[Senate Hearing 108-962]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-962
 
                  THE UNIVERSAL SERVICE E-RATE PROGRAM
=======================================================================


                                HEARING

                               before the

                         COMMITTEE ON COMMERCE,

                      SCIENCE, AND TRANSPORTATION

                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                            OCTOBER 5, 2004

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation





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   SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                     JOHN McCAIN, Arizona, Chairman
TED STEVENS, Alaska                  ERNEST F. HOLLINGS, South 
CONRAD BURNS, Montana                    Carolina, Ranking
TRENT LOTT, Mississippi              DANIEL K. INOUYE, Hawaii
KAY BAILEY HUTCHISON, Texas          JOHN D. ROCKEFELLER IV, West 
OLYMPIA J. SNOWE, Maine                  Virginia
SAM BROWNBACK, Kansas                JOHN F. KERRY, Massachusetts
GORDON H. SMITH, Oregon              JOHN B. BREAUX, Louisiana
PETER G. FITZGERALD, Illinois        BYRON L. DORGAN, North Dakota
JOHN ENSIGN, Nevada                  RON WYDEN, Oregon
GEORGE ALLEN, Virginia               BARBARA BOXER, California
JOHN E. SUNUNU, New Hampshire        BILL NELSON, Florida
                                     MARIA CANTWELL, Washington
                                     FRANK R. LAUTENBERG, New Jersey
      Jeanne Bumpus, Republican Staff Director and General Counsel
             Robert W. Chamberlin, Republican Chief Counsel
      Kevin D. Kayes, Democratic Staff Director and Chief Counsel
                Gregg Elias, Democratic General Counsel



                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on October 5, 2004..................................     1
Statement of Senator Burns.......................................     5
    Prepared statement...........................................     6
Statement of Senator McCain......................................     1
Statement of Senator Rockefeller.................................     2
    Prepared statement...........................................     4
    Letter dated October 1, 2004 to Hon. Michael K. Powell, 
      Chairman, Federal Communications Commission from Senators 
      Olympia J. Snowe and John D. Rockefeller IV................    33
Statement of Senator Snowe.......................................     7

                               Witnesses

Bennett, Thomas, Assistant Inspector General, USF Oversight, 
  Federal Communications Commission; accompanied by Thomas C. 
  Cline, Assistant Inspector General for Audits, Office of the 
  Inspector General, FCC.........................................     9
    Prepared statement of H. Walker Feaster III, Inspector 
      General, Federal Communications Commission.................    11
Gumper, Frank, Chairman of the Board, Universal Service 
  Administrative Company.........................................    18
    Prepared statement...........................................    20
Himsworth, Winston E., Executive Director, E-Rate Central........    25
    Prepared statement...........................................    27
McDonald, George, Vice President, Schools and Libraries Division, 
  Universal Service Administrative Company.......................    21
    Prepared statement...........................................    23


                  THE UNIVERSAL SERVICE E-RATE PROGRAM

                              ----------                              


                        TUESDAY, OCTOBER 5, 2004

                                       U.S. Senate,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 9:40 a.m. in room 
SD-253, Russell Senate Office Building, Hon. John McCain, 
Chairman of the Committee, presiding.

            OPENING STATEMENT OF HON. JOHN McCAIN, 
                   U.S. SENATOR FROM ARIZONA

    The Chairman. Good morning. Today the Committee meets to 
hear testimony on problems in the E-rate program. When the 
program was established in the Telecommunications Act of 1996, 
Congress was hopeful that every classroom in the country would 
be wired to the Internet. Eight years later, there are many 
success stories. There are also tales of waste, fraud and abuse 
in the $2.25 billion per year program and they are ubiquitous.
    Among those examining the E-rate program are the FCC 
Inspector General's Office, along with the Inspector Generals 
at the Department of the Interior and Education, the Government 
Accountability Office, the Subcommittee on Oversight and 
Investigations of the House Energy and Commerce Committee, the 
FBI, and the Antitrust Division of the Department of Justice. I 
understand that there are currently over 40 criminal cases 
pending in Federal and State courts involving program abuses.
    Criticisms of the program have been extensive and pointed. 
At a hearing earlier this summer, the former chairman of the 
House Subcommittee on Oversight and Investigations, Mr. 
Greenwood, said of E-rate, ``While a well-intentioned idea, the 
E-rate program as it is currently structured is an invitation 
for disaster. Indeed, if one were to design a program to pour 
money out the window, this would be the way to do it.''
    I understand that Chairman Barton is committed to 
continuing his committee's revealing probes of the program.
    Newspapers around the country have conducted their own 
investigations. The Atlanta Journal Constitution, which has 
provided some of the most revealing examinations, recently 
editorialized, quote: ``Handed a blank check from the Federal 
Government, Atlanta frittered away nearly $73 million on 
overblown and unnecessary computer systems that it now has to 
struggle to maintain. Born of the Internet boom and funded 
through a telephone service surcharge, the E-rate program was 
created to assure poor children computer access, and there is 
no proof that the lavish computer arsenal has done a thing to 
boost student learning. The only proven boost has been to the 
bottom lines of the technology companies that sold the schools 
all the pricey stuff.''
    The extent to which technology companies have been unjustly 
enriched at telephone users' expense is unknown, but the size 
of the schemes that were discovered and disallowed suggests 
that the enrichment has been substantial. In 2002 the E-rate 
Administrator, USAC, disallowed over $500 million in 
applications in which IBM had worked with school districts to 
effectively circumvent the competitive bidding system process 
that was supposed to ensure the integrity of the E-rate 
program.
    In May of this year, NEC Business Network Solutions agreed 
to plead guilty and pay $20.6 million in criminal fines, civil 
settlement, and restitution relating to charges of bid rigging 
at five different school districts in Michigan, Wisconsin, 
Arkansas, and South Carolina and for fraud with respect to the 
San Francisco Unified School District.
    Unscrupulous vendors are not the only problem. There is 
blame enough to go around. In Puerto Rico, State officials 
appear to be among those responsible for squandering over $100 
million in E-rate funds. School districts that have found ways 
to avoid paying their matching share for services and equipment 
have allowed themselves to be manipulated by crooked vendors or 
in some instances have been parties to bilking ratepayers and 
denying students much-needed equipment.
    I understand that one school in Michigan had a $750,000 
television studio built for it by its E-rate vendor, which 
gives you an idea of the vendor's excessive profits.
    As for the regulators, they too are to blame. The FCC, 
while making rule changes in response to exploding scandals, 
has been reactive and too gentle. Only last year did the FCC 
allow for disbarments, but the new rules seem lax. Vendors are 
prohibited from participating in the program only if there is a 
criminal conviction or finding of civil liability and, given 
the length, this means vendors can participate for a very, very 
long time.
    USAC, which administers E-rate, has had some successes in 
preventing the most blatant attempts to defraud the fund, but 
its audits have been too few, too late, and too forgiving.
    Lest we overlook ourselves, Congress also is responsible. 
We created the program and, despite its endemic problems, its 
popularity makes clear that it is not going away. It is 
incumbent upon us to ensure, either through oversight or 
legislation if necessary, that E-rate functions as intended. 
Today's hearing is just the beginning.
    Senator Rockefeller.

           STATEMENT OF HON. JOHN D. ROCKEFELLER IV, 
                U.S. SENATOR FROM WEST VIRGINIA

    Senator Rockefeller. Thank you, Mr. Chairman. I thank your 
accommodation with respect to the scheduling of this, and I 
look forward to hearing what people have to say.
    I have to tell you that I am very, very disappointed that 
the FCC, which was invited to testify today, declined to do so. 
I do not think that was accidental. They have their purposes 
with respect to E-rate and have revealed them in recent years. 
The FCC is charged with oversight of the universal service 
program. Both the FCC Inspector General, who is here, and the 
GAO have been critical of their oversight.
    Mr. Chairman, all of us--the waste, fraud and abuse 
argument has been used from the very beginning and I am not 
denying that there is some of that. I think it is also 
important to point out that there are millions and millions of 
kids who have access to computers and who can learn Japanese 
and do all kinds of things that could not before. So we are all 
concerned about waste, fraud and abuse in this or any other 
Federal program, including the Department of Defense and 
wherever it might be.
    So it is clear that USAC and the FCC have plans in place to 
combat waste and fraud. I want to hear about those. These are 
essential and should be monitored and strengthened as the 
Chairman has indicated.
    I know the Chairman would prefer that the hearing be 
limited or at least focused on waste, fraud and abuse, but I 
have got something else I have got to say which I think is 
equally important. That is the suspension of the E-rate. There 
was a little article in the New York Times. I do not think most 
people know about it, but the E-rate and Rural Health Care 
funding commitments have been suspended due to changes in 
accounting practices which are very technical at the 
administration corporation, USAC, which they administer the USF 
program, the Universal Service Fund program.
    They were forced to suspend these commitment letters. 
However, the policy, process, and impact leading up to this 
decision is unclear and needs to be resolved. The program is 
not in effect. Nobody is getting any money anywhere. So there 
is no waste, fraud and abuse going on now. There is not 
anything going on now.
    I have heard from schools that the suspension of funding is 
causing a significant disruption to their operations. It is 
inconceivable to me that funding was stopped as the school year 
was beginning. It appears that if the FCC had acted in a more 
timely manner, the absent FCC, the deliberately absent FCC, on 
this issue we would not be in this situation.
    Mr. Chairman, I want these questions answered today and I 
know that there are votes and other things. What are the plans 
to deal with the suspension of the E-rate and the Rural Health 
Care programs? I want to know. Is the FCC treating E-rate and 
Rural Health Care in a discriminatory fashion? I want to know. 
What happens in the first quarter of next year when the FCC has 
to find $550 million to make up for undercollected E-rate 
funding? Are we facing a huge rate spike, which is my fear, or 
will schools lose their money forever, which is also my fear?
    As many of you know, Senator Snowe and I sent a letter to 
the FCC asking for an explanation. I do not think we have heard 
anything from them.
    Mr. Chairman, I know that the bulk of the issue that you 
wish to address involves what I mentioned before and you will 
find no stronger ally for somebody who cares so much about the 
E-rate about getting rid of waste, fraud and abuse because that 
has been a rap on it from the beginning. I think it is partly 
true and partly untrue. I also know that you share my concerns 
that the entire Universal Service Fund is now jeopardized by 
recent events and we have an obligation to look into this 
matter further.
    Mr. Chairman, I have a longer statement. I submit it for 
the record.
    [The prepared statement of Senator Rockefeller follows:]

          Prepared Statement of Hon. John D. Rockefeller IV, 
                    U.S. Senator from West Virginia
    Mr. Chairman, I appreciate your cooperation in scheduling this 
hearing. I know that we are all pressed for time this week. I would 
also like to welcome our witnesses today. I look forward to hearing 
from you on issues affecting the E-Rate program.
    The E-rate program has fundamentally transformed education in this 
country--we have connected our most remote schools and libraries to the 
world. The E-rate has enabled schoolchildren across this country to 
participate in the information society. I have seen firsthand the 
benefits of the E-rate in West Virginia schools and our libraries. All 
students in West Virginia can have free access to the Internet in local 
libraries, and through these connection they can access free practice 
tests for the ACT and SAT. Our libraries and our schools would not be 
connected without E-rate. Unfortunately this message has been lost in a 
spate of negative headlines about the program, which all too often have 
not told the full story.
    All of us are concerned about waste, fraud and abuse in this 
program or any other Federal program. The E-rate program processes tens 
of thousands of applications annually. Unfortunately, a few bad actors 
have in some way tarnished the success of this program. We need to make 
sure that the E-rate program has strong program integrity and that any 
bad actors are appropriately punished so that we can make sure future 
bad actors cannot take advantage of schools or the program.
    We cannot nor should we tolerate any waste, fraud or abuse in this 
program because our schools and libraries need the dollars that the E-
rate provides. As the General Accountability Office has noted, we--
Congress, the Federal Communications Commission (FCC), and the 
Universal Service Administrative Corporation (USAC)--need to provide 
more effective and consistent oversight of not just E-rate but all of 
the Universal Service Fund programs, including High Cost, Low-Income 
and Rural Health Care.
    The impact of the E-rate on our schools has been impressive. For 
example, in 1996, when the Telecommunications Act was signed into law, 
only 14 percent of all classrooms were connected to the Internet, and 
among the poorest schools, only 5 percent of classrooms were connected. 
The most recent statistics for classroom connection are amazing--92 
percent of all classrooms are connected, and 89 percent of the poorest 
classrooms are connected. This is a wonderful story of success over the 
past 7 years. In addition to the direct education benefit that this has 
provided our children, it has exposed rural and inner city kids to 
technology helping bridge the digital divide.
    In addition to the impressive statistics on classroom connections, 
a recent GAO study released in September 2004 highlighted that 84 
percent of rural superintendents reported that E-rate was helping them 
comply with the federally-mandates No Child Left Behind Act 
requirements. The superintendents reported that E-rate was helping to 
provide affordable teacher training and development so teachers could 
earn the highly qualified status. It also allows students in isolated 
rural schools to use distance learning to take courses from qualified 
teachers at other locations. Such access is critical for our schools if 
we want them to achieve the new higher academic standards, especially 
when Federal funding for the No Child Left Behind Act is billions of 
dollars less than promised.
    Over the last several years, the FCC and USAC have been 
systematically improving the E-rate funding process and aggressively 
pursuing any hint of waste, fraud and abuse. USAC created its own 
whistler blower hotline to combat fraud and it established a task force 
to provide recommendation on ways to combat fraud. The FCC issued two 
orders to improve E-rate program integrity. These two actions will 
serve to strengthen the program.
    I will work with my colleagues, the FCC, and USAC to improve the 
operation of the E-rate program. We must not let a few high-profile 
cases of waste, fraud and abuse undermine the program. We must and will 
make the necessary changes to prevent future cases.
    As equally important to maintaining the E-rate's program integrity 
is making sure it can undertake its mission. I am deeply concerned by 
reports that in the last week of the year-long conversion of the 
Universal Service Fund from GAAP to Government GAAP accounting 
standards, the FCC has instituted changes that may significantly affect 
the operation and administration of the entire Fund, and in particular, 
the schools and libraries (``E-rate'') and rural health care funds. 
This action has led to the suspension since August 3, 2004 of the 
Funding Commitment Decision Letters (``Commitment Letters'') issued 
under those programs and the Commission's determination that funds held 
in the Universal Service Fund are Federal funds for purposes of the 
Anti-Deficiency Act. This suspension has already had already 
significant negative impact on schools, libraries and rural health care 
providers across the country.
    It is my understanding that the FCC and USAC are suggesting that 
the program will remain suspended until mid-November resulting in over 
4,000 schools and libraries with eligible applications for this year 
worth about $300 million being placed on hold. The number of schools 
and libraries waiting for funding will grow dramatically over the fall.
    In addition to the decision to suspend E-rate Commitment letters, I 
am troubled by the seemingly inconsistent decisions made by the 
Commission as it has implemented the accounting conversion. First, at 
the same time the Commission was deciding whether to treat Commitment 
Letters as ``obligations'' for accounting purposes USAC to have monies 
in its account to cover all existing and future Commitment Letters, the 
Commission took steps to ``under collect'' E-rate revenues by a total 
of $550 million. These decisions will to require substantial reductions 
in available outlays for the schools and libraries and rural health 
care programs and will increase significantly the contribution rate 
assessed on providers of interstate communications services and passed 
through to consumers early next year. It could be perceived that the 
Commission's decisions have been politically motivated and designed to 
undermine the Fund.
    Lastly, I am bothered that while the FCC has taken steps to ensure 
that the E-rate and rural health care programs are in compliance with 
the new accounting requirements, we understand the Commission has not 
completed a full review of the impact of the conversion on the high-
cost fund. In particular, the Commission's apparent decision regarding 
treatment of the E-rate and rural health care Commitment Letters as 
obligations may also impact how projected costs used to calculate high-
cost support should be treated for accounting purposes. If these 
projections are determined to be obligations, the high-cost fund could 
face disruptions similar to those currently being experienced in the E-
rate and rural health care programs, putting in jeopardy billions of 
dollars relied on by rural telecommunications carriers that bring 
essential services to consumers.
    I will not sit by and watch the FCC undermine our ability to 
provide universal service. The only reason many West Virginians have 
access to telephone service is because of universal service. I do not 
want to see their telephone bills jacked up dramatically because the 
Commission has been artificially keeping rates low over the last year.
    Mr. Chairman, this Committee will begin examining the future of 
telecommunications policy in the next Congress. Maintaining the 
integrity of universal service and the E-rate will be two of my highest 
priorities. Instead of a campaign to tear down these programs, we 
should be looking how we can leverage the investments we have already 
made in wiring schools and libraries to bring a wider array of new 
services to our most our children.

    The Chairman. Senator Rockefeller, I also read the same 
article and I share your concern, particularly since apparently 
no one was notified, including the Congress nor members of this 
Committee. That is very disturbing. We may have to have a 
follow up hearing, perhaps during the lame duck session, 
depending on what we get out of this. If we are talking about 
this kind of money and this kind of a program, we may have to 
delve deeper into it.
    Senator Burns.

                STATEMENT OF HON. CONRAD BURNS, 
                   U.S. SENATOR FROM MONTANA

    Senator Burns. Thank you, Mr. Chairman, and thank you for 
the hearing.
    The Chairman. By the way, I would just like to say Senator 
Burns and Senator Rockefeller and Senator Snowe, the three 
members here, had a huge amount of influence on the whole E-
rate program itself, and I thank them for their continuing 
involvement.
    Senator Burns. Well, thank you, Mr. Chairman. I want to 
associate myself with your words. There has been some waste, 
fraud and abuse, and to get to those, that is good.
    But I want to ask unanimous consent that my full statement 
can be put in the record.
    The Chairman. Without objection.
    Senator Burns. But I just want to point out a couple of 
things. The Anti-Deficiency Act, which is a Federal budget law, 
what it really caused here, and it is my understanding that the 
relationship between USAC and the FCC is not the best at this 
present time and it is causing real difficulties.
    But to get a little history on this, the real change was 
intended to improve oversight on USAC's administration of E-
rate funds to eliminate fraud and abuse. But this change 
apparently also limited USAC's ability to spend the money. So 
the E-rate program had excess money in the amount of around $3 
billion.
    Now, that might not seem like much for a lot of folks, but 
that sounds like a hell of a lot of money to me. The FCC then 
reduced the contribution factor and the surplus was placed in 
investments. We will talk about that in a little bit. This was 
followed by a change in the E-rate rules which forced USAC to 
hastily sell this $3 billion investment at a loss. Some would 
put the figure at around $21 million.
    I fail to see how these series of events resulted in more 
effective administration of the E-rate program. So I think this 
has caused a chain effect that has cost us money, not only in 
the fund, but also this drastic action of cutting off all funds 
now going to schools that need it. And I have got 33, 34 in my 
state that I have got phone calls from already. These are all 
rural schools. In Montana, like in West Virginia, when you talk 
about rural, we are rural.
    These funds are vital as far as the telephones it takes and 
the communications it takes to communicate with the outside 
world, so to speak.
    I just ask my full statement be put in the record, but 
thank you for calling this hearing.
    [The prepared statement of Senator Burns follows:]

   Prepared Statement of Hon. Conrad Burns, U.S. Senator from Montana
    I thank the Chairman for calling today's hearing, which addresses a 
matter of urgent importance. A change in FCC rules and accounting has 
caused many eligible schools and libraries which are dependent on E-
rate funds, including at least 33 in Montana, to suddenly lose this 
funding. While I have had many concerns over the administration of the 
E-rate program over the years, clearly the current situation is proving 
inappropriately harmful to many worthy institutions.
    The state of interaction between the FCC, USAC, and the other 
relevant budget entities has deteriorated to the extent that the 
program's administration has been interrupted. The rule changes in 
question go back at least a year, which would seem to have provided 
enough time to productively address legitimate accounting concerns 
without freezing funds. The rule change was intended to improve 
oversight over USAC's administration of E-rate funds to eliminate fraud 
and abuse. But this change apparently also limited USAC's ability to 
spend money. So the E-rate program had excess money, in the amount of 
about $3 billion; the FCC then reduced the contribution factor and the 
surplus was placed in investments. This was followed by a change in the 
E-rate rules which forced USAC to hastily sell this $3 billion 
investment at a loss. I fail to see how this sloppy series of events 
resulted in a more effective administration of the E-rate program.
    I realize that this hearing will address troublesome cases of 
waste, fraud and abuse in the E-rate program, and I understand that the 
problem we have today in part a consequence of an attempt to provide 
better oversight for the program and to reduce fraud. Obviously these 
are lofty and commonly-held goals. But cutting off all the bona fide 
schools and libraries in this way is about the worst way deal with the 
situation.
    I am seriously troubled at the dire prospects faced by scores of 
schools and libraries in Montana because of this cutoff of funds, and 
numerous other states face similar problems. A potential solution to 
restoring funding would be to simply postpone the budget rule changes 
that have been made until a full review can be undertaken.
    Ultimately this system must be made more effective and must work 
the way it is supposed to work. Bearing this in mind, once the 
immediate problem of restoring the program to operation is addressed, 
we must also strive to determine the best way out of this current, 
unacceptable situation in the long-run. In other words, several key 
policy matters must be decided, including how exactly USAC funds should 
be accounted for, given that they are not appropriated monies, but 
rather collected from private carriers; how oversight should be 
organized, under what part of the government; and how we get there from 
here.
    Should money held in universal service accounts, like E-rate, be 
included in the Federal budget? What other alternatives are there? Is 
generally accepted government accounting the only solution? If not, are 
there other ways to improve oversight? What can we learn from the ways 
that other universal service programs are run? I look forward to 
hearing the testimony of the witnesses on these vital issues. Thank 
you.

    The Chairman. Without objection.
    Senator Snowe.

              STATEMENT OF HON. OLYMPIA J. SNOWE, 
                    U.S. SENATOR FROM MAINE

    Senator Snowe. Thank you, Mr. Chairman. I am pleased to be 
here this morning to hopefully get some answers in terms of why 
we face this dilemma in the E-rate program at this juncture. I 
share the concerns and what has been expressed by the chairman 
and Senator Rockefeller and Senator Burns as well.
    We have all worked mightily to ensure that this program 
works effectively, efficiently, and appropriately. It has been 
an enormous success. It is one of the most successful 
education-related programs in our nation's history, when you 
consider the fact when the Telecommunications Act was first 
enacted in 1996 that only 14 percent of classrooms in America 
had Internet connection and today we are talking almost 99 
percent, 95, 99 percent, not to mention some of the poorest 
school districts in America.
    Since the program was created, more than $12 billion has 
been disbursed. I think absolutely we ought to be looking and 
focusing on those areas in which the money has not been 
appropriated within the legal parameters of the law, and if 
vendors and recipients are defrauding the government we ought 
to take appropriate action. I hope that the measures that have 
been put in place by the Inspector General, the FCC, those that 
have been identified by the General Accounting Office, also 
have been fully implemented as well. I know that the FCC has 
even issued recent actions with respect to taking some strong 
measures against fraud and abuse.
    The other dimension to this problem, as Senator Rockefeller 
indicated: We have a letter that has been sent to the Chairman 
of the FCC, Mr. Powell, on the issue of why USAC has been 
placed in this situation with respect to letters of commitments 
now, not being able to disburse those funds, with shifting to 
government accounting rules in midstream, especially since 
there had been some consideration of making this conversion 
last February, but they did not get notice until July, so that 
they had to put a halt to this in August.
    So it does affect school districts and libraries across the 
country. It is also going to cost USAC money. As I understand 
it, it is going to force them to liquidate their assets. From 
what I understand, they are going to lose $30 million in 
accrued interest as a result of having to liquidate these 
assets in order to meet these commitments.
    It is arbitrary application of these government accounting 
principles as I understand it. Senator Rockefeller and I have 
not been able to get any answers as to, first, who is 
responsible for this decision? Is it the FCC, or is it OMB? How 
did this come about? Why in this untimely fashion, an 
inconsistent application?
    The fact is they cannot offer a reason as to what exactly 
would require USAC to apply these rules at this moment in time. 
So now it is withholding more than $300 million in disbursement 
for E-rates, affecting schools when this decision coincided at 
the beginning of the school year. So now it is affecting 
schools who are dependent on this money.
    It is just really difficult to understand why this all 
transpired. I happen to think it may be another back door route 
to undermining this valuable program. So I hope that we are 
going to be able to get some answers here today, because 
obviously this was done in such a fashion to affect the well-
being of the program, but ultimately affecting school districts 
across America, and the fact is not giving USAC the time in 
which to comply with this type rule, this kind of change, in 
the future.
    We know that similar entities in government do not have to 
abide by the same standards. There was nothing to point to the 
fact that they should be required to move to these standards. 
But if that is the case, then why not give them appropriate 
timing in which to make the adjustments without having adverse 
and consequential impact on our schools as they are beginning 
the school year?
    So I hope we get to the bottom of this, Mr. Chairman, as 
well. I want to thank my colleagues, Senator Rockefeller most 
especially, for all the work and the leadership that he has 
provided on this issue.
    Thank you.
    The Chairman. Thank you.
    Our witnesses today are: Mr. Thomas Bennett, who is the 
Assistant Inspector General for USF Oversight, the Federal 
Communications Commission. He is accompanied by Mr. Cline from 
the FCC's Inspector General's Office. Mr. George McDonald, USAC 
Vice President, Schools and Libraries Division; Mr. Frank 
Gumper, USAC Chairman of the Board; and Mr. Winston E. 
Himsworth, President, E-Rate Central, and founder of State E-
Rate Coordinators Alliance.
    We only have about 4 minutes left in our vote, so I think 
it would probably be best to stand in recess for about 10 or 15 
minutes so we can get to the floor, vote, and return. Then we 
will hear from our witnesses then. We will stand in recess 
until our return in about 10 to 15 minutes. Thank you.
    [Recess from 9:57 a.m. to 10:17 a.m.]
    The Chairman. The Committee will reconvene. I thank the 
witnesses for their patience and I apologize that we were 
interrupted by a vote.
    We will begin with Mr. Bennett, who is Assistant Inspector 
General for USF Oversight, the Federal Communications 
Commission. Welcome, Mr. Bennett.

 STATEMENT OF THOMAS BENNETT, ASSISTANT INSPECTOR GENERAL, USF 
 OVERSIGHT, FEDERAL COMMUNICATIONS COMMISSION; ACCOMPANIED BY 
                       THOMAS C. CLINE, 
ASSISTANT INSPECTOR GENERAL FOR AUDITS, OFFICE OF THE INSPECTOR 
                          GENERAL, FCC

    Mr. Bennett. Mr. Chairman and Members of the Committee: I 
appreciate the opportunity to come before you today----
    The Chairman. You need to pull the microphone a little bit 
closer, please.
    Mr. Bennett. I appreciate the opportunity to come before 
you today to discuss oversight of the E-rate program and to 
discuss concerns that the FCC Office of Inspector General has 
with the program as a result of our involvement in audits and 
investigations.
    My name is Tom Bennett and I am the Assistant Inspector 
General for USF Oversight with the FCC OIG. The FCC Inspector 
General, Walker Feaster, had intended to provide testimony 
today, but Mr. Feaster has taken ill and is unable to be with 
us.
    I would like to introduce Tom Cline, who is the Assistant 
Inspector General for Audits with the FCC OIG. Tom has been 
heavily involved in oversight of the E-rate program.
    In my testimony I will briefly summarize our involvement in 
USF oversight and discuss concerns we have regarding the 
program. The FCC Office of Inspector General first looked at 
the USF in 1999 as part of our audit of the Commission's Fiscal 
Year 1999 financial statement when the USF was determined to be 
part of the FCC's reporting entity for financial statement 
reporting purposes.
    Starting with that audit, the Office of Inspector General 
has continued to devote considerable resources to oversight of 
the USF. Due to materiality and our assessment of audit risk, 
we have focused much of our attention on the USF mechanism for 
funding telecommunications and information services for schools 
and libraries, the E-rate program. We have designed an audit 
program around two corollary and complementary efforts. First, 
we have established a plan to conduct E-rate beneficiary 
audits, to evaluate beneficiary compliance with program rules 
and requirements, and to identify opportunities for 
programmatic improvement. Second, we have established a process 
for vigorously investigating allegations of fraud, waste and 
abuse in the program.
    Unfortunately, several obstacles have impeded our ability 
to implement effective independent oversight. The primary 
obstacle has been a lack of adequate resources to conduct 
audits and provide audit support to investigations. We have 
demonstrated our commitment to independent oversight of the USF 
by adding staff auditor positions and by organizing USF 
oversight activities under an Assistant Inspector General for 
USF oversight. We have also requested appropriated funding in 
each of the last three budget submissions to obtain contract 
support for our USF oversight activities.
    Most recently, we have requested a significant increase in 
funding for USF oversight in our Fiscal Year 2006 budget 
submission. The requested increase is primarily a result of a 
Commission request for the conduct of audits to meet the 
requirements of the Improper Payments Information Act of 2002 
and to calculate estimated improper payment error rates for USF 
programs, including E-rate.
    The Inspector General has been advocating for some time 
that the cost of USF oversight should be provided for through 
direct access to the USF and we have been advised that this 
idea is being considered. We are currently considering 
alternatives for obtaining access to contract audit support to 
implement the USF oversight portions of our audit plan. We are 
working with USAC to establish a three-way contract under which 
we can obtain audit resources to conduct USF audits.
    We are also working with USAC and a public accounting firm 
under contract to USAC to conduct the fourth large-scale audit 
of E-rate beneficiaries. 100 beneficiaries are being audited as 
part of this project. The project was initiated in August 2004, 
and is expected to be completed next summer.
    Despite limited resources, the FCC OIG has implemented an 
aggressive independent oversight program. Our oversight program 
includes audits conducted using internal resources, audits 
conducted by other Federal offices of inspector general under 
reimbursable agreements, review of audit work conducted by 
USAC, and active participation in Federal investigations of E-
rate fraud.
    In addition to conducting audits, we are providing audit 
support to a number of investigations of E-rate recipients and 
service providers.
    To implement the investigative component of our plan, we 
established a working relationship with the Antitrust Division 
of the ratings of Department of Justice. The Antitrust Division 
has established a task force to conduct E-rate investigations, 
comprised of attorneys in each of the Antitrust Division's 
seven field offices and the national criminal office. We are 
also supporting several investigations being conducted by 
assistant United States attorneys. We are currently supporting 
22 investigations and monitoring an additional 15 
investigations.
    Allegations being investigated in these cases include: 
procurement irregularities, including lack of a competitive 
process and bid-rigging; false claims; service providers 
billing for goods and services not provided; ineligible items 
being funded; and beneficiaries not paying the local portion of 
costs, resulting in inflated costs for goods and services to 
the program; and potential kickback issues.
    Our involvement in E-rate audits and investigations has 
highlighted numerous concerns with this program. General 
concerns include lack of clarity regarding program rules and 
lack of timely and effective resolution of audit findings.
    Specific concerns regarding program design include: 
weaknesses in program competitive procurement requirements; 
ineffective use of purchased goods and services; reliance on 
applicant certifications; weaknesses in technology planning; 
and issues relating to discount calculation and payment.
    The Office of Inspector General remains committed to 
meeting our responsibility for providing effective independent 
oversight of the USF and we believe we have made significant 
progress. While the Commission has taken steps to address 
programmatic weaknesses, more work remains to be done. Through 
our participation in the fourth large-scale round of E-rate 
beneficiary audits with USAC and through audits that we 
anticipate conducting under our three-way agreement with USAC, 
we are moving forward to evaluate the state of the program and 
to identify opportunities for programmatic improvements.
    In order to continue this important work, it is our belief 
that the Commission should have direct access to the USF. This 
will provide the resources for an effective and independent 
oversight program.
    Thank you. Tom Cline and I will be happy to answer any of 
your questions.
    [The prepared statement of Mr. Feaster follows:]

    Prepared Statement of H. Walker Feaster III, Inspector General, 
                   Federal Communications Commission
Executive Summary

   The FCC Office of Inspector General has devoted considerable 
        resources to oversight of the USF, and the E-rate program in 
        particular.

   Several obstacles have impeded our ability to implement 
        effective, independent oversight of the program. The primary 
        obstacle we have dealt with has been a lack of adequate 
        resources to conduct audits and provide audit support to 
        investigations.

   My office's involvement in E-rate audits and investigations 
        has highlighted numerous concerns with this program. These 
        include general programmatic and management concerns as well as 
        specific concerns related to program design. General concerns 
        include:

     lack of clarity regarding program rules, and;

     lack of timely and effective resolution of audit 
            findings.

    Specific concerns regarding program design include;

   weaknesses in program competitive procurement requirements;

   ineffective use of purchased goods and services;

   reliance on applicant certifications;

   weaknesses in technology planning; and

   issues relating to discount calculation and payment.

     Until my office has access to the resources and 
            funding necessary to provide effective, independent 
            oversight for the program, I am unable to provide assurance 
            that the program is protected from fraud, waste and abuse.

    Mr. Chairman and Members of the Committee, I appreciate the 
opportunity to come before you today to discuss oversight of the E-rate 
program and to discuss concerns that my office has with the program as 
a result of our involvement in audits and investigations. In my 
testimony, I will briefly summarize my office's involvement in USF 
oversight and discuss concerns my office has regarding the program.
Background on Independent Oversight of the Universal Service Fund (USF)
    My office first looked at the USF in 1999 as part of our audit of 
the Commission's FY 1999 financial statement when the USF was 
determined to be part of the FCC's reporting entity for financial 
statement reporting. During that audit, we questioned the Commission 
regarding the nature of the USF and, specifically, whether it was 
subject to the statutory and regulatory requirements for Federal funds. 
Starting with that inquiry, the Office of Inspector General has 
continued to devote considerable resources to oversight of the USF.
    Due to materiality and our assessment of audit risk, we have 
focused much of our attention on the USF mechanism for funding 
telecommunications and information services for schools and libraries, 
also known as the ``Schools and Libraries Program'' or the ``E-rate'' 
program. Applications for E-rate funding have increased from 30,675 in 
funding year 1998 to 43,050 for the current funding year. Applications 
have been received from schools and libraries in each of the 50 states, 
the District of Columbia, and most territories and included 15,255 
different service providers. Requested funding has increased from 
$2,402,291,079 in funding year 1998 to $4,538,275,093 for the current 
funding year.
OIG Oversight
    During FY 2001, we worked with Commission representatives as well 
as with the Defense Contract Audit Agency (DCAA) and the Universal 
Service Administrative Company (USAC), to design an audit program that 
would provide the Commission with programmatic insight into compliance 
with rules and requirements on the part of E-rate program beneficiaries 
and service providers. Our program was designed around two corollary 
and complementary efforts. First, we would conduct reviews on a 
statistical sample of beneficiaries large enough to allow us to derive 
inferences regarding beneficiary compliance at the program level. 
Second, we would establish a process for vigorously investigating 
allegations of fraud, waste, and abuse in the program.
    Unfortunately, several obstacles have impeded our ability to 
implement effective, independent oversight of the program. The primary 
obstacle has been a lack of adequate resources to conduct audits and 
provide audit support to investigations. Since our initial involvement 
in independent oversight of the USF as part of our conduct of the FY 
1999 financial statement audit, we have demonstrated our commitment to 
independent oversight of the USF by adding two (2) staff auditor 
positions and by organizing USF oversight activities under an Assistant 
Inspector General for USF Oversight. This represents dedication of 
three (3) of the eight (8) auditors on the staff of the FCC OIG to USF 
oversight. In addition to the OIG staff dedicated to USF oversight, two 
(2) audit staff members responsible for financial audit are also 
involved in USF oversight as part of the financial statement audit 
process. In July 2004, I was advised that the OIG would two (2) 
additional staff for USF oversight. We are currently in the process of 
hiring these additional staff.
    We have also requested appropriated funding to obtain contract 
support for our USF oversight activities. In our FY 2004 budget 
submission, we requested $2 million for USF oversight. That request was 
increased to $3 million in the President's budget submission for FY 
2004. This funding was not included in the Commission's final budget 
for FY 2004 and report language indicated that monies for USF audits 
should come from the fund itself. In our FY 2005 budget submission, we 
requested $5 million for USF oversight. We have been advised that this 
request was not included in this year's budget. We have requested a 
significant increase in funding for USF oversight in our FY 2006 budget 
submission. The requested increase is primarily a result of a 
Commission request for the conduct of audits to meet the requirements 
of the Improper Payments Information Act of 2002 and calculate 
estimated improper payment error rates for USF programs including E-
rate. I have been advocating for some time that the cost of USF 
oversight should be provided for through direct access to the USF. I 
have been advised that this alternative is being considered.
    We are currently considering alternatives for obtaining access to 
contract audit support to implement the USF oversight portions of our 
audit plan. We are working with USAC to establish a three-way contract 
under which my Office can obtain audit resources to conduct USF audits. 
We are also working with USAC and a public accounting firm under 
contract to USAC to conduct the fourth large-scale audit of E-rate 
beneficiaries. One-hundred beneficiaries are being audited as part of 
this project. The project was initiated in August 2004 and is expected 
to be completed next summer.
    Despite limited resources, my office has implemented an aggressive 
independent oversight program. My oversight program includes: (1) 
audits conducted using internal resources; (2) audits conducted by 
other Federal Offices of Inspector General under reimbursable 
agreements; (3) review of audit work conducted by USAC; and (4) active 
participation in Federal investigations of E-rate fraud.
    One-hundred and thirty five (135) audits have been completed by my 
office, USAC internal auditors, or USAC contract auditors in which the 
auditor reached a conclusion about beneficiary compliance. Of the 135 
audits, auditors determined that beneficiary were not compliance in 48 
audits (36 percent) and generally compliant in an additional 22 audits 
(16 percent). Beneficiaries were determined to be compliant in 65 
audits (48 percent). Recommended fund recoveries for those audits where 
problems were identified total over $17 million.
OIG Audits Using Internal Resources
    My office has completed thirteen (13) audits that we initiated 
during Fiscal Year 2002 using auditors detailed from the Commission's 
Common Carrier Bureau (since reorganized as the Wireline Competition 
Bureau). For these thirteen (13) audits, we concluded that applicants 
were compliant with program rules in five (5) of the audits, that 
applicants were generally compliant in two (2) of the audits, and that 
the applicants were not compliant with program rules in six (6) of the 
audits. We have recommended recovery of $1,794,792 as shown below:

------------------------------------------------------------------------
Report Date
                  Applicant         Conclusion   Potential Fund Recovery
------------------------------------------------------------------------
09/11/02     Enoch Pratt Free     Compliant                           $0
              Library
02/03/03     Robeson County       Compliant                            0
              Public Schools
02/05/03     Wake County Public   Compliant                            0
              Schools
08/27/03     Albemarle Regional   Compliant                            0
              Library
12/22/03     St. Matthews         Not Compliant                  136,593
              Lutheran School
12/22/03     Prince William       Generally                        5,452
              County Schools       Compliant
12/22/03     Arlington Public     Generally                        7,556
              School District      Compliant
03/24/04     Immaculate           Not Compliant                   68,846
              Conception School
04/06/04     Children's Store     Not Compliant                  491,447
              Front School
05/19/04     St. Augustine        Not Compliant                   21,600
              School
05/25/04     Southern             Compliant                            0
              Westchester BOCES
06/07/04     United Talmudical    Not Compliant                  934,300
              Academy
08/12/04     Annunciation         Not Compliant                  129,003
              Elementary School
                                                ------------------------
                                                              $1,794,797
                                                ========================
------------------------------------------------------------------------

Audits Conducted by Other Federal Offices of Inspector General
    On January 29, 2003, we executed a Memorandum of Understanding 
(MOU) with the Department of the Interior (DOI) OIG. The MOU is a 
three-way agreement among the Commission, DOI OIG, and USAC for reviews 
of schools and libraries funded by the Bureau of Indian Affairs and 
other universal service support beneficiaries under the audit 
cognizance of DOI OIG. Under the agreement, auditors from the 
Department of the Interior perform audits for USAC and the FCC OIG. In 
addition to audits of schools and libraries, the agreement allows for 
the DOI OIG to consider requests for investigative support on a case-
by-case basis. We have issued two (2) final audit reports under this 
MOU, three (3) draft audit reports, and have completed fieldwork on two 
(2) additional audits. For the audit where we determined that the 
applicant was not compliant, we have recommended recovery of 
$2,084,399. A summary of completed audits is as follows:

------------------------------------------------------------------------
Report Date
                  Applicant         Conclusion   Potential Fund Recovery
------------------------------------------------------------------------
11/06/03     Santa Fe Indian      Compliant                           $0
              School
01/07/04     Navajo Preparatory   Not Compliant                2,084,399
              Academy
------------------------------------------------------------------------

    We have also established a working relationship with the Office of 
Inspector General at the Education Department (Education OIG). In 
January 2004, Education OIG presented a plan for an audit of 
telecommunication services at the New York City Department of Education 
(NYCDOE). Because of the significant amount of E-rate funding for 
telecommunication services at NYCDOE, Education OIG has proposed that 
they be reimbursed for this audit under a three-way MOU similar to the 
existing MOU with DOI OIG. In April 2004, the Universal Service Board 
of Directors approved the MOU. In June 2004, the MOU was signed and the 
audit was initiated.
Review of USAC Audits
    We have reviewed work performed by USAC's Internal Audit Division 
and performed the procedures necessary under our audit standards to 
rely on that work. In December 2002, USAC established a contract with a 
public accounting firm to perform agreed-upon procedures at a sample of 
seventy-nine (79) beneficiaries from funding year 2000. The sample of 
beneficiaries was selected by the OIG. In a departure from the two 
previous large-scale rounds of E-rate beneficiary audits conducted by 
USAC contractors, the agreed-upon procedures being performed under this 
contract would be performed in accordance with both the Attestation 
Standards established by the American Institute of Certified Public 
Accountants (AICPA) Standards and Generally Accepted Government 
Auditing Standards, issued by the Comptroller General (GAGAS or 
``Yellow Book'' standards). In March 2003, we signed a contract with a 
public accounting firm to provide audit support services for USF 
oversight to the OIG. The first task order that we established under 
this contract was for the performance of those procedures necessary 
under ``Yellow Book'' standards to determine the degree to which we can 
rely on the results of that work (i.e., to verify that the work was 
performed in accordance with the AICPA and GAGAS standards). The OIG 
review team is currently completing this work. Many of the audit 
findings raised by this body of work are reflected in the section 
addressing concerns with the E-rate program.
Support to Investigations
    In addition to conducting audits, we are providing audit support to 
a number of investigations of E-rate recipients and service providers. 
To implement the investigative component of our plan, we established a 
working relationship with the Antitrust Division of the Department of 
Justice (DOJ). The Antitrust Division has established a task force to 
conduct USF investigations comprised of attorneys in each of the 
Antitrust Division's seven (7) field offices and the National Criminal 
Office. We are also supporting several investigations being conducted 
by Assistant United States Attorneys.
    We are currently supporting twenty-two (22) investigations and 
monitoring an additional fifteen (15) investigations. Unfortunately, 
the increased interest in these cases has resulted in an increased 
demand for OIG audit support. In fact, the amount of audit support has 
exacerbated our previously stated concern about the availability of 
resources and our ability to implement other components of our USF 
oversight plan. Allegations being investigated in these cases include 
the following:

   Procurement irregularities--including lack of a competitive 
        process and bid rigging;

   False Claims--Service Providers billing for goods and 
        services not provided;

   Ineligible items being funded; and

   Beneficiaries are not paying the local portion of the costs 
        resulting in inflated costs for goods and services to the 
        program and potential kickback issues.
Concerns with the E-rate Program
    My office's involvement in E-rate audits and investigations has 
highlighted numerous concerns with this program. These include general 
programmatic and management concerns as well as specific concerns 
related to program design. General concerns include:

   lack of clarity regarding program rules, and;

   lack of timely and effective resolution of audit findings.

    Specific concerns regarding program design include;

   weaknesses in program competitive procurement requirements;

   ineffective use of purchased goods and services;

   reliance on applicant certifications;

   weaknesses in technology planning; and

   issues relating to discount calculation and payment.
Lack of Clarity Regarding Program Rules
    Under Commission staff oversight, USAC has implemented numerous 
policies and procedures to administer the E-rate program. In some 
cases, the Commission has adopted these USAC operating procedures, in 
other cases however, USAC procedures have not been formally adopted by 
the FCC. In those cases where USAC implementing procedures have not 
been formally adopted by the Commission, it is the position of 
Commission staff that there is no legal basis for recovery of funds 
when applicants fail to comply with these procedures.
    We are concerned about the distinction that Commission staff makes 
between program rules and USAC implementing procedures for a number of 
reasons.

   First, we believe that this distinction represents a 
        weakness in program design. Within their authority under 
        program rules, USAC has established implementing procedures to 
        ensure that program beneficiaries comply with program rules and 
        that the objectives of the program are met. In those cases 
        where USAC has established implementing procedures that are not 
        supported by program rules, USAC and the Commission have no 
        mechanism for enforcing beneficiary compliance.

   Second, we believe that it is critical that participants in 
        the E-rate program have a clear understanding of the rules 
        governing the program and the consequences that exist if they 
        fail to comply with those rules. We are concerned that the 
        Commission has not determined the consequences of beneficiary 
        non-compliance in many cases and that, in those instances where 
        the Commission has addressed the issue of consequences for non-
        compliance, the consequences associated with clear violations 
        of program rules do not appear to be consistent.

   Third, a clear understanding of the distinction between 
        program rules and USAC implementing procedures is necessary for 
        the design and implementation of effective oversight. It is 
        necessary for the timely completion of audits and the timely 
        resolution of audit findings and implementation of corrective 
        action resulting from audits.
Lack of Timely and Effective Resolution of Audit Findings from E-rate 
        Beneficiary Audits
    Since our involvement in this program, I have become increasingly 
concerned about efforts to resolve audit findings and to recover funds 
resulting from E-rate beneficiary audits. It has been our observation 
that audit findings are not being resolved in a timely manner and that, 
as a result, actions to recover inappropriately disbursed funds are not 
being taken in a timely manner. In some cases, it appears that audit 
findings are not being resolved because USAC is not taking action in a 
timely manner. In other cases, findings are not being resolved because 
USAC is not receiving guidance from the Commission that is necessary to 
resolve findings. USAC is prohibited under program rules from making 
policy, interpreting unclear provisions of the statute or rules, or 
interpreting the intent of Congress. As a result of this prohibition, 
USAC must seek guidance from the Commission when audit findings are not 
clearly violations of Commission rules.
    The second large-scale audit of E-rate beneficiaries was conducted 
by the public accounting firm of Arthur Andersen under contract to 
USAC. In 2001, USAC contracted with Arthur Andersen to conduct audits 
at twenty-five (25) beneficiaries from funding years 1999 and 2000. E-
rate disbursements to these beneficiaries totaled $322 million. Arthur 
Andersen provided a draft audit report summarizing the results of these 
audits on May 31, 2002. The final report, including responses from the 
USAC Schools and Libraries Division, was released by the Schools and 
Libraries Committee of the USAC Board of Directors on April 23, 2003, 
eleven months after the draft report was provided by Arthur Andersen. 
The audit report disclosed monetary findings at fourteen (14) of the 
twenty-five (25) beneficiaries including $11.4 million in inappropriate 
disbursements and unsupported costs. As of September 30, 2003, USAC had 
recovered $1,927,579 in inappropriate disbursements and unsupported 
costs and initiated recovery actions for another $1,353,741, of which 
$709,013 is under appeal. We have been advised that USAC initiated 
recovery actions for the remaining $8,059,141.
    The final report adopted by the Universal Service Board also 
identified eleven (11) policy issues, relating to thirty-three (33) 
separate findings, for which USAC determined that FCC policy guidance 
was required. The dollar value of potential fund recoveries associated 
with these thirty-three (33) findings was not available because, in 
most cases, the final report indicated that those amounts had not been 
determined. Policy issues identified included the lack of fixed asset 
and associated records, maintenance of connectivity once it is 
established, technology plan approver control and requirements, 
insufficient documentation including lack of invoice detail and vendor 
payment information, incomplete or insufficient competitive bidding 
documentation, monitoring of technology plan goals and objectives, and 
physical security of equipment. Although the final report was released 
on April 23, 2003, USAC did not request policy guidance from Commission 
staff until October 2003. In January 2004, Commission staff provided 
``informal'' guidance to USAC related to E-rate beneficiary audits 
being conducted by KPMG. These informal comments included reference to 
four (4) of the eleven (11) Arthur Anderson round 2 policy questions 
raised by USAC in their October 2003 request. On March 4, 2004, 
Commission staff provided guidance to USAC on the eleven (11) policy 
issues, almost two years after the draft report was submitted by Arthur 
Andersen. Many of the policy questions raised in USAC's request for 
guidance address issues identified in other audits including other E-
rate beneficiary audits conducted by USAC's Internal Audit Division and 
those conducted by the FCC OIG.
Weaknesses in Program Competitive Procurement Requirements
    Program rules require that applicants use a competitive procurement 
process to select vendors. In establishing this requirement, the 
Commission recognized that ``(c)ompetitive bidding is the most 
efficient means for ensuring that eligible schools and libraries are 
informed about all of the choices available to them'' and that 
``(a)bsent competitive bidding, prices charged to schools and libraries 
may be needlessly high, with the result that fewer eligible schools and 
libraries would be able to participate in the program or the demand on 
universal service support mechanisms would be needlessly great.''
    Applicants are required to submit a form 470 identifying the 
products and services needed to implement the technology plan. The form 
470 is posted to the USAC web page to notify service providers that the 
applicant is seeking the products and services identified. Applicants 
must wait at least 28 days after the form 470 is posted to the website 
and consider all bids they receive before selecting the service 
provider to provide the services desired. In addition, applicants must 
comply with all applicable state and local procurement rules and 
regulations and competitive bidding requirements. The form 470 cannot 
be completed by a service provider who will participate in the 
competitive process as a bidder and the applicant is responsible for 
ensuring an open, fair competitive process and selecting the most cost-
effective provider of the desired services. Further, although no 
program rule establishes this requirement, applicants are encouraged by 
USAC to save all competing bids for services to be able to demonstrate 
that the bid chosen is the most cost-effective, with price being the 
primary consideration.
    Although the programs competitive bidding requirements were 
intended to ensure that schools and libraries are informed about all of 
the choices available to them, we have observed numerous instances in 
which beneficiaries are not following the program's competitive bidding 
requirements or are not able to demonstrate that competitive bidding 
requirements are being followed. We question whether the rules are 
adequate to ensure a competitive process is followed. In addition, weak 
recordkeeping requirements to support the procurement process, as well 
as other aspects of the E-rate application, offer little protection to 
the program. We believe that the competitive procurement requirements 
are based on some faulty assumptions. For example,

   Form 470s will have enough information for meaningful 
        proposals from prospective service providers.

   Service providers are reviewing and considering posted form 
        470s (particularly for smaller schools).

   ``Applicable'' state and local procurement regulations exist 
        and those regulations are consistent with program rules.
Ineffective Use of Purchased Goods and Services
    Site visits are conducted during most E-rate beneficiary audits. 
Site visits are conducted for several reasons including to evaluate the 
eligibility of facilities where equipment is installed, verify that 
equipment is installed and operational, and to verify that equipment is 
being used for its intended purpose. Examples of concerns identified 
during audits and investigations are as follows:

   Goods and services not being provided.

   Unauthorized substitution of goods and services.

   Goods and services being provided to ineligible facilities 
        (e.g., non-instructional building including dormitories, 
        cafeterias, and administrative facilities).

   Equipment not being installed or not operational. Program 
        rules require that nonrecurring services be installed by a 
        specified date. However, there is no specific FCC rule 
        requiring beneficiaries to use equipment in a particular way, 
        or for a specified period of time, or to full efficiency. 
        Commission staff have provided guidance stating that if the 
        equipment was uninstalled (i.e., still in a box) that would 
        represent a rule violation. However, Commission staff have also 
        provided guidance stating that the rules do not require that 
        beneficiaries effectively utilize the services provided or that 
        the beneficiaries maintain continuous network or Internet 
        connectivity once internal connections are installed.
Reliance on Applicant Certifications
    The E-rate program is heavily reliant on applicant and service 
provider certifications. For example, on the form 470, applicants 
certify that the support received is conditional upon the ability of an 
applicant to secure access to all of the resources, including 
computers, training, software, maintenance, and electrical connections, 
necessary to use effectively the services that will be purchased under 
this mechanism. On the form 471, applicants make several important 
certifications. Applicants certify that they have ``complied with all 
applicable state and local laws regarding procurement of services for 
which support is being sought'' and that ``the services that the 
applicant purchases . . . will not be sold, resold, or transferred in 
consideration for money or any other thing of value.'' Other 
certifications are required on various program forms.
    My office started to raise concerns about perceived weaknesses in 
the competitive procurement process and over reliance on certifications 
shortly after we became involved in program oversight. We first became 
concerned about the competitive procurement process as a result of our 
involvement in the Metropolitan Regional Education Service Agency 
(MRESA) investigation. During that investigation we observed how 
weaknesses in competitive bidding requirements and reliance on self 
certification were exploited resulting in, at a minimum, a significant 
amount of wasteful spending. We continued to express our concerns as we 
designed our oversight program, developed a program for auditing 
beneficiaries, and supported E-rate fraud investigations. In fact, we 
established a working relationship with the Antitrust Division of the 
Department of Justice in a large part because of the number of 
investigations that we were supporting that involved allegations 
regarding the competitive procurement process.
    Our level of concern regarding both the competitive procurement 
process and reliance on self-certification was heightened as we started 
to work with the Antitrust Division. During our discussions with 
Antitrust, they expressed a general concern with the lack of 
information regarding the competitive process and specific concerns 
regarding applicant and service provider certifications. Although we 
started to pursue these issues with Commission staff in the fall of 
2002, the Commission has only recently started to address some of the 
recommendations from Antitrust, and none of these recommendations are 
fully implemented. We have been informed by WCB that several of the 
Antitrust suggestions have been incorporated into the appropriate E-
rate forms and that those forms are now at the Office of Management and 
Budget for approval. Other recommended certifications, particularly 
regarding the competitive process, are still in the process of public 
comment, and we are as yet uncertain what the FCC may ultimately do 
with these recommendations. Numerous of the suggestions from Antitrust 
involved USAC obtaining and reviewing critical procurement documents 
during the application review process. The Commission's response to 
these suggestions was to include in the 5th Report and Order the 
requirement that the applicant retain these documents, but providing 
these documents for review along with an E-rate application was not 
required. And lastly, WCB has informed us that at this time they will 
not incorporate certain recommendations. I believe that the delay in 
implementing Antitrust's recommendations, and the exclusion of some of 
the recommendations from implementation, continues to place the program 
at risk.
Weaknesses in Technology Planning
    Program rules require that applicants prepare a technology plan and 
that the technology plan be approved. The approved technology plan is 
supposed to include a sufficient level of information to justify and 
validate the purpose of a request for E-rate funding. USAC implementing 
procedures state that approved technology plans must establish the 
connections between the information technology and the professional 
development strategies, curriculum initiatives, and library objectives 
that will lead to improved education and library services. Although the 
technology plan is intended to serve as the basis for an application, 
we have observed many instances of non-compliance with program rules 
and USAC procedures related to the technology planning process. 
Examples of technology planning concerns identified during audits and 
investigations are as follows:

   Technology plans are not being reviewed and approved in 
        accordance with program rules.

   Technology plans do not address all required plan elements 
        in accordance with USAC implementing procedures for technology 
        planning. Commission staff have provided guidance that failure 
        to comply with USAC implementing procedures for technology 
        plans is not a rule violation and does not warrant recovery of 
        funds.

   Applicants not being able to provide documentation to 
        support the review and approval of technology plan.

    USAC guidance on technology planning states that ``(i)n the event 
of an audit, you may be required to produce a certification similar to 
the SLD sample ``Technology Plan Certification Form,'' in order to 
document approval of your technology plan.'' Numerous audits have 
included findings beneficiaries were unable to provide documentation to 
demonstrate the review and approval of technology plans. Although 
program rules require that applicants have a technology plan and that 
the plan be approved, the rules do not require that the applicant 
maintain specific documentation regarding the approval process.
Discount Calculation and Payment of the Non-Discount Portion
    The E-rate program allows eligible schools and libraries to receive 
telecommunications services, Internet access, and internal connections 
at discounted rates. Discounts range from 20 percent to 90 percent of 
the costs of eligible services, depending on the level of poverty and 
the urban/rural status of the population served, and are based on the 
percentage of students eligible for free and reduced lunches under the 
National School Lunch Program (NSLP) and other approved alternative 
methods. A number of audits have identified audit findings that 
applicants have not followed program requirements for discount rate 
calculation or were unable to support the discount rate calculated.
    Applicants are required to pay the non-discount portion of the cost 
of the goods and services to their service providers and service 
providers are required to bill applicants for the non-discount portion. 
The discount rate calculation and program requirement for payment of 
the non-discount portion are intended to ensure that recipients avoid 
unnecessary and wasteful expenditures and encourage schools to seek the 
best pre-discount rate. Examples of concerns identified during audits 
and investigations are as follows:

   Applicant not paying the non-discount portion;

   Applicant not paying the non-discount portion in a timely 
        manner; and

   Service providers not billing recipients for the non-
        discount portion.
Conclusion
    The Office of Inspector General remains committed to meeting our 
responsibility for providing effective independent oversight of the USF 
and we believe we have made significant progress. While the Commission 
has taken steps to address programmatic weaknesses, more work remains 
to be done. Through our participation in the fourth large-scale round 
of E-rate beneficiary audits with USAC and through audits that we 
anticipate conducting under our three-way agreement with USAC, we are 
moving forward to evaluate the state of the program and identify 
opportunities for programmatic improvements. In order to continue this 
important work it is my belief that the Commission should have direct 
access to the USF. This will provide the resources for an effective and 
independent oversight program.

    The Chairman. Thank you very much.
    Mr. Gumper, welcome.

  STATEMENT OF FRANK GUMPER, CHAIRMAN OF THE BOARD, UNIVERSAL 
                 SERVICE ADMINISTRATIVE COMPANY

    Mr. Gumper. Good morning, Mr. Chairman and Members of the 
Committee. My name is Frank Gumper. I am the Chairman of the 
Board of Directors of the Universal Service Administrative 
Company, USAC. It is my privilege to be here today to speak 
with you about USAC and its administration of the schools and 
libraries universal service support mechanisms, commonly 
referred to as the E-rate program.
    USAC is a not-for-profit corporation designated by the FCC 
to administer the four universal service mechanisms based on 
the Telecommunications Act of 1996 and FCC regulations adopted 
pursuant to the Act. USAC is governed by a Board of Directors, 
each of whom is appointed by the Chairman of the FCC. The Board 
consists of 19 Directors, each of whom represents the interests 
of a particular constituency defined in FCC regulations. I 
represent large incumbent local exchange carriers. I was 
appointed by Chairman Reed Hundt in 1997, reappointed by 
Chairman Michael Powell in 2001, and have served on the Board 
since the creation of USAC. I was elected Chairman of the Board 
in January 2000.
    The USAC Board of Directors are purposely structured to 
ensure that the views of many different interests are heard and 
considered. Each Director brings to the attention of the Board 
the particular sensitivities and concerns of his or her 
constituency, thereby assisting the entire board and enhancing 
the Board's decisionmaking process.
    Each director must ultimately use his or her position to 
represent USAC's overall interests, that is the interest of 
USAC as a corporate entity and not the interest of his or her 
constituency. To that end, each Director is bound by a 
stringent statement of ethical conduct. All USAC Board members 
are obligated to discharge their responsibility to ensure that 
the universal service support mechanisms--High Cost; Low 
Income; Rural Health Care; and Schools and Libraries--are 
properly administered.
    My experience serving on the Board for the past 7 years has 
been that the USAC Board of Directors are particularly active 
and engaged with the issues facing the administration of the 
support mechanisms. The Board of Directors and USAC committees 
convene on a quarterly basis and as needed between the 
quarterly Board meetings. At each meeting USAC staff brings 
critical issues to the attention of the board, which takes 
action as needed.
    The Board is particularly concerned about waste, fraud and 
abuse. The Board represents all relevant constituencies, 
including consumer advocates and schools and libraries, and our 
job is to ensure that all contributions to the fund go to 
fulfil the promise of universal service, which in the case of 
the E-rate program is to provide access to advanced 
telecommunications services for schools and libraries.
    Working with USAC staff, numerous actions have been taken 
to protect the E-rate program and the Universal Service Fund in 
general. As a board member, I am confident that USAC's 
administration of the E-rate program has become increasingly 
sophisticated over time as USAC board and staff have responded 
to those who would abuse the program.
    There have been program violations and the USAC board and 
staff take these violations seriously. However, we have taken 
many actions to address them, including but certainly not 
limited to: improving the application and invoice review 
procedures; increasing the number of staff devoted to 
responding to whistleblower calls; increasing the number of 
audits; launching new initiatives, such as the thousand site 
visits that will occur over the next year; and providing 
support to law enforcement investigations. George McDonald, the 
Vice President of USAC responsible for the administration of 
the E-rate program, will discuss these tools in greater depth 
in his testimony.
    USAC is launching an important new communication and 
education initiative. At the last Board meeting, Board members 
engaged in a lively discussion of different strategies the 
prevent program rule violations from occurring. USAC denies 
funding requests when it determines that a violation has 
already occurred. USAC already provides a great deal of 
applicant and service provider training, but in light of the 
audit findings Board members questioned whether all the program 
participants are receiving the benefits of this coalition. 
Board members considered what steps could be taken to try to 
prevent program rule violations from happening in the first 
place and charged USAC's CEO with presenting a plan for 
implementing that effort at the next Board meeting later this 
month.
    We believe that this effort will help prevent waste, fraud 
and abuse by more effectively educating applicants and service 
providers about program requirements. In addition, USAC is 
working closely with the FCC's Office of Inspector General to 
expand our audit activity in all of the programs.
    Mr. Chairman, thank you for providing me the opportunity to 
address the Committee. We look forward to continuing to work 
with Congress to improve the schools and libraries support 
mechanism. I would be happy to respond to any questions you may 
have about these issues or the accounting issues you raised 
earlier.
    [The prepared statement of Mr. Gumper follows:]

Prepared Statement of Frank Gumper, Chairman of the Board of Directors, 
                Universal Service Administrative Company
    Good morning, Mr. Chairman and Members of the Committee. My name is 
Frank Gumper. I am the Chairman of the Board of Directors of the 
Universal Service Administrative Company (``USAC''). It is my privilege 
to be here today to speak with you about USAC and its administration of 
the Schools and Libraries Universal Service Support Mechanism, commonly 
referred to as the ``E-rate'' program.
Overview
    USAC is the not-for-profit corporation designated by the Federal 
Communications Commission (``FCC'') to administer four universal 
service support mechanisms based on the Telecommunications Act of 1996 
and FCC regulations adopted pursuant to the Act. USAC is governed by a 
Board of Directors, each of whom is appointed by the Chairman of the 
FCC. The Board consists of 19 Directors, each of whom represents the 
interests of a particular constituency defined in FCC regulations. I 
represent large incumbent local exchange carriers. I was appointed by 
Chairman Reed Hundt in 1997, re-appointed by Chairman Michael Power in 
2001, and have served on the Board since the creation of USAC. I was 
elected Chairman of the Board in January 2000.
    The USAC Board of Directors is purposely structured to ensure that 
the views of many differing interests are heard and considered. Each 
Director brings to the attention of the Board the particular 
sensitivities and concerns of his or her constituency, thereby 
assisting the entire Board and enhancing the Board's decision making 
process. Each Director must ultimately use his or her position to 
represent USAC's overall interests; that is, the interests of USAC as a 
corporate entity, and not the interests of his or her constituency. To 
that end, each Director is bound by a stringent Statement of Ethical 
Conduct.
The E-rate Program
    All USAC Board Members are obliged to discharge their 
responsibilities to ensure that the universal service support 
mechanisms--High Cost, Low Income, Rural Health Care, and Schools and 
Libraries, commonly known as the E-rate Program--are properly 
administered. My experience serving on the Board for the past seven 
years has been that the USAC Board of Directors is particularly active 
and engaged with the issues facing the administration of the support 
mechanisms. The Board of Directors and the USAC Committees convene on a 
quarterly basis and as needed between the quarterly board meetings. At 
each meeting, USAC staff brings critical issues to the attention of the 
Board, which takes action as needed.
    The Board is particularly concerned about waste, fraud and abuse. 
The Board represents all relevant constituencies, including consumer 
advocates and schools and libraries, and our job is to ensure that all 
contributions to the fund go to fulfill the promise of universal 
service--which in the case of the E-rate program is to provide access 
to advanced telecommunications service for schools and libraries.
    Working with USAC staff, numerous actions have been taken to 
protect the E-rate program, and the Universal Service Fund in general. 
As a Board member, I am confident that USAC's administration of the E-
rate program has become increasingly sophisticated over time as USAC's 
Board and staff have responded to those who would abuse the program. 
There have been program violations, and USAC's Board and staff takes 
those violations seriously. However, we have taken many actions to 
address them, including, but certainly not limited to, improving the 
application and invoice review procedures, increasing the number of 
staff devoted to responding to whistleblower calls, increasing the 
number of audits, launching new initiatives such as the 1,000 site 
visits that will occur over the next year, and providing support to law 
enforcement investigations. George McDonald, the Vice President of USAC 
responsible for the administration of the E-rate program, will discuss 
these tools in greater depth in his testimony.
    USAC is launching an important new Communications and Education 
initiative. At the last Board meeting, Board Members engaged in lively 
discussion of different strategies to prevent program rule violations 
from occurring. USAC denies funding requests when it determines that a 
violation has already occurred. USAC already provides a great deal of 
applicant and service provider training, but in light of audit 
findings, Board members questioned whether all program participants are 
receiving the benefits of this training. Board members considered what 
steps could be taken to try to prevent program rule violations from 
happening in the first place, and charged USAC's Chief Executive 
Officer with presenting a plan for implementing that effort at the next 
Board meeting later this month. We believe that this effort will help 
to prevent waste,fraud and abuse by more effectively educating 
applicants and service providers about program requirements. In 
addition, USAC is working closely with the FCC's Office of Inspector 
General to expand our audit activity in all of the programs.
Conclusion
    Mr. Chairman, thank you for providing me with the opportunity to 
address the Committee. We look forward to continuing to work with 
Congress to improve the Schools and Libraries Support Mechanism. I 
would be happy to respond to any questions you may have.

    The Chairman. Thank you very much.
    Mr. McDonald, welcome.

   STATEMENT OF GEORGE McDONALD, VICE PRESIDENT, SCHOOLS AND 
  LIBRARIES DIVISION, UNIVERSAL SERVICE ADMINISTRATIVE COMPANY

    Mr. McDonald. Thank you, Mr. Chairman, Senator Rockefeller. 
I am George McDonald, Vice President of the Universal Service 
Administrative Company responsible for the Schools and 
Libraries Division. I am pleased to be here today to discuss 
USAC's administration of the E-rate program.
    As Mr. Gumper has said, USAC is committed to helping 
prevent waste, fraud and abuse in the universal service support 
mechanisms and we devote substantial resources toward that goal 
so that the benefits of the discounts go only to eligible 
entities for eligible uses. Before we began making funding 
commitments in 1998, we hired an independent consultant, 
PriceWaterhouseCoopers, to advise us on our internal controls 
and attest to the adequacy of those controls. Our internal 
controls are designed to ensure that commitment and 
disbursement of E-rate funds are consistent with FCC rules 
relating, for example, to the eligibility of entities, of 
services, and appropriate discount rates.
    At your request as Chair of this Committee, Senator McCain, 
staff of the then-U.S. General Accounting Office reviewed our 
draft procedures in 1998 and recommended changes, which we 
implemented. We employ many tools to help ensure compliance 
with program rules. These include detailed application and 
invoice review procedures, denying funding commitments when 
appropriate, rejecting incorrect invoices, auditing program 
beneficiaries and service providers, recovering funds where 
rule violations are found, investigating whistleblower hot line 
complaints, supporting law enforcement investigations, and 
referring matters involving suspected program abuse to law 
enforcement authorities.
    USAC's application and invoice review procedures have 
greatly evolved over the past 6 years, becoming more detailed 
and comprehensive as we have gained experience with the 
program. For example, as we saw instances of service providers 
not making applicants pay the non-discount share, a key rule of 
the program, we initiated verification of payment of that share 
into our invoice review process. USAC's internal controls have 
prevented the unlawful disbursement of hundreds of millions of 
dollars, either as a result of denials based on failure to 
comply with program rules or cancellation of funding requests 
by the applicant as a result of our inquiries.
    Pursuant to SEC rules, USAC engages an independent auditor 
to conduct annual financial and operational audits of USAC. As 
part of that annual effort, auditors assess whether we are 
properly implementing our procedures, and there have been no 
significant issues raised in those audits.
    We receive approximately 35,000 E-rate applications per 
year. In addition, we process an average 80,000 individual 
requests for payment annually. Our fundamental responsibility 
is to make well-founded decisions to approve or deny these 
requests. Each of these documents is individually processed 
using detailed program integrity assurance, or PIA, review 
procedures to arrive at an appropriate decision consistent with 
program rules.
    We also conduct audits of beneficiaries to assess program 
rule compliance. As a result of audit findings, we have 
modified and strengthened our internal controls, improved our 
outreach, and better educated applicants and service providers 
regarding program rules.
    In order to provide the public with the means of reporting 
activities that may be in violation of E-rate program rules, 
USAC maintains a whistleblower hot line. USAC's special 
investigations team investigates every call to determine if 
further action is required. We receive and follow up on over 
100 calls per year.
    Comprehensive applicant and service provider training in 
program requirements are vital components of program integrity. 
USAC's applicant training, an annual conference of State E-rate 
coordinators, and regional meetings throughout the year 
emphasizes the importance of compliance with program rules and 
the consequences of noncompliance. USAC also provides training 
and education opportunities to service provider participants in 
the program and, as Mr. Gumper said, we are looking to 
significantly expand our outreach activities.
    One of the key lessons we have learned from our experience 
in administering the program and from the audits we have 
conducted as well as from law enforcement investigation and 
media reports is that USAC needs a larger oversight presence in 
the field. Site visits will allow us to assess more fully in 
real time how E-rate funds are being used, to learn about and 
publicize best practices in education technology and program 
compliance, and to help ensure that products and services have 
in fact been delivered and are being used effectively. We are 
currently in the process of selecting a vendor that will 
conduct some 1,000 site visits a year.
    While USAC has responsibility for ensuring applications are 
properly reviewed, applicants and service providers alike have 
responsibility for knowing and following the spirit, intent, 
and letter of the law and rules of the program. The FCC in a 
series of recent rulemakings has stressed that accountability. 
For example, applicants must conduct a fair and open 
competitive process to select service providers and must select 
the most cost-effective offeror, with price the primary factor. 
Applicants cannot abdicate their responsibility to a service 
provider who is soliciting their business or to a consultant.
    Service providers who are seeking an applicant's business 
cannot provide assistance to the applicant during the 
competitive bidding process. Similarly, service providers 
cannot waive the applicant's share of the cost and applicants 
must pay their share.
    USAC's responsibility as administrator of the E-rate 
program is to prevent commitments and disbursements from being 
made in violation of program rules. During application review 
we deny requests for such reasons as: the request includes 
ineligible services; or we conclude that applicants did not 
conduct a fair and open competitive process or cannot pay their 
share of the costs; or applicants fail to meet deadlines.
    To provide just a few examples, in funding year 2002 we 
denied funding requests totaling over $500 million associated 
with IBM Corporation because of a procurement approach that we 
determined was inconsistent with program rules. IBM and some 
applicants appealed our decision to the FCC and the FCC upheld 
our determination that the approach violated E-rate rules.
    In funding year 2001, 2002 and 2003, USAC denied funding 
requests totaling over $47 million associated with Connect2 
Internet Networks because of a variety of program rule 
violations. The owner and employees of Connect2 pled guilty to 
charges related to abuse of the program and two persons 
associated with that company have been debarred from the E-rate 
program by the FCC. We provided a great deal of assistance to 
law enforcement officials as they investigated that case.
    Finally, over different program years USAC has denied 
millions of dollars in funding requests when we have determined 
that consultants who provided free services to applicants were 
actually associated with the applicant's service provider.
    Mr. Chairman, thank you for providing me with the 
opportunity to address the Committee and we look forward to 
working with Congress to improve the E-rate program and I would 
be happy to respond to any questions you may have.
    [The prepared statement of Mr. McDonald follows:]

  Prepared Statement of George McDonald, Vice President, Schools and 
     Libraries Division, Universal Service Administrative Company,
    Good morning, Mr. Chairman and Members of the Committee. My name is 
George McDonald. I am Vice President of the Universal Service 
Administrative Company (``USAC'') responsible for the Schools and 
Libraries Division. I am pleased to be here today to discuss USAC's 
administration of the Schools and Libraries Universal Service Support 
Mechanism, commonly referred to as the ``E-rate'' program.
Overview
    USAC is the not-for-profit corporation designated by the Federal 
Communications Commission (``FCC'') to administer the E-rate program 
based on the Telecommunications Act of 1996 and FCC regulations adopted 
pursuant to the Act. In order to accomplish our mission, we work 
closely with the FCC, consulting almost daily on issues of 
implementation.
    We are committed to helping prevent waste, fraud, and abuse in the 
universal service support mechanisms, and we devote substantial 
resources towards that goal so that the benefits of the discounts go 
only to eligible recipients for eligible uses. I would like to describe 
some of the administrative procedures we use to help ensure program 
integrity. I will also outline a new initiative designed to further 
improve compliance with program rules. Finally, I will briefly discuss 
applicant and service provider responsibilities, and provide some 
examples of funding requests that we have denied because of non-
compliance with program rules.
    Before we began making funding commitments in 1998, we hired an 
independent consultant, Coopers and Lybrand--which later became 
PricewaterhouseCoopers--to advise us on our internal controls and 
attest to the adequacy of those controls. Our internal controls are 
designed to ensure that commitment and disbursement of E-rate funds are 
consistent with FCC rules relating, for example, to the eligibility of 
entities, of services, and appropriate discount rates. At your request 
as Chair of this Committee, Senator McCain, staff of the then-U.S. 
General Accounting Office reviewed our draft procedures and recommended 
changes, which we implemented. For example, we moved a procedure to 
scrutinize the resources applicants have to make effective use of the 
discounted services from after commitment of funds to before.
    We employ many tools to help assure compliance with program rules. 
These include detailed application and invoice review procedures, 
denying funding commitments when appropriate, rejecting incorrect 
invoices, auditing program beneficiaries and service providers, 
recovering funds where rule violations are found, investigating 
whistleblower hotline complaints, supporting law enforcement 
investigations, and referring matters involving suspected program abuse 
to law enforcement authorities.
    USAC's application and invoice review procedures have greatly 
evolved over the past six years, becoming more detailed and 
comprehensive, as we have gained experience with the program. For 
example, as we saw instances of service providers not making applicants 
pay the nondiscount share (a key rule of the program), we initiated 
verification of payment of that share into our invoice review process. 
USAC's internal controls have prevented the unlawful disbursement of 
hundreds of millions of dollars, either as a result of denials based on 
failure to comply with program rules or cancellation of funding 
requests by the applicant as a result of USAC inquiries.
    Pursuant to FCC rules, USAC engages an independent auditor to 
conduct annual financial and operational audits of USAC. As part of 
that annual effort, auditors assess whether we are properly 
implementing our procedures, and there have been no significant issues 
raised in those audits.
Application and Invoice Volumes
    We receive approximately 35,000 E-rate applications per year. In 
addition, we process an average 80,000 individual requests for payment 
annually. Our fundamental responsibility is to make well-founded 
decisions to approve or deny these requests. Each of these documents is 
individually processed using detailed Program Integrity Assurance, or 
PIA, review procedures to arrive at an appropriate decision consistent 
with program rules.
Audits
    We also conduct audits of beneficiaries to assess program rule 
compliance. As a result of audit findings, we have modified and 
strengthened our internal controls, improved our outreach, and better 
educated applicants and service providers regarding program rules.
Whistleblower Hotline and Special Investigations Team
    In order to provide the public with a means of reporting activities 
that may be in violation of E-rate program rules, USAC maintains a 
whistleblower hotline. USAC's Special Investigations Team investigates 
every call to determine if further action is required. We receive and 
follow up on over 100 calls per year.
Education Regarding Program Requirements
    Comprehensive applicant and service provider training in program 
requirements are vital components of program integrity. USAC's 
applicant training--an annual conference of state E-rate coordinators 
and regional meetings throughout the year--emphasizes the importance of 
compliance with program rules and the consequences of non-compliance. 
USAC also provides training and education opportunities to service 
provider participants in the program
New Site Visit Initiative
    One of the key lessons we have learned from our experience in 
administering the program and from the audits we have conducted, as 
well as from law enforcement investigations and media reports, is that 
USAC needs a larger oversight presence in the field. Site visits will 
allow us to assess more fully, in real-time, how E-rate funds are being 
used, to learn about and publicize best practices in education 
technology and program compliance, and to help ensure that products and 
services have in fact been delivered and are being used effectively. We 
are currently in the process of selecting the vendor that will conduct 
some 1,000 site visits a year. This step will further enhance program 
integrity.
Applicant and Service Provider Responsibilities
    While USAC has responsibility for ensuring applications are 
properly reviewed, applicants and service providers alike have 
responsibility for knowing and following the spirit, intent and letter 
of the law and rules of the program. The FCC, in a series of recent 
rulemakings, has stressed that accountability. For example, applicants 
must conduct a fair and open competitive process to select service 
providers, and must select the most cost-effective offer with price the 
primary factor. Applicants cannot abdicate their responsibility to a 
service provider who is soliciting their business, or to a consultant. 
Service providers who are seeking an applicant's business cannot 
provide assistance to the applicant during the competitive bidding 
process. Similarly, service providers cannot waive the applicant's 
share of the cost, and applicants must pay their share.
USAC 's Responsibility is to Deny Funding Requests that Do Not Comply 
        with Program Rules
    USAC's responsibility as administrator of the E-rate program is to 
prevent commitments and disbursements from being made in violation of 
program rules. During application review, we deny requests for such 
reasons as the requests include ineligible services or services to 
ineligible entities, or we conclude that applicants did not conduct a 
fair and open competitive process or cannot pay their share of the 
costs, or applicants failed to meet deadlines. To provide just a few 
examples, in Funding Year 2002, we denied funding requests totaling 
over $500 million associated with IBM Corporation (``IBM) because of a 
procurement approach that we determined was inconsistent with program 
rules. IBM and some applicants appealed our decision to the FCC, and 
the FCC upheld our determination that the approach violated E-rate 
rules. In Funding Years 2001 through 2003, USAC denied funding requests 
totaling over $47 million associated with Connect2 Internet Networks, 
Inc. because of a variety of program rule violations. The owner and 
employees of Connect2 pled guilty to charges related to abuse of the 
program and two persons associated with that company have been debarred 
from the E-rate program by the FCC. We provided a great deal of 
assistance to law enforcement officials as they investigated that case. 
Finally, over different program years, USAC has denied millions of 
dollars in funding requests when we have determined that 
``consultants'' who provided free services to applicants were actually 
associated with the applicants' service provider.
Conclusion
    Mr. Chairman, thank you for providing me with the opportunity to 
address the Committee. We look forward to continuing to work with 
Congress to improve the Schools and Libraries Support Mechanism. I 
would be happy to respond to any questions you may have.

    The Chairman. Thank you.
    Mr. Himsworth, welcome.

               STATEMENT OF WINSTON E. HIMSWORTH,

        EXECUTIVE DIRECTOR, E-RATE CENTRAL, AND FOUNDER,

               STATE E-RATE COORDINATORS ALLIANCE

    Mr. Himsworth. Thank you, Mr. Chairman, Senator 
Rockefeller.
    Let me make my position clear now. E-rate is my life. One 
of my kids once asked me to stay out of his and told me to get 
my own. This is what I got.
    E-Rate Central, which I am the Executive Director of, is 
involved in E-rate and has been involved in E-rate since 1997, 
before the program got started, at the local level working with 
applicants; at the state level, we have been serving as State 
Coordinator for E-rate for New York; and at the national level, 
working with a group of other state E-rate Coordinators in a 
group called the State E-rate Coordinators Alliance.
    I want to try to make four points in a few minutes. One, 
this is a great program. It is doing what it is supposed to do. 
It is allowing schools to do things that it could not have done 
otherwise. I work with New York City, which has used this 
program to bring Internet access into 1,200 schools in a well 
thought out project started early in the program called Project 
Connect. I work at the other extreme with a small school up in 
Alaska, Chatham, Alaska, that you best get to with float plane. 
Internet access at the T-1 level there is almost $20,000 a 
month. They just could not afford that type of service without 
this program.
    The second point I want to make is that tight application 
reviews and audits are important, but they seem to be working. 
I was glad, Mr. Chairman, you recognized and Mr. McDonald again 
said today that the problems that were talked about in the last 
House hearing on $500 million in requests that were not 
properly bid and/or were excessive were denied. So the program 
in that sense is working.
    I am a little concerned that some of the audit results that 
we are seeing are being a bit misconstrued. I have looked at a 
number of them. The Office of Inspector General did 11 with 
their internal sources. Four of those were noncompliant. In my 
state we had three of those noncompliant schools. All three 
were associated with Connect2, which, as Mr. McDonald said, has 
already been found guilty of all these things.
    There may be some laxness on the part of the schools in 
those cases. They are very small schools. But I view them more 
as victims.
    We also looked at the----
    The Chairman. How are they victims, Mr. Himsworth?
    Mr. Himsworth. They are victims, sir, because if you look 
through the reports what you find is that----
    The Chairman. Are they not always victims when there is 
wrongdoing, Mr. Himsworth?
    Mr. Himsworth. Are they always victims when there is 
wrongdoing?
    The Chairman. People do wrong things that are in charge of 
programs, like in Puerto Rico where many tens of millions of 
dollars were misused. I guess they were victims too.
    Mr. Himsworth. I think in those cases at least the children 
were, sir.
    The Chairman. Absolutely.
    Go ahead.
    Mr. Himsworth. I also looked at the KPMG audits, where in 
New York we had three noncompliants. Again, those were 
instances of administrative problems, violations of rules no 
doubt, but not what I would characterize as waste, fraud and 
abuse.
    The third point I want to make is, we need to be careful 
not to try to solve all the program's, the problems of a 
program like this, with more rules. Rules are important, but 
this is already a complex program with lots of rules, and that 
in fact is causing problems for a number of the applicants, 
just trying to keep up with them all.
    The fourth point I want to make is, we believe that perhaps 
more important than more and more rules is the program should 
be changed in a couple fundamental ways to decrease the 
incentives that certain applicants and vendors have to get 
involved in waste, fraud and abuse practices. The biggest 
change that needs to be made in our opinion, both personally, 
through our State E-Rate Coordinators Alliance, and I was also 
on the waste, fraud and abuse task force, the recommendation 
coming out of there, was to limit the amount of discount that's 
allowed in this program, to change the discount matrix so that 
the 90 percent discount maximum is lowered by 10 to 20 percent. 
A 10-percent share is just not enough to foster careful 
planning and it is presenting too large a target for certain 
vendors.
    I do not talk in my testimony about the funding freeze that 
was brought up this morning by several Senators. We are also 
concerned about that and I hope we will get into that in this 
discussion as well.
    Thank you, sir.
    [The prepared statement of Mr. Himsworth follows:]

    Prepared Statement of Winston E. Himsworth, Executive Director, 
                             E-Rate Central
    Thank you for inviting me to appear before you this morning. Let me 
make my position clear from the outset. E-rate is a great program. It 
may not be perfect--few programs are--but it is evolving in a 
responsive and responsible way to meet the needs of its school and 
library applicants and to satisfy the need for even greater 
accountability.
    E-Rate Central has been involved in the E-rate program since its 
inception. Our small company currently provides comprehensive E-rate 
support to approximately 125 medium-sized schools and school districts 
and to several large city school districts and school consortia. During 
the past six years, E-Rate Central has served as the New York State's 
E-rate coordinator. In that role, it was one of the founding members of 
the State E-Rate Coordinators' Alliance (``SECA''), an association of 
41 state coordinators, which has been a proactive supporter and change 
agent for the E-rate program at the national level. Under the SECA 
banner, E-Rate Central maintains a nationally-recognized E-rate 
website, and distributes a widely-read weekly E-rate newsletter for New 
York applicants and for redistribution to other applicants through 
their state coordinators. To avoid conflicts of interest, E-Rate 
Central does not offer any E-rate eligible services.
    In my testimony here today, it is my hope that four points will 
become clear.

   E-rate is a successful and valuable program serving mission-
        critical needs of schools and libraries across the country--
        large and small, rich and poor. It is doing precisely what its 
        early Senate sponsors envisioned.

    New York City Department of Education has been a large recipient of 
        E-rate funds stemming from an early and concerted effort, 
        dubbed ``Project Connect,'' to provide Internet access to 5-10 
        rooms in each of its 1,200 schools over the first few years of 
        the program. NYCDOE has been building upon this early success 
        by upgrading and expanding the LAN networks and equipment in 
        its schools and by developing a robust WAN network to 
        interconnect them. This could not have been done without E-
        rate.

    Chatham School District in Alaska is at the opposite end of the 
        spectrum. This small and poor school district (less than 300 
        students with a 90 percent discount rate) is located in an area 
        best reached by float plane. Telecom services, and most 
        particularly high speed T-1 access, in such a remote area are 
        expensive. Chatham's ongoing telecom and Internet budget this 
        year is over $225,000, almost $1,000 per student. Without E-
        rate--which is already a problem because of the current freeze 
        on new funding--Chatham would, at best, be able to afford dial-
        up Internet.

    About half the school districts in Nassau County (Long Island, NY) 
        have recently installed or are planning to install high-speed 
        WANs. As these networks are developed, they will provide 
        interconnectivity to share educational resources throughout the 
        county (and ultimately, perhaps, the state). While only a few 
        of the Nassau districts qualify for higher discounts, the E-
        rate program has clearly provided the impetus, and partial 
        funding support, for this effort.

   Certain applicants and vendors have attempted to make 
        unfair, or even fraudulent, use of the program, but USAC has 
        been quite successful in thwarting these efforts before funding 
        is actually disbursed and/or in seeking to recover funds 
        disbursed in error during the program's early years. Many of 
        the audit statistics on compliance problems reflect failures to 
        meet administrative rules which, while important, should not be 
        characterized as examples of waste, fraud, and abuse (``WFA'').

    E-rate is a program that was built on the fly. When the program 
        began (technically, January 1, 1998), application forms had not 
        yet been released. It was not until 1999 that applicants saw 
        any real funding. To counter skepticism about the program, the 
        administrators--quite properly in my opinion--focused most on 
        getting applications approved and funds flowing. Many of the 
        problems that have come to light over the past few years can be 
        traced to the early years.

    In recent years, USAC's compliance standards and enforcement 
        efforts have been greatly strengthened. As a result, USAC had 
        denied all or most applications that are now being put forth as 
        examples of abuse. The House hearings last month, for example, 
        focused on a number of applications submitted by large city 
        school districts for IBM services in FY 2002. Valid questions 
        were raised about the bidding procedures used by these 
        districts, and about the scope and costs of services being 
        proposed. Not stressed, however, was the fact that all of these 
        applications were denied by USAC, and that the denials were 
        upheld by the FCC on appeal. We believe that the lesson to be 
        taken from this experience is that abusive incentives remain in 
        the program, but that the program's administrators have 
        developed increasing capabilities to deal with potential 
        problems.

    We are also concerned with reports that a high percentage of E-rate 
        audits are finding evidence of non-compliance. We believe that 
        it is important to understand that these audits are not 
        completely ``random,'' as is often indicated, and that the many 
        of the instances of non-compliance are not as severe or 
        prevalent as implied.

    The FCC's Inspector General's testimony before the Subcommittee on 
        Oversight and Investigations of the House Committee on Energy 
        and Commerce last June listed the results of eleven audits of 
        FY 1999 and FY 2000 applicants conducted by the OIG's own 
        internal auditors. Four of the eleven audits (or 36 percent) 
        classified as ``Not Compliant.'' In our role as New York State 
        coordinator, we have reviewed the audit reports for the three 
        non-compliant schools located in New York. All three appear to 
        have been targeted audits of customers of one specific 
        supplier, Connect 2, whose officers have already been convicted 
        of E-rate fraud. Most of the serious audit findings in these 
        three cases were attributed directly to Connect 2 invoicing, 
        often without the apparent knowledge of the schools. While not 
        excusing the laxness on the part of these small private 
        schools, we view the schools as victims, not perpetrators, of 
        E-rate abuses.

    We have also reviewed the results of seven New York audits of FY 
        2000 funding commissioned by USAC and performed by KPMG. Of 
        these audits, three were classified as ``Not Compliant.'' The 
        problems in these cases appear to be largely administrative in 
        nature, and are not the result of rampant waste, fraud, or 
        abuse.

     One small school was found non-compliant because it 
            had used an unapproved method to determine its discount 
            rate. Because the school was not a participant in the 
            National School Lunch Program, it had submitted a letter to 
            USAC ``explaining its situation and providing an estimate 
            of the number of students who it believed would qualify for 
            the NSLP.'' USAC had apparently accepted the estimate, but 
            the auditors subsequently determined that the method used 
            was not approved. There was no indication that the discount 
            rate was wrong or that the funding requested was for 
            inappropriate services. We do not view this report as an 
            example of WFA.

     One small library was found non-compliant because it 
            had not maintained invoices to support its discount 
            reimbursements and other documentation to support its 
            discount rate calculation. Again, there was no indication 
            that the discount rate was wrong or that the funding 
            requested was inappropriate. We do not view this report as 
            an example of WFA.

     One larger school district was found non-compliant 
            primarily because it did not have an approved technology 
            plan. Although this is a clear program violation, our 
            investigation determined that the district did in fact have 
            a plan, but one that they had neglected to submit for 
            formal E-rate approval. The district is being asked to 
            repay almost $200,000 in FY 2000 discounts. In our view, 
            this is an inappropriately large penalty for what we deem 
            to be an administrative oversight. Again, we do not view 
            this audit finding as an example of WFA.

   One unfortunate aspect of the intensive focus on waste, 
        fraud, and abuse is the proliferation of new, and ever more 
        complicated, rules. Attempts to enforce these rules are 
        frustrating applicants, leading to funding delays, and probably 
        diverting USAC resources away from more targeted reviews.

    Each year, the E-rate rules and procedures have become increasingly 
        complex as USAC and FCC have refined service eligibility 
        definitions, added new certifications, and intensified 
        application and invoice reviews. Here are a few indicators or 
        examples of the problem:

     A reported 20-30 percent of all applications are 
            rejected by USAC, many for minor problems to meet minimum 
            process standards which, at least in the past, could be as 
            simple of leaving one field blank when it should have been 
            a zero.

     The two key application forms for FY 2005 are 13 and 
            16 pages long; the instructions are 20 and 35 pages long, 
            respectively.

     New procedures for application review in FY 2005 will 
            require virtually every applicant to respond to additional 
            inquiries from PIA reviewers.

     E-rate is a deadline driven program. For most 
            applicants, E-rate is not a full time job, but it is most 
            certainly a full year job. All four of the most common 
            applicant forms have deadlines or timing requirements 
            which, if missed, will result in funding denials or 
            reductions. Appeals, SPIN changes, and service 
            substitutions all have deadlines. To further compound the 
            problem, some deadlines are fixed for all applicants while 
            others depend upon applicant-specific conditions.

     Eligibility allocations for certain products and 
            services are often hidden from applicant view. We were 
            recently asked to breakout the costs for a firewall, a 
            product type which USAC lists as fully eligible, because, 
            as it turned out, this particular model had a 2.5 percent 
            ineligible feature.

     The FCC's new ``2 in 5'' rule, that limits new funded 
            equipment installations to two out of every five years on a 
            site-by-site basis, is going to be difficult to administer 
            for applicants and administrators alike.

    E-rate was initially conceived as being a simple program. In 1997, 
        we were told that an applicant would fill out a simple 
        application and that the vendors would simply discount the 
        bills. This vision never materialized.

    In frustration, many applicants have been turning to consultants 
        for assistance. While this may be good for our business, we 
        view it as bad for the program. Even those of us, for whom E-
        rate is a way of life, find it challenging to keep up and 
        comply with all the changing rules, procedures, and 
        interpretations. The knowledge that applications may be 
        rejected for simple oversights is a source of constant fear.

   As an alternative to relying entirely on ever more rules and 
        audits, we favor certain basic program changes--including a 
        change to the discount matrix--to help establish proper program 
        incentives.

    One of the biggest problems in the E-rate program is its reliance 
        on small percentage payments by the highest applicants to 
        assure cost-effective procurement of technology products and 
        services. The 10 percent that must be paid by the applicants 
        eligible for 90 percent discounts is just not high enough to 
        assure real cost accountability. As a result, it is the poorest 
        schools, often those with the least technological experience, 
        that have become the focus of vendor marketing programs. This 
        has led, if not to outright fraud, at least to expansive 
        product and service proposals that the same vendors would not 
        bother to market to schools and libraries at lower discount 
        levels. The problems have been especially prevalent in the 
        Internal Connections category.

    Over the past year, several important and knowledgeable parties--
        including SECA and USAC's Taskforce on Waste, Fraud and Abuse--
        have recommended to the FCC that the maximum discount on 
        Internal Connections be lowered from 90 percent to 70-80 
        percent. We understand that the FCC staff is about to recommend 
        a similar change. As a member of both SECA and the Taskforce, I 
        concur with this approach.

    I thank you again for the invitation to testify. I stand ready to 
answer any questions you may have.

    The Chairman. Thank you very much.
    I think it has been made clear, Mr. Himsworth, that all 
members of this Committee, at least that I know of, support 
this program. We also feel we have an obligation, and the 
Commerce Committee on the other side has been in the lead on 
this issue. Who is the victim when in February 2004, the House 
Energy and Commerce Committee staff, we do not usually hire 
staffs for their sleuth capabilities, discovered nearly $23.5 
million in E-rate-funded wireless Internet connection equipment 
in a warehouse that was to be used with 100,000 computers? Who 
is the victim there?
    Mr. Himsworth. The victim there is again the students and--
--
    The Chairman. Exactly. So is it not our obligation to make 
sure that there is not $23.5 million, that it is the staff of 
the House Commerce Committee that finds $23.5 million in 
Internet connection equipment in a warehouse? We have to rely 
on the staff of the House Commerce Committee to find that out?
    Mr. Himsworth. I should hope not, sir.
    The Chairman. I should hope not, but it is obvious that is 
what happened.
    I guess I would like to have the witnesses' response to a 
Providence Journal article of July 22, 2004. It stated that: 
``The problem with the E-rate program is twofold: First, the 
money is controlled, not by the government, but by the 
Universal Service Administrative Company, which is controlled 
by the very telecom companies that are bidding for contracts. 
Second, the Federal Communications Commission, which is 
supposed to oversee the program, has conducted audits on fewer 
than 200 of the 20,000 grants issued by the program, less than 
1 percent. All this adds up to a situation in which it is easy 
for sly computer and telecom companies to persuade poor and 
technologically unsavvy school districts to buy equipment and 
services that they do not need and to overcharge the districts, 
knowing that most of the tab will be picked up by E-rate.''
    I will begin with you, Mr. Bennett and Mr. Cline, if either 
one of you want to comment on that statement, particularly the 
first part of it, where the Universal Service Administration 
Company ``is controlled by the very telecom companies that are 
bidding for contracts''? We will begin with you, Mr. Bennett, 
and go through our witnesses.
    Mr. Bennett. I do not know that we have a real concern with 
the first issue you raised. Certainly the second issue you 
raised, with the number of audits that have been done, has been 
our primary of concern. It has been our feeling that we have 
not done enough work necessary to get our hands around the 
issue of what is the level of fraud, waste, and abuse in this 
program.
    The Chairman. I think it would be hard if you only audited 
200 of 20,000 grants.
    Mr. Bennett. The Office of the Inspector General has been 
trying from the earliest days to get access to the resources 
necessary to do the appropriate amount of work. We are a very 
small office.
    The Chairman. What do you need from us and why have you not 
come to us for additional help if you need it?
    Mr. Bennett. Well, I believe that we have. We have 
requested in our last three budgets funds for oversight of USF. 
The Inspector General has advocated----
    The Chairman. Was that in the President's budget?
    Mr. Bennett. The 2004 President's budget included a request 
for $3 million to provide contract audit support for audits and 
audit support to investigations.
    The Chairman. Well, thank you for bringing that to this 
committee's attention. The failing is in this body as well, I 
would assume. Thank you.
    Mr. Gumper?
    Mr. Gumper. As far as the first point, Mr. Chairman, I 
strongly disagree that the USAC Board is controlled by 
telecommunications service providers. As I mentioned in my 
statement, all board members are appointed by the Chairman of 
the FCC. The Board members, there are 19 of them. They spanned 
consumer advocate groups, state commissioners. We have people 
representing large, small telephone companies, long distance 
carriers, wireless. So the Board is constructed so that the 
people who pay into the fund, the people who provide services, 
the constituents who use the moneys, and the constituents 
themselves. The schools and libraries have four representatives 
on the Board.
    It is true I work for Verizon, but I can assure you that 
when it comes to the interests of USAC and the administration 
of USAC I basically report to the FCC. And, my boss Tom Tauke 
and Verizon, understands that and has never once ever told me I 
should do something in my capacity as Chairman of the Board 
that would be to the advantage of Verizon and the detriment of 
USAC or the administration of this program.
    As far as the number of audits, I will tell you this Board 
is very concerned about it. We realized very early in the 
process as we started to do selective audits that we had to 
expand the number, and we are very actively working now with 
the Inspector General to ensure that we have a significant 
expansion in the number of audits that we conduct.
    The Chairman. Has there been sufficient rules put forth by 
USAC to ensure that these abuses are curbed?
    Mr. Gumper. I believe that, as Mr. McDonald can go into 
more detail, given the results of audits as we have gone 
through this process, we have significantly tightened up the 
oversight of the application process. In fact, you heard the 
comments earlier that we are getting too many rules now. I 
disagree with that. I think what we need to do is to get out 
there and educate people about the programs and the 
requirements.
    As I also mentioned, one of the things we directed them to 
do at the last meeting was to provide us with a recommendation 
as to how we can educate people better who file applications in 
this program.
    The Chairman. Mr. McDonald?
    Mr. McDonald. Sir, I have been with Schools and Libraries 
Corporation/USAC since September 1997. I have watched this 
Board at work. My sense is this Board has been scrupulous about 
avoiding any conflict of interest. Board members recuse 
themselves when there are issued relating to their interests in 
discussion before the Board.
    We faced the issue of turning over our internal procedures, 
our internal controls, to Board members and the board agreed 
that that was not appropriate, so Board members do not know the 
triggers we use to decide what reviews to do, et cetera. I have 
never seen a discussion in the board where I thought anybody 
was trying to influence a decision in their company's interests 
or their school association or library association's interests.
    So from my perspective as a staff guy in this, I think the 
board has done a great job. They know the programs, they know 
the stakeholders in the programs, and I think they have worked 
together amazingly well over the years to protect the program's 
integrity.
    On the audit side, yes, we need to do more audits. We have 
ramped up significantly. We did 17 audits in the first program 
year, we did 25 audits in the second program year, we did 79 in 
the third. Now we are going to do 100 audits. Then if the IG is 
successful in the three-way agreement, we will do 250 or more.
    These audits are very expensive. My budget next year for 
audits is going to go from $5 million this year for the 79 
audits to as much as $17 million next year to support the 
three-way agreement and audits we will do. It seems to me that 
we have to have a different approach than these comprehensive 
audits and that is why we are kicking off this thousand site 
visits that, we went to Puerto Rico in that first funding year 
as part of our first round of audits. We saw that they did not 
have computers. We cut off the commitments and disbursements to 
Puerto Rico. So yes, $100 million did get out the door, but 
they have gone 3 years with no additional money.
    So I think the site visits, if we had gone even as a site 
visit and seen that there were no computers in the school, that 
would have been the trigger that we needed to cutoff those 
funds sooner. So I think the site visit initiative is a cost 
effective way to get a better handle on what's really 
happening.
    The Chairman. Mr. Himsworth?
    Mr. Himsworth. We have got 30,000 applicants here and it is 
true that there has been a relatively small number of audits. 
As you have heard, the number of audits is going up. I view 
that as good from the applicants' standpoint. I also look at 
the thousand site visits that the program plans to do and, 
although we may not call those audits, from the standpoint of 
an applicant if someone shows up at their door from the SLD 
they are going to treat that as an audit. So I think we are 
doing----
    The Chairman. That is what they plan to do, not what they 
have done, what they plan to do.
    Mr. Himsworth. Plan to, sir, yes.
    The only other point I would like to make is, I have seen 
through the review process that the SLD has been fairly 
successful in finding patterns of what could be abuse and 
stopping funding. In some cases that works very well and I 
believe, among other things, that led to the problems that were 
found with Connect2.
    We see the other side of that as well, though, because over 
the last couple years we have had several hundred small schools 
in New York who have just not received any funding for 2 or 3 
years because they were all using one of a dozen specific 
vendors. We cannot tell from our position whether there is 
anything wrong with those vendors or they are still under 
investigation. I suspect some of them are good and some of them 
are bad, but all those schools are sitting without funding.
    So I would like to see more dollars put into the 
investigatory aspects of this thing, not necessarily random 
audits, but when you identify problems or potential problems 
putting dollars to work specifically in those areas.
    The Chairman. Thank you.
    Senator Rockefeller.
    Senator Rockefeller. Thank you, Mr. Chairman. Before I ask 
a couple questions I want to, with your permission, put into 
the record an October 1 letter to Chairman Powell that Olympia 
Snowe and I wrote, addressing a number of the questions which 
you have raised and others, as well as a letter to USAC. And 
Olympia, I do not have a copy with me and I do not know whether 
you signed it or not, but I think we both did. We always do.
    I am going to do something different----
    The Chairman. Without objection.
    [The letter referred to follows:]

                                                U.S. Senate
                                    Washington, DC, October 1, 2004
Hon. Michael K. Powell,
Chairman,
Federal Communications Commission,
Washington, DC.

Dear Chairman Powell:

    Under the 1996 Telecommunications Act, Congress codified its long-
standing commitment to universal service, explicitly directing the 
Commission to ensure that consumers in rural, insular, and high cost 
areas have access to reasonably comparable telecommunications and 
information services at reasonably comparable rates and to expand 
universal service support to include eligible schools, libraries, and 
rural health care providers.
    Given Congress's commitment to universal service, we are seriously 
concerned by reports that in the final week of a year-long conversion 
of the Universal Service Fund from GAAP to Government GAAP accounting 
standards, the Federal Communications Commission (``Commission'') has 
instituted changes that may significantly affect the operation and 
administration of the entire Fund, and in particular, the schools and 
libraries (``E-rate'') and rural health care funds. We are particularly 
troubled that E-rate and rural health care funding has been suspended 
since August 3, 2004, as a result of the uncertainty surrounding the 
accounting treatment of the Funding Commitment Decision Letters 
(``Commitment Letters'') issued under those programs and the 
Commission's determination that funds held in the Universal Service 
Fund are Federal funds for purposes of the Anti-Deficiency Act. This 
suspension has already had a significant negative impact on schools, 
libraries and rural health care providers across the country. It is our 
understanding that Commitment Letters are unlikely to be issued again 
before November of this year, only exacerbating the impact on these 
institutions.
    We are also deeply troubled by the seemingly inconsistent decisions 
made in implementing the accounting conversion. First, at the same time 
the Commission at the direction of the OMB, was considering whether to 
treat Commitment Letters as ``obligations'' for accounting purposes 
(thus requiring the Universal Service Administrative Company (``USAC'') 
to have monies in its account to cover all existing and future 
Commitment Letters), the Commission decided to ``under collect'' E-rate 
revenues by a total of $550 million in order to limit increases to the 
Universal Service contribution factor. As recently as September 16, 
2004, the FCC issued a decision to reduce E-rate collections by $150 
million. Despite objections filed by several affected entities, the 
Commission allowed this decision to take effect, unchanged. We are 
concerned that the result of these decisions will be to require 
substantial reductions in available outlays for the E-rate and rural 
health care programs and to increase significantly early next year the 
contribution rate assessed on providers of interstate communications 
services and passed through to consumers.
    Second, during the same period that USAC was converting to the more 
stringent government accounting standards, we understand that the 
Commission also approved USAC's investment of over $3 billion in long-
term investment instruments. In the last week, we understand that the 
Commission reversed course and required USAC to liquidate these 
investments in order to comply with Government GAAP and to avoid 
criminal liability for FCC personnel under the Anti-Deficiency Act. It 
is our understanding that the forced sale of these investments has 
resulted in losses of millions of dollars.
    Finally, we are troubled that while the Commission has taken steps 
to ensure that the E-rate and rural health care programs are in 
compliance with the new accounting requirements, we understand that it 
has not completed a full review of the impact of the accounting 
conversion on the high-cost and low income fund. In particular, the 
Commission's apparent decision regarding treatment of the E-rate and 
rural health care Commitment Letters as obligations may also impact how 
projected costs used to calculate high-cost and low income support 
should be treated for accounting purposes. If these projections are 
determined to be obligations, the high-cost and low income funds could 
face disruptions similar to those currently being experienced in the E-
rate and rural health care programs, putting in jeopardy billions of 
dollars relied on by rural telecommunications carriers that bring 
essential services to consumers and could jeopardize affordable 
telephone service for low income consumers. Furthermore, it is our 
understanding that Commission personnel could be subject to criminal 
sanctions for non-compliance with the Anti-Deficiency Act.
    Given the significance of these issues, we would appreciate your 
providing us with relevant information and responses to our questions 
prior to the Senate Committee on Commerce, Science and Transportation 
hearing on the E-rate program.

   Is it the Commission's legal opinion that the Universal 
        Service Fund is subject to the provisions of the Federal Anti-
        Deficiency Act?

     If so, on what basis? What written or unwritten 
            guidance has the Commission received from the Office of 
            Management and Budget?

     If so, is such a conclusion consistent with an August 
            2000 legal opinion from the Office of Management and Budget 
            concluding that ``the Universal Service Fund does not 
            constitute public money . . . and is appropriately 
            maintained outside the Treasury by a non-governmental 
            manager''?

     If so, is such a conclusion consistent with Congress' 
            intent in an 1997 amendment to the Commerce, Justice, State 
            appropriations legislation stating that ``federal and state 
            universal service contributions are administered by an 
            independent, non-Federal entity and are not deposited into 
            the Federal Treasury and therefore [are] not available for 
            Federal appropriations?

   If the Commission concludes that funds held in the Universal 
        Service Fund are ``federal funds,'' can a non-governmental 
        entity such as USAC hold and disburse such funds?

   How should projected cost estimates used in the 
        administration of the universal service high-cost and low 
        income funds be treated for accounting purposes? If the 
        Commission is unable to decide this question, does such a 
        result create potential liability under the Anti-Deficiency Act 
        if actual high-cost and low income outlays exceed projected 
        estimates?

   Given these accounting changes, what action, if any, does 
        the Commission expect will be necessary to recover the $550 
        million that will have failed to collect over the 2nd, 3rd and 
        4th Quarters of 2004 to cover E-rate and rural health care 
        obligations?

   It is our understanding that these accounting changes will 
        require USAC to make changes in the way that cash balances are 
        invested. What guidelines govern the investment of cash 
        balances in the Universal Service Fund programs. Are those 
        guidelines subject to approval by USAC andlor the Commission? 
        What effect will recent changes ordered by the Commission have 
        on expected interest income?

    Thank you for your prompt response to our inquiries. If you have 
any questions, please contact either Ray Kvncevic in Senator Snowe's 
office or James Reid in Senator Rockefeller's office.
            Sincerely,

Olympia J. Snowe
John D. Rockefeller IV

cc: Commissioner Kathleen Q. Abernathy
Commissioner Jonathan S. Adelstein
Commissioner Michael J. Copps
Commissioner Kevin J. Martin

    Senator Rockefeller. Thank you.
    If the chairman will allow, I am going to ask a series of 
questions and it will not go over my time limit. George 
McDonald: How many schools and libraries now have legitimate 
applications, cannot get their funding due to suspension? What 
will the demand be for the program by November 1? Question 
number one.
    The IBM problems have attracted a great deal of press and 
attention, probably deservedly so. There were many stories 
about $200 million in fraud. Can you explain briefly how much 
money USAC paid to IBM? How many questionable applications were 
stopped? How did USAC handle the questionable applicants, Mr. 
McDonald? I am not finished.
    In your judgment as the Program Administrator, will the 
accounting change to require cash on hand for commitment 
letters help protect schools from aggressive vendors and 
potential fraud?
    Final question to Mr. Gumper: Can you briefly explain the 
process between the FCC and USAC regarding the management of 
the Universal Service Fund? I want to know how the FCC, quote, 
``undercollected'' $550 million for the E-rate earlier this 
year.
    Mr. Chairman, you understand we are being assaulted you 
wireless and the Universal Service Fund is getting clobbered in 
all directions. In other words, the FCC undercollected $550 
million earlier this year for E-rate, and then within a few 
weeks suspended the program, citing lack of cash on hand. This 
seems like a flip-flop--a term these days.
    Second, is it true that the FCC approved investments in 
government-backed securities in July, then reversed itself in 
September, requiring the liquidation of the investment at the 
cost of millions of dollars? How much did this cost? What are 
the long-term ramifications for all aspects of the funding of 
E-rate, High Cost, Low Income, and Rural Health Care, which 
nobody has mentioned this morning?
    That is it.
    Mr. McDonald. Sir, I believe your first question was how 
many schools are awaiting commitment letters that we could 
issue today. There are about 4,200 applicants who would be 
getting funding commitment decision letters today if we were 
able to issue them, for about $300 million.
    Senator Rockefeller. My question was, what will be the 
demand for the program by November 1.
    Mr. McDonald. I do not have an estimate of the number of 
applicants by November 1.
    Senator Rockefeller. Can you get that to me?
    Mr. McDonald. Yes, sir.
    Senator Rockefeller. IBM was the second one.
    Mr. McDonald. IBM, we have funded IBM, we have disbursed 
about $770 million over the life of the program to IBM, and I 
believe most of that was properly committed and disbursed.
    In 2002 we got a whistleblower letter alleging abuses in El 
Paso, Texas, with 2001 money. That led us to have a special 
investigations team of certified fraud examiners who conducted 
an investigation and made site visits to El Paso and to 
Isletta, Texas, who had filed an application for 2002 with IBM, 
and uncovered a procurement pattern that--basically, IBM was 
selected as a, quote, ``strategic technology partner'' with no 
prices on the table. After they were selected, with an 
agreement that their service provider identification number 
would be on every funding request for that applicant, they sat 
down with the applicant to figure out what did they really need 
and what would it cost the applicant. When the prices were 
settled, nobody was at the table but IBM.
    The fundamental concept of the rules is competition over 
prices for eligible goods and services. That did not occur. We 
concluded that was not consistent with the rules, denied those 
applications----
    Senator Rockefeller. Understood. You have answered that 
well.
    The accounting change to require cash on hand for 
commitment letters to help protect schools from aggressive 
vendors and potential fraud?
    Mr. McDonald. I do not see a relationship between the two, 
sir. To have cash on hand in terms of the commitments? You have 
to have unobligated cash to make commitments?
    Senator Rockefeller. Yes.
    Mr. McDonald. I do not see a connection between that and 
protecting the schools. That is just a question of when we can 
issue the funding commitment letters. We still have to do the 
same scrutiny of those applications to determine whether there 
is abuse by the service provider or the applicant.
    Senator Rockefeller. Mr. Gumper, this thing I mentioned, 
the undercollection of $550 million, then within a few weeks 
suspending the program, citing lack of cash on hand.
    Mr. Gumper. Because of the way USAC collects money; we 
collect money at the start of the school year. We make 
commitments, hopefully before the school year starts. But the 
reality is that there is a fairly long lead time between when 
we make a commitment to a school or a library and they actually 
come back and say, OK, the work has been done, here is the 
bill, pay it.
    As such, over the course of the last few years the USAC 
cash balance that we manage has increased significantly, to the 
point where at the beginning of this year it was close to $3 
billion. At that time our treasurer looked at the balance 
sheet, the cash flow needed, and suggested, because the fact 
that we had such a large balance of cash had been noted by the 
auditors in several audits, questioning why was USAC 
maintaining this huge cash balance and what was it growing. So 
as a result of that, in discussions with the FCC and on the 
advice of USAC, our finance people, it was determined that we, 
for cash management purposes, could use some of the money to 
keep down the contribution factor for a period of time.
    At that point in time there was no correlation between when 
we issued commitment letters and the cash balance we had. This 
looked like just prudent cash management.
    As mentioned in reply to one of your questions, a year ago 
the Commission told us that we would have to go to government 
accounting standards effective October 1, of this year. In the 
process of training for that and modifying our systems, the 
question came up from our people, because in government 
accounting, unlike what we were doing in GAAP. In GAAP we were 
booking an obligation in the program when we received an 
invoice for payment from a service provider and in effect 
processed it, adjudicated that it was correct, they followed 
the rules, it was within their commitment. At that point in 
time, we booked an obligation on our books.
    But in government accounting, you talk about the point of 
obligation. The question was raised, was the point of 
obligation when we sent out the commitment letter? That issue 
was discussed throughout the first part of this year, and 
toward the summer it looked like we were going to be told that 
this was a possibility, that commitments could be obligations.
    At that time we thought this would just be an accounting 
issue as to how we closed our books on October 1 and 
transferred to government accounting. In June the question was 
raised, though, might not USAC and the USF be subject to the 
Anti-Deficiency Act? And if we were subject to the Anti-
Deficiency Act, then the question is, if these commitments were 
obligations, did we have the correct appropriation from OMB to 
cover it?
    Because of the concerns of potentially violating the Anti-
Deficiency Act, it was in August 3 that, in the interest of 
being conservative until we could actually verify whether or 
not, A, we were subject, whether these commitments were going 
to be treated as obligations, that we suspended the issuing of 
new commitments, because this is our very busy time. As we 
approached the school year, we had already committed over $700 
million and were on the verge of committing a lot more. And 
suddenly this issue came up, well, you might be in violation of 
the Anti-Deficiency Act.
    So that is why we suspended the things at that time, sir.
    Senator Rockefeller. My time is up. I thank the witnesses 
and the Chairman.
    The Chairman. Senator Snowe.
    Senator Snowe. Thank you, Mr. Chairman.
    To follow up on that, Mr. Gumper. So you obviously were not 
certain as to whether or not these rules would apply. I mean, 
you knew they had been under discussion for a considerable 
period of time, is that correct?
    Mr. Gumper. We did not receive more certainty until the 
meeting early in September between the FCC, OMB, and USAC. At 
that point in time we were sort of given verbal direction that 
we should probably be thinking of treating these things as 
obligations when we closed our books. And for the very first 
time it was raised that under government accounting the 
investments that we had are invested in funds that were backed 
by government securities, but they were operated by private 
companies. This is where we got somewhat better return of 
interest.
    It was raised at that point in time, though, that those 
funds were counted as obligations also. So even though we 
considered them cash to balance against the commitment letters, 
they said: No, no, those are obligations.
    Senator Snowe. That is why you were forced to liquidate 
those assets at a loss?
    Mr. Gumper. That is why we were forced to liquidate. And 
when staff informed me at this meeting, I basically said we 
were not going to take such drastic action on a verbal OK, and 
I sent a letter to the Commissioner, Chairman Powell, saying we 
wanted written direction and the answers to some very specific 
questions as to how we should treat commitments, how we should 
basically handle this liquidation. And we got an answer back on 
September 27.
    Senator Snowe. And that is this letter that indicated you 
basically were compelled to take those steps?
    Mr. Gumper. Those steps. And we were also told not to 
inform anybody, because over the period of a short 2 days we 
sold and bought several billion dollars worth of government 
bonds and we did not want to disrupt the bond market.
    Senator Snowe. So is it correct that it becomes a loss to 
you in terms of having to liquidate those bonds?
    Mr. Gumper. We lost $4.6 million because of the interest 
rates. That number is higher than we had anticipated when we 
first wrote to the Chairman of the FCC. One of the reasons was 
in between the Fed raised the short-term interest rates, and we 
keep our investments in basically what are short-term. We call 
them long-term; they are 2 years. But most of it is short-term, 
money market, or maturities of 2 years or so, and those are 
short-term, so they were somewhat affected by the increase in 
the Fed rate.
    Senator Snowe. The letter to you from the FCC, the one that 
you referred to on September 27, it sounds to me like the 
Inspector General obviously knew for quite some time about this 
idea of conversion. I know it had been under consideration, but 
it seemed more emphatic in this letter to you from the FCC.
    How long had the Inspector General realized that this was 
going to be inevitable for USAC to implement the government 
accounting rules? Because I think it really gets to the heart 
of the matter and how E-rate has been treated, how this program 
is treated. It is obviously not throughout the entire Universal 
Service Fund. It is not the High Cost programs.
    Why is E-rate, why is this program being treated 
dissimilarly from other entities within the fund and also 
throughout government?
    Mr. Cline. I do not believe for financial management 
purposes and financial reporting that E-rate is being singled 
out differently for the requirement to, like for example, for 
USAC to move to gov-GAAP.
    Senator Snowe. Could you give me an example of another 
entity that has been treated similarly under these 
circumstances right now?
    Mr. Cline. All of the funding mechanisms are moving to 
government accounting standards.
    Senator Snowe. Did they get a lead time, that they have to 
act in such a time?
    Mr. Cline. My understanding would be they have the same 
lead time as E-rate.
    I think the other funding mechanisms, the High Cost, Low 
Income, the impact on the immediate stop in funding I would 
suspect, although I do not know--that would be USAC's call. I 
do not believe anybody else had that stop that the E-rate has 
experienced.
    Senator Snowe. So why could it not have been done 
differently?
    Mr. Cline. Why it could be done differently, to be honest 
with you, we in OIG would have a hard time answering that. Our 
questions are actually very similar to yours. We have presented 
to the Commission that, we need you, the Commission, to make a 
determination how these requirements are going to be 
implemented and how they are going to be represented in the 
financial statements.
    Our involvement in these issues are as part of the audit of 
the FCC's Fiscal Year 2004 financial statement audit. Numerous 
of the questions that you are asking we are asking, perhaps on 
a more mechanical level, but very similar questions. We are 
asking, how do you intend to gather this information, how do 
you intend to report it.
    The impact on the flow of funding, I do not believe that 
OIG had insight into that any earlier than anyone else. To my 
knowledge, in relation to the audit of the financial statement, 
we did not foresee that. We in OIG would not foresee that 
because our interest is in the financial presentation of the 
information included in the financial statement.
    Senator Snowe. Right, and no one has any argument with 
that. I think it is the question of how this program has been 
treated under these circumstances. Have you received anything, 
has anybody received anything, from OMB with respect to this 
directive in writing?
    Mr. Cline. OIG has not.
    Senator Snowe. OIG. Has anybody?
    Mr. Gumper. We certainly have not. I know in the letter 
that was sent back to me by the FCC they indicated that they 
had gone to OMB and had asked for a written opinion and had not 
received it yet.
    In terms of the question are we treating this program 
differently than the others, that is still an open issue with 
the High Cost, Low Income. We did raise the question in my 
letter to the Chairman as to whether or not the projections we 
make in the High Cost, Low Income program are in fact 
obligations. Prior to every quarter, we list every telephone 
company as to how much money we are going to pay them in the 
following quarter. We file that with the FCC. The FCC, after 
they approve it, basically then we go through with those 
payments.
    They indicated back to me in the letter that that had been 
an issue that had just recently come up, that they had been 
referred to the OMB as to whether or not we should treat these 
programs the same. We are waiting for that answer. I can tell 
you that if we treat those projections as obligations we will 
add another approximately $2 billion of obligations to our 
books, which at that time would put us in a deficient mode of 
operation.
    Senator Snowe. Well, I guess I think the question is, Mr. 
Bennett, why would the FCC force this kind of liquidation 
without a written directive. Is that unusual or is that a 
consistent manner of operation?
    Mr. Cline. Unfortunately, we in OIG do not have the answer 
to that question. You would have to place that to FCC 
management. That is not a decision that we are involved in.
    Senator Snowe. Thank you, Mr. Chairman. Thank you.
    The Chairman. Thank you. I thank the witnesses.
    Any more, Jay?
    Senator Rockefeller. No.
    The Chairman. I thank the witnesses. This hearing is 
adjourned.
    [Whereupon, at 11:10 a.m., the hearing was adjourned.]

                                  
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