[108th Congress House Hearings] [From the U.S. Government Printing Office via GPO Access] [DOCID: f:95461.wais] PROBLEMS WITH THE E-RATE PROGRAM: WASTE, FRAUD, AND ABUSE CONCERNS IN THE WIRING OF OUR NATION'S SCHOOLS TO THE INTERNET Part 2 ======================================================================= HEARING before the SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS of the COMMITTEE ON ENERGY AND COMMERCE HOUSE OF REPRESENTATIVES ONE HUNDRED EIGHTH CONGRESS SECOND SESSION __________ JULY 22, 2004 __________ Serial No. 108-103 __________ Printed for the use of the Committee on Energy and Commerce Available via the World Wide Web: http://www.access.gpo.gov/congress/ house _______ U.S. GOVERNMENT PRINTING OFFICE 94-835 WASHINGTON : 2004 _________________________________________________________________ For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866)512-1800; DC area (202) 512-1800 Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001 COMMITTEE ON ENERGY AND COMMERCE JOE BARTON, Texas, Chairman W.J. ``BILLY'' TAUZIN, Louisiana JOHN D. DINGELL, Michigan RALPH M. HALL, Texas Ranking Member MICHAEL BILIRAKIS, Florida HENRY A. WAXMAN, California FRED UPTON, Michigan EDWARD J. MARKEY, Massachusetts CLIFF STEARNS, Florida RICK BOUCHER, Virginia PAUL E. GILLMOR, Ohio EDOLPHUS TOWNS, New York JAMES C. GREENWOOD, Pennsylvania FRANK PALLONE, Jr., New Jersey CHRISTOPHER COX, California SHERROD BROWN, Ohio NATHAN DEAL, Georgia BART GORDON, Tennessee RICHARD BURR, North Carolina PETER DEUTSCH, Florida ED WHITFIELD, Kentucky BOBBY L. RUSH, Illinois CHARLIE NORWOOD, Georgia ANNA G. ESHOO, California BARBARA CUBIN, Wyoming BART STUPAK, Michigan JOHN SHIMKUS, Illinois ELIOT L. ENGEL, New York HEATHER WILSON, New Mexico ALBERT R. WYNN, Maryland JOHN B. SHADEGG, Arizona GENE GREEN, Texas CHARLES W. ``CHIP'' PICKERING, KAREN McCARTHY, Missouri Mississippi, Vice Chairman TED STRICKLAND, Ohio VITO FOSSELLA, New York DIANA DeGETTE, Colorado STEVE BUYER, Indiana LOIS CAPPS, California GEORGE RADANOVICH, California MICHAEL F. DOYLE, Pennsylvania CHARLES F. BASS, New Hampshire CHRISTOPHER JOHN, Louisiana JOSEPH R. PITTS, Pennsylvania TOM ALLEN, Maine MARY BONO, California JIM DAVIS, Florida GREG WALDEN, Oregon JANICE D. SCHAKOWSKY, Illinois LEE TERRY, Nebraska HILDA L. SOLIS, California MIKE FERGUSON, New Jersey CHARLES A. GONZALEZ, Texas MIKE ROGERS, Michigan DARRELL E. ISSA, California C.L. ``BUTCH'' OTTER, Idaho JOHN SULLIVAN, Oklahoma Bud Albright, Staff Director James D. Barnette, General Counsel Reid P.F. Stuntz, Minority Staff Director and Chief Counsel ______ Subcommittee on Oversight and Investigations JAMES C. GREENWOOD, Pennsylvania, Chairman MICHAEL BILIRAKIS, Florida PETER DEUTSCH, Florida CLIFF STEARNS, Florida Ranking Member RICHARD BURR, North Carolina DIANA DeGETTE, Colorado CHARLES F. BASS, New Hampshire TOM ALLEN, Maine GREG WALDEN, Oregon JANICE D. SCHAKOWSKY, Illinois Vice Chairman HENRY A. WAXMAN, California MIKE FERGUSON, New Jersey EDWARD J. MARKEY, Massachusetts MIKE ROGERS, Michigan JOHN D. DINGELL, Michigan, JOE BARTON, Texas, (Ex Officio) (Ex Officio) (ii) C O N T E N T S __________ Page Testimony of: Ackerman, Arlene, Superintendent, San Francisco Unified School District............................................ 9 Burger, Thomas J., President and CEO, NEC Unified Solutions; Inc; accompanied by William Holman, former Vice President of Sales for NEC BNS; George Marchelos, former consultant to and employee of Video Network Communications; Judy Green, former consultant to and employee of Video Network Communications, Inc........................................ 55 Cothran, George M., Investigator, San Francisco City Attorney Office..................................................... 17 Donovan, Timothy M., former Senior Vice President and General Counsel, NEC USA, Inc...................................... 57 Herrera, Dennis J., San Francisco City Attorney.............. 14 Maher, William F., Jr., Chief, Wireline Competition Bureau, Federal Communications Commission.......................... 78 McDonald, George, Vice President, Schools and Libraries Division, Universal Service Administrative Company......... 83 Renne, Louise H., General Counsel, San Francisco Unified School District............................................ 12 (iii) PROBLEMS WITH THE E-RATE PROGRAM: WASTE, FRAUD, AND ABUSE CONCERNS IN THE WIRING OF OUR NATION'S SCHOOLS TO THE INTERNET ---------- THURSDAY, JULY 22, 2004 House of Representatives, Committee on Energy and Commerce, Subcommittee on Oversight and Investigations, Washington, DC. The subcommittee met, pursuant to notice, at 10 a.m., in room 2123, Rayburn House Office Building, Greg Walden (vice chairman), presiding. Members present: Representatives Walden, Bass, Barton (ex officio), DeGette, and Schakowsky. Staff present: Mark Paoletta, majority counsel; Peter Spencer, majority professional staff; Tom Feddo, majority counsel; Jaylyn Jensen, legislative analyst; Michael Abraham, legislative clerk; David Nelson, minority investigator and economist; and Jessica McNiece, minority clerk. Mr. Walden. Good morning. The subcommittee will come to order. Last month we opened our hearing on E-Rate with a close look at the Puerto Rico Department of Education's experience with the program. That case, in which a large and needful district and its vendors literally wasted more than $100 million of E-Rate funds, shed light on a range of problem areas in the program set-up. The problems extended from the front to the back of the E- Rate funding process. The Puerto Rico case illustrated weaknesses in the competitive bidding process and the requirements that applicants certify they actually have the resources necessary to make effective educational use of E-Rate funds. In Puerto Rico, tens of millions of dollars were being billed, while few, if any, children actually got connected to the Internet. We saw problems in implementing the goods and services purchased with E-Rate funds, as the $20 million--$20 million--of dusty, shrink wrapped gear in a warehouse highlighted, and we saw weaknesses in oversight and in the audit process. This morning we will focus directly on the front end of the E-Rate process, the application and processing of applications in the E-Rate program. This is the part of the program where many problems begin and where many problems can be caught, if done right. This is where the planning and competitive bidding, the keystone to the program, take place and where E-Rate's administrators can catch applicants that run afoul of program requirements. Failure here at the front end assures wasteful spending and opens the way for fraud and for abuse. Today we will take a hard look at some of the very troubling actions on the part of vendors and consultants and how these actions were stopped, at least in one large school district. We will look at the facts and circumstances surrounding the application for E-Rate funds by the San Francisco Unified School District in the 2000 E-Rate funding year. San Francisco's experience is a story in which bad actors put the E-Rate application process to the test. We will learn that the program did not pass that test. As we will hear today, the E-Rate administrator, USAC, approved more than $58 million in funding, including the District's share, based on fraudulent applications. Each procedural safeguard then set up by USAC failed: Competitive bidding, application certification, application review, and selective review. Fortunately, a final check, a newly arrived superintendent whom we will hear from this morning had suspicions that led to uncovering program fraud and abuse not only in San Francisco but also around this country. Today's hearing focuses primarily on the San Francisco Unified School District's experience. We are continuing to examine the broader details of the conspiracy in other States. Questionable activity by the vendors and individuals who exploited the process in San Francisco has been identified in Arkansas, in Michigan, and in South Carolina, for example. One district, with the help of these bad actors, allegedly built a $750,000 television studio with E-Rate funds, something, be assured, that clearly should not have happened, and we will address these details in due course. Today's hearing, nevertheless, will shed light on the integrity of the E-Rate application process. Equally important, today's hearing will also let us focus a bright light on the very troubling behavior surrounding the bid rigging conspiracy and fraud underlying this particular school district's experience. We have before us today some of the key players in the San Francisco story. So this light should serve not only to illuminate where there are problems in program structure, but also to display clearly the kind of actions that cannot be allowed to occur in the program or to escape public scrutiny. The actions we will examine were made public when NEC Business Network Solutions, now doing business as NEC Unified Solutions, pleaded guilty this past May to wire fraud and to a conspiracy to suppress and eliminate competition for E-Rate program projects. NEC BNS also confirmed, among other facts, that as part of the conspiracy it assisted in submitting inflated prices to USAC, $26 million more than vendors had bid on the San Francisco project. NEC BNS admitted that it had informed USAC that it planed to ``donate'' ineligible equipment, but in fact intended to buy that equipment with $10 million in excess E-Rate receipts, and this was just in San Francisco. As part of the plea deal, NEC BNS agreed to pay $20.7 million in fines and restitution. At this point, I would note that three of the witnesses before us this morning are not appearing voluntarily, in large part, they maintain, due to ongoing criminal and civil cases into the matters we will be examining. We issued subpoenas last week to command their presence and their testimony. Among them today are the President and CEO of NEC BNS, Mr. Thomas Burger, as well as its former Price President of Sales, Mr. William Holman. I look forward to learning from Mr. Burger what he can say about his company's behavior, especially as he was the main man in charge at the time of this activity to which this company has pleaded guilty, and Mr. Holman, according to numerous documents, should have information that will help us understand how this situation developed. We also have an individual, Mr. George Marchelos who, San Francisco investigators suggest, has direct knowledge of what happened in that school district and elsewhere, and I hope he will help us understand this story. We also subpoenaed a Ms. Judy Green, another E-Rate consultant who, according to the U.S. Marshal's Service, has effectively avoided service for the past week. Given that the committee continues to investigate this conspiracy, let me just note that we will provide her another opportunity to testify. We will make sure this committee's subpoenas are served. She will eventually come before this committee and testify. The story of San Francisco is a story of corrupt school employees, E-Rate consultants controlling the process, and vendors conspiring to completely undercut competition. We will ask some probing questions of these people, but I also expect we will ask tough questions of other players. We have hard questions to ask of USAC, which set up the procedures for policing E-Rate applications for problems and, in the case of San Francisco, inexplicably neglected several red flags. Of course, we have the FCC, the agency in charge of the whole program. They have to answer to this story, too, and explain where they are leading this program now after cases like this. Let me conclude by extending a welcome to our witnesses, particularly those from San Francisco City Attorney's Office and from the San Francisco Unified School District. Superintendent Ackerman, who joins us via videoconference, has been most accommodating to assist us today, and we especially appreciate your willingness and your help. With that, let me recognize the ranking member for her opening statement. Good morning. Ms. DeGette. Thank you very much, Mr. Chairman, and I am pleased to call you Mr. Chairman and welcome you to the chairman's seat, Mr. Walden. Mr. Walden. I am delighted to be in the seat, but I remain as vice chairman of the committee. Ms. DeGette. Right. I think you will be there for the foreseeable future. I am really pleased to be back here for the second in what I hope will be a continuing series of hearings on the E-Rate program. I came out of the last hearing with an understanding that some of the problems we have seen with this important program can be resolved, but only if oversight is dramatically stepped up, and if there is a serious crack-down on some of the worst offenders and fraudulent practices. I want to take a minute again to emphasize why this issue is so important. Not only have millions of dollars been wasted over the years, but millions of dollars have not been wasted. Millions of dollars have gone to exactly what the program was intended to do, and if steps aren't taken to stop the fraud that has occurred, I am afraid we run the risk of ending an innovative program that has done amazing things for students across the country. I believe that Congress has the very serious responsibility of ensuring that the program runs the way it was intended to, and that the kids that it is intended to serve do not become the ultimate victims. I hope today will prove as informative as the last hearing, although I am disheartened that so many of our witnesses are not here of their own free will to help shed some light on the issue at hand, and have chosen not to submit testimony. On the other hand, I believe the first panel will demonstrate how important oversight at all levels is and how school districts themselves are very important players when it comes to ensuring that E-Rate funds are properly utilized. I am extremely impressed with the actions of the San Francisco Unified School District for sounding the alarm when they got the word that things were not as they should be. I think it took great courage and a strong commitment to ethical standards, something, as we are sadly learning throughout these hearings, that has been in too short supply. Frankly, it must have been pretty hard to turn down nearly $50 million that had already been approved for use, and I greatly admire that decision. There are a number of questions that come to mind when considering the case of what happened with E-Rate funds and the San Francisco Unified School District. First, how on earth did the funds get approved, to begin with, particularly since it seems like the Universal Service Administrative Company took extra steps to examine the applications that were later found to be fraudulent? Second, should it really be the responsibility of the recipient school districts or libraries to make sure that applications aren't wrongly approved? Shouldn't that be the responsibility of those who run the program and approve the applications? It seems that, certainly in this case, things were backwards, and it concerns me there are other cases out there that we are currently unaware of where funds have been wrongly approved, and recipients have not been diligent about reporting it. This could be due to ignorance or lax ethics, but either way it would be a huge problem, and I, for one, would like to see some evidence that San Francisco and their experience is not being replicated nationwide. At the last hearing, I laid out what I thought were two of the most serious problems that need to be addressed in order to ensure that the E-Rate is actually accomplishing its mission. First of all, the bad apple vendors and consultants who take advantage of school districts and then essentially take the money and run--we saw that last week--and also the apparent lack of oversight that has allowed for large amounts of money to go to schools that have no ability to proceed with actually utilizing the funds and the equipment they receive. Today, I am looking forward to further exploration of these issues, and I am pleased that we have a representative from USAC, Mr. George Mcdonald, to talk about the concerns. I am also interested in hearing from Mr. McDonald about the current status of the Puerto Rico case that we talked about in the last hearing. I want to know what is being done to help them fix the past mistakes so that these students can have the kind of computer programs that they should be having. Finally, there are a number of other issues we need to address in this hearing: How can we improve the E-Rate's competitive bidding process? Exactly what should the responsibilities of school administrators be, and what steps are the USAC taking to make sure that they never again make the mistake of approving fraudulent applications for millions of dollars? Mr. Chairman, I look forward to hearing the testimony, and I ask unanimous consent that Mr. Dingell and all other members' opening statements be placed in the record. Mr. Walden. Without objection, so ordered. [The prepared statement of Hon. John D. Dingell follows:] Prepared Statement of Hon. John D. Dingell, a Representative in Congress from the State of Michigan Mr. Chairman, thank you for continuing this investigation and holding this hearing. Today, this Subcommittee holds the first of its vendor-specific hearings, examining some of the fraudulent activity that a subsidiary of NEC America, Inc. (NEC) and its co- conspirators engaged in. While this hearing will specifically focus on NEC's unsuccessful attempt to defraud the E-rate program in San Francisco, NEC did succeed in procuring millions of dollars from illegal E-rate program claims that involved school districts from Michigan to Mississippi. We will hear from the local public servants who prevented the San Francisco fraud from going forward and who subsequently uncovered its nationwide scope. This case study is particularly revealing in that NEC and its vendors were actively involved in most of the criminal schemes that flourished, in part due to the lax oversight of the E-rate program by the Federal Communications Commission (FCC). These scams include bid rigging, hiding of ineligible equipment, and goldplating (specifying equipment acquisition that exceeded the school districts' needs). Scams also included the fraudulent inflation of prices, illegal kickbacks, illegal ``in-kind'' donations, the corruption of local officials, as well as directly or indirectly causing the filing of a plethora of false statements to the Universal Service Administrative Corporation (USAC), the non- profit corporation which disburses E-rate program funds. Fortunately, a newly hired Superintendent of the San Francisco Unified School District caught the fraudulent application for almost $50 million in E-rate funds and stopped the process before the money could be spent, stolen, or wasted. The City Attorney initiated an investigation that ultimately resulted in prosecution by the Department of Justice and a guilty plea by NEC. The federal investigation continues into the roles of various individuals in this sorry saga. Amazingly, NEC has petitioned the FCC to allow it to continue participating in the E-rate program, based upon its exceptional ``cooperation'' with the federal investigations. But NEC's cooperation did not begin until after they were caught. The guilty plea probably saved the Government a trial but little else. No important executive has lost his or her job, and employees directly implicated in the wrongdoing remain on the NEC payroll. I understand that today the senior executives who oversaw these schemes may invoke their right to avoid incriminating themselves and refuse to testify. This strikes me as very curious cooperation. The FCC should not be fooled into thinking that this company and its employees are now worthy of the taxpayers' trust. I support the work of this Subcommittee to expose all the major problems in the E-rate program, and I look forward to working with my colleagues to address them. Mr. Walden. We are now honored to have with us the chairman of the full committee, Mr. Barton. Chairman Barton. Thank you, Mr. Chairman, and before I give my prepared statement on this hearing, I just want to announce that we have a new addition to the committee room. We have our nameplates that have our States on it. I had always wanted to let people know what State I am from, and Mr. Bass was very happy when he walked in and noticed that it said he was from New Hampshire. Mr. Bass. If the gentleman would yield, I just want to make sure that--Texas is a long way from here. Chairman Barton. So I hope people enjoy the diversity of the committee, as will be seen as everybody shows up with different locations that we are from. Mr. Chairman, I appreciate the work that you have shown as vice chairman of this committee in working on this important issue. I want to give special commendation to the gentle lady from San Francisco, Dr. Arlene Ackerman who is joining us by video conference, for her strong moral stand in turning this issue in to be investigated. Not too many superintendents, I think, would have turned $40 million or $50 million down, and she had the moral courage to make sure that it was on the up and up. Unfortunately, it turned out that it wasn't. So I want to thank her long distance for her strong stand. It is the intent of this committee's investigation to ensure that E-Rate will operate without the waste and abuse that we have been discovering. Almost every rock that we turn over, it seems there is a problem under that particular rock. The E-Rate program deserves vigorous Congressional oversight. I support this oversight, and I look forward to continuing to work with this subcommittee as the full committee chairman to get to the bottom and then, if necessary, provide a legislative reform package in the next Congress to prevent these kinds of abuses from continuing to occur. These hearings are in large measure about accountability, accountability among the applicants and recipients of funding, that they are following the rules, and accountability among those running the program, that they have set it up to operate effectively without all the waste and abuse that we are continuously uncovering. This program is designed to provide recipients and applicants access to other people's money. When you spend somebody else's money, you don't have the same incentive to spend as carefully as you would if you were spending your own money. When tens of millions of dollars are at issue, there is a powerful incentive to spend wastefully and abuse the program. To address this powerful incentive, the solution is to ensure accountability of program participants and managers so that they spend wisely and manage effectively. This hearing is about the process put in place to ensure people act responsibly or with the appropriate authority and understand the consequence of acting irresponsibly. Today we are going to look at a fraudulent $50 million application at the San Francisco School District that sailed through the normal process and was approved. The money was eventually rejected, because one person, one person who is going to testify later this morning, Dr. Arlene Ackerman, had the gumption to look at this and say that it didn't look like it was on the up and up. Again, as I have already said, I want to commend her for her acting responsibly in accountability. I look forward to hearing her testimony in greater detail this morning. We also have before us this morning people on the other side, the company, NEC Unified Solutions, who will answer questions and actions about their employees. This company recently pleaded guilty to E-Rate bid rigging in San Francisco and other districts, and has paid a $20 million fine. I would like to hear how their CEO answers for the actions of his employees. We have an E-Rate consultant who was on the ground at the school districts who can answer to the development of what turned out to be fraudulent but successful applications for E- Rate funding and, as you have already pointed out, Mr. Chairman, last week we issued subpoenas for four witnesses. Three of them are before us today. One of them, Ms. Judy Green, has successfully ducked service so far. I take very seriously our oversight function in the House, and I will not allow people who have information necessary to accomplish our work to avoid our legitimate inquiries. I have spoken with the ranking member of the full committee, the Honorable John Dingell of Michigan, and when we go into recess today or tomorrow, under the rules of the House of Representatives, as full committee chairman I have the right to issue a recess subpoena, and I will do so. If Ms. Green's representatives are in this audience or watching on television or have access to the record, let them know that there will be another subpoena issued, and at sometime this fall she will come before this committee. The Energy and Commerce Committee, to my knowledge, in the 20 years that I have been in the House, 18 on this committee, has never had a subpoena that was not successfully served, and we don't intend to change that record on this hearing. So again, in consultation with the ranking member of the full committee, Mr. Dingell, he is very supportive of my authority as full committee chairman issuing a recess subpoena to get Ms. Green to appear at the appropriate time before the committee, and we will do that. Finally, we have the Administrator of the program, the E- Rate program. We have the person who runs the Bureau at the FCC that is in charge of the E-Rate program. They are responsible for clear and effective rules and procedures, and we look forward to hearing from them what they have to say about the larger program, the larger issues before us. Mr. Chairman, this is a very, very important hearing. I appreciate you holding it. I appreciate the fine bipartisan work that we have done at the staff level in preparing for it, and I look forward to a very instructive hearing. With that, I yield back the balance of my time. Mr. Walden. Thank you, Mr. Chairman, and thanks for your leadership on this committee. The Chair recognizes the gentleman from New Hampshire, who I understand does not have an opening statement. Is that correct? Mr. Bass. I will pass. Mr. Walden. The gentleman passes. The Chair now recognizes a member of the full committee, Ms. Schakowsky from Chicago, for an opening statement--from the subcommittee. I'm sorry. Ms. Schakowsky. Thank you, Mr. Chairman, for holding this hearing today. I am glad to have the opportunity to hear about how the current system's weaknesses allow vendors to use the E- Rate program for their own benefit. Once we understand those weaknesses, we can improve the system to make sure it is benefiting our children. NEC Business Network Solutions, Inc. entered into bid rigging schemes in five different school districts in Michigan, Wisconsin, Arkansas, and South Carolina. The company has also admitted into entering into a scheme to defraud the E-Rate program in the San Francisco Unified School District by inflating bids, agreeing to submit false and fraudulent documents to hide the fact that it planned on installing prohibited items, agreeing to donate so called free items for which it had planned to bill E-Rate, and submitting false and fraudulent documents to prevent inquiry into the legitimacy of the funding requests. I want to thank those dedicated public servants who are here today who discovered and helped to uncover these kinds of fraudulent activities. We really appreciate that kind of public service. NEC generously marked up prices on computer hardware, sometimes as much as 400 percent. On one small Internet switch, for example, NEC's bid would have given the firm a profit margin of $780,000. As shocking as the actions of NEC BNS are, I am sorry to say that the company is just one of a cast of bad characters profiting at the expense of our Nation's children. A price tag cannot be placed on the value of providing Internet access to the millions of children and teachers in our public schools. Even in its imperfect condition, the E-Rate program has helped millions of children gain the kind of technical knowledge that is crucial in today's society. Schools in my district and across the Nation have used E- Rate funds to provide access to the Internet for kids who might otherwise never have it. Access to the worldwide web can make a world of difference in our schools. The E-Rate program has helped us close the information divide, but the disparity in access to computers and online services by race and income still persists. We cannot afford to abandon the E-Rate program or to have any of our children left behind on the information superhighway. It is now our job to reform the E-Rate program to make sure that the benefits of the program go to those who need them most, our children. Again, Mr. Chairman, thank you for holding this hearing. I look forward to hearing the testimony of our witnesses, and I look forward to working to improve the E-Rate program. Mr. Walden. Thank you for your testimony, and we appreciate your work on this issue. Now I would like to welcome Panel 1: Dr. Arlene Ackerman, the Superintendent of the San Francisco Unified School District; Ms. Louise H. Renne, the General Counsel of the San Francisco Unified School District; Mr. Dennis J. Herrera, City Attorney of San Francisco; and Mr. George Cothran, the investigator for the Office of the City Attorney. We appreciate your being here. As you are aware, the committee is holding an investigative hearing and, when doing so, has had the practice of taking testimony under oath. Do you have any objection to testifying under oath? Let the record show the witnesses indicate they have no objection. The Chair then advises you that, under the rules of the House and the rules of the committee, you are also entitled to be advised by counsel. Do you desire to be advised by counsel during your testimony today? The record shows they all indicate no. In that case, if you would rise and raise your right hand, I will then swear you in. [Witnesses sworn.] Mr. Walden. Thank you. They indicate they do. You are now under oath, and I will call on you to give your 5-minute summary of your written statement, and we will start with Dr. Ackerman. Before I do that, I am going to go ahead and ask unanimous consent to enter into the record the binders that are before us, which we will reference as we do our questioning. Without objection, they are now entered into the record. Dr. Ackerman, please go ahead. TESTIMONY OF ARLENE ACKERMAN, SUPERINTENDENT, SAN FRANCISCO UNIFIED SCHOOL DISTRICT; LOUISE H. RENNE, GENERAL COUNSEL, SAN FRANCISCO UNIFIED SCHOOL DISTRICT; DENNIS J. HERRERA, SAN FRANCISCO CITY ATTORNEY; AND GEORGE M. COTHRAN, INVESTIGATOR, SAN FRANCISCO CITY ATTORNEY OFFICE Ms. Ackerman. Thank you. Good morning, Vice Chairman Walden and members of the subcommittee. Thank you for the opportunity to appear before you on the matter of the Federal E-Rate program and the extremely interesting and revealing experiences that we have had in San Francisco schools as participants in the program. I began my current role as Superintendent of San Francisco Unified School District which serves approximately 59,000 students in the city and county of San Francisco in July of 2000. Needless to say, as I went about my work in these first several months, I had a considerable amount to learn about the detailed context and conditions of San Francisco schools. In addition to dealing with the core work of a school superintendent, such as evaluating school performance, organizing and reorganizing the district office and collective bargaining, I was also hired with a mandate to improve the district's business practices. Although I had worked on difficult fiscal and operational issues in other school districts, I soon learned of activities that, for me, represented a new low in my 30-plus years of public education. I saw the beginning of a trail of evidence that was ultimately found to lead to a number of individuals and organizations who plotted carefully to enrich themselves by depriving our children. In the fall of 2000, two former staff members provided me a copy of an E-Rate application that had been submitted for $50 million. As I reviewed the document, several elements of the application troubled me. First, it indicated that the district had set aside the approximately $8 million that was necessary to contribute as a matching requirement. I knew that this was not the case. One of my first priorities had been to become intimately familiar with our financial condition, and nothing I had studied or heard of indicated that any district funds had been set aside for this purpose. Second, the description of the equipment and infrastructure that was to be funded with the grant proceeds seemed incoherent and did not reflect a strategy to align technology with instructional objectives. I saw woefully little evidence of sufficient planning, especially for an investment of this size. Finally and perhaps most obvious, the document materially misstated facts in describing our district. Among other things, the grant indicated that the district covered 400 square miles, in contrast to the actual figure of 49 square miles. It also claimed that there is no mass transit system in San Francisco, when we actually have one of the Nation's largest public transportation systems. In many respects, the grant seemed to be describing another district altogether. As superintendent, I typically require that documents that bind the district to any funding or other commitments undergo legal review. In this case, my elevated concerns about this grant led me to contact then City Attorney Louise Renne for assistance in reviewing the document. As Ms. Renne and then current City Attorney Dennis Herrera and Investigator George Cothran will describe in detail, so began an investigation that ultimately led to the extremely disturbing conclusions that necessitate this morning's hearing. However, despite the disturbing and cautionary aspects of our experience with E-Rate, I very much hope that members of this subcommittee and the public will interpret my comments as supporting reform of the program, not its elimination. I fully agree with the goals of the program, to increase all students' access to technology, paying particular attention to the digital divide that would otherwise place the Internet out of the reach of many children of low income families. While our experience in San Francisco and those of several other school districts have revealed serious problems with the E-Rate program, I would respectfully ask policymakers to consider that the program has brought technology to unprecedented numbers of public school students. Nearly all classrooms and school libraries are now connected to the Internet, and most as a direct result of the E-Rate program. The program certainly needs to be reformed, and to that end I am gratified that San Francisco schools and the extremely capable attorneys and investigators who have assisted us have helped accelerate discussions about how to increase scrutiny of E-Rate applications and otherwise reduce the possibility of waste, fraud and abuse in this important program. At this point, I would like to introduce San Francisco's former City Attorney and our school district's former General Counsel, Louise Renne. Thank you. [The prepared testimony of Arlene Ackerman follows:] Prepared Statement of Arlene Ackerman, Superintendent, San Francisco Unified School District Good morning Chairman Greenwood, Ranking member Deutsch, and members of the subcommittee. Thank you for the opportunity to appear before you on the matter of the federal E-rate program and the extremely interesting and revealing experiences that we have had in San Francisco's schools as participants in the program. I began my current role as Superintendent of San Francisco Unified School District, which serves the 59,000 public school students in the City and County of San Francisco, in July 2000. Needless to say, as I went about my work in these first several months I had a considerable amount to learn about the detailed context and conditions of San Francisco's schools. In addition to dealing with the core work of a school superintendent, such as evaluating school performance, organizing the district office, and collective bargaining, I was also hired with a mandate to improve the District's business practices. Although I had worked on difficult fiscal and operational issues in other school districts, I soon learned of activities that for me represented a new low in my thirty-plus years of public education. I saw the beginning of a trail of evidence that was ultimately found to lead to a number of individuals and organizations who plotted carefully to enrich themselves by depriving children. In the fall of 2000, two former staff members provided me a copy of an E-Rate application that had been submitted for $50 million. As I reviewed the document, several elements of the application troubled me. First, it indicated that the District had set aside the approximately $8 million that was necessary to contribute as a matching requirement. I knew that this was not the case. One of my first priorities had been to become intimately familiar with our financial condition, and nothing I had studied or heard indicated that any District funds had been set aside for this purpose. Second, the description of the equipment and infrastructure that was to be funded with the grant proceeds seemed incoherent and did not reflect a strategy to align technology with instructional objectives. I saw woefully little evidence of sufficient planning, especially for an investment of this size. Finally, and perhaps most obvious, the document materially misstated facts in describing the District. Among other things, the grant indicated that the District covered 400 square miles, in contrast to the actual figure of forty-nine (49) square miles. It also claimed that there is no mass transit system in San Francisco when we actually have one of the nation's largest public transportation systems. In many respects, the grant seemed to be describing another district altogether. As Superintendent, I typically require that documents that bind the District to any funding or other commitments undergo legal review. In this case, my elevated concerns about this grant led me to contact then City Attorney Louise Renne for assistance in reviewing the document. As Ms. Renne, current City Attorney Dennis Herrera, and investigator George Cothran will describe in detail, so began an investigation that ultimately led to the extremely disturbing conclusions that necessitate this morning's hearing. However, despite the disturbing and cautionary aspects of our experience with E-Rate, I very much hope the members of the Subcommittee and the public will interpret my comments as supporting reform of the program, not its elimination. I fully agree with the goals of the program--to increase all students' access to technology, paying particular attention to the digital divide that would otherwise place the internet out of the reach of many children of low income families. While our experience and those of several other school districts have revealed serious problems with the E-Rate program, I would respectfully ask policymakers to consider that the program has brought technology to unprecedented numbers of public school students. Nearly all classrooms and school libraries are now connected to the internet, most as a direct result of the E-Rate program. The program certainly needs to be reformed. To that end, I am gratified that San Francisco schools and the extremely capable attorneys and investigators who have assisted us have helped accelerate discussion about how to increase scrutiny of E-Rate applications and otherwise reduce the possibility of waste, fraud, and abuse in this important program. At this point I would like to introduce San Francisco's former City Attorney and our school district's former General Counsel Louise Renne. Mr. Walden. Thank you for your testimony. The committee now would like to hear from Ms. Renne. Thank you for being here. We appreciate your work and your comments. TESTIMONY OF LOUISE H. RENNE Ms. Renne. Thank you. Good morning, Mr. Chairman and members. As Dr. Ackerman has indicated, the nationwide scheme to defraud the E-Rate program came to our attention shortly after she became the superintendent of San Francisco schools and at the time I was the City Attorney. I still very well remember the day when I got a phone call from Dr. Ackerman saying I think we have some funny business going on over here, and at her request an investigation was started. A group of attorneys was assembled, including an investigator, George Cothran, and as our investigation progressed, the national scope of the E-Rate problem soon became quite clear. During the process we called in the FBI and our local United States Attorney, Kevin Ryan, as well, and as City Attorney, Dennis Herrera, will describe in more detail, too, we during the course of the investigation prepared a whistleblower lawsuit which was unprecedented for a school district, was filed in Federal court by my successor, Dennis Herrera, and that suit resulted in the guilty plea that has already been described. During the course of the process, we learned that the matter, not just in San Francisco, but that there was the same or similar fraud going on across the country, and that it was part of a well orchestrated effort, it would seem. In San Francisco, investigator George Cothran will describe in quite a bit of detail how this process started with the filing basically of a bogus application, how Inter-Tel Technology started the ball rolling, if you will, by approaching some of our district people, and then involved, as you have already indicated as well, Judy Green, George Marchelos in the process. The proposal, the E-Rate proposal, was drafted in such a way that it would be prejudiced toward goods and services sold by VNCI, which was associated with Judy Green and group. They bundled VNCI equipment inside a bid. The bids were not advertised, as required by law. So again, as will be described in far more detail by Mr. Cothran, the companies ensured, as a result of the whole bid rigging process and their conspiracy, that they would be the primary recipients of the E-Rate funding. So what has happened is, in short, the companies involved really soaked the whole E-Rate process, in San Francisco's case, of approximately $50 million, who knows how much more in other jurisdictions. We think, and we know, that for the first time San Francisco's lawsuit was the first time, to our knowledge, that a school district has ever file a whistleblower claim, and it is our hope that, as the results of the investigation are detailed for this committee by Dennis Herrera and George Cothran, that these actions and some of the corresponding enforcement actions which are undoubtedly going on around the country will put government agencies and businesses alike on their guard against the kinds of practices that will be described this morning, and will help root out the problems that beset the E-Rate program. We think at the district that the goals of the program are important for the future. Our children cannot compete in the modern world without knowledge of computers and technology and, surely for those companies that have put this program at risk, we hope that the committee hearings will get to the bottom and root out this fraud. My successor in office is my good friend, Dennis Herrera. [The prepared testimony of Louise H. Renne follows:] Prepared Statement of Louise H. Renne, Special Counsel, San Francisco Unified School District Mr. Chairman and Members: The nationwide scheme to defraud the E- Rate program came to our attention in San Francisco soon after Arlene Ackerman, the former chief of the Washington, D.C. schools, took over as superintendent of the San Francisco Unified School District. At the time I was the San Francisco City Attorney. Ms. Ackerman had grown suspicious of a number of situations at the school district. I still remember very well the day when she called me and said, ``I think there's some funny business going on over here.'' I ordered an investigation, assembling a team of attorneys and investigators, including George Cothran, who will also testify today. As our investigation progressed, the national scope of the E-Rate problem soon became clear. In the process, we alerted the FBI and U.S. Attorney Kevin Ryan. In addition, we prepared a whistleblower lawsuit, unprecedented for a school district, which was filed in federal court by my successor in office, Dennis Herrera. That suit resulted in a guilty plea last May by one of the companies that perpetrated the San Francisco fraud, NEC Business Network Solutions. But the matter does not end there. We learned that some of the San Francisco co-conspirators were likely committing the same or similar fraud across the country. The misappropriation of E-Rate money from disadvantaged schools and the children they serve was a well orchestrated effort by several corporate players working in concert with one another. In San Francisco, the school district's initial contact with the corporate con game came when a representative of Inter-Tel Technologies approached the district with a proposal for the purchase of telecommunications equipment. The Inter-Tel representative introduced district officials to Judy Green and George Marchellos, employees of Video Network Communications Inc., or VNCI, both experts in the E-Rate program. As our chief E-Rate investigator, George Cothran, will testify in detail, Ms. Green and Mr. Marchellos infiltrated the district's competitive bidding process to win inflated E-Rate funding for district projects directly benefiting VNCI, Inter-Tel, and NEC. Specifically, they wrote the district's request for proposals so that it would be prejudiced toward goods and services sold by VNCI. Then they bundled VNCI equipment inside a bid submitted by Inter-Tel. As part of the conspiracy, the RFP was not advertised as required by law. The investigation suggested that the three companies used the same or similar schemes elsewhere, with VNCI typically managing the bidding process and hiding its equipment inside bids submitted either by Inter- Tel, as in San Francisco, or by NEC. As a result of their conspiracy, these companies ensured that they would be the primary recipients of E-Rate funding provided to the San Francisco Unified School District. But their fraud didn't stop with a phony bidding process. They also submitted a falsified application for E-Rate funding on behalf of the district that inflated their bid prices by more than $60 million, well above the artificially high rates already enabled by the rigged bids. In short, they thoroughly soaked the E-Rate process for millions of dollars with lies, overcharges, and fraud. San Francisco's lawsuit marks the first time to our knowledge that a school district has filed a whistleblower claim. It is my hope that our unprecedented action, along with other enforcement efforts around the country, will put government agencies and businesses alike on their guard against these practices, and will help to root out the problems that have beset the E-Rate program. The goals of the program are important for the future. Our children cannot compete in the modern world without knowledge of computers and technology, which is why a well-run program is so necessary. Thank you. Mr. Walden. Thank you for your testimony. We appreciate it. Mr. Herrera, thank you for being here. Thank you for your work. We look forward to your testimony. TESTIMONY OF DENNIS HERRERA Mr. Herrera. Chairman Walden, distinguished members of the subcommittee, I thank you for the opportunity to appear before you today to discuss San Francisco's experience with efforts to defraud the Federal E-Rate program. I am also honored to join San Francisco Unified School District General Counsel, Louise Renne, in testifying today. As my immediate predecessor as City Attorney, Louise first ordered the investigation that was so capably undertaken and thoroughly investigated by George Cothran of my office, with whom I am also honored to appear today. When I took office in January 2002, our office's investigation into the E-Rate fraud had been underway for more than a 8 months. As much or more than any of the cases I inherited or have undertaken since, the E-Rate case represented exactly the kind of public policy priority that I had talked about extensively during the course of my campaign for City Attorney. In establishing a permanent public integrity unit in my office, I sought to take as aggressive a stand as possible against those who would seek to defraud our city; because, as I am sure this subcommittee is well aware, the harm government suffers when it is defrauded cannot be quantified in mere dollar amounts. Schemes such as these aren't just greedy. They are a corrosive influence on the integrity of our public institutions. They are an insult to our citizens' faith in their government to do the right thing, and they are an insult to the honest businesses and contractors who play by the rules and yet lose government contracts to competitors who cheat. The E-Rate scheme we unmasked in San Francisco represented all of that, plus one aggravating circumstance for which it deserves an especially prominent place in the ripoff hall of shame. It targeted funds intended to benefit the poorest, most vulnerable school children of America. For disadvantaged kids in San Francisco, growing up in Silicon Valley's backyard, in a city that is itself a high tech capital, the abuse of a program to help them bridge the digital divide represents an all too real theft of future job opportunities and economic advancement. Indeed, had San Francisco not blown the whistle on the fraud we uncovered, vendors associated in the scheme in our school system stood to receive a total of nearly $55 million, and for all that money, according to their funding applications, San Francisco schools would have been left with an incomplete computer network that was, by itself, inoperable. Schools throughout our school district would have been saddled with millions of dollars in equipment that was functionally equivalent to paperweights, routers, cabling and switches with no servers, a phone system with no phones, a computer system with no work stations, videoconferencing equipment that wasn't even eligible for E-Rate funding. When our investigation was completed, the details of which Mr. Cothran, more than I, is best equipped to discuss, the evidence confirmed that E-Rate applications for San Francisco schools had been fraudulently conceived and executed in almost every respect. Moreover, the investigation demonstrated that these practices were not confined to San Francisco. We discovered fraudulent applications in several other school districts, frequently involving the same co- conspirators. On May 16, 2002, I filed a false claim action under seal on behalf of our school district and the people of the State of California. In filing the case as what we call a Qui Tam action, the San Francisco Unified School District became the whistleblower on a nationwide scam, and we turned the results of our investigation over to the U.S. Department of Justice with whom we have continued to work. Under terms of a partial settlement announced in our case several weeks ago, NEC Business Network Solutions paid a total of nearly $16 million in cash and services to the Federal Government to settle the lawsuit's civil claims. As a Qui Tam whistleblower in the case, the San Francisco Unified School District will receive nearly $3.4 million. NEC BNS also pled guilty to felony counts of wire fraud and conspiring to violate Federal anti-trust laws and paid a criminal fine to the feds of $4.6 million. Clearly, the settlement represents an excellent outcome for the San Francisco public schools, but it also is an important vindication for a brave and controversial decision by our school superintendent, Arlene Ackerman, to refuse suspect funding from the E-Rate program in the first place. Moreover, it is testimony to the outstanding work of U.S. Attorney Kevin Ryan of San Francisco, my predecessor, SFUSD General Counsel Louise Renne, and to the investigators and attorneys in my office, particularly George Cothran whose many months of living, breathing and sleeping the details of this highly complex case paid off so impressively. We are, of course, delighted and proud to see justice done in a manner that realizes such significant benefits for San Francisco's school children. We are no less proud to be here today to offer our assistance to this subcommittee and to this Congress to assure that no other school district in this country, not one more school kid in America, suffers for the waste, fraud and abuse of the E-Rate program. Mr. Chairman and distinguished members of the subcommittee, in concluding my formal statement I thank you for the opportunity to appear before you today, and while I am glad to answer any questions you may have, I will confess that I would likely defer to our own investigator, the expert on this matter, George Cothran, from whom you will hear next. [The prepared testimony of Dennis Herrera follows:] Prepared Statement of Dennis Herrera, City Attorney of San Francisco Chairman Greenwood, distinguished Members of the Subcommittee: I thank you for the opportunity to appear before you today to discuss San Francisco's experience with efforts to defraud the federal E-Rate Program. I'm also honored to join San Francisco Unified School District General Counsel Louise Renne in testifying today. As my immediate predecessor as San Francisco City Attorney, Louise first ordered the investigation that was so capably undertaken and thoroughly investigated by George Cothran of my office, with whom I'm also honored to appear today. When I took office in January 2002, our office's investigation into E-Rate fraud had been underway for more than eight months. As much or more than any of the cases I inherited or have undertaken since, the E- Rate case represented exactly the kind of public policy priority I had talked about extensively in my campaign for City Attorney. In establishing a permanent Public Integrity Unit in my office, I sought to take as aggressive a stand as possible against those who would seek to defraud our City. Because as I'm sure this subcommittee is well aware, the harm government suffers when it is defrauded cannot be quantified in mere dollar amounts. Schemes such as these aren't just greedy. They're a corrosive influence on the integrity of our public institutions. They're an assault on our citizens' faith in their government to do the right thing. And they're an insult to the honest businesses and contractors who play by the rules--and yet LOSE government contracts to competitors who cheat. The E-Rate scheme we unmasked in San Francisco represented all of that--plus one aggravating circumstance for which it deserves an especially prominent place in the Government Rip-off Hall of Shame: it targeted funds intended to benefit the poorest, most vulnerable schoolchildren in America. For disadvantaged kids in San Francisco--growing up in Silicon Valley's backyard, in a city that is ITSELF a high-tech capital--the abuse of a program to help them bridge the ``Digital Divide'' represents an all too real theft of future job opportunities and economic advancement. Indeed, had San Francisco NOT blown the whistle on the fraud we uncovered, vendors associated in the scheme in our school system stood to receive a total of nearly $60 million. And for all that money, according to their funding applications, San Francisco schools would have been left with an incomplete computer network that was, by itself, inoperable. Schools throughout our school district would have been saddled with millions of dollars in equipment that was functionally equivalent to paperweights. Routers, cabling and switches with no servers A phone system with no phones A computer system with no workstations Video-conferencing equipment that wasn't even eligible for E-Rate funding When our investigation was completed--the details of which Mr. Cothran more than I is best equipped to discuss--the evidence confirmed that E-Rate applications for San Francisco schools had been fraudulently conceived and executed in almost every respect. Moreover, the investigation demonstrated that these practices were not confined to San Francisco. We discovered fraudulent applications in several other school districts, frequently involving the same co-conspirators. On May 16, 2002, I filed a false claims action under seal on behalf of our School District and the People of the State of California. In filing the case as what we lawyers call a ``Qui Tam'' action, the San Francisco Unified School District became the whistleblower on a nationwide scam. And we turned the results of our investigation over to the U.S. Department of Justice, with whom we've continued to work. Under terms of a partial settlement announced in our own case several weeks ago, NEC Business Network Solutions, a subsidiary of NEC Corporation, paid a total of nearly $16 million in cash and services to the federal government to settle the lawsuit's civil claims. As the ``qui tam'' whistleblower in the case, the San Francisco School District will receive 21 percent--or nearly $3.4 million. NEC/BNS also pled guilty to felony counts of wire fraud and conspiring to violate federal antitrust laws, and paid a criminal fine to the feds of $4.6 million. Clearly, the settlement represents an excellent outcome for San Francisco public schools. But it was also an important vindication for a brave and controversial decision by our School Superintendent, Arlene Ackerman, to refuse suspect funding from the E-Rate program in the first place. Moreover, it is testimony to the outstanding work of U.S. Attorney Kevin Ryan of San Francisco, SFUSD General Counsel Louise Renne and to the investigators and attorneys of my office--particularly George Cothran, whose many months of living, breathing and sleeping the details of this highly complex case paid off so impressively. We are, of course, delighted and proud to see justice done in a manner that realizes such significant benefits for San Francisco's schoolchildren. But we are no less proud to be here today to offer our assistance to this subcommittee and to this Congress to assure that no other school district in this country--not one more school kid in America--suffers for the waste, fraud and abuse of the E-Rate program. Mr. Chairman and distinguished Members of the Subcommittee, in concluding my formal statement I would like to thank you again for the opportunity to appear before you today. While I'm glad to answer any questions you may have at this time, I will confess that I would likely defer to my OWN investigator on the subject, George Cothran, from whom you'll hear next. Mr. Walden. Thank you. Thank you for your testimony, and we appreciate the work of your office. Mr. Cothran, thank you for being here today. We look forward to your testimony. Please begin. TESTIMONY OF GEORGE M. COTHRAN Mr. Cothran. Thank you, Chairman. One of the major findings of the City Attorney investigation into the attempted E-Rate fraud in San Francisco in 1999 and 2000 was that every action taken by defendants in our Qui Tam lawsuit was geared toward one narrow goal, to put money in their pockets. We found no evidence that defendants once considered the needs of the school district or its student bodies as they went about corrupting a government bid process and submitting fraudulently inflated E-Rate funding applications in January of 2000, seeking to defraud the E-Rate program of approximately $53 million. Thank you for the opportunity to allow me to walk you through conclusions the city attorney's office reached based on the evidence that was available to us. The fraud scheme had its roots in the district declining to do business with one of our defendants, Inter-Tel Technologies. In 1999 an Inter-Tel representative was rebuffed by the school district as he tried to make a sale of his employer's products. Instead of taking this refusal as the thoughtful and perhaps correct decision by a government agency, the Inter-Tel representative sought business through the back door. The sales representative contacted Desmond McQuoid, a friend he knew from having lived in the same town as McQuoid some years earlier, though McQuoid had no authority to purchase said equipment. He was merely a custodial supervisor. To flesh out his product pitch, the Inter-Tel representative then involved two employees from Video Networks Communications, Incorporated, a small New Hampshire firm that manufactured videoconferencing equipment. From this point on, the Inter-Tel proposal included VNCI videoconferencing equipment. At the time, Inter-Tel had an agreement with VNCI that called for the company to bundle VNCI equipment into its E-Rate bids and to pay VNCI a so-called marketing fee for identifying E-Rate opportunities, all despite the fact that VNCI's equipment was not eligible for E-Rate funding at the time. Once VNCI was involved, this fraud scheme began, and it only grew larger and more ambitious as time passed. VNCI employees, Judy Green and George Marchelos, hijacked the San Francisco procurement process, taking over all of the roles, responsibilities and obligations of the school district. At the same time, Green and Marchelos invited another VNCI E-Rate bidding partner, NEC Business Network Solutions, into the process. VNCI had the same agreement with NEC that it had with Inter-Tel, and as Inter-Tel was bundling VNCI equipment in San Francisco, NEC was bundling VNCI equipment into E-Rate bids in several school districts' E-Rate proposals nationwide. Once Green and Marchelos had control of the San Francisco bid process, they were in a position to make decisions properly left to the district in order to benefit themselves, their employer, their employer's business partners, and other co- conspirators as it pleased them. VNCI, through Green and Marchelos, provided a request for proposal to McQuoid which called for phone switch bidders to include videoconferencing equipment in their responses. Green and Marchelos assumed a degree of control over who participated in the bid, inviting VNCI partners and associates from past E- Rate bids. At the same time, McQuoid declined to advertise the bid publicly, as called for in California law. Marchelos ran the January 3, 2000, pre-bid meeting, according to witnesses, where he distributed the VNCI RFP. According to witnesses, he told meeting participants he was acting as a consultant to the school district, which was not true. He did not identify his affiliation with VNCI, even though many of his co-conspirators in the room most likely knew where his interests lay. Green and Marchelos ran a January 14, 2000, bid opening meeting where they selected winners and declared noncompliant the one bid that stood in the way of VNCI business partner, NEC, and Sprig Electric, a Green invitee into the San Francisco bid she and VNCI had done business with in past E-Rate bid situations. The losing firm, Pacific Bell Network Integration, had been invited to bid by McQuoid as a precautionary measure. Pacific Bell was conducting extensive work under contract with the district at various locations, including many affected by the VNCI RFP. PBNI won McQuoid's agreement to bid off specification from the VNCI RFP, because Pac Bell believed the RFP was far too expensive and needlessly complex. Pac Bell offered modest, affordable bids on data and cabling. The Pac Bell proposal was many millions of dollars less than the competing bid on data by NEC and the competing Sprig Electric cabling bid. Regardless, Green and Marchelos ruled the Pac Bell bid noncompliant with the VNCI RFP, paving the way for NEC and Sprig Electric to receive E-Rate monies. In the process, they dramatically increased the cost to the E-Rate program of the project. At the same meeting Inter-Tel's bid was approved by Green and Marchelos. The City Attorney investigation included NEC, which was concurrently bidding PBX proposals nationwide, and any of VNCI's ineligible equipment did not make the PBX bid in San Francisco. We suspect this was by arrangement between the two firms, Inter-Tell and NEC, and VNCI, and we are confident our ongoing litigation and investigation will confirm the suspicion. Consequently, Inter-Tel was the only PBX bidder in San Francisco. In approving Inter-Tel's $20.6 million bid, Green and Marchelos were awarding a contract on a bid that included more than $15 million of VNCI equipment and which would presumably result in sales commissions to the two VNCI employees. Nearly all parties in the January 14, 2000, meeting had knowledge of VNCI's conflict of interest or they had ample reason to suspect that Green and Marchelos were improperly ruling on bids. Immediately following the bid opening meeting, Green and Marchelos began engineering a process by which NEC assumed control over two aspects of the project where the company had apparently lost the bid. The two VNCI employees, with McQuoid's help, relegated Sprig Electric, which had won the cabling bid, and U.S. Machinery, a local area firm that had won the server bid, to subcontractor status and replaced them on the E-Rate funding application or Form 471 with NEC. The City Attorney's office suspects VNCI performed this act in order to ensure that E-Rate monies flowed to a firm that was bound by agreement to pay a VNCI marketing fee based on its E- Rate income. At this point Green and Marchelos, NEC and Inter-Tel, without including McQuoid in this instance, engaged in their most ambitious attempt at fraud. The parties took the already inflated rigged bid prices and increased them by more than $50 million when filling out two false and fraudulent Form 471 application forms. The Sprig Electric bid on cabling went from $13.6 million to $39.7 million, once in the hands of NEC. The U.S. Machinery bid on servers went from $9.2 million to $32.9 million, once it was in the hands of NEC. The NEC bid on switchers and routers went from $19.7 million to $32.9 million, and the Inter-Tel bid on the PBX, which included the ineligible VNCI equipment, went from $20.6 million to $29.4 million. After factoring in E-Rate discount rates, the two applications for funding requested a little over $100 million. The results of the rigged bid totaled about $52 million. Consequently, the two Form 471s contained a fraud attempt of at least $53 million. Moreover, one of the two applications would have included 18 schools not involved in the rigged bid process. This application, as far as we could tell, was not premised on any bid process whatsoever, and the dollar figures included on it were most likely picked out of thin air. Once McQuoid learned of the two inflated applications, he had a decision to make: Call off the deal and blow the whistle or go along for the ride. He chose the latter, and in the process won NEC BNS's agreement to use some of the excess E- Rate award to purchase computer work stations that were not eligible for E-Rate funds. After the two fraudulent applications were submitted and E- Rate administrators at the Universal Service Administrative Company began their review, Green, Marchelos, McQuoid and representatives of NEC conspired to submit false and forged documentation to the E-Rate program to conceal their wrongdoing and to facilitate the award of funds they were not properly due. Let me just give you the highlights. An altered copy of the RFP was provided to USAC omitting references to the videoconferencing equipment. Names were forged on a list of attendees at the pre-bid meeting on January 3 in order to conceal the rigged nature of the process. A document bearing NEC's logo purporting to show the size of seven sample schools in the school district justifying cabling costs was exaggerated in size by nearly 50 acres and more than 70 rooms and, most damaging, a counterfeit copy of the San Francisco Unified School District budget was submitted with a fraudulent line item purporting to show that the district had more than $40 million in E-Rate matching funds, when in reality the district had no such funds available. In closing, I would like to point out that this last misrepresentation made to the E-Rate program was perhaps the most egregious. In responding to written questions, a USAC employee informed the City Attorney's office that, had the E- Rate program Administrator known the school district had no available matching funds, USAC would have denied the entire funding request. Thank you for the opportunity to testify today, and I look forward to any questions you might have. [The prepared testimony of George M. Cothran follows:] Prepared Statement of George M. Cothran, Investigator, City Attorney's Office, City and County of San Francisco Beginning in the fall of 1999 and extending into fall of 2000, San Francisco Unified School District (SFUSD) served as the staging ground for an attempted defrauding of the E-Rate program. The fraud scheme was expansive in its ambition. Involved parties included 1) Desmond McQuoid, a SFUSD custodial supervisor; 2) NEC Business Network Solutions (NEC BNS), a United States affiliate of the multi-national corporation, NEC Corp. of Tokyo, Japan; 3) Inter-Tel Technologies, Inc., a publicly-traded telecommunications firm; 4) Video Network Communications, Inc. (VNCI), a publicly traded manufacturer of video-conferencing equipment; 5) US Machinery, a San Francisco Bay Area computer re-seller; and 6) Sprig Electric, a San Francisco Bay Area electrical contractor. City Attorney Dennis J. Herrera on behalf of the People of California, and the San Francisco Unified School District, as whistleblower under the provisions of the False Claims Act, sued the above parties on May 16, 2002 for their misdeeds in San Francisco and elsewhere in the United States where our investigation uncovered evidence of their likely involvement in similar wrongdoing. In San Francisco, the parties had varying degrees of culpability. The main wrongdoers were McQuoid, NEC BNS, VNCI, and Inter-Tel Technologies. VNCI was the ringleader. Through two grossly inflated and fraudulent SFUSD E-Rate funding applications, NEC BNS, Inter-Tel, and VNCI sought to defraud the E-Rate program out of $60,387,081.56. To accomplish this defendants hijacked and rigged a government procurement and competitive bid process, suppressing competition and making the resulting E- Rate proposal vastly more expensive; concealed the presence of equipment ineligible for E-Rate funding in the bids and the funding applications; filed fraudulent and inflated funding applications to the E-Rate program; conspired to use the fraudulently obtained E-Rate funds for ineligible and improper purposes including the payment of a so- called marketing fee to VNCI which the City Attorney's Office contends is little more than a kickback; and submitted false and fraudulent documentation to the E-Rate program in order to conceal their wrongdoing and facilitate the award of E-Rate monies not properly due to them. the rigged bid: Though VNCI had a financial interest in the outcome of the bid, two VNCI employees, Judy Green and George Marchelos, controlled nearly every aspect of the San Francisco bid process, from provision of design specifications to the selection of winning bidders and the disqualification of a firm not involved in the conspiracy. a) VNCI, through Green and Marchelos, authored and provided a Request for Proposal (RFP), the equipment specifications mandating the type and amount of equipment bidding firms were required to include in their responses--a job that should have been left to SFUSD. The VNCI RFP required firms bidding on the Private Branch Exchange (PBX), or phone switch, to include a video-conferencing solution, thus tailoring the project, and the bid responses, in the direction of equipment VNCI manufactured. The VNCI RFP required a video-conferencing solution even though VNCI and its co-conspirators knew or should have known that video- conferencing equipment was not eligible for E-Rate funding at the time. Inter-Tel, which had an agreement with VNCI whereby it provided VNCI equipment as part of its E-Rate bids, introduced Marchelos and Green to McQuoid and the SFUSD E-Rate opportunity during the fall of 1999. From the onset, Inter-Tel included ineligible VNCI equipment as part of the company's proposal. And as VNCI, through Marchelos and Green, increasingly took control of the bid process, Inter-Tel representatives did nothing to interrupt that control even though they were aware of VNCI's conflict of interest and stood to profit financially from it. By the time of the San Francisco bid, Inter-Tel's relationship with VNCI was entering its second year. Evidence suggests Inter-Tel had made E-Rate bids including VNCI equipment in other school districts the year prior to the San Francisco bid. By late 1999 and early 2000, when the San Francisco bid was corrupted, VNCI had business agreements with both Inter-Tel and NEC BNS whereby the two firms included VNCI video-conferencing equipment in their E-Rate bids. In the case of the San Francisco E-Rate bid, VNCI was planning on selling its equipment to Inter-Tel in order for Inter-Tel to comply with the PBX specifications of the VNCI RFP. But at the same time, VNCI was bundling its ineligible equipment in NEC BNS's E-Rate bids in approximately 10 school districts across the United States. Evidence demonstrates that when Inter-Tel submitted its San Francisco E-Rate bid on January 14, 2000, nearly three-quarters of the equipment was manufactured by VNCI. Consequently, when VNCI representatives Green and Marchelos manipulated the bid process in favor of the NEC BNS and Inter-Tel bids, they were doing so, for the most part, to benefit their employer, VNCI. On January 3, 2000, Marchelos ran a pre-bid meeting where he distributed and explained the VNCI RFP. Marchelos introduced himself to the participants of the meeting as a consultant to the school district, though this was not true. Moreover, witnesses said, he did not reveal that he was employed by VNCI. Regardless, evidence suggests that employees or representatives of Inter-Tel, NEC BNS, and Sprig Electric present at the January 3, 2000 meeting most likely knew some or all of the following facts: Marchelos's VNCI affiliation, VNCI's role as author of the RFP, the RFP's requirement for a video-conferencing solution, the ineligibility of video-conferencing equipment for E-Rate funding, and VNCI's role as certain or most likely supplier of the video-conferencing equipment to the winning PBX bidder. All three firms were at the time or had been in the recent past involved in E-Rate bid opportunities elsewhere where Marchelos and Green represented VNCI's interests, sometimes influencing school district decisions at the same time as they were doing in San Francisco. b) VNCI, through Marchelos and Green, and McQuoid took steps to control who responded to the San Francisco E-Rate bid opportunity. Green and Marchelos invited bidders they had past or current business arrangements with--NEC and Sprig Electric (Inter-Tel did not need to be invited as they alerted VNCI to the opportunity in San Francisco). Desmond McQuoid failed to advertise the existence of the bid in a local newspaper, as required by California law. At the same time he invited US Machinery with whom he was engaged in a separate criminal fraud conspiracy that would eventually net him a federal prison sentence. The City Attorney's Office suspects that McQuoid did so at the suggestion or direction of Green and Marchelos and is confident that this suspicion will be confirmed as true through the course of our ongoing litigation and investigation. c) The bidders, for the most part, did not compete against each other. Sprig Electric bid on cabling, and no other aspect of the RFP. US Machinery bid on servers, and no other aspect of the RFP. NEC bid on servers and switches and routers, and no other aspect of the RFP. And Inter-Tel bid on the private branch exchange (PBX), and no other aspect of the RFP. The City Attorney's Office suspects that this failure to compete was by agreement between the parties and is confident it will be shown to have been so arranged during the course of litigation and further investigation. One firm, Pacific Bell Network Integration (PBNI), was invited by McQuoid at the last minute, the day the RFP was distributed to bidders. The City Attorney's Office investigation concluded that PBNI was invited only because McQuoid had been warned by other school district employees that the work prefigured in the VNCI RFP conflicted with contracts PBNI had with SFUSD. The City Attorney's Office concluded that PBNI was not part of the E-Rate fraud conspiracy in San Francisco. d) VNCI, through Green and Marchelos, ran the meeting where bids were received and ruled on. Green and Marchelos awarded contracts to firms with whom VNCI had ongoing business relationships and disqualified PBNI, which was in competition with VNCI business partner NEC BNS and Sprig Electric, a Green invitee into the process. On January 14, 2000, at approximately 3 p.m. in the afternoon, bidders convened in McQuoid's office at 834 Toland St., San Francisco, Calif., the headquarters of the buildings and grounds division of SFUSD. Bids were turned in and Marchelos and Green ruled on and announced the winners, according to individuals present at the meeting. The City Attorney investigation concluded that most of the participants in the meeting, with the exception of U.S. Machinery and PBNI, knew Green and Marchelos were VNCI employees, that VNCI had a conflict of interest and that their decision-making role over the bids was improper. The Inter-Tel representatives certainly knew VNCI had a conflict of interest; nearly three-quarters of the bid they were submitting consisted of VNCI equipment. NEC BNS representatives knew Green and Marchelos were with VNCI, and they knew VNCI had a conflict of interest as it related to their bid as well. They had worked with Green and Marchelos to include VNCI equipment in approximately 10 NEC BNS E-Rate bids nationwide during the same funding cycle prior to involving themselves in the San Francisco bid. Findings of the City Attorney Office investigation suggests Sprig Electric also was aware of the VNCI conflict of interest and the office is confident that its ongoing litigation and investigation will demonstrate conclusively that Sprig Electric was aware of VNCI's conflict of interest and Green and Marchelos' improper control over the bid process. The City Attorney investigation concluded that Green and Marchelos assumed a key role not only in declaring winning bids for their co- conspirators, but also in declaring PBNI's bid on data (switches and routers) and cabling non-compliant with the VNCI RFP and disqualifying it. PBNI sales representative Jim Pillsbury later informed the City Attorney's Office during its investigation that he believed the VNCI RFP to be overblown, far too expensive, and much more elaborate than what the district needed. He felt confident that he knew what the district needed and required in terms of information technology because PBNI was already under contract with the school district, laying cable at 30 schools and providing other telecommunications and information technology services. In fact, around the time of the bids, PBNI had been laying cabling in many of the schools covered by the VNCI RFP. Pillsbury said he had engaged in discussions with McQuoid about what kind of technology solutions made the most sense for the district, and he felt he had received McQuoid's consent to produce a bid response that did not exactly conform to the VNCI RFP, but which, he believed, was more reasonable, dramatically less expensive, and would work just as well. Pillsbury recalls that at the January 3, 2000 meeting where Marchelos distributed the VNCI RFP, McQuoid informed the gathering that the data communications (switches and routers) solution called for in the VNCI RFP--Asynchronous Transfer Mode (ATM)--was not necessarily his preferred solution and that he would also entertain other types of data solutions. Likewise, Pillsbury believed that since PBNI was laying cable at 30 schools for the district he knew enough about the district's cabling needs to depart from the VNCI RFP cabling specifications. Again the PBNI proposal for cabling was less expensive and less grandiose than that called for in the VNCI RFP. The VNCI RFP called for 30 cable lines into each classroom. The cable jobs PBNI was working on for the district at the time included 5 to 7 lines into each classroom. Pillsbury believed this more modest, less expensive cabling scheme was what was best for the district, especially considering that most of the schools covered by the VNCI RFP were elementary schools and less computer intensive. Pillsbury instructed his team to prepare a bid that departed from the VNCI RFP in these two ways: Instead of the more expensive ATM data solution, PBNI proposed a less expensive alternative; PBNI also offered a less expensive and more modest cabling scheme. But according to meeting participants, both Marchelos and Green intervened and declared the PBNI bids on cabling and data, or switches and routers, non-complaint, thus paving the way for VNCI business partner NEC BNS to win the data bid and Sprig Electric, which had been invited into the procurement process by Green, to win the cabling portion. Marchelos and Green orchestrated this result even though it produced a much more costly solution and would have eaten up many millions more E-Rate dollars. PBNI offered a range of data bids costing between $1.2 million and $7.5 million. After Green and Marchelos eliminated PBNI, they awarded the work to NEC BNS at a cost of $19.7 million. PBNI submitted a $6.7 million cabling bid. After Green and Marchelos eliminated the PBNI bid, they awarded the work to Sprig Electric for $13.6 million. In its guilty plea on May 27, 2004, NEC BNS provided a version of events at the bid open meeting that supports City Attorney investigative findings regarding Judy Green's and George Marchelos' roles in selecting winning bidders. the concealment of vnci equipment in the inter-tel bid: Despite the ineligibility of its equipment for E-Rate funding, VNCI had bundled $15,312,435.60 of its equipment into Inter-Tel's $20,633,732.60 bid, according to Inter-Tel documents. When the Form 471 application was prepared by VNCI, Inter-Tel and NEC BNS representatives, Inter-Tel's funding request was characterized as being merely for a PBX, a phone switch, which was eligible for E- Rate funding. The PBX parts list that accompanied the Form 471 was crafted in such a way as to conceal the fact that nearly three quarters of the dollar amount of the request was ineligible for E-Rate funding in Year 3 of the program (FY 2000-01) ¹ --------------------------------------------------------------------------- \1\ Video-conferencing equipment became eligible for E-Rate funding in Year 4 of the program (FY 2001-02). --------------------------------------------------------------------------- Based on the findings of its investigation, The City Attorney's Office suspects Green and Marchelos and representatives from Inter-Tel of conspiring to falsify these PBX parts lists and conceal the true nature of the equipment so it could defraud the E-Rate program into funding ineligible equipment. The City Attorney's Office is confident its ongoing litigation and investigation will confirm this suspicion. The City Attorney's Office further believes that VNCI, NEC BNS and Inter-Tel similarly falsified PBX parts lists and E-Rate applications nationwide in fiscal year 2000-01 to conceal VNCI equipment. Evidence further suggests that as part of other school district E- Rate applications, NEC BNS, Inter-Tel and VNCI provided false and misleading answers to the E-Rate program administrators when asked specifically about the function of the fraudulently-described VNCI equipment. When it plead guilty on May 27, 2004, information provided by NEC BNS supported City Attorney findings indicating that Inter-Tel and VNCI conspired to falsely describe PBX parts to conceal the ineligible VNCI equipment in the San Francisco E-Rate application. the fraudulent inflation of the sfusd applications: As a result of its investigation, the City Attorney's Office concluded that the rigged bid process orchestrated by the defendants in San Francisco produced costs much higher than would have grown out of a legal, competitive bid. The rejection of the PBNI bid is one example of how the defendants' corrupt process spiked prices. Another example lies in the NEC BNS design of the Local Area Networks it planned to implement in SFUSD, which called for servers and switches in every classroom, a magnitude of equipment deployment that was entirely unnecessary and constitutes ``gold plating.'' (As a point of interest, this same ``gold plating'' technique of placing servers and switches in every classroom was proposed nationwide by NEC BNS in fiscal year 2000-01.) If the San Francisco bid had been open and competitive, it is unlikely a firm would have submitted a bid calling for servers and switches in every classroom, and inconceivable that any such bid would have been selected in a truly competitive process. The conspirators' gold-plated proposal thus greatly inflated the cost of the proposed project. While the rigged bids were fraudulently inflated, a more dramatic financial fraud attempt occurred when NEC, Inter-Tel and VNCI conspired to submit two grossly inflated Form 471 applications in January 2000. One of these applications for funding was premised on no bid process whatsoever. These three parties, with the acquiescence and later acceptance of McQuoid, took the total of the rigged bid prices--$63,383,768.66--and inflated that total project cost to $135,142,258.70 when they submitted Form 471 202712 and Form 471 202719 to the Universal Service Administrative Company (USAC) in mid-January 2000. After factoring in discount rates, Form 471 202719 asked for $75,020,586.05 in E-Rate funds and Form 471 202712 asked for $37,975,023.45 in E-Rate funds for a total E-Rate funding request of $112,995,609.50. Had McQuoid, VNCI, Inter-Tel and NEC BNS used the results of the rigged bid process they would have requested $52,608,527.94 in E-Rate money, itself a fraudulent request in that it grew out of a rigged bid process. But the second layer of fraud--the inflation of the Form 471s--was more ambitious by far. It amounted to $60,387,081.56 ($112,995,609.50-- $52,608,527.94). But even $52,608,527.94 would have been dramatically more than what was reasonable and ethical. In 2000, SFUSD had a wide area network affording nearly every classroom and office a phone system, access to the Internet and all the other benefits of a modern information technology and telecommunications system including computers for students. It could be argued that the entire VNCI RFP project was not needed nor wanted by SFUSD. The individuals the City Attorney's Office spoke to in the SFUSD Information Technology and Telecommunications division--the proper avenue for E-Rate applications--certainly voiced this point of view. When inflating project costs on the Form 471s, NEC BNS and VNCI abandoned the results of the rigged bid process and created a new, even less competitive, and even more costly scheme, relegating Sprig Electric and US Machinery to subcontractor status and elevating NEC to prime contractor over the server and cabling portions of the project, areas in which they had lost the bid to Sprig Electric and US Machinery. The City Attorney's Office believes this was done in order to ensure that E-Rate money flowed to firms with which VNCI had formal business ties. NEC BNS and Inter-Tel had agreements with VNCI whereby NEC BNS and Inter-Tel shared with VNCI a percentage of profit from successful E- Rate deals identified and brought to the attention of NEC and Inter-Tel by VNCI. The agreement also called for NEC BNS and Inter-Tel to bundle VNCI video-conferencing equipment into its E-Rate bids. The more E-Rate money VNCI steered toward NEC BNS and Inter-Tel, the more money these firms would presumably pay VNCI under their arrangements. The City Attorney's Office has long believed this ``marketing fee'' paid to VNCI constitutes little more than a kickback. These fees were paid to VNCI not only for identifying and bringing E-Rate funding opportunities to the attention of NEC BNS and Inter-Tel, but also to compensate VNCI for illegal activity, such as rigging bids and inflating costs. Though Sprig Electric had produced the lowest responsive bid on the cabling portion of the RFP, and though US Machinery produced the lowest responsive bid on the servers portion of the RFP, McQuoid, NEC BNS and VNCI employees Green and Marchelos orchestrated a process by which US Machinery and Sprig were replaced by NEC BNS when it came time to fill out the Form 471 E-Rate funding application. According to the City Attorney investigation, Judy Green informed a Sprig Electric consultant at the January 14, 2000 bid opening meeting that NEC would most likely be the prime contractor for the cabling portion, despite the fact that NEC had issued a more expensive bid on that section of the RFP. Later, Marchelos convinced a Sprig Electric official to sign a letter agreeing to become a subcontractor to NEC BNS for the cabling portion of the project. Representatives of US Machinery told the City Attorney's Office that Desmond McQuoid called them shortly after the January 14, 2000 bid opening meeting and presented them with a choice. Either fill out the application for E-Rate funding by the following Monday or Tuesday (January 14, 2000 was a Friday) or accept subcontractor status to NEC for the server portion of the project. Since US Machinery did not have the means nor the expertise to fill out an E-Rate funding application, they relented to NEC as prime contractor. The City Attorney's Office suspects that McQuoid performed this act at the direction of Green, Marchelos, and representatives of NEC BNS and is confident this suspicion will be confirmed through the course of litigation and further investigation. US Machinery did not strike a subcontracting agreement with NEC BNS until August 2000. Representatives of US Machinery informed the City Attorney's Office during the course of its investigation that the firm felt as if NEC BNS was ignoring US Machinery's frequent requests to formalize their subcontractor role. They said it took many calls to NEC BNS and McQuoid, in addition to hiring a business manager to concentrate his efforts on obtaining the agreement, for the effort to be realized. It is unclear if Sprig Electric ever signed an actual subcontract with NEC BNS. What is known is that a NEC BNS representative asked a Sprig Electric manager to sign a document swearing that Sprig Electric had assessed the capacity of the SFUSD electrical system and its ability to accommodate the additional information technology equipment the E-Rate applications was requesting--even though Sprig had conducted no such analysis. When the Sprig manager declined to do so, he said he never heard again from NEC BNS on any issue related to the E-Rate project. Despite the fact that on January 14, 2000 when the bids were opened and VNCI, through Marchelos and Green, picked the winners, including Sprig Electric and US Machinery, and despite the fact that US Machinery did not strike an agreement to subcontract for NEC until August and Sprig may never have signed any such agreement, NEC BNS prepared and signed a purchase agreement with SFUSD on January 14, 2000 which included portions of the bid won by US Machinery and Sprig Electric. A signature purporting to be that of Thomas J. Burger, the then- president and CEO of NEC BNS, is on the signature line of the purchase agreement for NEC BNS. The City Attorney's Office has no way of commenting on the authenticity of this signature. A signature purporting to be that of Desmond McQuoid is on the signature line for SFUSD, even though he had no such authority. This signature is a forgery. The City Attorney's Office suspects that either Green or Marchelos or a NEC BNS representative committed this forgery. In pleading guilty to federal criminal charges on May 27, 2004, NEC BNS provided information that supports the City Attorney's conclusion that Green and Marchelos were the prime movers behind the decision to relegate Sprig Electric and US Machinery to subcontractor status in order to benefit VNCI business partner NEC BNS. Placing NEC BNS into the prime contractor role, and therefore placing NEC BNS on the E-Rate funding application as it pertained to cabling and servers, meant more E-Rate money would potentially flow to NEC BNS and presumably meant more money would flow to VNCI through their ``marketing fee'' arrangement with NEC BNS. After rigging the bid process and allocating contracts as they saw fit, regardless of price or merit, representatives of NEC BNS and Inter-Tel, and Green and Marchelos, on behalf of VNCI, placed NEC and Inter-Tel's E-Rate identifier number (called a spin number) on two Form 471 applications (numbers 202712 and 202719) requesting a total of $112,995,609.50. Form 471 202712 included an additional 18 schools not included in the bid process governed by the VNCI RFP. This Form 471 was premised on no bid process whatsoever. The prices on this Form 471 were most likely plucked out of thin air. Only NEC BNS and Inter-Tel's spin numbers were included. This entire application was denied by the Universal Service Administrative Company due to the use of an improper discount rate. The City Attorney investigation found that McQuoid, Sprig Electric and US Machinery were most likely unaware of the fraudulent inflated nature of Form 471 202719 or even the existence of Form 471 202712 until after they were submitted. The evidence supports a conclusion that VNCI, through Green and Marchelos, and representatives of NEC BNS and Inter-Tel joined together in preparing and submitting these fraudulently inflated applications without consulting with or including anyone from SFUSD, including three of their bid rigging co- conspirators. When NEC BNS pled guilty to federal criminal charges and settled civil claims with the City Attorney's Office and the SFUSD on May 27, 2004, NEC BNS admitted the following: On or about January 15-18, 2000 Consultants One and Two ² and defendants' employees met to prepare the USAC application Form 471 for the SFUSD and other school districts. The Form 471 is a school district's application for E-Rate funding. It is supposed to set out the selected vendors' bid amounts, memorialized in contracts, for the equipment and services called for by the district's Request for Proposal. Consultant One told the defendant's employees the total prices she wanted to submit to USAC on the Form 471s and then directed them to prepare false spreadsheets justifying those prices. With NEC/BNS's assistance Consultant One prepared the SFUSD Form 471 with inflated prices. On or about January 19, 2000, Consultant Two delivered the SFUSD Form 471 to USAC . . . In addition, Consultants One and Two worked with others to falsely describe the actual equipment to be supplied to SFUSD, including VX Company equipment, which is not eligible for funding under the E-Rate program, in order to have E-Rate pay for that equipment.'' --------------------------------------------------------------------------- \2\ In the NEC BNS guilty plea, Consultant One and Consultant Two are identified as sales representatives working for a ``company that manufactured and installed video-teleconferencing switches,'' also described in the plea document as ``VX Company.'' In its plea, NEC BNS acknowledged entering into an agreement with this VX Company ``under which (NEC BNS) agreed to pay VX Company a fee for all business opportunities VX Company brought to the (NEC BNS).'' --------------------------------------------------------------------------- During the course of its investigation, the City Attorney's Office discovered that the business relationship between VNCI and Inter-Tel and VNCI and NEC BNS reached across the United States. The City Attorney investigation found that at the same time VNCI and its co-conspirators were rigging the San Francisco bid, concealing VNCI equipment in and inflating the San Francisco applications, VNCI and its employees, including Green and Marchelos, were most likely conspiring with NEC BNS and others to rig bids, conceal equipment, and inflate applications in several other school districts, a suspicion supported by NEC BNS when it entered a guilty plea in federal court on May 27, 2004 to anti-trust violations in other states. In the course of its investigation, the City Attorney's Office had an opportunity to speak to Dorothy Travis Johnson, the principal and chief executive officer of the Ceria M. Travis Academy in Milwaukee, Wisconsin. She described her experience in dealing with Green and Marchelos and NEC BNS as, ``This is a little nightmare to me.'' In the course of interviews conducted in the Spring of 2002, Johnson told the City Attorney's Office that in fiscal years 2000-01 and 2001-02, VNCI, through Green and Marchelos, selected winning bidders and filled out and submitted Form 471s that included NEC BNS and VNCI equipment. In fiscal year 2000-01, the Marchelos and Green application netted $1.2 million for NEC BNS and VNCI. Johnson said Marchelos took bids submitted to her by local companies back to California and she never saw them again. ``George has vendors pre-selected,'' she said, referring to Marchelos. ``Local people gave me bids. George took that but I know he's going to give it to his vendors.'' Referring to both Marchelos and Green, Johnson said, ``They walked us through this. They did all the numbers. George did the whole application for me.'' She said the NEC BNS was one of the main vendors in the fiscal year 2000-01 and fiscal year 2001-02. She told the City Attorney's Office she believed her name was forged on several documents including a purchase agreement with a company providing servers. The purchase agreement, she said, called for 12 servers to be deployed at her school. Johnson said she showed the purchase agreement to a friend who was knowledgeable about information technology and he informed her that she needed only one server for a school her size. During the course of its investigation, the City Attorney's Office came to suspect that VNCI was conspiring with Inter-Tel and other firms to rig bids, conceal VNCI equipment, and inflate applications in California (West Fresno School District, Fresno) and Michigan (Highland Park School District, Highland Park) during the same general time period as the other school district frauds. In August 2003, Duane Maynard, the former chief estimator for the Fresno-based Howe Electric, pled guilty to federal criminal bid rigging charges and in the process pointed toward the involvement of co- conspirators. Maynard stated in his plea: On or about February 19, 1999 the defendant, on behalf of his employer, attended a pre-bid meeting at the West Fresno Elementary School District (WFESD), in the Eastern District of California. The pre-bid meeting related to a project to provide, among other things, equipment and services related to telecommunications, Internet access, and internal connections to the WFESD (``the WFESD E-Rate Project''). Those present at the pre-bid meeting understood that the project was related to the E-Rate program, in which the Universal Service Administrative Company (``USAC'') subsidizes the provision of telecommunications, Internet access, and internal connections to underprivileged schools. Competitive bidding was required for the WFESD E-Rate Project. Nonetheless, the defendant, together with school district representatives, a consultant, and others representing potential competitors, combined, conspired, and agreed that: 1) The defendants' employer would be the successful bidder and have general responsibility for the WFESD E-Rate Project; 2) No co-conspirator other than the defendant's employer would submit a general bid for the WFESD E-Rate Project; 3) Other co-conspirator companies would be the defendant's employer's subcontractors for the WFESD E-Rate Project; and 4) any bid competing with the defendant's employer's bid would be stricken as nonresponsive. The defendant, his superiors at his company, and his other co-conspirators did what they agreed to do to carry out the conspiracy. They further acted in concert to provide equipment and services related to the WFESD E-Rate Project and receive from USAC payment therefor. Documents obtained from USAC by the City Attorney's Office show Inter-Tel subcontracting to Howe as part of Howe's E-Rate contracts during the same time period. The City Attorney's Office suspects Inter- Tel to be one of the co-conspirators Maynard referred to in his guilty plea and is confident its ongoing litigation and investigation will confirm this suspicion and show Inter-Tel to indeed be one of Howe Electric's bid rigging co-conspirators. Likewise, documents obtained from USAC by the City Attorney's Office show VNCI involved in E-Rate applications out of West Fresno Elementary School District during the same funding years in which Howe Electric was the prime contractor. Sprig management officials and its consultant Bob Waters informed the City Attorney's Office that the firm was involved in West Fresno E- Rate bids during the same time period. The City Attorney's Office suspects that both VNCI and Sprig were among the co-conspirators Maynard referred to in his guilty plea and is confident its ongoing litigation and investigation will confirm this suspicion and show that VNCI and Sprig were indeed among Howe Electric's bid rigging co-conspirators in West Fresno. the plan to misuse e-rate funds: In other school districts where Inter-Tel and NEC BNS appear to have acted in concert with VNCI to rig bids, conceal VNCI equipment in bids and inflate applications, evidence suggests the firms agreed to not charge the school districts their portion of the project costs, which usually came to 10 percent of the total cost. Based on its evidence, the City Attorney's Office believes VNCI, Inter-Tel, and NEC BNS built this cost into their non-competitive bids and later into the inflation of E-Rate applications. The City Attorney's Office believes the inflated costs associated with the two San Francisco Form 471s were to be used, in part, for this purpose. Another purpose of the fraudulently inflated project costs in San Francisco would have gone to fund equipment not eligible for E-Rate monies--in addition to the ineligible VNCI video-conferencing equipment. The City Attorney investigation found that NEC BNS had agreed to spend more than $10 million of the inflated project costs to pay for 2250 computer work stations, which are not eligible for E-Rate funding. When NEC BNS pled guilty and settled civil claims with our office, they admitted as much, and stated that though NEC BNS characterized this $10 million expense as an ``in-kind'' donation, it had indeed planned on using a portion of its E-Rate award to pay for the workstations. lying to usac: On September 22, 2000, USAC issued a Funding Commitment Decision Letter (FCDL) to McQuoid regarding Form 471 202719. The FCDL announced a total award to Inter-Tel for the PBX of $14,791,335.38. Inter-Tel had requested $17,769,776.27 for the PBX. The request had been reduced to remove some of the VNCI equipment as ineligible though it is not clear from USAC documents if the equipment was deemed ineligible because USAC understood it to be video- conferencing equipment. NEC BNS was awarded $18,156,829. 34 in funding for cabling, the exact amount they had requested. NEC BNS was awarded $15,731,613.33 in funding for data equipment (switches and routers). USAC reduced the requested amount of $18,953,751.00 to remove funding for an extended warranty. NEC BNS was not awarded the $18, 249,395.09 it requested for servers. USAC denied the entire funding request because more than 30 percent of the use of the servers would have been for ineligible purposes. It is not clear from USAC documents what ineligible purposes the servers would have been put to. Likewise NEC BNS was denied its entire service contract request of $1,898,970.78. The total E-Rate award to SFUSD as a result of the two fraudulently inflated applications was $48,679,778.05 Prior to issuing the award, USAC pursued its normal program integrity review process. In addition, USAC subjected the McQuoid applications to an Item 25 review, a higher level of scrutiny USAC brings to bear on some but not all applications. In the course of this two-fold review, USAC asked many questions of McQuoid regarding his applications. Moreover, USAC asked for documents to support McQuoid's answers. Based on the findings of our investigation, the City Attorney's Office concluded that VNCI, through Green and Marchelos, controlled this process as well--with NEC BNS and McQuoid's knowledge and consent. We discovered a July 27, 2000 letter from McQuoid to VNCI Chief Financial Officer Bob Emery authorizing VNCI to assist SFUSD in the preparation and submittal of School's and Library Division's (SLD) Item 25 review. ``Under the direction of the District, VNCI will be aggregating the information required to complete the Item 25 review. We authorize VNCI to collect, collate and prioritize documentation for our intended contractors to facilitate the completion of the Item 25 review.'' Likewise the City Attorney's Office discovered a letter from John Colvin, NEC BNS Director of Sales, Public Sector, to Judy Green, identified as VNCI Regional Manager, authorizing her ``to provide documentation on behalf of NEC BNS to facilitate the completion of the Item 25 review.'' But it also appears from the evidence that Green and Marchelos, on behalf of VNCI, NEC BNS, and Inter-Tel controlled pre-Item 25 responses to USAC inquiries as well. We base this conclusion in part on the fact that McQuoid's signature was forged on an initial pre-Item 25 review submittal of information justifying various aspects of the applications. Evidence suggests that Green and Marchelos, acting on behalf of VNCI, NEC BNS, and Inter-Tel either prepared, helped to prepare, directed the preparation of and transmitted or knew of the preparation of and transmittal of counterfeit, misleading and fraudulent documentation meant to conceal wrongdoing and facilitate the award of E-Rate money not properly due to NEC BNS, Inter-Tel, and VNCI. Evidence indicates that as part of the Item 25 review, Green, Marchelos, and McQuoid caused to be sent to USAC a list of individuals who purportedly attended the pre-bid meeting on January 3, 2000. Two of the fourteen supposed attendees listed as having signed in and being present were not actually present. Both names and signatures are clearly in the handwriting of McQuoid. City Attorney interviews with both individuals indicated that neither was present. In one instance, the individual purported on the sign in sheet to have been present at the pre-bid meeting had never been to San Francisco. A third individual who signed in as having attended the pre-bid meeting and picked up an RFP in order to submit a bid, informed the City Attorney's Office that he was a friend of McQuoid's who was doing some minor alarm repair for McQuoid at the buildings and grounds division when McQuoid asked him to come to the meeting where he was asked by another individual believed to be Marchelos to sign in as having been present as a potential bidder. This individual informed the City Attorney's Office that he had no intention of bidding, had no capacity to do so, and had no real understanding of what transpired in the meeting except that he was asked to sign in as if he were a potential bidder. During the review process conducted by USAC, documents bearing the NEC logo were transmitted to USAC purporting to show the size of seven of the schools to receive cabling funded by the San Francisco E-Rate proposal. The size of these schools was grossly exaggerated on these documents, increasing the seven elementary schools by 73 rooms and 58.75 acres. The City Attorney's Office concluded that the reason for the exaggeration was to better justify the excessive request for cabling funds. In submitting to USAC proof that SFUSD had the ability to pay its approximately $10 million share of the E-Rate project costs, McQuoid conspired with Judy Green and others to submit fraudulently altered budget documents. The key document, a budget summary page, was altered to show that the school district had $41.5 million available under a line item fraudulently titled ``E-Rate District Match.'' By the time this falsified document was transmitted to USAC in August 2000, the SFUSD Board of Education had already approved a fiscal year budget for July 1, 2000 to June 30, 2001 and no such line item was included. In fact, in a separate portion of the true budget, SFUSD reduced the available E-Rate match fund from $1.26 million to zero. Inter-Tel sales representative Jason King informed the City Attorney's Office that he attended a meeting where Judy Green of VNCI, Gerard McNulty of NEC BNS, and he assisted McQuoid in responding to the USAC Item 25 review. During this meeting, Green asked for and received SFUSD budget information and documentation to submit to USAC. When USAC asked McQuoid to provide a Technology Plan, a requirement of receiving USAC funding, McQuoid simply obtained one from Green which had been written by Green and others as part of a Los Angeles Unified School District planning process. The Green-provided plan had not been subject to any discussion or deliberative process by anyone at SFUSD nor had it been submitted and approved by the SFUSD Board of Education. As part of the Item 25 review, USAC requested a copy of bid results, the RFP, and other bid-related documents. Spreadsheets prepared by and transmitted to USAC by McQuoid and others, most likely VNCI, through Green and Marchelos, on behalf of NEC BNS and Inter-Tel, contained false information about the bid results. And the copy of the VNCI RFP sent to USAC had the references to the required video conferencing solution omitted in order to conceal the fact that PBX bidders were required to include ineligible equipment in their bids. Evidence suggests that in justifying the cost of a labor/service agreement with NEC BNS, Green and Marchelos, on behalf of NEC BNS, submitted a document to USAC claiming that the costs were at the proposed rates because San Francisco had ``no mass transit'' system when in fact it has a robust mass transit system, and some schools were 45 miles apart even though San Francisco is seven miles by seven miles. McQuoid's signature on this document is clearly forged. conclusion The City Attorney's investigation into the E-Rate proposal that was purportedly submitted on behalf of the San Francisco Unified School District demonstrated that the proposal was fraudulent in almost every respect. The proposal resulted from a bid process that was rigged from its inception. The bid process was controlled by parties who had a direct financial stake in its outcome. After the conspirators prevailed in the rigged process, they included a large amount of ineligible equipment in their funding requests. They also grossly inflated the prices used in their funding requests, and made numerous misrepresentations during the funding process. Fortunately, when Superintendent Arlene Ackerman learned of these proposals, she suspected they were fraudulent. The San Francisco Unified School District therefore did not accept any funding from the E-Rate program as a result of these applications. However, the City Attorney's investigation demonstrated that these same conspirators successfully obtaining E-Rate funding for other school districts, based on similar fraudulent tactics. Investigations into the scope of these improper activities are on-going. Mr. Walden. Thank you, Mr. Cothran, for your testimony and for your diligent efforts to expose this fraud and conspiracy and abuse. Superintendent Ackerman, again thank you for your diligence in this matter as well. You touched on this during your testimony, but can you please explain for us the types of financial and budget issues and problems that you found when you arrived in San Francisco? Ms. Ackerman. Prior to my arriving in San Francisco, there had been a fiscal audit by the State, called the PCMAT Report, and it makes clear that there were serious oversight and accountability or lack of accountability structures in our fiscal house. We didn't know how much money we had. There were problems with--We hadn't had proper audits. In addition to that, we had problems getting certified by the State, and then we had problems with credit. So there were a multitude of fiscal problems when I arrived. There was a blueprint for how we could rectify some of our fiscal problems in this report called the PCMAT report. So I came into the district understanding that there were serious issues and proper oversight procedures in our fiscal house. Mr. Walden. So how obvious was it to you that there wasn't funding there to do the match for the E-Rate program that was being offered? Ms. Ackerman. Well, as Investigator Cothran said, there was no line item represented in our budget for the matching funds. That was one clue. That wasn't the obvious, though, for me initially. I mean that was one of the things. There were probably several. I was initially alerted, though, when I read the E-Rate application, and I saw the misrepresentation of what I knew to be not factual statements describing our city. That started my first red flag that went up, and then further looking at-- Because I was acutely aware of the problems we had in our fiscal house, our department, then I began to look at other issues that were raised as a result of this application. There were other fraudulent--appearance of other fraudulent contracts also that I was aware of at the time. So I was already on high alert. Mr. Walden. But not in the E-Rate program? Ms. Ackerman. No, not initially. Not initially. Mr. Walden. All right. Thank you. Mr. Cothran, so everyone at the bid rigging--or excuse me--bid meeting on January 14 knew that Marchelos and Judy Green were affiliated with VNCI the equipment vendor except Pacific Bell? Mr. Cothran. That is the conclusion of our investigation. NEC, in our opinion, was definitely aware of their affiliation, because they had been working with them for sometime at that point to make E-Rate bids bundling VNCI equipment in about 10 other school districts. Inter-Tel, same situation. They were also working--had worked in previous E-Rate funding years and were working in that current funding year, bundling VNCI equipment into bids in other school districts across the country. So when they looked out across the table at Judy Green and George Marchelos, they knew they were VNCI employees, and they knew that they were doing business with their firms. Sprig Electric, which was present at the meeting in the person of a consultant to the firm--that consultant had worked with Judy Green and George Marchelos as VNCI representatives in other school districts in prior funding years as well. I believe the only other remaining party at the bid opening meeting during my investigation was Pac Bell, and they did not know, according to their interviews with me, that Judy Green or George Marchelos were VNCI reps. As a matter of fact, Mr. Marchelos, according to a Pac Bell representative, had identified himself at the earlier January 3 meeting as a San Francisco consultant. I will make the point again that he was not a consultant to the school district. He had no such contract. That was just not true. Mr. Walden. Tab 9, 10, 12 and 86: These appear to indicate that Judy Green's influence of the bid process--I'm sorry, Ms. Ackerman, did you want to comment on that? I'm sorry. Ms. Ackerman. Yes. I wanted to add to your prior question about when was I aware of a problem with E-Rate. It actually happened fairly early in my tenure, not about this particular application but about a new $96 million application that I was asked to sign and refused to sign it, because--that happened in early fall. So we never actually applied--made an application for the $96 million. So there was---- Mr. Walden. Who brought that application forward, the same cast of characters? Ms. Ackerman. Yes, and at that point with Desmond McQuoid was our then facilities director, Tim Tronson. So this happened even before the $50 million application, which had actually already been approved. Mr. Walden. Okay. Does the $96 million application you were approached to sign come after the fraudulent $58 million one? Ms. Ackerman. No. It came before. We actually--I'm sorry, go ahead. Mr. Walden. No, you go ahead. That's fine. Ms. Ackerman. I was asked a new application for $96 million in the early fall, sometime in September, by Tim Tronson and Desmond McQuoid. I actually refused to sign that application, and we never submitted it. Soon after that came the $50 million application that had already been submitted,and what we were supposed to then do was to actually have the matching funds of $8 million. So there was at least attempt to get me to sign off on a $96 million application, which I initially refused to do. Mr. Walden. All right. Thank you. So let me go to Mr. Cothran now. These tabs I referenced earlier, 9, 10, 12, 86, appear to indicate Judy Green's influence in the bid process, Bill Holman as well as a number of other NEC employees are listed on these e-mails. If you look at Tab 9, Gerard McNulty, the salesman at NEC who appears to work most closely with the schools, and Judy Green describes Green's ``flexibility to award the whole project to NEC.'' At first, Holman in particular appears to be questioning Judy's role. Can you comment on what we are seeing here? Mr. Cothran. Well, I have never seen this e-mail before, but what it appears to me to be is sort of an internal admission on the part of Mr. McNulty and others that Judy Green controlled the bid process at least. And if I am not mistaken, this is referring to Covert, which is a school district outside of Detroit, I believe. So at least in this one instance, it appears that there is some rather frank discussion here about Judy Green's control over the process. Mr. Holman raises the issue of a potential conflict of interest, and then Gerard offers an additional explanation, and he uses the term heavy influence in the outcome. Supposedly, I guess that is enough to soothe the fears of Mr. Holman, and he doesn't think that is a conflict of interest--heavy influence as opposed to awarding the contract. Mr. Walden. Do you think there is a conflict there? If you were Mr. Holman, would you think? Mr. Cothran. Oh, absolutely. Mr. Walden. Okay. Looking at Tab 10, Coleman tells Holman that Judy Green, ``owns the bid process and seems to be the brains behind the VNCI operation.'' Can you comment on that? Mr. Cothran. That is my understanding. As a result of my investigation, I developed the strong opinion that Judy Green was pretty much the brains of the VNCI operation. Mr. Walden. Okay. Then looking at Tab 12, McNulty tells Holman that he and Judy will lobby the district to award the projects to NEC. Did Judy Green and George Marchelos rig the bids this way in other school districts? Mr. Cothran. Could you repeat the question? I'm sorry. Mr. Walden. Did Judy Green and George Marchelos rig the bids this way in other school districts? Mr. Cothran. Well, as you can refer to in my written testimony, I interviewed a CEO and principal at Ceria M. Travis Academy in Milwaukee, Wisconsin, and her comments to me over the course of two interviews indicated to me that indeed Mr. Marchelos and Ms. Green rigged the bid and controlled the process in that school district. There are documents we received from USAC that finally indicated to us that that same control was exercised in other school districts, in Michigan, in Arkansas. Mr. Walden. Have you seen dollar amounts on those? How much money are we talking about that these two may have been engaged in? Mr. Cothran. I wouldn't want to hazard a guess without the documents in front of me, but to answer your question, yes, I do have documents relating to those requests and those awards, and while not as grandiose as the San Francisco application, they did involve millions of dollars, and in some cases, I believe, tens of millions of dollars. Mr. Walden. In your opinion, how far up the chain of command do you think the knowledge of the bid rigging and other behavior went within VNCI? Who knew? Mr. Cothran. I have to apologize. I have no evidence about how far up the chain of command it went at NEC. My investigation just didn't probe that far. I apologize. Mr. Walden. No, but VNCI was my question. Mr. Cothran. Oh, VNCI. Certainly, Judy and George were the main actors. I have a strong suspicion that Bob Emery, the CFO, was aware of their activities, although in an interview he denied it to me. But I have a strong suspicion that that wasn't an accurate portrayal. Other than that, I simply don't know. Mr. Walden. My time has expired. I would now like to recognize the gentle woman from Colorado. Ms. DeGette. Thank you, Mr. Chairman. Dr. Ackerman, I was wondering, since having to deal with this E-rate conspiracy that was initiated by VNCI, NEC BNS, and Inter-Tel, what has been your experience with the E-Rate since these firms were taken out of the equation? Ms. Ackerman. Well, I would like to say that, as I made the point in my comments, I believe that the E-Rate program has benefited many young people in our school district. Approximately 20,000 students in 112 of our schools have benefited from the E-Rate program. Ms. DeGette. And have you applied for E-Rate money since the scandal happened? Ms. Ackerman. Yes, but much smaller amounts. In the last-- in 2001 it was about $800,000, in 2002 about a million, and in 2003 about a million. Ms. DeGette. And how have you been able to use these monies in the San Francisco School District for the benefit of children? You keep saying--I'd like to get on the record exactly how this program benefits kids and what kind of kids it benefits. Ms. Ackerman. It has benefited students especially in some of our more disadvantaged and challenged neighborhoods, the schools that are located in those communities, providing Internet connections and infrastructure as well as telecommunication systems with some of those schools, some of our schools, as well as wiring of our libraries and bringing our libraries up to the 21st Century. I would say that it has made, certainly, a difference in this school district. Ms. DeGette. And these are kids who wouldn't have those kinds of services at home. Correct? Ms. Ackerman. Yes. Absolutely. Ms. DeGette. Now I know, Dr. Ackerman, that you have many years of experience in the education field in other school districts before you went to San Francisco. My question for you is: As policymakers, how do you think we can improve oversight of the E-Rate program so that these many hundreds of millions of dollars actually go to benefit kids and we avoid fraud in the future? Ms. Ackerman. Well, I certainly think that there has to be put in place some checks and balances. The fact that this $50 million application was submitted--I caught the $96 million application and refused to sign it, but we actually had applied for two others, and they were--somehow they went through a process, even after it left the district, and nobody was able to--and I don't know the process after it leaves the district, but certainly there needs to be some checks and balances in place at the Federal level to ensure that these applications aren't fraudulent and that the applications actually--the processes and procedures that are laid out in the applications have actually taken place. Ms. DeGette. Have you put additional checks and balances in place within your own school district since this happened? Ms. Ackerman. Absolutely. We have in place not only a review from our legal department, but we now have an office of risk management that also takes a look at any major applications or grants that we apply for. We also took our technology department out of facilities and put it in the technology department where it belonged. It was really strange to me that a facilities person was bringing to me--that was a really big clue--that a facilities person was bringing to me a serious E-Rate application. And it has to be vetted through several layers in our district of overview and oversight, including our risk management department and our Chief Financial Officer has to check off and sign off of it before it comes to me for review. Ms. DeGette. And do you think that a review of the school district's auditing procedures and checks and balances would be an important component of Federal oversight? In other words, when a school district submitted an application, part of the review by the Federal Government would be to make sure that the school district had appropriate oversight in place as well. Ms. Ackerman. I think that is absolutely appropriate. Ms. DeGette. Okay. I wanted to ask the investigative team, who I am very proud of, about some of the details of this investigation. Mr. Cothran, I was wondering. You testified about how VNCI declared PBNI's bid on data and cabling noncompliant with the RFP, and subsequently disqualified it from contention. Now if the appropriate officials at the school district knew about the PBNI bid, do you think they would have still chosen that much more elaborate system that the NEC bid proposed? Mr. Cothran. I don't think they would, if this had gone through the appropriate channel which, to my knowledge, would have been the information technology and telecommunications division, which was already doing business with Pac Bell in 30 schools under other contracts. Pac Bell was a well known contractor to them. I am confident that their bid would at least been taken a lot more seriously, and most likely it wouldn't have been ruled noncompliant with the bid, since it fit the specifications of the projects they were already working on. Ms. DeGette. Now you also said that, if folks had used the results of the initial rigged bid process instead of the subsequent inflation, that they would have requested almost $53 million in E-Rate money, and you said this amount would have been dramatically more than was reasonable and ethical. What figure do you think would have been reasonable and ethical? Mr. Cothran. You know, I don't think I am qualified to make that kind of guess, but I would point you to previous E-Rate applications that have been made through the appropriate avenues at the school district. If memory serves--I haven't looked at them in a while--they were in the single--I don't even think some of them reached a million dollars. Ms. DeGette. Yes, and I think that is just what Dr. Ackerman just testified for subsequent proposals. Mr. Cothran. Right. Previous, I believe, I was informed, were less than a million dollars. So you can take that as a benchmark. We believe--if I might add, we believe the $52 million figure, even before it got to the second layer of fraud--we believe that initial rigged bid was fraud, in and of itself. We see that as a fraudulent number as well. We see this as two layers of fraud. Ms. DeGette. Right. Now you testified that McQuoid's signature on the final purchase agreement was a forgery and that McQuoid had no such authority to sign off on the agreement. Was the NEC signature forged as well? Mr. Cothran. We have no way of commenting on that. I don't have the true exemplar of--I believe it was Thomas Burger's signature on that document, if memory serves, and I have no true exemplar of that signature to compare it to. Ms. DeGette. Okay. Did you ever see any documents that suggested that an NEC official was having second thoughts about filing the grossly inflated purchase order? Mr. Cothran. No. I mean, until today. Ms. DeGette. Mr. Chairman, I don't have anymore questions at this time. I yield back. Mr. Walden. The Chair now recognizes the chairman of the full committee, Mr. Barton, for questions. Chairman Barton. Thank you, Mr. Walden. Dr. Ackerman, can you hear me? Ms. Ackerman. Yes, I can. Chairman Barton. Again, I want to commend you for what you have done. My first question is just a general question. What was it that you saw that kind of raised a red flag in your mind that this particular grant or proposal might not be on the up and up? Ms. Ackerman. As I mentioned before, the first application that was brought to me in September actually was for $96 million, and it came to me from staff members from the facilities department. They actually wanted me to sign it that day. They brought me the document, and they were standing there waiting for me to sign it. I actually refused to sign it, said I needed time to look at it, and that review--the review of that particular application then alerted me that there were--and I asked some questions about what I believed to be false statements within the document. At that point, I was told that the contents of the $96 million application was the same as the other two previous applications that were submitted. So at that point I knew that it was fraudulent. The other two applications were fraudulent, and I refused to sign that one, and then alerted Louise Renne, then City Attorney, that there was a problem. Chairman Barton. Where were you before you came to San Francisco? Ms. Ackerman. I was in Washington, DC. Chairman Barton. Were you the superintendent in Washington, DC? Ms. Ackerman. Yes, I was. Chairman Barton. And had you made application for similar funds for a similar program in Washington, DC? Ms. Ackerman. I don't remember if there were applications made when I was there. I was there only 3 years and superintendent 2, but I had been involved in previous school districts, and even there I knew that that was a lot of money. I knew there was something wrong with the application, the amount of money. In addition, in my experiences in DC and in Seattle and other places where I have actually worked, the application came as a result of a technology plan that was vetted and developed in the technology department. That this application was coming to me from the facilities department was something I had never seen before. Chairman Barton. Now as a consequence of you refusing to sign that application and all that flowed from that, did the school board in San Francisco pressure you to reconsider or did they give you the benefit of the doubt or did they actually commend you? What was the reaction immediately after you refused to sign the application? Ms. Ackerman. Well, it depended upon the school board member. I got a little bit of both. I actually--I think, initially, people across the city and country thought I was a little bit crazy to turn down $50 million. There were several news stories, both locally and nationally, where I felt that there was pressure for me to at least explain myself in a rational way, why I would turn down $50 million. But at that point, I did know that there were serious investigations going on, and I would just have to wait, and time would tell the true story. Chairman Barton. But today, given the fact that we have had this plea bargain, the fine that has been paid, the $20 million fine, what is the attitude now? Are you considered a heroine in San Francisco or are you still considered that crazy superintendent who turned down $50 million? Ms. Ackerman. Well, I think I am a heroine. In addition to that, since this, this actually led to other investigations, and a couple of weeks ago we actually were awarded another $43 million settlement from an energy company that had defrauded the school district. So in the last month, we have actually gained another $50 million as a result of the phone call to then City Attorney Louise Renne. I am feeling pretty good and vindicated. Chairman Barton. Okay. Well, your forthrightness is probably going to save the U.S. taxpayers hundreds of millions of dollars--hundreds of millions, if not more. So on behalf of the country, I want to say thank you, and I would hope San Francisco appreciates you, because everybody thinks it is somebody else's money and it is free money, but ultimately it is our money. Ms. Ackerman. Absolutely. Chairman Barton. If we don't have people like you doing the right thing, the whole system falls apart. You know, we are going to make structural changes in this program statutorily probably in the next Congress, if not this Congress. The reason we are going to be able to do that is because of the stand that you have taken. So I thank you. I really--I'd love you to come down to my part of the country and be a school superintendent in one of my school districts, you know. Ms. Ackerman. Well, don't tell anybody here in San Francisco you've made that offer. Chairman Barton. Well, they would probably hoot you out of town if they thought you were coming to Texas. I want to ask one substantive question of you. Why was the facilities department, not the technology department, handling this issue for the schools in your system? Ms. Ackerman. One of the things that I discovered was basically the facilities department was a separate operation from every other department in the school district, and much of the fraud that we have uncovered came as a direct result from the fact that the facilities department was acting as a separate agency. They had their own budget, their own contract compliance manager. They didn't go through any vetted process or procedure for oversight. So a lot of this could happen, because there were no checks and balances. Now that we have a contract review, a risk management department, in addition to those two departments, and then now we separated all of the fiscal procedures and put them back in the Office of Finance, it has put in place natural checks and balances. That could never happen again. By the time it gets to me, it has gone through several layers of oversight, but this was an unusual practice, and probably one of the first things that I noticed, that this was very unusual, that this facilities department acted on its own. Chairman Barton. Okay. My staff has indicated that there was a concerted lobbying campaign undertaken to convince you to change your mind by Mr. Desmond McQuoid and Mr. Tim Tronson, the NEC company and VNCI. Do you want to elaborate a little bit on that, if it is true? Did they try to convince you to change your mind and, if so, how did they do that? Ms. Ackerman. I think there were phone calls. There was at least one meeting with some of the--I believe NEC staffpersons. I don't remember who was there. It has been a while back. There were meetings with the board, some of the board members. I did call NEC on this and, you know, felt it was really inappropriate that vendors would be talking to board members. But I am a pretty stubborn person, and you know, all of that pressure--I didn't really feel pressure at the time. I had already made up my mind, and I knew that there was a process, investigative process, underway. So it was--you know, fell on deaf ears. Chairman Ackerman. When did you think it was time, and what made you decide that it was time to contact the FBI? Ms. Ackerman. Well, we went through a facilities audit by Arthur Anderson, and there were also some recommendations in the original PCMAT report, the fiscal management audit that was done the spring before I actually came to San Francisco, and there were other contracts that appeared to be fraudulent in other areas, including our energy savings department. So there was a combination of things. I knew that the district was strapped for money and, having lived in Washington and understanding clearly that the E-Rate is a Federal grant, I did call then City Attorney Louise Renne and ask if we could call in the FBI. I knew, once they came in, that we would have an extensive investigation that would support what was already happening in the City Attorney's office. Chairman Barton. Now did anybody try to pressure you not to contact the FBI? Did anybody say I really wish you wouldn't do that; we probably ought not do that, or were you pretty well supported in making that decision? Ms. Ackerman. I was well supported. At that point I was well supported. After we read the--we submitted the audit and shared it with the board of education, the facilities audit, I think at that point everybody knew that something was wrong, and I got no pressure in terms of my wanting to call the FBI. In fact, I was very supported, including supported by Louise Renne. Chairman Barton. Okay. I want to ask Mr. Herrera here in the hearing room, how often is it that the school district would contact the City Attorney of San Francisco for assistance? Does that happen a lot, never? Mr. Herrera. Yes, it is fairly common. The fact of the matter is we provide legal counsel to the school district on a variety of matters. So we have a very good interplay. Under my predecessor, Ms. Renne, there was a very close relationship between the school district and the City Attorney's office, and that has continued since I became City Attorney. We work very closely with them on a day to day basis in terms of providing legal advice. I have a Deputy City Attorney assigned to the school district to assist Ms. Renne with general counsel duties at the school district, and there is a very close interplay also in terms of investigations of allegations of fraud and mismanagement. So it is not uncommon. Chairman Barton. Okay. Ms. Renne, how long have you been the General Counsel for the school district? Ms. Renne. It has been approximately 3 years now, Dennis? Mr. Herrera. About that. Ms. Renne. Actually, when I decided not to run for City Attorney again, I actually was going to do something quite different, but Dr. Ackerman asked me to come over and be general counsel for the school district, which I have been until June 30. Now I really feel that all of the things that Dr. Ackerman had asked us to do to basically root out the corruption, take a look at the E-Rate program, are over. So as of July 1, I am no longer the general counsel, but I continue to handle special matters for the district. Chairman Barton. But in the beginning, you were the City Attorney? Ms. Renne. I was. I was the City Attorney. Chairman Barton. Superintendent Ackerman contacted you initially in your capacity as City Attorney? Ms. Renne. Correct. Correct. Chairman Barton. And so she provided the information, and then you provided the investigative muscle to track this down? Ms. Renne. Absolutely, and if I may just say one thing, Mr. Chairman, I think Dr. Ackerman is being somewhat modest. There really was quite a lot of criticism against Dr. Ackerman for turning down these applications. In fact, there were some public hearings about it, but she was determined that we were going to root out what was going on. I would say that she and her board, the board of education, were supportive in terms of going forward with these investigations. Chairman Barton. Now your position as City Attorney was an elected position. Ms. Renne. It is elected, and then when I decided not to run, I am very happy that the voters of San Francisco had the intelligence and good luck to have Mr. Herrera as City Attorney in San Francisco now. Chairman Barton. That will be a good commercial. Ms. Renne. So be it. Chairman Barton. Did you get any pressure as City Attorney to back off the investigation? Ms. Renne. No. There was some effort, I would say, to try to not have me become general counsel for the school district, but it was minor in the scheme of things. No. Chairman Barton. I am going to yield back, Mr. Chairman. I have probably improved the reelection chances of--I don't know Mr. Herrera's political affiliation, but given it is San Francisco, it is probably not the same as mine. Ms. DeGette. If the chairman will yield, I just have to say: So rarely do we see such dedicated public servants who are doing the right thing. It is almost too much of a love fest to bear here, but we are really glad you all did what you did. Chairman Barton. My guess is, though, at the time they were doing it, it wasn't a love fest. My guess is there are a lot of people out there that thought that was what they call easy money and found money, and to stand up and do what is right at the time they did it, it was not universally acclaimed. So I again appreciate everybody involved. With that, Mr. Chairman, I yield back. Mr. Walden. Mr. Chairman, I am sure Mr. Herrera would love to have you come out and go door to door with him. Chairman Barton. I would probably lower his reelection by 20 points. Mr. Walden. The Chair now recognizes the gentle woman from Illinois. Ms. Schakowsky. I thank you, and perhaps the chairman and Mr. Herrera could pose together for a picture he could use in his campaign. I join, though, in the love fest and in thanking all of you for the--well, really, for doing your job the way it should be done. It is really a model, I think, for people around the country, and we thank you for that. I do understand. I have heard that there was some pretty negative press at the time, too, saying that, you know, you are turning the money down, etcetera. So withstanding that kind of pressure is not always easy, and I appreciate it, as we all do. Really, good work. I read in your testimony, Dr. Ackerman, that you said, ``Despite the disturbing and cautionary aspects of our experience with E-Rate, I very much hope the members of the subcommittee and the public will interpret my comments as supporting reform of the program, not its elimination.'' So I wanted to ask you if you had specific recommendations of things that could be built into the program that would reform it, and--Well, let me leave it at that for now. Ms. Ackerman. Certainly. I believe that--As I have had to put in certain procedures and processes of oversight and checks and balances, I think that that has to happen also at the Federal level, including some kind of oversight even at the district level, making sure that our procedures and processes are in place so that this will never happen again. I am not sure what they would look like at the Federal level. I just think that these two applications got through, past the district level was disturbing to me and, you know, not only as a professional but as a taxpayer. Ms. Schakowsky. Mr. Herrera testified. You said schools throughout our district would have been saddled with millions of dollars in equipment that was functionally equivalent to paperweights, and you talked about routers, cabling and switches with no servers, a phone system with no phones, a computer system with no work stations, and you add the issue of the video conference, which wasn't even eligible. Isn't that, Dr. Ackerman, a limitation of the program itself? The program, as I understand the E-Rate program, really ends at the wall; that is, that the E-Rate program itself just provides the wiring and the equipment to the wall, so that it is the school districts themselves, if you want to make it function and have the servers, the phones, the work stations, that that is an expense borne by the districts. Is that right? Ms. Ackerman. Absolutely. But what we see with the E-Rate program are discounts, and that is where--you know, of the hardware, as opposed to the infrastructure. Even with the infrastructure, though, we saw evidences of infrastructure that, I would say, was like a Cadillac and we only needed a Chevrolet is the way I like to explain it. So there are problems, I think, on both sides that we have to be aware of. The infrastructure is one that is needed, not necessarily an expensive infrastructure, and then the discounts that happen on the other side. We actually have to be sure that there are no opportunities for people to defraud the school district. So it is actually on both sides. Ms. Schakowsky. So the fraud did occur, Mr. Herrera, also on the discount part, on the equipment--or Mr. Cothran? Mr. Cothran. I wonder if you could repeat the question. Ms. Schakowsky. Well, I am concerned that, even when the infrastructure is done, that school districts can't get--end up, as Mr. Herrera described, with equipment functionally equivalent to paperweights, that they can't complete the program. I am trying to understand what are the limitations of the program itself, because it does--and then where did the fraud come in? Was there fraud dealing with servers, phones, work stations, those things that would complete the system, as well? Mr. Cothran. We can only really guess at what the plan was in San Francisco once they received--the vendors received the money. What we do know, because NEC admitted so in their guilty plea, is that they planned on using $10 million of the excessive request to fund computer work stations which would have in part help complete the project. We in the City Attorney's office strongly suspect that other portions of the inflation, if you will, were going to go to pay for handsets, phone handsets, voice mail and other things that aren't eligible. But as part of making an E-Rate application, a school district has to make sure of two things, if they want to do it properly, based on my understanding of the program. They have to make sure that they have the co-pay to pay for the equipment that E-Rate is going to be paying for. In addition to that, they have to make sure, and also certify to USAC, that they also are able to purchase the ineligible equipment that will complete the program, to complete the IT backbone, if you will, that the E-Rate program is going to pay for. At San Francisco in year three of the program when this fraud occurred, there was no deliberative process on the part of the school district to ensure that they had the additional equipment that E-Rate would not pay for, which would complete the program. We strongly suspect that one of the reasons they inflated it so grossly was to pay for that equipment with E- Rate money, which would have been a fraud on the program. Ms. Schakowsky. Dr. Ackerman, does the school district now use the E-Rate program, and do you have--did you have sufficient funds to do the match and to provide the ineligible equipment? Ms. Ackerman. Yes, we have, but it is a very scaled down application and program now, and so I think over the last year or so we have barely spent a million dollars each year on the E-Rate program. We have certainly gone through a fiscal crisis in California, and this district has been impacted by that crisis, and we now have a technology plan that drives the E-Rate program as opposed to the other way around. So I think that was what was missing at that point also, was a plan, a technology plan that would actually lay out where we wanted to go, and inclusive of that would be a budget that would match the needs of the E-Rate program and the needs of this district, prioritize those needs. Ms. Schakowsky. So while I understand that today we are focusing on your wonderful work in rooting out this fraud, I do want to ask: If the district itself had more of a budget, would your E-Rate program be more expansive or are you sufficiently providing for the needs of your kids? Ms. Ackerman. I think that we certainly would do more. As I think somebody mentioned in the technology, we are in the shadow of the Silicon Valley, and one of my big disappointments when coming to San Francisco was the fact that I felt our district needed more technology. If we want our children to leave the school system technologically competent, there is a lot of work we have to do in terms of providing more technology resources to our children and into our classrooms. So with more money, we would certainly do more. Ms. Schakowsky. Well, it is clear that you not only have your children but your taxpayers and all of the taxpayers in mind as you do your job, and so thank you again to all of you for your good work. I yield back. Ms. Ackerman. You're welcome. Mr. Walden. Thank you for your questions. We've got a few other questions. Let me kind of outline for the committee and the panels what we anticipate. We have been notified that there will be votes on the House floor sometime between now and 12:15. We would like to do another round of questions of this panel, but I understand, Ms. Ackerman, you may--or Dr. Ackerman, you may need to move on, and we understand that. So we won't keep you in this phase of the hearing. But we do have some other questions for Mr. Cothran and Herrera and Ms. Renne. So what we are looking at, we will start into that--Did you want to say something, Ms. Ackerman? Ms. Ackerman. No, I am okay for about another hour. So if you would like me to stay, I will stay. Mr. Walden. Okay. I thought it was sooner than that. The problem we are going to face, though, is we are going to break here when the bells go off in probably 5 or 10 minutes, and then we are going to recess until 1:30, our time. So it may cause you some problems. So, anyway, if you need to leave, the point is, feel free to, but we definitely appreciate what you have testified to today and the work you have done on this issue. Ms. Ackerman. I just want to say, in case I am not here when you come back, that I really do appreciate the opportunity to speak before you today and the fact that this subcommittee is looking at this issue. Again, it is unfortunate what happened to our program, E- Rate program, and the fact that it has hurt our children. But I do firmly believe in this program and the benefits that it brings to young people who would not have the access to technology, if it were not for the E-Rate program. I just hope that you will bear that in mind in your deliberations as you hear further testimony. Understand that I hope that this is not the norm. I always believe that the glass is half full, and I want to look at the benefits. So I thank you, Mr. Vice Chair, for inviting me to speak today. Mr. Walden. We want to make sure that that glass doesn't have a big hole drilled in the bottom of it, because there are a lot of schools out there that could benefit greatly by the money rather than a couple of fraudulent operators putting it in their pockets. Ms. DeGette and I were talking about how many school districts could be wired with the amount of money that could have been loaned in this case, and may have been wrongfully taken out the of the E-Rate system in other cases. So we appreciate your diligence. Ms. Ackerman. Thank you. Mr. Walden. I am going to go ahead then into the next round. Again, if you need to leave, feel free to do so. I want to go to Ms. Renne. What has happened to Tim Tronson, the former director of operations management of the facilities department? Ms. Renne. Well, Tim Tronson is, obviously, not with the school district anymore. He has been indicted by the Grand Jury in San Francisco and is awaiting trial in San Francisco on matters not necessarily related to the E-Rate. We had some other--As Dr. Ackerman indicated, we did have some other scandals, for lack of a better word, involving the school district, and Mr. Tronson has been at the heart of that. Mr. Walden. I understand. Okay. Mr. Cothran, what was the traveling road show? Mr. Cothran. The traveling road show is a term that I came up with internally when discussing the case with attorneys. That is how I described the Judy Green---- Mr. Walden. Why? Why do you describe it that way? Mr. Cothran. It is just a conversational term I used in private meetings with attorneys, you know, because they were going all over the country and doing this. Mr. Walden. I guess that is the question. From what you have seen so far, you believe they tried to perpetrate this same type of scam elsewhere in the country? Mr. Cothran. Correct. Mr. Walden. All right. Mr. Cothran. And succeeded in some cases. Mr. Walden. Yes. If you would turn to the chart on Table 133, Tab 133, I am hoping you can explain a little bit about what this chart is and where it came from. Is this relating to the 471s? Mr. Cothran. Since we are currently still in the process of litigation with many defendants, I don't want to get into too great a specificity, if it is all right with you, about where I got things and the state of my evidence. All I can say is that I have seen this document before. It is part of the evidence that is part of the City Attorney investigation, and it is our belief that this was prepared by Mr. McQuoid or at least with Mr. McQuoid's knowledge as part of his process and the process of others of trying to figure out what the heck happened when the 471 applications were filled out, and the type of inflation that occurred from bid to application. It is our belief that Mr. McQuoid was unaware at first of this second layer of fraud where the rigged bid prices were then---- Mr. Walden. He was unaware or said he was unaware? Mr. Cothran. I never interviewed Mr. McQuoid, one of my great disappointments in this investigation. Mr. Walden. Where is he now? Mr. Cothran. He is currently, I believe, in Federal prison doing 21 months for a separate fraud scheme that he was involved in with one of the E-Rate bidders. Mr. Walden. A different E-Rate bidder than we have heard from today? Mr. Cothran. An E-Rate bidder that is mentioned in my written testimony called U.S. Machinery. They were involved in a separate fraud scheme. I can explain that to you, if you want. Mr. Walden. That's fine. So you tell me what you can't answer because of your investigation, but is this relating to the 471s? Mr. Cothran. It is our strong belief that this was a document or a spreadsheet, if you will, that was created during the process that Mr. McQuoid and others engaged in, in trying to figure out what Judy Green and other parties had done when they went about filling out the 471s, taking control of that process as well, and inflating the already rigged bid price. Mr. Walden. Okay. That is what I would like to get. Can you tell us, as you look at this chart, what is the inflation rate here? How much was inflated? What are we really looking at? Mr. Cothran. It would take me a while to do that. I really--I mean, first of all, you have to understand that this is relating to just one part of the RFP. It is relating to the data portion. You have your backbone switch, your intermediate switch, your router and so forth. This would have related to the portion of the bid that was won by NEC outright in the initial process that Green and Marchelos ran, and then was inflated even further on the 471. It is just one of several aspects of the project. So it looks here like he is trying to figure out how the NEC bid on data had been inflated when the 471s were filled out. Mr. Walden. I guess that is what we are trying to figure out, is how did they manipulate this 471 process? How did they basically double the bids? Mr. Cothran. They just filled it out. They just filled out the 471 application. Mr. Walden. And just put in whatever numbers they wanted? Mr. Cothran. I encourage you to read the NEC guilty plea. I think there is a very articulate explanation of that process in their guilty plea. They just--A party referred to as Consultant 1 and later referred to by the feminine pronoun, she, directed NEC representatives what amounts that she wanted on the 471, and then I believe the NEC guilty plea says that spreadsheets, phony spreadsheets were created to justify those prices she dictated, and that was what was submitted as the 471. Mr. Walden. So the elusive Ms. Green, whom we are not able yet to find to serve the subpoena, but will, is the one who you say was basically telling NEC people what to put on the 471s for numbers? Mr. Cothran. Based on my investigation, and setting aside for a second what the NEC guilty plea says--Based on my investigation, the conclusion we reached is that Judy Green, and to some extent George Marchelos, were the architects of drafting and submitting the 471, and it is also our strong belief that Desmond McQuoid was not part of that process and didn't know anything about it. So we have a case where, at this stage of the fraud, no one at the school district, not even school district co- conspirators, were knowledgeable, it is our investigative conclusion--were knowledgeable about this layer of fraud until later. When he found out, as I said, he had a choice to make, and he chose to join the fraud. Mr. Walden. Interesting. So it sounds like you had--From what you have said, you had two frauds going. Mr. Cothran. Right. Mr. Walden. And you had one group committing a fraud down here unbeknownst to the other group until they kind of--How did they tumble on it? Mr. Cothran. I don't know how Mr. McQuoid found out that the 471---- Mr. Walden. But when he did, it is your opinion that he said, great, let's up the ante? Mr. Cothran. Well, I think that he might have pitched a fit, but we do know for certain he didn't blow the whistle. He didn't tell any law enforcement officials. He didn't tell our office. He didn't tell USAC. He didn't tell anyone and, as a matter of fact, he then went to NEC and got them to agree to use some of this inflated portion to pay for ineligible equipment. Mr. Walden. If you could please turn to Tab 19, this is an e-mail that shows an employee of NEC marking up prices and making up part numbers on VNCI equipment. What do you think this was? Was he working on the 471's pricing? Tab 19. Mr. Cothran. Yes, I am getting there. It is a rather convoluted e-mail, and it has a lot of assumed knowledge embedded in it that the recipient knows what they are talking about. My guess would be, my educated guess on this is there is evidence embedded in this e-mail that VNCI equipment, or references to VNCI equipment on parts lists in other parts of 471 applications was obscured and changed in order to conceal the nature of the equipment, since it was ineligible. That would be my educated guess. Mr. Walden. Okay, Tab 16. This document is an e-mail in which an NEC employee--hopefully, I will get the pronunciation somewhere correct--Sohail Qasim, expresses concerns about Judy Green and talks about, ``money and a system that will not work properly.'' So first, we don't believe the school district even needed this project and, second, it would appear from this e- mail that the system might not even work properly. Mr. Cothran. On the first part of your question, it is certainly the overwhelming opinion of members of the Information Technology and Telecommunications Division, the proper avenue for E-Rate funding, that this system was utterly and completely unnecessary. There was already a wide area network and local area networks operating in the school district, and nearly all the schools had Internet access, computers, routers, switches, data, everything, and that this, in their opinion, not only conflicted with the system that they already had in place and were in the process of building through E-Rate applications and other funding avenues, but that it was entirely unnecessary. Mr. Walden. All right. Turning to Tab 27, this is an e-mail to Tom Burger, the CEO. Mr. Cothran. Which number? I'm sorry. Mr. Walden. Twenty-seven, which talks about in-kind NABSE bonus and value added section, NABSE bonus and value added section. Mr. Cothran. Twenty-seven? I apologize. Mr. Walden. Twenty-seven. Mr. Cothran. Twenty-seven is a spreadsheet of prices. It is not a--It doesn't refer to NABSE bonus, 27, 2-7. In my binder, it is not that. Mr. Walden. We will have it brought down. Mr. Cothran. What I can tell you is that my investigation did not touch on the NABSE arrangement or relationship with any of the parties involved in our lawsuit. We are interested in learning more about that, but it did not form part of my investigation. Mr. Walden. All right. So you are then not familiar with the in-kind contributions known to NEC, within NEC as the NABSE bonus? Mr. Cothran. It was not part of my investigation. It did not touch on that, no. Mr. Walden. All right. Could you talk to me about the Inter-Tel Trojan horse? What is that? Mr. Cothran. Well, that is another term that I made up when discussing the case internally with attorneys. That, to me, was how I described Inter-Tel serving as a Trojan horse for VNCI, because of the percentages of equipment differential that I saw in not only the San Francisco E-Rate application but in documentation related to other E-Rate applications for Inter- Tel or NEC that were funneling VNCI equipment. When talking about the case internally, I explained to attorneys that in these situations, you know, if the same percentages that we saw in San Francisco, which was $15 million of a $20 million bid--of a $20 million Inter-Tel bid being VNCI equipment, it was really essentially a VNCI bid parading as an Inter-Tel bid, if you follow me, since the vast majority of the funding would have gone to pay for VNCI equipment. In that way, I explained to the attorneys in the office using that term, that at least in the case of San Francisco, Inter-Tel appeared to have been acting as a Trojan horse for VNCI, because of also the additional acts of concealing the ineligibles. Mr. Walden. And it was hidden on the form. Mr. Cothran. It was hidden. PBX parts lists that were submitted to USAC, according to a witness, purposely obscured the nature of the equipment, and not as it relates to San Francisco but as it relates to other school districts, documents indicate that, when USAC asked probing questions about that very equipment and about its functionality, that the answers that flowed back from the school district did not reveal that it was videoconferencing equipment. It is our strong belief and suspicion that those school district responses were controlled by Judy Green, George Marchelos, and representatives of Inter-Tel and/or NEC. Mr. Walden. When you say controlled by Judy Green or these others, is that to say that the school district had no knowledge of the responses? Mr. Cothran. I think what you are going to find eventually, and I think what we are going to find in the course of our litigation is a variety of situations across the country. You will sometimes find that there was a Desmond McQuoid figure at the school district who was knowledgeable about parts of the scam but not all of it. You will find, I would guess, situations where the school district officials were utterly blind to the fraud that was going on and were just more than happy to have these people getting them this money that was so sorely needed by their districts, which is one of the things that we found rather distasteful about this scam, is that they preyed on the desperation of poor, underfunded school districts. Mr. Walden. Are there other Judy Greens out there? Have you stumbled across any? Mr. Cothran. Not in the course of my investigation. I wouldn't be surprised. Mr. Walden. All right. We are going to recess now until 1:30. There are some additional questions we have for this panel, and then we will reconvene, as I say, at 1:30. So we will stand in recess. Thank you again for your patience, and we look forward to reconvening after our votes. [Brief recess.] Mr. Walden. I am going to call the Subcommittee on Oversight and Investigations back to order, and I again thank you for your patience in bearing with our legislative schedules today. Mr. Cothran, there are a number of documents I would like to walk through with you, Tabs 51, 53, 58, 62, 124. We will go through them one at a time. Could you take us through the Item 25 review and the falsified documents that were submitted by Judy and George? Mr. Cothran. Well, as I pointed out in my testimony, there were several documents that flowed from the school district to USAC in response to USAC inquiries. It is my understanding that those inquiries from USAC existed on two levels: One, the sort of initial routine review that, I think, is performed on all applications; and then some applications, but not all applications, are selected for what is called an Item 25 review, which is an elevated and more detailed level of review. All applications flowing out of San Francisco Unified School District that funding year were subjected to an Item 25 review because of questions USAC had about how unit costs, which are amongst the highest in the nation, that attended the Desmond McQuoid applications and also the sort of what we in the City Attorney's office are terming the gold plating that went on with the proposal, the most striking example being the proposal to create a Local Area Network in every classroom which would have meant a server and switches in every classroom. So this is my understanding---- Mr. Walden. What would a LAN in every classroom serve? Why would you do that? Mr. Cothran. It is the opinion of the City Attorney's office that it would serve no function other than to drive up the cost of the proposal and put more money in the pockets of the people who perpetrated this fraud. Mr. Walden. All right. Tab 58, Judy Green giving Desmond McQuoid responses for the SLD. Do you have a comment on that one? Mr. Cothran. This appears to be--Let me see. Okay, I did not have an opportunity to review this. So would you mind if I just read through it? Mr. Walden. That's fine. Go ahead and take your time. Mr. Cothran. Okay, I have read enough of it to issue my opinion on this. This is interesting to me. This puts together a piece of the puzzle I didn't have before. Mr. Walden. How so? Mr. Cothran. What I did know is that Desmond McQuoid sent an e-mail to USAC in response to USAC questions about budget documents that flowed from the school district to USAC purporting to show that there was more than $40 million in E- Rate matching funds. An E-Rate reviewer, I believe, by the name of Tom Schnipp caught a discrepancy between that document that Mr. McQuoid and Mr. Tronson under his signature sent to USAC and the actual document that was on the website. I think it is also interesting for you to know that at this point in time the school district budget--this was in August of 2000. As you will see, this e-mail was on August 8, 2000. Mr. Walden. Yes. Mr. Cothran. The document that was sent from SFUSD to USAC purporting to show this E-Rate matching fund line item of $41- some-odd million was dated August 1. Who knows when it was actually sent. I think it was actually sent more in the week of August 22, but I won't bog down with such niggling details. Desmond McQuoid--It is our belief that Desmond McQuoid, Tim Tronson conspired--and others, including people of VNCI, conspired to send this fraudulent budget document to USAC showing that they had the matching funds. As a matter of fact, they had more than the needed matching funds, $41 million. Unfortunately, that was a lie. That was just not true. Matter of fact, the school district had actually decreased their E-Rate matching fund line item elsewhere in the budget from $1.2 million, I believe, to zero. So they had---- Mr. Walden. Zeroed out their line item matching. Mr. Cothran. For that year. Mr. Walden. For that year. Mr. Cothran. So this alert USAC reviewer, Tom Schnipp, caught this. They caught the discrepancy between the budget that flowed from Tronson, McQuoid and others to USAC and the one that was on the website. He simply went on the web and found the real budget. Then he e-mailed Desmond McQuoid. Mr. Walden. Right. Mr. Cothran. And asked him about this discrepancy. The e- mail that flowed back from Desmond McQuoid's e-mail address at San Francisco Unified School District was a classic example, in my opinion, of tap dancing around a difficult question where you just don't want to answer it, because the answer would put you into trouble. This shows me for the first time that my long held suspicions, and our long held suspicions, that Judy Green directed him to do that or directed him in some way in answering that question was indeed confirmed by this e-mail. It shows that Judy Green sent to Des, which was the prefix of his e-mail address, how to answer the questions Tom Schnipp had. As I just read the first two or three items, it comports with my memory of Desmond McQuoid's e-mail to Tom Schnipp, this tap dancing e-mail that I told you about. So it indicates to me in a very clear way that Judy Green was behind the budget document flowing--the fraudulent budget document flowing to USAC, and also in attempting to help Mr. McQuoid explain away the discrepancy that resulted. Mr. Walden. Would you mind turning to Tab 124? I believe that is the budget, the altered budget, allegedly altered budget. Mr. Cothran. Oh, I got the date right. Good, August 1. I know that to be Tim Tronson's signature from other exemplars I have seen. If you look at Bates USAC Sub 4855 toward the bottom under the general category of Other Outgo---- Mr. Walden. Right. The E-Rate District Manager. Mr. Cothran. The E-Rate District Manager. I have in my file received from the CFO of the school district this actual page, and it includes no such line item. Mr. Walden. And on the next page I think you will see the actual budget line item. Mr. Cothran. Right. Right. I actually have the actual--You are right, and this shows it, I believe, being zeroed out, if I am not mistaken. Mr. Walden. On 125, I guess. Mr. Cothran. Oh, on 125. I'm sorry. Right. This apparently looks like what Mr. Schnipp found on the website, which shows that Other Outgo line item on Bates 4796--there is no such line item. They simply got into that document and altered it and falsified it and sent it to USAC, and that e-mail indicates to me rather strongly that Judy Green was involved in that conspiracy. Mr. Walden. So you had a USAC reviewer--or not you, but there was a USAC reviewer who caught this, is what you are saying? Mr. Cothran. Yes. Based on written questions I submitted to E-Rate--Sorry. I submitted written questions to USAC at their request, and they submitted written answers sometime in the April timeframe of 2002, shortly before we filed our lawsuit. Amongst those written answers Mr. Schnipp explained to me his experience with this document. Mr. Walden. So he spotted it before you raised the questions? Mr. Cothran. I got most of my documents relating to the San Francisco Unified School District application from USAC. They were very helpful in that regard. Mr. Walden. But my point is, did you trigger Mr.--Sip, is it? Mr. Cothran. No. Mr. Schnipp did this all on his own. Mr. Walden. He did it all on his own? He spotted it? Mr. Cothran. He spotted it in the year 2000. My investigation didn't start until the following year. Mr. Walden. Okay. Then what happened with what he learned? Mr. Cothran. I reviewed his answers to my questions last night for the first time in a while, and he, in sum, told me that he doubted the accuracy of the document. His answer was not sufficiently--His questions about the discrepancy between the online document and the document Mr. McQuoid sent him were not settled by Mr. McQuoid's tap dancing e-mail. Mr. Walden. Got it. Mr. Cothran. And he alerted his superior, who at the time was, I believe, a gentleman named Mark Werner, given other information that flowed from USAC to me, who was then, I believe, the manager of program integrity assurance select review--I may have that title a little wrong--and alerted him to the problem. Mr. Walden. Verbally or in writing? Mr. Cothran. I don't think--Well, I don't think it specified, but what I do know is Mr. Schnipp informed in his written replies to my questions that he alerted his superior to this problem, and passed the file on up the chain of command, so to speak, with his concern attached to it, so to speak, and that was the last time he saw that file, and he could not answer my questions about why, despite this, the funding request was approved. At the time that he answered my questions, which was some 2 years later, he still didn't know how and why and by whom it had been approved, according to his written answers to my questions. Mr. Walden. Have you pursued that line of questioning within USAC? Mr. Cothran. When I got the answers, it was in April of 2002, and we were busy preparing a lawsuit, and our energies were focused on that. And, no, I did not pick up on that line of inquiry again. Mr. Walden. I guess the question would be: Is there any back-door channel going on here between USAC and some of the conspirators and co-conspirators? Mr. Cothran. I think that is a legitimate question to ask. Mr. Walden. All right. Could you turn to Tab 77? This is an e-mail describing how Judy Green at VNCI has a high level contact within USAC. Mr. Cothran. Yes, I read this earlier today. Seventy-seven, you said? Mr. Walden. Yes, sir. Do you think that Judy Green had a contact inside USAC? Mr. Cothran. Well, you know, I have always ascribed to Clint Eastwood's maxim of a man has to know his limitations, and as it regards this investigation I will observe that maxim, and I don't have any evidence that she did, and I really don't want to speculate on that. Mr. Walden. I understand. Mr. Cothran. I just think speculating on that would be irresponsible. Mr. Walden. I understand. But you do think it is a question that is worth asking of somebody? Mr. Cothran. Yes, I think it is a line of inquiry that is definitely worth following up, absolutely. Mr. Walden. All right. Looking at Tab 90, Desmond McQuoid e-mail discusses a year four 471 application, so for the fourth year 471 application, that Desmond says was submitted with his name on it that he knows nothing about. Mr. Cothran. That is my information as well. During the course of my investigation I uncovered evidence that Mr. Marchelos approached individuals at the school district the following funding year with an E-Rate application, walking into people's offices literally and trying to find some official at the school district to sign the document so that it could be submitted to USAC. An alert CFO assistant--assistant to the CFO had a conversation with Mr. McQuoid that she--I mean, sorry, Mr. Marchelos that she reported to me. Basically, her version--My memory of her version of events is that he was going into offices, looking for some sort of official signature to place on what I believe to be a 471 Form for year four, and I don't believe that was ever accomplished. Mr. Walden. Okay. That is not the one that Dr. Ackerman refused to sign, is it? Mr. Cothran. I don't know. Mr. Walden. All right. I don't mean to dwell on this, but I guess I will for a moment. I want to go back to this Judy Green/USAC issue. Has anybody told you they thought there might be a contact going on there? Mr. Cothran. Yes. I had one witness tell me that his belief was that--or suspicion was that she had someone inside USAC who helped her out. Mr. Walden. All right. I think we just have one more question for this panel. Do you have any reason to believe that the schools and school districts in which NEC BNS was either awarded or subcontracted other questionable E-Rate deals were at all complicit in the conspiracy to defraud the E-Rate program? So were there schools or school districts that you are aware of? Mr. Cothran. Where NEC was---- Mr. Walden. Yes, in which NEC BNS was either awarded or subcontracted other questionable E-Rate deals? Were they at all--Were any of those school district complicit? I am delighted we have a Dr. Ackerman at San Francisco. Given what we are learning about all this, it seems like corruption can run rampant in this program. Mr. Cothran. The only information I have on that front is the information that the CEO and principal of Ceria M. Travis shared with me in those two interviews I had with her. It was my impression from those interviews that this individual, Ms. Johnson, Dorothy Travis Johnson, was uncomfortable with what was going on around her, was suspicious. Her antennae were raised by it, but she didn't understand enough about the process, either competitive bidding process or the E-Rate process, to follow through her thinking to the point where she would have been complicit or have guilty knowledge. That was my impression of her, but this was only from two brief phone interviews. So I think the value of that is somewhat limited. Mr. Walden. I think just one more question of each of you. As we struggle with this issue, do what is right to make sure the program functions as it was intended, that it doesn't get ripped off by people for ill gotten gains, what would you do if you were us? What are the one or two most important things we can do to fix USAC and fix the oversight? You know, you have answered everything so far. We will let you breathe for a second. Mr. Cothran. Thank you. Mr. Walden. Ms. Renne? Ms. Renne. Well, I think, first of all, with regard to school districts, as Dr. Ackerman indicated, you need to make sure that internally your procedures are strong. Of course, that is something only school districts can do, but certainly in the review process that ought to be looked at. I think, second, if I were sitting in your shoes, I would be taking a look at this program in not only San Francisco but in a variety of school district areas across the country, which I think you are already. Mr. Walden. Right. Ms. Renne. And I would certainly take a look at the organization that is doing the review. Are they sufficiently distanced from---- Mr. Walden. Independent? Ms. Renne. And independent to be able to take an independent look at the program, and to be ready to ask the tough questions? Mr. Walden. Mr. Herrera? Mr. Herrera. To echo Ms. Renne's comments, I think that one thing that we have learned through our office's investigation, not just of this matter but other waste, fraud and abuse cases that we are looking into in our office, is the necessity for strict internal controls to make sure that the administrative agencies have their own house in order and, to the extent that you have a Federal overlay, obviously, there is the opportunity for waste, fraud and abuse to enter into it at another level. So at least from our perspective, certainly, there is a responsibility that school districts have their own internal house in order, and that aids investigative agencies immeasurably. But from your perspective, I think that looking at how the oversight of the program is structured and whether there needs to be more direct government oversight is something that, I think, you need to take a very serious look at. Mr. Walden. Well, it just really troubles me what I have come to better understand through this hearing and the data behind the hearing is that you have a dedicated public servant who within USAC says this doesn't look right, these budget numbers don't add up--I mean, I would think somebody would put a screeching halt on the whole application and demand a review to find out--At minimum, ask the question. I guess we will ask USAC that later, but then to go ahead and move forward when you've got an identified altered budget document. We are not talking pennies here. What is it, $48 million? Mr. Cothran. $41.5 million. Mr. Walden. 41.5. Mr. Cothran. And this is a document that had--You know, this is a point on which, I was informed by Mr.Schnipp, that had--they verified to a certainty further up the chain, I imagine, that they didn't have the funds. Mr. Walden. That it had been altered? Mr. Cothran. The decision would have been entirely the opposite, that they would have received no money. Mr. Walden. So they had verified with the school district that they had no money in their legitimate budget to match against this? Is that what you are saying? Mr. Cothran. I wouldn't put it that way. They verified by checking the budget document online that was the true budget document that was different from the budget document that Mr. McQuoid sent them, and now apparently with the help of Ms. Green. And they saw this discrepancy, this rather striking discrepancy. Mr. Walden. Do you know if the folks at USAC then got hold of the superintendent's office or the chairman of the school board or somebody and said, hey, we are seeing this discrepancy, can you explain it? Did they ever ask for an explanation, that you are aware of? Mr. Cothran. I don't know if they ever sought further confirmation through the school district. I think that is a question better put to USAC. Mr. Walden. For USAC? Okay. I really again appreciate not only your work but your testimony and your patience today with our process. Thank you very much for being here. We appreciate it. Mr. Walden. At this time the Chair will call forward the following witnesses: Mr. Thomas Burger, President and CEO of NEC Unified Solutions, Inc; Mr. William Holman, former Vice President of Sales for NEC BNS; Mr. George Marchelos, former consultant to and employee of Video Network Communications, Inc; and Ms. Judy Green, wherever she may be, former consultant to and employee of Video Network Communications, Inc. Please come forward and be seated at the table. Before we proceed any further, I would like to note the absence of Ms. Judy Green. The committee invited her to testify today, as I mentioned earlier, but she did not respond to that invitation as we requested. Subsequently, the committee issued a subpoena to command her attendance here. The United States Marshals have attempted for the past week to serve Ms. Green. They have staked out her home and have personally spoken to her husband, but she is nowhere to be seen, apparently shopping for a new home, but her husband does not expect to hear from her until Friday at the earliest. That is tomorrow. We will enter into the record the Marshals' e-mails regarding their attempts to serve the subpoena. [The information referred to follows:] [GRAPHICS NOT AVAILABLE IN TIFF FORMAT] Mr. Walden. As you know, when conducting an investigative hearing, this subcommittee follows the practice of taking testimony under oath. So if you would, please rise and raise your right hand. [Witnesses sworn.] Mr. Walden. Let the record show they all indicated ``I do.'' Please be seated. Gentlemen, under the rules of the House and this committee, you have the right to be advised by counsel as to your Constitutional rights. Do you have legal counsel here today,Mr. Burger? Mr. Burger. Yes, sir, I do. Mr. Walden. Can you please state for the record the name of the counsel that is here today to advise you with respect to such matters? Mr. Niespolo. Mr. Chairman, my name is George D. Niespolo, and I am counsel for Mr. Burger. Mr. Walden. Thank you. The Chair--let's go on down then. Mr. Holman? Mr. Holman. Yes, Mr. Chairman, I am represented by counsel. It is Mr. Greg Evans. Mr. Walden. Okay. If you could kind of lean toward the microphone, that will be good. Mr. Evans. Good afternoon, Mr. Chairman and committee. My name is Gregory Evans of the law firm of Orrick, Herrington & Sutcliffe, representing Mr. Holman this afternoon. Mr. Walden. Thank you for being here. Mr. Marchelos? Mr. Marchelos. No, I do not. Mr. Walden. Do not have counsel? Okay. Mr. Donovan? Mr. Donovan. Yes, Mr. Niespolo is counsel for me also. TESTIMONY OF THOMAS J. BURGER, PRESIDENT AND CEO OF NEC UNIFIED SOLUTIONS; INC; WILLIAM HOLMAN, FORMER VICE PRESIDENT OF SALES FOR NEC BNS; GEORGE MARCHELOS, FORMER CONSULTANT TO AND EMPLOYEE OF VIDEO NETWORK COMMUNICATIONS; JUDY GREEN, FORMER CONSULTANT TO AND EMPLOYEE OF VIDEO NETWORK COMMUNICATIONS, INC.; AND TIMOTHY M. DONOVAN, FORMER SENIOR VICE PRESIDENT AND GENERAL COUNSEL, NEC USA, INC. Mr. Walden. All right. Thank you. The Chair now recognizes Mr. Burger for purposes of making an opening statement, if you so desire. Mr. Burger? Mr. Burger. I don't have an opening statement, no, sir. Mr. Walden. Very well. The Chair now recognizes Mr. Holman for purposes of making an opening statement, if you desire. Mr. Holman. Mr. Chairman, I do not have an opening statement. Thank you. Mr. Walden. Very well. The Chair now recognizes Mr. Marchelos for purpose of making an opening statement if you so desire. Mr. Marchelos. No opening statement, sir. Mr. Walden. Very well. We will be back at you in a moment, Mr. Donovan. Mr. Burger, this morning we heard from San Francisco City Attorney's Office, and this afternoon, about an elaborate conspiracy between individuals at NEC BNS and VNCI, including Judy Green, George Marchelos and others, in which the co- conspirators eliminated competitive bidding and inflated prices on contracts related to the E-Rate program. As you know, NEC BNS pleaded guilty to conspiracy to suppress and eliminate competition for E-Rate program projects and to wire fraud. As the President and CEO of NEC BNS, were you aware of the conspiracy by NEC BNS, VNCI, Judy Green, George Marchelos and the others to defraud the E-Rate program by rigging bids, inflating contract prices, forging the signatures of school district officials, and lying to USAC during its review process? Mr. Burger. Mr. Chairman, as you know from my correspondence and my request to appear at a future hearing, it is my sincere desire to cooperate with this subcommittee's investigation. However, due to the ongoing Department of Justice investigation and on advice of counsel, I respectfully decline to answer the question on the basis of the privilege afforded me under the 5th and 14th Amendments of the United States Constitution. Mr. Walden. Mr. Burger, are you then refusing to answer all of our questions on the right against self-incrimination afforded to you under the 5th Amendment of the U.S. Constitution? Mr. Burger. Yes, Mr. Chairman. Mr. Walden. And is it your intention to assert such right in response to all further questions from the subcommittee today? Mr. Burger. Yes, Mr. Chairman. Mr. Walden. Given that, if there are no further questions from the members, I will dismiss you at this time, subject to the right of the subcommittee to recall you, if necessary. So at this time, you are excused. Mr. Burger. Thank you, Mr. Chairman. Mr. Walden. Thank you for coming. Mr. Holman, this morning we heard from the San Francisco City Attorney's Office about an elaborate conspiracy between individuals at NEC BNS and VNCI, including Judy Green, George Marchelos, and others, in which the co-conspirators eliminated competitive bidding and inflated prices on contracts related to the E-Rate program. As you know, NEC BNS pleaded guilty to conspiracy to suppress and eliminate competition for E-Rate program projects and to wire fraud. As the former Vice President of Sales for NEC BNS, were you aware of the conspiracy by NEC BNS, VNCI, Judy Green, George Marchelos, and others to defraud the E-Rate program by rigging bids, inflating contract prices, forging the signatures of school district officials, and lying to USAC during its review process? Mr. Holman. Mr. Chairman, on advice of counsel, I respectfully decline to answer the questions on the basis of my 5th Amendment rights under the United States Constitution, on the basis that any testimony might be a witness against myself. Mr. Walden. Mr. Holman, are you refusing to answer all these questions on the right against self-incrimination afforded to you under the 5th Amendment of the U.S. Constitution? Mr. Holman. Yes, Mr. Chairman. Mr. Walden. And is it your intention to assert such right in response to all further questions from the subcommittee today? Mr. Holman. Yes, Mr. Chairman. Mr. Walden. Given that, if there are no further questions from the members, I will dismiss you at this time, subject to the right of the subcommittee to recall you, if necessary. So at this time, you are excused. Mr. Holman. Thank you, sir. Mr. Marchelos, this morning we heard from the San Francisco City Attorney's office about an elaborate conspiracy between individuals at NEC BNS and VNCI, including Judy Green, yourself, and others in which the co-conspirators eliminated competitive bidding and inflated prices on contracts related to the E-Rate program. As you know, NEC BNS pleaded guilty to conspiracy to suppress and eliminate competition for E-Rate program projects and to wire fraud. As a former employee of VNCI who extensively assisted Mr. Desmond McQuoid with San Francisco's E-Rate program, were you aware of the conspiracy by NEC BNS, VNCI, Judy Green and others to defraud the E-Rate program by rigging bids, inflating contract prices, forging the signatures of school district officials, and lying to USAC during its review process? Mr. Marchelos. Mr. Chairman, because of the ongoing criminal and civil investigations, I must invoke my 5th Amendment rights. Mr. Walden. Mr. Marchelos, are you refusing to answer all of these questions on the right against self-incrimination afforded to you under the 5th Amendment of the United States Constitution? Mr. Marchelos. Yes, sir. Mr. Walden. And is it your intention to assert such right in response to all further questions from the subcommittee today? Mr. Marchelos. Yes, sir. Mr. Walden. Given that, if there are no further questions from the subcommittee members, I will dismiss you at this time, subject to the right of the subcommittee to recall you, if necessary. So at this time, you are excused. Mr. Marchelos. Thank you, sir. Mr. Walden. At this time, the Chair calls forward our next witness, Mr. Tim Donovan, former General Counsel for NEC-USA. We appreciate your being at the table. As you know, in conducting an investigative hearing, the subcommittee has the practice of taking testimony under oath. We have already sworn you in under oath. So we appreciate your being here today, and I just remind you, you are under oath, and we would welcome an opening statement, if you have one, sir. TESTIMONY OF TIMOTHY M. DONOVAN Mr. Donovan. Thank you, Mr. Chairman. Good afternoon to Mr. Chairman and the distinguished members of the subcommittee. My name is Timothy Donovan, and during the time period relevant to the matters before you today, I was acting as Senior Vice President, General Counsel and Corporate Secretary of NEC-USA, and I was also Corporate Secretary for NEC Business Network Solutions. Although I left that position at the end of March 2004 after 20 years within the NEC organization, I remain an officer today, Corporate Secretary, of one of the other affiliates, and I am happy to be able to testify here today. For some time now, my colleagues and I have been asking ourselves what I am sure members of this distinguished committee are asking themselves as well: How did a good company with thousands of dedicated and hard working employees and a program with admirable goals get to the point we are today? I will do what I can to answer that question, but I think the more important question for NEC, since we have already admitted our wrongdoing, and for everyone involved in E-Rate is: How can we ensure this never, never happens again? During the time in question, BNS had more than 1,000 employees spread across 36 offices around the United States. This company provided systems and installation maintenance not only to educational institutions, both under the E-Rate program and many other programs, but to the financial, health care and many other industries. During the time that BNS was actively involved in E-Rate, the program revenues were only about 3 to 5 percent of BNS total revenues. The company did not have more than five employees out of the 1,000-plus employees that worked for BNS dedicated to sales on E-Rate, and BNS' primary business focus was on the private sector. It is not typically a government contractor. BNS' first serious involvement in the E-Rate program began in late 1999. As the subcommittee may be aware, it is not unusual for a company like BNS to team with a consultant that is a specialist in a particular area, and VNCI held itself out as an E-Rate expert. In 1999, BNS entered into a teaming arrangement with VNCI, the consultant in the telecommunications field and the vendor of certain types of telecommunications products that were going to be offered. This initial effort involving NEC and VNCI was the project for San Francisco Unified School District, an opportunity that was identified for BNS by VNCI. From the moment NEC learned that DoJ was investigating San Francisco schools in 2001--and this was before NEC knew that it was the target of the investigation--and after we learned later that the company was itself a target in the inquiry, NEC has fully cooperated with the government. In October 2002 we made a commitment to the Justice Department to accept full and complete responsibility for the conduct of these employees, and sought to resolve all issues. I believe the committee has received a letter--the staff has received a letter from the Department of Justice which applauds NEC for its full and continuing cooperation in this investigation. This was not a cover-up situation. As part of that resolution announced this past May, BNS has taken steps to ensure that this conduct is not repeated and that all of its employees will act responsibly and properly. Some of these steps include empowering a compliance officer with broad powers to oversee compliance in government contracting and elsewhere. It is my understanding that a person with substantial government contracts and internal audit experience has accepted that position and will shortly start employment with the company Commencing the training of all employees in established ethics and compliance policies and procedures; implementing expanded services for its anonymous hotline, so that employees can report suspected wrongdoing or unethical conduct; scheduling regular audits of all government contracts; and BNS is also agreed to provide periodic reports and permit the FCC to conduct annual audits of all of its activities in this area. Our company has learned an expensive lesson, an embarrassing lesson, but certainly a valuable lesson. The E- Rate program with effective oversight and management can assist needy schools. At the same time, please do not lose sight of the fact that there were many diligent, hard working field engineers and other employees within BNS who were implementing Internet solutions within schools unaware of the wrongdoing by a few. They believed they were making a meaningful effort to enhance the success of students in those schools. Mistakes that were made by a few BNS employees tarnished this effort and all of our beliefs. Thank you for allowing me to appear before you today, and I hope I can answer your questions. [The prepared testimony of Timothy M. Donovan follows:] Prepared Statement of Timothy Donovan Former Senior Vice-President, General Counsel and Corporate Secretary, NEC USA, Inc. Good morning, Chairman Greenwood, distinguished members of the Subcommittee. My name is Timothy Donovan. During the time period relevant to the matters before you today, I was acting as Senior Vice- President, General Counsel and Corporate Secretary of NEC USA, Inc. and Corporate Secretary of NEC Business Network Solutions, Inc. (BNS). Although I left my position at the end of March 2004, having completed almost 20 years within the NEC organization, I remain an officer today of one of the affiliated companies. I appreciate the opportunity to appear before the Committee today and address matters relating to the E-Rate Program, created by the FCC under the Telecommunications Act of 1996. As Secretary of BNS, I had no role in its day-to-day activities. Other corporate executives of BNS might have more direct knowledge of the events that are the subject of your questions today, but as you are no doubt aware, the Department of Justice is conducting an ongoing criminal investigation. It is expected that this investigation may be concluded in a matter of a month or so. I am advised that, due to the pendency of that investigation, legal counsel to other executives you invited to testify advised them that it would be inappropriate for them to testify today. I understand that counsel for these individuals have asked that these hearings be postponed until September or October, to give the Justice Department time to complete their ongoing investigation, so that management of BNS would be able to participate and give substantive testimony after the conclusion of that process. Since the Committee's schedule would not allow a postponement, and consistent with BNS' commitment to provide full and complete cooperation with all relevant inquiries into this matter, BNS asked, and I agreed to appear and give testimony for the Committee today. With your understanding of these circumstances, I will do my best to assist the Committee in its inquiry at this time. i. background of bns involvement in the e-rate program in san francisco and elsewhere BNS was founded in 1989 as a multi-systems integrator and a direct sales and service organization for NEC America, the NEC America subsidiary that markets and sells telecommunications equipment and systems in the U.S. BNS designs, sells, installs and services a broad range of voice, data, and video communication systems and networks. BNS has in excess of 1000 employees spread across 36 regional sales and operations offices. A very small proportion of these employees ever had any involvement in the E-Rate Program. BNS' first serious involvement in the E-Rate Program began in late 1999. Although BNS was aware of the program, prior to 1999 it had no significant involvement in the E-Rate Program, or government contracting in this sector, for all intents and purposes. In 1999, however, BNS entered into a teaming arrangement with VNCI, a consultant in the telecommunications field and vendor of certain telecommunications (video related) products. The main contact with BNS at VNCI during the early stages of the relationship was Ms. Judy Green. VNCI assisted BNS in identifying potential school districts and opportunities. Ms. Green and VNCI assisted the schools in their consideration of E-Rate funding. BNS participated in the E-Rate Program by selling and installing data equipment and telecommunications equipment to school districts that qualified for funding under the E- Rate Program. BNS provided systems and installation and maintenance not only to educational institutions, but to the financial sector, healthcare sector, and many other industries and customers. During the time that BNS was actively involved in the E-Rate Program the E-Rate Program revenues constituted a little over 3% of the gross revenues of BNS. At the start of its venture into the E-Rate business, BNS had three sales and marketing employees who were involved full or part time in this sector. At the conclusion of BNS' participation, there were about 5. The activities were conducted for the most part in one of the company's regional offices in the San Francisco Bay Area. These individuals did not have extensive prior experience in government contracting or, for that matter, the E-Rate Program prior to the Year 3 bids that BNS submitted. The initial effort involving NEC and VNCI included the project for San Francisco Unified School District (the ``SFUSD''), an opportunity identified by Ms. Green and VNCI. This was a bid effort for what is generally referred to as Year 3 E-Rate Funding. In January 2000, a few weeks after establishing the teaming relationship with VNCI and Ms. Green, BNS submitted a bid for E-Rate work to the SFUSD. By the time BNS suspended all activity relating to E-Rate, it had already severed the consulting relationship with VNCI and Ms. Green. ii. the justice department investigation, bns cooperation and the resulting bns settlement In the Summer of 2001, BNS learned that there was an investigation into the SFUSD; and BNS cooperated with the investigation, unaware at that time that the investigation concerned BNS. By the end of October 2002, it had become apparent to BNS that some of its employees' activities were in fact involved in the investigation. At that time, BNS retained independent legal investigators to begin a full scale internal investigation into BNS' E-Rate operations. That process continued over many months and included interviews of witnesses, review of documents, e-mail and other records. As soon as BNS began to appreciate the nature of the activities by this small group of individuals engaged in E-Rate Program marketing and sales, BNS suspended all requests for payment with the Schools and Libraries Division ("SLD"), pending a determination of the outcome of the investigation so as to ensure that there would be no further injury to the Government or to any other affected party as a result of continuing this business. BNS also resolved at that point that it should cooperate fully and completely with the federal investigators. BNS made a commitment to the Justice Department to accept full and complete responsibility for the conduct of the employees and sought to resolve all issues. Well along in the inquiry and negotiations, we learned that there was a civil qui tam complaint that the City and County of San Francisco had commenced. BNS sought to resolve this matter as well, as part of its overall resolution and commitment to make restitution. In order to make good on its commitment to resolve the criminal issues and the civil qui tam action, BNS agreed to pay, and did pay, $15 million in cash fines and restitution, and further agreed to provide equipment, continuing maintenance and services (valued at an additional $5.7 million) to school districts that are BNS customers under the E-Rate Program. We believe the Government has been made whole with this settlement. BNS sincerely regrets that the conduct by these several employees caused this kind of financial harm. Some of these individuals are no longer employed by the company. Any further action with regard to the others will be suspended until the DOJ completes its investigation as to individual culpability. iii. legislative solutions to the perceived problems in the e-rate program We understand that this Committee is making inquiry into what can be done to eliminate the factors that led to this disappointing state of events. BNS does not pretend to have answers to this inquiry from the standpoint of operations of the SLD and the E-Rate Program. However, from the vendor side, BNS has become aware that in the E-Rate Program arena, a few employees, improperly supervised, trained and overseen, can engage in conduct that, in short time, can cause a great deal of damage. In the BNS case, BNS is first and foremost a private sector vendor. There was no substantial line of business and operations dedicated to the government sector for any significant time period. Further, the company did not have the checks and balances in place to supervise the sales personnel who responded to this business opportunity. Working with the Justice Department, BNS is taking key steps to ensure that such conduct is not repeated and that all of its employees will act responsibly and properly. BNS is taking the following first steps as part of a long-term process to improve oversight and management: Empowering a Chief Compliance Officer with broad powers to oversee compliance in governmental contracting and elsewhere. Commencing the training of all employees in established ethics and compliance policies and procedures. Implementing expanded services for its anonymous hot-line for employees to report suspected wrongdoing or unethical conduct. Scheduling regular audits of all government contracts. BNS has also agreed to permit the FCC Enforcement Bureau and the FCC-OIG, at BNS' expense, to conduct an annual audit of BNS' compliance with applicable laws and regulations relating to the E-Rate Program and other government sponsored or funded telecommunications programs. BNS will make annual reports to the FCC Enforcement Bureau and the FCC-OIG concerning its compliance with the established compliance policy. It would be impossible, from a legislative standpoint, to codify a code of conduct that might directly address all anticipated problems on the vendor side. However, from BNS' experience, it has become clear that any vendor involved in the E-Rate Program needs to have employees who are properly trained in the requirements of government contracting and, in particular, the rules and regulations of the E-Rate Program. To be sure, even in Year 3 of the E-Rate Program, there was still an absence of clear definition as to what products and services were to be funded and a lack of clarity in other areas as well. Bright line rules are better than leaving matters to subjective judgment. This, however, does not excuse in any way BNS' conduct, but the ambiguity fostered an environment for mistake, negligence and active misconduct to occur. We are also concerned that the present operational parameters under the E-Rate Program leaves an informational void between the vendor of systems and services and the school districts. School administrators, especially in the neediest districts, have little or no expertise in the installation of sophisticated voice, video, and data networks. The vendors do, but they are in the business of selling equipment and services that are requested by customers. This information void can be exploited by opportunistic or dishonest individuals in some cases. Although it would be laudable if vendors would spend their time and efforts in scaling down a project to save unnecessary expense for the school districts and the E-Rate program, since this would reduce their revenues, it is unrealistic to think this will often be the case, even in a competitive response to an RFP. Many of the school districts need to have the assistance and advice of an informed and independent consultant. They should not be left in a position of either asking the vendor to provide those consulting services or providing a reference for those services. The E-Rate Program, with effective oversight and management, can assist needy schools in acquiring technology that may enhance the education of children in the urban and rural schools. There were many diligent, hardworking field engineers and other employees within BNS who were implementing Internet solutions within schools unaware to the wrongdoing by a few. They believed they were making a meaningful effort to enhance the success of students in those schools. Mistakes that were made by a few BNS employees tarnished this effort and their beliefs. Thank you for the opportunity to appear before the Committee today. Mr. Walden. Mr. Donovan, thank you for appearing today. I noticed in your original draft statement submitted to the committee, you indicated you thought the Justice Department investigation would be over in a matter of a month or so. Is that a view you still hold? Mr. Donovan. That is a little speculative. Counsel for the company that has been cooperating with the Justice Department believes that the investigation, which is still continuing-- there is a Grand Jury proceeding--insofar as NEC employees may be completed to a point where some of the employees would be able to testify. Mr. Walden. Okay, because I noticed in the press release that was put out, you indicate--or your press people at least indicate circumstances may change in the near future which may allow executives to participate subsequently before the subcommittee hearing. But that--the press release doesn't make any reference to the investigation being concluded within a month or so. I just wondered. Your draft release indicates September or October, complete the investigation. There seems to be a month or so or September or October--It's kind of an interesting couple of days. something must have changed. Mr. Donovan. I don't think so. I think, as you know, that schedule is not up to NEC or to the individuals who are under investigation. So it is a good faith guess. Mr. Walden. Okay. Isn't NEC's position about the ratio of E-Rate revenues to total company revenues a red herring? We have been told this was like a very small portion of NEC BNS's revenues or NEC's revenues, the E-Rate program itself. Mr. Donovan. Three to 5 percent as a of business, and I think that is the way the E-Rate program was viewed. It was almost like a new line of business with some different factors and circumstances that needed to be dealt with. Three to 5 percent would not be a large business line. Mr. Walden. But wouldn't that business line have doubled, had the 471 been approved by USAC for San Francisco? Wouldn't it have taken it to $100 million or something? Mr. Donovan. I don't know. Mr. Walden. Well, I think we have those numbers, don't we? I think it would have nearly doubled. Mr. Donovan. This is for the San Francisco school district? Mr. Walden. Well, for your overall revenues, it would have nearly doubled them in this line, business line. I'm a small business owner. If some chunk of my business that was 3 percent was suddenly going to double, I would probably sit up and take notice, and I would think the managers down the line would want me to take notice, if I were CEO, and say, look at what we are doing for you. Did that happen in your company? Mr. Donovan. Could you rephrase the question? I'm not sure how to answer that. Mr. Walden. Well, I want to know who knew and what they knew, bottom line. Mr. Donovan. Yes. Mr. Walden. And I guess, maybe in a big company like NEC, 3 percent of revenue doesn't matter, but if you are going to add 3 percent--If you are going to basically double this line of business with this, looked to me like, one contract, I would think somebody would be saying look at me, look at me, I'm over here in this division of the E-Rate, new line of business, and look at what we are able to do here. Did that happen? Mr. Donovan. That could be the case, but in my experience as an attorney for the last 20 years-plus, people who were doing some of the things that we are hearing about today and that I as a former NEC employee am not proud of, by any means, do not flag those situations. So it would not be surprising to me that, if people were engaged, and we believe they were, in the kinds of things that were happening, they would do everything they could to hide that. Mr. Walden. Right, but somebody is above them. Right? Mr. Donovan. Yes. Mr. Walden. And I assume, aren't there like monthly revenue forecasts in your company? Mr. Donovan. There are periodic revenue forecasts. Mr. Walden. Okay, periodic. Is there a look at new contracts coming in? Mr. Donovan. I'm not sure. There are thousands of contracts that come in. This one would have been a larger contract, but not the largest. That is not my belief. But there are many, many---- Mr. Walden. There could be a larger contract? Mr. Donovan. I would think so, yes. Mr. Walden. Okay. So you got a couple of folks down here doing nefarious acts. Somebody above them, though--Who did they report to? Mr. Donovan. They being who, Congressman? Mr. Walden. The people who have been identified as engaging and working with your company. I mean, there were people in your company, obviously, who knew something was wrong. Right? Mr. Donovan. At some point, yes. Mr. Walden. I mean, you have admitted to that in your settlement, haven't you? Mr. Donovan. Today, yes, we wish we could have done a lot of things differently, Congressman. The question is this was not a single isolated case. It involved the San Francisco School District. There were acts which took place over a period of time, and the question as to when different people realized what was going on is a difficult question to answer. Mr. Walden. Let's go to Tab 27, sir, if you would. This is an e-mail from--and I apologize up front--Zahid Masoud to a Mr. Tom Burger and to you--well, no, to Mr. Holman. Mr. Donovan. Scared me for a moment. Mr. Walden. No, I am sorry. To Glen Means. So Mr. Holman, Mr. Means, Mr. Burger, and cc'ed to Mr. Rathinson and to Bob Bliss. It calls VNCI pricing, and it says importance is high. ``Gentlemen, below you will find the pricing summary of the E- Rate projects as we bid to the individual school districts. I have also included attachments detailing pricing for each of these projects. Glen, you can find in-kind NABSE bonuses in the value added section. I will be on hand for the 9 a.m. meeting to discuss further. Zahid.'' Now who is Mr. Burger? Wasn't he the gentleman who was just here? Mr. Donovan. Yes. Mr. Walden. And what would this summary sheet on submitted bids for the E-Rate projects be? Mr. Donovan. I don't know. Sorry. Mr. Walden. Well, it is titled ``Summary sheet on submitted bids for the E-Rate projects.'' Mr. Donovan. Yes. Mr. Walden. And what role is Mr. Burger in on February 18, 2000, in the company? Mr. Donovan. He was the Chief Executive Officer of the company. Mr. Walden. All right. So the bids for these E-Rate projects that amount to 3 percent of your business were being provided to the CEO of the company. Correct? Mr. Donovan. It looks that way. Yes. Can you point me to-- -- Mr. Walden. I'm sorry, did you not get the tab? Mr. Donovan. I have it, yes. What I would like to know is I am not sure where the wrongdoing is in this. I am looking at this for the first time. Mr. Walden. Well, I didn't say there was wrongdoing in this, but if you think there is, we can explore that. But my point was who knew in the company. What I thought I have heard you say is that this was such a small part of the business, you didn't know where it went up in the chain, because I was asking about reporting. You know, wouldn't revenue--a new line of business, who knew in the company? This e-mail would indicate the CEO at least knew of these E-Rate projects and the bids that were submitted. If this is that small a piece of business, does every project where there is a bid go to the CEO? Mr. Donovan. I don't know the answer to that. Mr. Walden. This is a $131,249,100 total project bids and accepted for 471. Chairman. Barton. Would the chairman yield on that point? Mr. Walden. I certainly would, Mr. Chairman. Chairman. Barton. You, Mr. Donovan, at this time were General Counsel for BNS. Isn't that right? Mr. Donovan. I was General Counsel for the holding company, NEC USA, but my staff also provided legal services to this company. That is correct. Chairman. Barton. In this year, calendar year 2000, do you recollect what the total revenues of the company were in the United States? Mr. Donovan. I don't know offhand, but I know it was probably several hundred million dollars. Chairman. Barton. Several hundred? Mr. Donovan. Million. Chairman. Barton. Million. So $131 million would be a significant portion, if your total revenue were several hundred million. Mr. Donovan. I don't know if this was a single period. Sometimes when bids are submitted, there is a long period of time between the date that the bid is submitted and a contract is begun, but I am not sure---- Chairman. Barton. But, I mean, you would admit that, if you were CEO of a company and a revenue projection was presented to you that, let's say, is 25 to 50 percent of your total revenue, you would look at it. Mr. Donovan. If I were CEO? Chairman. Barton. Yes, sir. Mr. Donovan. Yes, I would look at that. Chairman. Barton. Okay. Mr. Donovan. I am not sure what detail I would look at it, but certainly I would be very interested in that. Chairman. Barton. Well, I would certainly look at it in great detail. I yield back. Mr. Walden. Well, Mr. Chairman, I would also like to know from the company who was on hand at the 9 a.m. meeting to discuss this further, since this was sent to Mr. Burger, Mr. Means, Mr. Holman and cc'ed, obviously, Mr. Bliss and Mr. Rathinson. Mr. Donovan. Rafinson. Mr. Walden. Thank you. And it would imply that perhaps all these people were going to be at whatever this meeting was at 9 a.m. Do you know if there are minutes of that meeting available? Mr. Donovan. I don't. Mr. Walden. Do you know who attended that meeting? Mr. Donovan. No, I don't know. I'm sorry. Mr. Walden. Do you know if at the bottom of this--At the bottom of this same memo, it is marked Confidential. It says, ``The above districts include 45 NEC PBX systems, almost all of them NEACs 2000.'' Then it appears there are Excel spreadsheets for each district included. I wonder, are those spreadsheets available in the form that either--the form that they are referenced here? Mr. Donovan. May I speak with counsel? Mr. Walden. Sure. Certainly, sir. Mr. Donovan. Yes, they are. Mr. Walden. And have those been supplied to the committee yet? Mr. Donovan. Not yet. Mr. Walden. When would it be possible to produce those spreadsheets, gentlemen? Mr. Donovan. As soon as possible, tomorrow or Monday. Yes. Mr. Walden. All right. Thank you. That would be helpful to know. My time has expired. I will turn to the gentle woman from Colorado. Ms. DeGette. Thank you, Mr. Chairman. Now, Mr. Donovan, I guess I have been trying to figure out what you are doing here today. So I just want to ask you a little bit of question-- other than the fact you are the lawyer. But now Mr. Burger and Mr. Holman were both employed by the company during this timeframe. Correct? Mr. Donovan. Correct. Ms. DeGette. And they took the 5th today because of the ongoing criminal investigation. Correct? Mr. Donovan. Correct. Ms. DeGette. So you have been sent over to testify, and so I want to ask you some questions. Now during this time period, you were the Senior Vice President, General Counsel, and Corporate Secretary of NEC. Correct? Mr. Donovan. NEC USA. Correct. Ms. DeGette. And you were also the Corporate Secretary of BNS. Correct? Mr. Donovan. Correct. Ms. DeGette. Now as you yourself said in your written testimony, you did not have any role in BNS's day to day activities. Correct? Mr. Donovan. Not directly, no. Ms. DeGette. Now you were the legal counsel for--Were you the legal counsel for BNS and also for NEC USA? Mr. Donovan. The NEC USA Legal Department, which has about six attorneys, is legal counsel for most of the NEC companies in the United States. Ms. DeGette. And that would include BNS? Mr. Donovan. Yes, it would. Ms. DeGette. And were you the supervisor of the lawyers in the legal counsel's office? Mr. Donovan. Correct. Ms. DeGette. So, basically, they were the ones reviewing contracts and negotiations, and then you were supervising that. Would that be a fair characterization? Mr. Donovan. Yes, it would. Ms. DeGette. Now in your written testimony and, I think, also orally, you said in 1999 BNS entered into a teaming arrangement with VNCI. Correct? Mr. Donovan. That is my understanding. Ms. DeGette. Were you involved in the negotiation of that teaming arrangement? Mr. Donovan. No, I was not. Ms. DeGette. Were you aware of the arrangement at all? Mr. Donovan. Not at that time, no. Ms. DeGette. Did you review any kind of a contract with VNCI? Mr. Donovan. No, I did not. Ms. DeGette. Did anybody in your office review that agreement? Mr. Donovan. I don't know if anyone reviewed that agreement, but to answer your question, typically teaming agreements, which are very, very common when you are dealing with large systems with different types of products--they are very common. Assuming that they are used correctly, they are not illegal. Ms. DeGette. Well, absolutely. I know that. But what you are saying is maybe a teaming--If it is a routine teaming agreement done in the course of business, that would not necessarily be reviewed by one of the attorneys. Is that what you are saying? Mr. Donovan. Not by an attorney. Ms. DeGette. Okay. So you don't know whether this was or wasn't, but it wasn't reviewed by you? Mr. Donovan. Correct. Ms. DeGette. Now do you know how VNCI came to enter into an agreement with BNS? Mr. Donovan. No, I am sorry. I don't. Ms. DeGette. Do you know who would know? Mr. Donovan. No, I don't. Ms. DeGette. So you don't know what the relationship of the parties was, whoever was representing BNS and whoever was-- Well, I guess it was probably Judy Green. Right? Mr. Donovan. Of VNCI? Ms. DeGette. Yes. Mr. Donovan. It appears that way. Ms. DeGette. Now you say it appears that way. Is that because of information you have subsequently received? Mr. Donovan. Yes. Ms. DeGette. At the time this transaction was entered into, did you know Judy Green? Mr. Donovan. No. Ms. DeGette. Okay. Have you ever met Judy Green to this day? Mr. Donovan. No, I have not. Ms. DeGette. And I assume you don't know where she is, because we are looking for her. Mr. Donovan. I'd rather not have anything to do with Judy Green. Ms. DeGette. I would believe that. Mr. Donovan. But I wish you much success in finding her. Ms. DeGette. Thank you. Okay. So you basically can't tell us about how BNS came to enter into this arrangement. Mr. Donovan. Not this arrangement. Correct. Ms. DeGette. Okay. Well, looking at Tab 27 which is this e- mail about all the other E-Rate projects, do you know how any of those arrangements came to be entered into? Mr. Donovan. No. Ms. DeGette. No, because you didn't have day to day involvement in this? Mr. Donovan. That's correct. Ms. DeGette. Okay. Now I just ask you again. Have you subsequently learned who at BNS entered into this teaming arrangement? Who was the individual who did it? Mr. Donovan. There should be a signature on the written agreement. Ms. DeGette. Yes, it was Mr. Holman. Have you reviewed any of that? Mr. Donovan. I probably have seen that during the course of the investigation. Ms. DeGette. All right. But you didn't see it sooner? Mr. Donovan. No. Ms. DeGette. Okay. Now you testified about a small group of individuals at NEC BNS who were engaged in E-Rate program deceptions. What are the names of the small group of individuals? Mr. Donovan. I think the names are in the records that have been provided, but I would like to speak with counsel. Ms. DeGette. Be my guest. Mr. Donovan. The names that I have seen on the correspondence include Mr. McNulty, Mr. Collen, Mr. Holman, Sohail--sorry, I can't pronounce his name either. He is in the record before you, I think, from a previous question. Those are some of the individuals who are involved. Ms. DeGette. All right. And has the company conducted an internal investigation to see whether the individuals involved in deceptions--whether the group is broader than that? Mr. Donovan. The company responded, yes, with an internal investigation before we realized the scope of what was going on, when we first realized something is wrong. That internal investigation led to the retention of outside legal counsel who were more experienced with this type of investigation, and when they advised us of what was involved, we worked with the Justice Department. Ms. DeGette. Now Mr. Burger is still the CEO of the company? Mr. Donovan. Yes, he is. Ms. DeGette. Is Mr. Holman still employed with the company? Mr. Donovan. No, he is not. Ms. DeGette. And do you have any evidence that Mr. Burger was involved with these transactions? Mr. Donovan. Again, I would like to speak to counsel. I am not aware of any. Ms. DeGette. Has your company instituted any new procedures designed for this type of activity in the future? Mr. Donovan. Yes. Ms. DeGette. Could you please describe those procedures for us? Mr. Donovan. Yes, I can. Probably the most important is the hiring of a person who has quite a bit of knowledge about government contracts and, at the same time, internal audit procedures. One of the reasons this may have occurred is because there were insufficient checks and balances, not so unlike the school district that testified earlier today. The internal audit department has been expanded, and this person will take a very leading role in any type of activity like this in the future. We have also started training programs for employees about this particular type of problem, and we have also instituted an 800 number and provided training and quite a bit of marketing information about that number to encourage employees to use it. Ms. DeGette. Do those audit procedures and also the anti- fraud procedures you have put in place include having these contracts reviewed by legal counsel? Mr. Donovan. Any government contract will be passed first to the person with the expertise in that area, and then will involve Legal. It is my understanding, although I am not directly involved with the company since April 1, that the General Counsel, who I know very well, and this new person will work hand in glove to make sure this does not happen again. Ms. DeGette. When were the procedures instituted? Mr. Donovan. Some of the procedures--it has been ongoing during this process. The anonymous hotline was instituted earlier this year before I left the company. That would be probably January or February of this year. The compliance officer--I am not sure how long a search that was, but the compliance officer accepted an offer and will start--this is a person outside the company with substantial experience. They will be starting soon. Under the continuing work with the Justice Department, NEC is going to be filing expanded policies, and some of the training has already commenced. Ms. DeGette. All right. Let me just say, because everyone else left, I will communicate to you how seriously this committee obviously takes this investigation, and I appreciate you being willing to come and testify. Unfortunately, of course, the events we need to know about are not within your knowledge. So, Mr. Chairman, if I may, I think it is going to be critical for us to try to have the rest of these employees come back, Mr. Burger, Mr. Holman, when we find Judy Green; because Mr. Donovan doesn't know a doggone thing about the transactions here. I do appreciate him coming and talking about the company's investigations and corporate practices, but it doesn't get to the meat of the issue. I yield back. Thank you. Mr. Donovan. I'm sorry. Mr. Walden. Thank you for your questions and your comments, Ms. DeGette. I couldn't agree more. The Chair now recognizes the chairman of the full committee, Mr. Barton. Chairman. Barton. Thank you. I have to ask a few just kind of simplistic questions to make sure I understand the current framework. Mr. Burger, who is listed as President and CEO of NEC, took the 5th Amendment. He is still the current President. Is that correct? Mr. Donovan. That is correct. Chairman. Barton. Mr. Holman is a former Vice President of NEC. He also took the 5th Amendment. What is his relationship, if any, with NEC today? Mr. Donovan. He is no longer employed by NEC. His employment was terminated at some point in the past. Chairman. Barton. But he is not a current--He has no affiliation? Mr. Donovan. None. Chairman. Barton. And his separation from NEC was voluntary or involuntary? Mr. Donovan. His separation was involuntary. Chairman. Barton. And Mr. Marchelos is listed as a former E-Rate consultant with VNCI, which is not affiliated other than through a contractual affiliation with NEC. Mr. Donovan. That is correct. Chairman. Barton. And, of course, Ms. Green who did not appear is of the same affiliation as Mr. Marchelos. You were listed as a former Senior Vice President and General Counsel for NEC. What, if any, is your affiliation with NEC today? Mr. Donovan. I continue to have a consulting agreement with NEC, but I am not a full time employee. Chairman. Barton. You are a consulting? Mr. Donovan. And I am Corporate Secretary for NEC Laboratories America, which is a research institution in Princeton, New Jersey. Chairman. Barton. And what affiliation do they have with NEC? Mr. Donovan. NEC Laboratories America is a wholly owned subsidiary of the holding company for whom I was employed until recently. Chairman. Barton. Now at the time in question in 1999 and 2000, you were General Counsel for NEC USA? Mr. Donovan. Correct. Chairman. Barton. And in that capacity, what level of contracts would you normally personally be appraised of? Mr. Donovan. The attorneys would be involved with unusual contracts, and this may be confusing. I hope you will allow me to explain. We sometimes have contracts which involve many, many dollars, but the product itself is very simple. An example would be cellphones. Those might be sold on the basis of a purchase order. So even though this might be a $25 million order for cellphones, the attorney would not need to look at the contract. It is a purchase order basis. A contract, for example, like a software development contract for a new product, that is the type of contract that very often might involve the attorney input, because it is a new contract. Chairman. Barton. Okay. Now you are here today as a consultant to NEC, and you are not taking the 5th Amendment, and I don't want to lead you. But apparently, your role, your former role as General Counsel, and your current role as a consultant apparently is not part of the ongoing investigation. Is that correct? Mr. Donovan. That is a broad question. Chairman. Barton. It is. Mr. Donovan. I did not take an active role in the investigation but, certainly, when the company realized that wrongdoing had taken place, I was advised by the attorney who worked on the investigation of the matters and the seriousness of those matters. Chairman. Barton. Well, I am puzzled, because the company that you were the General Counsel of has entered into a plea bargain, and we've got a copy of it, in which you have paid a fine and given in-kind services, equipment, that is over $20 million. In that plea bargain, the essence of it is that a few employees lower in the food chain did something wrong, and as soon as senior management found out about it, put a stop to it, and you are moving on down the road. Now if that is the case, there is no reason to take the 5th Amendment. Now the company has entered into a plea bargain, and you know, we've got it, and you all have good guys or your former company is doing the right thing. So I don't understand why we have to go through the spectacle that we just went through of standing up and taking the 5th Amendment while sending out press releases that you are doing everything you can to cooperate. If you've got nothing to hide, there is no reason to take the 5th Amendment. You are an attorney. You are General Counsel. I mean you are here. Mr. Donovan. Yes. Chairman. Barton. So apparently you believe you have nothing to hide, and your counsel believes you have nothing to hide. I just don't understand that. Mr. Donovan. This is not a simple situation, as you are very much aware, and in trying to see how I could explain the fact that some of the people are still employed with NEC, I tried to think of some way to come up with analogy, and the analogy would be this. We all watch television, and some of you may be former prosecutors or law enforcement. The first thing you do at a crime scene, you touch nothing. The first thing that we did when we spoke with the Justice Department was turn over all the evidence we had from the internal investigation. We cooperated with them in providing that information, and we have also, it is my understanding, had discussions with them about where they are in terms of the individual culpability of the employees. It is also my understanding that until some of the Grand Jury investigations which are pending are completed, NEC is not going to take any further involvement. Specifically, I was asked about Mr. Burger. Although his name may appear on an e- mail or two, it is my understanding that there is nothing which shows that he was involved in these discussions about changing numbers, changing prices and so on. Chairman. Barton. And we are not alleging. This committee is not alleging that he personally was involved. We are just puzzled that he won't testify if, as his press release says, he's got nothing to hide. Now we do have documents that are in the record that show that he is at least aware that VNCI submitted a bid for $37 million on behalf of VNCI and his company, NEC; and it was rated a high priority that he take a look at it. So I mean, he was at least aware, if he read the e-mail and attended the meeting, that quite a bit of business with VNCI was being generated, and a big chunk of that was coming through the San Francisco Unified School District. So I think it would be fair for this committee, if he had agreed to testify, to ask a few questions about what he knew about that. But the company has admitted in a plea bargain arrangement $20 million worth of compliance or retribution or whatever you want to call it. I want to ask some questions about VNCI. What do you know about VNCI? Do you know anything about their business model? Mr. Donovan. No. Chairman. Barton. Do you know what their general revenues are? Mr. Donovan. No, I don't. Chairman. Barton. Do you know if they are a target of this ongoing investigation by the Justice Department? Mr. Donovan. I think that they are. I know VNCI was a consultant. I know that NEC didn't know much about E-Rate, and that was a mistake. I am not trying to justify that. Chairman. Barton. Did you, when you were General Counsel, review the general contract that was signed with VNCI? Mr. Donovan. No, I did to. Chairman. Barton. Okay. At what level of the Counsel's office would that contract be reviewed? Mr. Donovan. A teaming agreement would probably not be reviewed at all unless---- Chairman. Barton. Regardless of the amount of dollars involved? Mr. Donovan. As I had mentioned, the amount of dollars is not always---- Chairman. Barton. You said it was a special--Here is a company that you all had never done business with in an area you claim not to have ever attempted to do business in, and this company comes in, in the e-mail offering $131 million worth of business. It is a new company. It is a new area, and yet nobody in the General Counsel's office would review that contract? I find that hard to believe. I am not saying you would review it, but somebody in the General Counsel's office, I would think, would review that. Mr. Donovan. I wish that someone in the General Counsel's office had reviewed that, Congressman. The reality is there are six attorneys, thousands of contracts, and somehow what you have to do is figure out where you can make the most impact. I think that part of the mistake that NEC made was exactly what you are describing, that when this came in, it should have been flagged as an area of business that this particular business group was not involved in and, if it really involved $130 million of business, we should have put people with government contract experience on. If we didn't have them in the General Counsel's office or in the contract administration group, then we should have brought them in from the outside. We didn't do that. Mr. Walden. Would the gentleman yield for a moment on this point? Chairman. Barton. Sure, since my time just expired. Mr. Walden. I'll try and figure out which tab this is, but we do have an e-mail relative to this that was sent to Mr. John Holman, a draft of which, I believe--Well, I don't know who else it went to. Maybe it did go to--I thought it went to Mr. Burger. One form of it went to Mr. Burger. In it, there is a whole paragraph here that talks about risks with partnering with VNCI where NEC is the prime contractor. I believe that was one of the questions you were trying to get to the heart of. I believe it is Tab--Is it 22? Is that right? It says, ``VNCI is a small company traded publicly at the NASDAQ. They are not financially sound, but see this opportunity which can contribute 35 to 40 percent to their this year's sales numbers. They expect to do about $17 million this year. I have checked with the sales engineers, and we can substitute other products to fulfill BNS obligations as a prime in the event VNCI becomes insolvent.'' So it is the third page of Tab 21. I'm sorry. Chairman. Barton. Well, while he is reviewing that document, my main point is here is a business relationship that has developed out of whole cloth, and a fair amount of revenue is generated right off the bat, and nobody at NEC apparently took the time to determine the genesis of where that revenue was coming from. It's just manna from heaven. It is just appearing on the balance sheet, and everybody thinks it is just--Is it, you know, don't ask, don't tell, because you don't want to know the answer? I mean, you were general counsel. Surely, there were meetings in which revenue projections and estimations according to sales projects from prior years were discussed, and here is this revenue stream coming up, and to your knowledge, none of the senior management expressed any wonderment about this at all? That just begs credulity, that there wouldn't be somebody that said, well, where is that coming from? How are we getting it? What are the underlying--What is the real product and the real genesis of the revenue stream? Apparently, until the San Francisco School District and the city of San Francisco started asking questions, nobody in the company, either company, did anything but make sure the checks that might come in were cashable. Do you have a comment on that? Mr. Donovan. That is a long question, Congressman. Yes, I do have a comment on it, because this has been an embarrassing chapter for NEC, and I think that all NEC employees, not just those people who were involved in the wrongdoing, share some of the taint from that. This did not come in as a situation where someone said, listen, we want to defraud the city of San Francisco out of a whole bunch of money. It is very typical to have consultants involved in these kinds of projects. Very often the school districts hire the consultants. I think, as one of the people from San Francisco said, when those consultants are truly independent and doing their job, that is a great check and balance on the situation. In this particular case, I am not sure, and I have not seen anything which would have let someone know early on at the high level in NEC--we are talking about the CEO and the General Counsel for that company--that there was something amiss. Certainly, people who attended some of the sessions where numbers were marked should have known something was wrong. They weren't telling the General Counsel and the CEO that they were doing that. That is what I have seen from the record. Chairman. Barton. Well, my time has expired. I am going to read into the record Tab 18 of our binder. It is an e-mail dated January 13, 2000. It is from Bill Holman, who at that time was Vice President of Sales. He has since been involuntarily separated from the company, according to your sworn testimony. It was sent to him from a Mr. Glen Means. The subject is E-Rate/VNCI, and I quote: ``Bill. I was wondering what guidance you could give me as to who is really running the show on these deals from a high level. One of the things that came out as I got into conversations with the Chief Financial Officer of VNCI is their financial condition, which is tenuous at best. ``They have a story as to how they are going to tack the company onto a run, but they have huge cumulative losses and insufficient sales, less than $10 million a year, to cover their overhead, which is at least $8 million a year, and they have an accumulated deficit of $50 million.'' Then it's got three exclamation marks. ``Have we done any background work on how we will deal with long term warranty? Do we have a workout solution, i.e., product replacement, if they go bust? I am concerned that we are protected.'' So somebody, this Mr. Glen Means, was asking these questions. What was his hierarchical position in the company at that time, if you know? Mr. Donovan. Just to make sure I understand this e-mail, this sounds like Mr. Means who was a financial person---- Chairman. Barton. It is not my company. You tell me. Mr. Donovan. I'm trying.--was looking at this in terms of what happens if VNCI goes insolvent. At this particular point in time, there are a lot of technology companies that were on pretty shaky ground. I am not sure how this is relevant to the wrongdoing that took place, but it appears that Mr. Means, who is something equivalent to the CFO for the company, was concerned about the financial health of VNCI. Chairman. Barton. Well, here is how it is relevant. NEC, in my opinion, is a reputable company. I have heard of NEC. I mean, you have been around. It is not a fly by night dot.com, so to speak. You enter into a relationship with a company that nobody has heard of, and right off the bat huge revenues as a percent of your total revenues are projected, and we have that memo that totals $131 million. Now I haven't run multi-billion dollar companies or even hundred million dollar companies, but I have been a plant manager. I have worked for corporations with profit and loss responsibility--that I had profit and loss responsibility. When somebody walked in the door and offered me a new revenue stream, before I took it at face value, I investigated the person offering the deal. You all apparently did nothing, or your former company did nothing of that. Now you have pled guilty and have paid $20 million. This other company is apparently still under investigation, and I say apparently because I don't know that for a fact, and it is the company that brought this revenue to your former company. That is why it is relevant. I have way over-exceeded my time. So I am going to yield back to the chairman. Mr. Walden. Thank you, Mr. Chairman. I just have one more question for you, Mr. Donovan, and then I think we will try and move on. If you go to Tab 27 again, that is the reference. This is the e-mail that went to, among other people, Mr. Burger. In it, it says, ``Glen, you can find in-kind NABSE bonuses in the value added section.'' Do you have any knowledge about those terms, in-kind, NABSE, bonuses, and the value added section? Have you talked to anybody in the company about what that means? Mr. Donovan. I don't have a clear understanding of that, no. Mr. Walden. You have no understanding of what your company was doing on bonuses, in-kind? Mr. Donovan. I don't have a clear understanding of it and, since I am under oath, I would like to be accurate. Mr. Walden. Do you have any understanding? Mr. Donovan. No. Mr. Walden. All right. Turn to Tab 82. It is obvious we are going to have to have additional hearings when we can get somebody here who can answer some of these questions. Tab 82 shows the NABSE bonus products and services package, and in the center--Section B, it says--it says, ``As a result of agreements with National Association of Black School Educators, NABSE, NEC and its partners will be providing the district and its schools the following 'in-kind' bonus products and services, as depicted in the attached memo.'' You don't have this one under Tab 82? Mr. Donovan. No, sir. Mr. Walden. Okay, we will get that down to you. Sorry about that. You do have it then? Mr. Niespolo. It is the second page. Mr. Walden. Yes, it is. I'm sorry. I should have told you that. Okay. The first page is the Laura-Tom-Mac e-mail, it says. In the center column there under in-kind bonus products, it lists student stations complete with Microsoft Office 97, monitors, digital plan, tilt and zoom cameras, inkjet printers, Xerox color network copier or equivalent, higher education training for teachers and staff, specialized end user technical training, etcetera, etcetera, and then it talks about the services based on volume of purchase, any changes in the total volume will result in adjusted bonus package. Do you know if any of these items are allowable to be paid for with E-Rate funds? Mr. Donovan. No, I don't. Mr. Walden. Do any of your counsels know anything about the E-Rate program and what is allowed and isn't? Mr. Donovan. I don't think they are offering testimony today, Mr. Chairman. Mr. Walden. Thank you. I have no other questions. All right. You are dismissed. Thank you, sir. Mr. Donovan. Thank you. Mr. Walden. Unless the chairman--did you have another question for Mr. Donovan? Chairman. Barton. I have just a few more. I am not going to take another full 10 minutes. Mr. Walden. All right. Go ahead. Chairman. Barton. You may have asked these, and I just didn't hear it, but I want to get them on the record. Do you have any knowledge of how many people at NEC were involved with this situation, what we are calling a conspiracy? Your written testimony, I think, said 3 to 5 people. Mr. Donovan. That is based on the records that I have seen from e-mail. Yes. Chairman. Barton. Okay. Do you know how many, if any, of those people are still employed by NEC? Mr. Donovan. I think two, but I would like to check with counsel. The reason that I am having the discussion, again until the Grand Jury proceedings are finalized, we are not sure who has criminal liability. But at this moment it looks like one person may be still---- Chairman. Barton. But there are some people still employed who might have criminal liability, although that is a very small number? Mr. Donovan. There are some people who are still under investigation. Chairman. Barton. Do you know when NEC decided to cooperate? Did they come forward voluntarily or were they caught with their hand in the cookie jar and decided to cooperate after they were caught? Mr. Donovan. Voluntary. Chairman. Barton. If I call the San Francisco people back, they would say that, too? Mr. Donovan. If you call the law enforcement authorities who are investigating it, I am sure they will say the same thing. Yes. Mr. Niespolo. Mr. Chairman, may I say something, please? Chairman. Barton. As long as you---- Mr. Walden. I think we will have to swear him in. Chairman. Barton. If you are willing to be sworn in, you may. Mr. Niespolo. I just want to speak with my client. Chairman. Barton. Well, you certainly have that right. Mr. Walden. Yes. Mr. Niespolo. Thank you so much. Mr. Donovan. Long-winded lawyers. My apologies. Chairman. Barton. It's all right. Mr. Donovan. Could someone repeat the question for me? Chairman. Barton. My question was how many people still employed by NEC were a part of this program, and you said--I think you said two, one of whom may be criminally liable. Mr. Donovan. I said I think one, and that person is still under investigation, as are some of the other employees whose names appear on these e-mail. Chairman. Barton. My last question--again, this may have been asked: Under the current E-Rate rules, a company that has been found either criminally or civilly liable is subject to being debarred from the program for 3 years. Is NEC still involved in the E-Rate program, to your knowledge? Mr. Donovan. To my knowledge, all of that activity has been suspended, and has been for sometime when we realized there was a problem. Chairman. Barton. Okay. If you were working as an attorney at the FCC and had to make a recommendation whether NEC should be disbarred, what would that recommendation be, based on the knowledge of the case as you know it today? Mr. Donovan. I don't know that I could make a decision without hearing from all sides. I know that the FCC has posted a notice and is receiving comments, and certainly, my opinion might be biased. I think that the difference between some of the cases that we read about in the news and the NEC situation is that NEC made a mistake, but we didn't try to cover it up. We have never lied to prosecutors. We have never destroyed e-mails. We have made data bases available, and that has been since the very first day of this process. I think, if you--there are provisions in the law which reward---- Chairman. Barton. So we only disbar companies that destroy e-mails, lie to prosecutors, and don't voluntarily cooperate? That is your standard? Mr. Donovan. That is not my answer, Congressman, no. I think my answer was---- Chairman. Barton. It sure sounded like your answer. Mr. Donovan. I'm sorry. My answer was that I would need to look at all the facts and circumstances. If I were making the decision, I don't know that I would disbar NEC. NEC has done a lot of good things and, yes, this kind of money--It's a tremendous amount of money, to me. It was a lot of money to this company, but NEC has done some great things with automated fingerprint identification systems. They are working with various law enforcement on very advanced technologies, some of the other NEC companies, such as face recognition for airport security, and NEC scientists discovered the carbon nanotube, and---- Chairman. Barton. It is okay that in this case they defrauded the taxpayers of tens of millions of dollars? All the other good deeds that they did allow them to do some bad deeds here. Mr. Donovan. No, I think justice can't be blind, and I think what justice does--and I think you could agree with this--is to balance the rights and the wrongs. If every time a company makes a mistake, we destroy that company, I think many good companies would---- Chairman. Barton. I didn't say we are trying to destroy the company. By your own testimony, this was a small percentage of their total revenues. I just asked the question, if somebody--A company, in this case NEC, that has already pleaded to wrongdoing, under the current rules are supposed to be, or at least are allowed to be disbarred, to send a signal to other companies, we shouldn't consider disbarring this company. I mean, I don't know how many other companies have done what NEC has done. We've got investigations on several other companies, but if we want to get the program right, at sometime you've got to hold accountable the companies that have abused the program. Mr. Donovan. To answer the question, I would look at all the facts and circumstances that were involved, and I think I would give quite a bit of credence to the opinion of some of the enforcement agencies, such as the Department of Justice whose letter in support of NEC, I think, is part of the materials provided to the committee. Chairman. Barton. I have read that. I am going to give you one more chance. You told me in direct response that NEC voluntarily came forward. Then you talked to your attorney, and you didn't answer the question, because I asked, if I called the San Francisco representatives back, if they would answer it the same way. So I am going to give you one more chance. Do you think NEC voluntarily came forward? Mr. Donovan. I think, in my opinion, NEC voluntarily came forward. I can't tell you what San Francisco would say, Congressman. Chairman. Barton. All right. I yield back. Mr. Walden. Thank you, Mr. Chairman. Thank you, Mr. Donovan. You are excused now. Mr. Donovan. Thank you. Mr. Walden. Let's see here. Now we would like to call up our third and final panel: Mr. William Maher, Chief, Wireline Competition Bureau, Federal Communications Commission; and Mr. George McDonald, Vice President, Schools and Libraries Division, Universal Service Administrative Company, USAC. Gentlemen, thank you for your patience today. I know it has been a long one. As you are aware, the committee is holding an investigative hearing and, when doing so, has had the practice of taking testimony under oath. Do you have any objection to testifying under oath? The Chair then advises you that under the rules of the House and the rules of the committee, you are entitled to be advised by counsel. Do you desire to be advised by counsel during your testimony today? Both answered no. In that case, if you could rise and raise your right hands, I will swear you in. [Witnesses sworn.] Mr. Walden. Let the record show, they said ``I do.'' So you are now under oath, and you may now make a 5-minute summary of your written statement. We welcome you, and look forward to your comments. Let's start with Mr. Maher. TESTIMONY OF WILLIAM F. MAHER, JR., CHIEF, WIRELINE COMPETITION BUREAU, FEDERAL COMMUNICATIONS COMMISSION; AND GEORGE McDONALD, VICE PRESIDENT, SCHOOLS AND LIBRARIES DIVISION, UNIVERSAL SERVICE ADMINISTRATIVE COMPANY Mr. Maher. Thank you and good afternoon, Chairman Walden, Representative DeGette, and Chairman Barton. My name is William Maher. I am Chief of the FCC's Wireline Competition Bureau, and I have served in this post since August 2002. I appreciate the opportunity to discuss the FCC's continuing efforts to improve the E-Rate program and the lessons from the recently concluded criminal and civil case associated with funding year 2000 involving NEC and the E-Rate service provider. Your attention E-Rate issues, as demonstrated by this and last month's hearing, confirms the FCC's understanding that Congress wants this program administered efficiently and fairly. In its first 6 years, the E-Rate program committed over $11 billion to permit an average of about 90,000 schools and libraries each year to pay more affordable discounted rates. In 1998, the first year of the program, only 51 percent of classrooms in public schools were connected to the Internet. That figure reached 92 percent in 2002, and 94 percent of schools now have broadband connections. In reviewing these numbers, the E-Rate program has been an overall success, but the program has been the target of some bad actors and those who have tried to beat the system. The subject of today's hearing involving NEC is an object lesson for the FCC, for USAC, and for all participants in the E-Rate program. The Commission and its staff work closely with USAC in administering the E-Rate program. As described in detail in the recent hearing regarding Puerto Rico, we are improving program performance through actions and rulemakings, fact specific adjudications, and an improved audit program. Regarding NEC, on May 27 of this year NEC agreed to plead guilty to two criminal charges, wire fraud and bid rigging for E-Rate activities, largely in funding year 2000. NEC also agreed to pay a total of $20.6 million criminal fine, a civil settlement, and restitution. NEC was charged with wire fraud for entering a scheme to defraud the E-Rate program in the San Francisco Unified School District, and it was also charged with bid rigging and allocating contracts at five school districts in Michigan, Wisconsin, Arkansas, and South Carolina. The monetary amount of the civil settlement makes the E- Rate program whole. Because NEC has pled guilty to activity related to the E-Rate program, it is subject to suspension and debarment under the Commission's E-Rate debarment rule. On May 27 NEC petitioned the Commission for waiver of its debarment rule, and there is a proceeding pending on that petition. This case illustrates the importance of deterring those who would seek to defraud or abuse the E-Rate program. Deterrence is an essential and a challenging goal, because as the San Francisco experience shows, defrauders will stop at very little to cover their tracks. At the same time, the Commission must encourage efficient participation by the large majority of E- Rate participants who are law abiding. The Wireline Competition Bureau has recommended to the Commission rule changes to improve deterrence for action at the August 2004 open meeting. Also in the last 15 months, the Commission has adopted several new rules that address aspects of the NEC situation. Moveover, I have directed USAC's chief executive officer to report to the Bureau on changes to procedures and rules in light of NEC, and the staffs of the FCC and USAC are in close communication to improve USAC's review process. An initial step in such deterrence is to require applicants to document thoroughly their participation in the E-Rate program. The Bureau has recommended expansion of the document retention requirements for applicants, in order to maintain a comprehensive paper trail for 5 years after service is provided. The Bureau has also recommended improvements to the certifications that beneficiaries and service providers make regarding their compliance with substantive program rules. We plan to modify numerous E-Rate forms to expand the required certifications. Expanded certifications help deter bad actors, because their falsification is a Federal criminal offense. As an additional deterrent, the Bureau is recommending that USAC must engage in heightened scrutiny of applications from E- Rate beneficiaries that have violated the statute or the Commission's rules in the past. This is consistent with the general framework adopted in the Puerto Rico DOE Order of 2003 for when one or more parties to an E-Rate application is under investigation for waste, fraud or abuse. The Commission's E-Rate debarment rule is a significant deterrent to fraudulent behavior. Since the rule's adoption in 2003, the FCC's Enforcement Bureau has debarred three individuals in matters not related to NEC, and the Commission has sought comment on whether to expand the reach of the debarment rule as a further deterrent. Encouragement of whistleblowers and early outreach to applicants and service providers regarding the E-Rate program are also important components of deterrence. Continuing strong review and auditing programs serve as a long term deterrent to waste, fraud and abuse. We on the Commission staff will continue to work with our Office of Inspector General to implement such programs. We at the FCC are proud of the schools and libraries support program, but we will never be satisfied with the status quo. We are happy to assist the subcommittee as needed. Thank you, Mr. Chairman, for the opportunity to participate in your review of E-Rate, and I look forward to your questions on the issue. [The prepared testimony of William F. Maher, Jr. follows:] Prepared Statement of William F. Maher, Jr., Chief, Wireline Competition Bureau, Federal Communications Commission Good morning, Chairman Greenwood, Representative DeGette, and distinguished members of the Subcommittee. My name is William Maher. I am chief of the FCC's Wireline Competition Bureau, and have served in this post since August 2002. I appreciate the opportunity to discuss the FCC's continuing efforts to improve the E-rate program and the lessons from the recently concluded criminal and civil case involving NEC Business Network Solutions, Inc. (``NEC-BNS''), an E-rate service provider, regarding its activities associated with Funding Year 2000. Your attention to the issues involved with the E-rate program, as evidenced by this and last month's hearings, confirms the FCC's understanding that Congress wants the program administered efficiently and fairly. introduction The schools and libraries mechanism of the FCC's universal service program, known as the E-rate program, implements the directive of the Telecommunications Act of 1996 to help schools and libraries gain access to modern telecommunications and information services for educational purposes. In its first six years, the E-rate program has committed over $11 billion to permit an average of almost 90,000 schools and libraries each year, including those in the nation's poorest and most isolated communities, to pay more affordable, discounted rates. While in 1998, the first year of the program, only 51 percent of classrooms in public schools were connected to the Internet, the figure reached 92 percent in 2002. Moreover, 94 percent of schools now have broadband connections. In reviewing these numbers, the E-rate program has been an overall success. But from day one, it has been the Commission's goal to improve operation of the E-rate program. The FCC seeks to learn from its experience with this program. The Commission and its staff work closely with the Universal Service Administrative Company (``USAC''), the not-for-profit company that is responsible for day-to-day administration of the E-rate program. In particular, whenever we discover examples of potential waste, fraud, or abuse, we seek to address the individual cases and to improve the relevant program rules or practices. The Wireline Competition Bureau works to oversee and implement the E-rate program with several other FCC bureaus and offices, including the Office of the Inspector General, the Office of General Counsel, the Office of Managing Director, and the Enforcement Bureau. As Commission staff described in detail in the recent hearing regarding Puerto Rico, we are improving program performance through actions in rulemakings, fact-specific adjudicatory decisions, and an improved audit program. The FCC also works closely with law enforcement agencies when those agencies investigate and prosecute possible criminal activity by E-rate participants. The E-rate program has been the target of some bad actors and those who have tried to beat the system. The subject of today's hearing, involving NEC-BNS, is an example of such activity. It is an object lesson for the FCC, for USAC, and for all participants in the E- rate program. The Commission is committed to applying this lesson in eradicating waste, fraud and abuse in the E-rate program. the nec-bns case Criminal Plea Agreement and Civil Settlement: On May 27, 2004, NEC- BNS, a subsidiary of NEC America Inc., agreed to plead guilty to two criminal charges-- wire fraud and bid rigging--and to pay a total $20.6 million dollar criminal fine, civil settlement, and restitution for its activities related to the E-rate program, largely in Funding Year 2000. The Justice Department charged NEC-BNS with wire fraud for entering a scheme to defraud the E-rate program and the San Francisco Unified School District (``the San Francisco schools''). The Justice Department also charged NEC-BNS with bid rigging and allocating contracts at five school districts in Michigan, Wisconsin, Arkansas, and South Carolina. Among other things, the plea agreement requires NEC-BNS to cooperate with the United States in investigating and prosecuting others involved in criminal violations at E-rate funded projects, and NEC-BNS agreed to enter into a comprehensive Corporate Compliance Program as well. In addition to its criminal plea agreement, NEC-BNS entered a settlement agreement to end a civil lawsuit initially brought by the San Francisco schools, in which the United States, acting through the Department of Justice, intervened. Among other things, the monetary portion of the settlement agreement makes the E-rate program whole. The settlement agreement notes that the civil claims of the United States and others against NEC-BNS included (1) engaging in non- competitive bidding practices; (2) paying fees termed ``marketing fees'' to at least one entity involved in selecting vendors to obtain e-rate funds; (3) requesting and receiving E-rate funds for goods and services that were ineligible for such funding; (4) providing false information to the United States regarding the goods and services that were be provided to schools and school districts under the E-rate program; (5) disregarding the requirement that schools and school districts make a co-payment to match a percentage of their E-rate funding; and (6) inflating prices on invoices and other documents provided to the United States to conceal some or all of these practices. San Francisco as an Example: I summarize, as a case study of the foregoing practices, the situation with the San Francisco schools, based largely on the description in the NEC-BNS criminal plea agreement. In December 1999, NEC-BNS agreed with a switch manufacturing company (``VX Company'') to pay VX Company a fee for all business opportunities brought to NEC-BNS, and NEC-BNS agreed to include VX Company equipment in its E-rate proposals and bids. VX Company employed two consultants to work as its sales representatives. The consultants specialized in marketing VX Company products to school districts, and acted as consultants to school districts in identifying potential government-sponsored funding sources, including E-rate. On or before December 1999, the consultants began working with the San Francisco schools to obtain E-rate funds. The consultants worked with an official of the San Francisco schools to put together a request for proposal for equipment and services for E-rate to fund. In January 2000, NEC-BNS submitted its bid on the E-rate project for the San Francisco schools. One of the consultants managed the opening of the bids and, together with an official of the San Francisco schools, opened and reviewed them. That consultant declared that NEC-BNS had submitted the winning bid for the data equipment portion of the project, and that two other firms had submitted low bids on other portions of the project. The consultants and the official of the San Francisco schools then decided to make NEC-BNS the prime contractor for the project and to have other firms act as subcontractors to NEC-BNS. Still in January 2000, NEC-BNS employees and the consultants met to prepare the USAC Form 471, which is the application form for E-rate funding. With the assistance of NEC-BNS, one of the consultants prepared the Form 471 with prices inflated over the amounts originally bid, and the other consultant then delivered the Form 471 to USAC. In late May or early June 2000, USAC began to review the San Francisco schools' Form 471 submitted in January 2000. USAC asked the San Francisco schools to supply information to justify certain parts of the project. One of the consultants, and others acting under her direction, submitted spreadsheets to USAC that contained false information regarding the bidding process, the bidding participants, the winning bids, and the bid amounts. USAC subjected the San Francisco schools' application to a review to determine whether the services requested were supported by adequate resources. The San Francisco schools passed the review. In September 2000, USAC approved funding for the San Francisco schools in part, but denied E-rate funding for some requests for ineligible equipment, products, and services. The Investigation: The NEC-BNS plea agreement and civil settlement resulted from a two-year investigation conducted by the Department of Justice and the Federal Bureau of Investigation. The FCC's Office of Inspector General assisted in the investigation, and various FCC bureaus and offices, including the Wireline Competition Bureau, reviewed the civil settlement agreement earlier in 2004. The monetary amount of the civil settlement makes the universal service fund whole. Because NEC-BNS has pled guilty to activity related to the E-rate program, it is subject to suspension and debarment under the Commission's E-rate debarment rule, 47 C.F.R. 54.521. On May 27, 2004, NEC-BNS petitioned the Commission for waiver of its suspension and debarment rule. On July 7, 2004, the Commission's Enforcement Bureau sought public comment on the waiver petition, and the pleading cycle will close on July 29, 2004. policy and program lessons There are multiple lessons to be learned from the NEC-BNS case. This case illustrates the importance of deterring those who would seek to defraud or abuse the program. Deterrence is an essential and challenging goal because, as the San Francisco experience shows, defrauders and bad actors will stop at very little to cover their tracks. At the same time, the Commission must encourage efficient participation by the large majority of E-rate applicants and service providers who are law-abiding. The Wireline Competition Bureau has already recommended a number of relevant rule changes, described below, to the Commission for action at its August 2004 Open Meeting. In the past 15 months, the Commission has adopted several new rules that address aspects of the NEC-BNS situation. Moreover, I have directed USAC's chief executive officer to report to the Bureau on changes to procedures and rules in light of NEC-BNS, and the staffs of the FCC and USAC are remaining in close communication to improve USAC's review process. Tightening our rules and USAC's review procedures will expose, at the front end, improper or fraudulent activities. Deterring Bad Actors: To deter bad actors, E-rate applicants must be held accountable for the contents of their applications and other filings. An initial step in such deterrence is to require applicants to document thoroughly their participation in the E-rate program. Based on input from our Office of Inspector General, the Wireline Competition Bureau has recommended to the Commission that it expand the document retention requirements for applicants, in order to maintain a comprehensive paper trail for five years after receipt of E-rate supported services. By documenting every step in the E-rate process-- from initial application, through competitive bidding and selection of a service provider, to final service and equipment delivery and invoicing--such a paper trail aids the initial review of applications as well as later program audits. It places a major obstacle before those who would consider lying to the federal government for their personal gain. The Wireline Competition Bureau has also recommended to the Commission improvements in the certifications that beneficiaries make regarding their compliance with substantive program rules. Upon adoption of the Bureau's recommendations, we will modify numerous E- rate forms to expand the required certifications. Expanded certifications help deter bad actors because their falsification is a federal criminal violation. This reform is the product of discussions among the Bureau, the FCC's Office of Inspector General, and the Justice Department. As an additional deterrent to bad actors, the Bureau is recommending that the Commission reinforce that USAC should engage in heightened scrutiny of applications from E-rate beneficiaries that have violated the statute or the Commission's rules in the past. This is consistent with the general framework adopted in the Puerto Rico DOE Order of 2003 to deal with situations in which one or more parties to an E-rate application is under investigation for potential waste, fraud or abuse. The Commission has already acted in several ways to deter conduct similar to that of NEC-BNS. In April 2003, the Commission adopted its E-rate debarment rule, which bars from E-rate participation for a period of three years any individuals or companies that have been found criminally or civilly liable for activities associated with or related to the E-rate program. We believe the debarment rule to be a significant deterrent to fraudulent behavior. Since the rule's adoption in 2003, the FCC's Enforcement Bureau has debarred three individuals in matters not related to NEC-BNS. The Commission also has sought comment on whether to expand the reach of the debarment rule as a further deterrent to E-rate waste, fraud and abuse. Encouragement of whistleblowers and early outreach to potential applicants and service providers regarding the E-rate program are also important components of deterrence. Timely information from well- informed and honest citizens is one of the best means of exposing fraudulent activity. Wider understanding of E-rate rules can help USAC and program participants isolate and identify potential bad actors. For example, in 2000, roughly the time of the San Francisco situation, the Commission's Mastermind Order found a violation of the competitive bidding rules where a service provider listed in the Form 470 as a contact person for an applicant also participated as a bidder in the applicant's competitive bidding process. Wider understanding of that ruling in the San Francisco schools could have helped expose the NEC- BNS case earlier. USAC has announced plans to increase its outreach regarding the E-rate program. Continuing strong review and auditing programs also serve as a long-term deterrent to waste, fraud, and abuse. We on the Commission staff will continue to work with our Office of Inspector General to implement such programs. Incentives For Good Actors To Use The Program Efficiently: The Commission must also encourage efficient use of program funding by those who respect and follow the program rules. In December 2003, the Commission asked for comment on fundamental E-rate policy issues in this area. The Commission asked whether to adjust the schedule of discount rates so that, for example, applicants would pay for a greater share of their E-rate services. This would provide greater incentives for applicants to make only prudent, cost effective purchases. The Commission also sought comment on possible means of determining whether applicants have made ``cost effective'' funding requests. We are evaluating the record we have compiled with the goal of making recommendations to the Commission in this calendar quarter. conclusion We at the FCC are proud of the schools and libraries support program, but we will never be satisfied with the status quo. We will continue to use all tools at our disposal to help us identify areas of E-rate program administration that are vulnerable to fraud, waste, or abuse. At the same time, we will continue to encourage participation in the program so that those that the program's true beneficiaries--the nation's students, library patrons, and all Americans--receive the support they need. We are happy to assist the Subcommittee as it considers these important issues. Thank you, Mr. Chairman, for the opportunity to participate in your review of the NEC-BNS matter, and I look forward to your questions on these issues. Mr. Walden. Thank you for being here today, and for your comments. Mr. McDonald, welcome. TESTIMONY OF GEORGE McDONALD Mr. McDonald. Thank you, sir. Good afternoon, Congresswoman DeGette and Chairman Barton. My name is George McDonald. I am the Vice President of the Universal Service Administrative Company responsible for the Schools and Libraries Division. It is my privilege to be here today to speak with you again about USAC and its administration of the Schools and Libraries Universal Service Support Mechanism, commonly referred to as the E-Rate program. I appeared before this subcommittee on June 17, 2004, and my statement at that time provided an overview of USAC and its administration of the E-Rate program. In the interest of time, I won't repeat that overview, but I would like to reiterate a few key points. Before we began making funding commitments in 1998, our internal controls were carefully reviewed by PricewaterhouseCoopers and staff of GAO. PwC provided an attest opinion about those procedures, and USAC implemented all of the changes recommended by GAO. As we have gained experience, we have strengthened some procedures and added others to continue to protect the integrity of the program and the Universal Service Fund. An early enhancement was the establishment of a whistleblower hotline, which receives an average of 100 calls per year. Out Special Investigations Team investigates every call and ensures that appropriate follow-up action is taken. Today we have an assortment of tools to help assure compliance with program rules. These include: Employing detailed application and invoice review procedures; denying funding commitments when appropriate; rejecting incorrect invoices; auditing program beneficiaries and service providers; recovering funds where rule violations are found; investigating whistleblower hotline complaints; supporting law enforcement investigations; and referring matters involving suspected program abuse to law enforcement authorities. As I indicated to the subcommittee last month, it has become clear to us that we need another tool, a larger oversight presence in the field. We are now reviewing proposals we have received in response to a request for proposals soliciting bids to conduct some 1,000 site visits a year. These visits will allow us to assess even more fully how E- Rate funds are being used, to learn about and publicize best practices in education technology and program compliance, and to help ensure that products and services have, in fact, been delivered and are being used effectively. Now let me turn to the participation of the San Francisco Unified School District in the E-Rate program. San Francisco has received funding in each year of the program. We have disbursed approximately $6.4 million to various service providers for providing eligible products and services to San Francisco for the past 6 years. In regard to San Francisco's application for products and services to be provided by NEC Business Network Solutions, which is the focus of this hearing, we committed approximately $48.6 million to San Francisco, as you have heard here today. San Francisco later canceled those funding requests and, consequently, we never disbursed any of those funds. I would like to join the subcommittee in commending Dr. Ackerman for taking responsible action to protect these funds. Mr. Chairman, I regret to report to you that I believe we made the wrong decision in response to this funding request and that we had information that should have provided a clear warning to us. As you heard today from Mr. Cothran, my review of the files indicates that we had reason to question whether one of the pieces of documentation that San Francisco provided to us, its budget, had been improperly altered when it was submitted to us. We should have done more to assure ourselves that the budget San Francisco provided to us was accurate, but we did not. If we had, in light of what we have learned since, I believe we would have denied this funding request. We requested San Francisco's budget and other documentation as part of our review of whether San Francisco had the funds to pay the non-discount portion of the cost of eligible services, and had acquired the goods and services not eligible for discount but necessary to make effective use of these services, such as computers and software. This particular review had been part of our application review procedures since the first year of the program, and we have strengthened this review every year. For example, in the year in which we reviewed this particular application, our reviewers' notes were not entered into the computer system, and our reviewers brought novel issues to the attention of their supervisors orally. In this case, the issue of whether San Francisco's budget was accurate was a novel issue, and so the reviewer would have communicated the concerns orally. Today, reviewers note their observations in our computer system, and novel issues such as San Francisco's budget must be communicated in writing and are required to be addressed. The decision regarding the novel issue must be documented before a final decision is made with respect to the application. Beyond these changes, we have established an additional layer of review through our quality assurance function to review the work of our application reviewers, which further safeguards program funds. Since August of 2001, we have provided support to the law enforcement investigation of NEC in the form of documentation, answering numerous questions about the program in general and this application in particular, and meeting with law enforcement officials. As we provided this support, we coordinated closely with the Federal Communications Commission, Office of Inspector General, and through that process strengthened our joint efforts to protect the fund from waste, fraud and abuse by supporting law enforcement investigations of those who would take advantage of the program. As a result of our support of this investigation, we learned that San Francisco officials and NEC had provided us with false information in response to many of our questions about this application. Mr. Chairman, thank you for providing me with the opportunity to address the subcommittee. I would be happy to respond to questions. [The prepared testimony of George McDonald follows:] Prepared Statement of George McDonald, Universal Service Administrative Company Vice President, Schools and Libraries Division Good morning, Mr. Chairman and Members of the Subcommittee. My name is George McDonald. I am the Vice President of the Universal Service Administrative Company (``USAC'') responsible for the Schools and Libraries Division. It is my privilege to be here today to speak with you again about USAC and its administration of the Schools and Libraries Universal Service Support Mechanism, commonly referred to as the ``E-rate'' program. Overview I appeared before this Subcommittee on June 17, 2004, and my statement at that time provided an overview of USAC and its administration of the E-rate program. In the interest of time, I will not repeat that overview, but I would like to reiterate a few key points. Before we began making funding commitments in 1998, our internal controls were carefully reviewed by PricewaterhouseCoopers (PwC) and staff of the U.S. General Accounting Office (GAO). PwC provided an attest opinion about those procedures, and USAC implemented all of GAO's recommended changes. As we have gained experience, we have strengthened some procedures and added others to continue to protect the integrity of the program and the Universal Service Fund. An early enhancement was the establishment of the whistleblower hotline, which receives an average of 100 calls per year. Our Special Investigations Team investigates every call and ensures that appropriate follow up action is taken. Today we have an assortment of tools to help assure compliance with program rules. These include employing detailed application and invoice review procedures, denying funding commitments when appropriate, rejecting incorrect invoices, auditing program beneficiaries and service providers, recovering funds where rule violations are found, investigating whistleblower hotline complaints, supporting law enforcement investigations, and referring matters involving suspected program abuse to law enforcement authorities. But, as I indicated to you last month, it has become clear to us that we need another tool)--a larger oversight presence in the field. We are now reviewing proposals we have received in response to a Request for Proposals (RFP) soliciting bids to conduct some 1,000 site visits a year. These visits will allow us to assess even more fully how E-rate funds are being used, to learn about and publicize best practices in education technology and program compliance, and to help ensure that products and services have in fact been delivered and are being used effectively. Participation of the San Francisco Unified School District in the E- rate Program Let me now turn to the participation of the San Francisco Unified School District (SFUSD) in the E-rate program. SFUSD has received funding in each year of the program. We have disbursed approximately $6.4 million to various service providers for providing eligible products and services to SFUSD for the past six years. In regard to SFUSD's application for products and services to be provided by NEC Business Network Solutions, Inc. (NEC), which is the focus of this hearing, we committed approximately $48.6 million to SFUSD. SFUSD later cancelled those funding requests, and consequently, we never disbursed any of these funds. Mr. Chairman, I regret to report to you that I believe we made the wrong decision in response to this funding request and that we had information that should have provided a clear warning to us. My review of the file indicates that we had reason to question whether one of the pieces of documentation that SFUSD provided to us--its budget--had been improperly altered when it was submitted to us. We should have done more to assure ourselves that the budget SFUSD provided to us was accurate, but we did not. If we had, in light of what we have learned since, I believe we would have denied this funding request. We requested SFUSD's budget and other documentation as part of our review of whether SFUSD had the funds to pay the non-discount portion of the cost of eligible services and had acquired the goods and services not eligible for discount but necessary to make effective use of these services, such as computers and software. This particular review has been part of our application review procedures since the first year of the program, and we have strengthened this review every year. For example, in the year in which we reviewed this particular application, our reviewers' notes were not entered into our computer system, and our reviewers brought novel issues to the attention of their supervisors orally. In this case, the issue of whether SFUSD's budget was accurate was a novel issue, and so the reviewer would have communicated the concerns orally. Today, reviewers note their observations in our computer system, and novel issues such as SFUSD's budget must be communicated in writing and are required to be addressed. The decision regarding the novel issue must be documented before a final decision is made with respect to the application. Beyond these changes, we have established an additional layer of review through our quality assurance function to review the work of our application reviewers, which further safeguards program funds. Since August of 2001, we have provided support to the law enforcement investigation of NEC in the form of documentation, answering numerous questions about the program in general and this application in particular, and meeting with law enforcement officials. As we provided this support, we coordinated closely with the Federal Communications Commission Office of Inspector General, and through that process, strengthened our joint efforts to protect the fund from waste, fraud and abuse by supporting law enforcement investigations of those who would take advantage of the program. As a result of our support of this investigation, we learned that SFUSD officials and NEC had provided us with false information in response to our many questions about this application. Conclusion Mr. Chairman, thank you for providing me with the opportunity to address the Subcommittee. I would be happy to respond to any questions you may have. Mr. Walden. Mr. McDonald, thank you for being here, and thank you for your testimony. I want to go back on San Francisco, because what we have heard today is that somebody in USAC reviewing the initial application identified the problem with the budget. It had been falsified, or at least there was, what, a $41 million discrepancy between what was on their website and what had been submitted. We were told that that information was passed up the chain in USAC. Who got it? Mr. McDonald. That employee's manager, Mr. Werner whose name was referred to earlier. Mr. Walden. What did he do with the information? Mr. McDonald. And let me say, I am relying on the same evidence that Mr. Cothran had, the written answers to the questions that he posed to us. Mr. Walden. Why? Mr. McDonald. Because there is no written documentation in the file of this issue. Mr. Schnipp reportedly, by his own report, raised the issue orally to Mr. Werner, did not document it in the file, got no guidance from Mr. Werner. Mr. Walden. Is he supposed to do that? Mr. McDonald. He should have documented this in the file so that everybody would have seen it, and we would have had an open resolution of it. Mr. Walden. Does his--Is it Mr. Werner, you said, is his supervisor? Mr. McDonald. Was at that time, yes. Mr. Walden. Was? Have you talked to him? Does he admit that Mr. Schnipp made him aware of this discrepancy? Mr. McDonald. We talked with him last week in preparation for this hearing. He said that he remembered dealing with that file. He didn't remember this issue being raised to him. So there was a miscommunication at least between these two individuals. Mr. Walden. Is that the first time you had talked to Mr. Werner about this? Mr. McDonald. This is the first time that we have talked to Mr. Werner about this. Yes, sir. Mr. Walden. Last week? Mr. McDonald. Yes, sir. Mr. Walden. Maybe I'm missing something here, but I am troubled by that answer, sir. When did you learn of Mr. Schnipp's--I'm not saying his name right, I'm sure, but his concern? When did this letter come out to the City Attorney's Office saying there is a problem? Mr. McDonald. In 2002. Mr. Walden. And last week was the first time you talked to the supervisor on this? Mr. McDonald. San Francisco had canceled the funding commitments at that point. There was no issue anymore about these commitments. Mr. Werner left the employment of our contractor in 2000. Mr. Walden. So Mr. Werner didn't work--Now wait. Mr. Werner left--What did you say, the employment of your contractor in 2000? So he has been out of the process? Mr. McDonald. Yes, sir. Mr. Walden. Okay. How do you know this isn't still going on? Mr. McDonald. Well, we heard this discussion today about whether there is a contact within USAC with Judy Green. We have not positively funded any application associated with her since her name began appearing on any documentation in 2003. So that is the first I have heard an allegation about that. I did ask whether Mr. Werner left under adverse situation, and he did not. He chose to leave. So we didn't have any suspicion. Certainly, Mr. Werner took no other action to try to hide what was going on. This wasn't documented in the file. Mr. Schnipp hasn't said he was directed not to document this in the file. So I think it was a human error, is what I believe, and we have taken---- Mr. Walden. Human error by Mr. Schnipp or Mr. Werner? Mr. McDonald. Well, Mr. Schnipp in not documenting it, Mr. Werner in not following up on it. Mr. Walden. But Mr. Schnipp contends he talked to Mr. Werner about it, made him aware of it. Mr. McDonald. Yes. Mr. Walden. But he has no documentation to prove that conversation. Is that the issue? Mr. McDonald. Unfortunately, that is correct. And I do applaud Mr. Schnipp, as Mr. Cothran did, for exercising the initiative to find this budget. Mr. Walden. What kind of documentation was required by your rules? Mr. McDonald. There is a worksheet. This is the Item 25 review. Item 25 on the Form 471 is a certification that I have secured access to all the resources necessary to make effective use of the discounted services, including the matching share. Mr. Walden. I mean the reviewer documentation. Mr. McDonald. Oh, there is a worksheet that walks through: Does the applicant have the budget? Does he have hardware? Does he have software, teacher training, etcetera. Mr. Walden. Got it. And so Mr. Schnipp would review that? Mr. Mcdonald. Mr. Schnipp would put his conclusions into that document, and in the budget section of that document ``Pass'' is circled, and there is no issue raised in the write- up about this budget discrepancy. Mr. Walden. Oh. So the written document that would have gone up your chain does not indicate that there was any problem with the budget? Mr. McDonald. That is correct, and that is very unfortunate, because that would have flagged this to get other reviews subsequent to Mr. Schnipp's review, and it would have flagged this for others. Mr. Walden. All right. Are you satisfied with the current document retention policies of the E-Rate program? Mr. McDonald. No, and I think Mr. Maher has addressed that. The rules don't require document retention. That has been a problem in audits, and the Commission is addressing that. Mr. Walden. How long has that been an issue? Mr. McDonald. I didn't realize it was an issue early on. The forms say that the applicants certify they will retain documents, but as this became an audit issue, the guidance that we got was that, since it is not established in the rules, there can't be recoveries for that. Mr. Walden. And those are rules that would have to be promulgated by the FCC? Mr. McDonald. Yes, sir. Mr. Walden. So have you made recommendations to the FCC about what you think needs to be done on the records retention issues? Mr. Mcdonald. This has been on the table since at least the first round of audits when there was documentation--lack of documentation for a program. Mr. Walden. I see. When was that? Mr. McDonald. In 2000 for the funding year 1998. Mr. Walden. So the issue of the lack of retention has been at the FCC's door since 2000? Mr. McDonald. It's been on all of our--All of us have been aware of it since 2000, and our team wasn't on the scene in 2000, but---- Mr. Walden. No, but isn't that one of the issues? There has been quite a bit of turnover at the FCC level on this program. Correct? Mr. McDonald. Compared to USAC. I've been here since 1997. So more turnover than here. Mr. Walden. And, Mr. Maher, has the FCC known since 2000 that record retention was an issue on an audit trail? Mr. Maher. I spoke with the Inspector General about this within the last year. Mr. Walden. I don't know what that means. How long has what he has proposed been before the FCC? Mr. Maher. It has not appeared in an open docket before the FCC, but this issue---- Mr. Walden. That is what it would take? Mr. Maher. It has been put on the table, and the Bureau has recommended the rule change for the August meeting. Mr. Walden. Oh, for the August meeting? Mr. Maher. Yes. Mr. Walden. So it has been basically 4 years to require record retention so we can perform audits in a multi-billion dollar program? Mr. Maher. The issue so far has been that the current rule, and there is an FCC rule regarding document retention, is indefinite. The current rule requires the applicant to retain the same types of documents as it would for other procurements, for example, within its school district. The issue that has been raised is that that is indefinite. It varies among school districts and libraries. What we are looking for is to have a clear bright line rule that will aid the audit process and also aid law enforcement. So what we are doing is improving an existing rule. Mr. Walden. I know in some of the other FCC rules, it is pretty clear you have to maintain certain records for, you know, 2 years, 5 years, whatever it is. What am I missing here that is so hard it takes 4 years to make a decision that these records should be retained for 4 years or 3 years? Did you make a recommendation as to a length of time? Mr. McDonald. The forms--there was an inconsistency in the forms. Some said 3 years. Some said 5 years. I think the Commission is moving to 5 years. Mr. Maher. So our goal is to clean up these discrepancies. Yes. Mr. Walden. Yes, but why does it take 4 years to make that decision between whether a form is 3 years or 5 years for retention purposes? I'm not picking on you. I am just---- Mr. Maher. Absolutely. What we have tried to do with many aspects of the program is to look at what is required and move ahead, and our goal is to improve what we find in place. Mr. Walden. All right. Mr. Maher, you note in your testimony the importance of certifications on forms. The Department of Justice in December of 2002 made a number of recommendations regarding certification to the FCC. If you don't mind turning to Tab 130, please, and I'll give you the chance there to find Tab one-three-zero. Mr. Maher. Yes. Mr. Walden. These included requiring a noncollusion certificate, among others. Why only now is the Bureau recommending certification changes to the forms 18 months after these recommendations and more than 6 years into the program? Mr. Maher. We have worked both with the Department of Justice and the Office of Inspector General to go through a variety of forms, and there's--I think 8 forms have been brought to our attention, and we are altering roughly 16, 17 of these certifications. It has been a back and forth process in getting the certifications right. We have actually submitted the revised forms with certifications to the OMB approval process. it is underway now. These will be in place for the next funding year. Mr. Walden. Okay. My time has expired. I will turn now to the ranking member, Ms. DeGette, of Colorado. Ms. DeGette. Thank you, Mr. Chairman. Mr.--Is it Marh? Mr. Maher. Maher. Ms. DeGette. Maher. I wanted to follow up on the chairman's questions. The Commission is considering rules. Are they considering proposing rules or enacting rules in August? Mr. Maher. What was referred to in my testimony is actual rules, not proposing them in August but to adopt them. Ms. DeGette. But to adopt rules? Mr. Maher. Yes. Ms. DeGette. And this document at Tab 130--this is the memorandum, ``Suggestions for E-Rate program''--has a number of suggestions in it. Have you seen that document before? Mr. Maher. I have seen it before, yes. Ms. DeGette. Okay. Do you know if the No. 1 suggestion, requiring a certificate of independent pricing, is among the rules that will be adopted in August? Mr. Maher. Well, there's a couple of different processes going on. Many of these certification changes, the Bureau has already proceeded on, that a formal rule isn't required. What we did, we had to submit it to OMB for approval. We did that in early June. They were published in the Federal Register. There's 60 days notice before they are adopted. So we expect a variety of the certifications will be in place in September. Now the specific one that is referenced here I would have to check on. Ms. DeGette. Okay. Do you think it is a good idea to have a rule requiring a certificate of independent pricing? Mr. Maher. I think, in general, certifications are very important for three reasons. One, they sort of educate the program participants. The other one is a deterrent effect, because people are certifying to the government. They are saying that they understand the rule and that they are representing so to the government. Finally, they are good for evidentiary purposes. Ms. DeGette. Right. So is it your belief that a rule will be promulgated to require certificates of independent pricing, either through the June rulemaking process that is underway or the August process? Mr. Maher. Well, let's see. That particular one--and I am looking at another chart, but that particular one should be included, and I think it is a great idea. Ms. DeGette. Thank you. Also, this memorandum at Tab 130 suggests that you require that the process require at least three bidders and award the contract to the lowest bidder. Do you think that is a rule that will be promulgated in August? Mr. Maher. That will not be promulgated in August, because it poses a difficult policy issue. This program serves schools and libraries in all parts of the country, very rural isolated ones as well as large cities. The difficulty there is that in some places there just aren't three competing bidders. The policy issue that we are grappling with is what do you do to make sure the competitive bidding process--if you don't have a rule like that, that the competitive bidding process works, and you can keep out the cheats. Ms. DeGette. Right. I mean, if you don't have some kind of a baseline--I would imagine, especially given the amount of money that we have heard over the past two hearings is involved in the contracts, I would think that for the vast majority of projects you could find at least three bidders who were willing to bid on it. Wouldn't you think so, sir? Mr. Maher. The experience--Maybe Mr. McDonald could comment, but experience varies among school districts and libraries. Ms. DeGette. Okay. So what kind of rule can be promulgated that would assure a competitive bidding process, if you are not going to require a minimum number of bidders? Mr. Maher. Actually, the Commission in its Ysletta order-- that is involving the Ysletta, Texas, school district-- promulgated some--made some law which clarified the competitive bidding process. For example, it made very clear that price--In any bidding circumstance, price has to be the primary factor to be considered in bidding. Ms. DeGette. Okay, but if you don't have a competitive bid, then how do you know if the price is unreasonable or not? Mr. Maher. The other side of the equation is something that the subcommittee discussed in the last hearing, which is looking at that schedule of discounts that schools are eligible for; because the notion is that, if a school or a library has to pay more, they will be more interested in getting an efficient system in place or efficient facilities, and that that, too, will help reinforce the---- Ms. DeGette. You mean the percentage of the contract that the institution has to pay? Mr. Maher. Yes. Ms. DeGette. And are you considering then increasing that percentage for all entities? Mr. Maher. Yes. We are looking at that in an ongoing rulemaking. Ms. DeGette. And I understand that might make institutions pay a little closer attention to the contracts, but wouldn't that also eliminate some very poor school districts' ability to actually make their share of the E-Rate program? I mean, isn't it counterproductive for some of the very poorest school districts? Mr. Maher. This is the policy debate that has faced the program, and I will note that in its first 6 years--you have spoken about its benefits--that many of those school districts, the poorest ones, have received the up-to-date technology. So what we are trying to do is to weigh these concerns, both making sure they have the facilities and making sure that the process can work well. Ms. DeGette. It would seem to me, you could have a rule that required a certain number of bidders, and then if a school district couldn't find those bidders, they could apply for a waiver. Wouldn't that make some sense? That way you would have a basic rule, but that exceptions could be granted in extreme cases. Mr. Maher. It is certainly worth considering, ma'am. Ms. DeGette. Okay Do you think you will go back and consider that? Mr. Maher. Yes, ma'am. Ms. DeGette. Now you are leaving at the end of August, I understand. Is that right? Mr. Maher. I believe the beginning of September, ma'am. Ms. DeGette. Who is going to be taking over this program when you leave? Mr. Maher. It would be the next Chief of the Wireline Competition Bureau, who hasn't been designated yet. Ms. DeGette. All right. So are you going to be working with that person when they come in or are we going to be starting from Ground Zero with someone new right about the time we come back into the fall session? Mr. Maher. I will be working with that person, and also our professional staff. Our head manager on this is a former State prosecutor and an expert in the schools program. So I think it is in good hands. Ms. DeGette. Okay. I just want to ask one more question. Then I know we have a series of votes. The final requirement is to require additional documentation--Oh, the final suggestion in this memo is to require additional documentation and notice. Are you familiar with that recommendation? Mr. Maher. I'd have to refresh my recollection. Ms. DeGette. It is on page 4 of the memo. Mr. Maher. Yes, I see it. Ms. DeGette. Okay. Are you familiar with that, besides just looking at it today? Mr. Maher. Yes. Ms. DeGette. Okay. What kinds of additional--and do you agree that additional documentation and notice are going to be necessary to restore the integrity of the program? Mr. Maher. I think the best answer to the issue posed by the suggestion on page 4 is a comprehensive document retention program and effective review of USAC. Ms. DeGette. You testified to that before. Mr. Maher. Yes, ma'am. Ms. DeGette. And is that going to be put into place? Mr. Maher. We have recommended that for Commission consideration at the August meeting. Ms. DeGette. Well, let me just say for the record, and I know the chairman has a question, I think everybody needs to get on this fast and enact some very, very stringent rules at every level. I yield back. Mr. Walden. Thank you. The Chair recognizes the chairman of the committee. Chairman. Barton. And I am going to be very brief, and I hope your answers are brief, because we are going to have to leave here in about 4 minutes. What is the total amount of contracts or grants that are awarded under the E-Rate program right now? Mr. Maher. The program is capped at $2.25 billion a year, and that---- Chairman. Barton. $2.25 billion. Mr. Maher. Yes, sir, and that is awarded. Chairman. Barton. Isn't it true that the number of requests for funding is going up almost geometrically? I thought we had requests last year for over $5 billion, $5.6 billion. Is that right, or not right? Mr. Maher. Sir, Mr. McDonald has the number. I believe the actual demand has decreased from 2003 to 2004 by 9 percent, as far as dollars. But Mr. McDonald perhaps has the best---- Chairman. Barton. Well, so it has probably gone up. Mr. McDonald. 2002 is the highest level. It has declined in 2003 and 2004. It is still $4.3 billion. Chairman. Barton. Okay. When somebody--We have seen, not just on the issues that are before us that we put on the record, Puerto Rico and San Francisco, but everywhere across the country we see instances where requests for funds under this program start out in what appear to be very reasonable, and then some consultants come in, and the next year the funding levels go up by orders of magnitude, you know, from like $4 million to $40 million or $20 million to $100 million. Is there no system in the review process that checks back from prior years and questions some of these big increases? Mr. McDonald. In 2002, the highest year, we identified a pattern, procurement pattern, that we felt was inconsistent with the rules, and denied over $500 million. The Commission largely upheld us on appeal, and I believe that contributed to the reduction in demand in 2003. Chairman. Barton. Well, what it appears to me is that we had a program that was put in place 5 or 6 years ago, and in the beginning a lot of people didn't understand it, and a lot of especially the smaller school districts don't like dealing with the Federal Government. Then word got out that there was easy money to be had, and these applications would almost be rubber stamped. I mean, we have on the record one of these applications where they built a television studio. Now surely somebody at the regional and Federal level would look at something like that. I mean, thank God for groups like the San Francisco School District that are kind of self-enforcing, but I don't see a whole lot of effort at the Federal level to do anything but kind of manage the available fund and portion out the amount of money that is allowed to go out each year. Am I wrong about that? Mr. McDonald. Let me say, sir, that we work really hard to identify issues in this program. Service providers--we look for patterns across applications. The set of applications that is really the heart of the issue here today was really the first time we identified issues like this across applications. Now we have a special investigations team with certified fraud examiners on our staff that would dig right into an issue like this. I am confident we wouldn't have made the San Francisco commitment if we had seen that now. I think we have beefed up a lot our ability to identify fraud and stop it. Chairman. Barton. Well, we are going to have to go vote. So I am going to yield back. But I would like there to be a set of recommendations about how to make changes to the program that force more automatic compliance, so that we don't have to depend on people like the superintendent of the San Francisco School District to be a watchdog for the taxpayers' money. With that, Mr. Chairman, I yield back. Mr. Walden. Thank you, Mr. Chairman. I am going to note that we are going to keep the record open for members to submit questions in writing to all our witnesses today, including you two gentlemen, if that is acceptable. Well, yes, without objection. Mr. McDonald. Yes, sir. Mr. Walden. We will keep it open for 30 days to submit questions. No other business to come before the subcommittee, I appreciate all the witnesses today, and we stand adjourned. [Whereupon, at 3:38 p.m., the subcommittee was adjourned.] [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]