Un ed States Government Accountability Office

Washington, DC 20548 

it

September 15, 2009 

The Honorable Steven O. App 

Deputy to the Chairman and Chief Financial Officer 

Federal Deposit Insurance Corporation 

Subject: Management Report: Opportunities for Improvements in FDIC’s Internal Controls and 

Accounting Procedures 

Dear Mr. App: 

In May 2009, we issued our opinions on the calendar year 2008 financial statements of the 

Deposit Insurance Fund (DIF) and the FSLIC1

 Resolution Fund (FRF). We also issued our 

opinion on the effectiveness of the Federal Deposit Insurance Corporation’s (FDIC) internal 

control over financial reporting (including safeguarding assets) as of December 31, 2008, and 

our evaluation of FDIC’s compliance with provisions of selected laws and regulations for the 

two funds for the year ended December 31, 2008.

2

The purpose of this report is to present issues identified during our audit of the 2008 financial 

statements regarding certain internal controls and accounting procedures and to recommend 

actions to address these issues. We are making four recommendations for strengthening FDIC’s 

internal controls and accounting procedures. 

Results in Brief 

During our audits of the 2008 financial statements, we identified four internal control issues that 

affected FDIC’s accounting for the funds it administers. Although we do not consider them to be 

material weaknesses or significant deficiencies,3 and thus do not consider them to be material in 

 

1

 The Federal Savings and Loan Insurance Corporation (FSLIC) was a government corporation that administered 

deposit insurance for savings and loan institutions in the United States. FSLIC’s responsibilities were transferred to 

the FDIC in the late 1980s. 

2

 GAO, Financial Audit: Federal Deposit Insurance Corporation Funds' 2008 and 2007 Financial Statements, 

GAO-09-535 (Washington, D.C.: May 28, 2009). 

3

 A significant deficiency is a control deficiency, or combination of deficiencies, in internal control that is less 

severe than a material weakness, yet important enough to merit attention by those charged with governance. A 

material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable 

possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and 

corrected on a timely basis. 

1 GAO-09-943R FDIC Management Report 2008 
relation to DIF’s and FRF’s financial statements, we believe that they warrant management’s 

attention and action. These issues concern the following: 

• Written policies and procedures were not updated to document FDIC’s new methodology 

used to determine the estimated cash recovery of receivership assets. 

• Controls did not ensure that correct amounts were paid for services provided by contractors 

and that operating expenses were appropriately allocated among the funds FDIC administers. 

• Oversight of contracted lockbox operations did not provide adequate assurance that controls 

were effectively designed to minimize the risk of loss, theft, and misreporting of receivership 

receipts. 

• Controls over the processing of receivership receipt transactions did not result in transactions 

being timely applied to the appropriate receivership accounts. 

These issues increase the risk that FDIC would not prevent or timely detect (1) errors or 

inconsistencies in valuing failed bank assets, (2) erroneous payments and errors in allocating 

operating expenses, (3) loss or theft of receivership receipts processed at a contractor-operated 

lockbox facility, or (4) misstatements in receivership accounts. 

At the end of our discussion of each of these issues in the following sections, we make 

recommendations for strengthening FDIC’s internal controls or accounting procedures. These 

recommendations are intended to improve management’s oversight and controls, decrease the 

risk of theft or misappropriation of assets, and minimize the risk of misstatements in DIF’s and 

FRF’s financial statements. 

In its comments, FDIC agreed with our recommendations and described actions it has taken or 

plans to take to address the control weaknesses described in this report. At the end of our 

discussion of each of the issues in this report, we have summarized FDIC’s related comments 

and our evaluation. 

Scope and Methodology 

As part of our audits of the 2008 and 2007 financial statements of the two funds administered by 

FDIC, we evaluated FDIC’s internal controls and tested its compliance with selected provisions 

of laws and regulations. We designed our audit procedures to test relevant controls over financial 

reporting, including those designed to provide reasonable assurance that transactions are properly 

recorded, processed, and summarized to permit the preparation of DIF’s and FRF’s financial 

statements in conformity with U.S. generally accepted accounting principles, and that assets are 

safeguarded against loss from unauthorized acquisition, use, or disposition. 

2 GAO-09-943R FDIC Management Report 2008 
We requested comments on a draft of this report from the FDIC Deputy to the Chairman and 

Chief Financial Officer. We received written comments from FDIC and have reprinted the 

comments in their entirety in enclosure I. We conducted our audits in accordance with U.S. 

generally accepted government auditing standards. Further details on our scope and methodology 

are included in our May 2009 report on the results of our audits of the 2008 and 2007 financial 

statements and are summarized in enclosure II. 

Receivership Asset Valuations 

During 2008, FDIC changed its valuation methodology for estimating the recoveries FDIC 

expects to receive from the disposition of assets of failed financial institutions in receivership. 

While we concluded based on our audit work that the new methodology resulted in reasonable 

estimates, we determined that FDIC had not documented the new process to ensure its consistent 

and proper application in subsequent years. 

When a federally insured financial institution fails, the institution is placed into a receivership 

administered by FDIC. As part of this process, FDIC, through the DIF, will either close the 

institution and pay off insured depositors outright, operate the institution until it can find another 

institution to acquire some or all of the failed institution’s assets and liabilities, or sell some or all 

of the failed institution to an acquiring institution. The amounts FDIC disburses on behalf of the 

DIF to pay off insured depositors or to pay an acquiring institution to assume responsibility for 

some or all of the failed institution’s liabilities represents a claim, or receivable, the DIF has 

against the failed institution’s receivership, which is also operated by FDIC. Subsequent to the 

closing and initial disbursement of funds, the FDIC, through DIF, may periodically advance 

additional funds to the failed institution receivership to cover operating costs while the assets and 

liabilities of the receivership are sold or otherwise disposed of. These subsequent advances add 

to the DIF’s claim, or receivable, against the receivership. Proceeds from the servicing, sale, or 

disposition of the failed institution receivership’s assets are used to pay off, or reduce the DIF’s 

outstanding receivable. 

For financial reporting purposes, FDIC must periodically estimate what portion of the 

outstanding balance of the DIF’s receivable from resolutions is collectible. This estimate is 

primarily based on the amounts FDIC expects DIF will recover through the servicing, sale, and 

disposition of the receivership’s assets. The difference between the outstanding receivable 

balance and the amount FDIC estimates will ultimately be collected represents the allowance for 

losses on the receivable to be included in DIF’s financial statements. 

In prior years, FDIC used a standardized methodology—the Standard Asset Valuation 

Estimation methodology, or SAVE—to estimate the dollar value of recoveries from failed 

institution receivership assets. This methodology involved selecting a statistical sample from the 

complete inventory of DIF receivership assets at midyear and, through application of a set of 

procedures, deriving an expected recovery for those assets. The results were then statistically 

projected to the population of receivership assets to derive an overall recovery estimate for the 

3 GAO-09-943R FDIC Management Report 2008 
assets. However, this approach had limitations that proved substantial in 2008. Specifically, in 

order for this approach to produce reliable results in time to prepare year-end financial 

statements, the vast majority of the failed institutions’ assets in a given year would have to be 

included in the DIF’s inventory of receivership assets by midyear. However, in 2008, the vast 

majority of institution failures, and resulting failed institution assets to be included in DIF’s 

inventory of receivership assets, did not occur until the latter half of the year. As a result, FDIC 

was unable to use its standard methodology to derive the year-end estimated recovery value for 

the DIF receivership assets and related allowance for losses on DIF’s receivables. 

FDIC developed a new methodology for valuing receivership assets in 2008 that employed a 

combination of information on current or pending asset sales, failed institution-specific asset 

valuation data, aggregate asset valuation data on several recently failed or troubled institutions, 

and empirical asset recovery data based on historical information on institution failures. We 

reviewed and tested this process and concluded that it generated reasonable estimates of asset 

recovery values and, consequently, in a reliable estimate of DIF’s allowance for losses on its 

receivables from resolutions for financial reporting. However, FDIC had not documented this 

new process in formal guidance for its staff. Standards for Internal Control in the Federal 

Government4

 provides that internal controls are to be clearly documented in official procedural 

guidance. FDIC expects the rate of failures of financial institutions to continue to be high 

throughout 2009 and into 2010. Consequently, FDIC will likely need to continue to utilize this 

new methodology for the foreseeable future. Without clearly documented guidance, which is 

disseminated to staff involved in the estimation process, and effective implementation of this 

guidance, FDIC increases the risk that receivership assets will not be valued in a consistent or 

appropriate manner. This, in turn, could impact the consistency and reasonableness of FDIC’s 

calculation of DIF’s allowance for losses on its receivables from resolutions. 

Recommendation

We recommend that the Chief Financial Officer (1) document procedural guidance for estimating 

failed financial institution receivership asset recoveries to derive the allowance for losses on the 

DIF’s receivables from resolutions, (2) disseminate the guidance to appropriate staff, and (3) 

effectively implement the guidance. 

FDIC Comments and Our Evaluation

FDIC agreed with this recommendation and stated that the corporation would develop procedural 

guidance that reflects the new methodology for estimating receivership asset recoveries used for 

determining the allowance for loss on DIF receivables from resolutions. FDIC further stated the 

updated guidance would be formally implemented and disseminated with appropriate staff by 

 

4

 GAO, Standards for Internal Control in the Federal Government, GAO/AIMD-00-21.3.1 (Washington, D.C.: 

November 1999). 

4 GAO-09-943R FDIC Management Report 2008 
September 30, 2009. We will evaluate FDIC’s documentation of the new procedures and its 

implementation thereof during our 2009 financial audit. 

Operating Expenses 

During our testing of operating expense transactions conducted as part of our 2008 audit, we 

found that FDIC’s internal controls did not effectively ensure that correct amounts were paid for 

services provided by contractors, or that operating expenses were appropriately allocated among 

the funds FDIC administers. We found that a contractor overbilled for certain services, and that 

FDIC inaccurately allocated expenses incurred from that contractor between DIF and FRF. 

Specifically, in two of the operating expense transactions we tested, we found that a contractor 

charged FDIC incorrect amounts by using the wrong rates in billing for services provided. We 

notified the FDIC official responsible for monitoring and evaluating this contractor’s 

performance— the oversight manager— who stated that her review did not identify the mistake. 

FDIC’s written procedures require that the oversight manager review invoices to ensure they are 

in compliance with the terms of the contract. After learning of the error, FDIC reviewed other 

invoices from this contractor and determined that the vendor used the wrong billing rates in 43 

invoices and that FDIC overpaid the vendor about $4,700. 

We also found that FDIC misallocated operating expenses between the DIF and FRF. Two of the 

transactions we tested were for shredding and general records services performed by a 

contractor. To allocate shared expenses to each fund, FDIC used a spreadsheet called the fund 

distribution schedule. However, FDIC officials did not properly enter invoice information into 

appropriate sections of the fund distribution schedule, resulting in a misallocation of expenses 

between the DIF and FRF. We notified FDIC about the misallocation and the manager agreed 

that the total invoice amounts were entered incorrectly. Based on our findings, FDIC reviewed 

past cost allocations related to services provided by this contractor and determined there were 

errors in allocating the expenses from eight invoices. FDIC corrected these errors by posting 

adjustments to the DIF and FRF. The adjustments resulted in a $700,000 decrease in DIF’s 

operating expenses and a corresponding $700,000 increase in FRF’s operating expenses. 

We determined that FDIC did not have documented operating procedures or instructions for 

entering data into the fund distribution schedule, nor were there documented procedures for 

independent review or verification of the cost allocations before they were entered into FDIC’s 

general ledger system. Standards for Internal Control in the Federal Government provides that 

agencies are to implement procedures to ensure the accurate and timely recording of transactions 

and events. This includes documenting operating procedures and internal controls. The standards 

also provide that qualified and continuous supervision be provided to ensure that internal control 

objectives are achieved. The lack of written instructions and independent review increases the 

risk that FDIC’s process for allocating shared costs and posting expenses into the general ledger 

5 GAO-09-943R FDIC Management Report 2008 
will not always timely prevent or detect errors, and that operating expenses may be incorrectly 

classified and presented in DIF’s and FRF’s financial statements. 

Subsequent to the completion of our testing, FDIC issued new procedures for the independent 

review of both invoices and the fund distribution schedule. The additional review is intended to 

provide added assurance that all discrepancies in billing rates are identified and the data entered 

into the schedule are accurate. However, the new procedures do not contain instructions for 

entering information into the fund distribution schedule. 

Recommendation

We recommend that the Chief Financial Officer document and implement the procedures to be 

followed for entering data into the fund distribution schedule. 

FDIC Comments and Our Evaluation

FDIC agreed with this recommendation and stated that it would revise the procedures for the 

invoice review process for this contract, including procedures for entering the invoice data into 

the fund distribution schedule, by September 30, 2009. We will evaluate the design and the 

implementation of these new procedures during our 2009 financial audit. 

Oversight of Lockbox Bank 

During our 2008 audit, we found that FDIC did not effectively monitor the safeguarding and 

processing of receivership receipts at the Dallas lockbox facility5

 operated by JPMorgan Chase 

Bank, N.A. (JPMorgan). As a result, FDIC did not have adequate assurance about whether the 

controls in place at this facility were designed and operating effectively to minimize the risk of 

misappropriation and misreporting of receivership receipts. 

FDIC, in its receivership capacity, receives payments either at its Dallas field office cashier unit 

or through the lockbox. Receivership receipts include payments on loans serviced by FDIC, 

proceeds from the sale of various assets of failed financial institutions in receivership, restitution 

payments, and amounts from professional liability claims. Receipts received at the Dallas 

lockbox facility are processed by JPMorgan. Similarly, receipts that are received at the FDIC 

 

5

 A lockbox bank is a commercial bank with a designated post office address to which payments and related 

documents for FDIC receiverships are to be sent. The lockbox bank processes the documents, deposits the receipts, 

and then forwards the documents and data to FDIC. The intent of the lockbox program is to accelerate the deposit of 

receipts and increase interest savings, thus enhancing the efficiency of cash management. 

6 GAO-09-943R FDIC Management Report 2008 
Dallas field office cashier unit are forwarded to the lockbox facility where they are processed. In 

2008, the Dallas lockbox received, processed, and recorded almost $46 million in FDIC 

receivership receipts. 

We previously reported6 that FDIC’s policies and procedures do not require the examination of 

internal controls at the Dallas lockbox facility to ensure those controls are effective and operating 

as intended. Safeguarding controls over lockbox operations are critical in preventing the theft, 

loss, or misappropriation of cash or checks. We recommended that FDIC modify its policies and 

procedures to require regular review and take appropriate actions to address the results of 

examinations of internal controls at the lockbox facility to ensure that controls are effective and 

operating as intended. In response, FDIC modified its policies and procedures to 1) regularly 

obtain JPMorgan’s annual financial audit reports, 2) review them for any deficiencies related to 

controls, and 3) require that any identified deficiencies be corrected by JPMorgan in a timely 

manner. FDIC also requested copies of JPMorgan’s internal audit reports or SAS 70 reports7

 for 

the lockbox operation, but the bank reported that it had not engaged a public accounting firm to 

perform a SAS 70 examination on its cash management product operations and, therefore could 

not provide a SAS 70 report. 

Although FDIC reviews JPMorgan’s annual report, the accompanying auditor’s report is limited 

to an audit of the bank’s financial reporting and it did not consider the effectiveness of internal 

controls over the Dallas lockbox operations. Additionally, while FDIC modified its policies and 

procedures to require review of these annual reports, it did not require obtaining and evaluating 

internal audit reports or other reports covering the internal controls of the lockbox facility. 

During our 2008 audit, FDIC officials stated that they did not request internal audit reports 

specifically related to the lockbox operations because in prior years JP Morgan did not share 

these reports due to concern with the possible release of proprietary information. 

Standards for Internal Control in the Federal Government provides that agencies are to establish 

appropriate accounting and physical controls to record, secure, and safeguard vulnerable assets. 

It is FDIC’s responsibility to ensure that all receivership receipts are safeguarded and properly 

recorded. When this assurance is dependent on the internal controls of an outside entity—or 

service provider—it is up to FDIC management to monitor whether these controls are effective 

and functioning as intended. This is especially important in this case because FDIC does not 

have a record of all the receivership receipts that are sent to the Dallas lockbox, and therefore 

must fully rely upon the internal controls at the lockbox facility to ensure that all cash and checks 

received are protected, fully accounted for, and accurately reported. 

 

6

 GAO, Management Report: Opportunities for Improvement’s in FDIC’s Internal Controls and Accounting 

Procedures, GAO-07-942R (Washington, D.C.: June 27, 2007). 

7

 SAS 70 reports refer to reports typically prepared by an independent auditor based on a review of the internal 

controls over an entity’s servicing operations as discussed in the American Institute of Certified Public Accountants 

(AICPA)'s Statement on Auditing Standards (SAS) No. 70, Service Organizations. A service organization provides 

services to the entity whose financial statements are being audited. 

7 GAO-09-943R FDIC Management Report 2008 
Because the annual reports gathered and reviewed by FDIC do not evaluate lockbox operations 

and are not designed to identify weaknesses in the design or implementation of the lockbox 

facility’s internal controls, FDIC management does not have information to determine whether 

appropriate and effective controls exist over receivership receipts sent to the lockbox. The 

increasing number of bank failures has resulted, and will continue to result, in a growing volume 

of receivership receipts processed at the lockbox facility, thereby increasing the importance of 

effective internal controls over its operation. Safeguarding controls are critical in preventing the 

theft of cash or checks. The lack of effective oversight and monitoring of safeguarding controls 

increases the risk of theft, loss, or misappropriation of assets. 

Recommendation

We recommend that the Chief Financial Officer revise procedures to obtain assurance—through 

such means as SAS 70 reports, internal audit reports, and other monitoring processes—that 

internal controls over receivership receipts are in place and functioning properly at the Dallas 

lockbox facility. 

FDIC Comments and Our Evaluation

FDIC agreed with this recommendation. FDIC stated it had requested a SAS 70 report from 

JPMorgan's Customer Representative. However, because JPMorgan did not have a SAS 70 

assessment of its lockbox operations conducted, it provided a letter detailing the specific 

components of the risk management framework over its cash management product operations. 

Further, FDIC stated that on or before December 31, 2009, it would revise procedures over the 

Dallas lockbox facility to include requesting the SAS 70 or other similar reports on JPMorgan's 

lockbox services. We will evaluate the effectiveness of FDIC’s actions during our 2009 financial 

audit. 

Processing Receivership Receipts 

During our testing of receivership receipts conducted as part of our 2008 audit, we found that 

FDIC did not always timely apply payments to the appropriate receivership assets (and other) 

accounts. When FDIC, in its receivership capacity, receives a payment, the receipt is deposited 

and initially recorded in the receivership’s general ledger as an asset (cash) with an offsetting 

entry to the cash-in-process suspense account (a liability account). Until FDIC determines how to 

apply the receipt, it remains in this account, and other receivership accounts are misstated until 

the receipts are properly applied to those accounts. 

8 GAO-09-943R FDIC Management Report 2008 
In our sampling of 45 receivership receipts, we found that 7 receipts were not cleared from the 

suspense account and applied to the correct accounts within 90 days. As of the date of our 

testing, these 7 receipts had been in the suspense account from 118 to 366 days. We also 

reviewed all the receivership receipts in the suspense account as of January 2, 2009, and 

determined that 203 receipts (totaling $12 million) had been in the suspense account for more 

than 90 days. While FDIC officials we spoke with stated that they try to clear receipts from the 

suspense account within 90 days, FDIC had no written policy establishing time frames for how 

quickly receipts should be cleared from the suspense account and applied to the appropriate asset 

account on the receivership books. The officers also stated that the delay in applying the 

payments and clearing these accounts was due to the increased workload resulting from the 

increased number of bank failures in 2008. 

Standards for Internal Control in the Federal Government provides that agencies are to 

implement procedures to ensure the timely and accurate recording of transactions and events. 

While there ultimately was no impact on DIF’s and FRF’s financial statements, the lack of a 

formal policy for applying payments in a timely manner increases the risk that receivership 

receipts will not be timely processed, resulting in misstating the receivership’s financial records. 

Recommendation

We recommend that the Chief Financial Officer document and implement a policy regarding a 

time frame, such as the current target of 90 days, by which receivership receipts are to be applied 

to the appropriate receivership accounts. 

FDIC Comments and Our Evaluation

FDIC agreed with this recommendation, and stated that by December 31, 2009, it would 

document and implement a policy regarding the time frame by which receivership receipts are to 

be applied to the appropriate receivership accounts. We will evaluate the effectiveness of FDIC’s 

actions during our 2009 financial audit. 

_______ 

This report contains recommendations to you. We would appreciate receiving a description and 

status of your corrective actions within 30 days of the date of this report. 

This report is intended for use by FDIC management, members of the FDIC Audit Committee, 

and the FDIC Inspector General. We are sending copies of this report to the Chairman and 

Ranking Member of the Senate Committee on Banking, Housing, and Urban Affairs; the 

Chairman and Ranking Member of the House Committee on Financial Services; the Chairman of 

the Board of Directors of the Federal Deposit Insurance Corporation; the Chairman of the Board 

9 GAO-09-943R FDIC Management Report 2008 
of Governors of the Federal Reserve System; the Comptroller of the Currency; the Director of 

the Office of Thrift Supervision; the Secretary of the Treasury; the Director of the Office of 

Management and Budget; and other interested parties. In addition, this report will be available at 

no charge on GAO’s Web site at http://www.gao.gov. 

We acknowledge and appreciate the cooperation and assistance provided by FDIC management 

and staff during our audits of FDIC’s 2008 and 2007 financial statements. If you have any 

questions about this report or need assistance in addressing these issues, please contact me at 

(202) 512-3406 or sebastians@gao.gov. Contact points for our Offices of Congressional 

Relations and Public Affairs may be found on the last page of this report. GAO staff who made 

major contributions to this report are William Cordrey, Assistant Director; Gloria Cano; Jody 

Ecie; Gary Chupka; Nina Crocker; Teressa Broadie-Gardner; Angel Sharma; Jay Thomas; J. 

Mark Yoder; and Gregory Ziombra. 

Sincerely yours,

Steven J. Sebastian 

Director 

Financial Management and Assurance 

Enclosures - 2 

10 GAO-09-943R FDIC Management Report 2008 
Enclosure I 

Comments from the Federal Deposit Insurance Corporation 

11 GAO-09-943R FDIC Management Report 2008 
12 GAO-09-943R FDIC Management Report 2008 
13 GAO-09-943R FDIC Management Report 2008 
14 GAO-09-943R FDIC Management Report 2008 

Enclosure II 

Details on Audit Scope and Methodology 

To fulfill our responsibilities as auditor of the financial statements of the two funds administered 

by the Federal Deposit Insurance Corporation (FDIC), we did the following: 

• Examined, on a test basis, evidence supporting the amounts and disclosures in the 

financial statements. 

• Assessed the accounting principles used and significant estimates made by FDIC 

management. 

• Evaluated the overall presentation of the financial statements. 

• Obtained an understanding of FDIC and its operations, including its internal control 

related to financial reporting (including safeguarding assets) and compliance with laws 

and regulations. 

• Assessed the risk that a material misstatement exists. 

• Tested relevant internal controls over financial reporting and compliance, and evaluated 

the design and operating effectiveness of FDIC’s internal control based on the assessed 

risk. 

• Considered FDIC’s process for evaluating and reporting on internal control based on 

criteria established by the Federal Managers’ Financial Integrity Act of 1982. 

• Tested compliance with certain laws and regulations, including selected provisions of the 

Federal Deposit Insurance Act, as amended, and the Federal Deposit Insurance Reform 

Act of 2005. 

• Performed such other procedures as we considered necessary in the circumstances. 

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