# Audit of the National Student Loan Program's

# Establishment of the Federal Family Education Loan Program Federal and Operating Funds

# 

# 

# 

# 

# FINAL AUDIT REPORT

### 

### 

### 

### ED-OIG/A07-B0002

### September 2002

Our mission is to promote the efficiency, U.S. Department of Education

effectiveness, and integrity of the Office of Inspector General

Department's programs and operations. Region VII - Kansas City Office

# 

# NOTICE

**Statements that managerial practices need improvements, as well as
other conclusions and recommendations in this report represent the
opinions of the Office of Inspector General. Determinations of
corrective action to be taken will be made by the appropriate Department
of Education Officials.**

**In accordance with the Freedom of Information Act (5 U.S.C. § 552),
reports issued by the Office of Inspector General are available, if
requested, to members of the press and general public to the extent
information contained therein is not subject to the exemptions in the
Act.**

# Audit of the National Student Loan Program's

Establishment of Federal Family Education Loan Program

Federal and Operating Funds

# 

Table of Contents

# 

**Executive
Summary**.........................................................................................
1

**Audit
Results**..................................................................................................
3

Finding No. 1 -- Unallowable and Unsupported Marketing and Public
Relations Costs........ 3

###### Finding No. 2 -- Unallowable Information System Costs......\...................................... 6

####### Finding No. 3 -- Unallowable Employee Benefit Costs............................................. 8 

Finding No. 4 -- Unallowable Administration
Costs..............................................\... 10

######## Finding No. 5 -- Unallowable and Unsupported Communication and Design Costs........... 13

Finding No. 6 -- Unsupported Salary
Costs.......................................................... 15

Finding No. 7 -- Inadequate Standards of
Conduct................................................. 17

**Other
Matters**...............................................................................................
20

# Background\...\...\...\...\...\...\...\...\...\...\...\...\...\...\...\...\.....................\...\............\..............\...\........\....... 21

# Objective, Scope, and Methodology\...\...\...\...\...\...\...\...\.....................\...\...............\............... 22

> **Statement on Management
> Controls**\...\...\...\...\...\..........................\...\...\...\...\...\......................
> 24

**Exhibit --** FES and Its Affiliated
Organizations..........................................................
25

**Appendix** -- National Student Loan Program Response to the Draft
Audit Report................. 26

# 

# Audit of the National Student Loan Program's

Establishment of Federal Family Education Loan Program

Federal and Operating Funds

# 

Executive Summary

# 

# We conducted an audit of the National Student Loan Program's (NSLP's) establishment of Federal Family Education Loan (FFEL) Program Federal and Operating Funds, whose establishment was required by the 1998 amendments to the Higher Education Act of 1965 (HEA). 

We found that NSLP understated the beginning balance of its Federal Fund
by \$942,941, because it used federal funds to pay for unallowable and
unsupported costs for marketing and public relations, information
systems, employee benefits, administration, and communication and design
during Fiscal Year (FY) 1998. We also found that NSLP used federal funds
to pay for \$1.73 million of unsupported FY 1998 salary costs and did
not maintain and update adequate standards of conduct.

We recommend that the Chief Operating Officer (COO) for Federal Student
Aid[^1] (FSA) require NSLP to reimburse the Federal Fund

-   \$231,525 for unallowable marketing and public relations costs;

-   \$440,626 for unallowable information system costs;

-   \$4,015 for unallowable employee benefit costs;

-   \$47,700 for unallowable administration costs; and

-   \$4,317 for unallowable communication and design costs.

We also recommend that the COO for FSA

Require NSLP to provide supporting documentation for, or reimburse
\$214,193 in unsupported FY 1998 marketing and public relations costs
charged by the Foundation for Educational Services (FES) plus imputed
interest calculated through September 30, 2001 to the Federal Fund.

Require NSLP to provide supporting documentation for, or reimburse
\$1.73 million FY 1998 salary expense it was charged plus imputed
interest calculated through September 30, 2001 to the Federal Fund.

Require NSLP to provide supporting documentation for, or reimburse \$565
in college fair advertisement costs charged by FES plus imputed interest
calculated through September 30, 2001 to the Federal Fund.

-   Require NSLP to maintain documentation sufficient to support salary
    costs charged by FES; and

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-   Assure that NSLP's conflict-of-interest standards adhere with
    federal regulations.

In most instances, NSLP disagreed with our findings. We have summarized
its responses at the end of the respective findings and provided the
full text of the responses as an appendix to this report.

Audit Results

We found that NSLP complied with the HEA and federal regulations
governing the establishment of the Federal and Operating Funds, except
that it understated the beginning balance of its Federal Fund by at
least \$942,941 because it used federal funds to pay for unallowable and
unsupported FY 1998 costs for marketing and public relations costs
(\$445,718), information systems (\$440,626), employee benefits
(\$4,015), administration (\$47,700), and communication and design
(\$4,882). These expenditures were not in accordance with 34 C.F.R. §
682.410 (a)(2)(ii),[^2] which provides that a guaranty agency must use
the assets of its reserve fund to pay only costs that are reasonable and
that are ordinary and necessary for the agency to fulfill its
responsibilities under HEA. We also found that NSLP used federal funds
to pay for unsupported FY 1998 salary costs (approximately \$1.73
million) and did not maintain and update adequate standards of conduct.

# 

# Finding No. 1 -- Unallowable and Unsupported Marketing and Public 

#  Relations Costs

NSLP used federal funds for unallowable and unsupported marketing and
public relations costs. As a result, the Federal Fund's beginning
balance was understated. FES charged NSLP \$414,193 for FY 1998 "default
prevention services" performed by Educational Planning Centers (EPCs).
According to NSLP officials the EPCs spent 25 percent of their time on
default prevention programs; therefore, NSLP was allocated 25 percent of
the EPCs' costs. Statements in EPC annual reports indicated that the
purpose of the EPCs was to market the names and images of FES and its
affiliated companies. We concluded from these statements that EPCs were
actually marketing/public relations departments for FES and its
affiliates.

Prohibited uses of reserve fund assets in regard to public relations are
defined under 34 C.F.R. § 682.418 (b)(8). These regulations state that
the following are not allowable:

> Public relations, and all associated costs, paid directly or through a
> third party, to the extent that those costs are used to promote or
> maintain a favorable image of the guaranty agency. The term "public
> relations" does not include any activity that is ordinary and
> necessary for the fulfillment of the agency's FFEL guaranty
> responsibilities under the HEA, including appropriate and reasonable
> advertising designed specifically to communicate with the public and
> program participants for the purpose of facilitating the agency's
> ability to fulfill its FFEL guaranty responsibilities . . . .

According to 34 C.F.R. § 682.410 (a)(11), "\[T\]he burden of proof is
upon the guaranty agency, as a fiduciary under its agreements with the
Secretary, to establish that costs are reasonable."

Actual EPC costs for FY 1998 totaled \$856,770. According to FES' cost
allocation plan, NSLP should have been allocated \$214,193 (\$856,770 x
25 percent) for EPC services. NSLP paid a total of \$414,193 for the
EPCs in FY 1998 (\$214,193 in monthly billings and \$200,000 for
additional services in September 1998). NSLP officials could not provide
supporting documentation showing that EPC costs were "designed
specifically for . . . the purpose of facilitating \[its\] ability to
fulfill its FFEL guaranty responsibilities.

NSLP officials could not provide supporting documentation showing NSLP
had received additional "default prevention" services as of September
1998. Further review showed that FES posted this \$200,000 payment in a
deferred revenue account, which means that it constituted a prepayment
from the Federal Fund. As such, it was not allowable since the Federal
Fund must only be used to pay lender claims and to pay the Operating
Fund a default aversion fee. (Section 422A (d) of the HEA)

The payment of the \$214,193 in EPC costs is unsupported and the
additional \$200,000 for FY 1998 EPC costs is unallowable.

######### Recommendations

We recommend that the COO for FSA require NSLP to

1.1 Reimburse the Federal Fund \$231,525. This amount includes

(a) \$200,000 in unallowable EPC costs NSLP paid in FY 1998; and

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(b) Imputed interest of \$31,525 calculated through September 30,
    2001.[^3]

1.2 Provide supporting documentation for, or reimburse \$214,193 in
unsupported FY 1998 EPC costs charged by FES plus imputed interest
calculated through September 30, 2001, to the Federal Fund.

### NSLP Comments -- NSLP did not agree with this finding. NSLP stated that the finding was incorrectly based on the Cost Principles of OMB Circular A-87 instead of the applicable authority for guaranty agency allowable costs (34 C.F.R. § 682.418 (b)(8)), which "allows 'ordinary and necessary' public relations activities." NSLP stated that the EPC costs it was charged under the FES cost allocation plan were allocated on the basis of the number of presentations that were made to colleges and high schools, college fairs, and brochures distributed to prospective loan applicants. NSLP also claims that the 25 percent allocation from the EPCs was understated and that FES could have allocated at least 53 percent of the EPC costs to NSLP. NSLP stated that the \$200,000 charge it made in addition to the standard 25 percent rate was required for an end-of-year reconciliation. 

OIG Response -- NSLP's comments did not alter our overall position on
the finding. However, we modified the finding to address some of NSLP's
concerns. OMB Circular A-87, as well as 34 C.F.R. § 682.418 (b), applied
to the EPC expenditures during FY 1998. We added the additional criteria
to our report. We deleted a recommendation relating to recoveries from
years subsequent to FY 1998. As discussed in the Other Matters section
of this report, we determined subsequent to the issuance of the draft
report that the OMB Circular A-87 criteria were not applicable to NSLP
during those years.

NSLP did not provide adequate documentary evidence to support that the
activities in which EPCs were engaged were "ordinary and necessary for
the fulfillment of \[NSLP's\] FFEL guaranty responsibilities under the
HEA," as required by 34 C.F.R. § 682.418 (b)(8). NSLP also did not
provide documentation to support that its EPC allocation percentage from
FES could have been much greater.

###  

The FY 1998 FES annual EPC reports included the following statements:

> These contacts continuously provide us the opportunity to directly
> reach our target audience and the ability to market our companies
> products and services.
>
> These new contacts provide additional opportunities to build a
> positive image and name recognition for FEF and NSLP.

NSLP did not provide any evidence that the additional \$200,000 in EPC
costs paid in September 1998 were used for FFEL purposes. Our review
showed that the September 1998 billing from FES included a year-end
adjustment of \$3,671.52 for FY 1998 default prevention services. We
found nothing to indicate there was any other year-end adjustment. NSLP
did not explain why the \$200,000 appeared in a FES deferred revenue
account. We found that NSLP was no longer being billed for a line item
titled default prevention services after September 30, 1998.

# Finding No. 2 -- Unallowable Information System Costs

NSLP used federal funds to pay for \$380,629 of information system costs
that its affiliate, FES, could not collect from other customers,
specifically, the Utah Higher Education Assistance Authority (UHEAA) and
the Utah State Board of Regents (USBR). As a result, the Federal Fund's
beginning balance was understated. According to 34 C.F.R. § 682.410
(a)(2)(ii), a guaranty agency must use the assets of the reserve fund to
pay only costs that are reasonable and that are ordinary and necessary
for the agency to fulfill its responsibilities under the HEA.

In September 1998, NSLP paid \$380,629 to FES for information system
charges that were unsupported by invoices. The only support NSLP
provided for these charges, which covered 9,155 hours of service, was a
spreadsheet showing these hours being allocated to UHEAA and USBR. These
charges were for changes in computer programs that, according to NSLP
officials, were needed to meet an industry standard for transmitting
data called *Commonline.*[^4] The 9,155 hours were billed to NSLP for
the following items:

  ---------------------- -------------------------------------------------------------
  \$131,789              (2,512.66 hours x \$52.45/hour) for customer support related
                         to *Commonline*

  \+ 444,038             (6,642.31 hours x \$66.85/hour) for programming support
                         related to *Commonline*

  [-                     Credit for *Commonline* costs covered by UHEAA/USBR
  195,198]{.underline}   

  \$380,629              Total questioned information system costs billed to NSLP
  ---------------------- -------------------------------------------------------------

NSLP and FES provided documentation to us that specified that UHEAA and
USBR would pay FES no more than \$250,000 for charges relating to
*Commonline*. FES billed NSLP for the charges above \$250,000. This was
in addition to the *Commonline* charges on NSLP's monthly invoices from
FES.

######### Recommendation

We recommend that the COO for FSA require NSLP to

2.1 Reimburse the Federal Fund \$440,626. This amount includes

a.  \(a\) \$380,629 in questioned information systems costs NSLP paid in
    FY 1998; and

    \(b\) Imputed interest of \$59,997 calculated through September 30,
    2001.

### NSLP Comments -- NSLP disagreed with our finding. NSLP stated that the costs were reasonable, ordinary, and necessary. NSLP stated that FES collected all that it was due from UHEAA and USBR according to a fixed fee contract. Moreover, the Federal Fund benefited from the fully-collected contract and NSLP contends that it would have incurred all of the Commonline costs whether FES had the Utah contracts or not. NSLP states that the Federal Fund benefited from the \$195,198 billed to and paid by the Utah agencies. 

OIG Response - NSLP's comments did not alter our position on the
finding. NSLP did not provide evidence that these costs were reasonable,
ordinary, and necessary. The only support that NSLP provided for the
Commonline amounts was a spreadsheet that showed total FES Information
Systems programming hours spent on various IS projects. Included with
this spreadsheet were tapes and notes showing the Commonline support
(2,512 hours) and programming (6,642 hours) allocated to the Utah
organizations. A FES internal e-mail provided by FES stated ". . . bill
NSLP for the time that we had allocated to SBR and UHEAA that they won't
pay us for . . ." The FES contracts with UHEAA and USBR showed that
these contracts were not fixed price contracts. The contracts did have
fixed price elements but also allowed for additional custom programming
at a rate of \$90 per hour and customer support at a rate of \$75 per
hour plus fees for daily consulting. The fixed price costs that UHEAA
and USBR were obligated to pay amounted to \$735,000 per year plus
additional customer programming, customer service, and consulting fees.

The UHEAA contract dated June 30, 1998, shows a \$25,000 monthly fee for
the ULTRA software and a \$75,000 yearly fee for other software (noted
as Exhibit A in the contract), which amounts to a total of \$375,000
fixed costs per year that UHEAA was obligated to pay. UHEAA was also
responsible for any custom programming, customer support, or consulting
beyond the services included in the monthly fees (noted as Section 7.b.
in the contract).

The USBR contract dated June 30, 1998, shows a \$30,000 monthly fee for
the EASEL and EDGE software (noted as Exhibit A in the contract), which
amounts to a total of \$360,000 fixed costs per year that USBR was
obligated to pay. USBR was also responsible for any custom programming,
customer support, or consulting beyond the services included in the
monthly fees (noted as Section 7.b. in the contract).

Paragraphs 7.a. of the UHEAA contracts states the following:

> For the Licensed Programs and Documentation and related services
> described in Section 2 hereof, UHEAA shall pay the charges and costs
> set forth in Exhibits "A" and "C" respectively. . . . FES shall direct
> bill UHEAA for all license fees, services, and support, including
> charges for technical assistance provided by FES to each End User
> associated with UHEAA in accordance with Section 2(f) hereof . . . .

The USBR contract contained the same language regarding payment.

We deleted a recommendation relating to recoveries from years subsequent
to FY 1998.

# Finding No. 3 -- Unallowable Benefit Costs

NSLP used federal funds to pay \$3,468 for unallowable benefit
administration costs. We found that FES included the following costs in
the Human Relations (HR) benefit administration cost pool that are
unallowable per OMB Circular A-87, Attachment B, Section 18:

  --------------------------------------------------------- -------------
  Employee Appreciation Day                                 \$ 1,121

  Employee Relations -- Basketball League                   120

  Employee Relations -- Gifts                               381

  Holiday Party                                             5,197

  Party Pak Expenses                                        1,066

  Wellness Committee                                        244

                                                            

  Total Unallowable Costs                                   \$ 8,129
  --------------------------------------------------------- -------------

We removed the unallowable costs of \$8,129 from the HR benefit
administration cost pool, which resulted in a revised cost pool of
\$441,339. We then calculated a revised HR benefit administration rate
of \$.101, a difference of \$.002 from the \$.103 charged by FES. When
we

applied this difference to NSLP direct salaries of \$1,734,182.72, we
calculated a \$3,468 NSLP overpayment to FES from the reserve fund.

**Recommendation**

We recommend that the COO for FSA require NSLP to

3.1 Reimburse the Federal Fund \$4,015. This amount includes

c.  \(a\) \$3,468 in unallowable benefit costs that NSLP paid to FES in
    1998; and

\(b\) Imputed interest of \$547 calculated through September 30, 2001.

**NSLP Comments --** NSLP did not agree with the first part of the
finding as presented in the draft report regarding duplicative benefits
cost. NSLP does not agree with the second part of this finding regarding
unallowable human resource cost. It views Section 17 of Attachment B to
OMB Circular A-87 as more relevant than Section 18, cited in our report.
The NSLP response states that all of the questioned costs are allowable
per Section 17 in that they support activities intended to improve
employee morale, which is included as part of the title to Section 17,
[i.e.]{.underline}, "Employee morale, health, and welfare costs."

OIG Response -- Based on NSLP's response regarding duplicative benefits
costs, we deleted that aspect of the finding. NSLP provided sufficient
additional information to support its position. NSLP stated that because
of the allocation plan complexities, officials offered to walk through
the allocation process with the auditors and that we declined. We did
have discussions with NSLP officials regarding the cost allocation plan
during our fieldwork. We also deleted our recommendation relating to
recoveries from years subsequent to FY 1998. We did not change our
position regarding the benefit administration costs. While entertainment
(such as the party we cite in our report) may improve employee morale,
it is nevertheless unallowable under OMB Circular A-87, Section 18.

# Finding No. 4 -- Unallowable Administration Costs

NSLP used federal funds to pay for unallowable administration costs
amounting to \$41,205 (\$14,852 of directly billed insurance costs plus
\$26,353 of indirect charges). These unallowable administration costs
are summarized below.

*Insurance*

We analyzed the invoices and policy terms of insurance policies for
director and officer liability, non-profit liability, and for a broker's
blanket bond policy. FES directly billed NSLP for a portion of the costs
for these policies and included a portion in the administration cost
pool. We found that \$14,852 of the \$15,934 in insurance cost directly
billed to NSLP and paid for with federal funds was unallowable. We also
found that \$19,122 of the \$26,597 in insurance cost included in the
FES administration cost pool was unallowable.

The above insurance costs were unallowable for two reasons. First, the
amount of director and officer liability insurance allocated to NSLP was
overstated because 12 of the 13 personnel listed in the insurance policy
did not work for NSLP. According to 34 C.F.R. § 682.410 (a)(2)(ii)(A),
guaranty agencies must use assets of the reserve fund only for costs
that are allocable to the FFEL program. Second, all of the policies
covered periods after the conclusion of FY 1998. We considered the costs
of the policies prorated for the portion that extended beyond FY 1998 to
be prepayments from the Federal Fund, because they were not allocable to
the reserve fund in FY 1998. As such, they were not allowable since the
Federal Fund must only be used to pay lender claims and to pay the
Operating Fund a default aversion fee. (Section 422A (d) of the HEA)

*Personnel Administration*

The only expense in this category was severance pay of \$25,805 for a
former FES employee. According to this individual's employment contract,
FES was not obligated to provide severance pay because he resigned.
Section 8 of the employment contract states:

Termination. Employer is obligated to pay the base salary due to
Employee under the terms of this Agreement for the entire one year term
of employment under this Agreement without limitation, reduction, or
restriction, unless the Employee's employment is terminated as a result
of the employee's attainment of normal retirement age, death,
incapacity, resignation or is terminated for cause . . . .

In addition, OMB Circular A-87, Attachment B, 11 (g) states:

Payments in addition to regular salaries and wages made to workers whose
employment is being terminated are allowable to the extent that, in each
case, they are required by (a) law, (b) employer-employee agreement, or
(c) established written policy.

*Directors Fees and Expenses*

Expenses in this category included the costs for a retreat for FES
directors and wine for an FES board meeting. Our review of the
documentation showed a \$12,489 invoice from Collegiate Financial
Services, Inc. (an FES affiliate) to FES for an "April 1998 Board
Meeting in Florida," of which \$11,480 was allocated to other cost
centers as an indirect cost. The invoice shows food, beverage, golf, and
tip expenses for various board members and their spouses. The retreat
expense is not a reasonable cost to be paid for with federal funds and
is, therefore, unallowable. We also noted that all of the other board
meetings were held at FES offices in Lincoln, Nebraska.

For one of the latter board meetings, documentation showed a \$101
charge for wine, which is also unallowable.

According to 34 C.F.R. § 682.410 (a)(2)(ii), a guaranty agency must use
the assets of the reserve fund to pay only costs that are reasonable and
that are ordinary and necessary for the agency to fulfill its
responsibilities under the HEA.

According to 34 C.F.R. § 682.418 (b)(3), the following costs are not
allowable: "amusement, diversion, hospitality suites, and social
activities, and any costs associated with those activities, such as . .
. meals, alcoholic beverages, lodging, rentals, transportation, and
gratuities . . . ." OMB Circular A-87, Attachment B, Section 4
specifically disallows the cost of alcoholic beverages.

######### Recommendation

We recommend that the COO for FSA require NSLP to

4.1 Reimburse the Federal Fund \$47,700. This amount includes

(a) \$41,205 in unallowable administration costs NSLP paid to FES in
    1998, and

(b) Imputed interest of \$6,495 calculated through September 30, 2001.

**NSLP Comments** -- [Insurance]{.underline}: NSLP agreed with our
findings regarding the liability and blanket bond insurance policies but
disagreed with some elements of our finding on the Director and Officer
(D&O) insurance policy. NSLP comments that we overlooked Endorsement #8,
dated June 1, 1997, which lists both NSLP and FES as corporations for
which coverage was being provided, and that the 50 percent allocation to
NSLP was accurate. NSLP agreed that a portion of the premiums covered a
period beyond FY 1998 and that it should reimburse the Federal Fund the
applicable portions of the NSLP and FES prepayments.

[Personnel Administration]{.underline}: NSLP stated that the severance
payment FES made to a former employee should be allowed since FES
determined that such a payment would avoid the risks of litigation and
related expenses.

### 

[Directors Fees and Expenses]{.underline}: NSLP concurred with this part
of Finding No. 3.

OIG Response -- Our review of NSLP's comments did not change our
position. We deleted our recommendation relating to recoveries from
years subsequent to FY 1998.

### 

### [Insurance]{.underline}: Our review of NSLP's comments, as well as Endorsement #8, has not changed our position. The D&O policy states that "This policy shall pay the Loss of each and every Director, Officer, or Trustee of the Organization arising from any claim or claims first made against the Directors, Officers, or Trustees . . . ." The policy clearly covers losses on behalf of the directors, officers, and trustees and as such, the cost should have been allocated by the number of directors, officers, or trustees at the two companies. Only one of the personnel listed as covered by this policy was an employee of NSLP and this is the only portion of the cost that should be directly allocated to NSLP.

[Personnel Administration]{.underline}: We did not change our position
on this matter. While the decision to make this payment may have best
served FES' interests, this does not change the fact that using federal
funds for the payment is unallowable.

# Finding No. 5 -- Unallowable and Unsupported Communication and Design Costs

NSLP used federal funds to pay for \$4,971 of unallowable and
unsupported communication and design costs. These costs were unallowable
under the following guidelines and cost principles of OMB Circular A-87:

-   Section C.1.a of Attachment A of this circular states that costs are
    allowable only when they are "necessary and reasonable for proper
    and efficient performance and administration of Federal awards."

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-   Section 2 of Attachment B of the circular states, "Advertising costs
    are allowable only when incurred for the recruitment of personnel,
    the procurement of goods and services, the disposal of surplus
    materials, and any other specific purposes necessary to meet the
    requirements of the Federal award."

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-   Section 2 also states that public relations costs are allowable only
    when

    1.  Specifically required by the Federal award . . . ;

    2.  Incurred to communicate with the public and press pertaining to
        specific activities or accomplishments that result from
        performance of the Federal award . . . ; or

    3.  Necessary to conduct general liaison with news media and
        government public relations officers, to the extent that such
        activities are limited to communication and liaison necessary to
        keep the public informed on matters of public concern, such as
        notices of Federal contract/grant awards, financial matters,
        etc.

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-   Section 13 of Attachment B states, "Contributions and donations,
    including cash, property, and services, by governmental units to
    others, regardless of the recipient, are unallowable."

We determined the following costs to be unallowable or unsupported under
the aforementioned OMB cost principles:

-   Advertising, [e.g.]{.underline}, for a college fair (\$565) and the
    "KEZG Festival of Music" (\$555);

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-   Marketing and Business Development (\$1,097);

-   Printing and Copying, specifically printing for a "storytelling
    brochure" and for the Lincoln Public Schools Foundation (\$821);

-   Employee Relations, [e.g.]{.underline}, sunglasses for employees,
    Paint-A-Thon T-shirts and supplies, and Jingle Bell Run Entry Fees
    (for the Arthritis Foundation) (\$713); and

-   Dues and Subscriptions, specifically membership dues for the Lincoln
    Chamber of Commerce (\$543).

######### 

######### Recommendations

We recommend that the COO for FSA require NSLP to

5.1 Reimburse the Federal Fund \$4,317. This amount includes

d.  \(a\) \$3,729 in unallowable communication and design costs NSLP
    paid to FES in 1998, and

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(b) Imputed interest of \$588 calculated through September 30, 2001.

5.2 Provide supporting documentation for, or reimburse \$565 in
unsupported college fair advertisement costs charged by FES plus imputed
interest calculated through September 30, 2001 to the Federal Fund.

**NSLP Comments -** NSLP concurred with this finding with two
exceptions. In its view a college fair advertisement and membership dues
for the Lincoln Chamber of Commerce are allowable. NSLP believes that
the college fair function is a reasonable and allowable expense under
the HEA. NSLP also stated that the Chamber of Commerce dues are
allowable based on Attachment B, Section 30 of OMB Circular A-87, which
states that cost of "memberships in business, technical, and
professional organizations are allowable."

OIG Response - Our review of NSLP's comments did not change our overall
position. We modified the recommendation to categorize the college fair
advertisement unsupportable because NSLP did not provide evidence that
the fair was solely to disseminate FFEL information. As such, we could
not determine whether this expense was reasonable or allowable. The
provisions of Attachment B stand within the context of the basic cost
principle guidelines of Section C.1.a. of Attachment A of the Circular,
which reads as follows, "To be allowable under Federal awards, costs
must . . . . be necessary and reasonable for proper and efficient
performance and administration of Federal awards." Membership in a
Chamber of Commerce is not necessary for a guaranty agency to fulfill
its responsibilities under the HEA.

# Finding No. 6 -- Unsupported Salary Costs

FES charged NSLP approximately \$1.73 million in FY 1998 salary expenses
that were not supported by required documentation. As a result, we were
unable to determine if the charges were reasonable and appropriate.

OMB Circular A-87, Attachment B, 11, h (3), requires signed periodic
certifications at least semi-annually for employees that work solely on
a single federal cost objective in order for charges for their salaries
and wages to be considered supported costs. The regulations at 34 C.F.R.
§ 682.410 (a)(2)(ii) provide that a guaranty agency must use the assets
of the reserve fund to pay only costs that are reasonable and that are
ordinary and necessary for the agency to fulfill its responsibilities
under the HEA. According to 34 C.F.R. § 682.410 (a)(11)(iii), "the
burden of proof is upon the guaranty agency, as a fiduciary under its
agreements with the Secretary, to establish that costs are reasonable."

According to the FES Cost Allocation Plan, FES provides all staff (not
including company officers) to perform the operating functions of member
companies. FES only required timesheets for employees who worked on a
part-time basis. All other employees were paid based on Employee Status
Forms. These forms contained only basic information about the employees
and their salary or hourly wage amounts. By not having timesheets or
employee certifications available for review, we were unable to
determine whether full-time salary and benefit costs paid by NSLP were
allowable or allocable to NSLP.

######### Recommendations

We recommend that the COO for FSA require NSLP to

6.1 Provide required supporting documentation for, or reimburse \$1.73
million in FY 1998 salary expenses charged by FES plus imputed interest
calculated through September 30, 2001, to the Federal Fund; and

6.2 Maintain documentation sufficient to support salary costs charged by
FES.

**NSLP Comments--** NSLP disagreed with this finding. NSLP did not agree
that the OMB Circular A-87 criteria applied to years subsequent to FY
1998. NSLP also stated that it has already provided OIG auditors with
documentation sufficient to support its salary costs in FY 1998. NSLP
provided that it has demonstrated that NSLP-designated employees are
dedicated to the single cost objective of providing guarantor-related
services. NSLP further stated, ". . . what was raised on the subject of
unsupported salary costs was the issue of documentation. The Finding is
based in large part on the OIG's interpretation of OMB A-87, Attachment
B, Section 11(h)(3). That Section requires periodic "certifications"
from agency employees on a semi-annual basis. While it is true that no
actual "certificates" were issued by NSLP in a formal sense, other
significant formal checks and balances were in place and consistently
applied . . . ." NSLP states that it provided payroll registers, annual
reviews, and sick/vacation balance reports to support that employees
were working on NSLP business.

OIG Response -- NSLP's response did not change our overall position
regarding the finding. We deleted our recommendation relating to
recoveries from years subsequent to FY 1998.

NSLP did provide documentation that supported the amounts FES paid
employees, but the documentation did not show what portion of each
employee's time was devoted to activity supporting NSLP, FES, CFSI, or
FEF. Our review of the payroll registers, annual reviews, and
sick/vacation balance reports did not support NSLP's claim that these
FES employees were NSLP dedicated. Without this information, a
determination of the reasonableness and allocability of NSLP salary
costs cannot be made.

### 

# Finding No. 7 -- Inadequate Standards of Conduct

NSLP did not maintain and update adequate standards of conduct to
prevent and detect possible conflicts of interest. The standards were
not consistent with regulatory provisions in that they did not require
disclosures as to the interests of the NSLP directors and officers with
respect to certain entities with which NSLP had contracts or agreements,
and did not require any disclosures as to the interests of the immediate
family members of NSPL directors and officers.

Under 34 C.F.R. § 682.410 (b)(11), guaranty agencies are required to
"maintain and enforce written standards of conduct governing the
performance of its employees, officers, directors, trustees, and agents
engaged in the selection, award, and administration of contracts or
agreements.... The standards must mandate disinterested decision-making
\[and\] provide for appropriate disciplinary actions to be applied for
violations of the standards . . . ." The potential conflicts of interest
covered by these provisions include those that may arise with the
immediate families of employees as well as the employees themselves.

NSLP did not satisfy these provisions in the following ways:

-   NSLP's Policy for Managing Standards of Conduct and Conflicts of
    Interest was effective July 1, 1997. This policy required all NSLP
    officers and directors to complete a financial and other interest
    disclosure form provided by NSLP and to update the form on an annual
    basis. According to NSLP officials, disclosure statements dated
    August 1997 were the only ones they had on file.

-   The disclosure forms only required disclosure as to the interests of
    NSLP directors and officers. The forms did not require disclosure of
    financial and other interests of the immediate family members of the
    directors and officers.

-   The disclosure statements only required disclosure as to the
    interests NSLP directors and officers had in "external contracting
    parties" and listed only collection agencies and a guarantor systems
    servicer. The form made no reference to FES, with whom it had a
    management agreement for a number of services, or with any lending
    institutions, which, by the nature of the services NSLP provides, it
    would have had agreements.

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-   The President of NSLP was not a disinterested decision-maker because
    of personal interests and positions she had in organizations with
    which NSLP had financial relationships, [i.e.]{.underline}, she was
    a member of the boards of directors of FES and Collegiate Financial
    Services.

######### Recommendation

We recommend that the COO for FSA

7.1 Assure that NSLP's conflict-of-interest standards adhere with
federal regulations, particularly that NSLP

a.  Obtains from its officers and directors disclosure of any interest
    they or their immediate family members have in entities with which
    NSLP has contracts or agreements, including but not limited to FES
    and its affiliates;

b.  Updates its disclosure statements on an annual basis; and

c.  Provides for appropriate disciplinary actions to be applied for
    violations of the standards.

**NSLP Comments --** NSLP did not fully agree with this finding but
states that it has revised its disclosure statement to conform to the
OIG recommendations and obtained signatures on the statements for FYs
1998 through 2001. NSLP states that the OIG working papers acknowledge
that the Conflicts of Interest policy itself was in full compliance and
that the criticisms were of several perceived deficiencies in the annual
disclosure statements and NSLP's failure to obtain signatures on an
annual basis. NSLP also states that it believes that the prototype
disclosure statement was adequate since it is simply a tool to assist in
the administration of the formal Conflicts of Interest policy.

**OIG Response --** NSLP's response did not alter our position. The OIG
working papers referred to by NSLP did not acknowledge that NSLP's
Conflicts of Interest Policy was in full compliance. The working papers
stated that "we reviewed NSLP's written standards of conduct and found
that in general the policy contained the requirements of 34
682.410(b)(11); however, the disclosure statements signed by the
officers and directors only required disclosures as to interests in a
few specific entities. The list did not include FES, with whom NSLP has
service agreements (leases, equipment, etc.) or any lenders with whom
the agency has guaranty agreements, both of which have been supported by
reserve fund monies. The disclosure statements did not require the
disclosure of immediate family interests in the entities and are not
updated annually . . . ." The disclosure statements are an integral part
of NSLP's Conflicts of Interest Policy as noted in the policy itself.
Paragraph I.A. of NSLP's "Policy for Managing Standards of Conduct and
Conflicts of Interest" provides that written standards of conduct
require disclosure of financial and other interests. Further, Paragraph
III. D. of the policy mandates all directors and officers to complete a
disclosure form.

NSLP's revised disclosure/policy statement ("Annual Disclosure
Statement: Policy for Managing Standards of Conduct and Conflicts of
Interest"), in Exhibit D, does not adequately respond to all of our
recommendations in that it allows NSLP

-   Board members to accept from FES or any of its affiliates Board and
    committee fees;

-   Officers to accept from FES or any of its affiliates standard
    compensation packages;

-   Directors and officers and other covered parties to benefit from
    contracts or agreements with FES or any of its affiliates in other
    than directly monetary terms ([e.g.]{.underline}, the benefits
    accruing to the President of NSLP resulting from her serving on the
    boards of directors of FES and Collegiate Financial Services); and

-   NSLP directors and officers and other covered parties to have
    financial interests below specified thresholds in entities with
    which NSLP has contracts or agreements.

In addition, the revised disclosure/policy statement does not provide
for appropriate disciplinary actions to be applied for violations of the
standards and other than failures to disclose actual or possible
conflicts of interest.

# Other Matters

We noted an additional issue that warrants FSA's attention. NSLP did not
have a cost allocation plan for costs billed to it from FES after FY
1998. According to an NSLP official the last cost allocation plan on
file was for FY 1998, for which FES billed NSLP over \$5 million in
staffing, building, equipment, information systems, and other costs.
NSLP continues to share costs with FES.

The Higher Education Amendments of 1998 provided that the Department may
not regulate the uses or expenditures of moneys in the Operating Fund,
unless a loan is outstanding from the Federal Fund. As a result, a
guaranty agency without a loan outstanding from the Federal Fund does
not have to comply with the cost allocation plan requirements of 34
C.F.R. § 682.418 (c) (2001). (The current text of § 682.418 (c) predates
the 1998 amendments and does not condition its application on the
existence of an outstanding loan.)

The 1998 amendments also prescribed the permitted uses of the Operating
Fund:

> **application processing, loan disbursement, enrollment and repayment
> status management, default aversion activities . . . default
> collection activities, school and lender training, financial aid
> awareness and related outreach activities, compliance monitoring, and
> other student financial aid related activities, as selected by the
> guaranty agency. (HEA § 422B (d)(1)**

A cost allocation plan would provide assurance that funds are being used
for appropriate purposes. Although cost allocation plans are no longer
required of every guaranty agency, § 422B (e)(2) of the HEA authorizes
the Department to require reports on the use of the Operating Fund.
Reporting is needed for the Department to monitor use of the Operating
Fund for statutory purposes.

.

# Background

######### Federal and Operating Funds

The Higher Education Amendments of 1998, enacted on October 7, 1998,
required each guaranty agency to establish a Federal and Operating Fund
within 60 days of enactment. All funds, securities, and other liquid
assets previously held in an agency's reserve fund were to be deposited
into a Federal Student Loan Reserve Fund (Federal Fund) by December 6,
1998.

The Federal Fund, which is used to pay lender claims and default
aversion fees, is the property of the Department. The Operating Fund is
used to pay for application processing, loan disbursement, enrollment
and repayment status management, and other guaranty agency activities.
It is the property of the guaranty agency, except for any funds it may
contain by means of transfer from the Federal Fund. Funds transferred
from the Federal Fund remain the property of the Department and are
subject to federal regulations.

######### The National Student Loan Program

NSLP is the designated guaranty agency for Nebraska and is located in
Lincoln, Nebraska. It is a private, not-for-profit business. NSLP
established its Federal and Operating Funds on December 6, 1998.

An affiliated private, not-for-profit business, FES, provides office
space, equipment, personnel, and support services to NSLP and to other
affiliated businesses, all of which are housed in the same building. In
FY 1998,[^5] NSLP paid FES[^6] over \$5 million for such services. The
organizational chart in the exhibit at the end of this report shows the
relationships between these

affiliated businesses.

# 

Objectives, Scope, and Methodology

# 

The objective of the audit was to determine whether NSLP complied with
the HEA and regulations governing the establishment of its Federal and
Operating Funds. The period covered by the audit extended from October
1, 1997 through December 1, 1998.

To accomplish our audit objective, we

-   Reviewed the HEA and regulations, Department policy guidance, and
    program information;

-   Reviewed NSLP's financial and single audit reports for the years
    ended September 1998 and 1999 to determine whether there were
    significant findings related to our audit;

-   Reviewed the working papers of the independent public accountant who
    performed the FY 1999 Single Audit;

-   Reviewed NSLP and FES accounting records and meeting minutes of
    boards of directors;

-   Interviewed managers and staff of NSLP and FES; and

-   Interviewed officials in the Department.

We judgmentally selected 7 of the 14 cost centers contained in FES' cost
allocation plan based on our perception of which ones were most
susceptible to including unallowable costs and would have the most
impact on the opening balance of the Federal Fund. For each sampled cost
center we recalculated allocation computations to assess accuracy. We
reviewed line item expenses included as part of the allocation and
assessed compliance with OMB Circular A-87. We judgmentally selected
line item expenses in order to determine if they were reasonable,
allocable, and consistent in treatment. For each sampled cost center, we
judgmentally selected the line items with the largest amounts of expense
and those that we perceived to be most susceptible to including
unallowable costs.

To achieve our objective, we relied on data from FES' and NSLP's
automated accounting systems. To assess the reliability of this data, we
reviewed work completed by the independent public accountant and
conducted additional tests. We concluded that the data contained in
NSLP's accounting system and FES' accounting system was sufficiently
reliable to be used in meeting the audit's objective.

We performed on-site fieldwork at NSLP and FES offices periodically from
January to September 2001 and continued to collect and analyze data in
our offices through November 2001. We held an exit conference with
officials of NSLP on September 24, 2001, and sent them updated
information on November 30, 2001. On March 29, 2002, we issued a draft
audit report, and on May 17, 2002, we received NSLP's comments on the
draft report. Regulatory citations are from the 1998 Volume of the Code
of Federal Regulations. We conducted the audit in accordance with
government auditing standards appropriate to the scope of the audit
described above.

Statement on Management Controls

As part of our audit, we made an assessment of NSLP's management control
structure, policies, procedures, and practices applicable to its
administration of the FFEL programs. The purpose of our assessment was
to determine the level of control risk, [e.g.]{.underline}, the risk
that material errors, irregularities, or illegal acts may occur. We
performed the control risk assessment to assist us in determining the
nature, extent, and timing of the substantive tests needed to accomplish
our audit objectives.

To make our assessment, we identified significant controls and
classified them as follows:

-   Establishment of the Federal and Operating Funds in compliance with
    HEA;

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-   Transactions involving the federal reserve fund, prior to the
    establishment of the Federal and Operating Funds, which
    significantly impacted the opening balances of the latter funds,
    [e.g.]{.underline}, payments made to FES and its affiliates; and

-   Conflict of interest standards.

Due to inherent limitations, a study and evaluation made for the limited
purpose described above would not necessarily disclose all material
weaknesses in the control structure. However, we identified weaknesses
in NSLP's controls over the transactions involving the federal reserve
fund, prior to the establishment of the Federal and Operating Funds,
that significantly impacted the opening balance of the Federal Fund. We
also identified weaknesses in the conflict-of-interest management
controls. We describe these weaknesses in the Audit Results section of
this report.

Exhibit

Organizational Chart of

FES and Its Affiliated Organizations

![](media/image3.wmf)September 1998

# Appendix

**NSLP Comments On The Draft Report**[^7]

[^1]: Prior to March 6, 2002, Federal Student Aid was known as Student
    Financial Assistance but will be referred to as Federal Student Aid
    throughout this document.

[^2]: All regulatory citations in this report are from the 1998 Volume
    of the Code of Federal Regulations unless otherwise noted.

[^3]: Throughout this report, imputed interest has been calculated by
    using the U.S. Department of the Treasury's Current Value of Funds
    Rate.

[^4]: *Commonline* is a computer program that makes it easier for
    schools, lenders, etc. to exchange information through common file
    layouts.

[^5]: NSLP defines its fiscal year as being from October 1 to September
    30. This definition is used throughout this report.

[^6]: During part of FY 1998, FES was known as the Foundation for
    Educational Funding. In order to avoid confusion, this organization
    will be referred to as FES throughout this document.

[^7]:  We have included NSLP Appendices A, B, and D as part of this
    appendix. NSLP's Appendix C contained numerous personal identifiers
    and is on file at the Kansas City OIG office.