its E-rate program vendors in Atlanta. Because this information was not fully developed, Subcommittee staff has chosen not

to include a ‘‘findings’’ section within this report.

In February 2005, however, APS issued a press release on its

Internet website entitled ‘‘National E-rate Investigations Not Focused on APS,’’ 96 in which it misrepresented the outcome of the

Subcommittee’s work. The school district declared that it had conducted an ‘‘exhaustive probe’’ and provided the Subcommittee with

a report and eight boxes of documents. The document further stated that ‘‘after reviewing the files, Congress took no action against

the APS,’’ implying that the Subcommittee gave APS a clean bill

of health regarding its participation in the E-rate program.97 As

previously mentioned, contrary to APS’ representations, the documents and interim report did not answer all the serious questions

regarding the school district’s management of its E-rate program.

Additionally, the report incorrectly declared that APS had ‘‘no documentary evidence’’ regarding an allegation that vendors had improperly influenced the E-rate program application process during

Funding Year 2002. In fact, the school district had e-mail documents that supported the allegation and that at least called for further examination by APS.98

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allow Alpha to prepare the E-rate forms, so that Alpha could ‘‘ensure that IBM would be awarded an E-rate funded contract.’’ Id. The Greenberg Interim Report stated that there was no evidence of such communications with Alpha before the application’s submission in January 2002.

However, Alpha produced e-mail documents to the Subcommittee that show IBM’s and Alpha’s

interaction with Mr. Beman regarding the E-rate program and which support the APS employee’s account. APS’ Funding Year 2002 application was denied because it was part of the ‘‘technology integrator’’ pattern that was identified by USAC as subverting the competitive bid process. 99See USAC Memorandum to FCC, dated November 26, 2003. The recommendations by the

Task Force represented a broad consensus; i.e. recommendations were supported by at least 10

Task Force members and opposed by no more than two members. Thus, recommendations that

might have been viewed as affecting too much the interests of vendors (with five representatives), would not have been reported. 100See http://energycommerce.house.gov/108/Letters/12022003—1142.htm

F. GAO Work Requested by the Committee

The Subcommittee has examined various aspects of the E-rate

program and its impact in several school districts. Through this

work, a number of troubling failures and weaknesses were identified, as outlined in this report. More broadly, the failures in preventing waste, fraud, and abuse point to problems in the program’s

structure and the FCC’s management of the E-rate program.

In recent years, several initiatives were established to address

issues of waste, fraud, and abuse in the E-rate program. For example, USAC, with the support of FCC, convened a 14-member Task

Force of program ‘‘stakeholders’’—comprised of vendors, consultants, and school and library officials—to make recommendations to

reduce waste, fraud, and abuse and improve program effectiveness.

A number of its recommendations have subsequently been addressed in procedural changes or in FCC rulemaking.99 Since January 2002, the FCC has conducted a series of program rulemakings

to address a number of issues relating to reducing waste, fraud,

and abuse, such as strengthening application certifications or bidding requirements. While the Subcommittee considers these actions

to be positive steps, the effectiveness of any given program change

cannot be assessed until more information is collected from audits

and the FCC IG’s investigations. While the E-rate program has

evolved, and certainly operates better in some ways today than it

did in 2001, that evolution has proceeded much too slowly. Clearly,

not all problems have been addressed by these measures. Indeed,

the pattern of problems and failures involves more fundamental

questions about the FCC’s management.

Thus, with an eye toward gathering further information and

gaining a better understanding of the FCC’s stewardship of the Erate program, then-Chairman Tauzin and then-Subcommittee

Chairman Greenwood requested that the Government Accountability Office (GAO) ‘‘review the E-rate program’s structure and operations to determine whether federal funds are being used in accordance with program rules, whether the funds are being used effectively to achieve program goals, and whether the program needs

fundamental changes to ensure program goals are met.’’ 100 In response to the Committee’s request, the GAO set out to ‘‘evaluate

(1) the effect of the current structure of the E-rate program on

FCC’s management of the program, (2) FCC’s development and use

of performance goals and measures in managing the program, and

(3) the effectiveness of FCC’s oversight mechanisms—rulemaking

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101See ‘‘Telecommunications: Greater Involvement Needed by FCC in the Management and

Oversight of the E-Rate Program,’’ GAO-05-151, Feb. 2005 at 3 (hereinafter referred to as the

‘‘GAO Report’’); Available at http://www.gao.gov/new.items/d05151.pdf. 102See ‘‘Hearing on Problems with the E-rate Program: GAO Review of FCC Management and

Oversight,’’ March 16, 2005, Committee on Energy and Commerce, Serial No. 109-7. 103See, e.g., GAO-02-187, February 2002; GAO-01-673, May 2001; GAO-01-672, May 2001;

GAO-01-105, December 2000; GAO/HEHS-99-133, August 1999; RCED-99-51, March 1999; GAO/

T-HEHS-98-246, September 1998; T-RCED-98-243, July 1998; GAO/RCED/OGC-98-172R, May

1998; GAO/T-RCED/OGC-98-84, March 1998. 104For example, in later September and early October 2004, a last-minute decision by the FCC

regarding the Anti-Deficiency Act’s (ADA) effects on the E-rate program temporarily prevented

USAC from issuing commitment letters to E-rate program applicants, until Congress passed a

temporary exemption of the E-rate program from the ADA.

proceedings, beneficiary audits, and reviews of USAC decisions (appeals)—in managing the program.’’ 101

The completed report, released at a Subcommittee E-rate program hearing on March 16, 2005,102 raises serious questions about

the FCC’s management and oversight. The report finds an astounding degree of managerial neglect of the E-rate program. Due to this

neglect, Congress cannot confidently assess either: a) the adequacy

of the current program structure, or b) whether the program is in

fact achieving the goals contemplated by Congress when it ‘‘created’’ the program in 1996.

When Congress codified Universal Service in 1996, it effectively

changed the nature of the industry-managed universal service support from an administratively sanctioned process, to a statutorily

authorized collection of funds for universal service as determined

by Congress. The GAO details that this action caused the fund to

become, essentially, a permanent congressional appropriation. Consequently, a key series of questions were—or should have been—

brought to bear on the structure of the fund, the structure of the

various ‘‘funding mechanisms,’’ and the entities established to administer the fund. It was incumbent upon the FCC, as the agency

responsible for the fund, to follow the direction of Congress concerning universal service. Implicitly, the FCC had broader obligations to Congress to ensure the fund’s new structure adhered to all

the relevant statutes, including any and all requirements concerning the treatment of appropriated funds. This did not happen.

As a result, the E-rate program from the start has been hampered

by lingering questions concerning its organization and structure, as

mentioned in previous GAO reviews of the program.103 Furthermore, ‘‘new’’ questions continue to arise, many of which could have

been resolved early on in the program.104 The FCC’s failure to resolve these issues in a comprehensive fashion at the outset has led

to a number of problems that Congress must now address. The

GAO report’s main findings, with a brief Subcommittee staff commentary, include: • The FCC crafted an ambitious, multi-billion-dollar funding program, using an ‘‘unusual’’ organizational structure, and then never

conducted a comprehensive assessment to determine which federal

requirements, policies, and practices apply to the program, to

USAC, and to the Universal Service Fund itself.

This circumstance requires the resolution of several structural

and fiscal questions to ensure program integrity in the future. The

GAO notes that USAC—a non-profit, private entity—operates and

disburses funds under a less explicit federal affiliation than many

other federal programs. For example, USAC and the FCC share no

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105See GAO Report at 70. 106For example, Congressional guidance may be necessary expressly to make USAC the permanent administrator, or to place the E-rate program within the Executive Branch, or elsewhere. See Third Report and Order, FCC 98-306, November 19, 1998. 107See GAO Report at 66-68.

contract or memorandum of understanding for administering Erate. Moreover, USAC is a wholly owned subsidiary of another private entity—the National Exchange Carriers Association (NECA).

This relationship gives rise to unanswered questions concerning:

(a) the fact that a non-governmental entity administers billions of

dollars in ‘‘federal funds’’; and (b) the questionable and, by appearance, potentially conflicted relationship of USAC and NECA—further, while NECA is the sole shareholder of USAC, it is also a

major subcontractor for USAC that administers part of the fund.105

The GAO report provides some details regarding the current structure, established by the FCC in November 1998 when it appointed

USAC the ‘‘permanent’’ administrator of the program, in an effort

to address legal concerns raised by the GAO and Congress. Because

questions remained, the FCC made this appointment subject to a

one-year review. Significantly, and to some degree emblematic of

other promises made by the FCC regarding the program, that review was never performed. Furthermore, the plan the FCC adopted

to make USAC the permanent administrator—drafted by the funding administrators—recommended full divestiture of USAC from

NECA. In its 1998 Third Report and Order, the FCC pledged to review the divestiture issue after one year, but, again, that review

never happened. At this point, resolution of these structural issues

may likely need Congress to provide specific statutory guidance.106

The nature of the USAC/FCC relationship exacerbates current

issues concerning the treatment and handling of E-rate program

funds. The GAO explains that questions about whether Universal

Service Funds should be treated as ‘‘federal funds’’—and thus implicating all relevant federal statutes that protect taxpayer interests—have plagued the program from the start. The FCC failed at

the start to determine clearly and comprehensively the nature of

the funds. Instead, the FCC took a case-by-case approach to questions of fund status, and did so with some delay. As the GAO notes,

this ‘‘put FCC and the program in the position of reacting to problems as they occur rather setting up an organization and internal

controls designed to ensure compliance with applicable laws.’’ It

also raises questions about past FCC determinations. Given the

piecemeal decision making, the GAO states that ‘‘where FCC has

determined that fiscal controls and policy do apply [to the USF],

the commission should reconsider these determinations in light of

the status of universal service monies as federal funds.’’ 107 While

the FCC recently began to address some of the issues surrounding

the funds’ status, it has been slow to tackle the implications of

their status.

Indeed, the FCC’s hesitation has caused unnecessary disruptions

and waste in E-rate program operations. For example, on September 26, 2003—more than five years into the E-rate program—

the FCC mandated that USAC prepare USF financial statements

consistent with ‘‘generally accepted accounting principles for federal agencies’ (GovGAPP). The FCC expressly noted that this

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108 A bill has been introduced in the Senate, S. 241, that exempts the Universal Service Fund

from the Anti-Deficiency Act. Absent careful study, any exemptions from federal accounting statutes may be premature and may do more harm than good. 109 According to USAC data, as of October 5, 2005, it has committed over $15 billion and actually disbursed more than $10 billion in E-rate program funds. 110See ‘‘Internet Access in U.S. Public Schools and Classrooms: 1994-2003,’’ National Center

for Education Statistics, February 2005 at 3-7, 18-23.

change could have broad implications regarding compliance with a

myriad of federal accounting statutes, and therefore gave USAC

one year to transition to GovGAPP. But the FCC subsequently

failed to review in a timely manner the change’s implications and

provide the necessary guidance to USAC. Ultimately, the FCC’s

delay led to USAC suspending E-rate program commitments in August 2004 until the FCC responded to USAC’s query as to whether

the Anti-Deficiency Act applied to E-rate program funds. The FCC

did not address the issue until two weeks before the deadline for

the GovGAPP standards to take effect. As a result of the FCC’s actions, the USF lost approximately $4.6 million. Additionally, the

delay froze hundreds of millions of dollars in E-rate program commitment decisions, thus postponing and disrupting the planning at

school districts around the nation. As this report noted earlier,

funding delays by the FCC and USAC conflict with school districts’

budgeting and planning cycles and thus increase the risk of waste

and abuse.

The GAO report confirms that Universal Service Funds should be

treated as federal funds, and that all applicable federal statutes

and requirements apply to the administration of the USF, unless

specifically exempted by Congress. What remains unclear, however,

is the extent to which such requirements will affect USAC and the

Fund. For example, how do relevant statutes such as the Single

Audit Act, the Cash Management Improvement Act, and the Improper Payments Information Act of 2002 impact E-rate program

funds? Furthermore, absent a comprehensive review and assessment, poorly founded decisions may be made about Fund treatment, to the detriment of the taxpayers.108

• Although USAC has committed more than $15 billion to E-rate

program applicants during the past 8 years, the FCC did not develop performance goals and measures that could be used to assess

the specific impact of this spending and to improve the management of the program.109

The FCC, USAC, E-rate program participants, and observers of

the E-rate program have frequently noted that, since the program

began in 1998, the nation’s schools have significantly increased

their rates of Internet access and connectivity. The Department of

Education’s National Center for Education Statistics are frequently

cited—which report that, as of 2003, 100% of public schools and

93% of public school instructional classrooms had Internet access,

up from 89% and 51%, respectively, in 1998.110 While this information may be valuable to a broader assessment of the nation’s telecommunications and education policies, it does not provide or represent a meaningful measure of the E-rate program’s impact. The

GAO notes that ‘‘although billions of dollars of E-rate funds have

been committed since 1998, adequate program data was not developed to answer a fundamental performance question: how much of

the increase since 1998 in public schools’ Internet access has been

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111See GAO Report at 21-22. 112 Id. at 23. 113 Id. at 57.

a result of the E-rate program, as opposed to other sources of federal, state, local, and private funding?’’ 111

The failure to implement performance measures bears on a number of aspects of the FCC’s E-rate program management, in addition to the fact that it ignores requirements of the Government

Performance Results Act of 1993. Perhaps most troubling, Congress

has little or no information about the program’s effectiveness; yet,

more than $9 billion has been spent. This does not mean that the

program has not been effective—the Subcommittee’s investigation

has observed compelling examples of E-rate program funding being

used to improve classroom instruction and the coordination of effective instruction. However, the FCC has squandered the opportunity

to quantify and assess—and ultimately, to improve—the program’s

effectiveness and efficiency in a meaningful way. This is a profound

failure in the FCC’s responsibility and accountability to Congress,

which in the end must answer to American taxpayers about the

value and direction of the E-rate program.

The failure to institute performance measures is symptomatic of

the broader management problems at the FCC concerning the Erate program. In the past, the FCC has informed the GAO that it

would implement performance goals and plans for the E-rate program, but then failed to do so. For example, in December 2000 the

FCC told the GAO that it had finalized a new performance plan to

increase the rate of program participation by low-income, urban

schools. Yet, the current GAO report notes that when it inquired

in 2004 about the plan, ‘‘we were told that it had not been implemented and that none of the FCC staff currently working on E-rate

was familiar with the plan.’’ 112 Staff turnover, as well as the size

of the staff overseeing the USF,113 contributes to this lack of institutional follow-through and the general ability to address program

issues and policy questions in a timely manner, see below. Instances such as this undercut confidence in the FCC’s promises to

address these issues and increase its attention to the program.

• The FCC’s three key oversight mechanisms for the E-rate program—rulemaking procedures, beneficiary audits, and reviews of

USAC decisions (appeals decisions)—are not fully effective to manage the program.

This GAO finding highlights a number of observations and problems identified by the Subcommittee during the course of the investigation. However potentially effective these three oversight mechanisms may be for a regulatory agency, the record suggests that

they fall short in effectively managing a large, complicated, quasigrant program like E-rate. These mechanisms are even less effective because of the FCC’s evident inattention to the program.

The management and oversight issues identified by the GAO include:

(1) The FCC is currently relying on USAC to identify which procedures should be codified into rules, raising the question of which

‘‘entity is really establishing the rules of the program and—conVerDate 11-MAY-2000 11:37 Nov 09, 2005 Jkt 000000 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 24466.TXT HCOM1 PsN: HCOM1
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114 Id. at 29. 115 Id. at 27-30. 116 In connection with the GAO work and Subcommittee inquiry, the FCC announced in March

2005 that it had contracted with the National Academy of Public Administration (NAPA) for

NAPA to study and explore alternative models to the current organizational and government

structure of the Universal Service program. The GAO testified before the Subcommittee on

March 16, 2005 that this study would go ‘‘a long way toward addressing the concerns’’ on this

cerns about the depth of involvement by FCC staff with the management of the program.’’ 114

(2) The FCC has not fully addressed confusion and enforcement

issues arising from the distinction between USAC ‘‘implementing

procedures’’ and the FCC’s program rules. This causes confusion regarding rule enforcement and the ability to recover funds when

USAC procedures are violated. The GAO notes, for example, that,

even under the FCC’s August 2004 Fifth Report and Order, which

addressed some questions concerning codifying procedures, ‘‘the

commission did not clearly address the treatment of beneficiaries

who violate a USAC administrative procedure that has not been

codified.’’ The GAO explains that this ‘‘creates a potentially unfair

situation when the procedure is one that can lead to denial of an

application.’’ That is, if a procedure violation is caught in the application process, funding will be denied; if it is caught later, in a beneficiary audit, no action to recover funds can be taken.115

(3) The FCC resolves appeals too slowly, and has a very large

backlog of appeals—527 appeals were pending decisions at the time

the GAO completed its review. This adds uncertainty to the program and leaves applicants in an E-rate program ‘‘limbo,’’ and

raises the risk of both wasted funding opportunities and wasteful

spending. All of these examples raise questions about the FCC’s

ability to handle the additional burden of audit resolution that is

expected to arise from a new set of about 200 beneficiary audits

planned for the program. Resource demands are only likely to

grow, and it is not clear that the FCC will be able to keep up. In

short, the GAO concludes, the FCC simply has not done enough to

manage and provide a framework of government accountability for

the multi-billion-dollar E-rate program. The prospects for positive

progress in the future, given the FCC’s past actions, staff turnover,

and neglect, are not encouraging.

GAO Recommendations: The GAO concluded that the problems it identified signal that the FCC must take corrective action.

The GAO report recommended that the Chairman of the FCC direct the agency to take the following actions:

1. Conduct and document a comprehensive assessment to determine whether all necessary government accountability requirements, policies, and practices have been applied and are fully

in place to protect the program and the funding. The assessment should include, but not be limited to: (a) the implications

of the FCC’s determination that the Universal Service Fund

amounts to an ‘‘appropriation’’ by identifying the fiscal controls

that apply to the Universal Service Fund, including the collection, deposit, obligation, and disbursement of funds; and (b) an

evaluation of the legal authority for the organizational structure of the E-rate program, including the relationship between

the FCC and USAC and their respective authorities and roles

in implementing the E-rate program.116

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issue outlined in its report. However, at an April 26, 2005 House Appropriations Justice State

Subcommittee hearing, FCC Chairman Martin testified that the study had been put on hold

pending further review. On June 9, 2005 the FCC issued a Notice of Proposed Rulemaking and

Further Notice of Proposed Rulemaking to initiate ‘‘a broad inquiry into the management and

administration of the Universal Service Fund.’’ Because of this action, Chairman Martin cancelled the NAPA contract. Staff believes the FCC’s decisions on this front will demonstrate the

depth of the agency’s seriousness in implementing the GAO’s recommended reforms.

2. Establish performance goals and measures for the E-rate program that are consistent with the Government Performance

and Results Act. The FCC should use the resulting performance data to develop analyses of the actual impact of E-rate

program funding and to determine areas for improved program

operations.

3. Develop a strategy for reducing the E-rate program’s backlog, including ensuring that adequate staffing resources are devoted

to E-rate program appeals resolution.

The staff concurs with these recommendations. They are reasonable and necessary steps that the FCC must take to begin resolving

the problems identified both by this Subcommittee, the FCC IG,

and the GAO. Each of the recommendations addresses the main

findings in the GAO report. Further, as the GAO recommends, the

FCC should request of the Comptroller General an advance decision, as applicable under 31 U.S.C § 3529, on matters relating to

the complexities posed by the FCC’s arrangements with USAC and

the questions that flow from these arrangements.

Given the FCC’s history of E-rate program management, as identified by the GAO and this Subcommittee’s investigation, the FCC

should produce for the Committee a report with relevant findings

and actions, addressing the GAO’s recommendations. The FCC’s

analysis should recognize the dynamic state of technology, and

offer an assessment of the extent that, given the data that 100%

of schools are reportedly connected to the Internet, the emphasis

of the E-rate program’s non-Priority I funding may well shift to upgrades and maintenance. Given the current state of Internet

connectivity, measurement and goals matrices for assessing program progress that may have been appropriate for 1998 may no

longer be valid for 2006 and beyond. The FCC should account for

the current state of school technology in its analyses.

The staff agrees with the GAO’s view that any reassessment of

the program must consider the needs of the beneficiaries—the

schools and libraries across the country that use the E-rate program to support their purchase of telecommunications services. Efforts to protect the program from waste, fraud, and abuse do not

need to be mutually exclusive of a program that does not excessively burden the participants. This may first require an honest assessment of the program’s goals and operations. Additional assistance from the GAO to review and assess crosscutting efforts by

other Federal agencies to assist schools and school districts is probably necessary to develop an accurate picture of federal support of

telecommunications in education.

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