[Senate Hearing 108-962]
[From the U.S. Government Publishing Office]
S. Hrg. 108-962
THE UNIVERSAL SERVICE E-RATE PROGRAM
=======================================================================
HEARING
before the
COMMITTEE ON COMMERCE,
SCIENCE, AND TRANSPORTATION
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
OCTOBER 5, 2004
__________
Printed for the use of the Committee on Commerce, Science, and
Transportation
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SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
JOHN McCAIN, Arizona, Chairman
TED STEVENS, Alaska ERNEST F. HOLLINGS, South
CONRAD BURNS, Montana Carolina, Ranking
TRENT LOTT, Mississippi DANIEL K. INOUYE, Hawaii
KAY BAILEY HUTCHISON, Texas JOHN D. ROCKEFELLER IV, West
OLYMPIA J. SNOWE, Maine Virginia
SAM BROWNBACK, Kansas JOHN F. KERRY, Massachusetts
GORDON H. SMITH, Oregon JOHN B. BREAUX, Louisiana
PETER G. FITZGERALD, Illinois BYRON L. DORGAN, North Dakota
JOHN ENSIGN, Nevada RON WYDEN, Oregon
GEORGE ALLEN, Virginia BARBARA BOXER, California
JOHN E. SUNUNU, New Hampshire BILL NELSON, Florida
MARIA CANTWELL, Washington
FRANK R. LAUTENBERG, New Jersey
Jeanne Bumpus, Republican Staff Director and General Counsel
Robert W. Chamberlin, Republican Chief Counsel
Kevin D. Kayes, Democratic Staff Director and Chief Counsel
Gregg Elias, Democratic General Counsel
C O N T E N T S
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Page
Hearing held on October 5, 2004.................................. 1
Statement of Senator Burns....................................... 5
Prepared statement........................................... 6
Statement of Senator McCain...................................... 1
Statement of Senator Rockefeller................................. 2
Prepared statement........................................... 4
Letter dated October 1, 2004 to Hon. Michael K. Powell,
Chairman, Federal Communications Commission from Senators
Olympia J. Snowe and John D. Rockefeller IV................ 33
Statement of Senator Snowe....................................... 7
Witnesses
Bennett, Thomas, Assistant Inspector General, USF Oversight,
Federal Communications Commission; accompanied by Thomas C.
Cline, Assistant Inspector General for Audits, Office of the
Inspector General, FCC......................................... 9
Prepared statement of H. Walker Feaster III, Inspector
General, Federal Communications Commission................. 11
Gumper, Frank, Chairman of the Board, Universal Service
Administrative Company......................................... 18
Prepared statement........................................... 20
Himsworth, Winston E., Executive Director, E-Rate Central........ 25
Prepared statement........................................... 27
McDonald, George, Vice President, Schools and Libraries Division,
Universal Service Administrative Company....................... 21
Prepared statement........................................... 23
THE UNIVERSAL SERVICE E-RATE PROGRAM
----------
TUESDAY, OCTOBER 5, 2004
U.S. Senate,
Committee on Commerce, Science, and Transportation,
Washington, DC.
The Committee met, pursuant to notice, at 9:40 a.m. in room
SD-253, Russell Senate Office Building, Hon. John McCain,
Chairman of the Committee, presiding.
OPENING STATEMENT OF HON. JOHN McCAIN,
U.S. SENATOR FROM ARIZONA
The Chairman. Good morning. Today the Committee meets to
hear testimony on problems in the E-rate program. When the
program was established in the Telecommunications Act of 1996,
Congress was hopeful that every classroom in the country would
be wired to the Internet. Eight years later, there are many
success stories. There are also tales of waste, fraud and abuse
in the $2.25 billion per year program and they are ubiquitous.
Among those examining the E-rate program are the FCC
Inspector General's Office, along with the Inspector Generals
at the Department of the Interior and Education, the Government
Accountability Office, the Subcommittee on Oversight and
Investigations of the House Energy and Commerce Committee, the
FBI, and the Antitrust Division of the Department of Justice. I
understand that there are currently over 40 criminal cases
pending in Federal and State courts involving program abuses.
Criticisms of the program have been extensive and pointed.
At a hearing earlier this summer, the former chairman of the
House Subcommittee on Oversight and Investigations, Mr.
Greenwood, said of E-rate, ``While a well-intentioned idea, the
E-rate program as it is currently structured is an invitation
for disaster. Indeed, if one were to design a program to pour
money out the window, this would be the way to do it.''
I understand that Chairman Barton is committed to
continuing his committee's revealing probes of the program.
Newspapers around the country have conducted their own
investigations. The Atlanta Journal Constitution, which has
provided some of the most revealing examinations, recently
editorialized, quote: ``Handed a blank check from the Federal
Government, Atlanta frittered away nearly $73 million on
overblown and unnecessary computer systems that it now has to
struggle to maintain. Born of the Internet boom and funded
through a telephone service surcharge, the E-rate program was
created to assure poor children computer access, and there is
no proof that the lavish computer arsenal has done a thing to
boost student learning. The only proven boost has been to the
bottom lines of the technology companies that sold the schools
all the pricey stuff.''
The extent to which technology companies have been unjustly
enriched at telephone users' expense is unknown, but the size
of the schemes that were discovered and disallowed suggests
that the enrichment has been substantial. In 2002 the E-rate
Administrator, USAC, disallowed over $500 million in
applications in which IBM had worked with school districts to
effectively circumvent the competitive bidding system process
that was supposed to ensure the integrity of the E-rate
program.
In May of this year, NEC Business Network Solutions agreed
to plead guilty and pay $20.6 million in criminal fines, civil
settlement, and restitution relating to charges of bid rigging
at five different school districts in Michigan, Wisconsin,
Arkansas, and South Carolina and for fraud with respect to the
San Francisco Unified School District.
Unscrupulous vendors are not the only problem. There is
blame enough to go around. In Puerto Rico, State officials
appear to be among those responsible for squandering over $100
million in E-rate funds. School districts that have found ways
to avoid paying their matching share for services and equipment
have allowed themselves to be manipulated by crooked vendors or
in some instances have been parties to bilking ratepayers and
denying students much-needed equipment.
I understand that one school in Michigan had a $750,000
television studio built for it by its E-rate vendor, which
gives you an idea of the vendor's excessive profits.
As for the regulators, they too are to blame. The FCC,
while making rule changes in response to exploding scandals,
has been reactive and too gentle. Only last year did the FCC
allow for disbarments, but the new rules seem lax. Vendors are
prohibited from participating in the program only if there is a
criminal conviction or finding of civil liability and, given
the length, this means vendors can participate for a very, very
long time.
USAC, which administers E-rate, has had some successes in
preventing the most blatant attempts to defraud the fund, but
its audits have been too few, too late, and too forgiving.
Lest we overlook ourselves, Congress also is responsible.
We created the program and, despite its endemic problems, its
popularity makes clear that it is not going away. It is
incumbent upon us to ensure, either through oversight or
legislation if necessary, that E-rate functions as intended.
Today's hearing is just the beginning.
Senator Rockefeller.
STATEMENT OF HON. JOHN D. ROCKEFELLER IV,
U.S. SENATOR FROM WEST VIRGINIA
Senator Rockefeller. Thank you, Mr. Chairman. I thank your
accommodation with respect to the scheduling of this, and I
look forward to hearing what people have to say.
I have to tell you that I am very, very disappointed that
the FCC, which was invited to testify today, declined to do so.
I do not think that was accidental. They have their purposes
with respect to E-rate and have revealed them in recent years.
The FCC is charged with oversight of the universal service
program. Both the FCC Inspector General, who is here, and the
GAO have been critical of their oversight.
Mr. Chairman, all of us--the waste, fraud and abuse
argument has been used from the very beginning and I am not
denying that there is some of that. I think it is also
important to point out that there are millions and millions of
kids who have access to computers and who can learn Japanese
and do all kinds of things that could not before. So we are all
concerned about waste, fraud and abuse in this or any other
Federal program, including the Department of Defense and
wherever it might be.
So it is clear that USAC and the FCC have plans in place to
combat waste and fraud. I want to hear about those. These are
essential and should be monitored and strengthened as the
Chairman has indicated.
I know the Chairman would prefer that the hearing be
limited or at least focused on waste, fraud and abuse, but I
have got something else I have got to say which I think is
equally important. That is the suspension of the E-rate. There
was a little article in the New York Times. I do not think most
people know about it, but the E-rate and Rural Health Care
funding commitments have been suspended due to changes in
accounting practices which are very technical at the
administration corporation, USAC, which they administer the USF
program, the Universal Service Fund program.
They were forced to suspend these commitment letters.
However, the policy, process, and impact leading up to this
decision is unclear and needs to be resolved. The program is
not in effect. Nobody is getting any money anywhere. So there
is no waste, fraud and abuse going on now. There is not
anything going on now.
I have heard from schools that the suspension of funding is
causing a significant disruption to their operations. It is
inconceivable to me that funding was stopped as the school year
was beginning. It appears that if the FCC had acted in a more
timely manner, the absent FCC, the deliberately absent FCC, on
this issue we would not be in this situation.
Mr. Chairman, I want these questions answered today and I
know that there are votes and other things. What are the plans
to deal with the suspension of the E-rate and the Rural Health
Care programs? I want to know. Is the FCC treating E-rate and
Rural Health Care in a discriminatory fashion? I want to know.
What happens in the first quarter of next year when the FCC has
to find $550 million to make up for undercollected E-rate
funding? Are we facing a huge rate spike, which is my fear, or
will schools lose their money forever, which is also my fear?
As many of you know, Senator Snowe and I sent a letter to
the FCC asking for an explanation. I do not think we have heard
anything from them.
Mr. Chairman, I know that the bulk of the issue that you
wish to address involves what I mentioned before and you will
find no stronger ally for somebody who cares so much about the
E-rate about getting rid of waste, fraud and abuse because that
has been a rap on it from the beginning. I think it is partly
true and partly untrue. I also know that you share my concerns
that the entire Universal Service Fund is now jeopardized by
recent events and we have an obligation to look into this
matter further.
Mr. Chairman, I have a longer statement. I submit it for
the record.
[The prepared statement of Senator Rockefeller follows:]
Prepared Statement of Hon. John D. Rockefeller IV,
U.S. Senator from West Virginia
Mr. Chairman, I appreciate your cooperation in scheduling this
hearing. I know that we are all pressed for time this week. I would
also like to welcome our witnesses today. I look forward to hearing
from you on issues affecting the E-Rate program.
The E-rate program has fundamentally transformed education in this
country--we have connected our most remote schools and libraries to the
world. The E-rate has enabled schoolchildren across this country to
participate in the information society. I have seen firsthand the
benefits of the E-rate in West Virginia schools and our libraries. All
students in West Virginia can have free access to the Internet in local
libraries, and through these connection they can access free practice
tests for the ACT and SAT. Our libraries and our schools would not be
connected without E-rate. Unfortunately this message has been lost in a
spate of negative headlines about the program, which all too often have
not told the full story.
All of us are concerned about waste, fraud and abuse in this
program or any other Federal program. The E-rate program processes tens
of thousands of applications annually. Unfortunately, a few bad actors
have in some way tarnished the success of this program. We need to make
sure that the E-rate program has strong program integrity and that any
bad actors are appropriately punished so that we can make sure future
bad actors cannot take advantage of schools or the program.
We cannot nor should we tolerate any waste, fraud or abuse in this
program because our schools and libraries need the dollars that the E-
rate provides. As the General Accountability Office has noted, we--
Congress, the Federal Communications Commission (FCC), and the
Universal Service Administrative Corporation (USAC)--need to provide
more effective and consistent oversight of not just E-rate but all of
the Universal Service Fund programs, including High Cost, Low-Income
and Rural Health Care.
The impact of the E-rate on our schools has been impressive. For
example, in 1996, when the Telecommunications Act was signed into law,
only 14 percent of all classrooms were connected to the Internet, and
among the poorest schools, only 5 percent of classrooms were connected.
The most recent statistics for classroom connection are amazing--92
percent of all classrooms are connected, and 89 percent of the poorest
classrooms are connected. This is a wonderful story of success over the
past 7 years. In addition to the direct education benefit that this has
provided our children, it has exposed rural and inner city kids to
technology helping bridge the digital divide.
In addition to the impressive statistics on classroom connections,
a recent GAO study released in September 2004 highlighted that 84
percent of rural superintendents reported that E-rate was helping them
comply with the federally-mandates No Child Left Behind Act
requirements. The superintendents reported that E-rate was helping to
provide affordable teacher training and development so teachers could
earn the highly qualified status. It also allows students in isolated
rural schools to use distance learning to take courses from qualified
teachers at other locations. Such access is critical for our schools if
we want them to achieve the new higher academic standards, especially
when Federal funding for the No Child Left Behind Act is billions of
dollars less than promised.
Over the last several years, the FCC and USAC have been
systematically improving the E-rate funding process and aggressively
pursuing any hint of waste, fraud and abuse. USAC created its own
whistler blower hotline to combat fraud and it established a task force
to provide recommendation on ways to combat fraud. The FCC issued two
orders to improve E-rate program integrity. These two actions will
serve to strengthen the program.
I will work with my colleagues, the FCC, and USAC to improve the
operation of the E-rate program. We must not let a few high-profile
cases of waste, fraud and abuse undermine the program. We must and will
make the necessary changes to prevent future cases.
As equally important to maintaining the E-rate's program integrity
is making sure it can undertake its mission. I am deeply concerned by
reports that in the last week of the year-long conversion of the
Universal Service Fund from GAAP to Government GAAP accounting
standards, the FCC has instituted changes that may significantly affect
the operation and administration of the entire Fund, and in particular,
the schools and libraries (``E-rate'') and rural health care funds.
This action has led to the suspension since August 3, 2004 of the
Funding Commitment Decision Letters (``Commitment Letters'') issued
under those programs and the Commission's determination that funds held
in the Universal Service Fund are Federal funds for purposes of the
Anti-Deficiency Act. This suspension has already had already
significant negative impact on schools, libraries and rural health care
providers across the country.
It is my understanding that the FCC and USAC are suggesting that
the program will remain suspended until mid-November resulting in over
4,000 schools and libraries with eligible applications for this year
worth about $300 million being placed on hold. The number of schools
and libraries waiting for funding will grow dramatically over the fall.
In addition to the decision to suspend E-rate Commitment letters, I
am troubled by the seemingly inconsistent decisions made by the
Commission as it has implemented the accounting conversion. First, at
the same time the Commission was deciding whether to treat Commitment
Letters as ``obligations'' for accounting purposes USAC to have monies
in its account to cover all existing and future Commitment Letters, the
Commission took steps to ``under collect'' E-rate revenues by a total
of $550 million. These decisions will to require substantial reductions
in available outlays for the schools and libraries and rural health
care programs and will increase significantly the contribution rate
assessed on providers of interstate communications services and passed
through to consumers early next year. It could be perceived that the
Commission's decisions have been politically motivated and designed to
undermine the Fund.
Lastly, I am bothered that while the FCC has taken steps to ensure
that the E-rate and rural health care programs are in compliance with
the new accounting requirements, we understand the Commission has not
completed a full review of the impact of the conversion on the high-
cost fund. In particular, the Commission's apparent decision regarding
treatment of the E-rate and rural health care Commitment Letters as
obligations may also impact how projected costs used to calculate high-
cost support should be treated for accounting purposes. If these
projections are determined to be obligations, the high-cost fund could
face disruptions similar to those currently being experienced in the E-
rate and rural health care programs, putting in jeopardy billions of
dollars relied on by rural telecommunications carriers that bring
essential services to consumers.
I will not sit by and watch the FCC undermine our ability to
provide universal service. The only reason many West Virginians have
access to telephone service is because of universal service. I do not
want to see their telephone bills jacked up dramatically because the
Commission has been artificially keeping rates low over the last year.
Mr. Chairman, this Committee will begin examining the future of
telecommunications policy in the next Congress. Maintaining the
integrity of universal service and the E-rate will be two of my highest
priorities. Instead of a campaign to tear down these programs, we
should be looking how we can leverage the investments we have already
made in wiring schools and libraries to bring a wider array of new
services to our most our children.
The Chairman. Senator Rockefeller, I also read the same
article and I share your concern, particularly since apparently
no one was notified, including the Congress nor members of this
Committee. That is very disturbing. We may have to have a
follow up hearing, perhaps during the lame duck session,
depending on what we get out of this. If we are talking about
this kind of money and this kind of a program, we may have to
delve deeper into it.
Senator Burns.
STATEMENT OF HON. CONRAD BURNS,
U.S. SENATOR FROM MONTANA
Senator Burns. Thank you, Mr. Chairman, and thank you for
the hearing.
The Chairman. By the way, I would just like to say Senator
Burns and Senator Rockefeller and Senator Snowe, the three
members here, had a huge amount of influence on the whole E-
rate program itself, and I thank them for their continuing
involvement.
Senator Burns. Well, thank you, Mr. Chairman. I want to
associate myself with your words. There has been some waste,
fraud and abuse, and to get to those, that is good.
But I want to ask unanimous consent that my full statement
can be put in the record.
The Chairman. Without objection.
Senator Burns. But I just want to point out a couple of
things. The Anti-Deficiency Act, which is a Federal budget law,
what it really caused here, and it is my understanding that the
relationship between USAC and the FCC is not the best at this
present time and it is causing real difficulties.
But to get a little history on this, the real change was
intended to improve oversight on USAC's administration of E-
rate funds to eliminate fraud and abuse. But this change
apparently also limited USAC's ability to spend the money. So
the E-rate program had excess money in the amount of around $3
billion.
Now, that might not seem like much for a lot of folks, but
that sounds like a hell of a lot of money to me. The FCC then
reduced the contribution factor and the surplus was placed in
investments. We will talk about that in a little bit. This was
followed by a change in the E-rate rules which forced USAC to
hastily sell this $3 billion investment at a loss. Some would
put the figure at around $21 million.
I fail to see how these series of events resulted in more
effective administration of the E-rate program. So I think this
has caused a chain effect that has cost us money, not only in
the fund, but also this drastic action of cutting off all funds
now going to schools that need it. And I have got 33, 34 in my
state that I have got phone calls from already. These are all
rural schools. In Montana, like in West Virginia, when you talk
about rural, we are rural.
These funds are vital as far as the telephones it takes and
the communications it takes to communicate with the outside
world, so to speak.
I just ask my full statement be put in the record, but
thank you for calling this hearing.
[The prepared statement of Senator Burns follows:]
Prepared Statement of Hon. Conrad Burns, U.S. Senator from Montana
I thank the Chairman for calling today's hearing, which addresses a
matter of urgent importance. A change in FCC rules and accounting has
caused many eligible schools and libraries which are dependent on E-
rate funds, including at least 33 in Montana, to suddenly lose this
funding. While I have had many concerns over the administration of the
E-rate program over the years, clearly the current situation is proving
inappropriately harmful to many worthy institutions.
The state of interaction between the FCC, USAC, and the other
relevant budget entities has deteriorated to the extent that the
program's administration has been interrupted. The rule changes in
question go back at least a year, which would seem to have provided
enough time to productively address legitimate accounting concerns
without freezing funds. The rule change was intended to improve
oversight over USAC's administration of E-rate funds to eliminate fraud
and abuse. But this change apparently also limited USAC's ability to
spend money. So the E-rate program had excess money, in the amount of
about $3 billion; the FCC then reduced the contribution factor and the
surplus was placed in investments. This was followed by a change in the
E-rate rules which forced USAC to hastily sell this $3 billion
investment at a loss. I fail to see how this sloppy series of events
resulted in a more effective administration of the E-rate program.
I realize that this hearing will address troublesome cases of
waste, fraud and abuse in the E-rate program, and I understand that the
problem we have today in part a consequence of an attempt to provide
better oversight for the program and to reduce fraud. Obviously these
are lofty and commonly-held goals. But cutting off all the bona fide
schools and libraries in this way is about the worst way deal with the
situation.
I am seriously troubled at the dire prospects faced by scores of
schools and libraries in Montana because of this cutoff of funds, and
numerous other states face similar problems. A potential solution to
restoring funding would be to simply postpone the budget rule changes
that have been made until a full review can be undertaken.
Ultimately this system must be made more effective and must work
the way it is supposed to work. Bearing this in mind, once the
immediate problem of restoring the program to operation is addressed,
we must also strive to determine the best way out of this current,
unacceptable situation in the long-run. In other words, several key
policy matters must be decided, including how exactly USAC funds should
be accounted for, given that they are not appropriated monies, but
rather collected from private carriers; how oversight should be
organized, under what part of the government; and how we get there from
here.
Should money held in universal service accounts, like E-rate, be
included in the Federal budget? What other alternatives are there? Is
generally accepted government accounting the only solution? If not, are
there other ways to improve oversight? What can we learn from the ways
that other universal service programs are run? I look forward to
hearing the testimony of the witnesses on these vital issues. Thank
you.
The Chairman. Without objection.
Senator Snowe.
STATEMENT OF HON. OLYMPIA J. SNOWE,
U.S. SENATOR FROM MAINE
Senator Snowe. Thank you, Mr. Chairman. I am pleased to be
here this morning to hopefully get some answers in terms of why
we face this dilemma in the E-rate program at this juncture. I
share the concerns and what has been expressed by the chairman
and Senator Rockefeller and Senator Burns as well.
We have all worked mightily to ensure that this program
works effectively, efficiently, and appropriately. It has been
an enormous success. It is one of the most successful
education-related programs in our nation's history, when you
consider the fact when the Telecommunications Act was first
enacted in 1996 that only 14 percent of classrooms in America
had Internet connection and today we are talking almost 99
percent, 95, 99 percent, not to mention some of the poorest
school districts in America.
Since the program was created, more than $12 billion has
been disbursed. I think absolutely we ought to be looking and
focusing on those areas in which the money has not been
appropriated within the legal parameters of the law, and if
vendors and recipients are defrauding the government we ought
to take appropriate action. I hope that the measures that have
been put in place by the Inspector General, the FCC, those that
have been identified by the General Accounting Office, also
have been fully implemented as well. I know that the FCC has
even issued recent actions with respect to taking some strong
measures against fraud and abuse.
The other dimension to this problem, as Senator Rockefeller
indicated: We have a letter that has been sent to the Chairman
of the FCC, Mr. Powell, on the issue of why USAC has been
placed in this situation with respect to letters of commitments
now, not being able to disburse those funds, with shifting to
government accounting rules in midstream, especially since
there had been some consideration of making this conversion
last February, but they did not get notice until July, so that
they had to put a halt to this in August.
So it does affect school districts and libraries across the
country. It is also going to cost USAC money. As I understand
it, it is going to force them to liquidate their assets. From
what I understand, they are going to lose $30 million in
accrued interest as a result of having to liquidate these
assets in order to meet these commitments.
It is arbitrary application of these government accounting
principles as I understand it. Senator Rockefeller and I have
not been able to get any answers as to, first, who is
responsible for this decision? Is it the FCC, or is it OMB? How
did this come about? Why in this untimely fashion, an
inconsistent application?
The fact is they cannot offer a reason as to what exactly
would require USAC to apply these rules at this moment in time.
So now it is withholding more than $300 million in disbursement
for E-rates, affecting schools when this decision coincided at
the beginning of the school year. So now it is affecting
schools who are dependent on this money.
It is just really difficult to understand why this all
transpired. I happen to think it may be another back door route
to undermining this valuable program. So I hope that we are
going to be able to get some answers here today, because
obviously this was done in such a fashion to affect the well-
being of the program, but ultimately affecting school districts
across America, and the fact is not giving USAC the time in
which to comply with this type rule, this kind of change, in
the future.
We know that similar entities in government do not have to
abide by the same standards. There was nothing to point to the
fact that they should be required to move to these standards.
But if that is the case, then why not give them appropriate
timing in which to make the adjustments without having adverse
and consequential impact on our schools as they are beginning
the school year?
So I hope we get to the bottom of this, Mr. Chairman, as
well. I want to thank my colleagues, Senator Rockefeller most
especially, for all the work and the leadership that he has
provided on this issue.
Thank you.
The Chairman. Thank you.
Our witnesses today are: Mr. Thomas Bennett, who is the
Assistant Inspector General for USF Oversight, the Federal
Communications Commission. He is accompanied by Mr. Cline from
the FCC's Inspector General's Office. Mr. George McDonald, USAC
Vice President, Schools and Libraries Division; Mr. Frank
Gumper, USAC Chairman of the Board; and Mr. Winston E.
Himsworth, President, E-Rate Central, and founder of State E-
Rate Coordinators Alliance.
We only have about 4 minutes left in our vote, so I think
it would probably be best to stand in recess for about 10 or 15
minutes so we can get to the floor, vote, and return. Then we
will hear from our witnesses then. We will stand in recess
until our return in about 10 to 15 minutes. Thank you.
[Recess from 9:57 a.m. to 10:17 a.m.]
The Chairman. The Committee will reconvene. I thank the
witnesses for their patience and I apologize that we were
interrupted by a vote.
We will begin with Mr. Bennett, who is Assistant Inspector
General for USF Oversight, the Federal Communications
Commission. Welcome, Mr. Bennett.
STATEMENT OF THOMAS BENNETT, ASSISTANT INSPECTOR GENERAL, USF
OVERSIGHT, FEDERAL COMMUNICATIONS COMMISSION; ACCOMPANIED BY
THOMAS C. CLINE,
ASSISTANT INSPECTOR GENERAL FOR AUDITS, OFFICE OF THE INSPECTOR
GENERAL, FCC
Mr. Bennett. Mr. Chairman and Members of the Committee: I
appreciate the opportunity to come before you today----
The Chairman. You need to pull the microphone a little bit
closer, please.
Mr. Bennett. I appreciate the opportunity to come before
you today to discuss oversight of the E-rate program and to
discuss concerns that the FCC Office of Inspector General has
with the program as a result of our involvement in audits and
investigations.
My name is Tom Bennett and I am the Assistant Inspector
General for USF Oversight with the FCC OIG. The FCC Inspector
General, Walker Feaster, had intended to provide testimony
today, but Mr. Feaster has taken ill and is unable to be with
us.
I would like to introduce Tom Cline, who is the Assistant
Inspector General for Audits with the FCC OIG. Tom has been
heavily involved in oversight of the E-rate program.
In my testimony I will briefly summarize our involvement in
USF oversight and discuss concerns we have regarding the
program. The FCC Office of Inspector General first looked at
the USF in 1999 as part of our audit of the Commission's Fiscal
Year 1999 financial statement when the USF was determined to be
part of the FCC's reporting entity for financial statement
reporting purposes.
Starting with that audit, the Office of Inspector General
has continued to devote considerable resources to oversight of
the USF. Due to materiality and our assessment of audit risk,
we have focused much of our attention on the USF mechanism for
funding telecommunications and information services for schools
and libraries, the E-rate program. We have designed an audit
program around two corollary and complementary efforts. First,
we have established a plan to conduct E-rate beneficiary
audits, to evaluate beneficiary compliance with program rules
and requirements, and to identify opportunities for
programmatic improvement. Second, we have established a process
for vigorously investigating allegations of fraud, waste and
abuse in the program.
Unfortunately, several obstacles have impeded our ability
to implement effective independent oversight. The primary
obstacle has been a lack of adequate resources to conduct
audits and provide audit support to investigations. We have
demonstrated our commitment to independent oversight of the USF
by adding staff auditor positions and by organizing USF
oversight activities under an Assistant Inspector General for
USF oversight. We have also requested appropriated funding in
each of the last three budget submissions to obtain contract
support for our USF oversight activities.
Most recently, we have requested a significant increase in
funding for USF oversight in our Fiscal Year 2006 budget
submission. The requested increase is primarily a result of a
Commission request for the conduct of audits to meet the
requirements of the Improper Payments Information Act of 2002
and to calculate estimated improper payment error rates for USF
programs, including E-rate.
The Inspector General has been advocating for some time
that the cost of USF oversight should be provided for through
direct access to the USF and we have been advised that this
idea is being considered. We are currently considering
alternatives for obtaining access to contract audit support to
implement the USF oversight portions of our audit plan. We are
working with USAC to establish a three-way contract under which
we can obtain audit resources to conduct USF audits.
We are also working with USAC and a public accounting firm
under contract to USAC to conduct the fourth large-scale audit
of E-rate beneficiaries. 100 beneficiaries are being audited as
part of this project. The project was initiated in August 2004,
and is expected to be completed next summer.
Despite limited resources, the FCC OIG has implemented an
aggressive independent oversight program. Our oversight program
includes audits conducted using internal resources, audits
conducted by other Federal offices of inspector general under
reimbursable agreements, review of audit work conducted by
USAC, and active participation in Federal investigations of E-
rate fraud.
In addition to conducting audits, we are providing audit
support to a number of investigations of E-rate recipients and
service providers.
To implement the investigative component of our plan, we
established a working relationship with the Antitrust Division
of the ratings of Department of Justice. The Antitrust Division
has established a task force to conduct E-rate investigations,
comprised of attorneys in each of the Antitrust Division's
seven field offices and the national criminal office. We are
also supporting several investigations being conducted by
assistant United States attorneys. We are currently supporting
22 investigations and monitoring an additional 15
investigations.
Allegations being investigated in these cases include:
procurement irregularities, including lack of a competitive
process and bid-rigging; false claims; service providers
billing for goods and services not provided; ineligible items
being funded; and beneficiaries not paying the local portion of
costs, resulting in inflated costs for goods and services to
the program; and potential kickback issues.
Our involvement in E-rate audits and investigations has
highlighted numerous concerns with this program. General
concerns include lack of clarity regarding program rules and
lack of timely and effective resolution of audit findings.
Specific concerns regarding program design include:
weaknesses in program competitive procurement requirements;
ineffective use of purchased goods and services; reliance on
applicant certifications; weaknesses in technology planning;
and issues relating to discount calculation and payment.
The Office of Inspector General remains committed to
meeting our responsibility for providing effective independent
oversight of the USF and we believe we have made significant
progress. While the Commission has taken steps to address
programmatic weaknesses, more work remains to be done. Through
our participation in the fourth large-scale round of E-rate
beneficiary audits with USAC and through audits that we
anticipate conducting under our three-way agreement with USAC,
we are moving forward to evaluate the state of the program and
to identify opportunities for programmatic improvements.
In order to continue this important work, it is our belief
that the Commission should have direct access to the USF. This
will provide the resources for an effective and independent
oversight program.
Thank you. Tom Cline and I will be happy to answer any of
your questions.
[The prepared statement of Mr. Feaster follows:]
Prepared Statement of H. Walker Feaster III, Inspector General,
Federal Communications Commission
Executive Summary
The FCC Office of Inspector General has devoted considerable
resources to oversight of the USF, and the E-rate program in
particular.
Several obstacles have impeded our ability to implement
effective, independent oversight of the program. The primary
obstacle we have dealt with has been a lack of adequate
resources to conduct audits and provide audit support to
investigations.
My office's involvement in E-rate audits and investigations
has highlighted numerous concerns with this program. These
include general programmatic and management concerns as well as
specific concerns related to program design. General concerns
include:
lack of clarity regarding program rules, and;
lack of timely and effective resolution of audit
findings.
Specific concerns regarding program design include;
weaknesses in program competitive procurement requirements;
ineffective use of purchased goods and services;
reliance on applicant certifications;
weaknesses in technology planning; and
issues relating to discount calculation and payment.
Until my office has access to the resources and
funding necessary to provide effective, independent
oversight for the program, I am unable to provide assurance
that the program is protected from fraud, waste and abuse.
Mr. Chairman and Members of the Committee, I appreciate the
opportunity to come before you today to discuss oversight of the E-rate
program and to discuss concerns that my office has with the program as
a result of our involvement in audits and investigations. In my
testimony, I will briefly summarize my office's involvement in USF
oversight and discuss concerns my office has regarding the program.
Background on Independent Oversight of the Universal Service Fund (USF)
My office first looked at the USF in 1999 as part of our audit of
the Commission's FY 1999 financial statement when the USF was
determined to be part of the FCC's reporting entity for financial
statement reporting. During that audit, we questioned the Commission
regarding the nature of the USF and, specifically, whether it was
subject to the statutory and regulatory requirements for Federal funds.
Starting with that inquiry, the Office of Inspector General has
continued to devote considerable resources to oversight of the USF.
Due to materiality and our assessment of audit risk, we have
focused much of our attention on the USF mechanism for funding
telecommunications and information services for schools and libraries,
also known as the ``Schools and Libraries Program'' or the ``E-rate''
program. Applications for E-rate funding have increased from 30,675 in
funding year 1998 to 43,050 for the current funding year. Applications
have been received from schools and libraries in each of the 50 states,
the District of Columbia, and most territories and included 15,255
different service providers. Requested funding has increased from
$2,402,291,079 in funding year 1998 to $4,538,275,093 for the current
funding year.
OIG Oversight
During FY 2001, we worked with Commission representatives as well
as with the Defense Contract Audit Agency (DCAA) and the Universal
Service Administrative Company (USAC), to design an audit program that
would provide the Commission with programmatic insight into compliance
with rules and requirements on the part of E-rate program beneficiaries
and service providers. Our program was designed around two corollary
and complementary efforts. First, we would conduct reviews on a
statistical sample of beneficiaries large enough to allow us to derive
inferences regarding beneficiary compliance at the program level.
Second, we would establish a process for vigorously investigating
allegations of fraud, waste, and abuse in the program.
Unfortunately, several obstacles have impeded our ability to
implement effective, independent oversight of the program. The primary
obstacle has been a lack of adequate resources to conduct audits and
provide audit support to investigations. Since our initial involvement
in independent oversight of the USF as part of our conduct of the FY
1999 financial statement audit, we have demonstrated our commitment to
independent oversight of the USF by adding two (2) staff auditor
positions and by organizing USF oversight activities under an Assistant
Inspector General for USF Oversight. This represents dedication of
three (3) of the eight (8) auditors on the staff of the FCC OIG to USF
oversight. In addition to the OIG staff dedicated to USF oversight, two
(2) audit staff members responsible for financial audit are also
involved in USF oversight as part of the financial statement audit
process. In July 2004, I was advised that the OIG would two (2)
additional staff for USF oversight. We are currently in the process of
hiring these additional staff.
We have also requested appropriated funding to obtain contract
support for our USF oversight activities. In our FY 2004 budget
submission, we requested $2 million for USF oversight. That request was
increased to $3 million in the President's budget submission for FY
2004. This funding was not included in the Commission's final budget
for FY 2004 and report language indicated that monies for USF audits
should come from the fund itself. In our FY 2005 budget submission, we
requested $5 million for USF oversight. We have been advised that this
request was not included in this year's budget. We have requested a
significant increase in funding for USF oversight in our FY 2006 budget
submission. The requested increase is primarily a result of a
Commission request for the conduct of audits to meet the requirements
of the Improper Payments Information Act of 2002 and calculate
estimated improper payment error rates for USF programs including E-
rate. I have been advocating for some time that the cost of USF
oversight should be provided for through direct access to the USF. I
have been advised that this alternative is being considered.
We are currently considering alternatives for obtaining access to
contract audit support to implement the USF oversight portions of our
audit plan. We are working with USAC to establish a three-way contract
under which my Office can obtain audit resources to conduct USF audits.
We are also working with USAC and a public accounting firm under
contract to USAC to conduct the fourth large-scale audit of E-rate
beneficiaries. One-hundred beneficiaries are being audited as part of
this project. The project was initiated in August 2004 and is expected
to be completed next summer.
Despite limited resources, my office has implemented an aggressive
independent oversight program. My oversight program includes: (1)
audits conducted using internal resources; (2) audits conducted by
other Federal Offices of Inspector General under reimbursable
agreements; (3) review of audit work conducted by USAC; and (4) active
participation in Federal investigations of E-rate fraud.
One-hundred and thirty five (135) audits have been completed by my
office, USAC internal auditors, or USAC contract auditors in which the
auditor reached a conclusion about beneficiary compliance. Of the 135
audits, auditors determined that beneficiary were not compliance in 48
audits (36 percent) and generally compliant in an additional 22 audits
(16 percent). Beneficiaries were determined to be compliant in 65
audits (48 percent). Recommended fund recoveries for those audits where
problems were identified total over $17 million.
OIG Audits Using Internal Resources
My office has completed thirteen (13) audits that we initiated
during Fiscal Year 2002 using auditors detailed from the Commission's
Common Carrier Bureau (since reorganized as the Wireline Competition
Bureau). For these thirteen (13) audits, we concluded that applicants
were compliant with program rules in five (5) of the audits, that
applicants were generally compliant in two (2) of the audits, and that
the applicants were not compliant with program rules in six (6) of the
audits. We have recommended recovery of $1,794,792 as shown below:
------------------------------------------------------------------------
Report Date
Applicant Conclusion Potential Fund Recovery
------------------------------------------------------------------------
09/11/02 Enoch Pratt Free Compliant $0
Library
02/03/03 Robeson County Compliant 0
Public Schools
02/05/03 Wake County Public Compliant 0
Schools
08/27/03 Albemarle Regional Compliant 0
Library
12/22/03 St. Matthews Not Compliant 136,593
Lutheran School
12/22/03 Prince William Generally 5,452
County Schools Compliant
12/22/03 Arlington Public Generally 7,556
School District Compliant
03/24/04 Immaculate Not Compliant 68,846
Conception School
04/06/04 Children's Store Not Compliant 491,447
Front School
05/19/04 St. Augustine Not Compliant 21,600
School
05/25/04 Southern Compliant 0
Westchester BOCES
06/07/04 United Talmudical Not Compliant 934,300
Academy
08/12/04 Annunciation Not Compliant 129,003
Elementary School
------------------------
$1,794,797
========================
------------------------------------------------------------------------
Audits Conducted by Other Federal Offices of Inspector General
On January 29, 2003, we executed a Memorandum of Understanding
(MOU) with the Department of the Interior (DOI) OIG. The MOU is a
three-way agreement among the Commission, DOI OIG, and USAC for reviews
of schools and libraries funded by the Bureau of Indian Affairs and
other universal service support beneficiaries under the audit
cognizance of DOI OIG. Under the agreement, auditors from the
Department of the Interior perform audits for USAC and the FCC OIG. In
addition to audits of schools and libraries, the agreement allows for
the DOI OIG to consider requests for investigative support on a case-
by-case basis. We have issued two (2) final audit reports under this
MOU, three (3) draft audit reports, and have completed fieldwork on two
(2) additional audits. For the audit where we determined that the
applicant was not compliant, we have recommended recovery of
$2,084,399. A summary of completed audits is as follows:
------------------------------------------------------------------------
Report Date
Applicant Conclusion Potential Fund Recovery
------------------------------------------------------------------------
11/06/03 Santa Fe Indian Compliant $0
School
01/07/04 Navajo Preparatory Not Compliant 2,084,399
Academy
------------------------------------------------------------------------
We have also established a working relationship with the Office of
Inspector General at the Education Department (Education OIG). In
January 2004, Education OIG presented a plan for an audit of
telecommunication services at the New York City Department of Education
(NYCDOE). Because of the significant amount of E-rate funding for
telecommunication services at NYCDOE, Education OIG has proposed that
they be reimbursed for this audit under a three-way MOU similar to the
existing MOU with DOI OIG. In April 2004, the Universal Service Board
of Directors approved the MOU. In June 2004, the MOU was signed and the
audit was initiated.
Review of USAC Audits
We have reviewed work performed by USAC's Internal Audit Division
and performed the procedures necessary under our audit standards to
rely on that work. In December 2002, USAC established a contract with a
public accounting firm to perform agreed-upon procedures at a sample of
seventy-nine (79) beneficiaries from funding year 2000. The sample of
beneficiaries was selected by the OIG. In a departure from the two
previous large-scale rounds of E-rate beneficiary audits conducted by
USAC contractors, the agreed-upon procedures being performed under this
contract would be performed in accordance with both the Attestation
Standards established by the American Institute of Certified Public
Accountants (AICPA) Standards and Generally Accepted Government
Auditing Standards, issued by the Comptroller General (GAGAS or
``Yellow Book'' standards). In March 2003, we signed a contract with a
public accounting firm to provide audit support services for USF
oversight to the OIG. The first task order that we established under
this contract was for the performance of those procedures necessary
under ``Yellow Book'' standards to determine the degree to which we can
rely on the results of that work (i.e., to verify that the work was
performed in accordance with the AICPA and GAGAS standards). The OIG
review team is currently completing this work. Many of the audit
findings raised by this body of work are reflected in the section
addressing concerns with the E-rate program.
Support to Investigations
In addition to conducting audits, we are providing audit support to
a number of investigations of E-rate recipients and service providers.
To implement the investigative component of our plan, we established a
working relationship with the Antitrust Division of the Department of
Justice (DOJ). The Antitrust Division has established a task force to
conduct USF investigations comprised of attorneys in each of the
Antitrust Division's seven (7) field offices and the National Criminal
Office. We are also supporting several investigations being conducted
by Assistant United States Attorneys.
We are currently supporting twenty-two (22) investigations and
monitoring an additional fifteen (15) investigations. Unfortunately,
the increased interest in these cases has resulted in an increased
demand for OIG audit support. In fact, the amount of audit support has
exacerbated our previously stated concern about the availability of
resources and our ability to implement other components of our USF
oversight plan. Allegations being investigated in these cases include
the following:
Procurement irregularities--including lack of a competitive
process and bid rigging;
False Claims--Service Providers billing for goods and
services not provided;
Ineligible items being funded; and
Beneficiaries are not paying the local portion of the costs
resulting in inflated costs for goods and services to the
program and potential kickback issues.
Concerns with the E-rate Program
My office's involvement in E-rate audits and investigations has
highlighted numerous concerns with this program. These include general
programmatic and management concerns as well as specific concerns
related to program design. General concerns include:
lack of clarity regarding program rules, and;
lack of timely and effective resolution of audit findings.
Specific concerns regarding program design include;
weaknesses in program competitive procurement requirements;
ineffective use of purchased goods and services;
reliance on applicant certifications;
weaknesses in technology planning; and
issues relating to discount calculation and payment.
Lack of Clarity Regarding Program Rules
Under Commission staff oversight, USAC has implemented numerous
policies and procedures to administer the E-rate program. In some
cases, the Commission has adopted these USAC operating procedures, in
other cases however, USAC procedures have not been formally adopted by
the FCC. In those cases where USAC implementing procedures have not
been formally adopted by the Commission, it is the position of
Commission staff that there is no legal basis for recovery of funds
when applicants fail to comply with these procedures.
We are concerned about the distinction that Commission staff makes
between program rules and USAC implementing procedures for a number of
reasons.
First, we believe that this distinction represents a
weakness in program design. Within their authority under
program rules, USAC has established implementing procedures to
ensure that program beneficiaries comply with program rules and
that the objectives of the program are met. In those cases
where USAC has established implementing procedures that are not
supported by program rules, USAC and the Commission have no
mechanism for enforcing beneficiary compliance.
Second, we believe that it is critical that participants in
the E-rate program have a clear understanding of the rules
governing the program and the consequences that exist if they
fail to comply with those rules. We are concerned that the
Commission has not determined the consequences of beneficiary
non-compliance in many cases and that, in those instances where
the Commission has addressed the issue of consequences for non-
compliance, the consequences associated with clear violations
of program rules do not appear to be consistent.
Third, a clear understanding of the distinction between
program rules and USAC implementing procedures is necessary for
the design and implementation of effective oversight. It is
necessary for the timely completion of audits and the timely
resolution of audit findings and implementation of corrective
action resulting from audits.
Lack of Timely and Effective Resolution of Audit Findings from E-rate
Beneficiary Audits
Since our involvement in this program, I have become increasingly
concerned about efforts to resolve audit findings and to recover funds
resulting from E-rate beneficiary audits. It has been our observation
that audit findings are not being resolved in a timely manner and that,
as a result, actions to recover inappropriately disbursed funds are not
being taken in a timely manner. In some cases, it appears that audit
findings are not being resolved because USAC is not taking action in a
timely manner. In other cases, findings are not being resolved because
USAC is not receiving guidance from the Commission that is necessary to
resolve findings. USAC is prohibited under program rules from making
policy, interpreting unclear provisions of the statute or rules, or
interpreting the intent of Congress. As a result of this prohibition,
USAC must seek guidance from the Commission when audit findings are not
clearly violations of Commission rules.
The second large-scale audit of E-rate beneficiaries was conducted
by the public accounting firm of Arthur Andersen under contract to
USAC. In 2001, USAC contracted with Arthur Andersen to conduct audits
at twenty-five (25) beneficiaries from funding years 1999 and 2000. E-
rate disbursements to these beneficiaries totaled $322 million. Arthur
Andersen provided a draft audit report summarizing the results of these
audits on May 31, 2002. The final report, including responses from the
USAC Schools and Libraries Division, was released by the Schools and
Libraries Committee of the USAC Board of Directors on April 23, 2003,
eleven months after the draft report was provided by Arthur Andersen.
The audit report disclosed monetary findings at fourteen (14) of the
twenty-five (25) beneficiaries including $11.4 million in inappropriate
disbursements and unsupported costs. As of September 30, 2003, USAC had
recovered $1,927,579 in inappropriate disbursements and unsupported
costs and initiated recovery actions for another $1,353,741, of which
$709,013 is under appeal. We have been advised that USAC initiated
recovery actions for the remaining $8,059,141.
The final report adopted by the Universal Service Board also
identified eleven (11) policy issues, relating to thirty-three (33)
separate findings, for which USAC determined that FCC policy guidance
was required. The dollar value of potential fund recoveries associated
with these thirty-three (33) findings was not available because, in
most cases, the final report indicated that those amounts had not been
determined. Policy issues identified included the lack of fixed asset
and associated records, maintenance of connectivity once it is
established, technology plan approver control and requirements,
insufficient documentation including lack of invoice detail and vendor
payment information, incomplete or insufficient competitive bidding
documentation, monitoring of technology plan goals and objectives, and
physical security of equipment. Although the final report was released
on April 23, 2003, USAC did not request policy guidance from Commission
staff until October 2003. In January 2004, Commission staff provided
``informal'' guidance to USAC related to E-rate beneficiary audits
being conducted by KPMG. These informal comments included reference to
four (4) of the eleven (11) Arthur Anderson round 2 policy questions
raised by USAC in their October 2003 request. On March 4, 2004,
Commission staff provided guidance to USAC on the eleven (11) policy
issues, almost two years after the draft report was submitted by Arthur
Andersen. Many of the policy questions raised in USAC's request for
guidance address issues identified in other audits including other E-
rate beneficiary audits conducted by USAC's Internal Audit Division and
those conducted by the FCC OIG.
Weaknesses in Program Competitive Procurement Requirements
Program rules require that applicants use a competitive procurement
process to select vendors. In establishing this requirement, the
Commission recognized that ``(c)ompetitive bidding is the most
efficient means for ensuring that eligible schools and libraries are
informed about all of the choices available to them'' and that
``(a)bsent competitive bidding, prices charged to schools and libraries
may be needlessly high, with the result that fewer eligible schools and
libraries would be able to participate in the program or the demand on
universal service support mechanisms would be needlessly great.''
Applicants are required to submit a form 470 identifying the
products and services needed to implement the technology plan. The form
470 is posted to the USAC web page to notify service providers that the
applicant is seeking the products and services identified. Applicants
must wait at least 28 days after the form 470 is posted to the website
and consider all bids they receive before selecting the service
provider to provide the services desired. In addition, applicants must
comply with all applicable state and local procurement rules and
regulations and competitive bidding requirements. The form 470 cannot
be completed by a service provider who will participate in the
competitive process as a bidder and the applicant is responsible for
ensuring an open, fair competitive process and selecting the most cost-
effective provider of the desired services. Further, although no
program rule establishes this requirement, applicants are encouraged by
USAC to save all competing bids for services to be able to demonstrate
that the bid chosen is the most cost-effective, with price being the
primary consideration.
Although the programs competitive bidding requirements were
intended to ensure that schools and libraries are informed about all of
the choices available to them, we have observed numerous instances in
which beneficiaries are not following the program's competitive bidding
requirements or are not able to demonstrate that competitive bidding
requirements are being followed. We question whether the rules are
adequate to ensure a competitive process is followed. In addition, weak
recordkeeping requirements to support the procurement process, as well
as other aspects of the E-rate application, offer little protection to
the program. We believe that the competitive procurement requirements
are based on some faulty assumptions. For example,
Form 470s will have enough information for meaningful
proposals from prospective service providers.
Service providers are reviewing and considering posted form
470s (particularly for smaller schools).
``Applicable'' state and local procurement regulations exist
and those regulations are consistent with program rules.
Ineffective Use of Purchased Goods and Services
Site visits are conducted during most E-rate beneficiary audits.
Site visits are conducted for several reasons including to evaluate the
eligibility of facilities where equipment is installed, verify that
equipment is installed and operational, and to verify that equipment is
being used for its intended purpose. Examples of concerns identified
during audits and investigations are as follows:
Goods and services not being provided.
Unauthorized substitution of goods and services.
Goods and services being provided to ineligible facilities
(e.g., non-instructional building including dormitories,
cafeterias, and administrative facilities).
Equipment not being installed or not operational. Program
rules require that nonrecurring services be installed by a
specified date. However, there is no specific FCC rule
requiring beneficiaries to use equipment in a particular way,
or for a specified period of time, or to full efficiency.
Commission staff have provided guidance stating that if the
equipment was uninstalled (i.e., still in a box) that would
represent a rule violation. However, Commission staff have also
provided guidance stating that the rules do not require that
beneficiaries effectively utilize the services provided or that
the beneficiaries maintain continuous network or Internet
connectivity once internal connections are installed.
Reliance on Applicant Certifications
The E-rate program is heavily reliant on applicant and service
provider certifications. For example, on the form 470, applicants
certify that the support received is conditional upon the ability of an
applicant to secure access to all of the resources, including
computers, training, software, maintenance, and electrical connections,
necessary to use effectively the services that will be purchased under
this mechanism. On the form 471, applicants make several important
certifications. Applicants certify that they have ``complied with all
applicable state and local laws regarding procurement of services for
which support is being sought'' and that ``the services that the
applicant purchases . . . will not be sold, resold, or transferred in
consideration for money or any other thing of value.'' Other
certifications are required on various program forms.
My office started to raise concerns about perceived weaknesses in
the competitive procurement process and over reliance on certifications
shortly after we became involved in program oversight. We first became
concerned about the competitive procurement process as a result of our
involvement in the Metropolitan Regional Education Service Agency
(MRESA) investigation. During that investigation we observed how
weaknesses in competitive bidding requirements and reliance on self
certification were exploited resulting in, at a minimum, a significant
amount of wasteful spending. We continued to express our concerns as we
designed our oversight program, developed a program for auditing
beneficiaries, and supported E-rate fraud investigations. In fact, we
established a working relationship with the Antitrust Division of the
Department of Justice in a large part because of the number of
investigations that we were supporting that involved allegations
regarding the competitive procurement process.
Our level of concern regarding both the competitive procurement
process and reliance on self-certification was heightened as we started
to work with the Antitrust Division. During our discussions with
Antitrust, they expressed a general concern with the lack of
information regarding the competitive process and specific concerns
regarding applicant and service provider certifications. Although we
started to pursue these issues with Commission staff in the fall of
2002, the Commission has only recently started to address some of the
recommendations from Antitrust, and none of these recommendations are
fully implemented. We have been informed by WCB that several of the
Antitrust suggestions have been incorporated into the appropriate E-
rate forms and that those forms are now at the Office of Management and
Budget for approval. Other recommended certifications, particularly
regarding the competitive process, are still in the process of public
comment, and we are as yet uncertain what the FCC may ultimately do
with these recommendations. Numerous of the suggestions from Antitrust
involved USAC obtaining and reviewing critical procurement documents
during the application review process. The Commission's response to
these suggestions was to include in the 5th Report and Order the
requirement that the applicant retain these documents, but providing
these documents for review along with an E-rate application was not
required. And lastly, WCB has informed us that at this time they will
not incorporate certain recommendations. I believe that the delay in
implementing Antitrust's recommendations, and the exclusion of some of
the recommendations from implementation, continues to place the program
at risk.
Weaknesses in Technology Planning
Program rules require that applicants prepare a technology plan and
that the technology plan be approved. The approved technology plan is
supposed to include a sufficient level of information to justify and
validate the purpose of a request for E-rate funding. USAC implementing
procedures state that approved technology plans must establish the
connections between the information technology and the professional
development strategies, curriculum initiatives, and library objectives
that will lead to improved education and library services. Although the
technology plan is intended to serve as the basis for an application,
we have observed many instances of non-compliance with program rules
and USAC procedures related to the technology planning process.
Examples of technology planning concerns identified during audits and
investigations are as follows:
Technology plans are not being reviewed and approved in
accordance with program rules.
Technology plans do not address all required plan elements
in accordance with USAC implementing procedures for technology
planning. Commission staff have provided guidance that failure
to comply with USAC implementing procedures for technology
plans is not a rule violation and does not warrant recovery of
funds.
Applicants not being able to provide documentation to
support the review and approval of technology plan.
USAC guidance on technology planning states that ``(i)n the event
of an audit, you may be required to produce a certification similar to
the SLD sample ``Technology Plan Certification Form,'' in order to
document approval of your technology plan.'' Numerous audits have
included findings beneficiaries were unable to provide documentation to
demonstrate the review and approval of technology plans. Although
program rules require that applicants have a technology plan and that
the plan be approved, the rules do not require that the applicant
maintain specific documentation regarding the approval process.
Discount Calculation and Payment of the Non-Discount Portion
The E-rate program allows eligible schools and libraries to receive
telecommunications services, Internet access, and internal connections
at discounted rates. Discounts range from 20 percent to 90 percent of
the costs of eligible services, depending on the level of poverty and
the urban/rural status of the population served, and are based on the
percentage of students eligible for free and reduced lunches under the
National School Lunch Program (NSLP) and other approved alternative
methods. A number of audits have identified audit findings that
applicants have not followed program requirements for discount rate
calculation or were unable to support the discount rate calculated.
Applicants are required to pay the non-discount portion of the cost
of the goods and services to their service providers and service
providers are required to bill applicants for the non-discount portion.
The discount rate calculation and program requirement for payment of
the non-discount portion are intended to ensure that recipients avoid
unnecessary and wasteful expenditures and encourage schools to seek the
best pre-discount rate. Examples of concerns identified during audits
and investigations are as follows:
Applicant not paying the non-discount portion;
Applicant not paying the non-discount portion in a timely
manner; and
Service providers not billing recipients for the non-
discount portion.
Conclusion
The Office of Inspector General remains committed to meeting our
responsibility for providing effective independent oversight of the USF
and we believe we have made significant progress. While the Commission
has taken steps to address programmatic weaknesses, more work remains
to be done. Through our participation in the fourth large-scale round
of E-rate beneficiary audits with USAC and through audits that we
anticipate conducting under our three-way agreement with USAC, we are
moving forward to evaluate the state of the program and identify
opportunities for programmatic improvements. In order to continue this
important work it is my belief that the Commission should have direct
access to the USF. This will provide the resources for an effective and
independent oversight program.
The Chairman. Thank you very much.
Mr. Gumper, welcome.
STATEMENT OF FRANK GUMPER, CHAIRMAN OF THE BOARD, UNIVERSAL
SERVICE ADMINISTRATIVE COMPANY
Mr. Gumper. Good morning, Mr. Chairman and Members of the
Committee. My name is Frank Gumper. I am the Chairman of the
Board of Directors of the Universal Service Administrative
Company, USAC. It is my privilege to be here today to speak
with you about USAC and its administration of the schools and
libraries universal service support mechanisms, commonly
referred to as the E-rate program.
USAC is a not-for-profit corporation designated by the FCC
to administer the four universal service mechanisms based on
the Telecommunications Act of 1996 and FCC regulations adopted
pursuant to the Act. USAC is governed by a Board of Directors,
each of whom is appointed by the Chairman of the FCC. The Board
consists of 19 Directors, each of whom represents the interests
of a particular constituency defined in FCC regulations. I
represent large incumbent local exchange carriers. I was
appointed by Chairman Reed Hundt in 1997, reappointed by
Chairman Michael Powell in 2001, and have served on the Board
since the creation of USAC. I was elected Chairman of the Board
in January 2000.
The USAC Board of Directors are purposely structured to
ensure that the views of many different interests are heard and
considered. Each Director brings to the attention of the Board
the particular sensitivities and concerns of his or her
constituency, thereby assisting the entire board and enhancing
the Board's decisionmaking process.
Each director must ultimately use his or her position to
represent USAC's overall interests, that is the interest of
USAC as a corporate entity and not the interest of his or her
constituency. To that end, each Director is bound by a
stringent statement of ethical conduct. All USAC Board members
are obligated to discharge their responsibility to ensure that
the universal service support mechanisms--High Cost; Low
Income; Rural Health Care; and Schools and Libraries--are
properly administered.
My experience serving on the Board for the past 7 years has
been that the USAC Board of Directors are particularly active
and engaged with the issues facing the administration of the
support mechanisms. The Board of Directors and USAC committees
convene on a quarterly basis and as needed between the
quarterly Board meetings. At each meeting USAC staff brings
critical issues to the attention of the board, which takes
action as needed.
The Board is particularly concerned about waste, fraud and
abuse. The Board represents all relevant constituencies,
including consumer advocates and schools and libraries, and our
job is to ensure that all contributions to the fund go to
fulfil the promise of universal service, which in the case of
the E-rate program is to provide access to advanced
telecommunications services for schools and libraries.
Working with USAC staff, numerous actions have been taken
to protect the E-rate program and the Universal Service Fund in
general. As a board member, I am confident that USAC's
administration of the E-rate program has become increasingly
sophisticated over time as USAC board and staff have responded
to those who would abuse the program.
There have been program violations and the USAC board and
staff take these violations seriously. However, we have taken
many actions to address them, including but certainly not
limited to: improving the application and invoice review
procedures; increasing the number of staff devoted to
responding to whistleblower calls; increasing the number of
audits; launching new initiatives, such as the thousand site
visits that will occur over the next year; and providing
support to law enforcement investigations. George McDonald, the
Vice President of USAC responsible for the administration of
the E-rate program, will discuss these tools in greater depth
in his testimony.
USAC is launching an important new communication and
education initiative. At the last Board meeting, Board members
engaged in a lively discussion of different strategies the
prevent program rule violations from occurring. USAC denies
funding requests when it determines that a violation has
already occurred. USAC already provides a great deal of
applicant and service provider training, but in light of the
audit findings Board members questioned whether all the program
participants are receiving the benefits of this coalition.
Board members considered what steps could be taken to try to
prevent program rule violations from happening in the first
place and charged USAC's CEO with presenting a plan for
implementing that effort at the next Board meeting later this
month.
We believe that this effort will help prevent waste, fraud
and abuse by more effectively educating applicants and service
providers about program requirements. In addition, USAC is
working closely with the FCC's Office of Inspector General to
expand our audit activity in all of the programs.
Mr. Chairman, thank you for providing me the opportunity to
address the Committee. We look forward to continuing to work
with Congress to improve the schools and libraries support
mechanism. I would be happy to respond to any questions you may
have about these issues or the accounting issues you raised
earlier.
[The prepared statement of Mr. Gumper follows:]
Prepared Statement of Frank Gumper, Chairman of the Board of Directors,
Universal Service Administrative Company
Good morning, Mr. Chairman and Members of the Committee. My name is
Frank Gumper. I am the Chairman of the Board of Directors of the
Universal Service Administrative Company (``USAC''). It is my privilege
to be here today to speak with you about USAC and its administration of
the Schools and Libraries Universal Service Support Mechanism, commonly
referred to as the ``E-rate'' program.
Overview
USAC is the not-for-profit corporation designated by the Federal
Communications Commission (``FCC'') to administer four universal
service support mechanisms based on the Telecommunications Act of 1996
and FCC regulations adopted pursuant to the Act. USAC is governed by a
Board of Directors, each of whom is appointed by the Chairman of the
FCC. The Board consists of 19 Directors, each of whom represents the
interests of a particular constituency defined in FCC regulations. I
represent large incumbent local exchange carriers. I was appointed by
Chairman Reed Hundt in 1997, re-appointed by Chairman Michael Power in
2001, and have served on the Board since the creation of USAC. I was
elected Chairman of the Board in January 2000.
The USAC Board of Directors is purposely structured to ensure that
the views of many differing interests are heard and considered. Each
Director brings to the attention of the Board the particular
sensitivities and concerns of his or her constituency, thereby
assisting the entire Board and enhancing the Board's decision making
process. Each Director must ultimately use his or her position to
represent USAC's overall interests; that is, the interests of USAC as a
corporate entity, and not the interests of his or her constituency. To
that end, each Director is bound by a stringent Statement of Ethical
Conduct.
The E-rate Program
All USAC Board Members are obliged to discharge their
responsibilities to ensure that the universal service support
mechanisms--High Cost, Low Income, Rural Health Care, and Schools and
Libraries, commonly known as the E-rate Program--are properly
administered. My experience serving on the Board for the past seven
years has been that the USAC Board of Directors is particularly active
and engaged with the issues facing the administration of the support
mechanisms. The Board of Directors and the USAC Committees convene on a
quarterly basis and as needed between the quarterly board meetings. At
each meeting, USAC staff brings critical issues to the attention of the
Board, which takes action as needed.
The Board is particularly concerned about waste, fraud and abuse.
The Board represents all relevant constituencies, including consumer
advocates and schools and libraries, and our job is to ensure that all
contributions to the fund go to fulfill the promise of universal
service--which in the case of the E-rate program is to provide access
to advanced telecommunications service for schools and libraries.
Working with USAC staff, numerous actions have been taken to
protect the E-rate program, and the Universal Service Fund in general.
As a Board member, I am confident that USAC's administration of the E-
rate program has become increasingly sophisticated over time as USAC's
Board and staff have responded to those who would abuse the program.
There have been program violations, and USAC's Board and staff takes
those violations seriously. However, we have taken many actions to
address them, including, but certainly not limited to, improving the
application and invoice review procedures, increasing the number of
staff devoted to responding to whistleblower calls, increasing the
number of audits, launching new initiatives such as the 1,000 site
visits that will occur over the next year, and providing support to law
enforcement investigations. George McDonald, the Vice President of USAC
responsible for the administration of the E-rate program, will discuss
these tools in greater depth in his testimony.
USAC is launching an important new Communications and Education
initiative. At the last Board meeting, Board Members engaged in lively
discussion of different strategies to prevent program rule violations
from occurring. USAC denies funding requests when it determines that a
violation has already occurred. USAC already provides a great deal of
applicant and service provider training, but in light of audit
findings, Board members questioned whether all program participants are
receiving the benefits of this training. Board members considered what
steps could be taken to try to prevent program rule violations from
happening in the first place, and charged USAC's Chief Executive
Officer with presenting a plan for implementing that effort at the next
Board meeting later this month. We believe that this effort will help
to prevent waste,fraud and abuse by more effectively educating
applicants and service providers about program requirements. In
addition, USAC is working closely with the FCC's Office of Inspector
General to expand our audit activity in all of the programs.
Conclusion
Mr. Chairman, thank you for providing me with the opportunity to
address the Committee. We look forward to continuing to work with
Congress to improve the Schools and Libraries Support Mechanism. I
would be happy to respond to any questions you may have.
The Chairman. Thank you very much.
Mr. McDonald, welcome.
STATEMENT OF GEORGE McDONALD, VICE PRESIDENT, SCHOOLS AND
LIBRARIES DIVISION, UNIVERSAL SERVICE ADMINISTRATIVE COMPANY
Mr. McDonald. Thank you, Mr. Chairman, Senator Rockefeller.
I am George McDonald, Vice President of the Universal Service
Administrative Company responsible for the Schools and
Libraries Division. I am pleased to be here today to discuss
USAC's administration of the E-rate program.
As Mr. Gumper has said, USAC is committed to helping
prevent waste, fraud and abuse in the universal service support
mechanisms and we devote substantial resources toward that goal
so that the benefits of the discounts go only to eligible
entities for eligible uses. Before we began making funding
commitments in 1998, we hired an independent consultant,
PriceWaterhouseCoopers, to advise us on our internal controls
and attest to the adequacy of those controls. Our internal
controls are designed to ensure that commitment and
disbursement of E-rate funds are consistent with FCC rules
relating, for example, to the eligibility of entities, of
services, and appropriate discount rates.
At your request as Chair of this Committee, Senator McCain,
staff of the then-U.S. General Accounting Office reviewed our
draft procedures in 1998 and recommended changes, which we
implemented. We employ many tools to help ensure compliance
with program rules. These include detailed application and
invoice review procedures, denying funding commitments when
appropriate, rejecting incorrect invoices, auditing program
beneficiaries and service providers, recovering funds where
rule violations are found, investigating whistleblower hot line
complaints, supporting law enforcement investigations, and
referring matters involving suspected program abuse to law
enforcement authorities.
USAC's application and invoice review procedures have
greatly evolved over the past 6 years, becoming more detailed
and comprehensive as we have gained experience with the
program. For example, as we saw instances of service providers
not making applicants pay the non-discount share, a key rule of
the program, we initiated verification of payment of that share
into our invoice review process. USAC's internal controls have
prevented the unlawful disbursement of hundreds of millions of
dollars, either as a result of denials based on failure to
comply with program rules or cancellation of funding requests
by the applicant as a result of our inquiries.
Pursuant to SEC rules, USAC engages an independent auditor
to conduct annual financial and operational audits of USAC. As
part of that annual effort, auditors assess whether we are
properly implementing our procedures, and there have been no
significant issues raised in those audits.
We receive approximately 35,000 E-rate applications per
year. In addition, we process an average 80,000 individual
requests for payment annually. Our fundamental responsibility
is to make well-founded decisions to approve or deny these
requests. Each of these documents is individually processed
using detailed program integrity assurance, or PIA, review
procedures to arrive at an appropriate decision consistent with
program rules.
We also conduct audits of beneficiaries to assess program
rule compliance. As a result of audit findings, we have
modified and strengthened our internal controls, improved our
outreach, and better educated applicants and service providers
regarding program rules.
In order to provide the public with the means of reporting
activities that may be in violation of E-rate program rules,
USAC maintains a whistleblower hot line. USAC's special
investigations team investigates every call to determine if
further action is required. We receive and follow up on over
100 calls per year.
Comprehensive applicant and service provider training in
program requirements are vital components of program integrity.
USAC's applicant training, an annual conference of State E-rate
coordinators, and regional meetings throughout the year
emphasizes the importance of compliance with program rules and
the consequences of noncompliance. USAC also provides training
and education opportunities to service provider participants in
the program and, as Mr. Gumper said, we are looking to
significantly expand our outreach activities.
One of the key lessons we have learned from our experience
in administering the program and from the audits we have
conducted as well as from law enforcement investigation and
media reports is that USAC needs a larger oversight presence in
the field. Site visits will allow us to assess more fully in
real time how E-rate funds are being used, to learn about and
publicize best practices in education technology and program
compliance, and to help ensure that products and services have
in fact been delivered and are being used effectively. We are
currently in the process of selecting a vendor that will
conduct some 1,000 site visits a year.
While USAC has responsibility for ensuring applications are
properly reviewed, applicants and service providers alike have
responsibility for knowing and following the spirit, intent,
and letter of the law and rules of the program. The FCC in a
series of recent rulemakings has stressed that accountability.
For example, applicants must conduct a fair and open
competitive process to select service providers and must select
the most cost-effective offeror, with price the primary factor.
Applicants cannot abdicate their responsibility to a service
provider who is soliciting their business or to a consultant.
Service providers who are seeking an applicant's business
cannot provide assistance to the applicant during the
competitive bidding process. Similarly, service providers
cannot waive the applicant's share of the cost and applicants
must pay their share.
USAC's responsibility as administrator of the E-rate
program is to prevent commitments and disbursements from being
made in violation of program rules. During application review
we deny requests for such reasons as: the request includes
ineligible services; or we conclude that applicants did not
conduct a fair and open competitive process or cannot pay their
share of the costs; or applicants fail to meet deadlines.
To provide just a few examples, in funding year 2002 we
denied funding requests totaling over $500 million associated
with IBM Corporation because of a procurement approach that we
determined was inconsistent with program rules. IBM and some
applicants appealed our decision to the FCC and the FCC upheld
our determination that the approach violated E-rate rules.
In funding year 2001, 2002 and 2003, USAC denied funding
requests totaling over $47 million associated with Connect2
Internet Networks because of a variety of program rule
violations. The owner and employees of Connect2 pled guilty to
charges related to abuse of the program and two persons
associated with that company have been debarred from the E-rate
program by the FCC. We provided a great deal of assistance to
law enforcement officials as they investigated that case.
Finally, over different program years USAC has denied
millions of dollars in funding requests when we have determined
that consultants who provided free services to applicants were
actually associated with the applicant's service provider.
Mr. Chairman, thank you for providing me with the
opportunity to address the Committee and we look forward to
working with Congress to improve the E-rate program and I would
be happy to respond to any questions you may have.
[The prepared statement of Mr. McDonald follows:]
Prepared Statement of George McDonald, Vice President, Schools and
Libraries Division, Universal Service Administrative Company,
Good morning, Mr. Chairman and Members of the Committee. My name is
George McDonald. I am Vice President of the Universal Service
Administrative Company (``USAC'') responsible for the Schools and
Libraries Division. I am pleased to be here today to discuss USAC's
administration of the Schools and Libraries Universal Service Support
Mechanism, commonly referred to as the ``E-rate'' program.
Overview
USAC is the not-for-profit corporation designated by the Federal
Communications Commission (``FCC'') to administer the E-rate program
based on the Telecommunications Act of 1996 and FCC regulations adopted
pursuant to the Act. In order to accomplish our mission, we work
closely with the FCC, consulting almost daily on issues of
implementation.
We are committed to helping prevent waste, fraud, and abuse in the
universal service support mechanisms, and we devote substantial
resources towards that goal so that the benefits of the discounts go
only to eligible recipients for eligible uses. I would like to describe
some of the administrative procedures we use to help ensure program
integrity. I will also outline a new initiative designed to further
improve compliance with program rules. Finally, I will briefly discuss
applicant and service provider responsibilities, and provide some
examples of funding requests that we have denied because of non-
compliance with program rules.
Before we began making funding commitments in 1998, we hired an
independent consultant, Coopers and Lybrand--which later became
PricewaterhouseCoopers--to advise us on our internal controls and
attest to the adequacy of those controls. Our internal controls are
designed to ensure that commitment and disbursement of E-rate funds are
consistent with FCC rules relating, for example, to the eligibility of
entities, of services, and appropriate discount rates. At your request
as Chair of this Committee, Senator McCain, staff of the then-U.S.
General Accounting Office reviewed our draft procedures and recommended
changes, which we implemented. For example, we moved a procedure to
scrutinize the resources applicants have to make effective use of the
discounted services from after commitment of funds to before.
We employ many tools to help assure compliance with program rules.
These include detailed application and invoice review procedures,
denying funding commitments when appropriate, rejecting incorrect
invoices, auditing program beneficiaries and service providers,
recovering funds where rule violations are found, investigating
whistleblower hotline complaints, supporting law enforcement
investigations, and referring matters involving suspected program abuse
to law enforcement authorities.
USAC's application and invoice review procedures have greatly
evolved over the past six years, becoming more detailed and
comprehensive, as we have gained experience with the program. For
example, as we saw instances of service providers not making applicants
pay the nondiscount share (a key rule of the program), we initiated
verification of payment of that share into our invoice review process.
USAC's internal controls have prevented the unlawful disbursement of
hundreds of millions of dollars, either as a result of denials based on
failure to comply with program rules or cancellation of funding
requests by the applicant as a result of USAC inquiries.
Pursuant to FCC rules, USAC engages an independent auditor to
conduct annual financial and operational audits of USAC. As part of
that annual effort, auditors assess whether we are properly
implementing our procedures, and there have been no significant issues
raised in those audits.
Application and Invoice Volumes
We receive approximately 35,000 E-rate applications per year. In
addition, we process an average 80,000 individual requests for payment
annually. Our fundamental responsibility is to make well-founded
decisions to approve or deny these requests. Each of these documents is
individually processed using detailed Program Integrity Assurance, or
PIA, review procedures to arrive at an appropriate decision consistent
with program rules.
Audits
We also conduct audits of beneficiaries to assess program rule
compliance. As a result of audit findings, we have modified and
strengthened our internal controls, improved our outreach, and better
educated applicants and service providers regarding program rules.
Whistleblower Hotline and Special Investigations Team
In order to provide the public with a means of reporting activities
that may be in violation of E-rate program rules, USAC maintains a
whistleblower hotline. USAC's Special Investigations Team investigates
every call to determine if further action is required. We receive and
follow up on over 100 calls per year.
Education Regarding Program Requirements
Comprehensive applicant and service provider training in program
requirements are vital components of program integrity. USAC's
applicant training--an annual conference of state E-rate coordinators
and regional meetings throughout the year--emphasizes the importance of
compliance with program rules and the consequences of non-compliance.
USAC also provides training and education opportunities to service
provider participants in the program
New Site Visit Initiative
One of the key lessons we have learned from our experience in
administering the program and from the audits we have conducted, as
well as from law enforcement investigations and media reports, is that
USAC needs a larger oversight presence in the field. Site visits will
allow us to assess more fully, in real-time, how E-rate funds are being
used, to learn about and publicize best practices in education
technology and program compliance, and to help ensure that products and
services have in fact been delivered and are being used effectively. We
are currently in the process of selecting the vendor that will conduct
some 1,000 site visits a year. This step will further enhance program
integrity.
Applicant and Service Provider Responsibilities
While USAC has responsibility for ensuring applications are
properly reviewed, applicants and service providers alike have
responsibility for knowing and following the spirit, intent and letter
of the law and rules of the program. The FCC, in a series of recent
rulemakings, has stressed that accountability. For example, applicants
must conduct a fair and open competitive process to select service
providers, and must select the most cost-effective offer with price the
primary factor. Applicants cannot abdicate their responsibility to a
service provider who is soliciting their business, or to a consultant.
Service providers who are seeking an applicant's business cannot
provide assistance to the applicant during the competitive bidding
process. Similarly, service providers cannot waive the applicant's
share of the cost, and applicants must pay their share.
USAC 's Responsibility is to Deny Funding Requests that Do Not Comply
with Program Rules
USAC's responsibility as administrator of the E-rate program is to
prevent commitments and disbursements from being made in violation of
program rules. During application review, we deny requests for such
reasons as the requests include ineligible services or services to
ineligible entities, or we conclude that applicants did not conduct a
fair and open competitive process or cannot pay their share of the
costs, or applicants failed to meet deadlines. To provide just a few
examples, in Funding Year 2002, we denied funding requests totaling
over $500 million associated with IBM Corporation (``IBM) because of a
procurement approach that we determined was inconsistent with program
rules. IBM and some applicants appealed our decision to the FCC, and
the FCC upheld our determination that the approach violated E-rate
rules. In Funding Years 2001 through 2003, USAC denied funding requests
totaling over $47 million associated with Connect2 Internet Networks,
Inc. because of a variety of program rule violations. The owner and
employees of Connect2 pled guilty to charges related to abuse of the
program and two persons associated with that company have been debarred
from the E-rate program by the FCC. We provided a great deal of
assistance to law enforcement officials as they investigated that case.
Finally, over different program years, USAC has denied millions of
dollars in funding requests when we have determined that
``consultants'' who provided free services to applicants were actually
associated with the applicants' service provider.
Conclusion
Mr. Chairman, thank you for providing me with the opportunity to
address the Committee. We look forward to continuing to work with
Congress to improve the Schools and Libraries Support Mechanism. I
would be happy to respond to any questions you may have.
The Chairman. Thank you.
Mr. Himsworth, welcome.
STATEMENT OF WINSTON E. HIMSWORTH,
EXECUTIVE DIRECTOR, E-RATE CENTRAL, AND FOUNDER,
STATE E-RATE COORDINATORS ALLIANCE
Mr. Himsworth. Thank you, Mr. Chairman, Senator
Rockefeller.
Let me make my position clear now. E-rate is my life. One
of my kids once asked me to stay out of his and told me to get
my own. This is what I got.
E-Rate Central, which I am the Executive Director of, is
involved in E-rate and has been involved in E-rate since 1997,
before the program got started, at the local level working with
applicants; at the state level, we have been serving as State
Coordinator for E-rate for New York; and at the national level,
working with a group of other state E-rate Coordinators in a
group called the State E-rate Coordinators Alliance.
I want to try to make four points in a few minutes. One,
this is a great program. It is doing what it is supposed to do.
It is allowing schools to do things that it could not have done
otherwise. I work with New York City, which has used this
program to bring Internet access into 1,200 schools in a well
thought out project started early in the program called Project
Connect. I work at the other extreme with a small school up in
Alaska, Chatham, Alaska, that you best get to with float plane.
Internet access at the T-1 level there is almost $20,000 a
month. They just could not afford that type of service without
this program.
The second point I want to make is that tight application
reviews and audits are important, but they seem to be working.
I was glad, Mr. Chairman, you recognized and Mr. McDonald again
said today that the problems that were talked about in the last
House hearing on $500 million in requests that were not
properly bid and/or were excessive were denied. So the program
in that sense is working.
I am a little concerned that some of the audit results that
we are seeing are being a bit misconstrued. I have looked at a
number of them. The Office of Inspector General did 11 with
their internal sources. Four of those were noncompliant. In my
state we had three of those noncompliant schools. All three
were associated with Connect2, which, as Mr. McDonald said, has
already been found guilty of all these things.
There may be some laxness on the part of the schools in
those cases. They are very small schools. But I view them more
as victims.
We also looked at the----
The Chairman. How are they victims, Mr. Himsworth?
Mr. Himsworth. They are victims, sir, because if you look
through the reports what you find is that----
The Chairman. Are they not always victims when there is
wrongdoing, Mr. Himsworth?
Mr. Himsworth. Are they always victims when there is
wrongdoing?
The Chairman. People do wrong things that are in charge of
programs, like in Puerto Rico where many tens of millions of
dollars were misused. I guess they were victims too.
Mr. Himsworth. I think in those cases at least the children
were, sir.
The Chairman. Absolutely.
Go ahead.
Mr. Himsworth. I also looked at the KPMG audits, where in
New York we had three noncompliants. Again, those were
instances of administrative problems, violations of rules no
doubt, but not what I would characterize as waste, fraud and
abuse.
The third point I want to make is, we need to be careful
not to try to solve all the program's, the problems of a
program like this, with more rules. Rules are important, but
this is already a complex program with lots of rules, and that
in fact is causing problems for a number of the applicants,
just trying to keep up with them all.
The fourth point I want to make is, we believe that perhaps
more important than more and more rules is the program should
be changed in a couple fundamental ways to decrease the
incentives that certain applicants and vendors have to get
involved in waste, fraud and abuse practices. The biggest
change that needs to be made in our opinion, both personally,
through our State E-Rate Coordinators Alliance, and I was also
on the waste, fraud and abuse task force, the recommendation
coming out of there, was to limit the amount of discount that's
allowed in this program, to change the discount matrix so that
the 90 percent discount maximum is lowered by 10 to 20 percent.
A 10-percent share is just not enough to foster careful
planning and it is presenting too large a target for certain
vendors.
I do not talk in my testimony about the funding freeze that
was brought up this morning by several Senators. We are also
concerned about that and I hope we will get into that in this
discussion as well.
Thank you, sir.
[The prepared statement of Mr. Himsworth follows:]
Prepared Statement of Winston E. Himsworth, Executive Director,
E-Rate Central
Thank you for inviting me to appear before you this morning. Let me
make my position clear from the outset. E-rate is a great program. It
may not be perfect--few programs are--but it is evolving in a
responsive and responsible way to meet the needs of its school and
library applicants and to satisfy the need for even greater
accountability.
E-Rate Central has been involved in the E-rate program since its
inception. Our small company currently provides comprehensive E-rate
support to approximately 125 medium-sized schools and school districts
and to several large city school districts and school consortia. During
the past six years, E-Rate Central has served as the New York State's
E-rate coordinator. In that role, it was one of the founding members of
the State E-Rate Coordinators' Alliance (``SECA''), an association of
41 state coordinators, which has been a proactive supporter and change
agent for the E-rate program at the national level. Under the SECA
banner, E-Rate Central maintains a nationally-recognized E-rate
website, and distributes a widely-read weekly E-rate newsletter for New
York applicants and for redistribution to other applicants through
their state coordinators. To avoid conflicts of interest, E-Rate
Central does not offer any E-rate eligible services.
In my testimony here today, it is my hope that four points will
become clear.
E-rate is a successful and valuable program serving mission-
critical needs of schools and libraries across the country--
large and small, rich and poor. It is doing precisely what its
early Senate sponsors envisioned.
New York City Department of Education has been a large recipient of
E-rate funds stemming from an early and concerted effort,
dubbed ``Project Connect,'' to provide Internet access to 5-10
rooms in each of its 1,200 schools over the first few years of
the program. NYCDOE has been building upon this early success
by upgrading and expanding the LAN networks and equipment in
its schools and by developing a robust WAN network to
interconnect them. This could not have been done without E-
rate.
Chatham School District in Alaska is at the opposite end of the
spectrum. This small and poor school district (less than 300
students with a 90 percent discount rate) is located in an area
best reached by float plane. Telecom services, and most
particularly high speed T-1 access, in such a remote area are
expensive. Chatham's ongoing telecom and Internet budget this
year is over $225,000, almost $1,000 per student. Without E-
rate--which is already a problem because of the current freeze
on new funding--Chatham would, at best, be able to afford dial-
up Internet.
About half the school districts in Nassau County (Long Island, NY)
have recently installed or are planning to install high-speed
WANs. As these networks are developed, they will provide
interconnectivity to share educational resources throughout the
county (and ultimately, perhaps, the state). While only a few
of the Nassau districts qualify for higher discounts, the E-
rate program has clearly provided the impetus, and partial
funding support, for this effort.
Certain applicants and vendors have attempted to make
unfair, or even fraudulent, use of the program, but USAC has
been quite successful in thwarting these efforts before funding
is actually disbursed and/or in seeking to recover funds
disbursed in error during the program's early years. Many of
the audit statistics on compliance problems reflect failures to
meet administrative rules which, while important, should not be
characterized as examples of waste, fraud, and abuse (``WFA'').
E-rate is a program that was built on the fly. When the program
began (technically, January 1, 1998), application forms had not
yet been released. It was not until 1999 that applicants saw
any real funding. To counter skepticism about the program, the
administrators--quite properly in my opinion--focused most on
getting applications approved and funds flowing. Many of the
problems that have come to light over the past few years can be
traced to the early years.
In recent years, USAC's compliance standards and enforcement
efforts have been greatly strengthened. As a result, USAC had
denied all or most applications that are now being put forth as
examples of abuse. The House hearings last month, for example,
focused on a number of applications submitted by large city
school districts for IBM services in FY 2002. Valid questions
were raised about the bidding procedures used by these
districts, and about the scope and costs of services being
proposed. Not stressed, however, was the fact that all of these
applications were denied by USAC, and that the denials were
upheld by the FCC on appeal. We believe that the lesson to be
taken from this experience is that abusive incentives remain in
the program, but that the program's administrators have
developed increasing capabilities to deal with potential
problems.
We are also concerned with reports that a high percentage of E-rate
audits are finding evidence of non-compliance. We believe that
it is important to understand that these audits are not
completely ``random,'' as is often indicated, and that the many
of the instances of non-compliance are not as severe or
prevalent as implied.
The FCC's Inspector General's testimony before the Subcommittee on
Oversight and Investigations of the House Committee on Energy
and Commerce last June listed the results of eleven audits of
FY 1999 and FY 2000 applicants conducted by the OIG's own
internal auditors. Four of the eleven audits (or 36 percent)
classified as ``Not Compliant.'' In our role as New York State
coordinator, we have reviewed the audit reports for the three
non-compliant schools located in New York. All three appear to
have been targeted audits of customers of one specific
supplier, Connect 2, whose officers have already been convicted
of E-rate fraud. Most of the serious audit findings in these
three cases were attributed directly to Connect 2 invoicing,
often without the apparent knowledge of the schools. While not
excusing the laxness on the part of these small private
schools, we view the schools as victims, not perpetrators, of
E-rate abuses.
We have also reviewed the results of seven New York audits of FY
2000 funding commissioned by USAC and performed by KPMG. Of
these audits, three were classified as ``Not Compliant.'' The
problems in these cases appear to be largely administrative in
nature, and are not the result of rampant waste, fraud, or
abuse.
One small school was found non-compliant because it
had used an unapproved method to determine its discount
rate. Because the school was not a participant in the
National School Lunch Program, it had submitted a letter to
USAC ``explaining its situation and providing an estimate
of the number of students who it believed would qualify for
the NSLP.'' USAC had apparently accepted the estimate, but
the auditors subsequently determined that the method used
was not approved. There was no indication that the discount
rate was wrong or that the funding requested was for
inappropriate services. We do not view this report as an
example of WFA.
One small library was found non-compliant because it
had not maintained invoices to support its discount
reimbursements and other documentation to support its
discount rate calculation. Again, there was no indication
that the discount rate was wrong or that the funding
requested was inappropriate. We do not view this report as
an example of WFA.
One larger school district was found non-compliant
primarily because it did not have an approved technology
plan. Although this is a clear program violation, our
investigation determined that the district did in fact have
a plan, but one that they had neglected to submit for
formal E-rate approval. The district is being asked to
repay almost $200,000 in FY 2000 discounts. In our view,
this is an inappropriately large penalty for what we deem
to be an administrative oversight. Again, we do not view
this audit finding as an example of WFA.
One unfortunate aspect of the intensive focus on waste,
fraud, and abuse is the proliferation of new, and ever more
complicated, rules. Attempts to enforce these rules are
frustrating applicants, leading to funding delays, and probably
diverting USAC resources away from more targeted reviews.
Each year, the E-rate rules and procedures have become increasingly
complex as USAC and FCC have refined service eligibility
definitions, added new certifications, and intensified
application and invoice reviews. Here are a few indicators or
examples of the problem:
A reported 20-30 percent of all applications are
rejected by USAC, many for minor problems to meet minimum
process standards which, at least in the past, could be as
simple of leaving one field blank when it should have been
a zero.
The two key application forms for FY 2005 are 13 and
16 pages long; the instructions are 20 and 35 pages long,
respectively.
New procedures for application review in FY 2005 will
require virtually every applicant to respond to additional
inquiries from PIA reviewers.
E-rate is a deadline driven program. For most
applicants, E-rate is not a full time job, but it is most
certainly a full year job. All four of the most common
applicant forms have deadlines or timing requirements
which, if missed, will result in funding denials or
reductions. Appeals, SPIN changes, and service
substitutions all have deadlines. To further compound the
problem, some deadlines are fixed for all applicants while
others depend upon applicant-specific conditions.
Eligibility allocations for certain products and
services are often hidden from applicant view. We were
recently asked to breakout the costs for a firewall, a
product type which USAC lists as fully eligible, because,
as it turned out, this particular model had a 2.5 percent
ineligible feature.
The FCC's new ``2 in 5'' rule, that limits new funded
equipment installations to two out of every five years on a
site-by-site basis, is going to be difficult to administer
for applicants and administrators alike.
E-rate was initially conceived as being a simple program. In 1997,
we were told that an applicant would fill out a simple
application and that the vendors would simply discount the
bills. This vision never materialized.
In frustration, many applicants have been turning to consultants
for assistance. While this may be good for our business, we
view it as bad for the program. Even those of us, for whom E-
rate is a way of life, find it challenging to keep up and
comply with all the changing rules, procedures, and
interpretations. The knowledge that applications may be
rejected for simple oversights is a source of constant fear.
As an alternative to relying entirely on ever more rules and
audits, we favor certain basic program changes--including a
change to the discount matrix--to help establish proper program
incentives.
One of the biggest problems in the E-rate program is its reliance
on small percentage payments by the highest applicants to
assure cost-effective procurement of technology products and
services. The 10 percent that must be paid by the applicants
eligible for 90 percent discounts is just not high enough to
assure real cost accountability. As a result, it is the poorest
schools, often those with the least technological experience,
that have become the focus of vendor marketing programs. This
has led, if not to outright fraud, at least to expansive
product and service proposals that the same vendors would not
bother to market to schools and libraries at lower discount
levels. The problems have been especially prevalent in the
Internal Connections category.
Over the past year, several important and knowledgeable parties--
including SECA and USAC's Taskforce on Waste, Fraud and Abuse--
have recommended to the FCC that the maximum discount on
Internal Connections be lowered from 90 percent to 70-80
percent. We understand that the FCC staff is about to recommend
a similar change. As a member of both SECA and the Taskforce, I
concur with this approach.
I thank you again for the invitation to testify. I stand ready to
answer any questions you may have.
The Chairman. Thank you very much.
I think it has been made clear, Mr. Himsworth, that all
members of this Committee, at least that I know of, support
this program. We also feel we have an obligation, and the
Commerce Committee on the other side has been in the lead on
this issue. Who is the victim when in February 2004, the House
Energy and Commerce Committee staff, we do not usually hire
staffs for their sleuth capabilities, discovered nearly $23.5
million in E-rate-funded wireless Internet connection equipment
in a warehouse that was to be used with 100,000 computers? Who
is the victim there?
Mr. Himsworth. The victim there is again the students and--
--
The Chairman. Exactly. So is it not our obligation to make
sure that there is not $23.5 million, that it is the staff of
the House Commerce Committee that finds $23.5 million in
Internet connection equipment in a warehouse? We have to rely
on the staff of the House Commerce Committee to find that out?
Mr. Himsworth. I should hope not, sir.
The Chairman. I should hope not, but it is obvious that is
what happened.
I guess I would like to have the witnesses' response to a
Providence Journal article of July 22, 2004. It stated that:
``The problem with the E-rate program is twofold: First, the
money is controlled, not by the government, but by the
Universal Service Administrative Company, which is controlled
by the very telecom companies that are bidding for contracts.
Second, the Federal Communications Commission, which is
supposed to oversee the program, has conducted audits on fewer
than 200 of the 20,000 grants issued by the program, less than
1 percent. All this adds up to a situation in which it is easy
for sly computer and telecom companies to persuade poor and
technologically unsavvy school districts to buy equipment and
services that they do not need and to overcharge the districts,
knowing that most of the tab will be picked up by E-rate.''
I will begin with you, Mr. Bennett and Mr. Cline, if either
one of you want to comment on that statement, particularly the
first part of it, where the Universal Service Administration
Company ``is controlled by the very telecom companies that are
bidding for contracts''? We will begin with you, Mr. Bennett,
and go through our witnesses.
Mr. Bennett. I do not know that we have a real concern with
the first issue you raised. Certainly the second issue you
raised, with the number of audits that have been done, has been
our primary of concern. It has been our feeling that we have
not done enough work necessary to get our hands around the
issue of what is the level of fraud, waste, and abuse in this
program.
The Chairman. I think it would be hard if you only audited
200 of 20,000 grants.
Mr. Bennett. The Office of the Inspector General has been
trying from the earliest days to get access to the resources
necessary to do the appropriate amount of work. We are a very
small office.
The Chairman. What do you need from us and why have you not
come to us for additional help if you need it?
Mr. Bennett. Well, I believe that we have. We have
requested in our last three budgets funds for oversight of USF.
The Inspector General has advocated----
The Chairman. Was that in the President's budget?
Mr. Bennett. The 2004 President's budget included a request
for $3 million to provide contract audit support for audits and
audit support to investigations.
The Chairman. Well, thank you for bringing that to this
committee's attention. The failing is in this body as well, I
would assume. Thank you.
Mr. Gumper?
Mr. Gumper. As far as the first point, Mr. Chairman, I
strongly disagree that the USAC Board is controlled by
telecommunications service providers. As I mentioned in my
statement, all board members are appointed by the Chairman of
the FCC. The Board members, there are 19 of them. They spanned
consumer advocate groups, state commissioners. We have people
representing large, small telephone companies, long distance
carriers, wireless. So the Board is constructed so that the
people who pay into the fund, the people who provide services,
the constituents who use the moneys, and the constituents
themselves. The schools and libraries have four representatives
on the Board.
It is true I work for Verizon, but I can assure you that
when it comes to the interests of USAC and the administration
of USAC I basically report to the FCC. And, my boss Tom Tauke
and Verizon, understands that and has never once ever told me I
should do something in my capacity as Chairman of the Board
that would be to the advantage of Verizon and the detriment of
USAC or the administration of this program.
As far as the number of audits, I will tell you this Board
is very concerned about it. We realized very early in the
process as we started to do selective audits that we had to
expand the number, and we are very actively working now with
the Inspector General to ensure that we have a significant
expansion in the number of audits that we conduct.
The Chairman. Has there been sufficient rules put forth by
USAC to ensure that these abuses are curbed?
Mr. Gumper. I believe that, as Mr. McDonald can go into
more detail, given the results of audits as we have gone
through this process, we have significantly tightened up the
oversight of the application process. In fact, you heard the
comments earlier that we are getting too many rules now. I
disagree with that. I think what we need to do is to get out
there and educate people about the programs and the
requirements.
As I also mentioned, one of the things we directed them to
do at the last meeting was to provide us with a recommendation
as to how we can educate people better who file applications in
this program.
The Chairman. Mr. McDonald?
Mr. McDonald. Sir, I have been with Schools and Libraries
Corporation/USAC since September 1997. I have watched this
Board at work. My sense is this Board has been scrupulous about
avoiding any conflict of interest. Board members recuse
themselves when there are issued relating to their interests in
discussion before the Board.
We faced the issue of turning over our internal procedures,
our internal controls, to Board members and the board agreed
that that was not appropriate, so Board members do not know the
triggers we use to decide what reviews to do, et cetera. I have
never seen a discussion in the board where I thought anybody
was trying to influence a decision in their company's interests
or their school association or library association's interests.
So from my perspective as a staff guy in this, I think the
board has done a great job. They know the programs, they know
the stakeholders in the programs, and I think they have worked
together amazingly well over the years to protect the program's
integrity.
On the audit side, yes, we need to do more audits. We have
ramped up significantly. We did 17 audits in the first program
year, we did 25 audits in the second program year, we did 79 in
the third. Now we are going to do 100 audits. Then if the IG is
successful in the three-way agreement, we will do 250 or more.
These audits are very expensive. My budget next year for
audits is going to go from $5 million this year for the 79
audits to as much as $17 million next year to support the
three-way agreement and audits we will do. It seems to me that
we have to have a different approach than these comprehensive
audits and that is why we are kicking off this thousand site
visits that, we went to Puerto Rico in that first funding year
as part of our first round of audits. We saw that they did not
have computers. We cut off the commitments and disbursements to
Puerto Rico. So yes, $100 million did get out the door, but
they have gone 3 years with no additional money.
So I think the site visits, if we had gone even as a site
visit and seen that there were no computers in the school, that
would have been the trigger that we needed to cutoff those
funds sooner. So I think the site visit initiative is a cost
effective way to get a better handle on what's really
happening.
The Chairman. Mr. Himsworth?
Mr. Himsworth. We have got 30,000 applicants here and it is
true that there has been a relatively small number of audits.
As you have heard, the number of audits is going up. I view
that as good from the applicants' standpoint. I also look at
the thousand site visits that the program plans to do and,
although we may not call those audits, from the standpoint of
an applicant if someone shows up at their door from the SLD
they are going to treat that as an audit. So I think we are
doing----
The Chairman. That is what they plan to do, not what they
have done, what they plan to do.
Mr. Himsworth. Plan to, sir, yes.
The only other point I would like to make is, I have seen
through the review process that the SLD has been fairly
successful in finding patterns of what could be abuse and
stopping funding. In some cases that works very well and I
believe, among other things, that led to the problems that were
found with Connect2.
We see the other side of that as well, though, because over
the last couple years we have had several hundred small schools
in New York who have just not received any funding for 2 or 3
years because they were all using one of a dozen specific
vendors. We cannot tell from our position whether there is
anything wrong with those vendors or they are still under
investigation. I suspect some of them are good and some of them
are bad, but all those schools are sitting without funding.
So I would like to see more dollars put into the
investigatory aspects of this thing, not necessarily random
audits, but when you identify problems or potential problems
putting dollars to work specifically in those areas.
The Chairman. Thank you.
Senator Rockefeller.
Senator Rockefeller. Thank you, Mr. Chairman. Before I ask
a couple questions I want to, with your permission, put into
the record an October 1 letter to Chairman Powell that Olympia
Snowe and I wrote, addressing a number of the questions which
you have raised and others, as well as a letter to USAC. And
Olympia, I do not have a copy with me and I do not know whether
you signed it or not, but I think we both did. We always do.
I am going to do something different----
The Chairman. Without objection.
[The letter referred to follows:]
U.S. Senate
Washington, DC, October 1, 2004
Hon. Michael K. Powell,
Chairman,
Federal Communications Commission,
Washington, DC.
Dear Chairman Powell:
Under the 1996 Telecommunications Act, Congress codified its long-
standing commitment to universal service, explicitly directing the
Commission to ensure that consumers in rural, insular, and high cost
areas have access to reasonably comparable telecommunications and
information services at reasonably comparable rates and to expand
universal service support to include eligible schools, libraries, and
rural health care providers.
Given Congress's commitment to universal service, we are seriously
concerned by reports that in the final week of a year-long conversion
of the Universal Service Fund from GAAP to Government GAAP accounting
standards, the Federal Communications Commission (``Commission'') has
instituted changes that may significantly affect the operation and
administration of the entire Fund, and in particular, the schools and
libraries (``E-rate'') and rural health care funds. We are particularly
troubled that E-rate and rural health care funding has been suspended
since August 3, 2004, as a result of the uncertainty surrounding the
accounting treatment of the Funding Commitment Decision Letters
(``Commitment Letters'') issued under those programs and the
Commission's determination that funds held in the Universal Service
Fund are Federal funds for purposes of the Anti-Deficiency Act. This
suspension has already had a significant negative impact on schools,
libraries and rural health care providers across the country. It is our
understanding that Commitment Letters are unlikely to be issued again
before November of this year, only exacerbating the impact on these
institutions.
We are also deeply troubled by the seemingly inconsistent decisions
made in implementing the accounting conversion. First, at the same time
the Commission at the direction of the OMB, was considering whether to
treat Commitment Letters as ``obligations'' for accounting purposes
(thus requiring the Universal Service Administrative Company (``USAC'')
to have monies in its account to cover all existing and future
Commitment Letters), the Commission decided to ``under collect'' E-rate
revenues by a total of $550 million in order to limit increases to the
Universal Service contribution factor. As recently as September 16,
2004, the FCC issued a decision to reduce E-rate collections by $150
million. Despite objections filed by several affected entities, the
Commission allowed this decision to take effect, unchanged. We are
concerned that the result of these decisions will be to require
substantial reductions in available outlays for the E-rate and rural
health care programs and to increase significantly early next year the
contribution rate assessed on providers of interstate communications
services and passed through to consumers.
Second, during the same period that USAC was converting to the more
stringent government accounting standards, we understand that the
Commission also approved USAC's investment of over $3 billion in long-
term investment instruments. In the last week, we understand that the
Commission reversed course and required USAC to liquidate these
investments in order to comply with Government GAAP and to avoid
criminal liability for FCC personnel under the Anti-Deficiency Act. It
is our understanding that the forced sale of these investments has
resulted in losses of millions of dollars.
Finally, we are troubled that while the Commission has taken steps
to ensure that the E-rate and rural health care programs are in
compliance with the new accounting requirements, we understand that it
has not completed a full review of the impact of the accounting
conversion on the high-cost and low income fund. In particular, the
Commission's apparent decision regarding treatment of the E-rate and
rural health care Commitment Letters as obligations may also impact how
projected costs used to calculate high-cost and low income support
should be treated for accounting purposes. If these projections are
determined to be obligations, the high-cost and low income funds could
face disruptions similar to those currently being experienced in the E-
rate and rural health care programs, putting in jeopardy billions of
dollars relied on by rural telecommunications carriers that bring
essential services to consumers and could jeopardize affordable
telephone service for low income consumers. Furthermore, it is our
understanding that Commission personnel could be subject to criminal
sanctions for non-compliance with the Anti-Deficiency Act.
Given the significance of these issues, we would appreciate your
providing us with relevant information and responses to our questions
prior to the Senate Committee on Commerce, Science and Transportation
hearing on the E-rate program.
Is it the Commission's legal opinion that the Universal
Service Fund is subject to the provisions of the Federal Anti-
Deficiency Act?
If so, on what basis? What written or unwritten
guidance has the Commission received from the Office of
Management and Budget?
If so, is such a conclusion consistent with an August
2000 legal opinion from the Office of Management and Budget
concluding that ``the Universal Service Fund does not
constitute public money . . . and is appropriately
maintained outside the Treasury by a non-governmental
manager''?
If so, is such a conclusion consistent with Congress'
intent in an 1997 amendment to the Commerce, Justice, State
appropriations legislation stating that ``federal and state
universal service contributions are administered by an
independent, non-Federal entity and are not deposited into
the Federal Treasury and therefore [are] not available for
Federal appropriations?
If the Commission concludes that funds held in the Universal
Service Fund are ``federal funds,'' can a non-governmental
entity such as USAC hold and disburse such funds?
How should projected cost estimates used in the
administration of the universal service high-cost and low
income funds be treated for accounting purposes? If the
Commission is unable to decide this question, does such a
result create potential liability under the Anti-Deficiency Act
if actual high-cost and low income outlays exceed projected
estimates?
Given these accounting changes, what action, if any, does
the Commission expect will be necessary to recover the $550
million that will have failed to collect over the 2nd, 3rd and
4th Quarters of 2004 to cover E-rate and rural health care
obligations?
It is our understanding that these accounting changes will
require USAC to make changes in the way that cash balances are
invested. What guidelines govern the investment of cash
balances in the Universal Service Fund programs. Are those
guidelines subject to approval by USAC andlor the Commission?
What effect will recent changes ordered by the Commission have
on expected interest income?
Thank you for your prompt response to our inquiries. If you have
any questions, please contact either Ray Kvncevic in Senator Snowe's
office or James Reid in Senator Rockefeller's office.
Sincerely,
Olympia J. Snowe
John D. Rockefeller IV
cc: Commissioner Kathleen Q. Abernathy
Commissioner Jonathan S. Adelstein
Commissioner Michael J. Copps
Commissioner Kevin J. Martin
Senator Rockefeller. Thank you.
If the chairman will allow, I am going to ask a series of
questions and it will not go over my time limit. George
McDonald: How many schools and libraries now have legitimate
applications, cannot get their funding due to suspension? What
will the demand be for the program by November 1? Question
number one.
The IBM problems have attracted a great deal of press and
attention, probably deservedly so. There were many stories
about $200 million in fraud. Can you explain briefly how much
money USAC paid to IBM? How many questionable applications were
stopped? How did USAC handle the questionable applicants, Mr.
McDonald? I am not finished.
In your judgment as the Program Administrator, will the
accounting change to require cash on hand for commitment
letters help protect schools from aggressive vendors and
potential fraud?
Final question to Mr. Gumper: Can you briefly explain the
process between the FCC and USAC regarding the management of
the Universal Service Fund? I want to know how the FCC, quote,
``undercollected'' $550 million for the E-rate earlier this
year.
Mr. Chairman, you understand we are being assaulted you
wireless and the Universal Service Fund is getting clobbered in
all directions. In other words, the FCC undercollected $550
million earlier this year for E-rate, and then within a few
weeks suspended the program, citing lack of cash on hand. This
seems like a flip-flop--a term these days.
Second, is it true that the FCC approved investments in
government-backed securities in July, then reversed itself in
September, requiring the liquidation of the investment at the
cost of millions of dollars? How much did this cost? What are
the long-term ramifications for all aspects of the funding of
E-rate, High Cost, Low Income, and Rural Health Care, which
nobody has mentioned this morning?
That is it.
Mr. McDonald. Sir, I believe your first question was how
many schools are awaiting commitment letters that we could
issue today. There are about 4,200 applicants who would be
getting funding commitment decision letters today if we were
able to issue them, for about $300 million.
Senator Rockefeller. My question was, what will be the
demand for the program by November 1.
Mr. McDonald. I do not have an estimate of the number of
applicants by November 1.
Senator Rockefeller. Can you get that to me?
Mr. McDonald. Yes, sir.
Senator Rockefeller. IBM was the second one.
Mr. McDonald. IBM, we have funded IBM, we have disbursed
about $770 million over the life of the program to IBM, and I
believe most of that was properly committed and disbursed.
In 2002 we got a whistleblower letter alleging abuses in El
Paso, Texas, with 2001 money. That led us to have a special
investigations team of certified fraud examiners who conducted
an investigation and made site visits to El Paso and to
Isletta, Texas, who had filed an application for 2002 with IBM,
and uncovered a procurement pattern that--basically, IBM was
selected as a, quote, ``strategic technology partner'' with no
prices on the table. After they were selected, with an
agreement that their service provider identification number
would be on every funding request for that applicant, they sat
down with the applicant to figure out what did they really need
and what would it cost the applicant. When the prices were
settled, nobody was at the table but IBM.
The fundamental concept of the rules is competition over
prices for eligible goods and services. That did not occur. We
concluded that was not consistent with the rules, denied those
applications----
Senator Rockefeller. Understood. You have answered that
well.
The accounting change to require cash on hand for
commitment letters to help protect schools from aggressive
vendors and potential fraud?
Mr. McDonald. I do not see a relationship between the two,
sir. To have cash on hand in terms of the commitments? You have
to have unobligated cash to make commitments?
Senator Rockefeller. Yes.
Mr. McDonald. I do not see a connection between that and
protecting the schools. That is just a question of when we can
issue the funding commitment letters. We still have to do the
same scrutiny of those applications to determine whether there
is abuse by the service provider or the applicant.
Senator Rockefeller. Mr. Gumper, this thing I mentioned,
the undercollection of $550 million, then within a few weeks
suspending the program, citing lack of cash on hand.
Mr. Gumper. Because of the way USAC collects money; we
collect money at the start of the school year. We make
commitments, hopefully before the school year starts. But the
reality is that there is a fairly long lead time between when
we make a commitment to a school or a library and they actually
come back and say, OK, the work has been done, here is the
bill, pay it.
As such, over the course of the last few years the USAC
cash balance that we manage has increased significantly, to the
point where at the beginning of this year it was close to $3
billion. At that time our treasurer looked at the balance
sheet, the cash flow needed, and suggested, because the fact
that we had such a large balance of cash had been noted by the
auditors in several audits, questioning why was USAC
maintaining this huge cash balance and what was it growing. So
as a result of that, in discussions with the FCC and on the
advice of USAC, our finance people, it was determined that we,
for cash management purposes, could use some of the money to
keep down the contribution factor for a period of time.
At that point in time there was no correlation between when
we issued commitment letters and the cash balance we had. This
looked like just prudent cash management.
As mentioned in reply to one of your questions, a year ago
the Commission told us that we would have to go to government
accounting standards effective October 1, of this year. In the
process of training for that and modifying our systems, the
question came up from our people, because in government
accounting, unlike what we were doing in GAAP. In GAAP we were
booking an obligation in the program when we received an
invoice for payment from a service provider and in effect
processed it, adjudicated that it was correct, they followed
the rules, it was within their commitment. At that point in
time, we booked an obligation on our books.
But in government accounting, you talk about the point of
obligation. The question was raised, was the point of
obligation when we sent out the commitment letter? That issue
was discussed throughout the first part of this year, and
toward the summer it looked like we were going to be told that
this was a possibility, that commitments could be obligations.
At that time we thought this would just be an accounting
issue as to how we closed our books on October 1 and
transferred to government accounting. In June the question was
raised, though, might not USAC and the USF be subject to the
Anti-Deficiency Act? And if we were subject to the Anti-
Deficiency Act, then the question is, if these commitments were
obligations, did we have the correct appropriation from OMB to
cover it?
Because of the concerns of potentially violating the Anti-
Deficiency Act, it was in August 3 that, in the interest of
being conservative until we could actually verify whether or
not, A, we were subject, whether these commitments were going
to be treated as obligations, that we suspended the issuing of
new commitments, because this is our very busy time. As we
approached the school year, we had already committed over $700
million and were on the verge of committing a lot more. And
suddenly this issue came up, well, you might be in violation of
the Anti-Deficiency Act.
So that is why we suspended the things at that time, sir.
Senator Rockefeller. My time is up. I thank the witnesses
and the Chairman.
The Chairman. Senator Snowe.
Senator Snowe. Thank you, Mr. Chairman.
To follow up on that, Mr. Gumper. So you obviously were not
certain as to whether or not these rules would apply. I mean,
you knew they had been under discussion for a considerable
period of time, is that correct?
Mr. Gumper. We did not receive more certainty until the
meeting early in September between the FCC, OMB, and USAC. At
that point in time we were sort of given verbal direction that
we should probably be thinking of treating these things as
obligations when we closed our books. And for the very first
time it was raised that under government accounting the
investments that we had are invested in funds that were backed
by government securities, but they were operated by private
companies. This is where we got somewhat better return of
interest.
It was raised at that point in time, though, that those
funds were counted as obligations also. So even though we
considered them cash to balance against the commitment letters,
they said: No, no, those are obligations.
Senator Snowe. That is why you were forced to liquidate
those assets at a loss?
Mr. Gumper. That is why we were forced to liquidate. And
when staff informed me at this meeting, I basically said we
were not going to take such drastic action on a verbal OK, and
I sent a letter to the Commissioner, Chairman Powell, saying we
wanted written direction and the answers to some very specific
questions as to how we should treat commitments, how we should
basically handle this liquidation. And we got an answer back on
September 27.
Senator Snowe. And that is this letter that indicated you
basically were compelled to take those steps?
Mr. Gumper. Those steps. And we were also told not to
inform anybody, because over the period of a short 2 days we
sold and bought several billion dollars worth of government
bonds and we did not want to disrupt the bond market.
Senator Snowe. So is it correct that it becomes a loss to
you in terms of having to liquidate those bonds?
Mr. Gumper. We lost $4.6 million because of the interest
rates. That number is higher than we had anticipated when we
first wrote to the Chairman of the FCC. One of the reasons was
in between the Fed raised the short-term interest rates, and we
keep our investments in basically what are short-term. We call
them long-term; they are 2 years. But most of it is short-term,
money market, or maturities of 2 years or so, and those are
short-term, so they were somewhat affected by the increase in
the Fed rate.
Senator Snowe. The letter to you from the FCC, the one that
you referred to on September 27, it sounds to me like the
Inspector General obviously knew for quite some time about this
idea of conversion. I know it had been under consideration, but
it seemed more emphatic in this letter to you from the FCC.
How long had the Inspector General realized that this was
going to be inevitable for USAC to implement the government
accounting rules? Because I think it really gets to the heart
of the matter and how E-rate has been treated, how this program
is treated. It is obviously not throughout the entire Universal
Service Fund. It is not the High Cost programs.
Why is E-rate, why is this program being treated
dissimilarly from other entities within the fund and also
throughout government?
Mr. Cline. I do not believe for financial management
purposes and financial reporting that E-rate is being singled
out differently for the requirement to, like for example, for
USAC to move to gov-GAAP.
Senator Snowe. Could you give me an example of another
entity that has been treated similarly under these
circumstances right now?
Mr. Cline. All of the funding mechanisms are moving to
government accounting standards.
Senator Snowe. Did they get a lead time, that they have to
act in such a time?
Mr. Cline. My understanding would be they have the same
lead time as E-rate.
I think the other funding mechanisms, the High Cost, Low
Income, the impact on the immediate stop in funding I would
suspect, although I do not know--that would be USAC's call. I
do not believe anybody else had that stop that the E-rate has
experienced.
Senator Snowe. So why could it not have been done
differently?
Mr. Cline. Why it could be done differently, to be honest
with you, we in OIG would have a hard time answering that. Our
questions are actually very similar to yours. We have presented
to the Commission that, we need you, the Commission, to make a
determination how these requirements are going to be
implemented and how they are going to be represented in the
financial statements.
Our involvement in these issues are as part of the audit of
the FCC's Fiscal Year 2004 financial statement audit. Numerous
of the questions that you are asking we are asking, perhaps on
a more mechanical level, but very similar questions. We are
asking, how do you intend to gather this information, how do
you intend to report it.
The impact on the flow of funding, I do not believe that
OIG had insight into that any earlier than anyone else. To my
knowledge, in relation to the audit of the financial statement,
we did not foresee that. We in OIG would not foresee that
because our interest is in the financial presentation of the
information included in the financial statement.
Senator Snowe. Right, and no one has any argument with
that. I think it is the question of how this program has been
treated under these circumstances. Have you received anything,
has anybody received anything, from OMB with respect to this
directive in writing?
Mr. Cline. OIG has not.
Senator Snowe. OIG. Has anybody?
Mr. Gumper. We certainly have not. I know in the letter
that was sent back to me by the FCC they indicated that they
had gone to OMB and had asked for a written opinion and had not
received it yet.
In terms of the question are we treating this program
differently than the others, that is still an open issue with
the High Cost, Low Income. We did raise the question in my
letter to the Chairman as to whether or not the projections we
make in the High Cost, Low Income program are in fact
obligations. Prior to every quarter, we list every telephone
company as to how much money we are going to pay them in the
following quarter. We file that with the FCC. The FCC, after
they approve it, basically then we go through with those
payments.
They indicated back to me in the letter that that had been
an issue that had just recently come up, that they had been
referred to the OMB as to whether or not we should treat these
programs the same. We are waiting for that answer. I can tell
you that if we treat those projections as obligations we will
add another approximately $2 billion of obligations to our
books, which at that time would put us in a deficient mode of
operation.
Senator Snowe. Well, I guess I think the question is, Mr.
Bennett, why would the FCC force this kind of liquidation
without a written directive. Is that unusual or is that a
consistent manner of operation?
Mr. Cline. Unfortunately, we in OIG do not have the answer
to that question. You would have to place that to FCC
management. That is not a decision that we are involved in.
Senator Snowe. Thank you, Mr. Chairman. Thank you.
The Chairman. Thank you. I thank the witnesses.
Any more, Jay?
Senator Rockefeller. No.
The Chairman. I thank the witnesses. This hearing is
adjourned.
[Whereupon, at 11:10 a.m., the hearing was adjourned.]