News of the Week

FY 2008 and FY 2007 Funding Status

Wave 5 for FY 2008 is scheduled to be released on Wednesday, May 28th. Funding in this wave is expected to be $30 million. The cumulative national FY 2008 funding total is $538 million. No Internal Connections requests are being funded yet for this year.

Wave 52 for FY 2007 is also scheduled for release on Wednesday. Again, this will be a small wave providing funding for only ten applicants and totaling just under $2 million. The cumulative national FY 2007 funding total is $2.32 billion — actually down about $400 thousand from two weeks ago as a result of funding reductions or cancellations. The final Internal Connections funding threshold for FY 2007 is 81%.

Telephone Audits and E-Rate Implications

Google the phrase "telephone audit" and you will get a listing of telecommunications consulting firms who provide a highly specialized service of reviewing telephone bills, typically for large organizations interested in controlling their telecommunications expenses. Such reviews require a level of expertise not often found even among the more sophisticated Fortune 500 companies. Thorough audits normally involve the review of hundreds of pages of bills, access to carrier line records and underlying tariffs (often with multiple amendments), and physical inventories of circuits and/or services. In many cases, such audits uncover a number of unsubstantiated charges, often tracing back several years. When overcharges are identified, and confirmed by the telephone carriers, the auditing firms request refunds.

Telephone auditing firms typically work on a contingency basis, asking for a percentage (often up to 50%) of the funds recovered. The sales pitch is quite simple: "We do all the work. If we find no excess charges, you pay us nothing. If we find and recover overpayments, you pay us a portion and keep the rest - and you pay your telephone company less in the future. You can't lose." Indeed, judging from the client lists of many of these telephone auditing firms, many corporations have found this to be a valuable, no-lose service.

Large school districts and library systems are also candidates for telephone audits, and we often encourage them to use telephone auditors every few years. But — and this is a large "but" — it is important for applicants to understand the special E-rate implications of telephone audits.

Specifically, if an applicant has received E-rate discounts for telephone services, which an auditor subsequently finds were not provided and for which a refund is obtained, a discounted portion of that refund should be returned to USAC. Consider the following example:

Suppose a school district has had telephone bills averaging $10,000 per month for the past three years (often the maximum period for which refunds are available), and has been obtaining E-rate discounts on these charges of 60%. If a telephone auditor finds $500 per month in overpayments over that period, the telephone company would be refunding $18,000 ($500/mo. x 36 months). Since 60% of these overpayments had been funded by the E-rate program, the applicant would be expected to return $10,800 to USAC.

But if the district had agreed to pay 50% of the refund to its telephone auditor, it would owe the auditor $9,000. In total, therefore, the district would be paying out $19,800 - $10,800 to USAC and $9,000 to the auditor. In this situation, the supposedly "no-cost" audit means that the district is paying out $1,800 more than its gross refund. The higher the applicant's discount rate, and the higher the auditor's contingent fee percentage, the greater the applicant's out-of-pocket expense. In many cases, the only saving grace is that the applicant's ongoing phone bill should be less, and ultimately there will be a net savings.

The somewhat simplified example above illustrates the basic E-rate issue regarding telephone audits. As with many aspects of the E-rate program, however, there are a number of other issues, concerns, and unknowns. In particular:

1. As demonstrated above, E-rate changes the economics of telephone audits. As such, the nature of any contingent agreement with the auditing firm is more important. Generally, these agreements are negotiable. The following two points should be noted:
   1. In addition to a percentage of any refund, some auditors may ask for a percentage of any ongoing savings for a year or two. Since the net benefits of an audit to E-rate applicants may come entirely from future savings, such ongoing contingent fees may be particularly onerous.
   2. An argument can be made for calculating contingent fees on the basis of net refunds (after USAC repayments), rather than gross refunds. For a high discount applicant, however, this may make the arrangement uneconomic for the auditor.
2. Some telephone companies will not make a refund to an E-rate applicant without first remitting the discounted portion of the gross amount to USAC directly. In such cases, only the net refund is paid to the applicant (and its auditor). If the applicant must repay USAC itself, instructions for doing so are available in the Reference Section of the SLD Web site (see Returning Funds to USAC).
3. Refunds often include an interest component — in some cases, a significant component — to compensate the telephone customer for the time value of money of earlier overpayments. It is not clear whether the discounted portion of refunded interest must be returned to USAC. Since interest is not charged in a COMAD procedure (unless a debt becomes delinquent), when USAC determines that funds have been disbursed in error, there is no precedent for including interest in an applicant-initiated return of funds. Unless and until the FCC rules otherwise, we recommend not returning any portion of an interest refund to USAC. Not doing so improves the economics of telephone audits for E-rate applicants.
4. One potential FCC action that would make telephone audits more attractive to E-rate applicants is the approval of a waiver request by the New York City Department of Education. The filing "...asks the Commission to find that telephone audits are a valuable and cost-effective tool for controlling school and library telecommunications costs and for assuring Universal Service Fund integrity. The Commission should also find that reasonable fees incurred by applicants are a necessary expense for such audits. As a result, the calculation of funds to be repaid to USAC should be based on the discounted portion of carrier refunds - net of audit fees - actually received by an applicant. Such a procedure would assure that an applicant would not be penalized for voluntarily initiating an audit of its own telecommunications service charges." Unfortunately, this waiver request was filed in October 2003 and is still pending.

E-Rate Updates and Reminders

On-site audits being performed this year include a portion dealing with applicant fraud awareness and procedures. Essentially, the auditors are applying some of the same concepts used for corporate Sarbanes-Oxley compliance. Specifically, auditors are meeting with applicant personnel in the E-rate chain of command to discuss:

• Risks and risk assessment
• Procedures to identify fraud and abuse
• How potential instances of fraud are treated and communicated
• How beneficiary employees are made alert to the possibilities of fraud and how to identify or prevent it

For its part, the FCC is continuing with its policies of E-rate suspensions and debarments. This past week, the FCC issued Notices of Suspension and Initiation of Debarment Proceedings to five individuals convicted in connection with the United States v. Video Network Communications, Inc. et al criminal docket. Additionally, the FCC issued final Notices of Debarment to two other individuals who had been the subject of earlier debarment proceedings. Copies of these notices are available on the SLD Web site (see the May 2008 entries at Suspensions and Debarments).

Schools and Libraries News Brief for May 23rd

The SLD's News Brief for May 23rd includes the following three announcements:

1. The SLD has just begun mailing Form 500 Notification Letters for FY 2008. The article briefly summarizes the use of Form 500s to change service start or contract expiration dates (or, more precisely, to notify the SLD of such changes), or to reduce or cancel funding.
2. A series of Special Edition News Briefs will be issued this week to address the Selective Review process. We will provide summaries and comments on this topic in our next newsletter.
3. The SLD special "summer contact" procedures went into effect on May 23rd (the last Friday before Memorial Day) and will remain in effect until September 5th (the first Friday after Labor Day). During this period, the SLD will not hold applicants accountable for responding to PIA inquiries within 15 days if it cannot confirm by telephone that the applicants are available during to summer holiday period.

The downside of this procedure is that funding actions on affected applications will be delayed until applicant contacts are reinitiated. The SLD's application status indicator for "Deferred" indicates:

Your Form 471 is on hold. You were unavailable or you requested that PIA defer the Form 471 review during either our Summer or Winter deferral period. If you wish PIA to remove the hold and continue review, contact your PIA reviewer. If you don't know who your reviewer is, contact our Client Service Bureau at 1-888-203-8100.