November 18, 2019 – The U.S. Government Accountability Office (GAO) has issued a report on its investigation of potential fraud risk in the FCC’s universal service fund (USF) high-cost program that supports rate-of-return carriers.[1]

The report, FCC Should Take Additional Action to Manage Fraud Risks in Its Program to Support Broadband Service in High-Cost Areas, is largely a comparison of potential fraud risk in the two existing rate-of-return high-cost USF support mechanisms – the legacy, cost-based support regime and the Alternative Connect America (A-CAM) cost model support program.

The GAO refers to the first support method as the “traditional cost-accounting support mechanism,” which, as the GAO puts it, “retroactively provides support to carriers for costs already incurred, based on cost studies, including financial statements these companies provide each year.” According to FCC, as of September 2019, there were approximately 437 study areas served by rate-of-return carriers receiving support through the legacy cost-based rules.[2] The second support mechanism, the A-CAM, provides high-cost USF support to rate-of-return carriers based on modeled forward-looking network costs and revenues of an efficient carrier to serve an area with voice and broadband Internet access services. As of September 2019, rate-of-return companies serving 641 study areas were receiving support through the A-CAM mechanism (or almost 60 percent of all 1,078 rate-of-return carriers’ study areas).[3]

The GAO concludes the FCC has improved the ways it reimburses rate-of-return companies to prevent and reduce fraud risk, but also finds the FCC could do better, and makes five recommendations to help the FCC target its efforts to reduce the risk of fraud in the high-cost program.

Recommendations four and five are what have caused the GAO report to garner headlines. They recommend that the FCC assess the A-CAM support mechanism to determine the extent to which it produces reliable cost estimates and consider making its use mandatory all for rate-of-return carriers. According to the GAO, the FCC stated it would take steps to implement the recommendations made in the report.

So there you have it. The FCC, or at least someone from the FCC, has publicly indicated, albeit in a roundabout way through the GAO report, that forcing every rate-of-return carrier on to incentive regulation is the way to go.

Why exactly does the GAO think A-CAM or incentive regulation is better than traditional rate-of-return regulation? One reason offered by the GAO report is that the latter cost-based rules are simply too complex to enforce because it is very difficult to determine whether certain costs and the amounts of those costs are legitimate and prudent. Here is how the GAO report describes it:

[S]takeholders told us FCC’s traditional cost-accounting support mechanism is complex and difficult to audit, and that such weaknesses make it prone to fraud risks. For example, USAC officials told us it is time consuming to detect inflated costs associated with carriers’ affiliate company transactions. The traditional cost-accounting support mechanism also requires that carriers separate costs based upon the type of service with which the cost was associated. According to FCC’s OIG officials and representatives from accounting firms we contacted, determining whether a carrier has overly attributed costs to eligible services is difficult. For instance, determining if labor costs are properly being allocated between eligible and ineligible services requires looking at each employee’s timesheet.

USAC audits have traditionally been the vehicle for enforcing rate-of-return rules. As most carriers will say, these USF audits take forever and are extremely time consuming for all parties involved. The GAO report explains that USAC’s ability to perform these audits is not adequate due to a lack of resources and expertise. This implies there may be asymmetries of knowledge, expertise, information, and resources between the rate-of-return industry and the regulators. Rate-of-return carriers use cost consultants to perform cost studies that form the basis for the amounts of high-cost USF support they receive annually. These cost consultants are experts who have decades of experience working on rate-of-return high-cost USF rules. As explained in the GAO report, it seems USAC, as of late, has been unable to keep up:

According to USAC, it also faces challenges auditing traditional cost-accounting support payments due to limited expertise and capacity to address the complexity of the audits. USAC officials noted that this issue has been exacerbated by audit staff turnover. According to USAC officials and some stakeholders we contacted, auditing carriers receiving traditional cost-accounting support is also difficult due to the extensive documentation requirements for this type of support, requirements that often entails hundreds of pages of financial information per carrier. USAC officials told us that a single audit can take over 1,000 hours to complete, and USAC officials told us they only completed 10 audits of carriers that received support on a traditional cost-accounting basis in fiscal year 2018.[4]

This is the entire point of this GAO report. The rate-of-return carriers that still subject to traditional cost-based rules “cannot be effectively audited,” and because of this, “significant fraud risks remain for the high-cost program.”[5] An easy way to fix the problem, according to the GAO report, is to simply do away with rate-of-return and require every carrier to move to incentive regulation – the A-CAM.

This brings us back to recommendations four and five. By assessing the model, FCC would have greater assurance that it is producing reliable cost estimates and be better positioned to determine whether to make its use mandatory. This should not come as much of a surprise to any rate-of-return carrier. A mandatory move to model-based incentive regulation has been discussed as possibility since the release of the National Broadband Plan in 2010.

Of course, I’d surmise there are a large number of rate-of-return carriers that do not think the A-CAM accurately estimates the total cost of deploying and operating a broadband network in their service areas. There are characteristics and challenges specific to certain areas of the country that make it difficult and costly to deploy and operate broadband networks that have not been incorporated into the guts of the A-CAM because the model simply does not and cannot understand them.

At the same time, some carriers may say the support amounts spit out by the model for their study areas are  based on costs estimates that are identical to the cost data they submitted via cost studies for many years prior to electing to move to model-based support.

There’s also a good chance that if you were to break down everything in the A-CAM for many study areas, the model’s cost components and revenue assumptions would produce the a rate-of-return for carriers that is greater than the amount of return authorized under the legacy cost-based USF rules. In a sense, a deep-dive assessment of the A-CAM to determine the extent to which it produces reliable cost estimates is really an audit. It could be very interesting to compare a company’s cost study to the A-CAM audit for its study area. Nevertheless, if I had to make a prediction, I would say the writing is on the wall. The days are numbered for traditional rate-of-return regulation. Is that a bad thing? Not necessarily. Or at least it’s not a bad thing if the A-CAM accurately models the costs and revenues for your study area. The A-CAM’s not perfect. The rural carriers that elected A-CAM support think it’s at least good enough. Actually, a more accurate statement would be that those who chose the model thought the support amounts and buildout obligations were good enough.

If the FCC follows through on the GAO’s recommendation to assess the A-CAM, the results could be helpful to the FCC in making a decision to force all remaining rate-of-return carriers to cost model regulation. Of course, it seems the FCC could simply make this decision without performing an assessment.

Here’s some more information on the GAO’s report. The conclusion is worth reading.

GAO Report Background

Congressman Frank Pallone (D-NJ), Chairman of the House of Representatives Energy and Commerce Committee, requested the GAO to review FCC’s oversight of rate-of-return carriers participating in the USF high-cost program. The GAO report examines the extent to which FCC (1) has implemented reforms intended to improve the accountability of rate-of-return carriers’ funding, and (2) is managing fraud risks for the USF high-cost program in accordance with leading practices. As part of the review process and compiling the report, GAO reviewed FCC orders and policies, prior GAO and FCC OIG reports, and other relevant documents related to high-cost support reforms, assessed the FCC’s efforts implementing the reforms against federal internal-control standards and FCC’s strategic plan, and interviewed FCC officials responsible for setting USF policy, FCC auditors, rural industry association officials, representatives from four accounting firms that assist rate-of-return carriers, officials from state utility commissions, officials from the Universal Service Administrative Company (USAC), and a representative from the National Exchange Carrier Association (NECA).

GAO Recommendations for Executive Action

The GAO recommends the FCC take the following five actions to better target its efforts to improv the way it reimburses companies to prevent the risk of fraud:

1. Recommendation: The Chairman of FCC should ensure that FCC's Office of Managing Director follows the leading practices in GAO's fraud risk framework related to a dedicated entity's management of its antifraud activities, such as serving as the repository of knowledge on fraud risks and coordinating antifraud initiatives.

2. Recommendation: The Chairman of FCC should plan regular fraud-risk assessments tailored to the high-cost program and assess these risks to determine the program's fraud risk profile, as provided in GAO's fraud risk framework.

3. Recommendation: The Chairman of FCC should design and implement an antifraud strategy for the high-cost program with specific control activities, based upon the results of fraud-risk assessments and a corresponding fraud risk profile, as provided in GAO's fraud risk framework.

4. Recommendation: The Chairman of FCC should assess the model-based support mechanism to determine the extent to which it produces reliable cost estimates.

5. Recommendation: The Chairman of FCC should consider whether to make use of the model-based support mechanism mandatory depending on the results of the assessment.

GAO’s Conclusion

Here is the conclusion from the GAO’s report:

Given the continuing importance of deploying telecommunications services in difficult-to-serve areas, effective oversight for rate-of-return carriers is an important component for helping ensure that the high-cost program’s finite funds are used properly to meet the intent of the program. Overall, the traditional cost-accounting mechanism that FCC uses to provide support to a substantial number of rate-of-return carriers is complex, prone to fraud risks, and presents auditing challenges that FCC has not fully addressed. By following leading practices from GAO’s fraud risk framework, FCC could better ensure that it is addressing and strategically targeting the most significant fraud risks facing the high-cost program. Furthermore, FCC’s model-based support mechanism has now been in use by some rate-of-return carriers for several years and stakeholders agree that it is less prone to fraud risks. However, FCC has not assessed the extent to which the model is producing reliable cost estimates. By conducting such an assessment, FCC would have greater assurance that it is producing reliable cost estimates and be better positioned to determine whether to make its use mandatory.[6]

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[1] U.S. Government Accountability Office, FCC Should Take Additional Action to Manage Fraud Risks in Its Program to Support Broadband Service in High-Cost Areas, GAO-20-27 (Rel. Nov 18, 2019) (GAO Report).

[2] GAO Report at p. 7.

[3] GAO Report at p. 7; Wireline Competition Bureau Authorizes 171 Rate-Of-Return Companies To Receive $491 Million Annually In Alternative Connect America Cost Model Ii Support To Expand Rural Broadband, WC Docket No. 10-90, Public Notice, DA 19-808 (Aug. 22, 2019); Wireline Competition Bureau Authorizes 186 Rate-Of-Return Companies To Receive An Additional $65.7 Million Annually In Alternative Connect America Cost Model Support To Expand Rural Broadband, WC Docket No. 10-90, Public Notice, DA 19-349 (Apr. 29, 2019).

[4] GAO Report at p. 17.

[5] GAO Report at p. 18.

[6] GAO Report p. 24.