When large amounts of cash and the entrepreneurial spirit intersect with an institution as impoverished and trusting as schools, it's not long before financial scandal strikes. That time is now here, and the nation's public schools are getting a spectacular Enron-style education, soon to be elevated to the investigative chambers of Congress. This scandal also illustrates, rather painfully, the confusion among education's policy-makers about what really should be emphasized in the nation's classrooms.

The story begins with the schools' rapid investment over the past decade in computer technology and Internet systems. The dollars for many of those purchases have come from a little-known federal program called the "e-rate" (for education rate). Launched as part of the 1996 Telecommunications Act, the program is overseen by the Federal Communications Commission and its designees, a series of loosely run, quasi-public management firms. Each year, the e-rate provides poor schools with roughly $2.25 billion in subsidies for new Internet networks. The subsidies come from a tax on everyone's phone bill--a line innocuously labeled "universal service fee"--which started at 3 percent but now hovers around 9 percent.

The revenues from this tax cover up to 90 percent of a poor school's costs for Internet systems. This has allowed school districts to contract with some of the nation's top-of-the-line technology firms--outfits like NEC, Verizon and IBM. Construction contracting has always been fertile ground for inflated costs and corrupt payment schemes, but the Internet wiring jobs--with their wide popularity, unprecedented expense and technical complexity--have taken these opportunities to spectacular new levels.

Consider a few details from one such deal, in San Francisco. In October 2000 the FCC's management firm approved a $50 million grant to finance a massive school networking project in the city. (The school district was on tap for another $18 million, making the total cost come to $68 million.) Months later, to everyone's surprise, the district turned the $50 million grant down. After examining the contract, district technicians had discovered they could build the system themselves for less than their meager share of the costs--that is, for less than $18 million.

The reasons become apparent in the fine print of the voluminous bid from NEC, the firm that won the San Francisco contract. Onpage after page, NEC generously marked up prices on computer hardware, sometimes by 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. This is the educational equivalent of the $640 toilet seats famously sold to the Pentagon by military contractors during the Reagan Administration.

The basic problem here is well-known to federal authorities. Various Republican Congress members, wary of anything that smells like a new tax, have long been questioning the necessity of the e-rate program. In 1998 Senator John McCain was concerned enough about oversight weaknesses in the program that he asked the General Accounting Office to investigate. The GAO found that the FCC's first e-rate management firm was sending out letters of funding commitment before evaluating the projects it was financing, and that it had yet to set up an auditing system. The GAO also noted that the e-rate created a duplicate program for funding technology in schools, because $12 billion was already available through the Education Department.

Although the FCC's e-rate management firms promised to make corrections, little was done. An audit by the FCC's Inspector General last year found questionable financial dealings of one sort or another "at nearly all locations" where e-rate contracts were examined. By late 2002 federal authorities had begun to take some action. In one case prosecutors charged a New York company, Connect2 Internet Networks--which had done more than $9 million of business with thirty-six schools--with eight counts of federal crimes. The allegations: The firm bought more expensive gear than its customer schools could afford, created fake invoices to suggest the schools had paid their share, then coached school officials to lie about the arrangements. (Connect2's owner, John Angelides, eventually pleaded guilty to one count of conspiracy.)

As the Connect2 case was developing, federal auditors killed an $18 million e-rate job with IBM in Ysleta, Texas. They concluded that IBM had set up the job in such a way that it precluded bids from competing Internet contractors. IBM denied the charges, but government regulators said, "The record reflects that the overriding goal of the IBM-Ysleta relationship" was to maximize the federal subsidy, "not necessarily to promote educational goals." IBM, which offered the same "sole source" option to many districts around the country, was not a small player in this game. Up until the Ysleta contract, it had received $351 million of e-rate money. For 2003, IBM sought nearly $1 billion in e-rate projects--nearly half the program's annual budget. Most of that money is now being held up while the problems with IBM's bids are investigated.

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