In 2010, the FCC revised its rules for the Schools and Libraries Program of the federal Universal Service Fund (commonly known as the "e-rate" program).  One of the principal changes to the rules was the adoption of rules prohibiting e-rate recipients from receiving gifts from service providers.  The FCC has clarified its gift rules twice, but has had other clarification requests pending for some time.  Yesterday, the FCC issued a public notice addressing an aspect of its rules that has caused the most confusion -- when and how a service provider may provide free or discounted equipment bundled with eligible services without cost allocation of the ineligible portion.

Significantly, the public notice proposes to reverse course from the guidance provided in December 2010 that permitted, at least, cell phone contracts that include a free or discounted phone for customers signing a service contract.  Instead, under the proposal set forth in the public notice, service providers would be required to conduct a cost allocation in all instances where equipment is bundled with eligible services.  If adopted, the rule would end the "free cell phone" exemption from the cost allocation rules.

The roots of this issue date back to the December 2010 clarification of the e-rate gift rules.  In that clarification, the FCC stated that service providers could not offer special equipment discounts or equipment with service offerings if such offers were "not available to some other class of subscribers or segment of the public."  In a footnote to this conclusion, the FCC stated that schools and libraries could take advantage of free cell phones or discounted cell phones offered with two year service contracts and could do so without cost allocation.  However, the FCC concluded, a school could not accept free iPads in connection with Internet access if such offers were not also available to the public or a designated class of subscribers.

Not surprisingly, many service providers sought clarification of when an offer was available to the public or a designated class of subscribers.  This has led to significant confusion in the e-rate industry, with some providers offering bundles that they contend are permitted under the December 2010 clarification.  Since December 2010, both USAC and the State E-Rate Coordinators Alliance (SECA) have sought clarification from the FCC.  

The public notice effectively proposes to repeal the conclusion reached in the December 2010 clarification.  Specifically, the public notice proposes that, beginning with funding year 2014, all ineligible components must be cost allocated, "even if bundled with e-rate eligible services and offered to the public or some class of users."  This would apply to the free cell phone plans offered by wireless carriers as well as to other bundles service providers have created in reliance on the December 2010 clarification.  The Commission's rationale for this change is that the existing clarification would strain e-rate resources and would be overly burdensome to administer.  The FCC stresses that it is not proposing to alter its cost allocation methods, only the circumstances under which cost allocation is required.

The FCC is seeking comment on its proposal, with comment dates triggered by Federal Register publication of the public notice.