September 8, 2004

# 

# Control Number

# ED-OIG/A02-E0007

## Honorable César Rey-Hernández

## Secretary of Education

Puerto Rico Department of Education

Calle Teniente González, Esq. Calle Calaf -- 12^th^ Floor

Urb. Tres Monjitas

Hato Rey, Puerto Rico 00919

Dear Secretary Rey-Hernández:

This is our Final Audit Report entitled *Puerto Rico Department of
Education's (PRDE) Administration of Contracts Awarded to Rock Solid
Technologies (RST)*. The purpose of our audit was to determine whether
PRDE properly administered contracts awarded to RST. Our specific
objectives were to determine whether PRDE followed Federal and local
laws in procuring services through its contracts with RST and ensured
that contract requirements were met prior to payment of the contractor's
invoices.

We found PRDE did not properly administer contracts awarded to RST and
did not adequately manage its Title I and Technology Literacy Challenge
programs. PRDE improperly charged \$3,354,545 to the U.S. Department of
Education's (ED) Title I and Technology Literacy Challenge programs for
two State-funded contracts unrelated to these programs that totaled
\$7,354,545. These two contracts were awarded in 1999 and 2000 during
PRDE's prior administration. The improper charges occurred because PRDE
did not implement adequate controls to oversee RST's contract
administration and to properly allocate contract charges. As a result,
Title I and Technology Literacy Challenge students did not fully benefit
from ED funding. None of the RST costs should have been charged directly
to any ED grant because RST's services were related to maintaining
PRDE's payroll systems, its human resource systems, and its school lunch
program. We did not perform audit work to determine whether PRDE ensured
that contract requirements were met prior to payment of the contractor's
invoices because the contracts were State-funded.

## 

We provided a draft of this audit report to PRDE. In its response, dated
August 12, 2004, PRDE stated that its current administration was taking
proactive steps to improve the weaknesses inherited from the prior
administration. PRDE also stated it was working in close cooperation
with ED to update its procedures. PRDE's response did not cause us to
change our finding and recommendations. We have summarized PRDE's
comments after the finding and have included PRDE's entire response as
an Attachment.

**BACKGROUND**

RST is a software solutions company with offices in Austin, Texas and
San Juan, Puerto Rico. RST began providing services to PRDE in April
1998, under the administration of the former PRDE Secretary. PRDE
contracted with RST to work on the reengineering of PRDE's Computer
Center applications and implement a human resources operating system to
manage PRDE's employee payroll accounts. During our audit period, PRDE
awarded 10 contracts to RST that totaled \$13,451,859, including two
contracts awarded by the prior PRDE administration. All of the contracts
awarded to RST were for State-funded services. The current
administration continued to contract with RST because of RST's extensive
knowledge of PRDE's human resources and payroll processing systems and
because RST provided maintenance and support for PRDE's current
operations.

In February 2002, the former Secretary and Associate Secretary of PRDE,
as well as others, pled guilty to various felony charges involving
extortion, program fraud, and money laundering of Federal funds. In
August 2002, ED placed Special Conditions on PRDE's grants because of
problems with PRDE's fiscal and program accountability. Additionally, in
August 2003, PRDE's Internal Audit Office reported a payroll fraud case
that involved the illegal appropriation of \$104,161 in state funds.
According to PRDE's Internal Audit report, this occurred due to a lack
of supervision and controls over processing payroll payment
transactions. In September 2003, ED again placed Special Conditions on
PRDE's grants due, in part, to unallowable payment of employees'
salaries using Title I and other Federal program accounts.

**AUDIT RESULTS**

**Finding:** PRDE improperly charged \$3,354,545 to ED programs for
professional services provided by RST

PRDE did not properly administer contracts awarded to RST and did not
adequately manage its Title I and Technology Literacy Challenge
programs. PRDE improperly charged \$1,000,000 to ED's Title I program
and \$2,354,545 to the Technology Literacy Challenge program for two
State-funded contracts unrelated to these programs that totaled
\$7,354,545. This occurred because PRDE did not implement adequate
controls to oversee RST's contract administration and to properly
allocate contract charges. As a result, Title I and Technology Literacy
Challenge students did not fully benefit from ED funding.

The regulations at 34 C.F.R. § 76.702[^1] state that, "A State and a
subgrantee shall use fiscal control and fund accounting procedures that
insure proper disbursement of and accounting for Federal funds."

According to 34 C.F.R. § 80.20(a), "Fiscal control and accounting
procedures of the State . . . must be sufficient to: . . . (2) Permit
the tracing of funds to a level of expenditures adequate to establish
that such funds have not been used in violation of the restrictions and
prohibitions of applicable statutes." In addition, Office of Management
and Budget (OMB) Circular No. A-87 (1997), Attachment A, paragraph C.1
provides that to be an allowable cost, the cost must be allocable to a
Federal award.

PRDE paid RST \$14,496,446 for the 10 contracts reviewed. All costs
associated with the 10 contracts should have been charged to PRDE's
State account codes or to indirect cost codes because RST's costs were
primarily associated with PRDE's computer systems for payroll, human
resources, and the school lunch program. However, under the prior
administration, PRDE improperly charged \$3,354,545 as direct costs to
ED's Title I and Technology Literacy Challenge programs. This occurred
because PRDE's Program Office identified on its "Allocation of Funds"
form that Federal funds could be charged for RST's contracts. PRDE
justified the charges by claiming that a great portion of the payroll
processed by PRDE was for Federally funded employees. However, PRDE
should not have charged any direct costs to ED's programs because the
portion of payroll PRDE claimed it processed for Federally funded
employees was already charged through indirect costs. For the 10
contracts reviewed, PRDE charged a total of \$2,576,666 as indirect
costs.

**Recommendations:**

We recommend that the Assistant Secretary for the Office of Elementary
and Secondary Education require PRDE to

1.  Return to ED \$3,354,545 in questioned costs; and

2.  Establish controls to ensure contract related expenditures are
    properly allocated to Federal and State accounts.

##### PRDE's response

In general, PRDE agreed with our finding and recommendations. PRDE
stated that its current administration was taking proactive steps to
improve the weaknesses inherited from the prior administration. PRDE
also stated it was working in close cooperation with ED to improve
current procedures, and in some cases, institute new procedures that
will ensure that Federal funds are spent in accordance with Federal
requirements, including assuring that contract expenditures are properly
allocated to Federal and State accounts. Finally, PRDE stated it had
been working diligently to design and implement changes to improve the
contracting process consistent with State law and Federal grants
management requirements. This work included extensive site visits and
technical assistance by ED since September 2003, when PRDE and ED
formalized their collaborative efforts through the Cooperative Audit
Resolution and Oversight Initiative (CAROI), a collaborative method to
provide alternative and creative approaches to resolve audit findings,
as well as their underlying causes.

**OIG's reply**

We considered PRDE's response, but did not change our finding and
recommendations. PRDE's effort to improve current procedures through the
CAROI process may be considered by ED's Assistant Secretary for the
Office of Elementary and Secondary Education, as part of the audit
resolution process. However, PRDE must return to ED the \$3,354,545 PRDE
improperly charged to ED's Title I and Technology Literacy Challenge
programs.

### 

### OTHER MATTERS

In our audit reports of PRDE's administration of contracts awarded to
National School Services (ED-OIG/A01-A0004 and ED-OIG/A02-B0012) and
R.V. Research and Management Group, Inc. (ED-OIG/A02-B0025), we reported
that PRDE did not competitively bid contracts. Puerto Rico's procurement
regulations governing PRDE, require that any acquisition of goods, works
and services in excess of \$25,000 must use formal competitive
procedures.

Although the contracts PRDE awarded RST were State funded, PRDE could
not provide evidence that the contracts awarded to RST during PRDE's
prior administration were competitively bid. PRDE also did not maintain
in its procurement records evaluations conducted prior to awarding the
contracts. RST's contracts executed during the current administration
were not competitively bid because RST had extensive knowledge of PRDE's
human resources and payroll processing systems and because RST continued
to provide maintenance and support for PRDE's current operations.

Lack of competition in its procurement transactions with RST prevented
PRDE from assuring that the highest quality of services and products
were received at competitive prices or that certain vendors were not
given preferential treatment or were arbitrarily excluded.

##### PRDE's response

PRDE recognized the importance of upgrading its procurement and
contracting processes. PRDE stated it had been working diligently, in
cooperation with ED, to design and implement changes to improve the
inefficient and outdated contracting system inherited from the prior
administration. However, PRDE disputed the Draft Audit Report's
statement that "PRDE overpaid RST \$1,066,163 in State funds for two of
the contracts reviewed." PRDE provided evidence that the payment
vouchers were cancelled prior to the issuance of payment to RST.
Therefore, no improper overpayment in State funds took place.

###### OIG's reply

PRDE provided documentation confirming its assertion that no improper
overpayment in State funds took place. As a result, we removed the Draft
Audit Report's statement that "PRDE overpaid RST \$1,066,163 in State
funds for two of the contracts reviewed."

**OBJECTIVES, SCOPE, AND METHODOLOGY**

The purpose of our audit was to determine whether PRDE properly
administered contracts awarded to RST. Our specific objectives were to
determine whether PRDE followed Federal and local laws in procuring
services through its contracts with RST and ensured that contract
requirements were met prior to payment of the contractor's invoices.

The period of our audit was from May 1, 1999 through June 30, 2003. To
achieve the audit objectives, we interviewed officials from PRDE's
Budget Division and Office of Information Systems and Technological
Support to Teachers. We also reviewed 10 contracts between PRDE and RST
for services rendered from May 1, 1999 through June 30, 2003, as well as
payment vouchers, invoices, and supporting documentation for the 10
contracts. We performed our fieldwork at PRDE's offices in Hato Rey,
Puerto Rico from January 21, 2004 through April 29, 2004, the date of
our exit conference.

We did not rely on any computer-processed data for any conclusions
reached during this audit.

Our audit was performed in accordance with generally accepted government
auditing standards appropriate to the scope of the review described
above.

**STATEMENT ON MANAGEMENT CONTROLS**

As part of this audit, we assessed the system of management controls
applicable to PRDE's processing of invoices submitted by RST. Based on
previous knowledge gained through our prior audits (ED-OIG/A01-90006,
ED-OIG/A01-90007, ED-OIG/A01-A0004, ED-OIG/A02-B0012, ED-OIG/A02-B0025,
ED-OIG/A02-C0017, ED-OIG/A02-D0014, and ED-OIG/A02-D0020) and ED's
designation of PRDE as a "high-risk" grantee under 34 C.F.R. § 80.12, we
determined the level of control risk, that is the risk that material
errors, irregularities, or illegal actions may occur, to be high. We
found that PRDE did not charge the RST costs to the proper accounts.
This weakness and its effects are fully disclosed in the AUDIT RESULTS
section of the report.

**ADMINISTRATIVE MATTERS**

If you have any additional comments or information that you believe may
have a bearing on the resolution of this audit, you should send them
directly to the following Education Department official, who will
consider them before taking final Departmental action on this audit:

> Raymond J. Simon

Assistant Secretary

Office of Elementary and Secondary Education

Federal Office Building 6

400 Maryland Avenue, SW, Room 3W315

Washington, DC 20202

[]{.mark}

It is the policy of the U.S. Department of Education to expedite the
resolution of audits by initiating timely action on the findings and
recommendations contained therein. Therefore, receipt of your comments
within 30 days would be greatly appreciated.

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 to
members of the press and general public to the extent the information
contained therein is not subject to exemptions in the Act.

> Sincerely,

/s/

Daniel P. Schultz

Regional Inspector General

> for Audit

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[^1]: Unless otherwise specified, all regulatory citations are to the
    July 1, 2002 volume.