Members will hear testimony on allegations of waste, fraud and abuse surrounding the Universal Service E-rate program. Senator McCain will preside. Witnesses will be announced at a later time.
Witness Panel 1
Mr. George McDonald
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.
Mr. Frank 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 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 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 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.
Mr. Thomas Bennett
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: o lack of clarity regarding program rules, and; o lack of timely and effective resolution of audit findings. Specific concerns regarding program design include; o weaknesses in program competitive procurement requirements; o ineffective use of purchased goods and services; o reliance on applicant certifications; o weaknesses in technology planning; and o 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%) and generally compliant in an additional 22 audits (16%). Beneficiaries were determined to be compliant in 65 audits (48%). 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 Library Compliant $0 02/03/03 Robeson County Public Schools Compliant 0 02/05/03 Wake County Public Schools Compliant 0 08/27/03 Albemarle Regional Library Compliant 0 12/22/03 St. Matthews Lutheran School Not Compliant 136,593 12/22/03 Prince William County Schools Generally Compliant 5,452 12/22/03 Arlington Public School District Generally Compliant 7,556 03/24/04 Immaculate Conception School Not Compliant 68,846 04/06/04 Children’s Store Front School Not Compliant 491,447 05/19/04 St. Augustine School Not Compliant 21,600 05/25/04 Southern Westchester BOCES Compliant 0 06/07/04 United Talmudical Academy Not Compliant 934,300 08/12/04 Annunciation Elementary School Not Compliant 129,003 $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 School Compliant $0 01/07/04 Navajo Preparatory Academy Not Compliant 2,084,399 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 dollars 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 web site 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% to 90% 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.
Mr. Winston E. Himsworth
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 Web site, 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% 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%) 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. o 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. o 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. o 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: o A reported 20-30% 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. o The two key application forms for FY 2005 are 13 and 16 pages long; the instructions are 20 and 35 pages long, respectively. o New procedures for application review in FY 2005 will require virtually every applicant to respond to additional inquiries from PIA reviewers. o 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. o 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% ineligible feature. o 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% that must be paid by the applicants eligible for 90% 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% to 70 80%. 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.