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Witness Testimony
Mr. George McDonald
Problems with the E-rate Program: Waste, Fraud, and Abuse Concerns in the Wiring of Our Nation's Schools to the Internet
Good morning, Mr. Chairman and Members of the Subcommittee. I am George McDonald, Vice President of the Universal Service Administrative Company ("USAC") with responsibility for the Schools and Libraries Division. Thank you for inviting me here today to discuss USAC's administration of the "E-rate" program. Protecting Against Pre-Commitment Program Abuse Previous hearings held by this Subcommittee about E-rate have given me the opportunity to outline our procedures to combat those who would try to circumvent program rules, which can lead to waste, fraud or abuse. Today, I will focus on requirements for conducting a fair and open competitive process and ensuring cost-effective use of E-rate funds. These are the responsibilities of the applicant and areas that the applicant must take responsibility for prior to submitting an application. 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 Federal Communications Commission (FCC), in a series of recent rulemakings, has stressed that accountability. Free, Ineligible Services - We have been concerned from the beginning of the program about service providers offering and applicants accepting free, ineligible services and have taken steps to address this potential for abuse. Since service providers must cover their costs, these "free" services would not be free to E-rate; they would be paid for through inflated prices on eligible equipment. For example, NEC-Business Network Solutions Inc. (NEC) admitted in its recent plea agreement that it planned to "donate" millions of dollars worth of ineligible computer workstations to the San Francisco Unified School District (SFUSD) and that NEC actually planned to use E-rate funds to cover the costs of these "donated" workstations. NEC also admitted that the funding requests that were submitted to us for SFUSD contained inflated prices. An applicant can, however, accept free, ineligible services, along with eligible services, request discounts, and satisfy the rules if the applicant complies with the following requirement. The applicant must reduce the prediscount cost of the eligible services by the fair market value of the ineligible services it will be provided at no cost. When we review applications, we look for free, ineligible services so that we may take appropriate action. USAC is authorized to provide funding for eligible services only. This prohibits applicants and service providers from using discounts to subsidize the procurement of ineligible or unrequested services. The value of all price reductions, promotional offers, and "free" services must be deducted from the pre-discount cost of services. In this manner, universal service funds are not used to subsidize ineligible services. Similarly, since applicants are required to choose the most cost-effective bid with the price of eligible services being the primary factor, applicants cannot base their decisions on free, ineligible offerings by service providers. Competitive Process to Select Service Provider and Payment of the Non-Discount Share of the Cost of Eligible Goods and Services - Two key program requirements designed to prevent waste, fraud, and abuse, and to protect the integrity of the program are that applicants must conduct fair and open competitive processes to select service providers and applicants must pay the non-discount share of the cost of eligible goods and services. If applicants do not comply with these requirements, their applications will be denied. These requirements are intended to ensure that the applicants and E-rate are getting fair value. The rules require competition over the price of eligible services, competitively neutral RFPs, and that applicants select the most cost-effective offer with price the primary factor. Applicants must remain in control of the procurement process and cannot abdicate their responsibilities to a service provider who is competing for their business, or to a consultant. The rules also require that applicants pay their share of the cost so that they have a stake in selecting the most cost-effective offer and so that they do not request services in excess of their needs. If service providers offer to waive the non-discount share of the cost, they remove any incentive for the applicant, who is the one making the decision, to select the most cost-effective alternative. This undermines the goal of preventing waste, fraud, and abuse. If service providers waive the non-discount share of the cost, they must still cover their costs. They do this by inflating the prediscount cost so that the discount share to be paid by USAC more than covers their costs, and E-rate is the loser. Goldplating - The E-rate program is designed to give applicants discretion in deciding which technology solutions best meet their educational objectives. Some applicants seek discounts only for basic phone service and dial-up Internet access. Others seek assistance in building sophisticated networks with broadband connections for Internet access and distance learning. USAC generally does not "second guess" the choices applicants make, but the Subcommittee and USAC have seen instances of "goldplating" - purchases that are clearly excessive for the use that will be made of them. Applicants are responsible for the reasonableness of their choices. To emphasize this responsibility, the Commission recently directed that applicants explicitly certify that "the selection of services and service providers is based on the most cost effective means of meeting educational needs and technology plan goals." We can and do deny requests when the applicant did not select the most cost-effective offering with price the primary factor, when applications include a substantial amount of ineligible services, or when requested services clearly go well beyond the requirements set out in the applicant's technology plan. Applicants are responsible for their requests - they must do the planning for technology solutions tied to their educational objectives, they make the certifications on the forms, they are to share the cost. If an applicant solely relies on service provider recommendations, this may lead to applications that run afoul of program rules. Therefore, applicants must take the necessary steps to be in a position to determine if the recommended solution is in fact what is needed. Consultants - As the E-rate program has matured, E-rate consultants have played an increasing role. Consultants offer a variety of services to applicants, from providing advice with respect to the available technologies, to submitting program forms, to overseeing the competitive process underlying the application. As with deciding which technology solutions best meet their educational objectives, applicants have discretion to choose a consultant. However, applicants remain responsible for their applications and for ensuring that there is a fair and open competitive process. USAC has denied millions of dollars in funding requests when we have determined that the "consultant" who provided free services to the applicant was associated with the service provider selected. Participation of IBM in the E-rate Program Let me now turn to the participation of IBM in the E-rate program. IBM has been participating as a provider of internal connections since the inception of the program. It has been paid over $760 million from 1998 until today - more than any other single E-rate service provider. In January 2002, USAC received an anonymous letter alleging program abuses at the El Paso Independent School District in Texas (El Paso). Our Special Investigations team began an investigation, which included a site visit. As we came to understand the procurement approach that had been used by El Paso to select IBM for Funding Year 2001, we became concerned that it may not have been consistent with program rules. We identified a number of Funding Year 2002 applicants who were requesting large amounts of E-rate discounts in funding requests associated with IBM and who may have used a similar procurement approach. We extended the investigation to cover these Funding Year 2002 applicants, which included El Paso. Ultimately, we concluded that the procurement approach was not consistent with the rules and denied requests for over $500 million because of that approach. Several of the applicants associated with IBM in Funding Year 2002 would have been selected for heightened scrutiny of their applications even if USAC had not received the whistleblower call. I believe that it's likely that would have resulted in USAC identifying these program rule violations independently of the whistleblower letter, but certainly the letter was helpful in the process. As I have discussed, the FCC rules are designed to ensure prudent use of E-rate funds by requiring applicants to conduct a fair and open competition for obtaining the eligible services the applicant has decided it needs. The rules require applicants to identify the specific eligible services for which they will seek funding based upon the applicant's technology plan, to solicit bids from competing service providers, and then to choose the most cost-effective alternative with price being the primary factor. These applicants and IBM participated in a two-step approach, involving a "Strategic Technology Partner." Generally, the Strategic Technology Partner is a consultant to help customers determine what their technology needs are, and a general contractor overseeing the implementation of the different projects. The two-step approach consisted of first choosing the Strategic Technology Partner, and then, with the help of that partner, deciding which eligible services to seek funding for. At the first step, each applicant used a generic Form 470 and a similar RFP indicating that they had not decided which specific services they needed and sought a partner to help them make those decisions. Since the applicants did not identify the specific services they were seeking, the bids that the service providers submitted did not state the cost of the services. Consequently, when the applicants selected the winning service provider, they did not make that selection based on which was the most cost-effective alternative with price the primary factor. After IBM was selected, the second step began. At this step, IBM worked with the applicants to develop detailed statements of work that identified the specific services for which funding would be sought on the applications submitted to USAC. This meant that, at the time decisions were made about what specific services to request E-rate discounts for and how much to request, there was only one service provider at the table. Consequently, the price competition for eligible services that the FCC rules envision never took place. IBM and the applicants appealed USAC's denials to the FCC, and in some cases to USAC. The FCC affirmed USAC's decisions to deny funding in all but one instance. USAC reversed one of its denials on appeal. The FCC decision affected two other appeals pending with USAC. We funded El Paso in Funding Year 2001 even though El Paso used the two-step approach that we determined was inconsistent with program rules in the next year. This occurred because our review procedures did not flag the El Paso application for a particular kind of heightened scrutiny. We review almost 40,000 applications for funding every year, and we use a staff of some 150 people to conduct those reviews. With a process of that magnitude, we appropriately rely on written procedures to guide the reviews to ensure consistency and equity for all applicants. Our procedures did not contemplate the "strategic technology partner" procurement approach in 2001 and, therefore, we did not identify this application as one requiring heightened scrutiny. We have learned much more about the services IBM was offering through our intense review of the Funding Year 2002 applications and concluded based on that analysis and review of Statements of Work for El Paso for Funding Year 2001 that our Funding Year 2001 funding commitments for El Paso may have included a substantial amount of ineligible services. We have asked IBM to respond to our tentative conclusions. Depending on that response, we may seek recovery of a substantial portion of the funds we disbursed to IBM for work in El Paso for Funding Year 2001. Conclusion Mr. Chairman, thank you for providing me with the opportunity to address the Subcommittee. I would be happy to respond to any questions you may have. |
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