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Published in Print: February 12, 2003, as E-Rate Audits Expose Abuses in the Program

E-Rate Audits Expose Abuses in the Program

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The $2.25 billion federal E-rate program, which helps thousands of schools and libraries connect to the Internet, is losing millions of dollars to fraud and other misuse, auditors say.

They say the problems, which range from minor noncompliance issues to alleged criminal offenses, could involve many schools and technology companies across the country.

But with government red tape, a lack of adequate funding for oversight, and a dearth of auditors for monitoring a program that receives 30,000 applications a year, accurately gauging the number of bad E-rate applications is difficult.

The Federal Communications Commission, the agency that oversees the popular program, is trying to revamp oversight and create a more rigorous system of checks and balances. It plans to increase auditing and provide closer monitoring with the help of the U.S. Department of Justice, the FBI, and other federal, state, and local agencies.

"We do have some serious concerns about this program," said Tom Cline, the audit director of the FCC's office of inspector general, which monitors all FCC programs. "With our resources and the audit work we've been able to perform so far, which has been fairly fragmented and ad hoc, we can't state with any degree of assurance that this program is adequately protected against fraud, waste, and abuse."

Still, Mr. Cline cautioned, "we're not saying the barn's burning down. We don't even know if the barn is on fire."

Links to Internet

The education-rate program, which has disbursed more than $8.25 billion since its inception in 1997, helps link public and private schools to the Internet by paying up to 90 percent of technology costs such as wiring and Internet-connection fees. It's part of the federal government's Universal Service Fund, a program that helps rural and low-income communities and those in high-cost areas afford telecommunications services and health care.

Consumers pay for the program through a "universal service" fee on their monthly phone bills. Telephone customers are charged at rates of about 10 percent of their bills for land lines and double that for cellular phones.

The potential severity of the abuse of the E-rate program became clear recently. In December, federal authorities filed criminal charges against a Long Island technology company for allegedly stealing $9 million in E-rate funds.

The owner and three employees of Connect 2 Internet Networks, which had been the E-rate Internet provider for more than 200 schools in New York state since 1998, were charged with eight counts of federal crimes, including wire fraud, obstruction of justice, and false claims on government programs. If convicted, they could face 20 to 60 years of prison and fines of up to $2 million.

Connect 2 is among 26 public and private schools and technology companies federal officials are investigating for E-rate noncompliance or fraud ranging from $4,000 to "hundreds of millions of dollars," according to FCC documents.

The International Business Machines Corp., which has received $351 million in E-rate money—the most of any technology company—also has come under federal scrutiny. Federal officials in November rejected the company's $18 million E-rate request for the 46,000-student Ysleta school district in Texas because the district allegedly had denied other service providers the opportunity to compete fairly against IBM for the project. That broke the E-rate's competitive bidding rules, said officials at the Universal Services Administrative Co., or USAC, the nonprofit organization that runs the program under the FCC.

IBM has denied any wrongdoing, and the district has asked the FCC to overrule USAC and restore the money.

While federal officials are stepping up the audits and investigations of schools and service providers, compliance problems with the E-rate program are nothing new. Since the start, federal authorities have red-flagged and audited suspicious applications.

In 1998, the first funding year, 17 beneficiaries made 15 errors in the program's competitive-bidding process, according to a preliminary audit by the accounting firm Arthur Andersen, which was hired by USAC. Those 17 were the only ones the firm audited. The mistakes cost taxpayers approximately $8 million in inappropriately disbursed E-rate funds. Federal officials are trying to recover that money, but are unable to get back several millions of dollars because of rule waivers.

The most frequent error was billing too much for technology services or not giving enough documentation to support the amount schools and technology companies requested in E-rate funding. That happened six times, according to the accounting firm.

Other mistakes include submitting technology invoices based on estimates rather than actual costs, delivering services after the deadline date, and billing for ineligible services.

For example, some schools in the Los Angeles Unified School District that requested $3.5 million in E-rate funds couldn't verify the existence of the equipment they had purchased with the money.

A second USAC audit of 22 E-rate beneficiaries by Arthur Andersen last year found more troubling results. The accounting firm's report indicated that there might be problems at "nearly all locations including several millions of dollars in inappropriate disbursements and unsupported costs."

USAC won't give specific details of the second audit, such as the names of the schools and technology companies. And final results of the audit were delayed because of the breakup of Arthur Andersen in the wake of the Enron scandal. But USAC officials said the report might be made public this spring.

A new USAC survey by the accounting firm KPMG Peat Marwick, now under way, will cover 78 beneficiaries in 28 states. Those schools and technology companies were awarded $408 million in E-rate funds for 2000. Their projects' costs ranged from $840 to as much as $157 million.

Federal officials stress that some of the beneficiaries' problems involved unintentional errors. The E-rate program is complex, with many regulations and copious amounts of paperwork.

"We've found a number of areas ... where the noncompliances were obviously based on a misunderstanding, or where somebody tried to do the right thing, but not quite hitting the target," said the FCC's Mr. Cline.

But others, such as Connect 2, are accused of knowingly defrauding the E-rate program.

Intentionally or not, federal officials say, some schools, libraries, and technology companies are getting millions of dollars they don't qualify for, potentially hindering eligible schools and libraries from receiving E-rate funds, and further casting a cloud of controversy over a program that has been the subject of political debate.

Unfortunately, officials say, finding the bad apples is proving to be an uphill battle.

Closer Monitoring

Against that challenging backdrop, the FCC recently devised a strategic audit plan to better monitor the E-rate program.

One main component is auditing a statistical sample of applications. The sample is tiny—well under 100 of the 30,000 applications submitted each year. The FCC doesn't have the money to do more than that, Mr. Cline said. But he said the sample would give auditors a better sense of the challenges they face.

"That's the linchpin for our oversight plans," he said.

Besides helping with 26 current E-rate investigations by the FBI and the antitrust division of the Justice Department, the FCC is also trying to partner with the U.S. Department of the Interior's Bureau of Indian Affairs to help audit and monitor BIA schools. Some of the schools that may be flagged for potential E-rate problems are on American Indian reservations, federal officials say.

The FCC wrote the bureau on details of that partnership in February 2002, but a year later, plans to work together remain at a standstill.

That "extremely long gestation period," an FCC report says, has resulted from the bureaucratic intricacies of ensuring that the Interior Department gets paid from E-rate program funds, and from the need to work out other "procedural concerns" between both the department and the FCC.

For two years, the FCC and USAC have also discussed implementing a suspension or debarment program for E-rate beneficiaries who repeatedly break the program's rules. Barring repeat offenders would ease the task of weeding out bad applicants, federal officials say. But they don't know when such a policy would take effect.

One big problem hampering the oversight efforts is the lack of auditors. Three full-time auditors in the office of the FCC's inspector general work on the E- rate program, along with a handful of other employees from the FCC and other federal agencies.

Last year, the FCC began 29 audits of E-rate funding of schools, libraries, and technology companies. The agency had extra help: four other auditors on loan for three months from other federal agencies. But two of them were pulled away to work on a criminal investigation in the commission's enforcement bureau. Partly as a result, 12 audits were canceled.

In fact, 15 full-time auditors are needed to adequately monitor the E-rate, according to FCC documents. But lack of funding makes that level of staffing impossible, agency officials say.

The Universal Service Fund, the umbrella program that includes the E-rate program, has billions of dollars. But the FCC cannot use one cent of that money to help monitor the program. While the E-rate is a federal program, there is considerable disagreement, officials explain, over whether the revenues in the Universal Service Fund are actually federal money.

Money for the Universal Service Fund doesn't go through the U.S. Treasury. Instead, it's disbursed directly by USAC. Moreover, USAC is a private, nonprofit entity, even though it's governed by the FCC.

The FCC's inability to use E-rate funds even though it oversees and is responsible for the program is a subject of great frustration for the agency, officials of the communications commission say. But the agency is reluctant to broach the possibility of getting access to that money.

"Any option for obtaining resources using USF funding may create an appearance of the commission augmenting its appropriation," a recent semiannual FCC report said.

Instead, the FCC has asked Congress for a little more oversight money. The agency included $2 million for monitoring the Universal Service Fund in its fiscal 2004 budget.

'30 Percent Rule'

USAC officials, meanwhile, defend their ability to detect problems. The nonprofit company has denied or trimmed $2.8 billion in E-rate requests by schools and libraries since 1999. Its officials also say that most of the questionable applications the FCC examined most recently had already been flagged by USAC.

"Where we find problems, we have shared that with the [FCC]," said George McDonald, USAC's vice president in charge of the E-rate.

USAC has also publicized on its Web site the mistakes beneficiaries have made and added clarifications and amendments to the program to help applicants navigate the sometimes cumbersome E-rate funding process.

The process starts with a review of applications. Many errors are corrected at that stage, saving applicants from being disqualified.

When reviewers find flaws in an application, USAC applies what it calls the "30 percent rule." If at least 30 percent of an application represents ineligible items, such as educational software, USAC denies the application. Projects at risk of significant problems or deemed especially complex are shunted to USAC's "program assurance" review for a closer look.

Political disputes have plagued the E-rate program from its beginning during the Clinton administration. Many Republicans derided the charge levied on phone bills as the "Gore tax," after then-Vice President Al Gore, who championed the program's creation. Among other complaints, critics questioned what they said were excessive salaries paid to program administrators.

Some also attacked the whole mechanism undergirding the program. Rep. W.J. "Billy" Tauzin, R-La., asserted in 1999 that the program was financed by "an illegal tax by an illegal corporation."

More recently, critics have said that the program should be dropped because it has completed its mission of connecting schools to the Internet. Two years ago, the Bush administration advocated combining the E-rate program with other technology programs managed by the Department of Education.

Some of the arguments against the E-rate have been the basis for lawsuits. Telephone companies and utility regulators from more than a dozen states challenged in a lawsuit the FCC design of the program and certain provisions of the Telecommunications Act of 1996, the law that authorized it. The plaintiffs alleged that the law didn't authorize providing E-rate discounts for wiring classrooms and Internet services. Most of the issues in the lawsuit were resolved in the FCC's favor in 1999.

But Sen. John D. Rockefeller IV, the West Virginia Democrat who co-sponsored the act that established the E-rate, and others staunchly defend the program.

Wendy Morigi, a spokeswoman for the senator, pointed out that while only a small percentage of schools were connected to the Internet a decade ago, almost all are today, thanks in part to the E-rate program. And the program is still very much needed, she argued.

"You've got to pay for periodic upgrades, pay for the monthly high-speed data lines," she said. "You have emerging technologies, and the E-rate helps schools keep pace."

Norris Dickard, a senior policy analyst at the Washington-based Benton Foundation, a nonprofit think tank that advocates policies that help close the "digital divide," and a former Education Department official, added that the E-rate isn't the only federal program that's been abused by some beneficiaries. Fraud in the federal student- loan program, for example, has not led to attempts to eliminate federal student loans, he remarked.

"Just because you've caught a bad apple, you don't tarnish the whole program," Mr. Dickard said. "It's still a good program."

Coverage of technology is supported in part by the William and Flora Hewlett Foundation.

Vol. 22, Issue 22, Pages 1,18-19

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