by Jeff Gerth, ProPublica
At the dawn of the Internet era, Congress set out to avert a digital divide between rich and poor students. In a landmark bill, lawmakers required the nation’s phone companies to provide bargain voice and data rates to schools and to subsidize the cost of equipment and services, with the biggest subsidies going to the schools with the most disadvantaged children.
More than a decade later, as schools struggle for funding amid widespread budget cuts, there is growing evidence that the program’s crucial low-price requirement has been widely neglected by federal regulators and at least one telecom giant.
A decade after the program started, AT&T was still not training its employees about the mandatory low rates, which are supposed to be set at the lowest price offered to comparable customers. Lawsuits and other legal actions in Indiana, Wisconsin, Michigan and New York have turned up evidence that AT&T and Verizon charged local school districts much higher rates than it gave to similar customers or more than what the program allowed.
AT&T has charged some schools up to 325 percent more than it charged others in the same region for essentially the same services. Verizon charged a New York school district more than twice as much as it charged government and other school customers in that state.
The companies say they comply with the rules of the program, known as E-Rate.
Meanwhile, the federal government has made scant effort to enforce the requirement that companies give the preferential rate to schools. The Federal Communications Commission, which oversees the program, has yet to bring an enforcement action against any carrier for violating the low-price rule, according to interviews and documents, some obtained under the Freedom of Information Act. And the FCC, acting through the private company that administers the program, has provided little if any guidance to companies on how to apply the best-price rule. Indeed, in 2010, companies such as AT&T and Verizon sought clarification on the rule.
“Time and again, we find that schools are rarely advised by the telephone companies of their best available rates,” said Howard Rotto, whose New York consulting firm has represented dozens of schools in the Northeast for four decades. “When representatives of the carrier do not even know of the existence of their best pricing,” Rotto asked, “how can such a rate ever be offered or known?”
At the most basic level, the victims of this failure are the nation’s schoolchildren who receive suboptimal broadband access. Many requests for assistance cannot be funded under the current program. If lower prices were charged, more schools could benefit.
But there’s another set of victims: the vast majority of people with a cellular or landline phone contract.
As designed by Congress, telecom companies must contribute to a fund, administered by the federal government, that subsidizes the equipment and services provided under the program. Most of the companies raise this money by directly charging their customers.
Sift through that pile of papers at home and take a look at your monthly bill. Amidst all those charges you’ve never really understood you’ll probably find a small one labeled “Universal Service Fund.” Skimmed off every consumer’s payment each month, those dollars and nickels add up, creating a pot of money of about $2.25 billion to subsidize telecom and Internet services for America’s schoolchildren and library users.
Schools and libraries draw on this fund to help pay for the services provided by the telecom companies — virtually all schools are eligible, but the poorer the school, the more it can draw. Requests for help almost always exceed the available funding. So when phone companies charge inflated rates to schools and government regulators turn a blind eye, this fund is depleted faster; fewer schools and libraries benefit; and money taken from millions of telephone customers goes to boost corporate profits instead of to help as many schoolchildren as possible.
Indeed, a perverse bureaucratic process denies most schools the funding to carry broadband services all the way into actual classrooms. Here’s how it works: Schools are rarely if ever turned down for funding to bring broadband main lines to the exterior walls of the schoolhouse.
But the internal connections, from wiring to jacks, that complete the last leg and extend connectivity down to actual classrooms, computers and telephones are deemed a lower priority, so-called “Priority 2.” (Priority 2 also includes maintenance.) As a result, only the very poorest schools are eligible for this funding. The rest — including many poor-but-not-destitute schools — don’t get the subsidies to carry broadband that last crucial stretch from outside the schoolhouse to inside classrooms.
Last year, the E-Rate program received Priority 2 requests totaling more than twice as much money as it could fund. Worse, many schools don’t even bother to apply for “Priority 2” services because they know they’ll be turned down. Wisconsin estimated in 2005 that 98 percent of its schools and libraries do not qualify. In 2010 New York wrote to the FCC, “Many otherwise needy schools and libraries have received no Internal Connections funding — ever!” And the FCC itself declared in 2010 that “the vast majority” of schools and libraries “do not receive funds for the internal infrastructure necessary to utilize increased broadband capacity.”
From 2009 to 2011, Priority 1 services accounted for about two-thirds of the funds committed. This year, the estimated demand for Priority 1 services will essentially exhaust the entire fund.
How could Congress’s plan have gone so far awry?
An examination of the program by ProPublica shows that from the beginning, oversight of how the money was spent was turned over to private companies that employ numerous former telecom executives.
The leading company hired to oversee the program provided little if any training or guidance to phone companies over the past decade in how to calculate the bargain prices, known as “lowest corresponding price.” Instead, according to documents and interviews, it focused on the schools, examining whether their purchases of equipment were cost effective.The company and the FCC even forced schools and libraries — many of them unskilled in negotiating complex telecom contracts — to pay millions of dollars in penalties for failing to follow the program’s voluminous and cumbersome rules.
Yet 16 years after the law passed the FCC has not brought even one case against a phone company for violating the “lowest corresponding price” requirement. Efforts to enforce the rule have come exclusively through private legal action, such as lawsuits, and one Justice Department-led investigation that examined pricing in Indiana.
Much about the E-Rate program remains hidden from public view. Telecom contracts are mostly private, so it is not possible to judge how frequent or widespread violations of the lowest-corresponding-price rule might be. For this report, ProPublica relied on documents, many obtained from lawsuits, as well as dozens of interviews.
Mike Balmoris, a spokesman for AT&T, declined to answer specific questions about the company’s practices but released a statement saying “AT&T complies fully with the E-Rate requirements, including the lowest corresponding price rule.”
In an email, Verizon spokesman Ed McFadden said the company regularly trains its employees on all legal obligations, “including requirements of the E-Rate program,” as part of a larger effort “to conduct business with all our customers at the highest ethical standards.” The FCC also declined to answer questions.
A statement provided by an FCC spokesman, Mark Wigfield, cited the program’s overall success; the commission’s efforts to improve “safeguards against waste, fraud and abuse;” rules requiring schools to engage in competitive bidding to ensure low prices; and audits by the private company regulating the program that compare prices that companies charge schools to “those charged other customers.”
The FCC declined to make those audits available. But through a FOIA request, ProPublica requested every audit for the first 12 years of the E-Rate program involving the lowest-corresponding-price rule. The government provided what it said was a complete set — a mere nine audits.
In broad terms, they show that regulators paid little attention to telecom service providers while coming down hard on schools. Indeed, most of the audits deal with the companies as a side issue; the main focus is on whether the schools, not the companies, complied with the program’s complex regulations. Some of the audits are heavily redacted, but in the available text none mentions lowest corresponding price, the key cost-saving requirement.
The E-Rate Program
E-Rate was created through the Telecommunications Act of 1996, which President Bill Clinton made law through the first e-signing of a federal bill. The act mandated broader telecommunications access through four programs, including E-Rate for the nation’s schools and libraries.
When a school or library qualifies for E-Rate, the fund subsidizes 20 percent to 90 percent of the telecom bill, depending on how poor the school or library is. (A key measure of poverty: the percentage of students who qualify for the government’s free or reduced-cost school lunch program.)
The FCC says the program has been a success. At the time of E-Rate’s launch, 65 percent of public schools were connected to the Internet. By 2005, about 97 percent were, thanks largely to E-Rate, according to the FCC.
A few days after signing the act, Clinton highlighted “a requirement for companies to provide a discount for connecting all of our classrooms and libraries to the information superhighway.”
One reason for the bargain-rate requirement is to make sure that as many schoolchildren and library patrons as possible benefit. Another reason to require companies to provide preferential rates, according to the FCC, is that many schools and libraries suffer from a “lack of experience” when it comes to “negotiating in a competitive telecommunications market.” Indeed, telecom pricing is notoriously complex and opaque, and the E-Rate program benefits “many of nation’s poorest and most isolated communities,” according to an FCC document.
Under FCC regulations, schools are required to try to obtain competitive bids from phone companies, while the companies are required to charge no more than their “lowest corresponding price,” which the agency defined as “the lowest price [a telecom company] charges to similarly situated non-residential customers for similar services.”
Almost from the inception of the program, phone companies have advocated for leeway in determining the lowest corresponding price. In 1997, representatives from five former Bell companies — three of which are now part of AT&T — wrote to the FCC that companies should be allowed “to determine the lowest corresponding price … based on a consideration of factors normally used in determining prices within a competitive market.”
Meanwhile, the FCC has repeatedly declined to back the pricing rule with tough enforcement. In 1997, the FCC proposed that companies could get reimbursed through the program only if they first certified that they had complied specifically with the pricing rule — a strong legal requirement that might have left companies liable to the federal False Claims Act if they misrepresented their prices. The FCC cited the “universe of records” a company “must review to determine lowest corresponding price.” But the agency never enacted that certification proposal.
In 2005, the FCC again proposed that service providers, as part of their annual E-Rate filings, certify specifically they had charged the “lowest” price to schools and libraries. But after industry opposition, the plan was dropped, according to public filings. Wigfield, the FCC spokesman, declined to say why the agency did not require certification. (The FCC does require a broad, annual certification, in which companies are instructed to affirm their compliance with E-Rate rules.)
The FCC, through the nonprofit firm Universal Service Administrative Co., or USAC, has taken action against phone companies for a variety of infractions — but never has it demanded a refund or penalty for violating the lowest-corresponding-price rule.
As for AT&T, as recently as 2007 it issued its employees a 61-page “E-Rate Compliance Training” manual, used as part of an annual required course for employees. The pricing rule is not mentioned.
In its statement to ProPublica, the company spokesman said, “AT&T has implemented training and procedures to ensure compliance with all E-Rate requirements.”
Working out of his modest home in Waupun, Wis., Todd Heath runs a niche business: He takes a cut from any refunds he manages to obtain for telecom customers, mainly schools. In 2008, Heath wondered why schools he represented, in small cities like Kaukauna, West Bend and Fond du Lac, were paying far more than others for essentially the same services from the same company: Wisconsin Bell, a unit of AT&T.
The schools were all in the E-Rate program, and it wasn’t long before Heath accused the company of violating the lowest-corresponding-price rule. His complaints are now in federal court.
Under whistleblower laws, if the suit results in a financial settlement, Heath stands to gain a portion of that money.
Heath’s complaint alleges that in 2005, school districts in Burlington, Grafton, Cudahy and Altoona paid as much as 80 percent more for the “identical” central office exchange service from Wisconsin Bell than did the Fond du Lac School District.
Also that year, according to the court complaint, Milwaukee, West Bend and Sheboygan were paying far higher rates for office exchange services than what was available under an agreement between Wisconsin Bell and the state of Wisconsin that allowed schools and libraries to get the same favored rate the state was getting. For example, the Wisconsin state contract price for a service called ISDN/PRI, which integrates voice and data into a single line, was $390 per month, according to the complaint. But schools in Fond du Lac, Hartford, Kaukana, Kimberly and West Bend were billed at prices ranging from $640 to $1,268 per month, the complaint states.
Heath’s complaint asserts that “Wisconsin Bell routinely has withheld information about these available rates from public school and library customers, and it has billed almost all of them at much higher rates, sometimes three times as high as LCP,” or lowest corresponding price.
The allegation that Wisconsin Bell hid the state rates from schools is wrong, the company says, because the contract rates were “publicly known.”
E-Rate regulations, however, require that the lowest corresponding price be more than just publicly known; that price must be provided to schools and libraries in the program. Phone companies “shall not charge” schools or libraries “a price above the lowest corresponding price,” the regulations state. (There is an exception for a rate so low that the company loses money, but the FCC must sign off on this exception. An agency spokesman, asked about any such cases, did not provide an example.)
Wisconsin Bell is seeking dismissal of the lawsuit on various grounds. One is that the FCC has, in essence, neglected its duty to train phone companies on how to determine the preferential rate. The agency, according to a Wisconsin Bell court filing, has “yet to provide authoritative benchmarks with respect to application of the lowest corresponding price requirement.”
The AT&T spokesman declined to discuss the Heath case but said the company “has worked diligently with industry to seek additional FCC clarifications of these rules where appropriate.”
Heath’s suit continues.
Regulatory filings with the New York State Public Service Commission paint a similar picture, but with Verizon. From 2005 to 2011, in the E-Rate program, Verizon charged far more to the Bronxville, N.Y., school district for ISDN/PRI and plain old telephone services than what was available under the state-negotiated rate. For example, according to the filings, the state rate for PRI since 2008 has been $275 per month, but Bronxville has been charged more than twice that: $611 per month.
Verizon originally contested the claim using a strategy similar to one AT&T deployed in Wisconsin: putting the onus on the school. In a filing last summer, Verizon said that the state master contract “process requires customers to submit a request to receive the discount,” and there is no evidence that the Bronxville school district “requested” the state rate for telephone service.
E-Rate regulations, however, prohibit phone companies from charging more than the lowest corresponding price.
Verizon and Bronxville recently settled the case, according to Rotto, the consultant, who worked with Bronxville on the matter. The terms of the settlement are confidential.
While declining to discuss specific disputes, Verizon spokesman McFadden said the company “is committed to resolving any such disputes fairly.”
“If we make a mistake,” he added, “it is our goal to fix it.”
Justice Department Steps In
USAC, the nonprofit company that administers the program on behalf of the FCC, audited the E-Rate bidding process in Indiana and gave it a clean bill of health. But a law firm’s examination of the same bidding process, done for the state, found problems and led to multimillion-dollar settlements with the Justice Department, according to department records.
One of those settlements took place in 2009, as the Justice Department was considering filing civil claims against an AT&T subsidiary about its Indiana E-Rate service, including for “overbilling the E-Rate program for services provided.” The telecom giant paid $8.3 million to settle. It did not admit wrongdoing.
The lowest-corresponding-price rule is not referenced in the settlement but figures prominently in a related compliance agreement with the FCC, executed the same day. There, AT&T agreed it “shall prepare a written analysis sufficient to document its compliance with the requirement that the rates it charges for E-Rate services in Indiana are not above the lowest corresponding price.”
This compliance agreement is the only example cited in the FCC’s statement to ProPublica, but records show it was the Justice Department —not the FCC — that led the investigation of the case. The FCC played a role in the latter stages.
AT&T declined to comment on the 2009 settlement.
The following year, AT&T urged the FCC to drop the pricing rule altogether. “The current competitive circumstances,” the company wrote the agency in 2010, “warrant elimination of the lowest corresponding price rule.”
“A Regulatory Wild West”
Numerous reports by Congress, the GAO and the FCC’s inspector general have criticized the E-Rate program over such issues as waste, fraud, poor management and the program’s hybrid oversight structure involving two private companies with links to the telecom industry.
The FCC is the final authority for E-Rate policies and oversight, but USAC administers the program, conducts audits, approves or rejects applications and pays invoices. USAC, in downtown Washington, employs “numerous” former telecom executives, according to Eric Iversen, USAC’s spokesman.
The back-office work for USAC is actually performed by another company, Solix, based in New Jersey. Solix is owned by fewer than 200 investors, some of which are small telecom companies, and Solix employees also include ex-telecom industry executives, according to public records and John Parry, the chief executive officer of Solix.
Both USAC and Solix say they hold their employees to stringent codes of conduct to eliminate potential conflicts of interest, and they have added protections in response to criticism.
Still, in an interview a former FCC official who spoke on condition of anonymity called the arrangement “a regulatory Wild West.”
USAC provides training to phone companies on how to comply with E-Rate rules, and its training materials from 2001 through 2011 are available on its website. Not once is lowest corresponding price mentioned in those materials. Indeed, in 2010, the telecom industry publicly complained to the FCC that USAC has not “provided any guidance” on the rule.
But while largely ignoring the rule requiring companies to provide the bargain rate, USAC requires schools, no matter how impoverished or small, to find a “cost-effective” price through competitive bidding and other means.
In 2004, USAC hired an outside accounting firm to audit 100 schools and libraries — not phone companies — in the E-Rate program. One section of the lengthy audit protocol calls for checking with phone companies to see if they were complying with the mandate to charge the lowest corresponding price, according to documents provided by the FCC. The auditors found no violations.
After that, USAC said in a statement to ProPublica, it “updated our audit program to perform separate audits of beneficiaries and service providers,” which allowed for more “focus” on the telecom industry. Still, the more recent audits found no violations of the lowest-corresponding-price rule, according to the USAC statement.
What USAC and the FCC have done is penalize schools that uncover overcharging.
The New York City Department of Education (NYCDOE) hired auditors to review mountains of tedious phone bills. The auditors, who work on a contingency basis and are commonly used by businesses and government, won refunds for several millions of dollars in overcharges dating back almost a decade.
But when city officials went to return part of those refunds to the E-Rate program, they were effectively punished for doing so.
FCC spokesman Wigfield said he could not comment because the matter is pending. Others familiar with the New York City matter say there have been discussions between the parties, but no resolution.
The education department’s quandary was explained in an Oct. 17, 2003, letter to the FCC. Three outside billing firms, the letter explained, had documented about $2 million in “overcharges” by Verizon and its predecessors. Verizon provided a refund.
The city then figured out how much of the refund to share with the federal fund. E-Rate subsidized the New York City schools at a rate of 78 percent. So first, New York deducted the audit fees, about 25 percent, then multiplied the remainder by 78 percent. That’s the amount it wanted to return to the E-Rate program.
But in August 2003, USAC informed the New York education department that it owed the fund’s share (78 percent) of the audit fee as well, according to New York’s filing with the FCC. In effect, USAC was refusing to pay its share of an audit that saved money for both New York and the E-Rate program.
This “exceedingly poor public policy,” the city told the FCC, “would penalize NYCDOE for its initiative,” and “discourage” similar audits.
At that time, USAC was auditing only schools in the E-Rate program, not phone companies.
The FCC says audits are not considered educational services under E-Rate rules and thus are not eligible for reimbursement.
Verizon, in a statement emailed by spokesman McFadden, declined to comment on any particular dispute, but McFadden said “occasional disagreements are unavoidable” and that the company’s “goal” is to issue refunds “promptly and in the correct amount.”
The last outside audit of New York City’s telephone bills was in 2009. Both Verizon and New York City would not discuss the results, which are still being resolved. Two people familiar with the results of the latest NYCDOE audit, who declined to be identified because of the ongoing negotiations, said the amount of overcharges detected exceeded $10 million.
New York is not alone. The Yonkers school district and the Detroit Public Schools, records show, have encountered the same disincentive.
Detroit hired a private firm to audit the school district’s telecom services, provided by AT&T. That 2010 audit recommended a recovery of almost $3 million for a variety of erroneous charges. Among its findings: “under the E-Rate program AT&T failed to offer [the Detroit Public Schools] the most favored rate,” according to a summary of the audit.
But Detroit is still reviewing the audit, according to spokesman Steven Wasko, who noted in an email the FCC’s disincentives for audits. “Savings identified can actually amount to additional costs for the district,” he wrote.
Detroit has chosen to “strengthen its own reviews” rather than rely on outside auditors, Wasco added.
AT&T declined to comment on the Detroit audit.
Schools have other complaints about the E-Rate program. Many say their requests to enroll get mired in a regulatory “black hole,” while others protest applications exceeding 300 pages. And there are hundreds of cases of rule infractions, some technical, that force schools to return money to the program, according to FCC documents.
The FCC spokesman says the agency has “streamlined” the application process.