[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]



 
 PROBLEMS WITH THE E-RATE PROGRAM: WASTE, FRAUD, AND ABUSE CONCERNS IN 
           THE WIRING OF OUR NATION'S SCHOOLS TO THE INTERNET
                                 Part 2
=======================================================================



                                HEARING

                               before the

                            SUBCOMMITTEE ON
                      OVERSIGHT AND INVESTIGATIONS

                                 of the

                    COMMITTEE ON ENERGY AND COMMERCE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 22, 2004

                               __________

                           Serial No. 108-103

                               __________

       Printed for the use of the Committee on Energy and Commerce







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

                                _______

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94-835                 WASHINGTON : 2004
_________________________________________________________________
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                    COMMITTEE ON ENERGY AND COMMERCE

                      JOE BARTON, Texas, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
RALPH M. HALL, Texas                   Ranking Member
MICHAEL BILIRAKIS, Florida           HENRY A. WAXMAN, California
FRED UPTON, Michigan                 EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida               RICK BOUCHER, Virginia
PAUL E. GILLMOR, Ohio                EDOLPHUS TOWNS, New York
JAMES C. GREENWOOD, Pennsylvania     FRANK PALLONE, Jr., New Jersey
CHRISTOPHER COX, California          SHERROD BROWN, Ohio
NATHAN DEAL, Georgia                 BART GORDON, Tennessee
RICHARD BURR, North Carolina         PETER DEUTSCH, Florida
ED WHITFIELD, Kentucky               BOBBY L. RUSH, Illinois
CHARLIE NORWOOD, Georgia             ANNA G. ESHOO, California
BARBARA CUBIN, Wyoming               BART STUPAK, Michigan
JOHN SHIMKUS, Illinois               ELIOT L. ENGEL, New York
HEATHER WILSON, New Mexico           ALBERT R. WYNN, Maryland
JOHN B. SHADEGG, Arizona             GENE GREEN, Texas
CHARLES W. ``CHIP'' PICKERING,       KAREN McCARTHY, Missouri
Mississippi, Vice Chairman           TED STRICKLAND, Ohio
VITO FOSSELLA, New York              DIANA DeGETTE, Colorado
STEVE BUYER, Indiana                 LOIS CAPPS, California
GEORGE RADANOVICH, California        MICHAEL F. DOYLE, Pennsylvania
CHARLES F. BASS, New Hampshire       CHRISTOPHER JOHN, Louisiana
JOSEPH R. PITTS, Pennsylvania        TOM ALLEN, Maine
MARY BONO, California                JIM DAVIS, Florida
GREG WALDEN, Oregon                  JANICE D. SCHAKOWSKY, Illinois
LEE TERRY, Nebraska                  HILDA L. SOLIS, California
MIKE FERGUSON, New Jersey            CHARLES A. GONZALEZ, Texas
MIKE ROGERS, Michigan
DARRELL E. ISSA, California
C.L. ``BUTCH'' OTTER, Idaho
JOHN SULLIVAN, Oklahoma

                      Bud Albright, Staff Director
                   James D. Barnette, General Counsel
      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

              Subcommittee on Oversight and Investigations

               JAMES C. GREENWOOD, Pennsylvania, Chairman

MICHAEL BILIRAKIS, Florida           PETER DEUTSCH, Florida
CLIFF STEARNS, Florida                 Ranking Member
RICHARD BURR, North Carolina         DIANA DeGETTE, Colorado
CHARLES F. BASS, New Hampshire       TOM ALLEN, Maine
GREG WALDEN, Oregon                  JANICE D. SCHAKOWSKY, Illinois
  Vice Chairman                      HENRY A. WAXMAN, California
MIKE FERGUSON, New Jersey            EDWARD J. MARKEY, Massachusetts
MIKE ROGERS, Michigan                JOHN D. DINGELL, Michigan,
JOE BARTON, Texas,                     (Ex Officio)
  (Ex Officio)

                                  (ii)












                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Ackerman, Arlene, Superintendent, San Francisco Unified 
      School District............................................     9
    Burger, Thomas J., President and CEO, NEC Unified Solutions; 
      Inc; accompanied by William Holman, former Vice President 
      of Sales for NEC BNS; George Marchelos, former consultant 
      to and employee of Video Network Communications; Judy 
      Green, former consultant to and employee of Video Network 
      Communications, Inc........................................    55
    Cothran, George M., Investigator, San Francisco City Attorney 
      Office.....................................................    17
    Donovan, Timothy M., former Senior Vice President and General 
      Counsel, NEC USA, Inc......................................    57
    Herrera, Dennis J., San Francisco City Attorney..............    14
    Maher, William F., Jr., Chief, Wireline Competition Bureau, 
      Federal Communications Commission..........................    78
    McDonald, George, Vice President, Schools and Libraries 
      Division, Universal Service Administrative Company.........    83
    Renne, Louise H., General Counsel, San Francisco Unified 
      School District............................................    12

                                 (iii)

  
















 PROBLEMS WITH THE E-RATE PROGRAM: WASTE, FRAUD, AND ABUSE CONCERNS IN 
           THE WIRING OF OUR NATION'S SCHOOLS TO THE INTERNET

                              ----------                              


                        THURSDAY, JULY 22, 2004

                  House of Representatives,
                  Committee on Energy and Commerce,
              Subcommittee on Oversight and Investigations,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10 a.m., in 
room 2123, Rayburn House Office Building, Greg Walden (vice 
chairman), presiding.
    Members present: Representatives Walden, Bass, Barton (ex 
officio), DeGette, and Schakowsky.
    Staff present: Mark Paoletta, majority counsel; Peter 
Spencer, majority professional staff; Tom Feddo, majority 
counsel; Jaylyn Jensen, legislative analyst; Michael Abraham, 
legislative clerk; David Nelson, minority investigator and 
economist; and Jessica McNiece, minority clerk.
    Mr. Walden. Good morning. The subcommittee will come to 
order.
    Last month we opened our hearing on E-Rate with a close 
look at the Puerto Rico Department of Education's experience 
with the program. That case, in which a large and needful 
district and its vendors literally wasted more than $100 
million of E-Rate funds, shed light on a range of problem areas 
in the program set-up.
    The problems extended from the front to the back of the E-
Rate funding process. The Puerto Rico case illustrated 
weaknesses in the competitive bidding process and the 
requirements that applicants certify they actually have the 
resources necessary to make effective educational use of E-Rate 
funds.
    In Puerto Rico, tens of millions of dollars were being 
billed, while few, if any, children actually got connected to 
the Internet. We saw problems in implementing the goods and 
services purchased with E-Rate funds, as the $20 million--$20 
million--of dusty, shrink wrapped gear in a warehouse 
highlighted, and we saw weaknesses in oversight and in the 
audit process.
    This morning we will focus directly on the front end of the 
E-Rate process, the application and processing of applications 
in the E-Rate program. This is the part of the program where 
many problems begin and where many problems can be caught, if 
done right.
    This is where the planning and competitive bidding, the 
keystone to the program, take place and where E-Rate's 
administrators can catch applicants that run afoul of program 
requirements. Failure here at the front end assures wasteful 
spending and opens the way for fraud and for abuse.
    Today we will take a hard look at some of the very 
troubling actions on the part of vendors and consultants and 
how these actions were stopped, at least in one large school 
district. We will look at the facts and circumstances 
surrounding the application for E-Rate funds by the San 
Francisco Unified School District in the 2000 E-Rate funding 
year.
    San Francisco's experience is a story in which bad actors 
put the E-Rate application process to the test. We will learn 
that the program did not pass that test.
    As we will hear today, the E-Rate administrator, USAC, 
approved more than $58 million in funding, including the 
District's share, based on fraudulent applications. Each 
procedural safeguard then set up by USAC failed: Competitive 
bidding, application certification, application review, and 
selective review.
    Fortunately, a final check, a newly arrived superintendent 
whom we will hear from this morning had suspicions that led to 
uncovering program fraud and abuse not only in San Francisco 
but also around this country.
    Today's hearing focuses primarily on the San Francisco 
Unified School District's experience. We are continuing to 
examine the broader details of the conspiracy in other States. 
Questionable activity by the vendors and individuals who 
exploited the process in San Francisco has been identified in 
Arkansas, in Michigan, and in South Carolina, for example.
    One district, with the help of these bad actors, allegedly 
built a $750,000 television studio with E-Rate funds, 
something, be assured, that clearly should not have happened, 
and we will address these details in due course.
    Today's hearing, nevertheless, will shed light on the 
integrity of the E-Rate application process. Equally important, 
today's hearing will also let us focus a bright light on the 
very troubling behavior surrounding the bid rigging conspiracy 
and fraud underlying this particular school district's 
experience.
    We have before us today some of the key players in the San 
Francisco story. So this light should serve not only to 
illuminate where there are problems in program structure, but 
also to display clearly the kind of actions that cannot be 
allowed to occur in the program or to escape public scrutiny.
    The actions we will examine were made public when NEC 
Business Network Solutions, now doing business as NEC Unified 
Solutions, pleaded guilty this past May to wire fraud and to a 
conspiracy to suppress and eliminate competition for E-Rate 
program projects.
    NEC BNS also confirmed, among other facts, that as part of 
the conspiracy it assisted in submitting inflated prices to 
USAC, $26 million more than vendors had bid on the San 
Francisco project.
    NEC BNS admitted that it had informed USAC that it planed 
to ``donate'' ineligible equipment, but in fact intended to buy 
that equipment with $10 million in excess E-Rate receipts, and 
this was just in San Francisco. As part of the plea deal, NEC 
BNS agreed to pay $20.7 million in fines and restitution.
    At this point, I would note that three of the witnesses 
before us this morning are not appearing voluntarily, in large 
part, they maintain, due to ongoing criminal and civil cases 
into the matters we will be examining. We issued subpoenas last 
week to command their presence and their testimony.
    Among them today are the President and CEO of NEC BNS, Mr. 
Thomas Burger, as well as its former Price President of Sales, 
Mr. William Holman. I look forward to learning from Mr. Burger 
what he can say about his company's behavior, especially as he 
was the main man in charge at the time of this activity to 
which this company has pleaded guilty, and Mr. Holman, 
according to numerous documents, should have information that 
will help us understand how this situation developed.
    We also have an individual, Mr. George Marchelos who, San 
Francisco investigators suggest, has direct knowledge of what 
happened in that school district and elsewhere, and I hope he 
will help us understand this story.
    We also subpoenaed a Ms. Judy Green, another E-Rate 
consultant who, according to the U.S. Marshal's Service, has 
effectively avoided service for the past week. Given that the 
committee continues to investigate this conspiracy, let me just 
note that we will provide her another opportunity to testify. 
We will make sure this committee's subpoenas are served. She 
will eventually come before this committee and testify.
    The story of San Francisco is a story of corrupt school 
employees, E-Rate consultants controlling the process, and 
vendors conspiring to completely undercut competition. We will 
ask some probing questions of these people, but I also expect 
we will ask tough questions of other players.
    We have hard questions to ask of USAC, which set up the 
procedures for policing E-Rate applications for problems and, 
in the case of San Francisco, inexplicably neglected several 
red flags. Of course, we have the FCC, the agency in charge of 
the whole program. They have to answer to this story, too, and 
explain where they are leading this program now after cases 
like this.
    Let me conclude by extending a welcome to our witnesses, 
particularly those from San Francisco City Attorney's Office 
and from the San Francisco Unified School District. 
Superintendent Ackerman, who joins us via videoconference, has 
been most accommodating to assist us today, and we especially 
appreciate your willingness and your help.
    With that, let me recognize the ranking member for her 
opening statement. Good morning.
    Ms. DeGette. Thank you very much, Mr. Chairman, and I am 
pleased to call you Mr. Chairman and welcome you to the 
chairman's seat, Mr. Walden.
    Mr. Walden. I am delighted to be in the seat, but I remain 
as vice chairman of the committee.
    Ms. DeGette. Right. I think you will be there for the 
foreseeable future.
    I am really pleased to be back here for the second in what 
I hope will be a continuing series of hearings on the E-Rate 
program. I came out of the last hearing with an understanding 
that some of the problems we have seen with this important 
program can be resolved, but only if oversight is dramatically 
stepped up, and if there is a serious crack-down on some of the 
worst offenders and fraudulent practices.
    I want to take a minute again to emphasize why this issue 
is so important. Not only have millions of dollars been wasted 
over the years, but millions of dollars have not been wasted. 
Millions of dollars have gone to exactly what the program was 
intended to do, and if steps aren't taken to stop the fraud 
that has occurred, I am afraid we run the risk of ending an 
innovative program that has done amazing things for students 
across the country.
    I believe that Congress has the very serious responsibility 
of ensuring that the program runs the way it was intended to, 
and that the kids that it is intended to serve do not become 
the ultimate victims.
    I hope today will prove as informative as the last hearing, 
although I am disheartened that so many of our witnesses are 
not here of their own free will to help shed some light on the 
issue at hand, and have chosen not to submit testimony.
    On the other hand, I believe the first panel will 
demonstrate how important oversight at all levels is and how 
school districts themselves are very important players when it 
comes to ensuring that E-Rate funds are properly utilized.
    I am extremely impressed with the actions of the San 
Francisco Unified School District for sounding the alarm when 
they got the word that things were not as they should be.
    I think it took great courage and a strong commitment to 
ethical standards, something, as we are sadly learning 
throughout these hearings, that has been in too short supply. 
Frankly, it must have been pretty hard to turn down nearly $50 
million that had already been approved for use, and I greatly 
admire that decision.
    There are a number of questions that come to mind when 
considering the case of what happened with E-Rate funds and the 
San Francisco Unified School District. First, how on earth did 
the funds get approved, to begin with, particularly since it 
seems like the Universal Service Administrative Company took 
extra steps to examine the applications that were later found 
to be fraudulent?
    Second, should it really be the responsibility of the 
recipient school districts or libraries to make sure that 
applications aren't wrongly approved? Shouldn't that be the 
responsibility of those who run the program and approve the 
applications?
    It seems that, certainly in this case, things were 
backwards, and it concerns me there are other cases out there 
that we are currently unaware of where funds have been wrongly 
approved, and recipients have not been diligent about reporting 
it. This could be due to ignorance or lax ethics, but either 
way it would be a huge problem, and I, for one, would like to 
see some evidence that San Francisco and their experience is 
not being replicated nationwide.
    At the last hearing, I laid out what I thought were two of 
the most serious problems that need to be addressed in order to 
ensure that the E-Rate is actually accomplishing its mission.
    First of all, the bad apple vendors and consultants who 
take advantage of school districts and then essentially take 
the money and run--we saw that last week--and also the apparent 
lack of oversight that has allowed for large amounts of money 
to go to schools that have no ability to proceed with actually 
utilizing the funds and the equipment they receive.
    Today, I am looking forward to further exploration of these 
issues, and I am pleased that we have a representative from 
USAC, Mr. George Mcdonald, to talk about the concerns. I am 
also interested in hearing from Mr. McDonald about the current 
status of the Puerto Rico case that we talked about in the last 
hearing. I want to know what is being done to help them fix the 
past mistakes so that these students can have the kind of 
computer programs that they should be having.
    Finally, there are a number of other issues we need to 
address in this hearing: How can we improve the E-Rate's 
competitive bidding process? Exactly what should the 
responsibilities of school administrators be, and what steps 
are the USAC taking to make sure that they never again make the 
mistake of approving fraudulent applications for millions of 
dollars?
    Mr. Chairman, I look forward to hearing the testimony, and 
I ask unanimous consent that Mr. Dingell and all other members' 
opening statements be placed in the record.
    Mr. Walden. Without objection, so ordered.
    [The prepared statement of Hon. John D. Dingell follows:]
    Prepared Statement of Hon. John D. Dingell, a Representative in 
                  Congress from the State of Michigan
    Mr. Chairman, thank you for continuing this investigation and 
holding this hearing. Today, this Subcommittee holds the first of its 
vendor-specific hearings, examining some of the fraudulent activity 
that a subsidiary of NEC America, Inc. (NEC) and its co- conspirators 
engaged in. While this hearing will specifically focus on NEC's 
unsuccessful attempt to defraud the E-rate program in San Francisco, 
NEC did succeed in procuring millions of dollars from illegal E-rate 
program claims that involved school districts from Michigan to 
Mississippi.
    We will hear from the local public servants who prevented the San 
Francisco fraud from going forward and who subsequently uncovered its 
nationwide scope. This case study is particularly revealing in that NEC 
and its vendors were actively involved in most of the criminal schemes 
that flourished, in part due to the lax oversight of the E-rate program 
by the Federal Communications Commission (FCC).
    These scams include bid rigging, hiding of ineligible equipment, 
and goldplating (specifying equipment acquisition that exceeded the 
school districts' needs). Scams also included the fraudulent inflation 
of prices, illegal kickbacks, illegal ``in-kind'' donations, the 
corruption of local officials, as well as directly or indirectly 
causing the filing of a plethora of false statements to the Universal 
Service Administrative Corporation (USAC), the non- profit corporation 
which disburses E-rate program funds.
    Fortunately, a newly hired Superintendent of the San Francisco 
Unified School District caught the fraudulent application for almost 
$50 million in E-rate funds and stopped the process before the money 
could be spent, stolen, or wasted. The City Attorney initiated an 
investigation that ultimately resulted in prosecution by the Department 
of Justice and a guilty plea by NEC. The federal investigation 
continues into the roles of various individuals in this sorry saga.
    Amazingly, NEC has petitioned the FCC to allow it to continue 
participating in the E-rate program, based upon its exceptional 
``cooperation'' with the federal investigations. But NEC's cooperation 
did not begin until after they were caught. The guilty plea probably 
saved the Government a trial but little else. No important executive 
has lost his or her job, and employees directly implicated in the 
wrongdoing remain on the NEC payroll.
    I understand that today the senior executives who oversaw these 
schemes may invoke their right to avoid incriminating themselves and 
refuse to testify. This strikes me as very curious cooperation. The FCC 
should not be fooled into thinking that this company and its employees 
are now worthy of the taxpayers' trust.
    I support the work of this Subcommittee to expose all the major 
problems in the E-rate program, and I look forward to working with my 
colleagues to address them.

    Mr. Walden. We are now honored to have with us the chairman 
of the full committee, Mr. Barton.
    Chairman Barton. Thank you, Mr. Chairman, and before I give 
my prepared statement on this hearing, I just want to announce 
that we have a new addition to the committee room. We have our 
nameplates that have our States on it. I had always wanted to 
let people know what State I am from, and Mr. Bass was very 
happy when he walked in and noticed that it said he was from 
New Hampshire.
    Mr. Bass. If the gentleman would yield, I just want to make 
sure that--Texas is a long way from here.
    Chairman Barton. So I hope people enjoy the diversity of 
the committee, as will be seen as everybody shows up with 
different locations that we are from.
    Mr. Chairman, I appreciate the work that you have shown as 
vice chairman of this committee in working on this important 
issue. I want to give special commendation to the gentle lady 
from San Francisco, Dr. Arlene Ackerman who is joining us by 
video conference, for her strong moral stand in turning this 
issue in to be investigated. Not too many superintendents, I 
think, would have turned $40 million or $50 million down, and 
she had the moral courage to make sure that it was on the up 
and up. Unfortunately, it turned out that it wasn't. So I want 
to thank her long distance for her strong stand.
    It is the intent of this committee's investigation to 
ensure that E-Rate will operate without the waste and abuse 
that we have been discovering. Almost every rock that we turn 
over, it seems there is a problem under that particular rock.
    The E-Rate program deserves vigorous Congressional 
oversight. I support this oversight, and I look forward to 
continuing to work with this subcommittee as the full committee 
chairman to get to the bottom and then, if necessary, provide a 
legislative reform package in the next Congress to prevent 
these kinds of abuses from continuing to occur.
    These hearings are in large measure about accountability, 
accountability among the applicants and recipients of funding, 
that they are following the rules, and accountability among 
those running the program, that they have set it up to operate 
effectively without all the waste and abuse that we are 
continuously uncovering.
    This program is designed to provide recipients and 
applicants access to other people's money. When you spend 
somebody else's money, you don't have the same incentive to 
spend as carefully as you would if you were spending your own 
money.
    When tens of millions of dollars are at issue, there is a 
powerful incentive to spend wastefully and abuse the program. 
To address this powerful incentive, the solution is to ensure 
accountability of program participants and managers so that 
they spend wisely and manage effectively.
    This hearing is about the process put in place to ensure 
people act responsibly or with the appropriate authority and 
understand the consequence of acting irresponsibly.
    Today we are going to look at a fraudulent $50 million 
application at the San Francisco School District that sailed 
through the normal process and was approved. The money was 
eventually rejected, because one person, one person who is 
going to testify later this morning, Dr. Arlene Ackerman, had 
the gumption to look at this and say that it didn't look like 
it was on the up and up. Again, as I have already said, I want 
to commend her for her acting responsibly in accountability. I 
look forward to hearing her testimony in greater detail this 
morning.
    We also have before us this morning people on the other 
side, the company, NEC Unified Solutions, who will answer 
questions and actions about their employees. This company 
recently pleaded guilty to E-Rate bid rigging in San Francisco 
and other districts, and has paid a $20 million fine. I would 
like to hear how their CEO answers for the actions of his 
employees.
    We have an E-Rate consultant who was on the ground at the 
school districts who can answer to the development of what 
turned out to be fraudulent but successful applications for E-
Rate funding and, as you have already pointed out, Mr. 
Chairman, last week we issued subpoenas for four witnesses. 
Three of them are before us today. One of them, Ms. Judy Green, 
has successfully ducked service so far.
    I take very seriously our oversight function in the House, 
and I will not allow people who have information necessary to 
accomplish our work to avoid our legitimate inquiries. I have 
spoken with the ranking member of the full committee, the 
Honorable John Dingell of Michigan, and when we go into recess 
today or tomorrow, under the rules of the House of 
Representatives, as full committee chairman I have the right to 
issue a recess subpoena, and I will do so. If Ms. Green's 
representatives are in this audience or watching on television 
or have access to the record, let them know that there will be 
another subpoena issued, and at sometime this fall she will 
come before this committee.
    The Energy and Commerce Committee, to my knowledge, in the 
20 years that I have been in the House, 18 on this committee, 
has never had a subpoena that was not successfully served, and 
we don't intend to change that record on this hearing.
    So again, in consultation with the ranking member of the 
full committee, Mr. Dingell, he is very supportive of my 
authority as full committee chairman issuing a recess subpoena 
to get Ms. Green to appear at the appropriate time before the 
committee, and we will do that.
    Finally, we have the Administrator of the program, the E-
Rate program. We have the person who runs the Bureau at the FCC 
that is in charge of the E-Rate program. They are responsible 
for clear and effective rules and procedures, and we look 
forward to hearing from them what they have to say about the 
larger program, the larger issues before us.
    Mr. Chairman, this is a very, very important hearing. I 
appreciate you holding it. I appreciate the fine bipartisan 
work that we have done at the staff level in preparing for it, 
and I look forward to a very instructive hearing.
    With that, I yield back the balance of my time.
    Mr. Walden. Thank you, Mr. Chairman, and thanks for your 
leadership on this committee.
    The Chair recognizes the gentleman from New Hampshire, who 
I understand does not have an opening statement. Is that 
correct?
    Mr. Bass. I will pass.
    Mr. Walden. The gentleman passes. The Chair now recognizes 
a member of the full committee, Ms. Schakowsky from Chicago, 
for an opening statement--from the subcommittee. I'm sorry.
    Ms. Schakowsky. Thank you, Mr. Chairman, for holding this 
hearing today. I am glad to have the opportunity to hear about 
how the current system's weaknesses allow vendors to use the E-
Rate program for their own benefit. Once we understand those 
weaknesses, we can improve the system to make sure it is 
benefiting our children.
    NEC Business Network Solutions, Inc. entered into bid 
rigging schemes in five different school districts in Michigan, 
Wisconsin, Arkansas, and South Carolina. The company has also 
admitted into entering into a scheme to defraud the E-Rate 
program in the San Francisco Unified School District by 
inflating bids, agreeing to submit false and fraudulent 
documents to hide the fact that it planned on installing 
prohibited items, agreeing to donate so called free items for 
which it had planned to bill E-Rate, and submitting false and 
fraudulent documents to prevent inquiry into the legitimacy of 
the funding requests.
    I want to thank those dedicated public servants who are 
here today who discovered and helped to uncover these kinds of 
fraudulent activities. We really appreciate that kind of public 
service.
    NEC generously marked up prices on computer hardware, 
sometimes as much as 400 percent. On one small Internet switch, 
for example, NEC's bid would have given the firm a profit 
margin of $780,000. As shocking as the actions of NEC BNS are, 
I am sorry to say that the company is just one of a cast of bad 
characters profiting at the expense of our Nation's children.
    A price tag cannot be placed on the value of providing 
Internet access to the millions of children and teachers in our 
public schools. Even in its imperfect condition, the E-Rate 
program has helped millions of children gain the kind of 
technical knowledge that is crucial in today's society.
    Schools in my district and across the Nation have used E-
Rate funds to provide access to the Internet for kids who might 
otherwise never have it. Access to the worldwide web can make a 
world of difference in our schools. The E-Rate program has 
helped us close the information divide, but the disparity in 
access to computers and online services by race and income 
still persists.
    We cannot afford to abandon the E-Rate program or to have 
any of our children left behind on the information 
superhighway. It is now our job to reform the E-Rate program to 
make sure that the benefits of the program go to those who need 
them most, our children.
    Again, Mr. Chairman, thank you for holding this hearing. I 
look forward to hearing the testimony of our witnesses, and I 
look forward to working to improve the E-Rate program.
    Mr. Walden. Thank you for your testimony, and we appreciate 
your work on this issue.
    Now I would like to welcome Panel 1: Dr. Arlene Ackerman, 
the Superintendent of the San Francisco Unified School 
District; Ms. Louise H. Renne, the General Counsel of the San 
Francisco Unified School District; Mr. Dennis J. Herrera, City 
Attorney of San Francisco; and Mr. George Cothran, the 
investigator for the Office of the City Attorney.
    We appreciate your being here. As you are aware, the 
committee is holding an investigative hearing and, when doing 
so, has had the practice of taking testimony under oath. Do you 
have any objection to testifying under oath? Let the record 
show the witnesses indicate they have no objection.
    The Chair then advises you that, under the rules of the 
House and the rules of the committee, you are also entitled to 
be advised by counsel. Do you desire to be advised by counsel 
during your testimony today? The record shows they all indicate 
no.
    In that case, if you would rise and raise your right hand, 
I will then swear you in.
    [Witnesses sworn.]
    Mr. Walden. Thank you. They indicate they do.
    You are now under oath, and I will call on you to give your 
5-minute summary of your written statement, and we will start 
with Dr. Ackerman.
    Before I do that, I am going to go ahead and ask unanimous 
consent to enter into the record the binders that are before 
us, which we will reference as we do our questioning. Without 
objection, they are now entered into the record. Dr. Ackerman, 
please go ahead.

  TESTIMONY OF ARLENE ACKERMAN, SUPERINTENDENT, SAN FRANCISCO 
UNIFIED SCHOOL DISTRICT; LOUISE H. RENNE, GENERAL COUNSEL, SAN 
   FRANCISCO UNIFIED SCHOOL DISTRICT; DENNIS J. HERRERA, SAN 
 FRANCISCO CITY ATTORNEY; AND GEORGE M. COTHRAN, INVESTIGATOR, 
               SAN FRANCISCO CITY ATTORNEY OFFICE

    Ms. Ackerman. Thank you. Good morning, Vice Chairman Walden 
and members of the subcommittee. Thank you for the opportunity 
to appear before you on the matter of the Federal E-Rate 
program and the extremely interesting and revealing experiences 
that we have had in San Francisco schools as participants in 
the program.
    I began my current role as Superintendent of San Francisco 
Unified School District which serves approximately 59,000 
students in the city and county of San Francisco in July of 
2000. Needless to say, as I went about my work in these first 
several months, I had a considerable amount to learn about the 
detailed context and conditions of San Francisco schools.
    In addition to dealing with the core work of a school 
superintendent, such as evaluating school performance, 
organizing and reorganizing the district office and collective 
bargaining, I was also hired with a mandate to improve the 
district's business practices. Although I had worked on 
difficult fiscal and operational issues in other school 
districts, I soon learned of activities that, for me, 
represented a new low in my 30-plus years of public education.
    I saw the beginning of a trail of evidence that was 
ultimately found to lead to a number of individuals and 
organizations who plotted carefully to enrich themselves by 
depriving our children.
    In the fall of 2000, two former staff members provided me a 
copy of an E-Rate application that had been submitted for $50 
million. As I reviewed the document, several elements of the 
application troubled me.
    First, it indicated that the district had set aside the 
approximately $8 million that was necessary to contribute as a 
matching requirement. I knew that this was not the case. One of 
my first priorities had been to become intimately familiar with 
our financial condition, and nothing I had studied or heard of 
indicated that any district funds had been set aside for this 
purpose.
    Second, the description of the equipment and infrastructure 
that was to be funded with the grant proceeds seemed incoherent 
and did not reflect a strategy to align technology with 
instructional objectives. I saw woefully little evidence of 
sufficient planning, especially for an investment of this size.
    Finally and perhaps most obvious, the document materially 
misstated facts in describing our district. Among other things, 
the grant indicated that the district covered 400 square miles, 
in contrast to the actual figure of 49 square miles.
    It also claimed that there is no mass transit system in San 
Francisco, when we actually have one of the Nation's largest 
public transportation systems. In many respects, the grant 
seemed to be describing another district altogether.
    As superintendent, I typically require that documents that 
bind the district to any funding or other commitments undergo 
legal review. In this case, my elevated concerns about this 
grant led me to contact then City Attorney Louise Renne for 
assistance in reviewing the document.
    As Ms. Renne and then current City Attorney Dennis Herrera 
and Investigator George Cothran will describe in detail, so 
began an investigation that ultimately led to the extremely 
disturbing conclusions that necessitate this morning's hearing. 
However, despite the disturbing and cautionary aspects of our 
experience with E-Rate, I very much hope that members of this 
subcommittee and the public will interpret my comments as 
supporting reform of the program, not its elimination.
    I fully agree with the goals of the program, to increase 
all students' access to technology, paying particular attention 
to the digital divide that would otherwise place the Internet 
out of the reach of many children of low income families.
    While our experience in San Francisco and those of several 
other school districts have revealed serious problems with the 
E-Rate program, I would respectfully ask policymakers to 
consider that the program has brought technology to 
unprecedented numbers of public school students. Nearly all 
classrooms and school libraries are now connected to the 
Internet, and most as a direct result of the E-Rate program.
    The program certainly needs to be reformed, and to that end 
I am gratified that San Francisco schools and the extremely 
capable attorneys and investigators who have assisted us have 
helped accelerate discussions about how to increase scrutiny of 
E-Rate applications and otherwise reduce the possibility of 
waste, fraud and abuse in this important program.
    At this point, I would like to introduce San Francisco's 
former City Attorney and our school district's former General 
Counsel, Louise Renne. Thank you.
    [The prepared testimony of Arlene Ackerman follows:]
 Prepared Statement of Arlene Ackerman, Superintendent, San Francisco 
                        Unified School District
    Good morning Chairman Greenwood, Ranking member Deutsch, and 
members of the subcommittee. Thank you for the opportunity to appear 
before you on the matter of the federal E-rate program and the 
extremely interesting and revealing experiences that we have had in San 
Francisco's schools as participants in the program.
    I began my current role as Superintendent of San Francisco Unified 
School District, which serves the 59,000 public school students in the 
City and County of San Francisco, in July 2000. Needless to say, as I 
went about my work in these first several months I had a considerable 
amount to learn about the detailed context and conditions of San 
Francisco's schools.
    In addition to dealing with the core work of a school 
superintendent, such as evaluating school performance, organizing the 
district office, and collective bargaining, I was also hired with a 
mandate to improve the District's business practices. Although I had 
worked on difficult fiscal and operational issues in other school 
districts, I soon learned of activities that for me represented a new 
low in my thirty-plus years of public education. I saw the beginning of 
a trail of evidence that was ultimately found to lead to a number of 
individuals and organizations who plotted carefully to enrich 
themselves by depriving children.
    In the fall of 2000, two former staff members provided me a copy of 
an E-Rate application that had been submitted for $50 million. As I 
reviewed the document, several elements of the application troubled me.
    First, it indicated that the District had set aside the 
approximately $8 million that was necessary to contribute as a matching 
requirement. I knew that this was not the case. One of my first 
priorities had been to become intimately familiar with our financial 
condition, and nothing I had studied or heard indicated that any 
District funds had been set aside for this purpose.
    Second, the description of the equipment and infrastructure that 
was to be funded with the grant proceeds seemed incoherent and did not 
reflect a strategy to align technology with instructional objectives. I 
saw woefully little evidence of sufficient planning, especially for an 
investment of this size.
    Finally, and perhaps most obvious, the document materially 
misstated facts in describing the District. Among other things, the 
grant indicated that the District covered 400 square miles, in contrast 
to the actual figure of forty-nine (49) square miles. It also claimed 
that there is no mass transit system in San Francisco when we actually 
have one of the nation's largest public transportation systems. In many 
respects, the grant seemed to be describing another district 
altogether.
    As Superintendent, I typically require that documents that bind the 
District to any funding or other commitments undergo legal review. In 
this case, my elevated concerns about this grant led me to contact then 
City Attorney Louise Renne for assistance in reviewing the document. As 
Ms. Renne, current City Attorney Dennis Herrera, and investigator 
George Cothran will describe in detail, so began an investigation that 
ultimately led to the extremely disturbing conclusions that necessitate 
this morning's hearing.
    However, despite the disturbing and cautionary aspects of our 
experience with E-Rate, I very much hope the members of the 
Subcommittee and the public will interpret my comments as supporting 
reform of the program, not its elimination. I fully agree with the 
goals of the program--to increase all students' access to technology, 
paying particular attention to the digital divide that would otherwise 
place the internet out of the reach of many children of low income 
families.
    While our experience and those of several other school districts 
have revealed serious problems with the E-Rate program, I would 
respectfully ask policymakers to consider that the program has brought 
technology to unprecedented numbers of public school students. Nearly 
all classrooms and school libraries are now connected to the internet, 
most as a direct result of the E-Rate program. The program certainly 
needs to be reformed. To that end, I am gratified that San Francisco 
schools and the extremely capable attorneys and investigators who have 
assisted us have helped accelerate discussion about how to increase 
scrutiny of E-Rate applications and otherwise reduce the possibility of 
waste, fraud, and abuse in this important program.
    At this point I would like to introduce San Francisco's former City 
Attorney and our school district's former General Counsel Louise Renne.

    Mr. Walden. Thank you for your testimony.
    The committee now would like to hear from Ms. Renne. Thank 
you for being here. We appreciate your work and your comments.

                  TESTIMONY OF LOUISE H. RENNE

    Ms. Renne. Thank you. Good morning, Mr. Chairman and 
members.
    As Dr. Ackerman has indicated, the nationwide scheme to 
defraud the E-Rate program came to our attention shortly after 
she became the superintendent of San Francisco schools and at 
the time I was the City Attorney. I still very well remember 
the day when I got a phone call from Dr. Ackerman saying I 
think we have some funny business going on over here, and at 
her request an investigation was started.
    A group of attorneys was assembled, including an 
investigator, George Cothran, and as our investigation 
progressed, the national scope of the E-Rate problem soon 
became quite clear.
    During the process we called in the FBI and our local 
United States Attorney, Kevin Ryan, as well, and as City 
Attorney, Dennis Herrera, will describe in more detail, too, we 
during the course of the investigation prepared a whistleblower 
lawsuit which was unprecedented for a school district, was 
filed in Federal court by my successor, Dennis Herrera, and 
that suit resulted in the guilty plea that has already been 
described.
    During the course of the process, we learned that the 
matter, not just in San Francisco, but that there was the same 
or similar fraud going on across the country, and that it was 
part of a well orchestrated effort, it would seem.
    In San Francisco, investigator George Cothran will describe 
in quite a bit of detail how this process started with the 
filing basically of a bogus application, how Inter-Tel 
Technology started the ball rolling, if you will, by 
approaching some of our district people, and then involved, as 
you have already indicated as well, Judy Green, George 
Marchelos in the process.
    The proposal, the E-Rate proposal, was drafted in such a 
way that it would be prejudiced toward goods and services sold 
by VNCI, which was associated with Judy Green and group. They 
bundled VNCI equipment inside a bid. The bids were not 
advertised, as required by law.
    So again, as will be described in far more detail by Mr. 
Cothran, the companies ensured, as a result of the whole bid 
rigging process and their conspiracy, that they would be the 
primary recipients of the E-Rate funding.
    So what has happened is, in short, the companies involved 
really soaked the whole E-Rate process, in San Francisco's 
case, of approximately $50 million, who knows how much more in 
other jurisdictions.
    We think, and we know, that for the first time San 
Francisco's lawsuit was the first time, to our knowledge, that 
a school district has ever file a whistleblower claim, and it 
is our hope that, as the results of the investigation are 
detailed for this committee by Dennis Herrera and George 
Cothran, that these actions and some of the corresponding 
enforcement actions which are undoubtedly going on around the 
country will put government agencies and businesses alike on 
their guard against the kinds of practices that will be 
described this morning, and will help root out the problems 
that beset the E-Rate program.
    We think at the district that the goals of the program are 
important for the future. Our children cannot compete in the 
modern world without knowledge of computers and technology and, 
surely for those companies that have put this program at risk, 
we hope that the committee hearings will get to the bottom and 
root out this fraud.
    My successor in office is my good friend, Dennis Herrera.
    [The prepared testimony of Louise H. Renne follows:]
 Prepared Statement of Louise H. Renne, Special Counsel, San Francisco 
                        Unified School District
    Mr. Chairman and Members: The nationwide scheme to defraud the E-
Rate program came to our attention in San Francisco soon after Arlene 
Ackerman, the former chief of the Washington, D.C. schools, took over 
as superintendent of the San Francisco Unified School District.
    At the time I was the San Francisco City Attorney.
    Ms. Ackerman had grown suspicious of a number of situations at the 
school district. I still remember very well the day when she called me 
and said, ``I think there's some funny business going on over here.''
    I ordered an investigation, assembling a team of attorneys and 
investigators, including George Cothran, who will also testify today. 
As our investigation progressed, the national scope of the E-Rate 
problem soon became clear. In the process, we alerted the FBI and U.S. 
Attorney Kevin Ryan.
    In addition, we prepared a whistleblower lawsuit, unprecedented for 
a school district, which was filed in federal court by my successor in 
office, Dennis Herrera.
    That suit resulted in a guilty plea last May by one of the 
companies that perpetrated the San Francisco fraud, NEC Business 
Network Solutions.
    But the matter does not end there. We learned that some of the San 
Francisco co-conspirators were likely committing the same or similar 
fraud across the country.
    The misappropriation of E-Rate money from disadvantaged schools and 
the children they serve was a well orchestrated effort by several 
corporate players working in concert with one another.
    In San Francisco, the school district's initial contact with the 
corporate con game came when a representative of Inter-Tel Technologies 
approached the district with a proposal for the purchase of 
telecommunications equipment.
    The Inter-Tel representative introduced district officials to Judy 
Green and George Marchellos, employees of Video Network Communications 
Inc., or VNCI, both experts in the E-Rate program. As our chief E-Rate 
investigator, George Cothran, will testify in detail, Ms. Green and Mr. 
Marchellos infiltrated the district's competitive bidding process to 
win inflated E-Rate funding for district projects directly benefiting 
VNCI, Inter-Tel, and NEC.
    Specifically, they wrote the district's request for proposals so 
that it would be prejudiced toward goods and services sold by VNCI. 
Then they bundled VNCI equipment inside a bid submitted by Inter-Tel. 
As part of the conspiracy, the RFP was not advertised as required by 
law.
    The investigation suggested that the three companies used the same 
or similar schemes elsewhere, with VNCI typically managing the bidding 
process and hiding its equipment inside bids submitted either by Inter-
Tel, as in San Francisco, or by NEC.
    As a result of their conspiracy, these companies ensured that they 
would be the primary recipients of E-Rate funding provided to the San 
Francisco Unified School District.
    But their fraud didn't stop with a phony bidding process. They also 
submitted a falsified application for E-Rate funding on behalf of the 
district that inflated their bid prices by more than $60 million, well 
above the artificially high rates already enabled by the rigged bids.
    In short, they thoroughly soaked the E-Rate process for millions of 
dollars with lies, overcharges, and fraud.
    San Francisco's lawsuit marks the first time to our knowledge that 
a school district has filed a whistleblower claim. It is my hope that 
our unprecedented action, along with other enforcement efforts around 
the country, will put government agencies and businesses alike on their 
guard against these practices, and will help to root out the problems 
that have beset the E-Rate program. The goals of the program are 
important for the future. Our children cannot compete in the modern 
world without knowledge of computers and technology, which is why a 
well-run program is so necessary.
    Thank you.

    Mr. Walden. Thank you for your testimony. We appreciate it.
    Mr. Herrera, thank you for being here. Thank you for your 
work. We look forward to your testimony.

                   TESTIMONY OF DENNIS HERRERA

    Mr. Herrera. Chairman Walden, distinguished members of the 
subcommittee, I thank you for the opportunity to appear before 
you today to discuss San Francisco's experience with efforts to 
defraud the Federal E-Rate program. I am also honored to join 
San Francisco Unified School District General Counsel, Louise 
Renne, in testifying today.
    As my immediate predecessor as City Attorney, Louise first 
ordered the investigation that was so capably undertaken and 
thoroughly investigated by George Cothran of my office, with 
whom I am also honored to appear today.
    When I took office in January 2002, our office's 
investigation into the E-Rate fraud had been underway for more 
than a 8 months. As much or more than any of the cases I 
inherited or have undertaken since, the E-Rate case represented 
exactly the kind of public policy priority that I had talked 
about extensively during the course of my campaign for City 
Attorney.
    In establishing a permanent public integrity unit in my 
office, I sought to take as aggressive a stand as possible 
against those who would seek to defraud our city; because, as I 
am sure this subcommittee is well aware, the harm government 
suffers when it is defrauded cannot be quantified in mere 
dollar amounts.
    Schemes such as these aren't just greedy. They are a 
corrosive influence on the integrity of our public 
institutions. They are an insult to our citizens' faith in 
their government to do the right thing, and they are an insult 
to the honest businesses and contractors who play by the rules 
and yet lose government contracts to competitors who cheat.
    The E-Rate scheme we unmasked in San Francisco represented 
all of that, plus one aggravating circumstance for which it 
deserves an especially prominent place in the ripoff hall of 
shame. It targeted funds intended to benefit the poorest, most 
vulnerable school children of America.
    For disadvantaged kids in San Francisco, growing up in 
Silicon Valley's backyard, in a city that is itself a high tech 
capital, the abuse of a program to help them bridge the digital 
divide represents an all too real theft of future job 
opportunities and economic advancement.
    Indeed, had San Francisco not blown the whistle on the 
fraud we uncovered, vendors associated in the scheme in our 
school system stood to receive a total of nearly $55 million, 
and for all that money, according to their funding 
applications, San Francisco schools would have been left with 
an incomplete computer network that was, by itself, inoperable.
    Schools throughout our school district would have been 
saddled with millions of dollars in equipment that was 
functionally equivalent to paperweights, routers, cabling and 
switches with no servers, a phone system with no phones, a 
computer system with no work stations, videoconferencing 
equipment that wasn't even eligible for E-Rate funding.
    When our investigation was completed, the details of which 
Mr. Cothran, more than I, is best equipped to discuss, the 
evidence confirmed that E-Rate applications for San Francisco 
schools had been fraudulently conceived and executed in almost 
every respect. Moreover, the investigation demonstrated that 
these practices were not confined to San Francisco.
    We discovered fraudulent applications in several other 
school districts, frequently involving the same co-
conspirators. On May 16, 2002, I filed a false claim action 
under seal on behalf of our school district and the people of 
the State of California. In filing the case as what we call a 
Qui Tam action, the San Francisco Unified School District 
became the whistleblower on a nationwide scam, and we turned 
the results of our investigation over to the U.S. Department of 
Justice with whom we have continued to work.
    Under terms of a partial settlement announced in our case 
several weeks ago, NEC Business Network Solutions paid a total 
of nearly $16 million in cash and services to the Federal 
Government to settle the lawsuit's civil claims. As a Qui Tam 
whistleblower in the case, the San Francisco Unified School 
District will receive nearly $3.4 million.
    NEC BNS also pled guilty to felony counts of wire fraud and 
conspiring to violate Federal anti-trust laws and paid a 
criminal fine to the feds of $4.6 million.
    Clearly, the settlement represents an excellent outcome for 
the San Francisco public schools, but it also is an important 
vindication for a brave and controversial decision by our 
school superintendent, Arlene Ackerman, to refuse suspect 
funding from the E-Rate program in the first place. Moreover, 
it is testimony to the outstanding work of U.S. Attorney Kevin 
Ryan of San Francisco, my predecessor, SFUSD General Counsel 
Louise Renne, and to the investigators and attorneys in my 
office, particularly George Cothran whose many months of 
living, breathing and sleeping the details of this highly 
complex case paid off so impressively.
    We are, of course, delighted and proud to see justice done 
in a manner that realizes such significant benefits for San 
Francisco's school children. We are no less proud to be here 
today to offer our assistance to this subcommittee and to this 
Congress to assure that no other school district in this 
country, not one more school kid in America, suffers for the 
waste, fraud and abuse of the E-Rate program.
    Mr. Chairman and distinguished members of the subcommittee, 
in concluding my formal statement I thank you for the 
opportunity to appear before you today, and while I am glad to 
answer any questions you may have, I will confess that I would 
likely defer to our own investigator, the expert on this 
matter, George Cothran, from whom you will hear next.
    [The prepared testimony of Dennis Herrera follows:]
  Prepared Statement of Dennis Herrera, City Attorney of San Francisco
    Chairman Greenwood, distinguished Members of the Subcommittee: I 
thank you for the opportunity to appear before you today to discuss San 
Francisco's experience with efforts to defraud the federal E-Rate 
Program.
    I'm also honored to join San Francisco Unified School District 
General Counsel Louise Renne in testifying today. As my immediate 
predecessor as San Francisco City Attorney, Louise first ordered the 
investigation that was so capably undertaken and thoroughly 
investigated by George Cothran of my office, with whom I'm also honored 
to appear today.
    When I took office in January 2002, our office's investigation into 
E-Rate fraud had been underway for more than eight months. As much or 
more than any of the cases I inherited or have undertaken since, the E-
Rate case represented exactly the kind of public policy priority I had 
talked about extensively in my campaign for City Attorney.
    In establishing a permanent Public Integrity Unit in my office, I 
sought to take as aggressive a stand as possible against those who 
would seek to defraud our City. Because as I'm sure this subcommittee 
is well aware, the harm government suffers when it is defrauded cannot 
be quantified in mere dollar amounts.
    Schemes such as these aren't just greedy.
     They're a corrosive influence on the integrity of our public 
institutions.
     They're an assault on our citizens' faith in their government to 
do the right thing.
     And they're an insult to the honest businesses and contractors 
who play by the rules--and yet LOSE government contracts to competitors 
who cheat.
    The E-Rate scheme we unmasked in San Francisco represented all of 
that--plus one aggravating circumstance for which it deserves an 
especially prominent place in the Government Rip-off Hall of Shame: it 
targeted funds intended to benefit the poorest, most vulnerable 
schoolchildren in America.
    For disadvantaged kids in San Francisco--growing up in Silicon 
Valley's backyard, in a city that is ITSELF a high-tech capital--the 
abuse of a program to help them bridge the ``Digital Divide'' 
represents an all too real theft of future job opportunities and 
economic advancement.
    Indeed, had San Francisco NOT blown the whistle on the fraud we 
uncovered, vendors associated in the scheme in our school system stood 
to receive a total of nearly $60 million. And for all that money, 
according to their funding applications, San Francisco schools would 
have been left with an incomplete computer network that was, by itself, 
inoperable.
    Schools throughout our school district would have been saddled with 
millions of dollars in equipment that was functionally equivalent to 
paperweights.
     Routers, cabling and switches with no servers
     A phone system with no phones
     A computer system with no workstations
     Video-conferencing equipment that wasn't even eligible for E-Rate 
funding
    When our investigation was completed--the details of which Mr. 
Cothran more than I is best equipped to discuss--the evidence confirmed 
that E-Rate applications for San Francisco schools had been 
fraudulently conceived and executed in almost every respect. Moreover, 
the investigation demonstrated that these practices were not confined 
to San Francisco. We discovered fraudulent applications in several 
other school districts, frequently involving the same co-conspirators.
    On May 16, 2002, I filed a false claims action under seal on behalf 
of our School District and the People of the State of California. In 
filing the case as what we lawyers call a ``Qui Tam'' action, the San 
Francisco Unified School District became the whistleblower on a 
nationwide scam. And we turned the results of our investigation over to 
the U.S. Department of Justice, with whom we've continued to work.
    Under terms of a partial settlement announced in our own case 
several weeks ago, NEC Business Network Solutions, a subsidiary of NEC 
Corporation, paid a total of nearly $16 million in cash and services to 
the federal government to settle the lawsuit's civil claims. As the 
``qui tam'' whistleblower in the case, the San Francisco School 
District will receive 21 percent--or nearly $3.4 million. NEC/BNS also 
pled guilty to felony counts of wire fraud and conspiring to violate 
federal antitrust laws, and paid a criminal fine to the feds of $4.6 
million.
    Clearly, the settlement represents an excellent outcome for San 
Francisco public schools. But it was also an important vindication for 
a brave and controversial decision by our School Superintendent, Arlene 
Ackerman, to refuse suspect funding from the E-Rate program in the 
first place.
    Moreover, it is testimony to the outstanding work of U.S. Attorney 
Kevin Ryan of San Francisco, SFUSD General Counsel Louise Renne and to 
the investigators and attorneys of my office--particularly George 
Cothran, whose many months of living, breathing and sleeping the 
details of this highly complex case paid off so impressively.
    We are, of course, delighted and proud to see justice done in a 
manner that realizes such significant benefits for San Francisco's 
schoolchildren. But we are no less proud to be here today to offer our 
assistance to this subcommittee and to this Congress to assure that no 
other school district in this country--not one more school kid in 
America--suffers for the waste, fraud and abuse of the E-Rate program.
    Mr. Chairman and distinguished Members of the Subcommittee, in 
concluding my formal statement I would like to thank you again for the 
opportunity to appear before you today.
    While I'm glad to answer any questions you may have at this time, I 
will confess that I would likely defer to my OWN investigator on the 
subject, George Cothran, from whom you'll hear next.

    Mr. Walden. Thank you. Thank you for your testimony, and we 
appreciate the work of your office.
    Mr. Cothran, thank you for being here today. We look 
forward to your testimony. Please begin.

                 TESTIMONY OF GEORGE M. COTHRAN

    Mr. Cothran. Thank you, Chairman. One of the major findings 
of the City Attorney investigation into the attempted E-Rate 
fraud in San Francisco in 1999 and 2000 was that every action 
taken by defendants in our Qui Tam lawsuit was geared toward 
one narrow goal, to put money in their pockets. We found no 
evidence that defendants once considered the needs of the 
school district or its student bodies as they went about 
corrupting a government bid process and submitting fraudulently 
inflated E-Rate funding applications in January of 2000, 
seeking to defraud the E-Rate program of approximately $53 
million.
    Thank you for the opportunity to allow me to walk you 
through conclusions the city attorney's office reached based on 
the evidence that was available to us.
    The fraud scheme had its roots in the district declining to 
do business with one of our defendants, Inter-Tel Technologies. 
In 1999 an Inter-Tel representative was rebuffed by the school 
district as he tried to make a sale of his employer's products.
    Instead of taking this refusal as the thoughtful and 
perhaps correct decision by a government agency, the Inter-Tel 
representative sought business through the back door. The sales 
representative contacted Desmond McQuoid, a friend he knew from 
having lived in the same town as McQuoid some years earlier, 
though McQuoid had no authority to purchase said equipment. He 
was merely a custodial supervisor.
    To flesh out his product pitch, the Inter-Tel 
representative then involved two employees from Video Networks 
Communications, Incorporated, a small New Hampshire firm that 
manufactured videoconferencing equipment. From this point on, 
the Inter-Tel proposal included VNCI videoconferencing 
equipment.
    At the time, Inter-Tel had an agreement with VNCI that 
called for the company to bundle VNCI equipment into its E-Rate 
bids and to pay VNCI a so-called marketing fee for identifying 
E-Rate opportunities, all despite the fact that VNCI's 
equipment was not eligible for E-Rate funding at the time.
    Once VNCI was involved, this fraud scheme began, and it 
only grew larger and more ambitious as time passed. VNCI 
employees, Judy Green and George Marchelos, hijacked the San 
Francisco procurement process, taking over all of the roles, 
responsibilities and obligations of the school district.
    At the same time, Green and Marchelos invited another VNCI 
E-Rate bidding partner, NEC Business Network Solutions, into 
the process. VNCI had the same agreement with NEC that it had 
with Inter-Tel, and as Inter-Tel was bundling VNCI equipment in 
San Francisco, NEC was bundling VNCI equipment into E-Rate bids 
in several school districts' E-Rate proposals nationwide.
    Once Green and Marchelos had control of the San Francisco 
bid process, they were in a position to make decisions properly 
left to the district in order to benefit themselves, their 
employer, their employer's business partners, and other co-
conspirators as it pleased them.
    VNCI, through Green and Marchelos, provided a request for 
proposal to McQuoid which called for phone switch bidders to 
include videoconferencing equipment in their responses. Green 
and Marchelos assumed a degree of control over who participated 
in the bid, inviting VNCI partners and associates from past E-
Rate bids. At the same time, McQuoid declined to advertise the 
bid publicly, as called for in California law.
    Marchelos ran the January 3, 2000, pre-bid meeting, 
according to witnesses, where he distributed the VNCI RFP. 
According to witnesses, he told meeting participants he was 
acting as a consultant to the school district, which was not 
true. He did not identify his affiliation with VNCI, even 
though many of his co-conspirators in the room most likely knew 
where his interests lay.
    Green and Marchelos ran a January 14, 2000, bid opening 
meeting where they selected winners and declared noncompliant 
the one bid that stood in the way of VNCI business partner, 
NEC, and Sprig Electric, a Green invitee into the San Francisco 
bid she and VNCI had done business with in past E-Rate bid 
situations.
    The losing firm, Pacific Bell Network Integration, had been 
invited to bid by McQuoid as a precautionary measure. Pacific 
Bell was conducting extensive work under contract with the 
district at various locations, including many affected by the 
VNCI RFP.
    PBNI won McQuoid's agreement to bid off specification from 
the VNCI RFP, because Pac Bell believed the RFP was far too 
expensive and needlessly complex. Pac Bell offered modest, 
affordable bids on data and cabling. The Pac Bell proposal was 
many millions of dollars less than the competing bid on data by 
NEC and the competing Sprig Electric cabling bid.
    Regardless, Green and Marchelos ruled the Pac Bell bid 
noncompliant with the VNCI RFP, paving the way for NEC and 
Sprig Electric to receive E-Rate monies. In the process, they 
dramatically increased the cost to the E-Rate program of the 
project. At the same meeting Inter-Tel's bid was approved by 
Green and Marchelos.
    The City Attorney investigation included NEC, which was 
concurrently bidding PBX proposals nationwide, and any of 
VNCI's ineligible equipment did not make the PBX bid in San 
Francisco. We suspect this was by arrangement between the two 
firms, Inter-Tell and NEC, and VNCI, and we are confident our 
ongoing litigation and investigation will confirm the 
suspicion.
    Consequently, Inter-Tel was the only PBX bidder in San 
Francisco. In approving Inter-Tel's $20.6 million bid, Green 
and Marchelos were awarding a contract on a bid that included 
more than $15 million of VNCI equipment and which would 
presumably result in sales commissions to the two VNCI 
employees.
    Nearly all parties in the January 14, 2000, meeting had 
knowledge of VNCI's conflict of interest or they had ample 
reason to suspect that Green and Marchelos were improperly 
ruling on bids.
    Immediately following the bid opening meeting, Green and 
Marchelos began engineering a process by which NEC assumed 
control over two aspects of the project where the company had 
apparently lost the bid. The two VNCI employees, with McQuoid's 
help, relegated Sprig Electric, which had won the cabling bid, 
and U.S. Machinery, a local area firm that had won the server 
bid, to subcontractor status and replaced them on the E-Rate 
funding application or Form 471 with NEC.
    The City Attorney's office suspects VNCI performed this act 
in order to ensure that E-Rate monies flowed to a firm that was 
bound by agreement to pay a VNCI marketing fee based on its E-
Rate income.
    At this point Green and Marchelos, NEC and Inter-Tel, 
without including McQuoid in this instance, engaged in their 
most ambitious attempt at fraud. The parties took the already 
inflated rigged bid prices and increased them by more than $50 
million when filling out two false and fraudulent Form 471 
application forms.
    The Sprig Electric bid on cabling went from $13.6 million 
to $39.7 million, once in the hands of NEC. The U.S. Machinery 
bid on servers went from $9.2 million to $32.9 million, once it 
was in the hands of NEC.
    The NEC bid on switchers and routers went from $19.7 
million to $32.9 million, and the Inter-Tel bid on the PBX, 
which included the ineligible VNCI equipment, went from $20.6 
million to $29.4 million.
    After factoring in E-Rate discount rates, the two 
applications for funding requested a little over $100 million. 
The results of the rigged bid totaled about $52 million. 
Consequently, the two Form 471s contained a fraud attempt of at 
least $53 million.
    Moreover, one of the two applications would have included 
18 schools not involved in the rigged bid process. This 
application, as far as we could tell, was not premised on any 
bid process whatsoever, and the dollar figures included on it 
were most likely picked out of thin air.
    Once McQuoid learned of the two inflated applications, he 
had a decision to make: Call off the deal and blow the whistle 
or go along for the ride. He chose the latter, and in the 
process won NEC BNS's agreement to use some of the excess E-
Rate award to purchase computer work stations that were not 
eligible for E-Rate funds.
    After the two fraudulent applications were submitted and E-
Rate administrators at the Universal Service Administrative 
Company began their review, Green, Marchelos, McQuoid and 
representatives of NEC conspired to submit false and forged 
documentation to the E-Rate program to conceal their wrongdoing 
and to facilitate the award of funds they were not properly 
due. Let me just give you the highlights.
    An altered copy of the RFP was provided to USAC omitting 
references to the videoconferencing equipment. Names were 
forged on a list of attendees at the pre-bid meeting on January 
3 in order to conceal the rigged nature of the process.
    A document bearing NEC's logo purporting to show the size 
of seven sample schools in the school district justifying 
cabling costs was exaggerated in size by nearly 50 acres and 
more than 70 rooms and, most damaging, a counterfeit copy of 
the San Francisco Unified School District budget was submitted 
with a fraudulent line item purporting to show that the 
district had more than $40 million in E-Rate matching funds, 
when in reality the district had no such funds available.
    In closing, I would like to point out that this last 
misrepresentation made to the E-Rate program was perhaps the 
most egregious. In responding to written questions, a USAC 
employee informed the City Attorney's office that, had the E-
Rate program Administrator known the school district had no 
available matching funds, USAC would have denied the entire 
funding request.
    Thank you for the opportunity to testify today, and I look 
forward to any questions you might have.
    [The prepared testimony of George M. Cothran follows:]
Prepared Statement of George M. Cothran, Investigator, City Attorney's 
                Office, City and County of San Francisco
    Beginning in the fall of 1999 and extending into fall of 2000, San 
Francisco Unified School District (SFUSD) served as the staging ground 
for an attempted defrauding of the E-Rate program. The fraud scheme was 
expansive in its ambition.
    Involved parties included 1) Desmond McQuoid, a SFUSD custodial 
supervisor; 2) NEC Business Network Solutions (NEC BNS), a United 
States affiliate of the multi-national corporation, NEC Corp. of Tokyo, 
Japan; 3) Inter-Tel Technologies, Inc., a publicly-traded 
telecommunications firm; 4) Video Network Communications, Inc. (VNCI), 
a publicly traded manufacturer of video-conferencing equipment; 5) US 
Machinery, a San Francisco Bay Area computer re-seller; and 6) Sprig 
Electric, a San Francisco Bay Area electrical contractor.
    City Attorney Dennis J. Herrera on behalf of the People of 
California, and the San Francisco Unified School District, as 
whistleblower under the provisions of the False Claims Act, sued the 
above parties on May 16, 2002 for their misdeeds in San Francisco and 
elsewhere in the United States where our investigation uncovered 
evidence of their likely involvement in similar wrongdoing.
    In San Francisco, the parties had varying degrees of culpability. 
The main wrongdoers were McQuoid, NEC BNS, VNCI, and Inter-Tel 
Technologies.
    VNCI was the ringleader.
    Through two grossly inflated and fraudulent SFUSD E-Rate funding 
applications, NEC BNS, Inter-Tel, and VNCI sought to defraud the E-Rate 
program out of $60,387,081.56.
    To accomplish this defendants

 hijacked and rigged a government procurement and competitive bid 
        process, suppressing competition and making the resulting E-
        Rate proposal vastly more expensive;
 concealed the presence of equipment ineligible for E-Rate funding in 
        the bids and the funding applications;
 filed fraudulent and inflated funding applications to the E-Rate 
        program;
 conspired to use the fraudulently obtained E-Rate funds for 
        ineligible and improper purposes including the payment of a so-
        called marketing fee to VNCI which the City Attorney's Office 
        contends is little more than a kickback; and
 submitted false and fraudulent documentation to the E-Rate program in 
        order to conceal their wrongdoing and facilitate the award of 
        E-Rate monies not properly due to them.
                            the rigged bid:
    Though VNCI had a financial interest in the outcome of the bid, two 
VNCI employees, Judy Green and George Marchelos, controlled nearly 
every aspect of the San Francisco bid process, from provision of design 
specifications to the selection of winning bidders and the 
disqualification of a firm not involved in the conspiracy.
    a) VNCI, through Green and Marchelos, authored and provided a 
Request for Proposal (RFP), the equipment specifications mandating the 
type and amount of equipment bidding firms were required to include in 
their responses--a job that should have been left to SFUSD.
    The VNCI RFP required firms bidding on the Private Branch Exchange 
(PBX), or phone switch, to include a video-conferencing solution, thus 
tailoring the project, and the bid responses, in the direction of 
equipment VNCI manufactured.
    The VNCI RFP required a video-conferencing solution even though 
VNCI and its co-conspirators knew or should have known that video-
conferencing equipment was not eligible for E-Rate funding at the time.
    Inter-Tel, which had an agreement with VNCI whereby it provided 
VNCI equipment as part of its E-Rate bids, introduced Marchelos and 
Green to McQuoid and the SFUSD E-Rate opportunity during the fall of 
1999.
    From the onset, Inter-Tel included ineligible VNCI equipment as 
part of the company's proposal.
    And as VNCI, through Marchelos and Green, increasingly took control 
of the bid process, Inter-Tel representatives did nothing to interrupt 
that control even though they were aware of VNCI's conflict of interest 
and stood to profit financially from it.
    By the time of the San Francisco bid, Inter-Tel's relationship with 
VNCI was entering its second year. Evidence suggests Inter-Tel had made 
E-Rate bids including VNCI equipment in other school districts the year 
prior to the San Francisco bid.
    By late 1999 and early 2000, when the San Francisco bid was 
corrupted, VNCI had business agreements with both Inter-Tel and NEC BNS 
whereby the two firms included VNCI video-conferencing equipment in 
their E-Rate bids.
    In the case of the San Francisco E-Rate bid, VNCI was planning on 
selling its equipment to Inter-Tel in order for Inter-Tel to comply 
with the PBX specifications of the VNCI RFP.
    But at the same time, VNCI was bundling its ineligible equipment in 
NEC BNS's E-Rate bids in approximately 10 school districts across the 
United States.
    Evidence demonstrates that when Inter-Tel submitted its San 
Francisco E-Rate bid on January 14, 2000, nearly three-quarters of the 
equipment was manufactured by VNCI.
    Consequently, when VNCI representatives Green and Marchelos 
manipulated the bid process in favor of the NEC BNS and Inter-Tel bids, 
they were doing so, for the most part, to benefit their employer, VNCI.
    On January 3, 2000, Marchelos ran a pre-bid meeting where he 
distributed and explained the VNCI RFP.
    Marchelos introduced himself to the participants of the meeting as 
a consultant to the school district, though this was not true. 
Moreover, witnesses said, he did not reveal that he was employed by 
VNCI.
    Regardless, evidence suggests that employees or representatives of 
Inter-Tel, NEC BNS, and Sprig Electric present at the January 3, 2000 
meeting most likely knew some or all of the following facts: 
Marchelos's VNCI affiliation, VNCI's role as author of the RFP, the 
RFP's requirement for a video-conferencing solution, the ineligibility 
of video-conferencing equipment for E-Rate funding, and VNCI's role as 
certain or most likely supplier of the video-conferencing equipment to 
the winning PBX bidder.
    All three firms were at the time or had been in the recent past 
involved in E-Rate bid opportunities elsewhere where Marchelos and 
Green represented VNCI's interests, sometimes influencing school 
district decisions at the same time as they were doing in San 
Francisco.
    b) VNCI, through Marchelos and Green, and McQuoid took steps to 
control who responded to the San Francisco E-Rate bid opportunity. 
Green and Marchelos invited bidders they had past or current business 
arrangements with--NEC and Sprig Electric (Inter-Tel did not need to be 
invited as they alerted VNCI to the opportunity in San Francisco).
    Desmond McQuoid failed to advertise the existence of the bid in a 
local newspaper, as required by California law. At the same time he 
invited US Machinery with whom he was engaged in a separate criminal 
fraud conspiracy that would eventually net him a federal prison 
sentence.
    The City Attorney's Office suspects that McQuoid did so at the 
suggestion or direction of Green and Marchelos and is confident that 
this suspicion will be confirmed as true through the course of our 
ongoing litigation and investigation.
    c) The bidders, for the most part, did not compete against each 
other. Sprig Electric bid on cabling, and no other aspect of the RFP. 
US Machinery bid on servers, and no other aspect of the RFP. NEC bid on 
servers and switches and routers, and no other aspect of the RFP. And 
Inter-Tel bid on the private branch exchange (PBX), and no other aspect 
of the RFP.
    The City Attorney's Office suspects that this failure to compete 
was by agreement between the parties and is confident it will be shown 
to have been so arranged during the course of litigation and further 
investigation.
    One firm, Pacific Bell Network Integration (PBNI), was invited by 
McQuoid at the last minute, the day the RFP was distributed to bidders. 
The City Attorney's Office investigation concluded that PBNI was 
invited only because McQuoid had been warned by other school district 
employees that the work prefigured in the VNCI RFP conflicted with 
contracts PBNI had with SFUSD. The City Attorney's Office concluded 
that PBNI was not part of the E-Rate fraud conspiracy in San Francisco.
    d) VNCI, through Green and Marchelos, ran the meeting where bids 
were received and ruled on. Green and Marchelos awarded contracts to 
firms with whom VNCI had ongoing business relationships and 
disqualified PBNI, which was in competition with VNCI business partner 
NEC BNS and Sprig Electric, a Green invitee into the process.
    On January 14, 2000, at approximately 3 p.m. in the afternoon, 
bidders convened in McQuoid's office at 834 Toland St., San Francisco, 
Calif., the headquarters of the buildings and grounds division of 
SFUSD.
    Bids were turned in and Marchelos and Green ruled on and announced 
the winners, according to individuals present at the meeting.
    The City Attorney investigation concluded that most of the 
participants in the meeting, with the exception of U.S. Machinery and 
PBNI, knew Green and Marchelos were VNCI employees, that VNCI had a 
conflict of interest and that their decision-making role over the bids 
was improper.
    The Inter-Tel representatives certainly knew VNCI had a conflict of 
interest; nearly three-quarters of the bid they were submitting 
consisted of VNCI equipment.
    NEC BNS representatives knew Green and Marchelos were with VNCI, 
and they knew VNCI had a conflict of interest as it related to their 
bid as well. They had worked with Green and Marchelos to include VNCI 
equipment in approximately 10 NEC BNS E-Rate bids nationwide during the 
same funding cycle prior to involving themselves in the San Francisco 
bid.
    Findings of the City Attorney Office investigation suggests Sprig 
Electric also was aware of the VNCI conflict of interest and the office 
is confident that its ongoing litigation and investigation will 
demonstrate conclusively that Sprig Electric was aware of VNCI's 
conflict of interest and Green and Marchelos' improper control over the 
bid process.
    The City Attorney investigation concluded that Green and Marchelos 
assumed a key role not only in declaring winning bids for their co-
conspirators, but also in declaring PBNI's bid on data (switches and 
routers) and cabling non-compliant with the VNCI RFP and disqualifying 
it.
    PBNI sales representative Jim Pillsbury later informed the City 
Attorney's Office during its investigation that he believed the VNCI 
RFP to be overblown, far too expensive, and much more elaborate than 
what the district needed.
    He felt confident that he knew what the district needed and 
required in terms of information technology because PBNI was already 
under contract with the school district, laying cable at 30 schools and 
providing other telecommunications and information technology services. 
In fact, around the time of the bids, PBNI had been laying cabling in 
many of the schools covered by the VNCI RFP.
    Pillsbury said he had engaged in discussions with McQuoid about 
what kind of technology solutions made the most sense for the district, 
and he felt he had received McQuoid's consent to produce a bid response 
that did not exactly conform to the VNCI RFP, but which, he believed, 
was more reasonable, dramatically less expensive, and would work just 
as well.
    Pillsbury recalls that at the January 3, 2000 meeting where 
Marchelos distributed the VNCI RFP, McQuoid informed the gathering that 
the data communications (switches and routers) solution called for in 
the VNCI RFP--Asynchronous Transfer Mode (ATM)--was not necessarily his 
preferred solution and that he would also entertain other types of data 
solutions.
    Likewise, Pillsbury believed that since PBNI was laying cable at 30 
schools for the district he knew enough about the district's cabling 
needs to depart from the VNCI RFP cabling specifications. Again the 
PBNI proposal for cabling was less expensive and less grandiose than 
that called for in the VNCI RFP.
    The VNCI RFP called for 30 cable lines into each classroom. The 
cable jobs PBNI was working on for the district at the time included 5 
to 7 lines into each classroom. Pillsbury believed this more modest, 
less expensive cabling scheme was what was best for the district, 
especially considering that most of the schools covered by the VNCI RFP 
were elementary schools and less computer intensive.
    Pillsbury instructed his team to prepare a bid that departed from 
the VNCI RFP in these two ways: Instead of the more expensive ATM data 
solution, PBNI proposed a less expensive alternative; PBNI also offered 
a less expensive and more modest cabling scheme.
    But according to meeting participants, both Marchelos and Green 
intervened and declared the PBNI bids on cabling and data, or switches 
and routers, non-complaint, thus paving the way for VNCI business 
partner NEC BNS to win the data bid and Sprig Electric, which had been 
invited into the procurement process by Green, to win the cabling 
portion.
    Marchelos and Green orchestrated this result even though it 
produced a much more costly solution and would have eaten up many 
millions more E-Rate dollars.
    PBNI offered a range of data bids costing between $1.2 million and 
$7.5 million. After Green and Marchelos eliminated PBNI, they awarded 
the work to NEC BNS at a cost of $19.7 million.
    PBNI submitted a $6.7 million cabling bid. After Green and 
Marchelos eliminated the PBNI bid, they awarded the work to Sprig 
Electric for $13.6 million.
    In its guilty plea on May 27, 2004, NEC BNS provided a version of 
events at the bid open meeting that supports City Attorney 
investigative findings regarding Judy Green's and George Marchelos' 
roles in selecting winning bidders.
        the concealment of vnci equipment in the inter-tel bid:
    Despite the ineligibility of its equipment for E-Rate funding, VNCI 
had bundled $15,312,435.60 of its equipment into Inter-Tel's 
$20,633,732.60 bid, according to Inter-Tel documents.
    When the Form 471 application was prepared by VNCI, Inter-Tel and 
NEC BNS representatives, Inter-Tel's funding request was characterized 
as being merely for a PBX, a phone switch, which was eligible for E-
Rate funding. The PBX parts list that accompanied the Form 471 was 
crafted in such a way as to conceal the fact that nearly three quarters 
of the dollar amount of the request was ineligible for E-Rate funding 
in Year 3 of the program (FY 2000-01) 1
---------------------------------------------------------------------------
    \1\ Video-conferencing equipment became eligible for E-Rate funding 
in Year 4 of the program (FY 2001-02).
---------------------------------------------------------------------------
    Based on the findings of its investigation, The City Attorney's 
Office suspects Green and Marchelos and representatives from Inter-Tel 
of conspiring to falsify these PBX parts lists and conceal the true 
nature of the equipment so it could defraud the E-Rate program into 
funding ineligible equipment. The City Attorney's Office is confident 
its ongoing litigation and investigation will confirm this suspicion.
    The City Attorney's Office further believes that VNCI, NEC BNS and 
Inter-Tel similarly falsified PBX parts lists and E-Rate applications 
nationwide in fiscal year 2000-01 to conceal VNCI equipment.
    Evidence further suggests that as part of other school district E-
Rate applications, NEC BNS, Inter-Tel and VNCI provided false and 
misleading answers to the E-Rate program administrators when asked 
specifically about the function of the fraudulently-described VNCI 
equipment.
    When it plead guilty on May 27, 2004, information provided by NEC 
BNS supported City Attorney findings indicating that Inter-Tel and VNCI 
conspired to falsely describe PBX parts to conceal the ineligible VNCI 
equipment in the San Francisco E-Rate application.
          the fraudulent inflation of the sfusd applications:
    As a result of its investigation, the City Attorney's Office 
concluded that the rigged bid process orchestrated by the defendants in 
San Francisco produced costs much higher than would have grown out of a 
legal, competitive bid.
    The rejection of the PBNI bid is one example of how the defendants' 
corrupt process spiked prices.
    Another example lies in the NEC BNS design of the Local Area 
Networks it planned to implement in SFUSD, which called for servers and 
switches in every classroom, a magnitude of equipment deployment that 
was entirely unnecessary and constitutes ``gold plating.'' (As a point 
of interest, this same ``gold plating'' technique of placing servers 
and switches in every classroom was proposed nationwide by NEC BNS in 
fiscal year 2000-01.)
    If the San Francisco bid had been open and competitive, it is 
unlikely a firm would have submitted a bid calling for servers and 
switches in every classroom, and inconceivable that any such bid would 
have been selected in a truly competitive process. The conspirators' 
gold-plated proposal thus greatly inflated the cost of the proposed 
project.
    While the rigged bids were fraudulently inflated, a more dramatic 
financial fraud attempt occurred when NEC, Inter-Tel and VNCI conspired 
to submit two grossly inflated Form 471 applications in January 2000.
    One of these applications for funding was premised on no bid 
process whatsoever.
    These three parties, with the acquiescence and later acceptance of 
McQuoid, took the total of the rigged bid prices--$63,383,768.66--and 
inflated that total project cost to $135,142,258.70 when they submitted 
Form 471 202712 and Form 471 202719 to the Universal Service 
Administrative Company (USAC) in mid-January 2000.
    After factoring in discount rates, Form 471 202719 asked for 
$75,020,586.05 in E-Rate funds and Form 471 202712 asked for 
$37,975,023.45 in E-Rate funds for a total E-Rate funding request of 
$112,995,609.50.
    Had McQuoid, VNCI, Inter-Tel and NEC BNS used the results of the 
rigged bid process they would have requested $52,608,527.94 in E-Rate 
money, itself a fraudulent request in that it grew out of a rigged bid 
process.
    But the second layer of fraud--the inflation of the Form 471s--was 
more ambitious by far. It amounted to $60,387,081.56 ($112,995,609.50--
$52,608,527.94).
    But even $52,608,527.94 would have been dramatically more than what 
was reasonable and ethical.
    In 2000, SFUSD had a wide area network affording nearly every 
classroom and office a phone system, access to the Internet and all the 
other benefits of a modern information technology and 
telecommunications system including computers for students. It could be 
argued that the entire VNCI RFP project was not needed nor wanted by 
SFUSD. The individuals the City Attorney's Office spoke to in the SFUSD 
Information Technology and Telecommunications division--the proper 
avenue for E-Rate applications--certainly voiced this point of view.
    When inflating project costs on the Form 471s, NEC BNS and VNCI 
abandoned the results of the rigged bid process and created a new, even 
less competitive, and even more costly scheme, relegating Sprig 
Electric and US Machinery to subcontractor status and elevating NEC to 
prime contractor over the server and cabling portions of the project, 
areas in which they had lost the bid to Sprig Electric and US 
Machinery.
    The City Attorney's Office believes this was done in order to 
ensure that E-Rate money flowed to firms with which VNCI had formal 
business ties.
    NEC BNS and Inter-Tel had agreements with VNCI whereby NEC BNS and 
Inter-Tel shared with VNCI a percentage of profit from successful E-
Rate deals identified and brought to the attention of NEC and Inter-Tel 
by VNCI. The agreement also called for NEC BNS and Inter-Tel to bundle 
VNCI video-conferencing equipment into its E-Rate bids.
    The more E-Rate money VNCI steered toward NEC BNS and Inter-Tel, 
the more money these firms would presumably pay VNCI under their 
arrangements.
    The City Attorney's Office has long believed this ``marketing fee'' 
paid to VNCI constitutes little more than a kickback. These fees were 
paid to VNCI not only for identifying and bringing E-Rate funding 
opportunities to the attention of NEC BNS and Inter-Tel, but also to 
compensate VNCI for illegal activity, such as rigging bids and 
inflating costs.
    Though Sprig Electric had produced the lowest responsive bid on the 
cabling portion of the RFP, and though US Machinery produced the lowest 
responsive bid on the servers portion of the RFP, McQuoid, NEC BNS and 
VNCI employees Green and Marchelos orchestrated a process by which US 
Machinery and Sprig were replaced by NEC BNS when it came time to fill 
out the Form 471 E-Rate funding application.
    According to the City Attorney investigation, Judy Green informed a 
Sprig Electric consultant at the January 14, 2000 bid opening meeting 
that NEC would most likely be the prime contractor for the cabling 
portion, despite the fact that NEC had issued a more expensive bid on 
that section of the RFP. Later, Marchelos convinced a Sprig Electric 
official to sign a letter agreeing to become a subcontractor to NEC BNS 
for the cabling portion of the project.
    Representatives of US Machinery told the City Attorney's Office 
that Desmond McQuoid called them shortly after the January 14, 2000 bid 
opening meeting and presented them with a choice. Either fill out the 
application for E-Rate funding by the following Monday or Tuesday 
(January 14, 2000 was a Friday) or accept subcontractor status to NEC 
for the server portion of the project. Since US Machinery did not have 
the means nor the expertise to fill out an E-Rate funding application, 
they relented to NEC as prime contractor.
    The City Attorney's Office suspects that McQuoid performed this act 
at the direction of Green, Marchelos, and representatives of NEC BNS 
and is confident this suspicion will be confirmed through the course of 
litigation and further investigation.
    US Machinery did not strike a subcontracting agreement with NEC BNS 
until August 2000. Representatives of US Machinery informed the City 
Attorney's Office during the course of its investigation that the firm 
felt as if NEC BNS was ignoring US Machinery's frequent requests to 
formalize their subcontractor role. They said it took many calls to NEC 
BNS and McQuoid, in addition to hiring a business manager to 
concentrate his efforts on obtaining the agreement, for the effort to 
be realized.
    It is unclear if Sprig Electric ever signed an actual subcontract 
with NEC BNS.
    What is known is that a NEC BNS representative asked a Sprig 
Electric manager to sign a document swearing that Sprig Electric had 
assessed the capacity of the SFUSD electrical system and its ability to 
accommodate the additional information technology equipment the E-Rate 
applications was requesting--even though Sprig had conducted no such 
analysis. When the Sprig manager declined to do so, he said he never 
heard again from NEC BNS on any issue related to the E-Rate project.
    Despite the fact that on January 14, 2000 when the bids were opened 
and VNCI, through Marchelos and Green, picked the winners, including 
Sprig Electric and US Machinery, and despite the fact that US Machinery 
did not strike an agreement to subcontract for NEC until August and 
Sprig may never have signed any such agreement, NEC BNS prepared and 
signed a purchase agreement with SFUSD on January 14, 2000 which 
included portions of the bid won by US Machinery and Sprig Electric.
    A signature purporting to be that of Thomas J. Burger, the then-
president and CEO of NEC BNS, is on the signature line of the purchase 
agreement for NEC BNS. The City Attorney's Office has no way of 
commenting on the authenticity of this signature.
    A signature purporting to be that of Desmond McQuoid is on the 
signature line for SFUSD, even though he had no such authority. This 
signature is a forgery.
    The City Attorney's Office suspects that either Green or Marchelos 
or a NEC BNS representative committed this forgery.
    In pleading guilty to federal criminal charges on May 27, 2004, NEC 
BNS provided information that supports the City Attorney's conclusion 
that Green and Marchelos were the prime movers behind the decision to 
relegate Sprig Electric and US Machinery to subcontractor status in 
order to benefit VNCI business partner NEC BNS.
    Placing NEC BNS into the prime contractor role, and therefore 
placing NEC BNS on the E-Rate funding application as it pertained to 
cabling and servers, meant more E-Rate money would potentially flow to 
NEC BNS and presumably meant more money would flow to VNCI through 
their ``marketing fee'' arrangement with NEC BNS.
    After rigging the bid process and allocating contracts as they saw 
fit, regardless of price or merit, representatives of NEC BNS and 
Inter-Tel, and Green and Marchelos, on behalf of VNCI, placed NEC and 
Inter-Tel's E-Rate identifier number (called a spin number) on two Form 
471 applications (numbers 202712 and 202719) requesting a total of 
$112,995,609.50.
    Form 471 202712 included an additional 18 schools not included in 
the bid process governed by the VNCI RFP. This Form 471 was premised on 
no bid process whatsoever. The prices on this Form 471 were most likely 
plucked out of thin air. Only NEC BNS and Inter-Tel's spin numbers were 
included. This entire application was denied by the Universal Service 
Administrative Company due to the use of an improper discount rate.
    The City Attorney investigation found that McQuoid, Sprig Electric 
and US Machinery were most likely unaware of the fraudulent inflated 
nature of Form 471 202719 or even the existence of Form 471 202712 
until after they were submitted. The evidence supports a conclusion 
that VNCI, through Green and Marchelos, and representatives of NEC BNS 
and Inter-Tel joined together in preparing and submitting these 
fraudulently inflated applications without consulting with or including 
anyone from SFUSD, including three of their bid rigging co-
conspirators.
    When NEC BNS pled guilty to federal criminal charges and settled 
civil claims with the City Attorney's Office and the SFUSD on May 27, 
2004, NEC BNS admitted the following:
          On or about January 15-18, 2000 Consultants One and Two 
        2 and defendants' employees met to prepare the USAC 
        application Form 471 for the SFUSD and other school districts. 
        The Form 471 is a school district's application for E-Rate 
        funding. It is supposed to set out the selected vendors' bid 
        amounts, memorialized in contracts, for the equipment and 
        services called for by the district's Request for Proposal. 
        Consultant One told the defendant's employees the total prices 
        she wanted to submit to USAC on the Form 471s and then directed 
        them to prepare false spreadsheets justifying those prices. 
        With NEC/BNS's assistance Consultant One prepared the SFUSD 
        Form 471 with inflated prices. On or about January 19, 2000, 
        Consultant Two delivered the SFUSD Form 471 to USAC . . . In 
        addition, Consultants One and Two worked with others to falsely 
        describe the actual equipment to be supplied to SFUSD, 
        including VX Company equipment, which is not eligible for 
        funding under the E-Rate program, in order to have E-Rate pay 
        for that equipment.''
---------------------------------------------------------------------------
    \2\ In the NEC BNS guilty plea, Consultant One and Consultant Two 
are identified as sales representatives working for a ``company that 
manufactured and installed video-teleconferencing switches,'' also 
described in the plea document as ``VX Company.'' In its plea, NEC BNS 
acknowledged entering into an agreement with this VX Company ``under 
which (NEC BNS) agreed to pay VX Company a fee for all business 
opportunities VX Company brought to the (NEC BNS).''
---------------------------------------------------------------------------
    During the course of its investigation, the City Attorney's Office 
discovered that the business relationship between VNCI and Inter-Tel 
and VNCI and NEC BNS reached across the United States.
    The City Attorney investigation found that at the same time VNCI 
and its co-conspirators were rigging the San Francisco bid, concealing 
VNCI equipment in and inflating the San Francisco applications, VNCI 
and its employees, including Green and Marchelos, were most likely 
conspiring with NEC BNS and others to rig bids, conceal equipment, and 
inflate applications in several other school districts, a suspicion 
supported by NEC BNS when it entered a guilty plea in federal court on 
May 27, 2004 to anti-trust violations in other states.
    In the course of its investigation, the City Attorney's Office had 
an opportunity to speak to Dorothy Travis Johnson, the principal and 
chief executive officer of the Ceria M. Travis Academy in Milwaukee, 
Wisconsin.
    She described her experience in dealing with Green and Marchelos 
and NEC BNS as, ``This is a little nightmare to me.''
    In the course of interviews conducted in the Spring of 2002, 
Johnson told the City Attorney's Office that in fiscal years 2000-01 
and 2001-02, VNCI, through Green and Marchelos, selected winning 
bidders and filled out and submitted Form 471s that included NEC BNS 
and VNCI equipment.
    In fiscal year 2000-01, the Marchelos and Green application netted 
$1.2 million for NEC BNS and VNCI.
    Johnson said Marchelos took bids submitted to her by local 
companies back to California and she never saw them again. ``George has 
vendors pre-selected,'' she said, referring to Marchelos. ``Local 
people gave me bids. George took that but I know he's going to give it 
to his vendors.''
    Referring to both Marchelos and Green, Johnson said, ``They walked 
us through this. They did all the numbers. George did the whole 
application for me.''
    She said the NEC BNS was one of the main vendors in the fiscal year 
2000-01 and fiscal year 2001-02. She told the City Attorney's Office 
she believed her name was forged on several documents including a 
purchase agreement with a company providing servers.
    The purchase agreement, she said, called for 12 servers to be 
deployed at her school. Johnson said she showed the purchase agreement 
to a friend who was knowledgeable about information technology and he 
informed her that she needed only one server for a school her size.
    During the course of its investigation, the City Attorney's Office 
came to suspect that VNCI was conspiring with Inter-Tel and other firms 
to rig bids, conceal VNCI equipment, and inflate applications in 
California (West Fresno School District, Fresno) and Michigan (Highland 
Park School District, Highland Park) during the same general time 
period as the other school district frauds.
    In August 2003, Duane Maynard, the former chief estimator for the 
Fresno-based Howe Electric, pled guilty to federal criminal bid rigging 
charges and in the process pointed toward the involvement of co-
conspirators.
    Maynard stated in his plea:
          On or about February 19, 1999 the defendant, on behalf of his 
        employer, attended a pre-bid meeting at the West Fresno 
        Elementary School District (WFESD), in the Eastern District of 
        California. The pre-bid meeting related to a project to 
        provide, among other things, equipment and services related to 
        telecommunications, Internet access, and internal connections 
        to the WFESD (``the WFESD E-Rate Project''). Those present at 
        the pre-bid meeting understood that the project was related to 
        the E-Rate program, in which the Universal Service 
        Administrative Company (``USAC'') subsidizes the provision of 
        telecommunications, Internet access, and internal connections 
        to underprivileged schools.
          Competitive bidding was required for the WFESD E-Rate 
        Project. Nonetheless, the defendant, together with school 
        district representatives, a consultant, and others representing 
        potential competitors, combined, conspired, and agreed that:
          1) The defendants' employer would be the successful bidder 
        and have general responsibility for the WFESD E-Rate Project;
          2) No co-conspirator other than the defendant's employer 
        would submit a general bid for the WFESD E-Rate Project;
          3) Other co-conspirator companies would be the defendant's 
        employer's subcontractors for the WFESD E-Rate Project; and
          4) any bid competing with the defendant's employer's bid 
        would be stricken as nonresponsive.
          The defendant, his superiors at his company, and his other 
        co-conspirators did what they agreed to do to carry out the 
        conspiracy. They further acted in concert to provide equipment 
        and services related to the WFESD E-Rate Project and receive 
        from USAC payment therefor.
    Documents obtained from USAC by the City Attorney's Office show 
Inter-Tel subcontracting to Howe as part of Howe's E-Rate contracts 
during the same time period. The City Attorney's Office suspects Inter-
Tel to be one of the co-conspirators Maynard referred to in his guilty 
plea and is confident its ongoing litigation and investigation will 
confirm this suspicion and show Inter-Tel to indeed be one of Howe 
Electric's bid rigging co-conspirators.
    Likewise, documents obtained from USAC by the City Attorney's 
Office show VNCI involved in E-Rate applications out of West Fresno 
Elementary School District during the same funding years in which Howe 
Electric was the prime contractor.
    Sprig management officials and its consultant Bob Waters informed 
the City Attorney's Office that the firm was involved in West Fresno E-
Rate bids during the same time period.
    The City Attorney's Office suspects that both VNCI and Sprig were 
among the co-conspirators Maynard referred to in his guilty plea and is 
confident its ongoing litigation and investigation will confirm this 
suspicion and show that VNCI and Sprig were indeed among Howe 
Electric's bid rigging co-conspirators in West Fresno.
                    the plan to misuse e-rate funds:
    In other school districts where Inter-Tel and NEC BNS appear to 
have acted in concert with VNCI to rig bids, conceal VNCI equipment in 
bids and inflate applications, evidence suggests the firms agreed to 
not charge the school districts their portion of the project costs, 
which usually came to 10 percent of the total cost.
    Based on its evidence, the City Attorney's Office believes VNCI, 
Inter-Tel, and NEC BNS built this cost into their non-competitive bids 
and later into the inflation of E-Rate applications.
    The City Attorney's Office believes the inflated costs associated 
with the two San Francisco Form 471s were to be used, in part, for this 
purpose.
    Another purpose of the fraudulently inflated project costs in San 
Francisco would have gone to fund equipment not eligible for E-Rate 
monies--in addition to the ineligible VNCI video-conferencing 
equipment.
    The City Attorney investigation found that NEC BNS had agreed to 
spend more than $10 million of the inflated project costs to pay for 
2250 computer work stations, which are not eligible for E-Rate funding. 
When NEC BNS pled guilty and settled civil claims with our office, they 
admitted as much, and stated that though NEC BNS characterized this $10 
million expense as an ``in-kind'' donation, it had indeed planned on 
using a portion of its E-Rate award to pay for the workstations.
                             lying to usac:
    On September 22, 2000, USAC issued a Funding Commitment Decision 
Letter (FCDL) to McQuoid regarding Form 471 202719.
    The FCDL announced a total award to Inter-Tel for the PBX of 
$14,791,335.38. Inter-Tel had requested $17,769,776.27 for the PBX.
    The request had been reduced to remove some of the VNCI equipment 
as ineligible though it is not clear from USAC documents if the 
equipment was deemed ineligible because USAC understood it to be video-
conferencing equipment.
    NEC BNS was awarded $18,156,829. 34 in funding for cabling, the 
exact amount they had requested.
    NEC BNS was awarded $15,731,613.33 in funding for data equipment 
(switches and routers). USAC reduced the requested amount of 
$18,953,751.00 to remove funding for an extended warranty.
    NEC BNS was not awarded the $18, 249,395.09 it requested for 
servers. USAC denied the entire funding request because more than 30 
percent of the use of the servers would have been for ineligible 
purposes. It is not clear from USAC documents what ineligible purposes 
the servers would have been put to.
    Likewise NEC BNS was denied its entire service contract request of 
$1,898,970.78.
    The total E-Rate award to SFUSD as a result of the two fraudulently 
inflated applications was $48,679,778.05
    Prior to issuing the award, USAC pursued its normal program 
integrity review process. In addition, USAC subjected the McQuoid 
applications to an Item 25 review, a higher level of scrutiny USAC 
brings to bear on some but not all applications.
    In the course of this two-fold review, USAC asked many questions of 
McQuoid regarding his applications. Moreover, USAC asked for documents 
to support McQuoid's answers.
    Based on the findings of our investigation, the City Attorney's 
Office concluded that VNCI, through Green and Marchelos, controlled 
this process as well--with NEC BNS and McQuoid's knowledge and consent.
    We discovered a July 27, 2000 letter from McQuoid to VNCI Chief 
Financial Officer Bob Emery authorizing VNCI to assist SFUSD in the 
preparation and submittal of School's and Library Division's (SLD) Item 
25 review.
    ``Under the direction of the District, VNCI will be aggregating the 
information required to complete the Item 25 review. We authorize VNCI 
to collect, collate and prioritize documentation for our intended 
contractors to facilitate the completion of the Item 25 review.''
    Likewise the City Attorney's Office discovered a letter from John 
Colvin, NEC BNS Director of Sales, Public Sector, to Judy Green, 
identified as VNCI Regional Manager, authorizing her ``to provide 
documentation on behalf of NEC BNS to facilitate the completion of the 
Item 25 review.''
    But it also appears from the evidence that Green and Marchelos, on 
behalf of VNCI, NEC BNS, and Inter-Tel controlled pre-Item 25 responses 
to USAC inquiries as well.
    We base this conclusion in part on the fact that McQuoid's 
signature was forged on an initial pre-Item 25 review submittal of 
information justifying various aspects of the applications.
    Evidence suggests that Green and Marchelos, acting on behalf of 
VNCI, NEC BNS, and Inter-Tel either prepared, helped to prepare, 
directed the preparation of and transmitted or knew of the preparation 
of and transmittal of counterfeit, misleading and fraudulent 
documentation meant to conceal wrongdoing and facilitate the award of 
E-Rate money not properly due to NEC BNS, Inter-Tel, and VNCI.
    Evidence indicates that as part of the Item 25 review, Green, 
Marchelos, and McQuoid caused to be sent to USAC a list of individuals 
who purportedly attended the pre-bid meeting on January 3, 2000. Two of 
the fourteen supposed attendees listed as having signed in and being 
present were not actually present.
    Both names and signatures are clearly in the handwriting of 
McQuoid. City Attorney interviews with both individuals indicated that 
neither was present. In one instance, the individual purported on the 
sign in sheet to have been present at the pre-bid meeting had never 
been to San Francisco.
    A third individual who signed in as having attended the pre-bid 
meeting and picked up an RFP in order to submit a bid, informed the 
City Attorney's Office that he was a friend of McQuoid's who was doing 
some minor alarm repair for McQuoid at the buildings and grounds 
division when McQuoid asked him to come to the meeting where he was 
asked by another individual believed to be Marchelos to sign in as 
having been present as a potential bidder. This individual informed the 
City Attorney's Office that he had no intention of bidding, had no 
capacity to do so, and had no real understanding of what transpired in 
the meeting except that he was asked to sign in as if he were a 
potential bidder.
    During the review process conducted by USAC, documents bearing the 
NEC logo were transmitted to USAC purporting to show the size of seven 
of the schools to receive cabling funded by the San Francisco E-Rate 
proposal.
    The size of these schools was grossly exaggerated on these 
documents, increasing the seven elementary schools by 73 rooms and 
58.75 acres. The City Attorney's Office concluded that the reason for 
the exaggeration was to better justify the excessive request for 
cabling funds.
    In submitting to USAC proof that SFUSD had the ability to pay its 
approximately $10 million share of the E-Rate project costs, McQuoid 
conspired with Judy Green and others to submit fraudulently altered 
budget documents.
    The key document, a budget summary page, was altered to show that 
the school district had $41.5 million available under a line item 
fraudulently titled ``E-Rate District Match.''
    By the time this falsified document was transmitted to USAC in 
August 2000, the SFUSD Board of Education had already approved a fiscal 
year budget for July 1, 2000 to June 30, 2001 and no such line item was 
included. In fact, in a separate portion of the true budget, SFUSD 
reduced the available E-Rate match fund from $1.26 million to zero.
    Inter-Tel sales representative Jason King informed the City 
Attorney's Office that he attended a meeting where Judy Green of VNCI, 
Gerard McNulty of NEC BNS, and he assisted McQuoid in responding to the 
USAC Item 25 review. During this meeting, Green asked for and received 
SFUSD budget information and documentation to submit to USAC.
    When USAC asked McQuoid to provide a Technology Plan, a requirement 
of receiving USAC funding, McQuoid simply obtained one from Green which 
had been written by Green and others as part of a Los Angeles Unified 
School District planning process. The Green-provided plan had not been 
subject to any discussion or deliberative process by anyone at SFUSD 
nor had it been submitted and approved by the SFUSD Board of Education.
    As part of the Item 25 review, USAC requested a copy of bid 
results, the RFP, and other bid-related documents. Spreadsheets 
prepared by and transmitted to USAC by McQuoid and others, most likely 
VNCI, through Green and Marchelos, on behalf of NEC BNS and Inter-Tel, 
contained false information about the bid results. And the copy of the 
VNCI RFP sent to USAC had the references to the required video 
conferencing solution omitted in order to conceal the fact that PBX 
bidders were required to include ineligible equipment in their bids.
    Evidence suggests that in justifying the cost of a labor/service 
agreement with NEC BNS, Green and Marchelos, on behalf of NEC BNS, 
submitted a document to USAC claiming that the costs were at the 
proposed rates because San Francisco had ``no mass transit'' system 
when in fact it has a robust mass transit system, and some schools were 
45 miles apart even though San Francisco is seven miles by seven miles.
    McQuoid's signature on this document is clearly forged.
                               conclusion
    The City Attorney's investigation into the E-Rate proposal that was 
purportedly submitted on behalf of the San Francisco Unified School 
District demonstrated that the proposal was fraudulent in almost every 
respect. The proposal resulted from a bid process that was rigged from 
its inception. The bid process was controlled by parties who had a 
direct financial stake in its outcome. After the conspirators prevailed 
in the rigged process, they included a large amount of ineligible 
equipment in their funding requests. They also grossly inflated the 
prices used in their funding requests, and made numerous 
misrepresentations during the funding process.
    Fortunately, when Superintendent Arlene Ackerman learned of these 
proposals, she suspected they were fraudulent. The San Francisco 
Unified School District therefore did not accept any funding from the 
E-Rate program as a result of these applications. However, the City 
Attorney's investigation demonstrated that these same conspirators 
successfully obtaining E-Rate funding for other school districts, based 
on similar fraudulent tactics. Investigations into the scope of these 
improper activities are on-going.

    Mr. Walden. Thank you, Mr. Cothran, for your testimony and 
for your diligent efforts to expose this fraud and conspiracy 
and abuse.
    Superintendent Ackerman, again thank you for your diligence 
in this matter as well. You touched on this during your 
testimony, but can you please explain for us the types of 
financial and budget issues and problems that you found when 
you arrived in San Francisco?
    Ms. Ackerman. Prior to my arriving in San Francisco, there 
had been a fiscal audit by the State, called the PCMAT Report, 
and it makes clear that there were serious oversight and 
accountability or lack of accountability structures in our 
fiscal house.
    We didn't know how much money we had. There were problems 
with--We hadn't had proper audits. In addition to that, we had 
problems getting certified by the State, and then we had 
problems with credit. So there were a multitude of fiscal 
problems when I arrived.
    There was a blueprint for how we could rectify some of our 
fiscal problems in this report called the PCMAT report. So I 
came into the district understanding that there were serious 
issues and proper oversight procedures in our fiscal house.
    Mr. Walden. So how obvious was it to you that there wasn't 
funding there to do the match for the E-Rate program that was 
being offered?
    Ms. Ackerman. Well, as Investigator Cothran said, there was 
no line item represented in our budget for the matching funds. 
That was one clue. That wasn't the obvious, though, for me 
initially. I mean that was one of the things. There were 
probably several.
    I was initially alerted, though, when I read the E-Rate 
application, and I saw the misrepresentation of what I knew to 
be not factual statements describing our city. That started my 
first red flag that went up, and then further looking at--
Because I was acutely aware of the problems we had in our 
fiscal house, our department, then I began to look at other 
issues that were raised as a result of this application.
    There were other fraudulent--appearance of other fraudulent 
contracts also that I was aware of at the time. So I was 
already on high alert.
    Mr. Walden. But not in the E-Rate program?
    Ms. Ackerman. No, not initially. Not initially.
    Mr. Walden. All right. Thank you. Mr. Cothran, so everyone 
at the bid rigging--or excuse me--bid meeting on January 14 
knew that Marchelos and Judy Green were affiliated with VNCI 
the equipment vendor except Pacific Bell?
    Mr. Cothran. That is the conclusion of our investigation. 
NEC, in our opinion, was definitely aware of their affiliation, 
because they had been working with them for sometime at that 
point to make E-Rate bids bundling VNCI equipment in about 10 
other school districts.
    Inter-Tel, same situation. They were also working--had 
worked in previous E-Rate funding years and were working in 
that current funding year, bundling VNCI equipment into bids in 
other school districts across the country. So when they looked 
out across the table at Judy Green and George Marchelos, they 
knew they were VNCI employees, and they knew that they were 
doing business with their firms.
    Sprig Electric, which was present at the meeting in the 
person of a consultant to the firm--that consultant had worked 
with Judy Green and George Marchelos as VNCI representatives in 
other school districts in prior funding years as well.
    I believe the only other remaining party at the bid opening 
meeting during my investigation was Pac Bell, and they did not 
know, according to their interviews with me, that Judy Green or 
George Marchelos were VNCI reps. As a matter of fact, Mr. 
Marchelos, according to a Pac Bell representative, had 
identified himself at the earlier January 3 meeting as a San 
Francisco consultant. I will make the point again that he was 
not a consultant to the school district. He had no such 
contract. That was just not true.
    Mr. Walden. Tab 9, 10, 12 and 86: These appear to indicate 
that Judy Green's influence of the bid process--I'm sorry, Ms. 
Ackerman, did you want to comment on that? I'm sorry.
    Ms. Ackerman. Yes. I wanted to add to your prior question 
about when was I aware of a problem with E-Rate. It actually 
happened fairly early in my tenure, not about this particular 
application but about a new $96 million application that I was 
asked to sign and refused to sign it, because--that happened in 
early fall.
    So we never actually applied--made an application for the 
$96 million. So there was----
    Mr. Walden. Who brought that application forward, the same 
cast of characters?
    Ms. Ackerman. Yes, and at that point with Desmond McQuoid 
was our then facilities director, Tim Tronson. So this happened 
even before the $50 million application, which had actually 
already been approved.
    Mr. Walden. Okay. Does the $96 million application you were 
approached to sign come after the fraudulent $58 million one?
    Ms. Ackerman. No. It came before. We actually--I'm sorry, 
go ahead.
    Mr. Walden. No, you go ahead. That's fine.
    Ms. Ackerman. I was asked a new application for $96 million 
in the early fall, sometime in September, by Tim Tronson and 
Desmond McQuoid. I actually refused to sign that application, 
and we never submitted it.
    Soon after that came the $50 million application that had 
already been submitted,and what we were supposed to then do was 
to actually have the matching funds of $8 million. So there was 
at least attempt to get me to sign off on a $96 million 
application, which I initially refused to do.
    Mr. Walden. All right. Thank you. So let me go to Mr. 
Cothran now. These tabs I referenced earlier, 9, 10, 12, 86, 
appear to indicate Judy Green's influence in the bid process, 
Bill Holman as well as a number of other NEC employees are 
listed on these e-mails.
    If you look at Tab 9, Gerard McNulty, the salesman at NEC 
who appears to work most closely with the schools, and Judy 
Green describes Green's ``flexibility to award the whole 
project to NEC.'' At first, Holman in particular appears to be 
questioning Judy's role. Can you comment on what we are seeing 
here?
    Mr. Cothran. Well, I have never seen this e-mail before, 
but what it appears to me to be is sort of an internal 
admission on the part of Mr. McNulty and others that Judy Green 
controlled the bid process at least. And if I am not mistaken, 
this is referring to Covert, which is a school district outside 
of Detroit, I believe.
    So at least in this one instance, it appears that there is 
some rather frank discussion here about Judy Green's control 
over the process. Mr. Holman raises the issue of a potential 
conflict of interest, and then Gerard offers an additional 
explanation, and he uses the term heavy influence in the 
outcome. Supposedly, I guess that is enough to soothe the fears 
of Mr. Holman, and he doesn't think that is a conflict of 
interest--heavy influence as opposed to awarding the contract.
    Mr. Walden. Do you think there is a conflict there? If you 
were Mr. Holman, would you think?
    Mr. Cothran. Oh, absolutely.
    Mr. Walden. Okay. Looking at Tab 10, Coleman tells Holman 
that Judy Green, ``owns the bid process and seems to be the 
brains behind the VNCI operation.'' Can you comment on that?
    Mr. Cothran. That is my understanding. As a result of my 
investigation, I developed the strong opinion that Judy Green 
was pretty much the brains of the VNCI operation.
    Mr. Walden. Okay. Then looking at Tab 12, McNulty tells 
Holman that he and Judy will lobby the district to award the 
projects to NEC. Did Judy Green and George Marchelos rig the 
bids this way in other school districts?
    Mr. Cothran. Could you repeat the question? I'm sorry.
    Mr. Walden. Did Judy Green and George Marchelos rig the 
bids this way in other school districts?
    Mr. Cothran. Well, as you can refer to in my written 
testimony, I interviewed a CEO and principal at Ceria M. Travis 
Academy in Milwaukee, Wisconsin, and her comments to me over 
the course of two interviews indicated to me that indeed Mr. 
Marchelos and Ms. Green rigged the bid and controlled the 
process in that school district. There are documents we 
received from USAC that finally indicated to us that that same 
control was exercised in other school districts, in Michigan, 
in Arkansas.
    Mr. Walden. Have you seen dollar amounts on those? How much 
money are we talking about that these two may have been engaged 
in?
    Mr. Cothran. I wouldn't want to hazard a guess without the 
documents in front of me, but to answer your question, yes, I 
do have documents relating to those requests and those awards, 
and while not as grandiose as the San Francisco application, 
they did involve millions of dollars, and in some cases, I 
believe, tens of millions of dollars.
    Mr. Walden. In your opinion, how far up the chain of 
command do you think the knowledge of the bid rigging and other 
behavior went within VNCI? Who knew?
    Mr. Cothran. I have to apologize. I have no evidence about 
how far up the chain of command it went at NEC. My 
investigation just didn't probe that far. I apologize.
    Mr. Walden. No, but VNCI was my question.
    Mr. Cothran. Oh, VNCI. Certainly, Judy and George were the 
main actors. I have a strong suspicion that Bob Emery, the CFO, 
was aware of their activities, although in an interview he 
denied it to me. But I have a strong suspicion that that wasn't 
an accurate portrayal. Other than that, I simply don't know.
    Mr. Walden. My time has expired. I would now like to 
recognize the gentle woman from Colorado.
    Ms. DeGette. Thank you, Mr. Chairman. Dr. Ackerman, I was 
wondering, since having to deal with this E-rate conspiracy 
that was initiated by VNCI, NEC BNS, and Inter-Tel, what has 
been your experience with the E-Rate since these firms were 
taken out of the equation?
    Ms. Ackerman. Well, I would like to say that, as I made the 
point in my comments, I believe that the E-Rate program has 
benefited many young people in our school district. 
Approximately 20,000 students in 112 of our schools have 
benefited from the E-Rate program.
    Ms. DeGette. And have you applied for E-Rate money since 
the scandal happened?
    Ms. Ackerman. Yes, but much smaller amounts. In the last--
in 2001 it was about $800,000, in 2002 about a million, and in 
2003 about a million.
    Ms. DeGette. And how have you been able to use these monies 
in the San Francisco School District for the benefit of 
children? You keep saying--I'd like to get on the record 
exactly how this program benefits kids and what kind of kids it 
benefits.
    Ms. Ackerman. It has benefited students especially in some 
of our more disadvantaged and challenged neighborhoods, the 
schools that are located in those communities, providing 
Internet connections and infrastructure as well as 
telecommunication systems with some of those schools, some of 
our schools, as well as wiring of our libraries and bringing 
our libraries up to the 21st Century.
    I would say that it has made, certainly, a difference in 
this school district.
    Ms. DeGette. And these are kids who wouldn't have those 
kinds of services at home. Correct?
    Ms. Ackerman. Yes. Absolutely.
    Ms. DeGette. Now I know, Dr. Ackerman, that you have many 
years of experience in the education field in other school 
districts before you went to San Francisco. My question for you 
is: As policymakers, how do you think we can improve oversight 
of the E-Rate program so that these many hundreds of millions 
of dollars actually go to benefit kids and we avoid fraud in 
the future?
    Ms. Ackerman. Well, I certainly think that there has to be 
put in place some checks and balances. The fact that this $50 
million application was submitted--I caught the $96 million 
application and refused to sign it, but we actually had applied 
for two others, and they were--somehow they went through a 
process, even after it left the district, and nobody was able 
to--and I don't know the process after it leaves the district, 
but certainly there needs to be some checks and balances in 
place at the Federal level to ensure that these applications 
aren't fraudulent and that the applications actually--the 
processes and procedures that are laid out in the applications 
have actually taken place.
    Ms. DeGette. Have you put additional checks and balances in 
place within your own school district since this happened?
    Ms. Ackerman. Absolutely. We have in place not only a 
review from our legal department, but we now have an office of 
risk management that also takes a look at any major 
applications or grants that we apply for. We also took our 
technology department out of facilities and put it in the 
technology department where it belonged.
    It was really strange to me that a facilities person was 
bringing to me--that was a really big clue--that a facilities 
person was bringing to me a serious E-Rate application. And it 
has to be vetted through several layers in our district of 
overview and oversight, including our risk management 
department and our Chief Financial Officer has to check off and 
sign off of it before it comes to me for review.
    Ms. DeGette. And do you think that a review of the school 
district's auditing procedures and checks and balances would be 
an important component of Federal oversight? In other words, 
when a school district submitted an application, part of the 
review by the Federal Government would be to make sure that the 
school district had appropriate oversight in place as well.
    Ms. Ackerman. I think that is absolutely appropriate.
    Ms. DeGette. Okay. I wanted to ask the investigative team, 
who I am very proud of, about some of the details of this 
investigation.
    Mr. Cothran, I was wondering. You testified about how VNCI 
declared PBNI's bid on data and cabling noncompliant with the 
RFP, and subsequently disqualified it from contention. Now if 
the appropriate officials at the school district knew about the 
PBNI bid, do you think they would have still chosen that much 
more elaborate system that the NEC bid proposed?
    Mr. Cothran. I don't think they would, if this had gone 
through the appropriate channel which, to my knowledge, would 
have been the information technology and telecommunications 
division, which was already doing business with Pac Bell in 30 
schools under other contracts. Pac Bell was a well known 
contractor to them.
    I am confident that their bid would at least been taken a 
lot more seriously, and most likely it wouldn't have been ruled 
noncompliant with the bid, since it fit the specifications of 
the projects they were already working on.
    Ms. DeGette. Now you also said that, if folks had used the 
results of the initial rigged bid process instead of the 
subsequent inflation, that they would have requested almost $53 
million in E-Rate money, and you said this amount would have 
been dramatically more than was reasonable and ethical.
    What figure do you think would have been reasonable and 
ethical?
    Mr. Cothran. You know, I don't think I am qualified to make 
that kind of guess, but I would point you to previous E-Rate 
applications that have been made through the appropriate 
avenues at the school district. If memory serves--I haven't 
looked at them in a while--they were in the single--I don't 
even think some of them reached a million dollars.
    Ms. DeGette. Yes, and I think that is just what Dr. 
Ackerman just testified for subsequent proposals.
    Mr. Cothran. Right. Previous, I believe, I was informed, 
were less than a million dollars. So you can take that as a 
benchmark. We believe--if I might add, we believe the $52 
million figure, even before it got to the second layer of 
fraud--we believe that initial rigged bid was fraud, in and of 
itself. We see that as a fraudulent number as well. We see this 
as two layers of fraud.
    Ms. DeGette. Right. Now you testified that McQuoid's 
signature on the final purchase agreement was a forgery and 
that McQuoid had no such authority to sign off on the 
agreement. Was the NEC signature forged as well?
    Mr. Cothran. We have no way of commenting on that. I don't 
have the true exemplar of--I believe it was Thomas Burger's 
signature on that document, if memory serves, and I have no 
true exemplar of that signature to compare it to.
    Ms. DeGette. Okay. Did you ever see any documents that 
suggested that an NEC official was having second thoughts about 
filing the grossly inflated purchase order?
    Mr. Cothran. No. I mean, until today.
    Ms. DeGette. Mr. Chairman, I don't have anymore questions 
at this time. I yield back.
    Mr. Walden. The Chair now recognizes the chairman of the 
full committee, Mr. Barton, for questions.
    Chairman Barton. Thank you, Mr. Walden. Dr. Ackerman, can 
you hear me?
    Ms. Ackerman. Yes, I can.
    Chairman Barton. Again, I want to commend you for what you 
have done. My first question is just a general question. What 
was it that you saw that kind of raised a red flag in your mind 
that this particular grant or proposal might not be on the up 
and up?
    Ms. Ackerman. As I mentioned before, the first application 
that was brought to me in September actually was for $96 
million, and it came to me from staff members from the 
facilities department. They actually wanted me to sign it that 
day. They brought me the document, and they were standing there 
waiting for me to sign it.
    I actually refused to sign it, said I needed time to look 
at it, and that review--the review of that particular 
application then alerted me that there were--and I asked some 
questions about what I believed to be false statements within 
the document.
    At that point, I was told that the contents of the $96 
million application was the same as the other two previous 
applications that were submitted. So at that point I knew that 
it was fraudulent. The other two applications were fraudulent, 
and I refused to sign that one, and then alerted Louise Renne, 
then City Attorney, that there was a problem.
    Chairman Barton. Where were you before you came to San 
Francisco?
    Ms. Ackerman. I was in Washington, DC.
    Chairman Barton. Were you the superintendent in Washington, 
DC?
    Ms. Ackerman. Yes, I was.
    Chairman Barton. And had you made application for similar 
funds for a similar program in Washington, DC?
    Ms. Ackerman. I don't remember if there were applications 
made when I was there. I was there only 3 years and 
superintendent 2, but I had been involved in previous school 
districts, and even there I knew that that was a lot of money. 
I knew there was something wrong with the application, the 
amount of money.
    In addition, in my experiences in DC and in Seattle and 
other places where I have actually worked, the application came 
as a result of a technology plan that was vetted and developed 
in the technology department. That this application was coming 
to me from the facilities department was something I had never 
seen before.
    Chairman Barton. Now as a consequence of you refusing to 
sign that application and all that flowed from that, did the 
school board in San Francisco pressure you to reconsider or did 
they give you the benefit of the doubt or did they actually 
commend you? What was the reaction immediately after you 
refused to sign the application?
    Ms. Ackerman. Well, it depended upon the school board 
member. I got a little bit of both. I actually--I think, 
initially, people across the city and country thought I was a 
little bit crazy to turn down $50 million. There were several 
news stories, both locally and nationally, where I felt that 
there was pressure for me to at least explain myself in a 
rational way, why I would turn down $50 million. But at that 
point, I did know that there were serious investigations going 
on, and I would just have to wait, and time would tell the true 
story.
    Chairman Barton. But today, given the fact that we have had 
this plea bargain, the fine that has been paid, the $20 million 
fine, what is the attitude now? Are you considered a heroine in 
San Francisco or are you still considered that crazy 
superintendent who turned down $50 million?
    Ms. Ackerman. Well, I think I am a heroine. In addition to 
that, since this, this actually led to other investigations, 
and a couple of weeks ago we actually were awarded another $43 
million settlement from an energy company that had defrauded 
the school district.
    So in the last month, we have actually gained another $50 
million as a result of the phone call to then City Attorney 
Louise Renne. I am feeling pretty good and vindicated.
    Chairman Barton. Okay. Well, your forthrightness is 
probably going to save the U.S. taxpayers hundreds of millions 
of dollars--hundreds of millions, if not more. So on behalf of 
the country, I want to say thank you, and I would hope San 
Francisco appreciates you, because everybody thinks it is 
somebody else's money and it is free money, but ultimately it 
is our money.
    Ms. Ackerman. Absolutely.
    Chairman Barton. If we don't have people like you doing the 
right thing, the whole system falls apart. You know, we are 
going to make structural changes in this program statutorily 
probably in the next Congress, if not this Congress. The reason 
we are going to be able to do that is because of the stand that 
you have taken. So I thank you. I really--I'd love you to come 
down to my part of the country and be a school superintendent 
in one of my school districts, you know.
    Ms. Ackerman. Well, don't tell anybody here in San 
Francisco you've made that offer.
    Chairman Barton. Well, they would probably hoot you out of 
town if they thought you were coming to Texas.
    I want to ask one substantive question of you. Why was the 
facilities department, not the technology department, handling 
this issue for the schools in your system?
    Ms. Ackerman. One of the things that I discovered was 
basically the facilities department was a separate operation 
from every other department in the school district, and much of 
the fraud that we have uncovered came as a direct result from 
the fact that the facilities department was acting as a 
separate agency. They had their own budget, their own contract 
compliance manager. They didn't go through any vetted process 
or procedure for oversight.
    So a lot of this could happen, because there were no checks 
and balances. Now that we have a contract review, a risk 
management department, in addition to those two departments, 
and then now we separated all of the fiscal procedures and put 
them back in the Office of Finance, it has put in place natural 
checks and balances. That could never happen again.
    By the time it gets to me, it has gone through several 
layers of oversight, but this was an unusual practice, and 
probably one of the first things that I noticed, that this was 
very unusual, that this facilities department acted on its own.
    Chairman Barton. Okay. My staff has indicated that there 
was a concerted lobbying campaign undertaken to convince you to 
change your mind by Mr. Desmond McQuoid and Mr. Tim Tronson, 
the NEC company and VNCI.
    Do you want to elaborate a little bit on that, if it is 
true? Did they try to convince you to change your mind and, if 
so, how did they do that?
    Ms. Ackerman. I think there were phone calls. There was at 
least one meeting with some of the--I believe NEC staffpersons. 
I don't remember who was there. It has been a while back. There 
were meetings with the board, some of the board members.
    I did call NEC on this and, you know, felt it was really 
inappropriate that vendors would be talking to board members. 
But I am a pretty stubborn person, and you know, all of that 
pressure--I didn't really feel pressure at the time. I had 
already made up my mind, and I knew that there was a process, 
investigative process, underway. So it was--you know, fell on 
deaf ears.
    Chairman Ackerman. When did you think it was time, and what 
made you decide that it was time to contact the FBI?
    Ms. Ackerman. Well, we went through a facilities audit by 
Arthur Anderson, and there were also some recommendations in 
the original PCMAT report, the fiscal management audit that was 
done the spring before I actually came to San Francisco, and 
there were other contracts that appeared to be fraudulent in 
other areas, including our energy savings department.
    So there was a combination of things. I knew that the 
district was strapped for money and, having lived in Washington 
and understanding clearly that the E-Rate is a Federal grant, I 
did call then City Attorney Louise Renne and ask if we could 
call in the FBI. I knew, once they came in, that we would have 
an extensive investigation that would support what was already 
happening in the City Attorney's office.
    Chairman Barton. Now did anybody try to pressure you not to 
contact the FBI? Did anybody say I really wish you wouldn't do 
that; we probably ought not do that, or were you pretty well 
supported in making that decision?
    Ms. Ackerman. I was well supported. At that point I was 
well supported. After we read the--we submitted the audit and 
shared it with the board of education, the facilities audit, I 
think at that point everybody knew that something was wrong, 
and I got no pressure in terms of my wanting to call the FBI. 
In fact, I was very supported, including supported by Louise 
Renne.
    Chairman Barton. Okay. I want to ask Mr. Herrera here in 
the hearing room, how often is it that the school district 
would contact the City Attorney of San Francisco for 
assistance? Does that happen a lot, never?
    Mr. Herrera. Yes, it is fairly common. The fact of the 
matter is we provide legal counsel to the school district on a 
variety of matters. So we have a very good interplay. Under my 
predecessor, Ms. Renne, there was a very close relationship 
between the school district and the City Attorney's office, and 
that has continued since I became City Attorney. We work very 
closely with them on a day to day basis in terms of providing 
legal advice.
    I have a Deputy City Attorney assigned to the school 
district to assist Ms. Renne with general counsel duties at the 
school district, and there is a very close interplay also in 
terms of investigations of allegations of fraud and 
mismanagement. So it is not uncommon.
    Chairman Barton. Okay. Ms. Renne, how long have you been 
the General Counsel for the school district?
    Ms. Renne. It has been approximately 3 years now, Dennis?
    Mr. Herrera. About that.
    Ms. Renne. Actually, when I decided not to run for City 
Attorney again, I actually was going to do something quite 
different, but Dr. Ackerman asked me to come over and be 
general counsel for the school district, which I have been 
until June 30. Now I really feel that all of the things that 
Dr. Ackerman had asked us to do to basically root out the 
corruption, take a look at the E-Rate program, are over.
    So as of July 1, I am no longer the general counsel, but I 
continue to handle special matters for the district.
    Chairman Barton. But in the beginning, you were the City 
Attorney?
    Ms. Renne. I was. I was the City Attorney.
    Chairman Barton. Superintendent Ackerman contacted you 
initially in your capacity as City Attorney?
    Ms. Renne. Correct. Correct.
    Chairman Barton. And so she provided the information, and 
then you provided the investigative muscle to track this down?
    Ms. Renne. Absolutely, and if I may just say one thing, Mr. 
Chairman, I think Dr. Ackerman is being somewhat modest. There 
really was quite a lot of criticism against Dr. Ackerman for 
turning down these applications. In fact, there were some 
public hearings about it, but she was determined that we were 
going to root out what was going on.
    I would say that she and her board, the board of education, 
were supportive in terms of going forward with these 
investigations.
    Chairman Barton. Now your position as City Attorney was an 
elected position.
    Ms. Renne. It is elected, and then when I decided not to 
run, I am very happy that the voters of San Francisco had the 
intelligence and good luck to have Mr. Herrera as City Attorney 
in San Francisco now.
    Chairman Barton. That will be a good commercial.
    Ms. Renne. So be it.
    Chairman Barton. Did you get any pressure as City Attorney 
to back off the investigation?
    Ms. Renne. No. There was some effort, I would say, to try 
to not have me become general counsel for the school district, 
but it was minor in the scheme of things. No.
    Chairman Barton. I am going to yield back, Mr. Chairman. I 
have probably improved the reelection chances of--I don't know 
Mr. Herrera's political affiliation, but given it is San 
Francisco, it is probably not the same as mine.
    Ms. DeGette. If the chairman will yield, I just have to 
say: So rarely do we see such dedicated public servants who are 
doing the right thing. It is almost too much of a love fest to 
bear here, but we are really glad you all did what you did.
    Chairman Barton. My guess is, though, at the time they were 
doing it, it wasn't a love fest. My guess is there are a lot of 
people out there that thought that was what they call easy 
money and found money, and to stand up and do what is right at 
the time they did it, it was not universally acclaimed. So I 
again appreciate everybody involved.
    With that, Mr. Chairman, I yield back.
    Mr. Walden. Mr. Chairman, I am sure Mr. Herrera would love 
to have you come out and go door to door with him.
    Chairman Barton. I would probably lower his reelection by 
20 points.
    Mr. Walden. The Chair now recognizes the gentle woman from 
Illinois.
    Ms. Schakowsky. I thank you, and perhaps the chairman and 
Mr. Herrera could pose together for a picture he could use in 
his campaign.
    I join, though, in the love fest and in thanking all of you 
for the--well, really, for doing your job the way it should be 
done. It is really a model, I think, for people around the 
country, and we thank you for that.
    I do understand. I have heard that there was some pretty 
negative press at the time, too, saying that, you know, you are 
turning the money down, etcetera. So withstanding that kind of 
pressure is not always easy, and I appreciate it, as we all do. 
Really, good work.
    I read in your testimony, Dr. Ackerman, that you said, 
``Despite the disturbing and cautionary aspects of our 
experience with E-Rate, I very much hope the members of the 
subcommittee and the public will interpret my comments as 
supporting reform of the program, not its elimination.'' So I 
wanted to ask you if you had specific recommendations of things 
that could be built into the program that would reform it, 
and--Well, let me leave it at that for now.
    Ms. Ackerman. Certainly. I believe that--As I have had to 
put in certain procedures and processes of oversight and checks 
and balances, I think that that has to happen also at the 
Federal level, including some kind of oversight even at the 
district level, making sure that our procedures and processes 
are in place so that this will never happen again.
    I am not sure what they would look like at the Federal 
level. I just think that these two applications got through, 
past the district level was disturbing to me and, you know, not 
only as a professional but as a taxpayer.
    Ms. Schakowsky. Mr. Herrera testified. You said schools 
throughout our district would have been saddled with millions 
of dollars in equipment that was functionally equivalent to 
paperweights, and you talked about routers, cabling and 
switches with no servers, a phone system with no phones, a 
computer system with no work stations, and you add the issue of 
the video conference, which wasn't even eligible.
    Isn't that, Dr. Ackerman, a limitation of the program 
itself? The program, as I understand the E-Rate program, really 
ends at the wall; that is, that the E-Rate program itself just 
provides the wiring and the equipment to the wall, so that it 
is the school districts themselves, if you want to make it 
function and have the servers, the phones, the work stations, 
that that is an expense borne by the districts. Is that right?
    Ms. Ackerman. Absolutely. But what we see with the E-Rate 
program are discounts, and that is where--you know, of the 
hardware, as opposed to the infrastructure. Even with the 
infrastructure, though, we saw evidences of infrastructure 
that, I would say, was like a Cadillac and we only needed a 
Chevrolet is the way I like to explain it.
    So there are problems, I think, on both sides that we have 
to be aware of. The infrastructure is one that is needed, not 
necessarily an expensive infrastructure, and then the discounts 
that happen on the other side. We actually have to be sure that 
there are no opportunities for people to defraud the school 
district. So it is actually on both sides.
    Ms. Schakowsky. So the fraud did occur, Mr. Herrera, also 
on the discount part, on the equipment--or Mr. Cothran?
    Mr. Cothran. I wonder if you could repeat the question.
    Ms. Schakowsky. Well, I am concerned that, even when the 
infrastructure is done, that school districts can't get--end 
up, as Mr. Herrera described, with equipment functionally 
equivalent to paperweights, that they can't complete the 
program.
    I am trying to understand what are the limitations of the 
program itself, because it does--and then where did the fraud 
come in? Was there fraud dealing with servers, phones, work 
stations, those things that would complete the system, as well?
    Mr. Cothran. We can only really guess at what the plan was 
in San Francisco once they received--the vendors received the 
money. What we do know, because NEC admitted so in their guilty 
plea, is that they planned on using $10 million of the 
excessive request to fund computer work stations which would 
have in part help complete the project.
    We in the City Attorney's office strongly suspect that 
other portions of the inflation, if you will, were going to go 
to pay for handsets, phone handsets, voice mail and other 
things that aren't eligible. But as part of making an E-Rate 
application, a school district has to make sure of two things, 
if they want to do it properly, based on my understanding of 
the program.
    They have to make sure that they have the co-pay to pay for 
the equipment that E-Rate is going to be paying for. In 
addition to that, they have to make sure, and also certify to 
USAC, that they also are able to purchase the ineligible 
equipment that will complete the program, to complete the IT 
backbone, if you will, that the E-Rate program is going to pay 
for.
    At San Francisco in year three of the program when this 
fraud occurred, there was no deliberative process on the part 
of the school district to ensure that they had the additional 
equipment that E-Rate would not pay for, which would complete 
the program. We strongly suspect that one of the reasons they 
inflated it so grossly was to pay for that equipment with E-
Rate money, which would have been a fraud on the program.
    Ms. Schakowsky. Dr. Ackerman, does the school district now 
use the E-Rate program, and do you have--did you have 
sufficient funds to do the match and to provide the ineligible 
equipment?
    Ms. Ackerman. Yes, we have, but it is a very scaled down 
application and program now, and so I think over the last year 
or so we have barely spent a million dollars each year on the 
E-Rate program.
    We have certainly gone through a fiscal crisis in 
California, and this district has been impacted by that crisis, 
and we now have a technology plan that drives the E-Rate 
program as opposed to the other way around. So I think that was 
what was missing at that point also, was a plan, a technology 
plan that would actually lay out where we wanted to go, and 
inclusive of that would be a budget that would match the needs 
of the E-Rate program and the needs of this district, 
prioritize those needs.
    Ms. Schakowsky. So while I understand that today we are 
focusing on your wonderful work in rooting out this fraud, I do 
want to ask: If the district itself had more of a budget, would 
your E-Rate program be more expansive or are you sufficiently 
providing for the needs of your kids?
    Ms. Ackerman. I think that we certainly would do more. As I 
think somebody mentioned in the technology, we are in the 
shadow of the Silicon Valley, and one of my big disappointments 
when coming to San Francisco was the fact that I felt our 
district needed more technology.
    If we want our children to leave the school system 
technologically competent, there is a lot of work we have to do 
in terms of providing more technology resources to our children 
and into our classrooms. So with more money, we would certainly 
do more.
    Ms. Schakowsky. Well, it is clear that you not only have 
your children but your taxpayers and all of the taxpayers in 
mind as you do your job, and so thank you again to all of you 
for your good work. I yield back.
    Ms. Ackerman. You're welcome.
    Mr. Walden. Thank you for your questions. We've got a few 
other questions. Let me kind of outline for the committee and 
the panels what we anticipate.
    We have been notified that there will be votes on the House 
floor sometime between now and 12:15. We would like to do 
another round of questions of this panel, but I understand, Ms. 
Ackerman, you may--or Dr. Ackerman, you may need to move on, 
and we understand that. So we won't keep you in this phase of 
the hearing. But we do have some other questions for Mr. 
Cothran and Herrera and Ms. Renne.
    So what we are looking at, we will start into that--Did you 
want to say something, Ms. Ackerman?
    Ms. Ackerman. No, I am okay for about another hour. So if 
you would like me to stay, I will stay.
    Mr. Walden. Okay. I thought it was sooner than that. The 
problem we are going to face, though, is we are going to break 
here when the bells go off in probably 5 or 10 minutes, and 
then we are going to recess until 1:30, our time. So it may 
cause you some problems.
    So, anyway, if you need to leave, the point is, feel free 
to, but we definitely appreciate what you have testified to 
today and the work you have done on this issue.
    Ms. Ackerman. I just want to say, in case I am not here 
when you come back, that I really do appreciate the opportunity 
to speak before you today and the fact that this subcommittee 
is looking at this issue.
    Again, it is unfortunate what happened to our program, E-
Rate program, and the fact that it has hurt our children. But I 
do firmly believe in this program and the benefits that it 
brings to young people who would not have the access to 
technology, if it were not for the E-Rate program.
    I just hope that you will bear that in mind in your 
deliberations as you hear further testimony. Understand that I 
hope that this is not the norm. I always believe that the glass 
is half full, and I want to look at the benefits.
    So I thank you, Mr. Vice Chair, for inviting me to speak 
today.
    Mr. Walden. We want to make sure that that glass doesn't 
have a big hole drilled in the bottom of it, because there are 
a lot of schools out there that could benefit greatly by the 
money rather than a couple of fraudulent operators putting it 
in their pockets.
    Ms. DeGette and I were talking about how many school 
districts could be wired with the amount of money that could 
have been loaned in this case, and may have been wrongfully 
taken out the of the E-Rate system in other cases. So we 
appreciate your diligence.
    Ms. Ackerman. Thank you.
    Mr. Walden. I am going to go ahead then into the next 
round. Again, if you need to leave, feel free to do so. I want 
to go to Ms. Renne.
    What has happened to Tim Tronson, the former director of 
operations management of the facilities department?
    Ms. Renne. Well, Tim Tronson is, obviously, not with the 
school district anymore. He has been indicted by the Grand Jury 
in San Francisco and is awaiting trial in San Francisco on 
matters not necessarily related to the E-Rate.
    We had some other--As Dr. Ackerman indicated, we did have 
some other scandals, for lack of a better word, involving the 
school district, and Mr. Tronson has been at the heart of that.
    Mr. Walden. I understand. Okay. Mr. Cothran, what was the 
traveling road show?
    Mr. Cothran. The traveling road show is a term that I came 
up with internally when discussing the case with attorneys. 
That is how I described the Judy Green----
    Mr. Walden. Why? Why do you describe it that way?
    Mr. Cothran. It is just a conversational term I used in 
private meetings with attorneys, you know, because they were 
going all over the country and doing this.
    Mr. Walden. I guess that is the question. From what you 
have seen so far, you believe they tried to perpetrate this 
same type of scam elsewhere in the country?
    Mr. Cothran. Correct.
    Mr. Walden. All right.
    Mr. Cothran. And succeeded in some cases.
    Mr. Walden. Yes. If you would turn to the chart on Table 
133, Tab 133, I am hoping you can explain a little bit about 
what this chart is and where it came from. Is this relating to 
the 471s?
    Mr. Cothran. Since we are currently still in the process of 
litigation with many defendants, I don't want to get into too 
great a specificity, if it is all right with you, about where I 
got things and the state of my evidence. All I can say is that 
I have seen this document before.
    It is part of the evidence that is part of the City 
Attorney investigation, and it is our belief that this was 
prepared by Mr. McQuoid or at least with Mr. McQuoid's 
knowledge as part of his process and the process of others of 
trying to figure out what the heck happened when the 471 
applications were filled out, and the type of inflation that 
occurred from bid to application.
    It is our belief that Mr. McQuoid was unaware at first of 
this second layer of fraud where the rigged bid prices were 
then----
    Mr. Walden. He was unaware or said he was unaware?
    Mr. Cothran. I never interviewed Mr. McQuoid, one of my 
great disappointments in this investigation.
    Mr. Walden. Where is he now?
    Mr. Cothran. He is currently, I believe, in Federal prison 
doing 21 months for a separate fraud scheme that he was 
involved in with one of the E-Rate bidders.
    Mr. Walden. A different E-Rate bidder than we have heard 
from today?
    Mr. Cothran. An E-Rate bidder that is mentioned in my 
written testimony called U.S. Machinery. They were involved in 
a separate fraud scheme. I can explain that to you, if you 
want.
    Mr. Walden. That's fine. So you tell me what you can't 
answer because of your investigation, but is this relating to 
the 471s?
    Mr. Cothran. It is our strong belief that this was a 
document or a spreadsheet, if you will, that was created during 
the process that Mr. McQuoid and others engaged in, in trying 
to figure out what Judy Green and other parties had done when 
they went about filling out the 471s, taking control of that 
process as well, and inflating the already rigged bid price.
    Mr. Walden. Okay. That is what I would like to get. Can you 
tell us, as you look at this chart, what is the inflation rate 
here? How much was inflated? What are we really looking at?
    Mr. Cothran. It would take me a while to do that. I 
really--I mean, first of all, you have to understand that this 
is relating to just one part of the RFP. It is relating to the 
data portion. You have your backbone switch, your intermediate 
switch, your router and so forth.
    This would have related to the portion of the bid that was 
won by NEC outright in the initial process that Green and 
Marchelos ran, and then was inflated even further on the 471. 
It is just one of several aspects of the project.
    So it looks here like he is trying to figure out how the 
NEC bid on data had been inflated when the 471s were filled 
out.
    Mr. Walden. I guess that is what we are trying to figure 
out, is how did they manipulate this 471 process? How did they 
basically double the bids?
    Mr. Cothran. They just filled it out. They just filled out 
the 471 application.
    Mr. Walden. And just put in whatever numbers they wanted?
    Mr. Cothran. I encourage you to read the NEC guilty plea. I 
think there is a very articulate explanation of that process in 
their guilty plea. They just--A party referred to as Consultant 
1 and later referred to by the feminine pronoun, she, directed 
NEC representatives what amounts that she wanted on the 471, 
and then I believe the NEC guilty plea says that spreadsheets, 
phony spreadsheets were created to justify those prices she 
dictated, and that was what was submitted as the 471.
    Mr. Walden. So the elusive Ms. Green, whom we are not able 
yet to find to serve the subpoena, but will, is the one who you 
say was basically telling NEC people what to put on the 471s 
for numbers?
    Mr. Cothran. Based on my investigation, and setting aside 
for a second what the NEC guilty plea says--Based on my 
investigation, the conclusion we reached is that Judy Green, 
and to some extent George Marchelos, were the architects of 
drafting and submitting the 471, and it is also our strong 
belief that Desmond McQuoid was not part of that process and 
didn't know anything about it.
    So we have a case where, at this stage of the fraud, no one 
at the school district, not even school district co-
conspirators, were knowledgeable, it is our investigative 
conclusion--were knowledgeable about this layer of fraud until 
later.
    When he found out, as I said, he had a choice to make, and 
he chose to join the fraud.
    Mr. Walden. Interesting. So it sounds like you had--From 
what you have said, you had two frauds going.
    Mr. Cothran. Right.
    Mr. Walden. And you had one group committing a fraud down 
here unbeknownst to the other group until they kind of--How did 
they tumble on it?
    Mr. Cothran. I don't know how Mr. McQuoid found out that 
the 471----
    Mr. Walden. But when he did, it is your opinion that he 
said, great, let's up the ante?
    Mr. Cothran. Well, I think that he might have pitched a 
fit, but we do know for certain he didn't blow the whistle. He 
didn't tell any law enforcement officials. He didn't tell our 
office. He didn't tell USAC. He didn't tell anyone and, as a 
matter of fact, he then went to NEC and got them to agree to 
use some of this inflated portion to pay for ineligible 
equipment.
    Mr. Walden. If you could please turn to Tab 19, this is an 
e-mail that shows an employee of NEC marking up prices and 
making up part numbers on VNCI equipment. What do you think 
this was? Was he working on the 471's pricing? Tab 19.
    Mr. Cothran. Yes, I am getting there. It is a rather 
convoluted e-mail, and it has a lot of assumed knowledge 
embedded in it that the recipient knows what they are talking 
about.
    My guess would be, my educated guess on this is there is 
evidence embedded in this e-mail that VNCI equipment, or 
references to VNCI equipment on parts lists in other parts of 
471 applications was obscured and changed in order to conceal 
the nature of the equipment, since it was ineligible. That 
would be my educated guess.
    Mr. Walden. Okay, Tab 16. This document is an e-mail in 
which an NEC employee--hopefully, I will get the pronunciation 
somewhere correct--Sohail Qasim, expresses concerns about Judy 
Green and talks about, ``money and a system that will not work 
properly.'' So first, we don't believe the school district even 
needed this project and, second, it would appear from this e-
mail that the system might not even work properly.
    Mr. Cothran. On the first part of your question, it is 
certainly the overwhelming opinion of members of the 
Information Technology and Telecommunications Division, the 
proper avenue for E-Rate funding, that this system was utterly 
and completely unnecessary.
    There was already a wide area network and local area 
networks operating in the school district, and nearly all the 
schools had Internet access, computers, routers, switches, 
data, everything, and that this, in their opinion, not only 
conflicted with the system that they already had in place and 
were in the process of building through E-Rate applications and 
other funding avenues, but that it was entirely unnecessary.
    Mr. Walden. All right. Turning to Tab 27, this is an e-mail 
to Tom Burger, the CEO.
    Mr. Cothran. Which number? I'm sorry.
    Mr. Walden. Twenty-seven, which talks about in-kind NABSE 
bonus and value added section, NABSE bonus and value added 
section.
    Mr. Cothran. Twenty-seven? I apologize.
    Mr. Walden. Twenty-seven.
    Mr. Cothran. Twenty-seven is a spreadsheet of prices. It is 
not a--It doesn't refer to NABSE bonus, 27, 2-7. In my binder, 
it is not that.
    Mr. Walden. We will have it brought down.
    Mr. Cothran. What I can tell you is that my investigation 
did not touch on the NABSE arrangement or relationship with any 
of the parties involved in our lawsuit. We are interested in 
learning more about that, but it did not form part of my 
investigation.
    Mr. Walden. All right. So you are then not familiar with 
the in-kind contributions known to NEC, within NEC as the NABSE 
bonus?
    Mr. Cothran. It was not part of my investigation. It did 
not touch on that, no.
    Mr. Walden. All right. Could you talk to me about the 
Inter-Tel Trojan horse? What is that?
    Mr. Cothran. Well, that is another term that I made up when 
discussing the case internally with attorneys. That, to me, was 
how I described Inter-Tel serving as a Trojan horse for VNCI, 
because of the percentages of equipment differential that I saw 
in not only the San Francisco E-Rate application but in 
documentation related to other E-Rate applications for Inter-
Tel or NEC that were funneling VNCI equipment.
    When talking about the case internally, I explained to 
attorneys that in these situations, you know, if the same 
percentages that we saw in San Francisco, which was $15 million 
of a $20 million bid--of a $20 million Inter-Tel bid being VNCI 
equipment, it was really essentially a VNCI bid parading as an 
Inter-Tel bid, if you follow me, since the vast majority of the 
funding would have gone to pay for VNCI equipment. In that way, 
I explained to the attorneys in the office using that term, 
that at least in the case of San Francisco, Inter-Tel appeared 
to have been acting as a Trojan horse for VNCI, because of also 
the additional acts of concealing the ineligibles.
    Mr. Walden. And it was hidden on the form.
    Mr. Cothran. It was hidden. PBX parts lists that were 
submitted to USAC, according to a witness, purposely obscured 
the nature of the equipment, and not as it relates to San 
Francisco but as it relates to other school districts, 
documents indicate that, when USAC asked probing questions 
about that very equipment and about its functionality, that the 
answers that flowed back from the school district did not 
reveal that it was videoconferencing equipment. It is our 
strong belief and suspicion that those school district 
responses were controlled by Judy Green, George Marchelos, and 
representatives of Inter-Tel and/or NEC.
    Mr. Walden. When you say controlled by Judy Green or these 
others, is that to say that the school district had no 
knowledge of the responses?
    Mr. Cothran. I think what you are going to find eventually, 
and I think what we are going to find in the course of our 
litigation is a variety of situations across the country. You 
will sometimes find that there was a Desmond McQuoid figure at 
the school district who was knowledgeable about parts of the 
scam but not all of it.
    You will find, I would guess, situations where the school 
district officials were utterly blind to the fraud that was 
going on and were just more than happy to have these people 
getting them this money that was so sorely needed by their 
districts, which is one of the things that we found rather 
distasteful about this scam, is that they preyed on the 
desperation of poor, underfunded school districts.
    Mr. Walden. Are there other Judy Greens out there? Have you 
stumbled across any?
    Mr. Cothran. Not in the course of my investigation. I 
wouldn't be surprised.
    Mr. Walden. All right. We are going to recess now until 
1:30. There are some additional questions we have for this 
panel, and then we will reconvene, as I say, at 1:30. So we 
will stand in recess. Thank you again for your patience, and we 
look forward to reconvening after our votes.
    [Brief recess.]
    Mr. Walden. I am going to call the Subcommittee on 
Oversight and Investigations back to order, and I again thank 
you for your patience in bearing with our legislative schedules 
today.
    Mr. Cothran, there are a number of documents I would like 
to walk through with you, Tabs 51, 53, 58, 62, 124. We will go 
through them one at a time.
    Could you take us through the Item 25 review and the 
falsified documents that were submitted by Judy and George?
    Mr. Cothran. Well, as I pointed out in my testimony, there 
were several documents that flowed from the school district to 
USAC in response to USAC inquiries. It is my understanding that 
those inquiries from USAC existed on two levels: One, the sort 
of initial routine review that, I think, is performed on all 
applications; and then some applications, but not all 
applications, are selected for what is called an Item 25 
review, which is an elevated and more detailed level of review.
    All applications flowing out of San Francisco Unified 
School District that funding year were subjected to an Item 25 
review because of questions USAC had about how unit costs, 
which are amongst the highest in the nation, that attended the 
Desmond McQuoid applications and also the sort of what we in 
the City Attorney's office are terming the gold plating that 
went on with the proposal, the most striking example being the 
proposal to create a Local Area Network in every classroom 
which would have meant a server and switches in every 
classroom.
    So this is my understanding----
    Mr. Walden. What would a LAN in every classroom serve? Why 
would you do that?
    Mr. Cothran. It is the opinion of the City Attorney's 
office that it would serve no function other than to drive up 
the cost of the proposal and put more money in the pockets of 
the people who perpetrated this fraud.
    Mr. Walden. All right. Tab 58, Judy Green giving Desmond 
McQuoid responses for the SLD. Do you have a comment on that 
one?
    Mr. Cothran. This appears to be--Let me see. Okay, I did 
not have an opportunity to review this. So would you mind if I 
just read through it?
    Mr. Walden. That's fine. Go ahead and take your time.
    Mr. Cothran. Okay, I have read enough of it to issue my 
opinion on this. This is interesting to me. This puts together 
a piece of the puzzle I didn't have before.
    Mr. Walden. How so?
    Mr. Cothran. What I did know is that Desmond McQuoid sent 
an e-mail to USAC in response to USAC questions about budget 
documents that flowed from the school district to USAC 
purporting to show that there was more than $40 million in E-
Rate matching funds.
    An E-Rate reviewer, I believe, by the name of Tom Schnipp 
caught a discrepancy between that document that Mr. McQuoid and 
Mr. Tronson under his signature sent to USAC and the actual 
document that was on the website. I think it is also 
interesting for you to know that at this point in time the 
school district budget--this was in August of 2000. As you will 
see, this e-mail was on August 8, 2000.
    Mr. Walden. Yes.
    Mr. Cothran. The document that was sent from SFUSD to USAC 
purporting to show this E-Rate matching fund line item of $41-
some-odd million was dated August 1. Who knows when it was 
actually sent. I think it was actually sent more in the week of 
August 22, but I won't bog down with such niggling details.
    Desmond McQuoid--It is our belief that Desmond McQuoid, Tim 
Tronson conspired--and others, including people of VNCI, 
conspired to send this fraudulent budget document to USAC 
showing that they had the matching funds. As a matter of fact, 
they had more than the needed matching funds, $41 million.
    Unfortunately, that was a lie. That was just not true. 
Matter of fact, the school district had actually decreased 
their E-Rate matching fund line item elsewhere in the budget 
from $1.2 million, I believe, to zero. So they had----
    Mr. Walden. Zeroed out their line item matching.
    Mr. Cothran. For that year.
    Mr. Walden. For that year.
    Mr. Cothran. So this alert USAC reviewer, Tom Schnipp, 
caught this. They caught the discrepancy between the budget 
that flowed from Tronson, McQuoid and others to USAC and the 
one that was on the website. He simply went on the web and 
found the real budget.
    Then he e-mailed Desmond McQuoid.
    Mr. Walden. Right.
    Mr. Cothran. And asked him about this discrepancy. The e-
mail that flowed back from Desmond McQuoid's e-mail address at 
San Francisco Unified School District was a classic example, in 
my opinion, of tap dancing around a difficult question where 
you just don't want to answer it, because the answer would put 
you into trouble.
    This shows me for the first time that my long held 
suspicions, and our long held suspicions, that Judy Green 
directed him to do that or directed him in some way in 
answering that question was indeed confirmed by this e-mail. It 
shows that Judy Green sent to Des, which was the prefix of his 
e-mail address, how to answer the questions Tom Schnipp had.
    As I just read the first two or three items, it comports 
with my memory of Desmond McQuoid's e-mail to Tom Schnipp, this 
tap dancing e-mail that I told you about. So it indicates to me 
in a very clear way that Judy Green was behind the budget 
document flowing--the fraudulent budget document flowing to 
USAC, and also in attempting to help Mr. McQuoid explain away 
the discrepancy that resulted.
    Mr. Walden. Would you mind turning to Tab 124? I believe 
that is the budget, the altered budget, allegedly altered 
budget.
    Mr. Cothran. Oh, I got the date right. Good, August 1. I 
know that to be Tim Tronson's signature from other exemplars I 
have seen. If you look at Bates USAC Sub 4855 toward the bottom 
under the general category of Other Outgo----
    Mr. Walden. Right. The E-Rate District Manager.
    Mr. Cothran. The E-Rate District Manager. I have in my file 
received from the CFO of the school district this actual page, 
and it includes no such line item.
    Mr. Walden. And on the next page I think you will see the 
actual budget line item.
    Mr. Cothran. Right. Right. I actually have the actual--You 
are right, and this shows it, I believe, being zeroed out, if I 
am not mistaken.
    Mr. Walden. On 125, I guess.
    Mr. Cothran. Oh, on 125. I'm sorry. Right. This apparently 
looks like what Mr. Schnipp found on the website, which shows 
that Other Outgo line item on Bates 4796--there is no such line 
item. They simply got into that document and altered it and 
falsified it and sent it to USAC, and that e-mail indicates to 
me rather strongly that Judy Green was involved in that 
conspiracy.
    Mr. Walden. So you had a USAC reviewer--or not you, but 
there was a USAC reviewer who caught this, is what you are 
saying?
    Mr. Cothran. Yes. Based on written questions I submitted to 
E-Rate--Sorry. I submitted written questions to USAC at their 
request, and they submitted written answers sometime in the 
April timeframe of 2002, shortly before we filed our lawsuit. 
Amongst those written answers Mr. Schnipp explained to me his 
experience with this document.
    Mr. Walden. So he spotted it before you raised the 
questions?
    Mr. Cothran. I got most of my documents relating to the San 
Francisco Unified School District application from USAC. They 
were very helpful in that regard.
    Mr. Walden. But my point is, did you trigger Mr.--Sip, is 
it?
    Mr. Cothran. No. Mr. Schnipp did this all on his own.
    Mr. Walden. He did it all on his own? He spotted it?
    Mr. Cothran. He spotted it in the year 2000. My 
investigation didn't start until the following year.
    Mr. Walden. Okay. Then what happened with what he learned?
    Mr. Cothran. I reviewed his answers to my questions last 
night for the first time in a while, and he, in sum, told me 
that he doubted the accuracy of the document. His answer was 
not sufficiently--His questions about the discrepancy between 
the online document and the document Mr. McQuoid sent him were 
not settled by Mr. McQuoid's tap dancing e-mail.
    Mr. Walden. Got it.
    Mr. Cothran. And he alerted his superior, who at the time 
was, I believe, a gentleman named Mark Werner, given other 
information that flowed from USAC to me, who was then, I 
believe, the manager of program integrity assurance select 
review--I may have that title a little wrong--and alerted him 
to the problem.
    Mr. Walden. Verbally or in writing?
    Mr. Cothran. I don't think--Well, I don't think it 
specified, but what I do know is Mr. Schnipp informed in his 
written replies to my questions that he alerted his superior to 
this problem, and passed the file on up the chain of command, 
so to speak, with his concern attached to it, so to speak, and 
that was the last time he saw that file, and he could not 
answer my questions about why, despite this, the funding 
request was approved.
    At the time that he answered my questions, which was some 2 
years later, he still didn't know how and why and by whom it 
had been approved, according to his written answers to my 
questions.
    Mr. Walden. Have you pursued that line of questioning 
within USAC?
    Mr. Cothran. When I got the answers, it was in April of 
2002, and we were busy preparing a lawsuit, and our energies 
were focused on that. And, no, I did not pick up on that line 
of inquiry again.
    Mr. Walden. I guess the question would be: Is there any 
back-door channel going on here between USAC and some of the 
conspirators and co-conspirators?
    Mr. Cothran. I think that is a legitimate question to ask.
    Mr. Walden. All right. Could you turn to Tab 77? This is an 
e-mail describing how Judy Green at VNCI has a high level 
contact within USAC.
    Mr. Cothran. Yes, I read this earlier today. Seventy-seven, 
you said?
    Mr. Walden. Yes, sir. Do you think that Judy Green had a 
contact inside USAC?
    Mr. Cothran. Well, you know, I have always ascribed to 
Clint Eastwood's maxim of a man has to know his limitations, 
and as it regards this investigation I will observe that maxim, 
and I don't have any evidence that she did, and I really don't 
want to speculate on that.
    Mr. Walden. I understand.
    Mr. Cothran. I just think speculating on that would be 
irresponsible.
    Mr. Walden. I understand. But you do think it is a question 
that is worth asking of somebody?
    Mr. Cothran. Yes, I think it is a line of inquiry that is 
definitely worth following up, absolutely.
    Mr. Walden. All right. Looking at Tab 90, Desmond McQuoid 
e-mail discusses a year four 471 application, so for the fourth 
year 471 application, that Desmond says was submitted with his 
name on it that he knows nothing about.
    Mr. Cothran. That is my information as well. During the 
course of my investigation I uncovered evidence that Mr. 
Marchelos approached individuals at the school district the 
following funding year with an E-Rate application, walking into 
people's offices literally and trying to find some official at 
the school district to sign the document so that it could be 
submitted to USAC.
    An alert CFO assistant--assistant to the CFO had a 
conversation with Mr. McQuoid that she--I mean, sorry, Mr. 
Marchelos that she reported to me. Basically, her version--My 
memory of her version of events is that he was going into 
offices, looking for some sort of official signature to place 
on what I believe to be a 471 Form for year four, and I don't 
believe that was ever accomplished.
    Mr. Walden. Okay. That is not the one that Dr. Ackerman 
refused to sign, is it?
    Mr. Cothran. I don't know.
    Mr. Walden. All right. I don't mean to dwell on this, but I 
guess I will for a moment. I want to go back to this Judy 
Green/USAC issue. Has anybody told you they thought there might 
be a contact going on there?
    Mr. Cothran. Yes. I had one witness tell me that his belief 
was that--or suspicion was that she had someone inside USAC who 
helped her out.
    Mr. Walden. All right. I think we just have one more 
question for this panel. Do you have any reason to believe that 
the schools and school districts in which NEC BNS was either 
awarded or subcontracted other questionable E-Rate deals were 
at all complicit in the conspiracy to defraud the E-Rate 
program? So were there schools or school districts that you are 
aware of?
    Mr. Cothran. Where NEC was----
    Mr. Walden. Yes, in which NEC BNS was either awarded or 
subcontracted other questionable E-Rate deals? Were they at 
all--Were any of those school district complicit? I am 
delighted we have a Dr. Ackerman at San Francisco. Given what 
we are learning about all this, it seems like corruption can 
run rampant in this program.
    Mr. Cothran. The only information I have on that front is 
the information that the CEO and principal of Ceria M. Travis 
shared with me in those two interviews I had with her.
    It was my impression from those interviews that this 
individual, Ms. Johnson, Dorothy Travis Johnson, was 
uncomfortable with what was going on around her, was 
suspicious. Her antennae were raised by it, but she didn't 
understand enough about the process, either competitive bidding 
process or the E-Rate process, to follow through her thinking 
to the point where she would have been complicit or have guilty 
knowledge.
    That was my impression of her, but this was only from two 
brief phone interviews. So I think the value of that is 
somewhat limited.
    Mr. Walden. I think just one more question of each of you. 
As we struggle with this issue, do what is right to make sure 
the program functions as it was intended, that it doesn't get 
ripped off by people for ill gotten gains, what would you do if 
you were us? What are the one or two most important things we 
can do to fix USAC and fix the oversight?
    You know, you have answered everything so far. We will let 
you breathe for a second.
    Mr. Cothran. Thank you.
    Mr. Walden. Ms. Renne?
    Ms. Renne. Well, I think, first of all, with regard to 
school districts, as Dr. Ackerman indicated, you need to make 
sure that internally your procedures are strong. Of course, 
that is something only school districts can do, but certainly 
in the review process that ought to be looked at.
    I think, second, if I were sitting in your shoes, I would 
be taking a look at this program in not only San Francisco but 
in a variety of school district areas across the country, which 
I think you are already.
    Mr. Walden. Right.
    Ms. Renne. And I would certainly take a look at the 
organization that is doing the review. Are they sufficiently 
distanced from----
    Mr. Walden. Independent?
    Ms. Renne. And independent to be able to take an 
independent look at the program, and to be ready to ask the 
tough questions?
    Mr. Walden. Mr. Herrera?
    Mr. Herrera. To echo Ms. Renne's comments, I think that one 
thing that we have learned through our office's investigation, 
not just of this matter but other waste, fraud and abuse cases 
that we are looking into in our office, is the necessity for 
strict internal controls to make sure that the administrative 
agencies have their own house in order and, to the extent that 
you have a Federal overlay, obviously, there is the opportunity 
for waste, fraud and abuse to enter into it at another level.
    So at least from our perspective, certainly, there is a 
responsibility that school districts have their own internal 
house in order, and that aids investigative agencies 
immeasurably. But from your perspective, I think that looking 
at how the oversight of the program is structured and whether 
there needs to be more direct government oversight is something 
that, I think, you need to take a very serious look at.
    Mr. Walden. Well, it just really troubles me what I have 
come to better understand through this hearing and the data 
behind the hearing is that you have a dedicated public servant 
who within USAC says this doesn't look right, these budget 
numbers don't add up--I mean, I would think somebody would put 
a screeching halt on the whole application and demand a review 
to find out--At minimum, ask the question. I guess we will ask 
USAC that later, but then to go ahead and move forward when 
you've got an identified altered budget document.
    We are not talking pennies here. What is it, $48 million?
    Mr. Cothran. $41.5 million.
    Mr. Walden. 41.5.
    Mr. Cothran. And this is a document that had--You know, 
this is a point on which, I was informed by Mr.Schnipp, that 
had--they verified to a certainty further up the chain, I 
imagine, that they didn't have the funds.
    Mr. Walden. That it had been altered?
    Mr. Cothran. The decision would have been entirely the 
opposite, that they would have received no money.
    Mr. Walden. So they had verified with the school district 
that they had no money in their legitimate budget to match 
against this? Is that what you are saying?
    Mr. Cothran. I wouldn't put it that way. They verified by 
checking the budget document online that was the true budget 
document that was different from the budget document that Mr. 
McQuoid sent them, and now apparently with the help of Ms. 
Green. And they saw this discrepancy, this rather striking 
discrepancy.
    Mr. Walden. Do you know if the folks at USAC then got hold 
of the superintendent's office or the chairman of the school 
board or somebody and said, hey, we are seeing this 
discrepancy, can you explain it? Did they ever ask for an 
explanation, that you are aware of?
    Mr. Cothran. I don't know if they ever sought further 
confirmation through the school district. I think that is a 
question better put to USAC.
    Mr. Walden. For USAC? Okay. I really again appreciate not 
only your work but your testimony and your patience today with 
our process. Thank you very much for being here. We appreciate 
it.
    Mr. Walden. At this time the Chair will call forward the 
following witnesses: Mr. Thomas Burger, President and CEO of 
NEC Unified Solutions, Inc; Mr. William Holman, former Vice 
President of Sales for NEC BNS; Mr. George Marchelos, former 
consultant to and employee of Video Network Communications, 
Inc; and Ms. Judy Green, wherever she may be, former consultant 
to and employee of Video Network Communications, Inc.
    Please come forward and be seated at the table.
    Before we proceed any further, I would like to note the 
absence of Ms. Judy Green. The committee invited her to testify 
today, as I mentioned earlier, but she did not respond to that 
invitation as we requested.
    Subsequently, the committee issued a subpoena to command 
her attendance here. The United States Marshals have attempted 
for the past week to serve Ms. Green. They have staked out her 
home and have personally spoken to her husband, but she is 
nowhere to be seen, apparently shopping for a new home, but her 
husband does not expect to hear from her until Friday at the 
earliest. That is tomorrow.
    We will enter into the record the Marshals' e-mails 
regarding their attempts to serve the subpoena.
    [The information referred to follows:]


    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

    
    Mr. Walden. As you know, when conducting an investigative 
hearing, this subcommittee follows the practice of taking 
testimony under oath. So if you would, please rise and raise 
your right hand.
    [Witnesses sworn.]
    Mr. Walden. Let the record show they all indicated ``I 
do.'' Please be seated. Gentlemen, under the rules of the House 
and this committee, you have the right to be advised by counsel 
as to your Constitutional rights. Do you have legal counsel 
here today,Mr. Burger?
    Mr. Burger. Yes, sir, I do.
    Mr. Walden. Can you please state for the record the name of 
the counsel that is here today to advise you with respect to 
such matters?
    Mr. Niespolo. Mr. Chairman, my name is George D. Niespolo, 
and I am counsel for Mr. Burger.
    Mr. Walden. Thank you. The Chair--let's go on down then. 
Mr. Holman?
    Mr. Holman. Yes, Mr. Chairman, I am represented by counsel. 
It is Mr. Greg Evans.
    Mr. Walden. Okay. If you could kind of lean toward the 
microphone, that will be good.
    Mr. Evans. Good afternoon, Mr. Chairman and committee. My 
name is Gregory Evans of the law firm of Orrick, Herrington & 
Sutcliffe, representing Mr. Holman this afternoon.
    Mr. Walden. Thank you for being here. Mr. Marchelos?
    Mr. Marchelos. No, I do not.
    Mr. Walden. Do not have counsel? Okay. Mr. Donovan?
    Mr. Donovan. Yes, Mr. Niespolo is counsel for me also.

TESTIMONY OF THOMAS J. BURGER, PRESIDENT AND CEO OF NEC UNIFIED 
SOLUTIONS; INC; WILLIAM HOLMAN, FORMER VICE PRESIDENT OF SALES 
    FOR NEC BNS; GEORGE MARCHELOS, FORMER CONSULTANT TO AND 
 EMPLOYEE OF VIDEO NETWORK COMMUNICATIONS; JUDY GREEN, FORMER 
  CONSULTANT TO AND EMPLOYEE OF VIDEO NETWORK COMMUNICATIONS, 
INC.; AND TIMOTHY M. DONOVAN, FORMER SENIOR VICE PRESIDENT AND 
                 GENERAL COUNSEL, NEC USA, INC.

    Mr. Walden. All right. Thank you. The Chair now recognizes 
Mr. Burger for purposes of making an opening statement, if you 
so desire. Mr. Burger?
    Mr. Burger. I don't have an opening statement, no, sir.
    Mr. Walden. Very well. The Chair now recognizes Mr. Holman 
for purposes of making an opening statement, if you desire.
    Mr. Holman. Mr. Chairman, I do not have an opening 
statement. Thank you.
    Mr. Walden. Very well. The Chair now recognizes Mr. 
Marchelos for purpose of making an opening statement if you so 
desire.
    Mr. Marchelos. No opening statement, sir.
    Mr. Walden. Very well. We will be back at you in a moment, 
Mr. Donovan.
    Mr. Burger, this morning we heard from San Francisco City 
Attorney's Office, and this afternoon, about an elaborate 
conspiracy between individuals at NEC BNS and VNCI, including 
Judy Green, George Marchelos and others, in which the co-
conspirators eliminated competitive bidding and inflated prices 
on contracts related to the E-Rate program.
    As you know, NEC BNS pleaded guilty to conspiracy to 
suppress and eliminate competition for E-Rate program projects 
and to wire fraud.
    As the President and CEO of NEC BNS, were you aware of the 
conspiracy by NEC BNS, VNCI, Judy Green, George Marchelos and 
the others to defraud the E-Rate program by rigging bids, 
inflating contract prices, forging the signatures of school 
district officials, and lying to USAC during its review 
process?
    Mr. Burger. Mr. Chairman, as you know from my 
correspondence and my request to appear at a future hearing, it 
is my sincere desire to cooperate with this subcommittee's 
investigation. However, due to the ongoing Department of 
Justice investigation and on advice of counsel, I respectfully 
decline to answer the question on the basis of the privilege 
afforded me under the 5th and 14th Amendments of the United 
States Constitution.
    Mr. Walden. Mr. Burger, are you then refusing to answer all 
of our questions on the right against self-incrimination 
afforded to you under the 5th Amendment of the U.S. 
Constitution?
    Mr. Burger. Yes, Mr. Chairman.
    Mr. Walden. And is it your intention to assert such right 
in response to all further questions from the subcommittee 
today?
    Mr. Burger. Yes, Mr. Chairman.
    Mr. Walden. Given that, if there are no further questions 
from the members, I will dismiss you at this time, subject to 
the right of the subcommittee to recall you, if necessary. So 
at this time, you are excused.
    Mr. Burger. Thank you, Mr. Chairman.
    Mr. Walden. Thank you for coming.
    Mr. Holman, this morning we heard from the San Francisco 
City Attorney's Office about an elaborate conspiracy between 
individuals at NEC BNS and VNCI, including Judy Green, George 
Marchelos, and others, in which the co-conspirators eliminated 
competitive bidding and inflated prices on contracts related to 
the E-Rate program.
    As you know, NEC BNS pleaded guilty to conspiracy to 
suppress and eliminate competition for E-Rate program projects 
and to wire fraud. As the former Vice President of Sales for 
NEC BNS, were you aware of the conspiracy by NEC BNS, VNCI, 
Judy Green, George Marchelos, and others to defraud the E-Rate 
program by rigging bids, inflating contract prices, forging the 
signatures of school district officials, and lying to USAC 
during its review process?
    Mr. Holman. Mr. Chairman, on advice of counsel, I 
respectfully decline to answer the questions on the basis of my 
5th Amendment rights under the United States Constitution, on 
the basis that any testimony might be a witness against myself.
    Mr. Walden. Mr. Holman, are you refusing to answer all 
these questions on the right against self-incrimination 
afforded to you under the 5th Amendment of the U.S. 
Constitution?
    Mr. Holman. Yes, Mr. Chairman.
    Mr. Walden. And is it your intention to assert such right 
in response to all further questions from the subcommittee 
today?
    Mr. Holman. Yes, Mr. Chairman.
    Mr. Walden. Given that, if there are no further questions 
from the members, I will dismiss you at this time, subject to 
the right of the subcommittee to recall you, if necessary. So 
at this time, you are excused.
    Mr. Holman. Thank you, sir.
    Mr. Marchelos, this morning we heard from the San Francisco 
City Attorney's office about an elaborate conspiracy between 
individuals at NEC BNS and VNCI, including Judy Green, 
yourself, and others in which the co-conspirators eliminated 
competitive bidding and inflated prices on contracts related to 
the E-Rate program.
    As you know, NEC BNS pleaded guilty to conspiracy to 
suppress and eliminate competition for E-Rate program projects 
and to wire fraud. As a former employee of VNCI who extensively 
assisted Mr. Desmond McQuoid with San Francisco's E-Rate 
program, were you aware of the conspiracy by NEC BNS, VNCI, 
Judy Green and others to defraud the E-Rate program by rigging 
bids, inflating contract prices, forging the signatures of 
school district officials, and lying to USAC during its review 
process?
    Mr. Marchelos. Mr. Chairman, because of the ongoing 
criminal and civil investigations, I must invoke my 5th 
Amendment rights.
    Mr. Walden. Mr. Marchelos, are you refusing to answer all 
of these questions on the right against self-incrimination 
afforded to you under the 5th Amendment of the United States 
Constitution?
    Mr. Marchelos. Yes, sir.
    Mr. Walden. And is it your intention to assert such right 
in response to all further questions from the subcommittee 
today?
    Mr. Marchelos. Yes, sir.
    Mr. Walden. Given that, if there are no further questions 
from the subcommittee members, I will dismiss you at this time, 
subject to the right of the subcommittee to recall you, if 
necessary. So at this time, you are excused.
    Mr. Marchelos. Thank you, sir.
    Mr. Walden. At this time, the Chair calls forward our next 
witness, Mr. Tim Donovan, former General Counsel for NEC-USA. 
We appreciate your being at the table.
    As you know, in conducting an investigative hearing, the 
subcommittee has the practice of taking testimony under oath. 
We have already sworn you in under oath. So we appreciate your 
being here today, and I just remind you, you are under oath, 
and we would welcome an opening statement, if you have one, 
sir.

                 TESTIMONY OF TIMOTHY M. DONOVAN

    Mr. Donovan. Thank you, Mr. Chairman. Good afternoon to Mr. 
Chairman and the distinguished members of the subcommittee. My 
name is Timothy Donovan, and during the time period relevant to 
the matters before you today, I was acting as Senior Vice 
President, General Counsel and Corporate Secretary of NEC-USA, 
and I was also Corporate Secretary for NEC Business Network 
Solutions.
    Although I left that position at the end of March 2004 
after 20 years within the NEC organization, I remain an officer 
today, Corporate Secretary, of one of the other affiliates, and 
I am happy to be able to testify here today.
    For some time now, my colleagues and I have been asking 
ourselves what I am sure members of this distinguished 
committee are asking themselves as well: How did a good company 
with thousands of dedicated and hard working employees and a 
program with admirable goals get to the point we are today?
    I will do what I can to answer that question, but I think 
the more important question for NEC, since we have already 
admitted our wrongdoing, and for everyone involved in E-Rate 
is: How can we ensure this never, never happens again?
    During the time in question, BNS had more than 1,000 
employees spread across 36 offices around the United States. 
This company provided systems and installation maintenance not 
only to educational institutions, both under the E-Rate program 
and many other programs, but to the financial, health care and 
many other industries.
    During the time that BNS was actively involved in E-Rate, 
the program revenues were only about 3 to 5 percent of BNS 
total revenues. The company did not have more than five 
employees out of the 1,000-plus employees that worked for BNS 
dedicated to sales on E-Rate, and BNS' primary business focus 
was on the private sector. It is not typically a government 
contractor.
    BNS' first serious involvement in the E-Rate program began 
in late 1999. As the subcommittee may be aware, it is not 
unusual for a company like BNS to team with a consultant that 
is a specialist in a particular area, and VNCI held itself out 
as an E-Rate expert.
    In 1999, BNS entered into a teaming arrangement with VNCI, 
the consultant in the telecommunications field and the vendor 
of certain types of telecommunications products that were going 
to be offered. This initial effort involving NEC and VNCI was 
the project for San Francisco Unified School District, an 
opportunity that was identified for BNS by VNCI.
    From the moment NEC learned that DoJ was investigating San 
Francisco schools in 2001--and this was before NEC knew that it 
was the target of the investigation--and after we learned later 
that the company was itself a target in the inquiry, NEC has 
fully cooperated with the government.
    In October 2002 we made a commitment to the Justice 
Department to accept full and complete responsibility for the 
conduct of these employees, and sought to resolve all issues. I 
believe the committee has received a letter--the staff has 
received a letter from the Department of Justice which applauds 
NEC for its full and continuing cooperation in this 
investigation. This was not a cover-up situation.
    As part of that resolution announced this past May, BNS has 
taken steps to ensure that this conduct is not repeated and 
that all of its employees will act responsibly and properly.
    Some of these steps include empowering a compliance officer 
with broad powers to oversee compliance in government 
contracting and elsewhere. It is my understanding that a person 
with substantial government contracts and internal audit 
experience has accepted that position and will shortly start 
employment with the company Commencing the training of all 
employees in established ethics and compliance policies and 
procedures; implementing expanded services for its anonymous 
hotline, so that employees can report suspected wrongdoing or 
unethical conduct; scheduling regular audits of all government 
contracts; and BNS is also agreed to provide periodic reports 
and permit the FCC to conduct annual audits of all of its 
activities in this area.
    Our company has learned an expensive lesson, an 
embarrassing lesson, but certainly a valuable lesson. The E-
Rate program with effective oversight and management can assist 
needy schools.
    At the same time, please do not lose sight of the fact that 
there were many diligent, hard working field engineers and 
other employees within BNS who were implementing Internet 
solutions within schools unaware of the wrongdoing by a few. 
They believed they were making a meaningful effort to enhance 
the success of students in those schools. Mistakes that were 
made by a few BNS employees tarnished this effort and all of 
our beliefs.
    Thank you for allowing me to appear before you today, and I 
hope I can answer your questions.
    [The prepared testimony of Timothy M. Donovan follows:]
  Prepared Statement of Timothy Donovan Former Senior Vice-President, 
         General Counsel and Corporate Secretary, NEC USA, Inc.
    Good morning, Chairman Greenwood, distinguished members of the 
Subcommittee. My name is Timothy Donovan. During the time period 
relevant to the matters before you today, I was acting as Senior Vice-
President, General Counsel and Corporate Secretary of NEC USA, Inc. and 
Corporate Secretary of NEC Business Network Solutions, Inc. (BNS). 
Although I left my position at the end of March 2004, having completed 
almost 20 years within the NEC organization, I remain an officer today 
of one of the affiliated companies.
    I appreciate the opportunity to appear before the Committee today 
and address matters relating to the E-Rate Program, created by the FCC 
under the Telecommunications Act of 1996. As Secretary of BNS, I had no 
role in its day-to-day activities. Other corporate executives of BNS 
might have more direct knowledge of the events that are the subject of 
your questions today, but as you are no doubt aware, the Department of 
Justice is conducting an ongoing criminal investigation. It is expected 
that this investigation may be concluded in a matter of a month or so. 
I am advised that, due to the pendency of that investigation, legal 
counsel to other executives you invited to testify advised them that it 
would be inappropriate for them to testify today. I understand that 
counsel for these individuals have asked that these hearings be 
postponed until September or October, to give the Justice Department 
time to complete their ongoing investigation, so that management of BNS 
would be able to participate and give substantive testimony after the 
conclusion of that process. Since the Committee's schedule would not 
allow a postponement, and consistent with BNS' commitment to provide 
full and complete cooperation with all relevant inquiries into this 
matter, BNS asked, and I agreed to appear and give testimony for the 
Committee today. With your understanding of these circumstances, I will 
do my best to assist the Committee in its inquiry at this time.
i. background of bns involvement in the e-rate program in san francisco 
                             and elsewhere
    BNS was founded in 1989 as a multi-systems integrator and a direct 
sales and service organization for NEC America, the NEC America 
subsidiary that markets and sells telecommunications equipment and 
systems in the U.S. BNS designs, sells, installs and services a broad 
range of voice, data, and video communication systems and networks. BNS 
has in excess of 1000 employees spread across 36 regional sales and 
operations offices. A very small proportion of these employees ever had 
any involvement in the E-Rate Program.
    BNS' first serious involvement in the E-Rate Program began in late 
1999. Although BNS was aware of the program, prior to 1999 it had no 
significant involvement in the E-Rate Program, or government 
contracting in this sector, for all intents and purposes. In 1999, 
however, BNS entered into a teaming arrangement with VNCI, a consultant 
in the telecommunications field and vendor of certain 
telecommunications (video related) products. The main contact with BNS 
at VNCI during the early stages of the relationship was Ms. Judy Green. 
VNCI assisted BNS in identifying potential school districts and 
opportunities. Ms. Green and VNCI assisted the schools in their 
consideration of E-Rate funding. BNS participated in the E-Rate Program 
by selling and installing data equipment and telecommunications 
equipment to school districts that qualified for funding under the E-
Rate Program.
    BNS provided systems and installation and maintenance not only to 
educational institutions, but to the financial sector, healthcare 
sector, and many other industries and customers. During the time that 
BNS was actively involved in the E-Rate Program the E-Rate Program 
revenues constituted a little over 3% of the gross revenues of BNS. At 
the start of its venture into the E-Rate business, BNS had three sales 
and marketing employees who were involved full or part time in this 
sector. At the conclusion of BNS' participation, there were about 5. 
The activities were conducted for the most part in one of the company's 
regional offices in the San Francisco Bay Area. These individuals did 
not have extensive prior experience in government contracting or, for 
that matter, the E-Rate Program prior to the Year 3 bids that BNS 
submitted.
    The initial effort involving NEC and VNCI included the project for 
San Francisco Unified School District (the ``SFUSD''), an opportunity 
identified by Ms. Green and VNCI. This was a bid effort for what is 
generally referred to as Year 3 E-Rate Funding. In January 2000, a few 
weeks after establishing the teaming relationship with VNCI and Ms. 
Green, BNS submitted a bid for E-Rate work to the SFUSD. By the time 
BNS suspended all activity relating to E-Rate, it had already severed 
the consulting relationship with VNCI and Ms. Green.
   ii. the justice department investigation, bns cooperation and the 
                        resulting bns settlement
    In the Summer of 2001, BNS learned that there was an investigation 
into the SFUSD; and BNS cooperated with the investigation, unaware at 
that time that the investigation concerned BNS. By the end of October 
2002, it had become apparent to BNS that some of its employees' 
activities were in fact involved in the investigation. At that time, 
BNS retained independent legal investigators to begin a full scale 
internal investigation into BNS' E-Rate operations. That process 
continued over many months and included interviews of witnesses, review 
of documents, e-mail and other records. As soon as BNS began to 
appreciate the nature of the activities by this small group of 
individuals engaged in E-Rate Program marketing and sales, BNS 
suspended all requests for payment with the Schools and Libraries 
Division ("SLD"), pending a determination of the outcome of the 
investigation so as to ensure that there would be no further injury to 
the Government or to any other affected party as a result of continuing 
this business.
    BNS also resolved at that point that it should cooperate fully and 
completely with the federal investigators. BNS made a commitment to the 
Justice Department to accept full and complete responsibility for the 
conduct of the employees and sought to resolve all issues. Well along 
in the inquiry and negotiations, we learned that there was a civil qui 
tam complaint that the City and County of San Francisco had commenced. 
BNS sought to resolve this matter as well, as part of its overall 
resolution and commitment to make restitution. In order to make good on 
its commitment to resolve the criminal issues and the civil qui tam 
action, BNS agreed to pay, and did pay, $15 million in cash fines and 
restitution, and further agreed to provide equipment, continuing 
maintenance and services (valued at an additional $5.7 million) to 
school districts that are BNS customers under the E-Rate Program. We 
believe the Government has been made whole with this settlement. BNS 
sincerely regrets that the conduct by these several employees caused 
this kind of financial harm. Some of these individuals are no longer 
employed by the company. Any further action with regard to the others 
will be suspended until the DOJ completes its investigation as to 
individual culpability.
  iii. legislative solutions to the perceived problems in the e-rate 
                                program
    We understand that this Committee is making inquiry into what can 
be done to eliminate the factors that led to this disappointing state 
of events. BNS does not pretend to have answers to this inquiry from 
the standpoint of operations of the SLD and the E-Rate Program. 
However, from the vendor side, BNS has become aware that in the E-Rate 
Program arena, a few employees, improperly supervised, trained and 
overseen, can engage in conduct that, in short time, can cause a great 
deal of damage. In the BNS case, BNS is first and foremost a private 
sector vendor. There was no substantial line of business and operations 
dedicated to the government sector for any significant time period. 
Further, the company did not have the checks and balances in place to 
supervise the sales personnel who responded to this business 
opportunity. Working with the Justice Department, BNS is taking key 
steps to ensure that such conduct is not repeated and that all of its 
employees will act responsibly and properly. BNS is taking the 
following first steps as part of a long-term process to improve 
oversight and management:

 Empowering a Chief Compliance Officer with broad powers to oversee 
        compliance in governmental contracting and elsewhere.
 Commencing the training of all employees in established ethics and 
        compliance policies and procedures.
 Implementing expanded services for its anonymous hot-line for 
        employees to report suspected wrongdoing or unethical conduct.
 Scheduling regular audits of all government contracts.
    BNS has also agreed to permit the FCC Enforcement Bureau and the 
FCC-OIG, at BNS' expense, to conduct an annual audit of BNS' compliance 
with applicable laws and regulations relating to the E-Rate Program and 
other government sponsored or funded telecommunications programs. BNS 
will make annual reports to the FCC Enforcement Bureau and the FCC-OIG 
concerning its compliance with the established compliance policy.
    It would be impossible, from a legislative standpoint, to codify a 
code of conduct that might directly address all anticipated problems on 
the vendor side. However, from BNS' experience, it has become clear 
that any vendor involved in the E-Rate Program needs to have employees 
who are properly trained in the requirements of government contracting 
and, in particular, the rules and regulations of the E-Rate Program. To 
be sure, even in Year 3 of the E-Rate Program, there was still an 
absence of clear definition as to what products and services were to be 
funded and a lack of clarity in other areas as well. Bright line rules 
are better than leaving matters to subjective judgment. This, however, 
does not excuse in any way BNS' conduct, but the ambiguity fostered an 
environment for mistake, negligence and active misconduct to occur.
    We are also concerned that the present operational parameters under 
the E-Rate Program leaves an informational void between the vendor of 
systems and services and the school districts. School administrators, 
especially in the neediest districts, have little or no expertise in 
the installation of sophisticated voice, video, and data networks. The 
vendors do, but they are in the business of selling equipment and 
services that are requested by customers. This information void can be 
exploited by opportunistic or dishonest individuals in some cases. 
Although it would be laudable if vendors would spend their time and 
efforts in scaling down a project to save unnecessary expense for the 
school districts and the E-Rate program, since this would reduce their 
revenues, it is unrealistic to think this will often be the case, even 
in a competitive response to an RFP. Many of the school districts need 
to have the assistance and advice of an informed and independent 
consultant. They should not be left in a position of either asking the 
vendor to provide those consulting services or providing a reference 
for those services.
    The E-Rate Program, with effective oversight and management, can 
assist needy schools in acquiring technology that may enhance the 
education of children in the urban and rural schools. There were many 
diligent, hardworking field engineers and other employees within BNS 
who were implementing Internet solutions within schools unaware to the 
wrongdoing by a few. They believed they were making a meaningful effort 
to enhance the success of students in those schools. Mistakes that were 
made by a few BNS employees tarnished this effort and their beliefs.
    Thank you for the opportunity to appear before the Committee today.

    Mr. Walden. Mr. Donovan, thank you for appearing today. I 
noticed in your original draft statement submitted to the 
committee, you indicated you thought the Justice Department 
investigation would be over in a matter of a month or so. Is 
that a view you still hold?
    Mr. Donovan. That is a little speculative. Counsel for the 
company that has been cooperating with the Justice Department 
believes that the investigation, which is still continuing--
there is a Grand Jury proceeding--insofar as NEC employees may 
be completed to a point where some of the employees would be 
able to testify.
    Mr. Walden. Okay, because I noticed in the press release 
that was put out, you indicate--or your press people at least 
indicate circumstances may change in the near future which may 
allow executives to participate subsequently before the 
subcommittee hearing. But that--the press release doesn't make 
any reference to the investigation being concluded within a 
month or so. I just wondered.
    Your draft release indicates September or October, complete 
the investigation. There seems to be a month or so or September 
or October--It's kind of an interesting couple of days. 
something must have changed.
    Mr. Donovan. I don't think so. I think, as you know, that 
schedule is not up to NEC or to the individuals who are under 
investigation. So it is a good faith guess.
    Mr. Walden. Okay. Isn't NEC's position about the ratio of 
E-Rate revenues to total company revenues a red herring? We 
have been told this was like a very small portion of NEC BNS's 
revenues or NEC's revenues, the E-Rate program itself.
    Mr. Donovan. Three to 5 percent as a of business, and I 
think that is the way the E-Rate program was viewed. It was 
almost like a new line of business with some different factors 
and circumstances that needed to be dealt with. Three to 5 
percent would not be a large business line.
    Mr. Walden. But wouldn't that business line have doubled, 
had the 471 been approved by USAC for San Francisco? Wouldn't 
it have taken it to $100 million or something?
    Mr. Donovan. I don't know.
    Mr. Walden. Well, I think we have those numbers, don't we? 
I think it would have nearly doubled.
    Mr. Donovan. This is for the San Francisco school district?
    Mr. Walden. Well, for your overall revenues, it would have 
nearly doubled them in this line, business line. I'm a small 
business owner. If some chunk of my business that was 3 percent 
was suddenly going to double, I would probably sit up and take 
notice, and I would think the managers down the line would want 
me to take notice, if I were CEO, and say, look at what we are 
doing for you. Did that happen in your company?
    Mr. Donovan. Could you rephrase the question? I'm not sure 
how to answer that.
    Mr. Walden. Well, I want to know who knew and what they 
knew, bottom line.
    Mr. Donovan. Yes.
    Mr. Walden. And I guess, maybe in a big company like NEC, 3 
percent of revenue doesn't matter, but if you are going to add 
3 percent--If you are going to basically double this line of 
business with this, looked to me like, one contract, I would 
think somebody would be saying look at me, look at me, I'm over 
here in this division of the E-Rate, new line of business, and 
look at what we are able to do here. Did that happen?
    Mr. Donovan. That could be the case, but in my experience 
as an attorney for the last 20 years-plus, people who were 
doing some of the things that we are hearing about today and 
that I as a former NEC employee am not proud of, by any means, 
do not flag those situations.
    So it would not be surprising to me that, if people were 
engaged, and we believe they were, in the kinds of things that 
were happening, they would do everything they could to hide 
that.
    Mr. Walden. Right, but somebody is above them. Right?
    Mr. Donovan. Yes.
    Mr. Walden. And I assume, aren't there like monthly revenue 
forecasts in your company?
    Mr. Donovan. There are periodic revenue forecasts.
    Mr. Walden. Okay, periodic. Is there a look at new 
contracts coming in?
    Mr. Donovan. I'm not sure. There are thousands of contracts 
that come in. This one would have been a larger contract, but 
not the largest. That is not my belief. But there are many, 
many----
    Mr. Walden. There could be a larger contract?
    Mr. Donovan. I would think so, yes.
    Mr. Walden. Okay. So you got a couple of folks down here 
doing nefarious acts. Somebody above them, though--Who did they 
report to?
    Mr. Donovan. They being who, Congressman?
    Mr. Walden. The people who have been identified as engaging 
and working with your company. I mean, there were people in 
your company, obviously, who knew something was wrong. Right?
    Mr. Donovan. At some point, yes.
    Mr. Walden. I mean, you have admitted to that in your 
settlement, haven't you?
    Mr. Donovan. Today, yes, we wish we could have done a lot 
of things differently, Congressman. The question is this was 
not a single isolated case. It involved the San Francisco 
School District. There were acts which took place over a period 
of time, and the question as to when different people realized 
what was going on is a difficult question to answer.
    Mr. Walden. Let's go to Tab 27, sir, if you would. This is 
an e-mail from--and I apologize up front--Zahid Masoud to a Mr. 
Tom Burger and to you--well, no, to Mr. Holman.
    Mr. Donovan. Scared me for a moment.
    Mr. Walden. No, I am sorry. To Glen Means. So Mr. Holman, 
Mr. Means, Mr. Burger, and cc'ed to Mr. Rathinson and to Bob 
Bliss. It calls VNCI pricing, and it says importance is high. 
``Gentlemen, below you will find the pricing summary of the E-
Rate projects as we bid to the individual school districts. I 
have also included attachments detailing pricing for each of 
these projects. Glen, you can find in-kind NABSE bonuses in the 
value added section. I will be on hand for the 9 a.m. meeting 
to discuss further. Zahid.''
    Now who is Mr. Burger? Wasn't he the gentleman who was just 
here?
    Mr. Donovan. Yes.
    Mr. Walden. And what would this summary sheet on submitted 
bids for the E-Rate projects be?
    Mr. Donovan. I don't know. Sorry.
    Mr. Walden. Well, it is titled ``Summary sheet on submitted 
bids for the E-Rate projects.''
    Mr. Donovan. Yes.
    Mr. Walden. And what role is Mr. Burger in on February 18, 
2000, in the company?
    Mr. Donovan. He was the Chief Executive Officer of the 
company.
    Mr. Walden. All right. So the bids for these E-Rate 
projects that amount to 3 percent of your business were being 
provided to the CEO of the company. Correct?
    Mr. Donovan. It looks that way. Yes. Can you point me to--
--
    Mr. Walden. I'm sorry, did you not get the tab?
    Mr. Donovan. I have it, yes. What I would like to know is I 
am not sure where the wrongdoing is in this. I am looking at 
this for the first time.
    Mr. Walden. Well, I didn't say there was wrongdoing in 
this, but if you think there is, we can explore that. But my 
point was who knew in the company. What I thought I have heard 
you say is that this was such a small part of the business, you 
didn't know where it went up in the chain, because I was asking 
about reporting. You know, wouldn't revenue--a new line of 
business, who knew in the company?
    This e-mail would indicate the CEO at least knew of these 
E-Rate projects and the bids that were submitted. If this is 
that small a piece of business, does every project where there 
is a bid go to the CEO?
    Mr. Donovan. I don't know the answer to that.
    Mr. Walden. This is a $131,249,100 total project bids and 
accepted for 471.
    Chairman. Barton. Would the chairman yield on that point?
    Mr. Walden. I certainly would, Mr. Chairman.
    Chairman. Barton. You, Mr. Donovan, at this time were 
General Counsel for BNS. Isn't that right?
    Mr. Donovan. I was General Counsel for the holding company, 
NEC USA, but my staff also provided legal services to this 
company. That is correct.
    Chairman. Barton. In this year, calendar year 2000, do you 
recollect what the total revenues of the company were in the 
United States?
    Mr. Donovan. I don't know offhand, but I know it was 
probably several hundred million dollars.
    Chairman. Barton. Several hundred?
    Mr. Donovan. Million.
    Chairman. Barton. Million. So $131 million would be a 
significant portion, if your total revenue were several hundred 
million.
    Mr. Donovan. I don't know if this was a single period. 
Sometimes when bids are submitted, there is a long period of 
time between the date that the bid is submitted and a contract 
is begun, but I am not sure----
    Chairman. Barton. But, I mean, you would admit that, if you 
were CEO of a company and a revenue projection was presented to 
you that, let's say, is 25 to 50 percent of your total revenue, 
you would look at it.
    Mr. Donovan. If I were CEO?
    Chairman. Barton. Yes, sir.
    Mr. Donovan. Yes, I would look at that.
    Chairman. Barton. Okay.
    Mr. Donovan. I am not sure what detail I would look at it, 
but certainly I would be very interested in that.
    Chairman. Barton. Well, I would certainly look at it in 
great detail. I yield back.
    Mr. Walden. Well, Mr. Chairman, I would also like to know 
from the company who was on hand at the 9 a.m. meeting to 
discuss this further, since this was sent to Mr. Burger, Mr. 
Means, Mr. Holman and cc'ed, obviously, Mr. Bliss and Mr. 
Rathinson.
    Mr. Donovan. Rafinson.
    Mr. Walden. Thank you. And it would imply that perhaps all 
these people were going to be at whatever this meeting was at 9 
a.m. Do you know if there are minutes of that meeting 
available?
    Mr. Donovan. I don't.
    Mr. Walden. Do you know who attended that meeting?
    Mr. Donovan. No, I don't know. I'm sorry.
    Mr. Walden. Do you know if at the bottom of this--At the 
bottom of this same memo, it is marked Confidential. It says, 
``The above districts include 45 NEC PBX systems, almost all of 
them NEACs 2000.'' Then it appears there are Excel spreadsheets 
for each district included.
    I wonder, are those spreadsheets available in the form that 
either--the form that they are referenced here?
    Mr. Donovan. May I speak with counsel?
    Mr. Walden. Sure. Certainly, sir.
    Mr. Donovan. Yes, they are.
    Mr. Walden. And have those been supplied to the committee 
yet?
    Mr. Donovan. Not yet.
    Mr. Walden. When would it be possible to produce those 
spreadsheets, gentlemen?
    Mr. Donovan. As soon as possible, tomorrow or Monday. Yes.
    Mr. Walden. All right. Thank you. That would be helpful to 
know.
    My time has expired. I will turn to the gentle woman from 
Colorado.
    Ms. DeGette. Thank you, Mr. Chairman. Now, Mr. Donovan, I 
guess I have been trying to figure out what you are doing here 
today. So I just want to ask you a little bit of question--
other than the fact you are the lawyer. But now Mr. Burger and 
Mr. Holman were both employed by the company during this 
timeframe. Correct?
    Mr. Donovan. Correct.
    Ms. DeGette. And they took the 5th today because of the 
ongoing criminal investigation. Correct?
    Mr. Donovan. Correct.
    Ms. DeGette. So you have been sent over to testify, and so 
I want to ask you some questions.
    Now during this time period, you were the Senior Vice 
President, General Counsel, and Corporate Secretary of NEC. 
Correct?
    Mr. Donovan. NEC USA. Correct.
    Ms. DeGette. And you were also the Corporate Secretary of 
BNS. Correct?
    Mr. Donovan. Correct.
    Ms. DeGette. Now as you yourself said in your written 
testimony, you did not have any role in BNS's day to day 
activities. Correct?
    Mr. Donovan. Not directly, no.
    Ms. DeGette. Now you were the legal counsel for--Were you 
the legal counsel for BNS and also for NEC USA?
    Mr. Donovan. The NEC USA Legal Department, which has about 
six attorneys, is legal counsel for most of the NEC companies 
in the United States.
    Ms. DeGette. And that would include BNS?
    Mr. Donovan. Yes, it would.
    Ms. DeGette. And were you the supervisor of the lawyers in 
the legal counsel's office?
    Mr. Donovan. Correct.
    Ms. DeGette. So, basically, they were the ones reviewing 
contracts and negotiations, and then you were supervising that. 
Would that be a fair characterization?
    Mr. Donovan. Yes, it would.
    Ms. DeGette. Now in your written testimony and, I think, 
also orally, you said in 1999 BNS entered into a teaming 
arrangement with VNCI. Correct?
    Mr. Donovan. That is my understanding.
    Ms. DeGette. Were you involved in the negotiation of that 
teaming arrangement?
    Mr. Donovan. No, I was not.
    Ms. DeGette. Were you aware of the arrangement at all?
    Mr. Donovan. Not at that time, no.
    Ms. DeGette. Did you review any kind of a contract with 
VNCI?
    Mr. Donovan. No, I did not.
    Ms. DeGette. Did anybody in your office review that 
agreement?
    Mr. Donovan. I don't know if anyone reviewed that 
agreement, but to answer your question, typically teaming 
agreements, which are very, very common when you are dealing 
with large systems with different types of products--they are 
very common. Assuming that they are used correctly, they are 
not illegal.
    Ms. DeGette. Well, absolutely. I know that. But what you 
are saying is maybe a teaming--If it is a routine teaming 
agreement done in the course of business, that would not 
necessarily be reviewed by one of the attorneys. Is that what 
you are saying?
    Mr. Donovan. Not by an attorney.
    Ms. DeGette. Okay. So you don't know whether this was or 
wasn't, but it wasn't reviewed by you?
    Mr. Donovan. Correct.
    Ms. DeGette. Now do you know how VNCI came to enter into an 
agreement with BNS?
    Mr. Donovan. No, I am sorry. I don't.
    Ms. DeGette. Do you know who would know?
    Mr. Donovan. No, I don't.
    Ms. DeGette. So you don't know what the relationship of the 
parties was, whoever was representing BNS and whoever was--
Well, I guess it was probably Judy Green. Right?
    Mr. Donovan. Of VNCI?
    Ms. DeGette. Yes.
    Mr. Donovan. It appears that way.
    Ms. DeGette. Now you say it appears that way. Is that 
because of information you have subsequently received?
    Mr. Donovan. Yes.
    Ms. DeGette. At the time this transaction was entered into, 
did you know Judy Green?
    Mr. Donovan. No.
    Ms. DeGette. Okay. Have you ever met Judy Green to this 
day?
    Mr. Donovan. No, I have not.
    Ms. DeGette. And I assume you don't know where she is, 
because we are looking for her.
    Mr. Donovan. I'd rather not have anything to do with Judy 
Green.
    Ms. DeGette. I would believe that.
    Mr. Donovan. But I wish you much success in finding her.
    Ms. DeGette. Thank you. Okay. So you basically can't tell 
us about how BNS came to enter into this arrangement.
    Mr. Donovan. Not this arrangement. Correct.
    Ms. DeGette. Okay. Well, looking at Tab 27 which is this e-
mail about all the other E-Rate projects, do you know how any 
of those arrangements came to be entered into?
    Mr. Donovan. No.
    Ms. DeGette. No, because you didn't have day to day 
involvement in this?
    Mr. Donovan. That's correct.
    Ms. DeGette. Okay. Now I just ask you again. Have you 
subsequently learned who at BNS entered into this teaming 
arrangement? Who was the individual who did it?
    Mr. Donovan. There should be a signature on the written 
agreement.
    Ms. DeGette. Yes, it was Mr. Holman. Have you reviewed any 
of that?
    Mr. Donovan. I probably have seen that during the course of 
the investigation.
    Ms. DeGette. All right. But you didn't see it sooner?
    Mr. Donovan. No.
    Ms. DeGette. Okay. Now you testified about a small group of 
individuals at NEC BNS who were engaged in E-Rate program 
deceptions. What are the names of the small group of 
individuals?
    Mr. Donovan. I think the names are in the records that have 
been provided, but I would like to speak with counsel.
    Ms. DeGette. Be my guest.
    Mr. Donovan. The names that I have seen on the 
correspondence include Mr. McNulty, Mr. Collen, Mr. Holman, 
Sohail--sorry, I can't pronounce his name either. He is in the 
record before you, I think, from a previous question. Those are 
some of the individuals who are involved.
    Ms. DeGette. All right. And has the company conducted an 
internal investigation to see whether the individuals involved 
in deceptions--whether the group is broader than that?
    Mr. Donovan. The company responded, yes, with an internal 
investigation before we realized the scope of what was going 
on, when we first realized something is wrong. That internal 
investigation led to the retention of outside legal counsel who 
were more experienced with this type of investigation, and when 
they advised us of what was involved, we worked with the 
Justice Department.
    Ms. DeGette. Now Mr. Burger is still the CEO of the 
company?
    Mr. Donovan. Yes, he is.
    Ms. DeGette. Is Mr. Holman still employed with the company?
    Mr. Donovan. No, he is not.
    Ms. DeGette. And do you have any evidence that Mr. Burger 
was involved with these transactions?
    Mr. Donovan. Again, I would like to speak to counsel.
    I am not aware of any.
    Ms. DeGette. Has your company instituted any new procedures 
designed for this type of activity in the future?
    Mr. Donovan. Yes.
    Ms. DeGette. Could you please describe those procedures for 
us?
    Mr. Donovan. Yes, I can. Probably the most important is the 
hiring of a person who has quite a bit of knowledge about 
government contracts and, at the same time, internal audit 
procedures. One of the reasons this may have occurred is 
because there were insufficient checks and balances, not so 
unlike the school district that testified earlier today.
    The internal audit department has been expanded, and this 
person will take a very leading role in any type of activity 
like this in the future.
    We have also started training programs for employees about 
this particular type of problem, and we have also instituted an 
800 number and provided training and quite a bit of marketing 
information about that number to encourage employees to use it.
    Ms. DeGette. Do those audit procedures and also the anti-
fraud procedures you have put in place include having these 
contracts reviewed by legal counsel?
    Mr. Donovan. Any government contract will be passed first 
to the person with the expertise in that area, and then will 
involve Legal. It is my understanding, although I am not 
directly involved with the company since April 1, that the 
General Counsel, who I know very well, and this new person will 
work hand in glove to make sure this does not happen again.
    Ms. DeGette. When were the procedures instituted?
    Mr. Donovan. Some of the procedures--it has been ongoing 
during this process. The anonymous hotline was instituted 
earlier this year before I left the company. That would be 
probably January or February of this year.
    The compliance officer--I am not sure how long a search 
that was, but the compliance officer accepted an offer and will 
start--this is a person outside the company with substantial 
experience. They will be starting soon.
    Under the continuing work with the Justice Department, NEC 
is going to be filing expanded policies, and some of the 
training has already commenced.
    Ms. DeGette. All right. Let me just say, because everyone 
else left, I will communicate to you how seriously this 
committee obviously takes this investigation, and I appreciate 
you being willing to come and testify. Unfortunately, of 
course, the events we need to know about are not within your 
knowledge.
    So, Mr. Chairman, if I may, I think it is going to be 
critical for us to try to have the rest of these employees come 
back, Mr. Burger, Mr. Holman, when we find Judy Green; because 
Mr. Donovan doesn't know a doggone thing about the transactions 
here. I do appreciate him coming and talking about the 
company's investigations and corporate practices, but it 
doesn't get to the meat of the issue. I yield back. Thank you.
    Mr. Donovan. I'm sorry.
    Mr. Walden. Thank you for your questions and your comments, 
Ms. DeGette. I couldn't agree more.
    The Chair now recognizes the chairman of the full 
committee, Mr. Barton.
    Chairman. Barton. Thank you. I have to ask a few just kind 
of simplistic questions to make sure I understand the current 
framework.
    Mr. Burger, who is listed as President and CEO of NEC, took 
the 5th Amendment. He is still the current President. Is that 
correct?
    Mr. Donovan. That is correct.
    Chairman. Barton. Mr. Holman is a former Vice President of 
NEC. He also took the 5th Amendment. What is his relationship, 
if any, with NEC today?
    Mr. Donovan. He is no longer employed by NEC. His 
employment was terminated at some point in the past.
    Chairman. Barton. But he is not a current--He has no 
affiliation?
    Mr. Donovan. None.
    Chairman. Barton. And his separation from NEC was voluntary 
or involuntary?
    Mr. Donovan. His separation was involuntary.
    Chairman. Barton. And Mr. Marchelos is listed as a former 
E-Rate consultant with VNCI, which is not affiliated other than 
through a contractual affiliation with NEC.
    Mr. Donovan. That is correct.
    Chairman. Barton. And, of course, Ms. Green who did not 
appear is of the same affiliation as Mr. Marchelos. You were 
listed as a former Senior Vice President and General Counsel 
for NEC. What, if any, is your affiliation with NEC today?
    Mr. Donovan. I continue to have a consulting agreement with 
NEC, but I am not a full time employee.
    Chairman. Barton. You are a consulting?
    Mr. Donovan. And I am Corporate Secretary for NEC 
Laboratories America, which is a research institution in 
Princeton, New Jersey.
    Chairman. Barton. And what affiliation do they have with 
NEC?
    Mr. Donovan. NEC Laboratories America is a wholly owned 
subsidiary of the holding company for whom I was employed until 
recently.
    Chairman. Barton. Now at the time in question in 1999 and 
2000, you were General Counsel for NEC USA?
    Mr. Donovan. Correct.
    Chairman. Barton. And in that capacity, what level of 
contracts would you normally personally be appraised of?
    Mr. Donovan. The attorneys would be involved with unusual 
contracts, and this may be confusing. I hope you will allow me 
to explain.
    We sometimes have contracts which involve many, many 
dollars, but the product itself is very simple. An example 
would be cellphones. Those might be sold on the basis of a 
purchase order. So even though this might be a $25 million 
order for cellphones, the attorney would not need to look at 
the contract. It is a purchase order basis.
    A contract, for example, like a software development 
contract for a new product, that is the type of contract that 
very often might involve the attorney input, because it is a 
new contract.
    Chairman. Barton. Okay. Now you are here today as a 
consultant to NEC, and you are not taking the 5th Amendment, 
and I don't want to lead you. But apparently, your role, your 
former role as General Counsel, and your current role as a 
consultant apparently is not part of the ongoing investigation. 
Is that correct?
    Mr. Donovan. That is a broad question.
    Chairman. Barton. It is.
    Mr. Donovan. I did not take an active role in the 
investigation but, certainly, when the company realized that 
wrongdoing had taken place, I was advised by the attorney who 
worked on the investigation of the matters and the seriousness 
of those matters.
    Chairman. Barton. Well, I am puzzled, because the company 
that you were the General Counsel of has entered into a plea 
bargain, and we've got a copy of it, in which you have paid a 
fine and given in-kind services, equipment, that is over $20 
million.
    In that plea bargain, the essence of it is that a few 
employees lower in the food chain did something wrong, and as 
soon as senior management found out about it, put a stop to it, 
and you are moving on down the road.
    Now if that is the case, there is no reason to take the 5th 
Amendment. Now the company has entered into a plea bargain, and 
you know, we've got it, and you all have good guys or your 
former company is doing the right thing. So I don't understand 
why we have to go through the spectacle that we just went 
through of standing up and taking the 5th Amendment while 
sending out press releases that you are doing everything you 
can to cooperate.
    If you've got nothing to hide, there is no reason to take 
the 5th Amendment. You are an attorney. You are General 
Counsel. I mean you are here.
    Mr. Donovan. Yes.
    Chairman. Barton. So apparently you believe you have 
nothing to hide, and your counsel believes you have nothing to 
hide. I just don't understand that.
    Mr. Donovan. This is not a simple situation, as you are 
very much aware, and in trying to see how I could explain the 
fact that some of the people are still employed with NEC, I 
tried to think of some way to come up with analogy, and the 
analogy would be this.
    We all watch television, and some of you may be former 
prosecutors or law enforcement. The first thing you do at a 
crime scene, you touch nothing. The first thing that we did 
when we spoke with the Justice Department was turn over all the 
evidence we had from the internal investigation.
    We cooperated with them in providing that information, and 
we have also, it is my understanding, had discussions with them 
about where they are in terms of the individual culpability of 
the employees.
    It is also my understanding that until some of the Grand 
Jury investigations which are pending are completed, NEC is not 
going to take any further involvement. Specifically, I was 
asked about Mr. Burger. Although his name may appear on an e-
mail or two, it is my understanding that there is nothing which 
shows that he was involved in these discussions about changing 
numbers, changing prices and so on.
    Chairman. Barton. And we are not alleging. This committee 
is not alleging that he personally was involved. We are just 
puzzled that he won't testify if, as his press release says, 
he's got nothing to hide.
    Now we do have documents that are in the record that show 
that he is at least aware that VNCI submitted a bid for $37 
million on behalf of VNCI and his company, NEC; and it was 
rated a high priority that he take a look at it. So I mean, he 
was at least aware, if he read the e-mail and attended the 
meeting, that quite a bit of business with VNCI was being 
generated, and a big chunk of that was coming through the San 
Francisco Unified School District.
    So I think it would be fair for this committee, if he had 
agreed to testify, to ask a few questions about what he knew 
about that. But the company has admitted in a plea bargain 
arrangement $20 million worth of compliance or retribution or 
whatever you want to call it.
    I want to ask some questions about VNCI. What do you know 
about VNCI? Do you know anything about their business model?
    Mr. Donovan. No.
    Chairman. Barton. Do you know what their general revenues 
are?
    Mr. Donovan. No, I don't.
    Chairman. Barton. Do you know if they are a target of this 
ongoing investigation by the Justice Department?
    Mr. Donovan. I think that they are. I know VNCI was a 
consultant. I know that NEC didn't know much about E-Rate, and 
that was a mistake. I am not trying to justify that.
    Chairman. Barton. Did you, when you were General Counsel, 
review the general contract that was signed with VNCI?
    Mr. Donovan. No, I did to.
    Chairman. Barton. Okay. At what level of the Counsel's 
office would that contract be reviewed?
    Mr. Donovan. A teaming agreement would probably not be 
reviewed at all unless----
    Chairman. Barton. Regardless of the amount of dollars 
involved?
    Mr. Donovan. As I had mentioned, the amount of dollars is 
not always----
    Chairman. Barton. You said it was a special--Here is a 
company that you all had never done business with in an area 
you claim not to have ever attempted to do business in, and 
this company comes in, in the e-mail offering $131 million 
worth of business. It is a new company. It is a new area, and 
yet nobody in the General Counsel's office would review that 
contract? I find that hard to believe.
    I am not saying you would review it, but somebody in the 
General Counsel's office, I would think, would review that.
    Mr. Donovan. I wish that someone in the General Counsel's 
office had reviewed that, Congressman. The reality is there are 
six attorneys, thousands of contracts, and somehow what you 
have to do is figure out where you can make the most impact.
    I think that part of the mistake that NEC made was exactly 
what you are describing, that when this came in, it should have 
been flagged as an area of business that this particular 
business group was not involved in and, if it really involved 
$130 million of business, we should have put people with 
government contract experience on. If we didn't have them in 
the General Counsel's office or in the contract administration 
group, then we should have brought them in from the outside. We 
didn't do that.
    Mr. Walden. Would the gentleman yield for a moment on this 
point?
    Chairman. Barton. Sure, since my time just expired.
    Mr. Walden. I'll try and figure out which tab this is, but 
we do have an e-mail relative to this that was sent to Mr. John 
Holman, a draft of which, I believe--Well, I don't know who 
else it went to. Maybe it did go to--I thought it went to Mr. 
Burger. One form of it went to Mr. Burger.
    In it, there is a whole paragraph here that talks about 
risks with partnering with VNCI where NEC is the prime 
contractor. I believe that was one of the questions you were 
trying to get to the heart of. I believe it is Tab--Is it 22? 
Is that right?
    It says, ``VNCI is a small company traded publicly at the 
NASDAQ. They are not financially sound, but see this 
opportunity which can contribute 35 to 40 percent to their this 
year's sales numbers. They expect to do about $17 million this 
year. I have checked with the sales engineers, and we can 
substitute other products to fulfill BNS obligations as a prime 
in the event VNCI becomes insolvent.''
    So it is the third page of Tab 21. I'm sorry.
    Chairman. Barton. Well, while he is reviewing that 
document, my main point is here is a business relationship that 
has developed out of whole cloth, and a fair amount of revenue 
is generated right off the bat, and nobody at NEC apparently 
took the time to determine the genesis of where that revenue 
was coming from. It's just manna from heaven. It is just 
appearing on the balance sheet, and everybody thinks it is 
just--Is it, you know, don't ask, don't tell, because you don't 
want to know the answer?
    I mean, you were general counsel. Surely, there were 
meetings in which revenue projections and estimations according 
to sales projects from prior years were discussed, and here is 
this revenue stream coming up, and to your knowledge, none of 
the senior management expressed any wonderment about this at 
all? That just begs credulity, that there wouldn't be somebody 
that said, well, where is that coming from? How are we getting 
it? What are the underlying--What is the real product and the 
real genesis of the revenue stream?
    Apparently, until the San Francisco School District and the 
city of San Francisco started asking questions, nobody in the 
company, either company, did anything but make sure the checks 
that might come in were cashable. Do you have a comment on 
that?
    Mr. Donovan. That is a long question, Congressman. Yes, I 
do have a comment on it, because this has been an embarrassing 
chapter for NEC, and I think that all NEC employees, not just 
those people who were involved in the wrongdoing, share some of 
the taint from that.
    This did not come in as a situation where someone said, 
listen, we want to defraud the city of San Francisco out of a 
whole bunch of money. It is very typical to have consultants 
involved in these kinds of projects.
    Very often the school districts hire the consultants. I 
think, as one of the people from San Francisco said, when those 
consultants are truly independent and doing their job, that is 
a great check and balance on the situation.
    In this particular case, I am not sure, and I have not seen 
anything which would have let someone know early on at the high 
level in NEC--we are talking about the CEO and the General 
Counsel for that company--that there was something amiss. 
Certainly, people who attended some of the sessions where 
numbers were marked should have known something was wrong. They 
weren't telling the General Counsel and the CEO that they were 
doing that. That is what I have seen from the record.
    Chairman. Barton. Well, my time has expired. I am going to 
read into the record Tab 18 of our binder. It is an e-mail 
dated January 13, 2000. It is from Bill Holman, who at that 
time was Vice President of Sales. He has since been 
involuntarily separated from the company, according to your 
sworn testimony. It was sent to him from a Mr. Glen Means. The 
subject is E-Rate/VNCI, and I quote:
    ``Bill. I was wondering what guidance you could give me as 
to who is really running the show on these deals from a high 
level. One of the things that came out as I got into 
conversations with the Chief Financial Officer of VNCI is their 
financial condition, which is tenuous at best.
    ``They have a story as to how they are going to tack the 
company onto a run, but they have huge cumulative losses and 
insufficient sales, less than $10 million a year, to cover 
their overhead, which is at least $8 million a year, and they 
have an accumulated deficit of $50 million.'' Then it's got 
three exclamation marks. ``Have we done any background work on 
how we will deal with long term warranty? Do we have a workout 
solution, i.e., product replacement, if they go bust? I am 
concerned that we are protected.''
    So somebody, this Mr. Glen Means, was asking these 
questions. What was his hierarchical position in the company at 
that time, if you know?
    Mr. Donovan. Just to make sure I understand this e-mail, 
this sounds like Mr. Means who was a financial person----
    Chairman. Barton. It is not my company. You tell me.
    Mr. Donovan. I'm trying.--was looking at this in terms of 
what happens if VNCI goes insolvent. At this particular point 
in time, there are a lot of technology companies that were on 
pretty shaky ground.
    I am not sure how this is relevant to the wrongdoing that 
took place, but it appears that Mr. Means, who is something 
equivalent to the CFO for the company, was concerned about the 
financial health of VNCI.
    Chairman. Barton. Well, here is how it is relevant. NEC, in 
my opinion, is a reputable company. I have heard of NEC. I 
mean, you have been around. It is not a fly by night dot.com, 
so to speak.
    You enter into a relationship with a company that nobody 
has heard of, and right off the bat huge revenues as a percent 
of your total revenues are projected, and we have that memo 
that totals $131 million.
    Now I haven't run multi-billion dollar companies or even 
hundred million dollar companies, but I have been a plant 
manager. I have worked for corporations with profit and loss 
responsibility--that I had profit and loss responsibility. When 
somebody walked in the door and offered me a new revenue 
stream, before I took it at face value, I investigated the 
person offering the deal.
    You all apparently did nothing, or your former company did 
nothing of that. Now you have pled guilty and have paid $20 
million. This other company is apparently still under 
investigation, and I say apparently because I don't know that 
for a fact, and it is the company that brought this revenue to 
your former company. That is why it is relevant.
    I have way over-exceeded my time. So I am going to yield 
back to the chairman.
    Mr. Walden. Thank you, Mr. Chairman. I just have one more 
question for you, Mr. Donovan, and then I think we will try and 
move on.
    If you go to Tab 27 again, that is the reference. This is 
the e-mail that went to, among other people, Mr. Burger. In it, 
it says, ``Glen, you can find in-kind NABSE bonuses in the 
value added section.''
    Do you have any knowledge about those terms, in-kind, 
NABSE, bonuses, and the value added section? Have you talked to 
anybody in the company about what that means?
    Mr. Donovan. I don't have a clear understanding of that, 
no.
    Mr. Walden. You have no understanding of what your company 
was doing on bonuses, in-kind?
    Mr. Donovan. I don't have a clear understanding of it and, 
since I am under oath, I would like to be accurate.
    Mr. Walden. Do you have any understanding?
    Mr. Donovan. No.
    Mr. Walden. All right. Turn to Tab 82. It is obvious we are 
going to have to have additional hearings when we can get 
somebody here who can answer some of these questions. Tab 82 
shows the NABSE bonus products and services package, and in the 
center--Section B, it says--it says, ``As a result of 
agreements with National Association of Black School Educators, 
NABSE, NEC and its partners will be providing the district and 
its schools the following 'in-kind' bonus products and 
services, as depicted in the attached memo.'' You don't have 
this one under Tab 82?
    Mr. Donovan. No, sir.
    Mr. Walden. Okay, we will get that down to you. Sorry about 
that. You do have it then?
    Mr. Niespolo. It is the second page.
    Mr. Walden. Yes, it is. I'm sorry. I should have told you 
that. Okay. The first page is the Laura-Tom-Mac e-mail, it 
says.
    In the center column there under in-kind bonus products, it 
lists student stations complete with Microsoft Office 97, 
monitors, digital plan, tilt and zoom cameras, inkjet printers, 
Xerox color network copier or equivalent, higher education 
training for teachers and staff, specialized end user technical 
training, etcetera, etcetera, and then it talks about the 
services based on volume of purchase, any changes in the total 
volume will result in adjusted bonus package.
    Do you know if any of these items are allowable to be paid 
for with E-Rate funds?
    Mr. Donovan. No, I don't.
    Mr. Walden. Do any of your counsels know anything about the 
E-Rate program and what is allowed and isn't?
    Mr. Donovan. I don't think they are offering testimony 
today, Mr. Chairman.
    Mr. Walden. Thank you. I have no other questions. All 
right. You are dismissed. Thank you, sir.
    Mr. Donovan. Thank you.
    Mr. Walden. Unless the chairman--did you have another 
question for Mr. Donovan?
    Chairman. Barton. I have just a few more. I am not going to 
take another full 10 minutes.
    Mr. Walden. All right. Go ahead.
    Chairman. Barton. You may have asked these, and I just 
didn't hear it, but I want to get them on the record.
    Do you have any knowledge of how many people at NEC were 
involved with this situation, what we are calling a conspiracy? 
Your written testimony, I think, said 3 to 5 people.
    Mr. Donovan. That is based on the records that I have seen 
from e-mail. Yes.
    Chairman. Barton. Okay. Do you know how many, if any, of 
those people are still employed by NEC?
    Mr. Donovan. I think two, but I would like to check with 
counsel. The reason that I am having the discussion, again 
until the Grand Jury proceedings are finalized, we are not sure 
who has criminal liability. But at this moment it looks like 
one person may be still----
    Chairman. Barton. But there are some people still employed 
who might have criminal liability, although that is a very 
small number?
    Mr. Donovan. There are some people who are still under 
investigation.
    Chairman. Barton. Do you know when NEC decided to 
cooperate? Did they come forward voluntarily or were they 
caught with their hand in the cookie jar and decided to 
cooperate after they were caught?
    Mr. Donovan. Voluntary.
    Chairman. Barton. If I call the San Francisco people back, 
they would say that, too?
    Mr. Donovan. If you call the law enforcement authorities 
who are investigating it, I am sure they will say the same 
thing. Yes.
    Mr. Niespolo. Mr. Chairman, may I say something, please?
    Chairman. Barton. As long as you----
    Mr. Walden. I think we will have to swear him in.
    Chairman. Barton. If you are willing to be sworn in, you 
may.
    Mr. Niespolo. I just want to speak with my client.
    Chairman. Barton. Well, you certainly have that right.
    Mr. Walden. Yes.
    Mr. Niespolo. Thank you so much.
    Mr. Donovan. Long-winded lawyers. My apologies.
    Chairman. Barton. It's all right.
    Mr. Donovan. Could someone repeat the question for me?
    Chairman. Barton. My question was how many people still 
employed by NEC were a part of this program, and you said--I 
think you said two, one of whom may be criminally liable.
    Mr. Donovan. I said I think one, and that person is still 
under investigation, as are some of the other employees whose 
names appear on these e-mail.
    Chairman. Barton. My last question--again, this may have 
been asked: Under the current E-Rate rules, a company that has 
been found either criminally or civilly liable is subject to 
being debarred from the program for 3 years. Is NEC still 
involved in the E-Rate program, to your knowledge?
    Mr. Donovan. To my knowledge, all of that activity has been 
suspended, and has been for sometime when we realized there was 
a problem.
    Chairman. Barton. Okay. If you were working as an attorney 
at the FCC and had to make a recommendation whether NEC should 
be disbarred, what would that recommendation be, based on the 
knowledge of the case as you know it today?
    Mr. Donovan. I don't know that I could make a decision 
without hearing from all sides. I know that the FCC has posted 
a notice and is receiving comments, and certainly, my opinion 
might be biased.
    I think that the difference between some of the cases that 
we read about in the news and the NEC situation is that NEC 
made a mistake, but we didn't try to cover it up. We have never 
lied to prosecutors. We have never destroyed e-mails. We have 
made data bases available, and that has been since the very 
first day of this process.
    I think, if you--there are provisions in the law which 
reward----
    Chairman. Barton. So we only disbar companies that destroy 
e-mails, lie to prosecutors, and don't voluntarily cooperate? 
That is your standard?
    Mr. Donovan. That is not my answer, Congressman, no. I 
think my answer was----
    Chairman. Barton. It sure sounded like your answer.
    Mr. Donovan. I'm sorry. My answer was that I would need to 
look at all the facts and circumstances. If I were making the 
decision, I don't know that I would disbar NEC. NEC has done a 
lot of good things and, yes, this kind of money--It's a 
tremendous amount of money, to me. It was a lot of money to 
this company, but NEC has done some great things with automated 
fingerprint identification systems. They are working with 
various law enforcement on very advanced technologies, some of 
the other NEC companies, such as face recognition for airport 
security, and NEC scientists discovered the carbon nanotube, 
and----
    Chairman. Barton. It is okay that in this case they 
defrauded the taxpayers of tens of millions of dollars? All the 
other good deeds that they did allow them to do some bad deeds 
here.
    Mr. Donovan. No, I think justice can't be blind, and I 
think what justice does--and I think you could agree with 
this--is to balance the rights and the wrongs. If every time a 
company makes a mistake, we destroy that company, I think many 
good companies would----
    Chairman. Barton. I didn't say we are trying to destroy the 
company. By your own testimony, this was a small percentage of 
their total revenues. I just asked the question, if somebody--A 
company, in this case NEC, that has already pleaded to 
wrongdoing, under the current rules are supposed to be, or at 
least are allowed to be disbarred, to send a signal to other 
companies, we shouldn't consider disbarring this company.
    I mean, I don't know how many other companies have done 
what NEC has done. We've got investigations on several other 
companies, but if we want to get the program right, at sometime 
you've got to hold accountable the companies that have abused 
the program.
    Mr. Donovan. To answer the question, I would look at all 
the facts and circumstances that were involved, and I think I 
would give quite a bit of credence to the opinion of some of 
the enforcement agencies, such as the Department of Justice 
whose letter in support of NEC, I think, is part of the 
materials provided to the committee.
    Chairman. Barton. I have read that. I am going to give you 
one more chance. You told me in direct response that NEC 
voluntarily came forward. Then you talked to your attorney, and 
you didn't answer the question, because I asked, if I called 
the San Francisco representatives back, if they would answer it 
the same way. So I am going to give you one more chance.
    Do you think NEC voluntarily came forward?
    Mr. Donovan. I think, in my opinion, NEC voluntarily came 
forward. I can't tell you what San Francisco would say, 
Congressman.
    Chairman. Barton. All right. I yield back.
    Mr. Walden. Thank you, Mr. Chairman. Thank you, Mr. 
Donovan. You are excused now.
    Mr. Donovan. Thank you.
    Mr. Walden. Let's see here. Now we would like to call up 
our third and final panel: Mr. William Maher, Chief, Wireline 
Competition Bureau, Federal Communications Commission; and Mr. 
George McDonald, Vice President, Schools and Libraries 
Division, Universal Service Administrative Company, USAC.
    Gentlemen, thank you for your patience today. I know it has 
been a long one. As you are aware, the committee is holding an 
investigative hearing and, when doing so, has had the practice 
of taking testimony under oath. Do you have any objection to 
testifying under oath?
    The Chair then advises you that under the rules of the 
House and the rules of the committee, you are entitled to be 
advised by counsel. Do you desire to be advised by counsel 
during your testimony today? Both answered no.
    In that case, if you could rise and raise your right hands, 
I will swear you in.
    [Witnesses sworn.]
    Mr. Walden. Let the record show, they said ``I do.'' So you 
are now under oath, and you may now make a 5-minute summary of 
your written statement. We welcome you, and look forward to 
your comments. Let's start with Mr. Maher.

TESTIMONY OF WILLIAM F. MAHER, JR., CHIEF, WIRELINE COMPETITION 
BUREAU, FEDERAL COMMUNICATIONS COMMISSION; AND GEORGE McDONALD, 
   VICE PRESIDENT, SCHOOLS AND LIBRARIES DIVISION, UNIVERSAL 
                 SERVICE ADMINISTRATIVE COMPANY

    Mr. Maher. Thank you and good afternoon, Chairman Walden, 
Representative DeGette, and Chairman Barton.
    My name is William Maher. I am Chief of the FCC's Wireline 
Competition Bureau, and I have served in this post since August 
2002.
    I appreciate the opportunity to discuss the FCC's 
continuing efforts to improve the E-Rate program and the 
lessons from the recently concluded criminal and civil case 
associated with funding year 2000 involving NEC and the E-Rate 
service provider. Your attention E-Rate issues, as demonstrated 
by this and last month's hearing, confirms the FCC's 
understanding that Congress wants this program administered 
efficiently and fairly.
    In its first 6 years, the E-Rate program committed over $11 
billion to permit an average of about 90,000 schools and 
libraries each year to pay more affordable discounted rates. In 
1998, the first year of the program, only 51 percent of 
classrooms in public schools were connected to the Internet. 
That figure reached 92 percent in 2002, and 94 percent of 
schools now have broadband connections.
    In reviewing these numbers, the E-Rate program has been an 
overall success, but the program has been the target of some 
bad actors and those who have tried to beat the system. The 
subject of today's hearing involving NEC is an object lesson 
for the FCC, for USAC, and for all participants in the E-Rate 
program.
    The Commission and its staff work closely with USAC in 
administering the E-Rate program. As described in detail in the 
recent hearing regarding Puerto Rico, we are improving program 
performance through actions and rulemakings, fact specific 
adjudications, and an improved audit program.
    Regarding NEC, on May 27 of this year NEC agreed to plead 
guilty to two criminal charges, wire fraud and bid rigging for 
E-Rate activities, largely in funding year 2000. NEC also 
agreed to pay a total of $20.6 million criminal fine, a civil 
settlement, and restitution.
    NEC was charged with wire fraud for entering a scheme to 
defraud the E-Rate program in the San Francisco Unified School 
District, and it was also charged with bid rigging and 
allocating contracts at five school districts in Michigan, 
Wisconsin, Arkansas, and South Carolina.
    The monetary amount of the civil settlement makes the E-
Rate program whole. Because NEC has pled guilty to activity 
related to the E-Rate program, it is subject to suspension and 
debarment under the Commission's E-Rate debarment rule. On May 
27 NEC petitioned the Commission for waiver of its debarment 
rule, and there is a proceeding pending on that petition.
    This case illustrates the importance of deterring those who 
would seek to defraud or abuse the E-Rate program. Deterrence 
is an essential and a challenging goal, because as the San 
Francisco experience shows, defrauders will stop at very little 
to cover their tracks. At the same time, the Commission must 
encourage efficient participation by the large majority of E-
Rate participants who are law abiding.
    The Wireline Competition Bureau has recommended to the 
Commission rule changes to improve deterrence for action at the 
August 2004 open meeting. Also in the last 15 months, the 
Commission has adopted several new rules that address aspects 
of the NEC situation.
    Moveover, I have directed USAC's chief executive officer to 
report to the Bureau on changes to procedures and rules in 
light of NEC, and the staffs of the FCC and USAC are in close 
communication to improve USAC's review process.
    An initial step in such deterrence is to require applicants 
to document thoroughly their participation in the E-Rate 
program. The Bureau has recommended expansion of the document 
retention requirements for applicants, in order to maintain a 
comprehensive paper trail for 5 years after service is 
provided.
    The Bureau has also recommended improvements to the 
certifications that beneficiaries and service providers make 
regarding their compliance with substantive program rules. We 
plan to modify numerous E-Rate forms to expand the required 
certifications. Expanded certifications help deter bad actors, 
because their falsification is a Federal criminal offense.
    As an additional deterrent, the Bureau is recommending that 
USAC must engage in heightened scrutiny of applications from E-
Rate beneficiaries that have violated the statute or the 
Commission's rules in the past. This is consistent with the 
general framework adopted in the Puerto Rico DOE Order of 2003 
for when one or more parties to an E-Rate application is under 
investigation for waste, fraud or abuse.
    The Commission's E-Rate debarment rule is a significant 
deterrent to fraudulent behavior. Since the rule's adoption in 
2003, the FCC's Enforcement Bureau has debarred three 
individuals in matters not related to NEC, and the Commission 
has sought comment on whether to expand the reach of the 
debarment rule as a further deterrent.
    Encouragement of whistleblowers and early outreach to 
applicants and service providers regarding the E-Rate program 
are also important components of deterrence. Continuing strong 
review and auditing programs serve as a long term deterrent to 
waste, fraud and abuse. We on the Commission staff will 
continue to work with our Office of Inspector General to 
implement such programs.
    We at the FCC are proud of the schools and libraries 
support program, but we will never be satisfied with the status 
quo. We are happy to assist the subcommittee as needed.
    Thank you, Mr. Chairman, for the opportunity to participate 
in your review of E-Rate, and I look forward to your questions 
on the issue.
    [The prepared testimony of William F. Maher, Jr. follows:]
     Prepared Statement of William F. Maher, Jr., Chief, Wireline 
         Competition Bureau, Federal Communications Commission
    Good morning, Chairman Greenwood, Representative DeGette, and 
distinguished members of the Subcommittee. My name is William Maher. I 
am chief of the FCC's Wireline Competition Bureau, and have served in 
this post since August 2002. I appreciate the opportunity to discuss 
the FCC's continuing efforts to improve the E-rate program and the 
lessons from the recently concluded criminal and civil case involving 
NEC Business Network Solutions, Inc. (``NEC-BNS''), an E-rate service 
provider, regarding its activities associated with Funding Year 2000. 
Your attention to the issues involved with the E-rate program, as 
evidenced by this and last month's hearings, confirms the FCC's 
understanding that Congress wants the program administered efficiently 
and fairly.
                              introduction
    The schools and libraries mechanism of the FCC's universal service 
program, known as the E-rate program, implements the directive of the 
Telecommunications Act of 1996 to help schools and libraries gain 
access to modern telecommunications and information services for 
educational purposes. In its first six years, the E-rate program has 
committed over $11 billion to permit an average of almost 90,000 
schools and libraries each year, including those in the nation's 
poorest and most isolated communities, to pay more affordable, 
discounted rates. While in 1998, the first year of the program, only 51 
percent of classrooms in public schools were connected to the Internet, 
the figure reached 92 percent in 2002. Moreover, 94 percent of schools 
now have broadband connections.
    In reviewing these numbers, the E-rate program has been an overall 
success. But from day one, it has been the Commission's goal to improve 
operation of the E-rate program. The FCC seeks to learn from its 
experience with this program.
    The Commission and its staff work closely with the Universal 
Service Administrative Company (``USAC''), the not-for-profit company 
that is responsible for day-to-day administration of the E-rate 
program. In particular, whenever we discover examples of potential 
waste, fraud, or abuse, we seek to address the individual cases and to 
improve the relevant program rules or practices.
    The Wireline Competition Bureau works to oversee and implement the 
E-rate program with several other FCC bureaus and offices, including 
the Office of the Inspector General, the Office of General Counsel, the 
Office of Managing Director, and the Enforcement Bureau. As Commission 
staff described in detail in the recent hearing regarding Puerto Rico, 
we are improving program performance through actions in rulemakings, 
fact-specific adjudicatory decisions, and an improved audit program.
    The FCC also works closely with law enforcement agencies when those 
agencies investigate and prosecute possible criminal activity by E-rate 
participants. The E-rate program has been the target of some bad actors 
and those who have tried to beat the system. The subject of today's 
hearing, involving NEC-BNS, is an example of such activity. It is an 
object lesson for the FCC, for USAC, and for all participants in the E-
rate program. The Commission is committed to applying this lesson in 
eradicating waste, fraud and abuse in the E-rate program.
                            the nec-bns case
    Criminal Plea Agreement and Civil Settlement: On May 27, 2004, NEC-
BNS, a subsidiary of NEC America Inc., agreed to plead guilty to two 
criminal charges-- wire fraud and bid rigging--and to pay a total $20.6 
million dollar criminal fine, civil settlement, and restitution for its 
activities related to the E-rate program, largely in Funding Year 2000. 
The Justice Department charged NEC-BNS with wire fraud for entering a 
scheme to defraud the E-rate program and the San Francisco Unified 
School District (``the San Francisco schools''). The Justice Department 
also charged NEC-BNS with bid rigging and allocating contracts at five 
school districts in Michigan, Wisconsin, Arkansas, and South Carolina. 
Among other things, the plea agreement requires NEC-BNS to cooperate 
with the United States in investigating and prosecuting others involved 
in criminal violations at E-rate funded projects, and NEC-BNS agreed to 
enter into a comprehensive Corporate Compliance Program as well.
    In addition to its criminal plea agreement, NEC-BNS entered a 
settlement agreement to end a civil lawsuit initially brought by the 
San Francisco schools, in which the United States, acting through the 
Department of Justice, intervened. Among other things, the monetary 
portion of the settlement agreement makes the E-rate program whole.
    The settlement agreement notes that the civil claims of the United 
States and others against NEC-BNS included (1) engaging in non-
competitive bidding practices; (2) paying fees termed ``marketing 
fees'' to at least one entity involved in selecting vendors to obtain 
e-rate funds; (3) requesting and receiving E-rate funds for goods and 
services that were ineligible for such funding; (4) providing false 
information to the United States regarding the goods and services that 
were be provided to schools and school districts under the E-rate 
program; (5) disregarding the requirement that schools and school 
districts make a co-payment to match a percentage of their E-rate 
funding; and (6) inflating prices on invoices and other documents 
provided to the United States to conceal some or all of these 
practices.
    San Francisco as an Example: I summarize, as a case study of the 
foregoing practices, the situation with the San Francisco schools, 
based largely on the description in the NEC-BNS criminal plea 
agreement. In December 1999, NEC-BNS agreed with a switch manufacturing 
company (``VX Company'') to pay VX Company a fee for all business 
opportunities brought to NEC-BNS, and NEC-BNS agreed to include VX 
Company equipment in its E-rate proposals and bids. VX Company employed 
two consultants to work as its sales representatives. The consultants 
specialized in marketing VX Company products to school districts, and 
acted as consultants to school districts in identifying potential 
government-sponsored funding sources, including E-rate.
    On or before December 1999, the consultants began working with the 
San Francisco schools to obtain E-rate funds. The consultants worked 
with an official of the San Francisco schools to put together a request 
for proposal for equipment and services for E-rate to fund. In January 
2000, NEC-BNS submitted its bid on the E-rate project for the San 
Francisco schools. One of the consultants managed the opening of the 
bids and, together with an official of the San Francisco schools, 
opened and reviewed them. That consultant declared that NEC-BNS had 
submitted the winning bid for the data equipment portion of the 
project, and that two other firms had submitted low bids on other 
portions of the project. The consultants and the official of the San 
Francisco schools then decided to make NEC-BNS the prime contractor for 
the project and to have other firms act as subcontractors to NEC-BNS.
    Still in January 2000, NEC-BNS employees and the consultants met to 
prepare the USAC Form 471, which is the application form for E-rate 
funding. With the assistance of NEC-BNS, one of the consultants 
prepared the Form 471 with prices inflated over the amounts originally 
bid, and the other consultant then delivered the Form 471 to USAC.
    In late May or early June 2000, USAC began to review the San 
Francisco schools' Form 471 submitted in January 2000. USAC asked the 
San Francisco schools to supply information to justify certain parts of 
the project. One of the consultants, and others acting under her 
direction, submitted spreadsheets to USAC that contained false 
information regarding the bidding process, the bidding participants, 
the winning bids, and the bid amounts. USAC subjected the San Francisco 
schools' application to a review to determine whether the services 
requested were supported by adequate resources. The San Francisco 
schools passed the review. In September 2000, USAC approved funding for 
the San Francisco schools in part, but denied E-rate funding for some 
requests for ineligible equipment, products, and services.
    The Investigation: The NEC-BNS plea agreement and civil settlement 
resulted from a two-year investigation conducted by the Department of 
Justice and the Federal Bureau of Investigation. The FCC's Office of 
Inspector General assisted in the investigation, and various FCC 
bureaus and offices, including the Wireline Competition Bureau, 
reviewed the civil settlement agreement earlier in 2004.
    The monetary amount of the civil settlement makes the universal 
service fund whole. Because NEC-BNS has pled guilty to activity related 
to the E-rate program, it is subject to suspension and debarment under 
the Commission's E-rate debarment rule, 47 C.F.R.  54.521. On May 27, 
2004, NEC-BNS petitioned the Commission for waiver of its suspension 
and debarment rule. On July 7, 2004, the Commission's Enforcement 
Bureau sought public comment on the waiver petition, and the pleading 
cycle will close on July 29, 2004.
                       policy and program lessons
    There are multiple lessons to be learned from the NEC-BNS case. 
This case illustrates the importance of deterring those who would seek 
to defraud or abuse the program. Deterrence is an essential and 
challenging goal because, as the San Francisco experience shows, 
defrauders and bad actors will stop at very little to cover their 
tracks. At the same time, the Commission must encourage efficient 
participation by the large majority of E-rate applicants and service 
providers who are law-abiding.
    The Wireline Competition Bureau has already recommended a number of 
relevant rule changes, described below, to the Commission for action at 
its August 2004 Open Meeting. In the past 15 months, the Commission has 
adopted several new rules that address aspects of the NEC-BNS 
situation. Moreover, I have directed USAC's chief executive officer to 
report to the Bureau on changes to procedures and rules in light of 
NEC-BNS, and the staffs of the FCC and USAC are remaining in close 
communication to improve USAC's review process. Tightening our rules 
and USAC's review procedures will expose, at the front end, improper or 
fraudulent activities.
    Deterring Bad Actors: To deter bad actors, E-rate applicants must 
be held accountable for the contents of their applications and other 
filings.
    An initial step in such deterrence is to require applicants to 
document thoroughly their participation in the E-rate program. Based on 
input from our Office of Inspector General, the Wireline Competition 
Bureau has recommended to the Commission that it expand the document 
retention requirements for applicants, in order to maintain a 
comprehensive paper trail for five years after receipt of E-rate 
supported services. By documenting every step in the E-rate process-- 
from initial application, through competitive bidding and selection of 
a service provider, to final service and equipment delivery and 
invoicing--such a paper trail aids the initial review of applications 
as well as later program audits. It places a major obstacle before 
those who would consider lying to the federal government for their 
personal gain.
    The Wireline Competition Bureau has also recommended to the 
Commission improvements in the certifications that beneficiaries make 
regarding their compliance with substantive program rules. Upon 
adoption of the Bureau's recommendations, we will modify numerous E-
rate forms to expand the required certifications. Expanded 
certifications help deter bad actors because their falsification is a 
federal criminal violation. This reform is the product of discussions 
among the Bureau, the FCC's Office of Inspector General, and the 
Justice Department.
    As an additional deterrent to bad actors, the Bureau is 
recommending that the Commission reinforce that USAC should engage in 
heightened scrutiny of applications from E-rate beneficiaries that have 
violated the statute or the Commission's rules in the past. This is 
consistent with the general framework adopted in the Puerto Rico DOE 
Order of 2003 to deal with situations in which one or more parties to 
an E-rate application is under investigation for potential waste, fraud 
or abuse.
    The Commission has already acted in several ways to deter conduct 
similar to that of NEC-BNS. In April 2003, the Commission adopted its 
E-rate debarment rule, which bars from E-rate participation for a 
period of three years any individuals or companies that have been found 
criminally or civilly liable for activities associated with or related 
to the E-rate program. We believe the debarment rule to be a 
significant deterrent to fraudulent behavior. Since the rule's adoption 
in 2003, the FCC's Enforcement Bureau has debarred three individuals in 
matters not related to NEC-BNS. The Commission also has sought comment 
on whether to expand the reach of the debarment rule as a further 
deterrent to E-rate waste, fraud and abuse.
    Encouragement of whistleblowers and early outreach to potential 
applicants and service providers regarding the E-rate program are also 
important components of deterrence. Timely information from well-
informed and honest citizens is one of the best means of exposing 
fraudulent activity. Wider understanding of E-rate rules can help USAC 
and program participants isolate and identify potential bad actors. For 
example, in 2000, roughly the time of the San Francisco situation, the 
Commission's Mastermind Order found a violation of the competitive 
bidding rules where a service provider listed in the Form 470 as a 
contact person for an applicant also participated as a bidder in the 
applicant's competitive bidding process. Wider understanding of that 
ruling in the San Francisco schools could have helped expose the NEC-
BNS case earlier. USAC has announced plans to increase its outreach 
regarding the E-rate program.
    Continuing strong review and auditing programs also serve as a 
long-term deterrent to waste, fraud, and abuse. We on the Commission 
staff will continue to work with our Office of Inspector General to 
implement such programs.
    Incentives For Good Actors To Use The Program Efficiently: The 
Commission must also encourage efficient use of program funding by 
those who respect and follow the program rules. In December 2003, the 
Commission asked for comment on fundamental E-rate policy issues in 
this area. The Commission asked whether to adjust the schedule of 
discount rates so that, for example, applicants would pay for a greater 
share of their E-rate services. This would provide greater incentives 
for applicants to make only prudent, cost effective purchases. The 
Commission also sought comment on possible means of determining whether 
applicants have made ``cost effective'' funding requests. We are 
evaluating the record we have compiled with the goal of making 
recommendations to the Commission in this calendar quarter.
                               conclusion
    We at the FCC are proud of the schools and libraries support 
program, but we will never be satisfied with the status quo. We will 
continue to use all tools at our disposal to help us identify areas of 
E-rate program administration that are vulnerable to fraud, waste, or 
abuse. At the same time, we will continue to encourage participation in 
the program so that those that the program's true beneficiaries--the 
nation's students, library patrons, and all Americans--receive the 
support they need.
    We are happy to assist the Subcommittee as it considers these 
important issues. Thank you, Mr. Chairman, for the opportunity to 
participate in your review of the NEC-BNS matter, and I look forward to 
your questions on these issues.

    Mr. Walden. Thank you for being here today, and for your 
comments.
    Mr. McDonald, welcome.

                  TESTIMONY OF GEORGE McDONALD

    Mr. McDonald. Thank you, sir. Good afternoon, Congresswoman 
DeGette and Chairman Barton. My name is George McDonald. I am 
the Vice President of the Universal Service Administrative 
Company responsible for the Schools and Libraries Division. It 
is my privilege to be here today to speak with you again about 
USAC and its administration of the Schools and Libraries 
Universal Service Support Mechanism, commonly referred to as 
the E-Rate program.
    I appeared before this subcommittee on June 17, 2004, and 
my statement at that time provided an overview of USAC and its 
administration of the E-Rate program. In the interest of time, 
I won't repeat that overview, but I would like to reiterate a 
few key points.
    Before we began making funding commitments in 1998, our 
internal controls were carefully reviewed by 
PricewaterhouseCoopers and staff of GAO. PwC provided an attest 
opinion about those procedures, and USAC implemented all of the 
changes recommended by GAO.
    As we have gained experience, we have strengthened some 
procedures and added others to continue to protect the 
integrity of the program and the Universal Service Fund. An 
early enhancement was the establishment of a whistleblower 
hotline, which receives an average of 100 calls per year. Out 
Special Investigations Team investigates every call and ensures 
that appropriate follow-up action is taken.
    Today we have an assortment of tools to help assure 
compliance with program rules. These include: Employing 
detailed application and invoice review procedures; denying 
funding commitments when appropriate; rejecting incorrect 
invoices; auditing program 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.
    As I indicated to the subcommittee last month, it has 
become clear to us that we need another tool, a larger 
oversight presence in the field. We are now reviewing proposals 
we have received in response to a request for proposals 
soliciting bids to conduct some 1,000 site visits a year.
    These visits will allow us to assess even more fully how E-
Rate funds are being used, to learn about and publicize best 
practices in education technology and program compliance, and 
to help ensure that products and services have, in fact, been 
delivered and are being used effectively.
    Now let me turn to the participation of the San Francisco 
Unified School District in the E-Rate program. San Francisco 
has received funding in each year of the program. We have 
disbursed approximately $6.4 million to various service 
providers for providing eligible products and services to San 
Francisco for the past 6 years.
    In regard to San Francisco's application for products and 
services to be provided by NEC Business Network Solutions, 
which is the focus of this hearing, we committed approximately 
$48.6 million to San Francisco, as you have heard here today. 
San Francisco later canceled those funding requests and, 
consequently, we never disbursed any of those funds.
    I would like to join the subcommittee in commending Dr. 
Ackerman for taking responsible action to protect these funds.
    Mr. Chairman, I regret to report to you that I believe we 
made the wrong decision in response to this funding request and 
that we had information that should have provided a clear 
warning to us. As you heard today from Mr. Cothran, my review 
of the files indicates that we had reason to question whether 
one of the pieces of documentation that San Francisco provided 
to us, its budget, had been improperly altered when it was 
submitted to us.
    We should have done more to assure ourselves that the 
budget San Francisco provided to us was accurate, but we did 
not. If we had, in light of what we have learned since, I 
believe we would have denied this funding request.
    We requested San Francisco's budget and other documentation 
as part of our review of whether San Francisco had the funds to 
pay the non-discount portion of the cost of eligible services, 
and had acquired the goods and services not eligible for 
discount but necessary to make effective use of these services, 
such as computers and software. This particular review had been 
part of our application review procedures since the first year 
of the program, and we have strengthened this review every 
year.
    For example, in the year in which we reviewed this 
particular application, our reviewers' notes were not entered 
into the computer system, and our reviewers brought novel 
issues to the attention of their supervisors orally. In this 
case, the issue of whether San Francisco's budget was accurate 
was a novel issue, and so the reviewer would have communicated 
the concerns orally.
    Today, reviewers note their observations in our computer 
system, and novel issues such as San Francisco's budget must be 
communicated in writing and are required to be addressed. The 
decision regarding the novel issue must be documented before a 
final decision is made with respect to the application.
    Beyond these changes, we have established an additional 
layer of review through our quality assurance function to 
review the work of our application reviewers, which further 
safeguards program funds.
    Since August of 2001, we have provided support to the law 
enforcement investigation of NEC in the form of documentation, 
answering numerous questions about the program in general and 
this application in particular, and meeting with law 
enforcement officials.
    As we provided this support, we coordinated closely with 
the Federal Communications Commission, Office of Inspector 
General, and through that process strengthened our joint 
efforts to protect the fund from waste, fraud and abuse by 
supporting law enforcement investigations of those who would 
take advantage of the program.
    As a result of our support of this investigation, we 
learned that San Francisco officials and NEC had provided us 
with false information in response to many of our questions 
about this application.
    Mr. Chairman, thank you for providing me with the 
opportunity to address the subcommittee. I would be happy to 
respond to questions.
    [The prepared testimony of George McDonald follows:]
Prepared Statement of George McDonald, Universal Service Administrative 
         Company Vice President, Schools and Libraries Division
    Good morning, Mr. Chairman and Members of the Subcommittee. My name 
is George McDonald. I am the Vice President of the Universal Service 
Administrative Company (``USAC'') responsible for the Schools and 
Libraries Division. It is my privilege to be here today to speak with 
you again about USAC and its administration of the Schools and 
Libraries Universal Service Support Mechanism, commonly referred to as 
the ``E-rate'' program.
Overview
    I appeared before this Subcommittee on June 17, 2004, and my 
statement at that time provided an overview of USAC and its 
administration of the E-rate program. In the interest of time, I will 
not repeat that overview, but I would like to reiterate a few key 
points.
    Before we began making funding commitments in 1998, our internal 
controls were carefully reviewed by PricewaterhouseCoopers (PwC) and 
staff of the U.S. General Accounting Office (GAO). PwC provided an 
attest opinion about those procedures, and USAC implemented all of 
GAO's recommended changes. As we have gained experience, we have 
strengthened some procedures and added others to continue to protect 
the integrity of the program and the Universal Service Fund. An early 
enhancement was the establishment of the whistleblower hotline, which 
receives an average of 100 calls per year. Our Special Investigations 
Team investigates every call and ensures that appropriate follow up 
action is taken.
    Today we have an assortment of tools to help assure compliance with 
program rules. These include employing detailed application and invoice 
review procedures, denying funding commitments when appropriate, 
rejecting incorrect invoices, auditing program beneficiaries and 
service providers, recovering funds where rule violations are found, 
investigating whistleblower hotline complaints, supporting law 
enforcement investigations, and referring matters involving suspected 
program abuse to law enforcement authorities. But, as I indicated to 
you last month, it has become clear to us that we need another tool)--a 
larger oversight presence in the field. We are now reviewing proposals 
we have received in response to a Request for Proposals (RFP) 
soliciting bids to conduct some 1,000 site visits a year. These visits 
will allow us to assess even more fully how E-rate funds are being 
used, to learn about and publicize best practices in education 
technology and program compliance, and to help ensure that products and 
services have in fact been delivered and are being used effectively.
Participation of the San Francisco Unified School District in the E-
        rate Program
    Let me now turn to the participation of the San Francisco Unified 
School District (SFUSD) in the E-rate program. SFUSD has received 
funding in each year of the program. We have disbursed approximately 
$6.4 million to various service providers for providing eligible 
products and services to SFUSD for the past six years. In regard to 
SFUSD's application for products and services to be provided by NEC 
Business Network Solutions, Inc. (NEC), which is the focus of this 
hearing, we committed approximately $48.6 million to SFUSD. SFUSD later 
cancelled those funding requests, and consequently, we never disbursed 
any of these funds.
    Mr. Chairman, I regret to report to you that I believe we made the 
wrong decision in response to this funding request and that we had 
information that should have provided a clear warning to us. My review 
of the file indicates that we had reason to question whether one of the 
pieces of documentation that SFUSD provided to us--its budget--had been 
improperly altered when it was submitted to us. We should have done 
more to assure ourselves that the budget SFUSD provided to us was 
accurate, but we did not. If we had, in light of what we have learned 
since, I believe we would have denied this funding request.
    We requested SFUSD's budget and other documentation as part of our 
review of whether SFUSD had the funds to pay the non-discount portion 
of the cost of eligible services and had acquired the goods and 
services not eligible for discount but necessary to make effective use 
of these services, such as computers and software. This particular 
review has been part of our application review procedures since the 
first year of the program, and we have strengthened this review every 
year.
    For example, in the year in which we reviewed this particular 
application, our reviewers' notes were not entered into our computer 
system, and our reviewers brought novel issues to the attention of 
their supervisors orally. In this case, the issue of whether SFUSD's 
budget was accurate was a novel issue, and so the reviewer would have 
communicated the concerns orally. Today, reviewers note their 
observations in our computer system, and novel issues such as SFUSD's 
budget must be communicated in writing and are required to be 
addressed. The decision regarding the novel issue must be documented 
before a final decision is made with respect to the application. Beyond 
these changes, we have established an additional layer of review 
through our quality assurance function to review the work of our 
application reviewers, which further safeguards program funds.
    Since August of 2001, we have provided support to the law 
enforcement investigation of NEC in the form of documentation, 
answering numerous questions about the program in general and this 
application in particular, and meeting with law enforcement officials. 
As we provided this support, we coordinated closely with the Federal 
Communications Commission Office of Inspector General, and through that 
process, strengthened our joint efforts to protect the fund from waste, 
fraud and abuse by supporting law enforcement investigations of those 
who would take advantage of the program. As a result of our support of 
this investigation, we learned that SFUSD officials and NEC had 
provided us with false information in response to our many questions 
about this application.
Conclusion
    Mr. Chairman, thank you for providing me with the opportunity to 
address the Subcommittee. I would be happy to respond to any questions 
you may have.

    Mr. Walden. Mr. McDonald, thank you for being here, and 
thank you for your testimony.
    I want to go back on San Francisco, because what we have 
heard today is that somebody in USAC reviewing the initial 
application identified the problem with the budget. It had been 
falsified, or at least there was, what, a $41 million 
discrepancy between what was on their website and what had been 
submitted.
    We were told that that information was passed up the chain 
in USAC. Who got it?
    Mr. McDonald. That employee's manager, Mr. Werner whose 
name was referred to earlier.
    Mr. Walden. What did he do with the information?
    Mr. McDonald. And let me say, I am relying on the same 
evidence that Mr. Cothran had, the written answers to the 
questions that he posed to us.
    Mr. Walden. Why?
    Mr. McDonald. Because there is no written documentation in 
the file of this issue. Mr. Schnipp reportedly, by his own 
report, raised the issue orally to Mr. Werner, did not document 
it in the file, got no guidance from Mr. Werner.
    Mr. Walden. Is he supposed to do that?
    Mr. McDonald. He should have documented this in the file so 
that everybody would have seen it, and we would have had an 
open resolution of it.
    Mr. Walden. Does his--Is it Mr. Werner, you said, is his 
supervisor?
    Mr. McDonald. Was at that time, yes.
    Mr. Walden. Was? Have you talked to him? Does he admit that 
Mr. Schnipp made him aware of this discrepancy?
    Mr. McDonald. We talked with him last week in preparation 
for this hearing. He said that he remembered dealing with that 
file. He didn't remember this issue being raised to him. So 
there was a miscommunication at least between these two 
individuals.
    Mr. Walden. Is that the first time you had talked to Mr. 
Werner about this?
    Mr. McDonald. This is the first time that we have talked to 
Mr. Werner about this. Yes, sir.
    Mr. Walden. Last week?
    Mr. McDonald. Yes, sir.
    Mr. Walden. Maybe I'm missing something here, but I am 
troubled by that answer, sir. When did you learn of Mr. 
Schnipp's--I'm not saying his name right, I'm sure, but his 
concern? When did this letter come out to the City Attorney's 
Office saying there is a problem?
    Mr. McDonald. In 2002.
    Mr. Walden. And last week was the first time you talked to 
the supervisor on this?
    Mr. McDonald. San Francisco had canceled the funding 
commitments at that point. There was no issue anymore about 
these commitments. Mr. Werner left the employment of our 
contractor in 2000.
    Mr. Walden. So Mr. Werner didn't work--Now wait. Mr. Werner 
left--What did you say, the employment of your contractor in 
2000? So he has been out of the process?
    Mr. McDonald. Yes, sir.
    Mr. Walden. Okay. How do you know this isn't still going 
on?
    Mr. McDonald. Well, we heard this discussion today about 
whether there is a contact within USAC with Judy Green. We have 
not positively funded any application associated with her since 
her name began appearing on any documentation in 2003. So that 
is the first I have heard an allegation about that. I did ask 
whether Mr. Werner left under adverse situation, and he did 
not. He chose to leave.
    So we didn't have any suspicion. Certainly, Mr. Werner took 
no other action to try to hide what was going on. This wasn't 
documented in the file. Mr. Schnipp hasn't said he was directed 
not to document this in the file.
    So I think it was a human error, is what I believe, and we 
have taken----
    Mr. Walden. Human error by Mr. Schnipp or Mr. Werner?
    Mr. McDonald. Well, Mr. Schnipp in not documenting it, Mr. 
Werner in not following up on it.
    Mr. Walden. But Mr. Schnipp contends he talked to Mr. 
Werner about it, made him aware of it.
    Mr. McDonald. Yes.
    Mr. Walden. But he has no documentation to prove that 
conversation. Is that the issue?
    Mr. McDonald. Unfortunately, that is correct. And I do 
applaud Mr. Schnipp, as Mr. Cothran did, for exercising the 
initiative to find this budget.
    Mr. Walden. What kind of documentation was required by your 
rules?
    Mr. McDonald. There is a worksheet. This is the Item 25 
review. Item 25 on the Form 471 is a certification that I have 
secured access to all the resources necessary to make effective 
use of the discounted services, including the matching share.
    Mr. Walden. I mean the reviewer documentation.
    Mr. McDonald. Oh, there is a worksheet that walks through: 
Does the applicant have the budget? Does he have hardware? Does 
he have software, teacher training, etcetera.
    Mr. Walden. Got it. And so Mr. Schnipp would review that?
    Mr. Mcdonald. Mr. Schnipp would put his conclusions into 
that document, and in the budget section of that document 
``Pass'' is circled, and there is no issue raised in the write-
up about this budget discrepancy.
    Mr. Walden. Oh. So the written document that would have 
gone up your chain does not indicate that there was any problem 
with the budget?
    Mr. McDonald. That is correct, and that is very 
unfortunate, because that would have flagged this to get other 
reviews subsequent to Mr. Schnipp's review, and it would have 
flagged this for others.
    Mr. Walden. All right. Are you satisfied with the current 
document retention policies of the E-Rate program?
    Mr. McDonald. No, and I think Mr. Maher has addressed that. 
The rules don't require document retention. That has been a 
problem in audits, and the Commission is addressing that.
    Mr. Walden. How long has that been an issue?
    Mr. McDonald. I didn't realize it was an issue early on. 
The forms say that the applicants certify they will retain 
documents, but as this became an audit issue, the guidance that 
we got was that, since it is not established in the rules, 
there can't be recoveries for that.
    Mr. Walden. And those are rules that would have to be 
promulgated by the FCC?
    Mr. McDonald. Yes, sir.
    Mr. Walden. So have you made recommendations to the FCC 
about what you think needs to be done on the records retention 
issues?
    Mr. Mcdonald. This has been on the table since at least the 
first round of audits when there was documentation--lack of 
documentation for a program.
    Mr. Walden. I see. When was that?
    Mr. McDonald. In 2000 for the funding year 1998.
    Mr. Walden. So the issue of the lack of retention has been 
at the FCC's door since 2000?
    Mr. McDonald. It's been on all of our--All of us have been 
aware of it since 2000, and our team wasn't on the scene in 
2000, but----
    Mr. Walden. No, but isn't that one of the issues? There has 
been quite a bit of turnover at the FCC level on this program. 
Correct?
    Mr. McDonald. Compared to USAC. I've been here since 1997. 
So more turnover than here.
    Mr. Walden. And, Mr. Maher, has the FCC known since 2000 
that record retention was an issue on an audit trail?
    Mr. Maher. I spoke with the Inspector General about this 
within the last year.
    Mr. Walden. I don't know what that means. How long has what 
he has proposed been before the FCC?
    Mr. Maher. It has not appeared in an open docket before the 
FCC, but this issue----
    Mr. Walden. That is what it would take?
    Mr. Maher. It has been put on the table, and the Bureau has 
recommended the rule change for the August meeting.
    Mr. Walden. Oh, for the August meeting?
    Mr. Maher. Yes.
    Mr. Walden. So it has been basically 4 years to require 
record retention so we can perform audits in a multi-billion 
dollar program?
    Mr. Maher. The issue so far has been that the current rule, 
and there is an FCC rule regarding document retention, is 
indefinite. The current rule requires the applicant to retain 
the same types of documents as it would for other procurements, 
for example, within its school district.
    The issue that has been raised is that that is indefinite. 
It varies among school districts and libraries. What we are 
looking for is to have a clear bright line rule that will aid 
the audit process and also aid law enforcement.
    So what we are doing is improving an existing rule.
    Mr. Walden. I know in some of the other FCC rules, it is 
pretty clear you have to maintain certain records for, you 
know, 2 years, 5 years, whatever it is. What am I missing here 
that is so hard it takes 4 years to make a decision that these 
records should be retained for 4 years or 3 years? Did you make 
a recommendation as to a length of time?
    Mr. McDonald. The forms--there was an inconsistency in the 
forms. Some said 3 years. Some said 5 years. I think the 
Commission is moving to 5 years.
    Mr. Maher. So our goal is to clean up these discrepancies. 
Yes.
    Mr. Walden. Yes, but why does it take 4 years to make that 
decision between whether a form is 3 years or 5 years for 
retention purposes? I'm not picking on you. I am just----
    Mr. Maher. Absolutely. What we have tried to do with many 
aspects of the program is to look at what is required and move 
ahead, and our goal is to improve what we find in place.
    Mr. Walden. All right. Mr. Maher, you note in your 
testimony the importance of certifications on forms. The 
Department of Justice in December of 2002 made a number of 
recommendations regarding certification to the FCC. If you 
don't mind turning to Tab 130, please, and I'll give you the 
chance there to find Tab one-three-zero.
    Mr. Maher. Yes.
    Mr. Walden. These included requiring a noncollusion 
certificate, among others. Why only now is the Bureau 
recommending certification changes to the forms 18 months after 
these recommendations and more than 6 years into the program?
    Mr. Maher. We have worked both with the Department of 
Justice and the Office of Inspector General to go through a 
variety of forms, and there's--I think 8 forms have been 
brought to our attention, and we are altering roughly 16, 17 of 
these certifications.
    It has been a back and forth process in getting the 
certifications right. We have actually submitted the revised 
forms with certifications to the OMB approval process. it is 
underway now. These will be in place for the next funding year.
    Mr. Walden. Okay. My time has expired. I will turn now to 
the ranking member, Ms. DeGette, of Colorado.
    Ms. DeGette. Thank you, Mr. Chairman. Mr.--Is it Marh?
    Mr. Maher. Maher.
    Ms. DeGette. Maher. I wanted to follow up on the chairman's 
questions. The Commission is considering rules. Are they 
considering proposing rules or enacting rules in August?
    Mr. Maher. What was referred to in my testimony is actual 
rules, not proposing them in August but to adopt them.
    Ms. DeGette. But to adopt rules?
    Mr. Maher. Yes.
    Ms. DeGette. And this document at Tab 130--this is the 
memorandum, ``Suggestions for E-Rate program''--has a number of 
suggestions in it. Have you seen that document before?
    Mr. Maher. I have seen it before, yes.
    Ms. DeGette. Okay. Do you know if the No. 1 suggestion, 
requiring a certificate of independent pricing, is among the 
rules that will be adopted in August?
    Mr. Maher. Well, there's a couple of different processes 
going on. Many of these certification changes, the Bureau has 
already proceeded on, that a formal rule isn't required. What 
we did, we had to submit it to OMB for approval. We did that in 
early June. They were published in the Federal Register. 
There's 60 days notice before they are adopted. So we expect a 
variety of the certifications will be in place in September.
    Now the specific one that is referenced here I would have 
to check on.
    Ms. DeGette. Okay. Do you think it is a good idea to have a 
rule requiring a certificate of independent pricing?
    Mr. Maher. I think, in general, certifications are very 
important for three reasons. One, they sort of educate the 
program participants. The other one is a deterrent effect, 
because people are certifying to the government. They are 
saying that they understand the rule and that they are 
representing so to the government. Finally, they are good for 
evidentiary purposes.
    Ms. DeGette. Right. So is it your belief that a rule will 
be promulgated to require certificates of independent pricing, 
either through the June rulemaking process that is underway or 
the August process?
    Mr. Maher. Well, let's see. That particular one--and I am 
looking at another chart, but that particular one should be 
included, and I think it is a great idea.
    Ms. DeGette. Thank you. Also, this memorandum at Tab 130 
suggests that you require that the process require at least 
three bidders and award the contract to the lowest bidder. Do 
you think that is a rule that will be promulgated in August?
    Mr. Maher. That will not be promulgated in August, because 
it poses a difficult policy issue. This program serves schools 
and libraries in all parts of the country, very rural isolated 
ones as well as large cities. The difficulty there is that in 
some places there just aren't three competing bidders.
    The policy issue that we are grappling with is what do you 
do to make sure the competitive bidding process--if you don't 
have a rule like that, that the competitive bidding process 
works, and you can keep out the cheats.
    Ms. DeGette. Right. I mean, if you don't have some kind of 
a baseline--I would imagine, especially given the amount of 
money that we have heard over the past two hearings is involved 
in the contracts, I would think that for the vast majority of 
projects you could find at least three bidders who were willing 
to bid on it. Wouldn't you think so, sir?
    Mr. Maher. The experience--Maybe Mr. McDonald could 
comment, but experience varies among school districts and 
libraries.
    Ms. DeGette. Okay. So what kind of rule can be promulgated 
that would assure a competitive bidding process, if you are not 
going to require a minimum number of bidders?
    Mr. Maher. Actually, the Commission in its Ysletta order--
that is involving the Ysletta, Texas, school district--
promulgated some--made some law which clarified the competitive 
bidding process.
    For example, it made very clear that price--In any bidding 
circumstance, price has to be the primary factor to be 
considered in bidding.
    Ms. DeGette. Okay, but if you don't have a competitive bid, 
then how do you know if the price is unreasonable or not?
    Mr. Maher. The other side of the equation is something that 
the subcommittee discussed in the last hearing, which is 
looking at that schedule of discounts that schools are eligible 
for; because the notion is that, if a school or a library has 
to pay more, they will be more interested in getting an 
efficient system in place or efficient facilities, and that 
that, too, will help reinforce the----
    Ms. DeGette. You mean the percentage of the contract that 
the institution has to pay?
    Mr. Maher. Yes.
    Ms. DeGette. And are you considering then increasing that 
percentage for all entities?
    Mr. Maher. Yes. We are looking at that in an ongoing 
rulemaking.
    Ms. DeGette. And I understand that might make institutions 
pay a little closer attention to the contracts, but wouldn't 
that also eliminate some very poor school districts' ability to 
actually make their share of the E-Rate program? I mean, isn't 
it counterproductive for some of the very poorest school 
districts?
    Mr. Maher. This is the policy debate that has faced the 
program, and I will note that in its first 6 years--you have 
spoken about its benefits--that many of those school districts, 
the poorest ones, have received the up-to-date technology. So 
what we are trying to do is to weigh these concerns, both 
making sure they have the facilities and making sure that the 
process can work well.
    Ms. DeGette. It would seem to me, you could have a rule 
that required a certain number of bidders, and then if a school 
district couldn't find those bidders, they could apply for a 
waiver. Wouldn't that make some sense? That way you would have 
a basic rule, but that exceptions could be granted in extreme 
cases.
    Mr. Maher. It is certainly worth considering, ma'am.
    Ms. DeGette. Okay Do you think you will go back and 
consider that?
    Mr. Maher. Yes, ma'am.
    Ms. DeGette. Now you are leaving at the end of August, I 
understand. Is that right?
    Mr. Maher. I believe the beginning of September, ma'am.
    Ms. DeGette. Who is going to be taking over this program 
when you leave?
    Mr. Maher. It would be the next Chief of the Wireline 
Competition Bureau, who hasn't been designated yet.
    Ms. DeGette. All right. So are you going to be working with 
that person when they come in or are we going to be starting 
from Ground Zero with someone new right about the time we come 
back into the fall session?
    Mr. Maher. I will be working with that person, and also our 
professional staff. Our head manager on this is a former State 
prosecutor and an expert in the schools program. So I think it 
is in good hands.
    Ms. DeGette. Okay. I just want to ask one more question. 
Then I know we have a series of votes. The final requirement is 
to require additional documentation--Oh, the final suggestion 
in this memo is to require additional documentation and notice. 
Are you familiar with that recommendation?
    Mr. Maher. I'd have to refresh my recollection.
    Ms. DeGette. It is on page 4 of the memo.
    Mr. Maher. Yes, I see it.
    Ms. DeGette. Okay. Are you familiar with that, besides just 
looking at it today?
    Mr. Maher. Yes.
    Ms. DeGette. Okay. What kinds of additional--and do you 
agree that additional documentation and notice are going to be 
necessary to restore the integrity of the program?
    Mr. Maher. I think the best answer to the issue posed by 
the suggestion on page 4 is a comprehensive document retention 
program and effective review of USAC.
    Ms. DeGette. You testified to that before.
    Mr. Maher. Yes, ma'am.
    Ms. DeGette. And is that going to be put into place?
    Mr. Maher. We have recommended that for Commission 
consideration at the August meeting.
    Ms. DeGette. Well, let me just say for the record, and I 
know the chairman has a question, I think everybody needs to 
get on this fast and enact some very, very stringent rules at 
every level. I yield back.
    Mr. Walden. Thank you. The Chair recognizes the chairman of 
the committee.
    Chairman. Barton. And I am going to be very brief, and I 
hope your answers are brief, because we are going to have to 
leave here in about 4 minutes.
    What is the total amount of contracts or grants that are 
awarded under the E-Rate program right now?
    Mr. Maher. The program is capped at $2.25 billion a year, 
and that----
    Chairman. Barton. $2.25 billion.
    Mr. Maher. Yes, sir, and that is awarded.
    Chairman. Barton. Isn't it true that the number of requests 
for funding is going up almost geometrically? I thought we had 
requests last year for over $5 billion, $5.6 billion. Is that 
right, or not right?
    Mr. Maher. Sir, Mr. McDonald has the number. I believe the 
actual demand has decreased from 2003 to 2004 by 9 percent, as 
far as dollars. But Mr. McDonald perhaps has the best----
    Chairman. Barton. Well, so it has probably gone up.
    Mr. McDonald. 2002 is the highest level. It has declined in 
2003 and 2004. It is still $4.3 billion.
    Chairman. Barton. Okay. When somebody--We have seen, not 
just on the issues that are before us that we put on the 
record, Puerto Rico and San Francisco, but everywhere across 
the country we see instances where requests for funds under 
this program start out in what appear to be very reasonable, 
and then some consultants come in, and the next year the 
funding levels go up by orders of magnitude, you know, from 
like $4 million to $40 million or $20 million to $100 million.
    Is there no system in the review process that checks back 
from prior years and questions some of these big increases?
    Mr. McDonald. In 2002, the highest year, we identified a 
pattern, procurement pattern, that we felt was inconsistent 
with the rules, and denied over $500 million. The Commission 
largely upheld us on appeal, and I believe that contributed to 
the reduction in demand in 2003.
    Chairman. Barton. Well, what it appears to me is that we 
had a program that was put in place 5 or 6 years ago, and in 
the beginning a lot of people didn't understand it, and a lot 
of especially the smaller school districts don't like dealing 
with the Federal Government. Then word got out that there was 
easy money to be had, and these applications would almost be 
rubber stamped.
    I mean, we have on the record one of these applications 
where they built a television studio. Now surely somebody at 
the regional and Federal level would look at something like 
that.
    I mean, thank God for groups like the San Francisco School 
District that are kind of self-enforcing, but I don't see a 
whole lot of effort at the Federal level to do anything but 
kind of manage the available fund and portion out the amount of 
money that is allowed to go out each year. Am I wrong about 
that?
    Mr. McDonald. Let me say, sir, that we work really hard to 
identify issues in this program. Service providers--we look for 
patterns across applications. The set of applications that is 
really the heart of the issue here today was really the first 
time we identified issues like this across applications.
    Now we have a special investigations team with certified 
fraud examiners on our staff that would dig right into an issue 
like this. I am confident we wouldn't have made the San 
Francisco commitment if we had seen that now.
    I think we have beefed up a lot our ability to identify 
fraud and stop it.
    Chairman. Barton. Well, we are going to have to go vote. So 
I am going to yield back. But I would like there to be a set of 
recommendations about how to make changes to the program that 
force more automatic compliance, so that we don't have to 
depend on people like the superintendent of the San Francisco 
School District to be a watchdog for the taxpayers' money.
    With that, Mr. Chairman, I yield back.
    Mr. Walden. Thank you, Mr. Chairman.
    I am going to note that we are going to keep the record 
open for members to submit questions in writing to all our 
witnesses today, including you two gentlemen, if that is 
acceptable. Well, yes, without objection.
    Mr. McDonald. Yes, sir.
    Mr. Walden. We will keep it open for 30 days to submit 
questions.
    No other business to come before the subcommittee, I 
appreciate all the witnesses today, and we stand adjourned.
    [Whereupon, at 3:38 p.m., the subcommittee was adjourned.]



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