GAO

United States General Accounting Office

Report to Congressional Requesters

July 2000 FINANCIAL

MANAGEMENT

Improvements Needed

in NIH’s Controls Over

Royalty Income

GAO/AIMD-00-210

Page 1 GAO/AIMD-00-210 NIH Royalty Income

United States General Accounting Office

Washington, D.C. 20548

Accounting and Information

Management Division

B-285582 Letr

July 21, 2000

The Honorable Tom Bliley

Chairman

Committee on Commerce

House of Representatives

The Honorable Fred Upton

Chairman, Subcommittee on Oversight

and Investigations

Committee on Commerce

House of Representatives

In our November 22, 1999 letter1 to your office, we summarized the results

of our work in response to your request that we (1) determine the extent of

and reasons for the differences between the number of the National

Institutes of Health (NIH) research inventions licensed under cooperative

research and development agreements (CRADA) compared to inventions

licensed under other intramural research projects and (2) review NIH’s

internal controls that ensure proper accountability for royalty income

resulting from these licenses. While carrying out our work on these

objectives, we identified deficiencies in NIH’s internal controls over royalty

income that is distributed to institutes and inventors. For fiscal year 1999,

NIH reported $45 million in royalty income from its licensees. As agreed

with your office, we continued our work to review NIH’s internal controls,

and this report provides the results of that review.

Results in Brief Although NIH has established policies and procedures for administering its

royalty income, we identified deficiencies in internal controls that affect

the monitoring of licensees and the completeness and accuracy of royalty

income received. Specifically, with the exception of one licensee, the Office

of Technology Transfer (OTT) did not follow up on the biennial audits of

licensees’ sales to ensure that licensees with sales that exceed $2 million

had been properly audited. OTT’s follow-up on one licensee yielded

1

Financial Management: National Institutes of Health Research Invention Licenses and

Royalties (GAO/AIMD-00-44R, November 1999).
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previously uncollected royalty payments of $9.2 million and the

expectation that another $1.2 million would be collected. Given the

experience with this licensee, it would seem reasonable for OTT to obtain

assurances that the net sales from these more lucrative licensees be

routinely and timely audited. Also, OTT did not exercise its right to

designate auditors to conduct reviews and verifications of semiannual

royalty reports and royalty payments for the majority of its licensees. These

biennial audits and verifications of semiannual royalty payments could

provide OTT assurance that royalty income received from licensees is

based on accurate sales amounts. We also found that OTT did not enforce

its collection policies and procedures to ensure timely payment of royalty

fees. As a result, institutes and inventors may not be receiving their share of

royalty income in a timely manner.

In addition, NIH’s systems and processes hampered proper management of

royalty income. The systems maintained by the Office of Financial

Management (OFM) and OTT that are used to account for royalty income

were not integrated.2 As a result, the monthly royalty income reconciliation

process was labor-intensive and was not always performed in a timely

manner.

Licensees are instructed to remit payments to a Treasury lockbox

administered by a commercial bank. OFM, which receives payment

information from the Treasury lockbox, did not record royalty income

received from licensees in its general ledger in a timely manner. Rather,

OFM records such receipts in a Treasury suspense account until it

identifies the licensee, institute, and inventor. Delays in recording royalty

income in its own general ledger increase the risk that financial and

budgetary reports to Treasury will be inaccurate and may tend to delay

distribution of funds. In its fiscal year 1999 financial audit report on

internal controls, the independent public accountant (IPA) responsible for

the financial statement audit of NIH noted a reportable condition related to

posting of royalty income transactions. The IPA reported that NIH did not

post royalty income to its general ledger in a timely manner. Timely posting

2

Federal financial system requirements define an integrated financial system as one that

coordinates a number of previously unconnected functions to improve overall efficiency

and control. Characteristics of such a system include (1) standard data classifications for

recording financial events, (2) common processes for processing similar transactions, (3)

consistent internal controls over data entry, transaction processing, and reporting, and (4) a

system design that eliminates unnecessary duplication of transaction entry.
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of royalty income to its general ledger could help provide assurance that

royalty income is properly accounted for and reported.

We are making recommendations to help NIH strengthen its internal

controls over the administration of royalty income. In comments on a draft

of this report, NIH agreed with four of our six recommendations and

disagreed with two, stating that the areas in which we are making

recommendations are areas where improvements can be, and are being,

made.

Background NIH, an operating division of the Department of Health and Human

Services, is made up of 25 institutes and centers with a combined fiscal

year 2000 appropriation of $17.8 billion. One of NIH’s primary missions is to

promote new knowledge through basic and applied biomedical research

that directly benefits public health. It performs biomedical research

through both extramural and intramural projects. Extramural projects,

which accounted for about $13 billion in funding in fiscal year 1999, are

carried out through grants and contracts with nonfederal organizations,

such as universities and other nonprofit research organizations, and forprofit corporations. Intramural projects, which accounted for about

$1.5 billion in funding in fiscal year 1999, are primarily conducted within

NIH laboratories.

Federal research performed under extramural and intramural projects can

result in inventions. If the invention is developed under an extramural

project, the contractor or grantee generally retains title to and profits from

the invention, subject to certain terms and conditions. If the invention is

developed under an intramural project, the federal agency normally retains

title to the invention and can license it to others who may then

commercialize it. The federal government receives royalty income from

inventions it licenses. This royalty income can be in various forms

including execution fees, minimum annual fees, patent fees, and earnings

based on sales. These fees are negotiated with the licensees and are

included in the licensing agreement.

Licensees pay a one-time execution fee to NIH for execution of the

licensing agreement. The minimum annual fee is what the licensee pays to

NIH for maintaining the license agreement, and the patent fees are paid for
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patent filings.3 Earnings are based on net sales of the licensed product or

licensed processes and are computed by the licensees based on an agreedupon rate specified in the license agreement. For fiscal year 1999, NIH

reported $45 million in royalty receipts from its licensees. It currently has a

reported 1,204 license agreements with approximately 516 licensees.

Licensees’ sales information is subject to a biennial audit by an

independent auditor.4

NIH management is responsible for establishing an internal control system

to properly account for royalty income. In November 1999, we updated our

Standards for Internal Control in the Federal Government. These

standards, which are issued pursuant to the Federal Managers’ Financial

Integrity Act, provide the overall framework for establishing and

maintaining internal control in the federal government.5 In implementing

these standards, management is responsible for developing the detailed

policies, procedures, and practices to fit their agency’s operations and to

ensure that they are built into and an integral part of operations. To comply

with the Comptroller General’s Standards, NIH needs to implement

procedures for (1) monitoring licensees, (2) receiving, recording, and

reconciling royalty income received, and (3) distributing royalty income to

institutes and inventors. Primarily, two offices within NIH manage royalty

income received from licensees: the Office of Technology Transfer (OTT)

and the Office of Financial Management (OFM). Figure 1 depicts how

royalty income is received, reconciled, and distributed.

3

Patents are property rights authorized by the U.S. Constitution and statutes enacted

pursuant thereto. An issued patent gives the owner the right to exclude others from making,

using, selling, or importing the claimed invention.

4

Beginning in fiscal year 1997 executed license agreements required licensees with sales

that exceeded $2 million to have a biennial audit performed. This requirement was not

applicable to license agreements executed prior to 1997. License agreements also require

licensees to submit semiannual sales reports to OTT.

5

Under the Federal Managers’ Financial Integrity Act of 1982, managers are responsible for

ensuring that adequate systems of internal controls are developed and implemented.
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Figure 1: Royalty Income Process

OTT is responsible for administering and maintaining the licensing

agreements and for billing licensees for royalty income when it is due. OTT

is also responsible for the oversight and monitoring of licensees that have

entered into license agreements with NIH. OTT’s oversight includes the

review of biennial audit reports and the enforcement of royalty collection

policies and procedures. OFM, which comprises the General Ledger

Branch (GLB) and the Government Accounts Section (GA), is responsible

for receiving information on licensees’ payments and distributing royalty

income to institutes and inventors. The GLB receives advices of royalty

payments from licensees through a Treasury lockbox at Mellon Bank. The

GA is responsible for reconciling royalty income with OTT monthly to

ensure that (1) the amounts to be distributed to institutes and inventors

agree with royalty income received from licensees and (2) payments are

OFM/GLB

Receipts via

Mellon Bank

OTT OFM/GA

Royalty income

payment data

Royalty income

payment data Bill for

royalty income

Inventors

Licensees

Institutes

Reconcile

royalty income

Royalty sales reports

and audit reports

Distribution of

royalty income

after approved

apportionment

by OMB

Distribution of

royalty income

after approved

apportionment

by OMB

Treasury

Payment

information via

Mellon Bank
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made to the correct institute and inventor. The Federal Technology

Transfer Act of 1986 (FTTA) provides for the distribution of royalty income

received by federal agencies. To fulfill the act’s requirements in this regard,

NIH royalty policy requires OFM to distribute inventor royalty payments

twice a year, in the early summer and early winter. Inventors’ share of

royalty income includes the first $2,000 of royalties received under the

license, 15 percent of receipts between $2,000 and $50,000, and 25 percent

of receipts over $50,000. An inventor may not receive more than $150,000 of

royalty receipts in a given year unless specifically approved by the

President. Even if their employment is terminated with the government,

inventors are still entitled to their share of royalty income. After the

inventors have received their share of the royalty income, the remaining

royalties are allocated to the institute from which the patents originated.

However, before royalty income can be allocated to institutes, it must be

apportioned by OMB.

Scope and

Methodology

To determine the controls that NIH has in place to ensure proper

accountability for royalty income, we obtained an understanding of the

royalty receipt and disbursement process by interviewing officials in OTT,

OFM, and two of NIH’s largest institutes—the National Cancer Institute and

the National Institute of Allergy and Infectious Diseases. To gain an

understanding of license requirements, we reviewed the contents of license

agreements. We reviewed and analyzed monthly reconciliations for June,

September, and November 1999 to determine the accuracy of royalty

receipts. To determine whether royalty receipts were properly accounted

for and reported, we selected and tested a statistical sample of fiscal year

1999 royalty receipts from OTT’s Invention Tracking System.6 We tracked

the sample of receipts from the Invention Tracking System to the related

license agreements. Because of the confidence level provided by the

statistical sample, which showed no discrepancies, we randomly selected

10 different license agreements from OTT’s files and tracked pertinent data

from these agreements to the Invention Tracking System. We reviewed the

audit work performed by the independent public accountant responsible

for the fiscal year 1999 financial statement audit of NIH and reviewed the

pertinent laws and regulations related to royalty income. We also reviewed

NIH policies and procedures related to the collection of royalty income.

6

The Invention Tracking System is used by NIH’s OTT to maintain data on federal inventions

and the licenses and royalties resulting from them.
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We conducted our work from January 2000 through June 2000 in

accordance with generally accepted government auditing standards. We

requested comments on a draft of this report from the Acting Director of

NIH or her designee. These comments are reprinted in appendix I.

NIH also provided technical comments, which we incorporated into this

report where appropriate but have not included in the appendix.

Monitoring Controls

Over Licensees Are

Insufficient

OTT did not adequately monitor its licensees to ensure accurate payments

of royalty fees because its monitoring controls over licensees were

insufficient. Monitoring controls are key internal controls for ensuring that

NIH receives accurate amounts of royalty income from licensees. The

Comptroller General’s Standards for Internal Control in the Federal

Government states that internal controls should generally be designed to

assure that ongoing monitoring occurs in the course of normal operations.

The standards also state that ongoing monitoring activities include

comparisons and reconciliations to identify inaccuracies or exceptions that

alert management to any internal control problems. OTT’s monitoring

controls include biennial audits of licensees’ sales information, semiannual

verifications of royalty reports and royalty payments, and enforcement of

collection policies and procedures. We found that OTT did not follow up on

the biennial audits of licensees’ sales and did not exercise its right to

designate accountants and auditors to conduct reviews and verifications of

licensees’ semiannual royalty reports and royalty payments. In addition,

OTT did not enforce its royalty collection policies and procedures to

ensure that licensees made royalty payments in a timely manner and did

not assess interest and penalties on delinquent licensees.

In 1997, OTT identified 14 licensees with annual sales over $2 million and

sent letters to them requesting that an audit be performed.7 The letters

specified areas that the auditors should address during the audit and report

on in the audit report to provide NIH a basis for determining if licensees

submit accurate amounts of royalty income. These areas included

determining (1) the amount of gross sales for each year covered by the

7

The letters sent to the 14 licensees stated that OTT requires licensees to have compliance

audits conducted of license agreements as a part of the company’s annual audit by an

independent audit firm. However, OTT officials told us that they viewed these audits as

voluntary because the audit requirement was not applicable to license agreements executed

prior to 1997.
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audit, (2) the amount of funds owed to the federal government for each

license agreement, and (3) whether the amounts owed the federal

government had been paid and were reflected in the licensee’s records.

Upon completion of the audits, the licensees were asked to submit the

audit reports to OTT. However, OTT did not specify a time frame for

submitting the audit reports but indicated that the audit reports should be

submitted in a timely manner. In 1998, the 14 licensees submitted audit

reports to OTT covering calendar years 1995 and 1996. According to OTT

officials, while the licensees’ independent public accountants (IPA)

properly performed 4 of the 14 audits covering calendar years 1995 and

1996, the remaining 10 were not properly performed in accordance with the

guidelines specified in OTT’s letters. The IPAs did not disclose in the 10

audit reports the gross sales amount and related expenses used to arrive at

net sales, which is the basis for calculating royalty fees.

In addition, OTT officials told us that 1 of the above 10 licensees submitted

its audit report much later than others did. As a result, OTT compared the

licensee’s sales information to similar information reported to the

Securities and Exchange Commission as an alternative means for

determining if the licensee had reported accurate sales amounts.8 Based on

this comparison, OTT found discrepancies and, in 1998, sent an auditor to

review and verify the licensee’s sales and royalties reports. As a result, in

1999 OTT recovered $9.2 million in unpaid royalty fees from this licensee

and is anticipating the collection of an additional $1.2 million.

At the time of our review, the sales and royalty reports had not been

verified for the remaining nine licenses for which OTT had questions about

their audit reports. OTT officials indicated that although letters requesting

an audit were sent to the 14 licensees, the audits were voluntary because

the audit requirement was not included in license agreements executed

prior to 1997. Therefore, according to OTT officials, it did not have a basis

for requiring the remaining 9 licensees to have additional audit work

performed. They told us that the institutes would have to finance those

audit costs. Given the amount of royalty income collected from the 1

licensee in which follow-up was performed, it would appear to have been in

the government’s best interest to follow up on the nine audits.

8

The Federal Securities Act of 1934 requires companies whose stock is publicly traded to

include sales information in financial reports submitted to the Securities and Exchange

Commission.
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OTT is still facing the same problem today. Starting with license

agreements executed in 1997, OTT requires the licensee to have an audit of

sales and related royalties conducted by an independent auditor at least

every 2 years if annual sales of the licensed product or the licensed

processes exceeded $2 million. Currently there are 13 licensees with

annual sales over $2 million. However, only 1 is required to have a biennial

audit because the audit requirement is not applicable to license agreements

executed prior to 1997. OTT did not separately contract for audits for the

remaining 12 licensees and did not require audits for the licensees with

annual sales that were $2 million and under.

OTT personnel told us that its licensing specialists performed some

monitoring of licensees’ semiannual sales reports that were submitted to

OTT. According to OTT, this monitoring included following up with

licensees that had sales significantly lower or higher than those submitted

on a prior semiannual sales report. In some instances, the follow-up

resulted in the licensees submitting a corrected sales report. However, OTT

could not provide supporting documentation of how it monitored

licensees. Without better-defined processes and documentation of what

OTT says it does, it cannot be assured that royalty receipts submitted by

licensees are accurate and reliable.

In addition to the biennial audits, the license agreements require the

licensee to submit a semiannual royalty report that shows the amount of

the licensed products sold, the net sales, and the amount of royalty fees

due. The license agreement further states that the licensee’s records should

be made available during normal business hours for inspection by an

accountant or other designated auditor selected by OTT for the sole

purpose of verifying reports and royalty payments. While licensees

submitted the required semiannual sales and royalty reports, OTT had not

exercised its right to have auditors review and verify these reports.

Because the majority of the licensees were not required to have biennial

audits, the semiannual reviews and verifications of sales information could

be a compensating control. Further, the reviews and verifications of royalty

reports and payments could help to ensure the accuracy of sales used to

determine royalty fees and the receipt of proper amounts of royalty income

from licensees.

In addition, OTT did not enforce its collection policy to ensure timely

payment of royalty fees. According to OTT’s collection policies and

procedures, if a royalty payment is not received within 90 calendar days of

the original due date, a letter should be sent to the licensee to terminate the
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license agreement. Our test results showed that 1 licensee owing $125,000

as of February 2000 in overdue royalty fees had not made payments to OTT

since January 1998. However, OTT did not send the required termination

letter to the licensee until January 2000—2 years after the payments

became delinquent. At the time of our review, the licensee had made a

payment of $100,000 of the $125,000 overdue royalty fee.

We identified 78 of the 1,204 license agreements in which the licensees

were over 90 days delinquent in making royalty payments as of April 2000,

which was the most recent data available at the time of our review. The

delinquent royalty payments for these 78 license agreements, which cover

36 licensees, amounted to $864,302. OTT allowed licensees to exceed the

90 days delinquency in certain instances where public health

considerations were involved. For example, according to OTT officials, a

licensee that has invented a drug for AIDS treatment would not be

terminated and would be allowed to exceed the 90-day delinquency

because of the impact AIDS has on public health and the urgent need for

effective drugs to combat the disease.

Also, NIH did not assess interest and penalty fees on licensees that were

delinquent in making their royalty payments. The licensing agreement

states that NIH may assess interest and penalties on any overdue payment.

We determined that delinquent debt was not referred to OFM. OTT plans to

refer future delinquent debt to OFM to assess interest and penalties. The

timely submission of royalty fees is an equity issue that has a direct impact

on NIH inventors and institutes that should receive a distributed share of

royalty income. If licensees do not submit royalty fees on a timely basis,

inventors payments are also delayed. Further, the institutes do not receive

their share of royalty income to support research laboratory operations and

for payment of related administrative expenses.

An Integrated System

Could Enhance

Management of

Royalty Income

According to the CFO Act, agencies should develop and maintain an

integrated accounting and financial management system that complies with

federal requirements and provides for complete, reliable, consistent, and

timely information that is responsive to the financial information needs of

the agency. An integrated financial system coordinates a number of

functions to improve overall efficiency and control. Two key NIH offices

that are responsible for reconciling royalty income records maintained

separate, nonintegrated systems. As a result, the monthly royalty income

reconciliation process was labor-intensive and was not always performed

in a timely manner. OTT recently changed its plans to develop and
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implement a new system to replace its current Invention Tracking System

when available funds for the contract ran out. OTT now has plans to

upgrade the Invention Tracking System. However, the planned upgrade

would not facilitate the royalty income reconciliation process performed

by offices in OTT and OFM.

OFM’s, General Ledger Branch (see figure 1) receives information on

licensees’ payments and forwards separate copies of original royalty

receipt documents to OTT and OFM’s Government Accounts Section so

that they can determine whether NIH received proper amounts. Because

NIH does not have an integrated system to account for royalty income,

each of the three offices maintains royalty income in separate systems.

OTT maintains royalty income data in the Invention Tracking System, and

the two OFM offices maintain royalty income data on separate Lotus

spreadsheets. At the end of each month, personnel from these offices

perform reconciliations of royalty income receipts recorded in each of their

systems. Reconciliation procedures are a control necessary to ensure

accurate reporting of royalty income received. At the same time, the

clerical effort involved in entering the same data into different systems is

not efficient and introduces the possibility of errors.

We found that OTT’s royalty income records were not always promptly

reconciled with OFM’s records. Of the royalty reconciliations we reviewed,

we found that the June 1999 royalty reconciliation was not completed until

October 1999, 3 months after the end of the accounting period. OTT

officials told us that the delay in the reconciliation process resulted from

licensees (1) submitting checks without proper identification such as the

license number and (2) making multiple payments with a single check. The

Comptroller General’s Standards for Internal Control in the Federal

Government states that internal control activities help ensure that

management’s directives are carried out. These activities include

approvals, authorizations, verifications, reconciliations, and maintenance

of related records that provide evidence of execution of these activities as

well as appropriate documentation. Performing monthly reconciliations of

royalty income information within 30 days could provide assurance that

reported royalty income is accurate and complete, available faster for use

by the institutes, and distributed in a timely manner to inventors.

We also found that the reconciliations we reviewed were prepared and

approved by the same individuals and lacked indication of supervisory

review, which further increases the risk of inaccurate and incomplete

royalty income. The Comptroller General’s Standards for Internal Control
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in the Federal Government states that key duties and responsibilities

should be divided or segregated among different people to reduce the risk

of error or fraud. This includes separating the responsibilities for

authorizing transactions, processing and recording them, reviewing the

transactions, and handling any related assets.

OTT and OFM could more efficiently record, retrieve, and reconcile royalty

income data if the OTT and OFM systems were integrated and the data

shared among those needing the information. In our November 1999

correspondence, we reported that OTT planned to replace its Invention

Tracking System with a new system, the Technology Transfer Information

Management System (TTIMS). In July 1997, OTT contracted for the

development of TTIMS. However, after available funds for the contract ran

out, OTT did not retain the contractor. According to OTT officials, after

spending about $414,000, OTT terminated the contractor because it did not

produce an adequate system. OTT could not provide us with the analysis it

said it performed as a basis for discontinuing TTIMS.

OTT now plans to upgrade the current Invention Tracking System.

However, OTT could not tell us how the upgrade to the Invention Tracking

System would improve the efficiency of its overall operations. The ClingerCohen Act requires agencies to establish a process to assess the value and

risks of information technology investments, including specific quantitative

and qualitative criteria for comparing and prioritizing alternative

information technology projects. Only by comparing the costs, benefits,

and risks of a full range of technical options can agencies ensure that the

best approaches are selected.

Royalty Income Was

Not Recorded

Promptly in the

General Ledger

OFM did not promptly record royalty income in its general ledger when it

was received from licensees. Rather, royalty income was recorded outside

of the general ledger on a Lotus spreadsheet. Recording transactions in the

general ledger in a timely manner can facilitate accurate reporting to

Treasury. The Comptroller General’s Standards for Internal Control in the

Federal Government states that transactions should be promptly recorded

to maintain their relevance and value to management in controlling

operations and making decisions.

When licensees make royalty payments, the funds are deposited in a

Treasury lockbox. Treasury requires agencies to submit monthly cash

collection and disbursement transaction reports that identify the

appropriation account in which Treasury should record the funds.
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However, OFM prepares the monthly cash collections and disbursement

transaction reports and instructs Treasury to post its royalty income

received to a suspense account. The Treasury suspense account is an

account that maintains transactions that cannot be readily identified.

Although Treasury allows agencies to record transactions in a suspense

account, these agencies are expected to clear the account in a timely

manner by transferring the receipts to the proper appropriation account.

According to OFM personnel, it generally takes 2 to 4 months to research

royalty income and for OFM and OTT to reconcile this income. After the

royalty income research process and the reconciliations are complete,

receipts are transferred out of Treasury’s suspense account and also

recorded in the NIH general ledger. However, we found that about

$50 million in royalty income had remained in the Treasury suspense

account since December 1998 and was not transferred to the proper

appropriation account until April 2000. In addition, only a portion of the

$50 million was recorded in the NIH general ledger in a timely manner. As a

result, the royalty receipts in NIH’s general ledger may not be complete and

accurate, resulting in inaccurate reporting in NIH’s financial statements

and other external reports sent to the Office of Management and Budget

(OMB) and the Treasury.

The IPA responsible for the fiscal year 1999 financial statement audit of

NIH identified the same issue as an example in support of a reportable

condition in its internal control report. The IPA reported that the financial

accounting systems at NIH do not have the appropriate controls in place to

ensure that transactions are posted to the general ledger in a timely

manner. Specifically, the IPA reported that royalty receipts were not posted

to the NIH general ledger in a timely manner.

Allotments Were

Improperly

Provided Before

Apportionments

Were Approved

NIH submitted its fiscal years 2000-2001 royalty income apportionment

request to OMB on March 21, 2000, and the request was approved in April

2000.9 However, 3 months before OMB approved the apportionment

9

NIH submits a 2-year apportionment request to OMB. Under the Federal Technology

Transfer Act of 1986, as amended, an agency may generally retain royalties for 2 years after

the fiscal year in which the royalties were received.
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request, NIH sent advice of allotments to its institutes.10 The distribution of

royalty income should not be made to NIH institutes until the royalty

apportionment request is approved by OMB. We found that in January 2000,

the NIH budget office provided one of the institutes an approved advice of

allotment that gave it the authority to obligate royalty income funds from

the first allotment for fiscal years 2000 and 2001. According to institute

officials, based on this allotment, it obligated royalty income.

NIH budget office officials told us that they notified some of the institutes

verbally and by electronic mail in March 2000 that they had prematurely

issued advice of allotments in January 2000 in error. The officials also told

us that they requested that the allotments not be disbursed until the fiscal

year 2000 apportionment had been approved. We were not able to verify

that notifications had been sent to the institutes because the NIH budget

office officials could not provide support. Timely submission and approval

of apportionment requests could ensure that the use of royalty income is

properly authorized prior to issuance of allotments to institutes.

Conclusions As a result of insufficient internal controls over its administration of royalty

income, NIH cannot ensure that reported sales and related royalty amounts

are reliable. In addition, by not adhering to collection policies and

procedures, NIH may be foregoing royalty income due to it. Further, NIH’s

lack of an integrated computerized system to process royalty income

transactions has hampered its ability to process and record royalty income

in a timely and efficient manner. As a result, a significant amount of time

and effort is spent on tasks such as reconciliations.

Recommendations To strengthen controls over the royalty receipt process, we recommend

that the Acting Director of NIH

• review and revise NIH policies and procedures for monitoring activities

to include (1) the use of biennial audits for all licensees with sales over

$2 million, (2) periodic reviews of the accuracy of semiannual royalty

sales reports, including those under $2 million, and (3) specific due

dates for the submission of biennial audit reports;

10An advice of allotment provides an institute the authority to obligate royalty funds.
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• impose and collect interest and penalties on licensees delinquent in

submitting royalty payments;

• discontinue the practice of recording royalty income in the Treasury

suspense account when received—instead, record royalty income in the

NIH general ledger when it is received;

• prepare timely royalty income reconciliations and ensure proper

supervisory review and approval of these reconciliations;

• develop and implement a centralized database system that integrates

data used by OFM and OTT to facilitate the reconciliation process; and

• ensure that royalty income apportionment requests are approved prior

to issuance of advice of allotments to institutes.

Agency Comments and

Our Evaluation

In written comments (see appendix I) on a draft of this report, NIH agreed

in principle with four of our six recommendations and did not concur with

two. NIH stated that our recommendations addressed current management

weaknesses and that it was aware of and addressing many of these

problems. It expressed disagreement with our overall observations and

conclusions concerning the problems encountered and reported on during

our review. NIH also said that, had we conducted a benchmark study of

organizations that license their technologies, it would have surfaced as a

leader in the level of sophistication of its monitoring activities.

First, regarding the scope of our evaluative work, we evaluated NIH’s

processes against commonly accepted business practices and

expectations. As noted in our report, our overarching conclusion is that

NIH systems, processes, and disciplines imposed internally and on its

licensee community were not adequate to meet what would be considered

reasonable expectations for achieving financial accountability as well as

for fulfilling NIH’s fiduciary role to its inventor community, which shares

the royalty proceeds.

Regarding the two recommendations with which it did not concur, NIH

tended to mischaracterize and misconstrue the thrust of our proposed

managerial enhancements. NIH agreed that appropriate and timely

monitoring activities are necessary but said it did not concur with

particular aspects of our recommendation related to biennial audits,

periodic reviews of the accuracy of semiannual sales reports, and specified

due dates for submission of the biennial audit reports. However, in

discussing its perception of what we were asking it to do, NIH’s comments

presumed a much more intensive effort than we had contemplated or

which could be justified by the circumstances involved.
B-285582

Page 16 GAO/AIMD-00-210 NIH Royalty Income

The intent of this recommendation was to help ensure that royalty income

due to NIH is collected in a timely and efficient manner. Performing

biennial audits for all licensees with sales over $2 million and periodic

reviews of the accuracy of semiannual sales reports are mechanisms to

ensure that accurate amounts of royalty income are received. NIH

expressed the view that it would not be cost-effective to audit sales data for

all 1,200 licenses because for many licensees, the cost of the audit would

exceed the royalty income owed. This was not our intent. An appropriate

approach would entail evaluating the risk of understatement of sales in

semiannual reports, selecting and reviewing those licensees with sales data

that exhibit a risk of understatement, and sampling the remaining licensees

for review. NIH also contends that OTT provided several letters as evidence

of the outcome of its monitoring activities. We requested support as

evidence of OTT’s monitoring of semiannual sales reports throughout our

review. However, this support has never been provided.

Further, specifying due dates for OTT to receive audit reports would help

to ensure that NIH receives royalty income on a timely basis and that its

institutes and inventors in turn receive their royalty income in a timely

manner. As NIH stated in its comments, it is not practical to require a single

due date for all licensees. We were not suggesting a single due date, but

rather that NIH set a time frame for audit reports to be submitted to

OTT—for example, a specified number of months after a licensee has met

the $2 million threshold or within a specified period after the close of the

licensee’s fiscal year. Merely asking that the audit reports be submitted

timely is not specific enough to ensure consistent submission of audit

reports from licensees.

NIH did not concur with our recommendation to discontinue the practice

of recording royalty income in the Treasury suspense account when

received and instead to record royalty income in its general ledger as

received. In its comments, NIH stated that when licensees make payments,

many do not provide sufficient data to allow proper recording of the

receipts to the appropriate accounts in a timely manner. Specifically, it

noted that it is obligated to acknowledge the receipt of the funds within its

Treasury Agency Location Code by classifying the receipts in a suspense

account until it can be properly classified to another specific account. We

understand that the varying types of payments and the data or lack thereof

accompanying licensees payments create accounting and recording

problems, making resolution both time consuming and expensive.

Therefore, it is incumbent upon NIH to change its expectations concerning

the completeness and accuracy of licensees’ submissions. It is reasonable
B-285582

Page 17 GAO/AIMD-00-210 NIH Royalty Income

for NIH business practices and policies to reflect an expectation that any

accounting and receipt questions be consistently resolved within 30 days.

NIH also said that if all receipts were recorded as royalty income, the

potential for overstating income and budgetary resources would be high.

We are not suggesting that all receipts be recorded as royalty income. NIH

currently enters royalty receipts on Lotus spreadsheets but not in its

accounting records until questions are resolved. Our point is that this

practice means that receipt data is not being controlled by the accounting

system and therefore poses a risk of lost data. Royalty receipts should be

recorded in the general ledger when received, possibly in a suspense

account there until resolved.

Related to royalty income reconciliations, NIH states that our report

inaccurately portrays the reconciliation process as an internal control issue

and that we do not present evidence or analysis to document the

vulnerability. Reconciliations are a critical part of any entity’s internal

control activities. Reconciliation procedures are a control necessary to

ensure accurate reporting of royalty income received. Also, while NIH said

it was not aware of any instances where payments to inventors were

delayed or missed because of a problem in the manner in which records

were reconciled between OTT and OFM, officials told us that inventors and

institutes cannot receive their share of royalty income until this process is

complete.

We are sending copies of this report to Representative John D. Dingell,

Ranking Minority Member, House Committee on Commerce;

Representative Ron Klink, Ranking Minority Member, Subcommittee on

Oversight and Investigations, House Committee on Commerce. We are also

sending copies of this report to the Honorable Donna Shalala, Secretary of

the Department of Health and Human Services; Dr. Ruth Kirschstein, the

Acting Director of the National Institutes of Health; and the Honorable

Jacob J. Lew, Director of the Office of Management and Budget. Copies will

also be made available to others upon request. Please contact me at
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Page 18 GAO/AIMD-00-210 NIH Royalty Income

(202) 512-4476 if you or your staff have any questions concerning this

report. Key contributors to the assignment were Chinero Nwaigwe, Rosa

Ricks Harris, Godwin Nwosu, and Debra Rucker.

Gloria L. Jarmon

Director, Health, Education, and Human Services

Accounting and Financial Management Division
Page 19 GAO/AIMD-00-210 NIH Royalty Income
Page 20 GAO/AIMD-00-210 NIH Royalty Income

Appendix I

Comments From the National Institutes of Apendxies

Health ApendxiI

Note: GAO comments

supplementing those in the

report text appear at the end

of this appendix.
Appendix I

Comments From the National Institutes of

Health

Page 21 GAO/AIMD-00-210 NIH Royalty Income

See comment 1.
Appendix I

Comments From the National Institutes of

Health

Page 22 GAO/AIMD-00-210 NIH Royalty Income

See comment 2.

See comment 2.

See comment 3.

See comment 3.
Appendix I

Comments From the National Institutes of

Health

Page 23 GAO/AIMD-00-210 NIH Royalty Income

See comment 4.

See comment 4.

See comment 2.

See comment 2.

See comment 2.

See comment 2.
Appendix I

Comments From the National Institutes of

Health

Page 24 GAO/AIMD-00-210 NIH Royalty Income

See comment 2.
Appendix I

Comments From the National Institutes of

Health

Page 25 GAO/AIMD-00-210 NIH Royalty Income

See comment 2.

See comment 2.

Now on p. 2.

See comment 2.

Now on p. 11.

See comment 2.
Appendix I

Comments From the National Institutes of

Health

Page 26 GAO/AIMD-00-210 NIH Royalty Income

See comment 5.
Appendix I

Comments From the National Institutes of

Health

Page 27 GAO/AIMD-00-210 NIH Royalty Income

GAO Comments 1. During a meeting with an OTT official, future plans for OTT’s

operations were discussed. However, OTT did not provide a written

plan of its business activities for our review.

2. Discussed in “Agency Comments and Our Evaluation” section of this

report.

3. This report has been revised to reflect that these audits are to be

conducted every 2 years, namely, “biennially.”

4. As stated in the report, it appears that it would have been in the

government’s best interest to follow up on other voluntary audits.

Although a firm under one of the voluntary audits paid NIH $9 million,

NIH stated that the firm did so under protest and that the case is now in

litigation in federal court. We do not believe that the threat of a lawsuit

should be a factor in determining if an audit should be performed.

5. In its comments, NIH stated that because many of its routine processes

have been delegated to highly qualified staff, it is not convinced that

much value would be added to having reconciliations reviewed and

approved by another supervisory layer. Contrary to NIH’s comment that

the OTT staff that signs the reconciliation supervises the staff that

prepares the reconciliation, our review of NIH royalty income

reconciliations for 3 months showed that the reconciliations were

signed by the preparer without supervisory review and approval.

Supervisory review and approval of royalty income reconciliations

could offer additional assurance that royalty income is accurate and

complete.

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