[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
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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
_________________________________________________________________
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866)512-1800;
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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.''
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\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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