Universal service traditionally has meant providing residential customers with affordable, nationwide access to basic telephone service. The Telecommunications Act of 1996, however, extended universal service support to eligible schools and libraries. The new program (often referred to as the “e-rate” program) is designed to improve schools’ and libraries’ access to modern telecommunications services. Generally, educational institutions that meet the definition of “schools” laid out in the Elementary and Secondary Education Act of 1965 are eligible to participate, as are libraries that can receive assistance from a state’s library administrative agency under the Library Services and Technology Act. Schools and libraries do not receive direct funding from the program. Instead, support comes in the form of discounts on the costs of telecommunications services. FCC’s orders provided for discounts ranging from 20 to 90 percent on all commercially available telecommunications services, Internet access, and internal connections. The act specifies that every telecommunications carrier providing interstate telecommunications services must contribute to a universal service fund, unless exempted by FCC. This fund is used to reimburse vendors for the discounted services that they provide to program participants. The act did not prescribe a structure for administering the program. However, in 1997, FCC directed the establishment of the Schools and Libraries Corporation to carry out this function. The Corporation works within the framework of the FCC’s orders and rules to administer certain program functions. The Corporation, with a 14-member staff based in Washington, D.C., contracted out most of its application-processing, client support, and review functions to the National Exchange Carrier Association (NECA), located in New Jersey. NECA’s key responsibilities include reviewing applications to ensure compliance with the program’s requirements and processing invoices from telecommunications vendors to reimburse them for the cost of discounts they provide. NECA, in turn, has subcontracted with two other organizations to help answer applicants’ questions, process and enter applications into the Corporation’s database, and establish and maintain the Corporation’s public web site, which contains important information about program operations and application procedures. FCC changed this administrative structure in November 1998 in response to the Congress’s directive that a single entity administer universal service support for schools and libraries and rural health care providers. FCC appointed the Universal Service Administrative Company (USAC) as the permanent administrator of the universal service fund and directed the Corporation to merge with USAC by January 1, 1999. Under this merger, the Corporation’s staff will become part of USAC’s Schools and Libraries Division, carrying out essentially the same functions as before. Since our review ended prior to the reorganization, we continue to refer to “the Corporation” in this report. In order to receive universal service support, each applicant completes a two-stage application process. During the first stage, the applicant submits a form that lists the services for which discounts are being requested. These forms are posted on the Corporation’s web site so that vendors can provide applicants with competitive bids on requested services. The second stage begins after the applicant accepts a bid and enters into a contract with a vendor. The applicant submits a second form that details the types and costs of the services being contracted for and the amount of the discount being requested. The Corporation checks these forms using its application review procedures, which are designed to ensure that support goes only to eligible entities, for eligible services, at appropriate discount levels. It then issues commitment letters to successful applicants informing them of the amount of discount they can expect to receive. We found that the Corporation has taken actions to implement the key recommendations we believed should be completed before issuing any funding commitment letters to applicants. Specifically, the Corporation has sampled applications that were already processed to identify and correct any systemic weaknesses in its program integrity review procedures; finalized the program’s procedures, automated systems, and internal controls; and obtained a report from its independent accountants that the Corporation had suitably designed its internal controls to prevent or detect material departures from program objectives, as of November 4, 1998, in conformity with criteria set forth by the Corporation in its “Management’s Statement of Universal Service Discount Mechanism Program Objectives and Internal Control Objectives.” In addition, the Corporation is following our recommendation to complete its special reviews of high-risk applications before issuing funding commitment letters to these applicants. One recommendation, however, still needs to be implemented: FCC needs to develop adequate goals, performance targets, and measures for the program. One of the Corporation’s primary responsibilities is to ensure that funding goes only to eligible applicants, for eligible services, at the appropriate levels of discount—as specified by FCC orders. During our initial review in June and July 1998, we found several areas of potential weakness in the Corporation’s program integrity procedures that could result in funding being directed to applicants for ineligible services or at inappropriately high levels of discount. FCC’s Chairman accepted our recommendation to delay issuing funding commitment letters until the Corporation randomly selected applications to assess how well its review procedures were actually working. One of the Corporation’s automated tests is designed to determine whether an applicant is eligible for support under the program. A computer program compares the name of the applying school or library against a database of eligible schools and libraries. Although we did not identify a weakness with this test approach during our initial review, we recommended that the Corporation verify the approach’s effectiveness as part of its review of a random sample of processed applications. The verification showed that only one application in a sample of 100 was from an ineligible applicant. This application, however, had already been flagged by the Corporation’s automated test for eligible applicants. This result indicates that the Corporation’s procedures for preventing ineligible schools and libraries from participating in the program appear to be working effectively. As noted earlier, FCC provides discounts for telecommunications services, Internet access, and internal connections. Checking on the eligibility of requested services is not easy, however, because of the variety and technical nature of many of these services—especially those related to internal connections. The Corporation’s review procedures for eligible services use both manual inspections and an automated system for flagging problem applications. An important internal control document in this review process is a checklist of ineligible items, which is used during the initial screening of applications. If a clerical staff member using this checklist finds an ineligible item on an application, the application is flagged in the application processing system for a second, more detailed review by a professional staff member who checks the eligibility of each requested service. We found, however, that as the Corporation processed applications and gained experience in the types of services being requested, it added items to its checklist of ineligible services. As a result, different criteria were applied to applications, depending on when they were first screened. In our early discussions with Corporation officials, we learned that they did not intend to recheck applications that had been processed before the checklist was updated. This raised our concern that some early applications may have cleared the screening process that should have been flagged for detailed review. The results of the Corporation’s review of a random sample showed that weaknesses indeed existed in its procedures for ensuring that only eligible services receive funding. At least 19 of the 100 applications in the sample contained requests for ineligible items as defined by FCC orders, totaling approximately $106,000 in inappropriately requested funding. Of these 19 applications, 7 had been classified as “clean” (that is, containing no ineligible items) by the Corporation’s earlier review and contained approximately $6,000 in inappropriately requested funding. The Corporation’s independent accountants, PricewaterhouseCoopers, subsequently requested the Corporation to conduct a further sample of 300 applications that had been classified as “clean.” This review found that 4.6 percent, or approximately $314,000, of the discount funding requested in these applications would have gone to ineligible items. Given the error level revealed by these two samples, Corporation officials concluded that their test had to be strengthened. Accordingly, they changed their review procedures to require staff to perform a complete manual review of every requested service item in all 32,000 applications, regardless of whether these applications had been flagged during the initial screening. To implement these new procedures in a timely manner, the Corporation’s contractor augmented its permanent staff with temporary staff to perform the reviews. Training and supervising new staff is, of course, important in ensuring that the new review procedures are carried out effectively. FCC orders state that the level of discount that each school or library can receive should be determined by the applicant’s economic need and location. Discounts range from 20 to 90 percent of the costs of the services to the applicants, with higher discounts going to those in low-income and rural areas. Applicants calculate the discount level to which they are entitled by following instructions and criteria on the application form and certify that their discount calculations are correct. When the Corporation processes an application, it uses an automated test to check the requested discount level. This test compares the applicant’s requested discount with a discount level calculated from data on schools in the Corporation’s database. If the applicant is requesting a higher discount than indicated by the Corporation’s database, the test can flag the application for special review. As part of this review, a program official contacts the applicant and gathers information to determine whether the requested discount level is in fact correct. It is possible for the automated system to flag every application that shows a variance from the Corporation’s own calculation. However, the Corporation decided that such a stringent approach was not warranted because of limitations in the database it uses to make its calculations. For example, the database contains the number of students actually participating in the National School Lunch Program, rather than the number eligible to participate, which is the measure adopted by FCC. Moreover, the data are about a year old. Mindful of these limitations, the Corporation decided to establish some latitude in its review procedures for eligible discounts.