Farm Program Payments: USDA Should Correct Weaknesses in Regulations and Oversight to Better Ensure Recipients Do Not Circumvent Payment Limitations
Published: 2004-06-16T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Farmers receive about $15 billion annually in federal payments to help produce major crops, such as corn, cotton, rice, and wheat. The Farm Program Payments Integrity Act of 1987 (1987 Act) limits payments to individuals and entities--such as corporations and partnerships--that are "actively engaged in farming." This testimony is based on GAO's report, Farm Program Payments: USDA Needs to Strengthen Regulations and Oversight to Better Ensure Recipients Do Not Circumvent Payment Limitations ( GAO-04-407 , April 30, 2004). Specifically, GAO (1) determined how well USDA's regulations limit payments and (2) assessed USDA's oversight of the 1987 Act.
section_title: What GAO Found
paragraphs: GAO's survey of USDA's field offices showed that for the compliance reviews the offices conducted, about 99 percent of payment recipients asserted they met eligibility requirements through active personal management. However, USDA's regulations to ensure recipients are actively engaged in farming do not provide a measurable standard for what constitutes a significant contribution of active personal management. By not specifying such a measurable standard, USDA allows individuals who may have limited involvement with the farming operation to qualify for payments. Moreover, USDA's regulations lack clarity as to whether certain transactions and farming operation structures that GAO found could be considered schemes or devices to evade, or that have the purpose of evading, payment limitations. Under the 1987 Act, if a person has adopted such a scheme or device, then that person is not eligible to receive payments for the year in which the scheme or device was adopted or the following year. Because it is not clear whether fraudulent intent must be shown to find that a person has adopted a scheme or device, USDA may be reluctant to pursue the question of whether certain farming operations, such as the ones GAO found, are schemes or devices. According to GAO's survey and review of case files, USDA is not effectively overseeing farm payment limitation requirements. That is, USDA does not review a valid sample of farm operation plans to determine compliance and thus does not ensure that only eligible recipients receive payments, and compliance reviews are often completed late. As a result, USDA may be missing opportunities to recoup ineligible payments. For about one-half of the farming operations GAO reviewed for 2001, field offices did not use available tools to determine whether persons were actively engaged in farming.

section_title: Letter
paragraphs: I am pleased to be here today to discuss the Committee’s interest in the  U.S. Department of Agriculture’s (USDA) implementation of the Farm  Program Payments Integrity Act of 1987 (1987 Act). My testimony today is  based on our recent report on this subject, which was requested by the  Chairman of the Senate Committee on Finance and which is being publicly  released today.
Between 1999 and 2002, USDA paid farmers an average of $15 billion  annually to help support the production of major commodities, including  corn, cotton, rice, soybeans, and wheat. These payments go to 1.3 million  producers: individuals and entities such as corporations, partnerships, and  trusts. Annually, almost two-thirds of these payments go to about 10  percent of the producers.
After hearing several concerns about farm payments going to individuals  not involved in farming, the Congress enacted the 1987 Act, which, among  other things, set eligibility conditions to limit the number of payments  going to recipients and to ensure that only individuals and entities  “actively engaged in farming” received payments. To be considered  actively engaged in farming, an individual recipient must make significant  contributions to the farming operation in two areas: (1) capital, land, or  equipment and (2) personal labor or active personal management. An  entity is considered actively engaged in farming if the entity separately  makes a significant contribution of capital, land, or equipment, and its  members collectively make a significant contribution of personal labor or  active personal management to the farming operation. For both  individuals and entities, their share of the farming operation’s profits or  losses must also be commensurate with their contributions to the farming  operation and those contributions must be at risk.
My testimony today focuses on two primary issues discussed in the report:  (1) how well USDA’s regulations for active engagement in farming help  limit farm program payments and (2) the effectiveness of USDA’s  oversight of farm program payments’ requirements for active engagement  in farming.
In summary, we found the following:  Individuals may circumvent the farm payment limitations because of  weaknesses in USDA’s regulations. These regulations are designed to  ensure recipients are actively engaged in farming. However, they do not  provide a measurable standard for what constitutes a significant  contribution of active personal management. By not specifying such a  measurable standard, USDA allows individuals who may have limited  involvement with the farming operation to qualify for payments. According  to our survey of USDA’s field offices, in the compliance reviews they  conducted, about 99 percent of payment recipients asserted they met  eligibility requirements through active personal management. Moreover,  USDA’s regulations lack clarity as to whether certain transactions and  farming operation structures that we found could be considered schemes  or devices to evade, or that have the purpose of evading, payment  limitations. Under the 1987 Act, if a person has adopted such a scheme or  device, then that person is not eligible to receive payments for two years.
According to our survey and review of case files, USDA is not effectively  overseeing farm program payments. That is, USDA does not review a valid  sample of farm operation plans to determine compliance and thus does  not ensure that only eligible recipients receive payments. Also, USDA’s  compliance reviews are often completed late. As a result, USDA may be  missing opportunities to recoup ineligible payments. Further, for about  one-half of the farming operations we reviewed for 2001, field offices did  not use available tools to determine whether persons were actively  engaged in farming.
In our report to you, we made eight recommendations to the Secretary of  Agriculture to strengthen FSA’s oversight of farmers’ compliance with the  1987 Act. In commenting on the report, USDA agreed to act on most of the  recommendations. However, USDA stated that its current regulations are  sufficient for determining active engagement in farming and for assessing  whether operations are schemes or devices to evade payment limitations.  We still believe measurable standards and clarified regulations would  better assure the act’s goals are realized.
subsections: section_title: Background
paragraphs: The 1987 Act requires that an individual or entity be actively engaged in  farming in order to receive farm program payments. To be considered  actively engaged in farming, the act requires an individual or entity to  provide a significant contribution of capital, land, or equipment, as well as  a significant contribution of personal labor or active personal management  to the farming operation. Hired labor or hired management may not be  used to meet the latter requirement. The act’s definition of a “person”  eligible to receive farm program payments includes an individual, as well  as certain kinds of corporations, partnerships, trusts, or similar entities.  Recipients must also demonstrate that their contributions to the farming  operation are in proportion to their share of the operation’s profits and  losses and that these contributions are at risk. The 1987 Act also limits the  number of entities through which a person can receive program payments.  Under the act, a person can receive payments as an individual and through  no more than two entities, or through three entities and not as an  individual. The statutory provision imposing this limit is commonly known  as the three-entity rule. Under the Farm Security and Rural Investment Act  of 2002, “persons”—individuals or entities—are generally limited to a total  of $180,000 annually in farm program payments, or $360,000 if they are  members of up to three entities.
Some farming operations may reorganize to overcome payment limits to  maximize their farm program benefits. Larger farming operations and  farming operations producing crops with high payment rates, such as rice  and cotton, may establish several related entities that are eligible to  receive payments. However, each entity must be separate and distinct and  must demonstrate that it is actively engaged in farming by providing a  significant contribution of capital, land or equipment, as well as a  significant contribution of personal labor or active personal management  to the farming operation.
Within USDA, the Farm Service Agency (FSA) is responsible for enforcing  the actively engaged in farming and payment limitation rules. FSA field  offices review a sample of farming plans at the end of the year to help  monitor whether farming operations were conducted in accordance with  approved plans, including whether payment recipients met the  requirement for active engagement in farming and whether the farming  operations have the documents to demonstrate that the entities receiving  payments are in fact separate and distinct legal entities. FSA selects its  sample of farming operations based on, among other criteria, (1) whether  the operation has undergone an organizational change in the past year by,  for example, adding another entity or partner to the operation and (2)  whether the operation receives payments above a certain threshold. These  criteria have principally resulted in sampling farming operations in areas  that produce cotton and rice—Arkansas, California, Louisiana, Mississippi,  and Texas.
section_title: Individuals May Circumvent Farm Payment Limitations Because of Weaknesses in FSA’s Regulations
paragraphs: Many recipients meet one of the farm program payments’ eligibility  requirements by asserting that they have made a significant contribution of  active personal management. Because FSA regulations do not provide a  measurable, quantifiable standard for what constitutes a significant  management contribution, people who appear to have little involvement  are receiving farm program payments, according to our survey of FSA field  offices and our review of 86 case files. Indeed, most large farming  operations meet the requirement for personal labor or active personal  management by asserting a significant contribution of management.  Survey respondents provided information on 347 partnerships and joint  ventures for which FSA completed compliance reviews in 2001; these  entities comprised 992 recipients, such as individuals and corporations  that were members of these farming operations. Of these 992 recipients, 46  percent, or 455, asserted that they contributed active personal  management; 1 percent, or 7, asserted that they contributed personal  labor; and the remaining 53 percent (530) asserted they provided a  combination of active personal management and personal labor to meet  the actively engaged in farming requirement.
While FSA’s regulations define active personal management more  specifically to include such things as arranging financing for the operation,  supervising the planting and harvesting of crops, and marketing the crops,  the regulations lack measurable criteria for what constitutes a significant  contribution of active personal management. FSA regulations define a  “significant contribution” of active personal management as “activities that  are critical to the profitability of the farming operation, taking into  consideration the individual’s or entity’s commensurate share in the  farming operation.” In contrast, FSA provides quantitative standards for  what constitutes a significant contribution of active personal labor,  capital, land, and equipment. For example, FSA’s regulations define a  significant contribution of active personal labor as the lesser of 1,000  hours of work annually, or 50 percent of the total hours necessary to  conduct a farming operation that is comparable in size to such individual’s  or entity’s commensurate share in the farming operation. By not specifying  quantifiable standards for what constitutes a significant contribution of  active personal management, FSA allows recipients who may have had  limited involvement in the farming operation to qualify for payments.
Some recipients appeared to have little involvement with the farming  operation for 26 of the 86 FSA compliance review files we examined in  which the recipients asserted they made a significant contribution of  active personal management to the farming operation. For example, in  2001, 11 partners in a general partnership operated a farm of 11,900 acres.  These partners asserted they met the actively engaged in farming  requirement by making a significant contribution of equipment and active  personal management. FSA’s compliance review found that all partners of  the farming operation were actively engaged in farming and met all  requirements for the approximately $1 million the partnership collected in  farm program payments in 2001. However, our review found that the  partnership held five management meetings during the year, three in a  state other than the state where the farm was located, and two on-site  meetings at the farm. Some of the partners attended the meetings in  person while others joined the meetings by telephone conference.  Although all 11 partners claimed an equal contribution of management,  minutes of the management meetings indicated seven partners  participated in all five meetings, two participated in four meetings, and  two participated in three meetings. All partners resided in states other  than the state where the farm was located, and only one partner attended  all five meetings in person. Based on our review of minutes documenting  the meetings, it is unclear whether some of the partners contributed  significant active personal management. If FSA had found that some of the  partners had not contributed active personal management, the  partnership’s total farm program payments would have been reduced by  about 9 percent, or $90,000, for each partner that FSA determined was  ineligible. State FSA officials agreed that the evidence to support the  management contribution for some partners was questionable and that  FSA reviewers could have taken additional steps to confirm the  contributions for these partners.
According to our survey of 535 FSA field offices, FSA could make key  improvements to strengthen the management contribution standard. These  offices reported that the management standard can be strengthened by  clarifying the standard, including providing quantifiable criteria, certifying  actual contributions, and requiring management to be on-site. More than  60 percent of those surveyed, for example, indicated that clarifying the  standard would be an improvement. In addition, in 2003, a USDA  commission established to look at the impact of changes to payment  limitations concluded that determining what constitutes a significant  contribution of active management is difficult and lack of clear criteria  likely makes it easier for farming operations to add recipients in order to  avoid payment limitations.
We also found that some individuals or entities have engaged in  transactions that might constitute schemes or devices to evade payment  limitations, but neither FSA’s regulations nor its guidance address whether  such transactions could constitute schemes or devices. Under the 1987 Act  as amended, if the Secretary of Agriculture determines that any person has  adopted a “scheme or device” to evade, or that has the purpose of evading,  the act’s provisions—in other words, the payment limitations—then that  person is not eligible to receive farm program payments for the year the  scheme or device was adopted and the following crop year. According to  FSA’s regulations, this statutory provision includes (1) persons who adopt  or participate in adopting a scheme or device and (2) schemes or devices  that are designed to evade or have “the effect of evading” payment  limitation rules. The regulations state that a scheme or device shall include  concealing information that affects a farm program payment application,  submitting false or erroneous information, or creating fictitious entities for  the purpose of concealing the interest of a person in a farming operation.
We found several large farming operations that were structured as one or  more partnerships, each consisting of multiple corporations that increased  farm program payments in a questionable manner. The following two  examples illustrate how farming operations, depending on how the FSA  regulations are interpreted, might be considered to evade, or have the  effect of evading, payment limitations. In one case, we found that a family  had set up the legal structures for its farming operation and also owned  the affiliated nonfarming entities. This operation included two farming  partnerships comprising eight limited liability companies. The two  partnerships operated about 6,000 acres and collected more than $800,000  in farm program payments in 2001. The limited liability companies  included family and non-family members, although power of attorney for  all of the companies was granted to one family member to act on behalf of  the companies, and ultimately the farming partnerships. The operation  also included nonfarming entities—nine partnerships, a joint venture, and  a corporation—that were owned by family members. The affiliated  nonfarming entities provided the farming entities with goods and services,  such as capital, land, equipment, and administrative services. The  operation also included a crop processing entity to purchase and process  the farming operation’s crop. According to our review of accounting  records for the farming operation, both farming partnerships incurred a  small net loss in 2001, even though they had received more than $800,000  in farm program payments. In contrast, average net income for similar- sized farming operations in 2001 was $298,000, according to USDA’s  Economic Research Service. The records we reviewed showed that the  loss occurred, in part, because the farming operations paid above-market  prices for goods and services and received a net return from the sale of the  crop to the nonfarming entities that appeared to be lower than market  prices because of apparent excessive charges. The structure of this  operation allowed the farming operation to maximize farm program  payments, but because the farm operated at a loss these payments were  not distributed to the members of the operation. In effect, these payments  were channeled to the family-held nonfarming entities. Figure 1 shows the  organizational structure of this operation and the typical flow of  transactions between farming and nonfarming entities.
Similarly, we found another general partnership that farmed more than  50,000 acres in 2001 and that conducted business with nonfarming entities,  including a land leasing company, an equipment dealership, a petroleum  distributorship, and crop processing companies, with close ties to the  farming partnership. The partnership, which comprised more than 30  corporations, collected more than $5 million in farm program payments in  2001. The shareholders who contributed the active personal management  for these corporations were officers of the corporations. Each officer  provided the active personal management for three corporations. Some of  these officers were also officers of the nonfarming entities—the entities  that provided the farming partnership goods and services such as the  capital, land, equipment, and fuel. The nonfarming entities also included a  gin as well as grain elevators to purchase and process the farming  partnership’s crops. Our review of accounting records showed that even  though the farming partnership received more than $5 million in farm  payments, it incurred a net loss in 2001, which was distributed among the  corporations that comprised the partnership.
As in the first example, factors contributing to the loss included the above- market prices for goods and services charged by the nonfarming entities  and the net return from the sale of crops to nonfarming entities that  appeared to be lower than market prices because of apparent excessive  charges for storage and processing. For example, one loan made by the  nonfarming financial services entity to the farming partnership for $6  million had an interest rate of 10 percent while the prevailing interest rate  for similar loans at the time was 8 percent. Similarly, the net receipts from  the sale of the harvested crop, which were sold almost exclusively to the  nonfarming entities, were below market price. For example, in one  transaction the gross receipt was about $1 million but after the grain  elevators deducted fees for the quality of the grain and such actions as  drying and storing the grain, the net proceeds to the farming entity were  only about $500,000. In this particular operation, all of the nonfarming  entities had common ownership linked to one individual. This individual  had also set up the legal structure for the farming entities but had no direct  ownership interest in the farming entities.
It is unclear whether either of these operations falls within the statutory  definition of a scheme or device or whether either otherwise circumvents  the payment limitation rules. State FSA officials in Arkansas, Louisiana,  Mississippi, and Texas, where many of the large farming operations are  located, believed that some large operations with relationships between  the farming and nonfarming entities were organized primarily to  circumvent payment limitations. In this manner, these farming operations  may be reflective of the organizational structures that some Members of  Congress indicated were problematic when enacting the 1987 Act and the  scheme or device provision. The House Report for the 1987 Act states: “A  small percentage of producers of program crops have developed methods  to legally circumvent these limitations to maximize their receipt of  benefits for which they are eligible. In addition to such reorganizations,  other schemes have been developed that allow passive investors to qualify  for benefits intended for legitimate farming operations.” In our  discussions with FSA headquarters officials in February 2004 on the issue  of farming operations that circumvent the payment limitation rules, they  noted that while an operation may be legally organized, it may be  misrepresenting who in effect receives the farm program payments. FSA  has no data on how many of the types of operations that we identified  exist. However, FSA is reluctant to question these operations because it  does not believe current regulations provide a sufficient basis to take  action.
Other FSA officials said that USDA could review such an operation under  the 1987 Act’s scheme or device provision if it becomes aware that the  operation is using a scheme or device for the purpose of evading the  payment limitation rules. However, these FSA officials stated it is difficult  to prove fraudulent intent—which they believe is a key element in proving  scheme or device—and requires significant resources to pursue such  cases. In addition, they stated that even if FSA finds a recipient ineligible  to receive payments, its decision might be overturned on appeal within  USDA. The FSA officials noted that when FSA loses these types of cases,  the loss tends to discourage other field offices from aggressively pursuing  these types of cases.
It is not clear whether either the statutory provision or FSA’s regulations  require a demonstration of fraudulent intent in order to find that someone  has adopted a scheme or device. As discussed above, the statute limits  payments if the Secretary of Agriculture determines that any person has  adopted a scheme or device “to evade, or that has the purpose of evading,”  the farm payment limitation provisions. The regulations state that  payments may be withheld if a person “adopts or participates in adopting a  scheme or device designed to evade or that has the effect of evading” the  farm payment limitations. The regulations note that schemes or devices  shall include, for example, creating fictitious entities for the purpose of  concealing the interest of a person in a farming operation. Some have  interpreted this provision as appearing to require intentionally fraudulent  or deceitful conduct. On the other hand, FSA regulations only provide this  as one example of what FSA considers to be a scheme or device. The  regulations do not specify that all covered schemes or devices must  involve fraudulent intent. As previously stated, covered schemes or  devices under FSA regulations include those that have “the effect of  evading” payment limitation rules. Finally, guidance contained in FSA  Handbook Payment Limitations, 1-PL (Revision 1), Amendment 40,  does not clarify the matter because it does not provide any additional  examples for FSA officials of the types of arrangements that might be  considered schemes or devices. This lack of clarity over whether  fraudulent intent must be shown in order for FSA to deny payments under  the scheme or device provision of the law may be inhibiting FSA from  finding that some questionable operations are schemes or devices.
section_title: Other Weaknesses in FSA’s Oversight May Also Enable Ineligible Farmers to Receive Program Payments
paragraphs: In addition to the weaknesses described above, FSA does not effectively  oversee farm program payments in five key areas, according to our  analysis of FSA compliance reviews and our survey of FSA field offices.  First, FSA does not review a valid sample of recipients to be reasonably  assured of compliance with the payment limitations. In 2001, FSA selected  1,573 farming operations from its file of 247,831 entities to review  producers’ compliance with actively engaged in farming requirements.  FSA’s sample selection focuses on entities that have undergone an  organizational change during the year or received large farm program  payments. Field staff responsible for these reviews seek waivers for  farming operations reviewed within the last 3 to 5 years—the time frame  varies by state. As a result, according to FSA officials, of the farming  operations selected for review each year, more than half are waived and  therefore not actually reviewed. Many of the waived cases show up year  after year because FSA’s sampling methodology does not take into  consideration when an operation was last reviewed. In 2001, the latest  year for which data are available, only 523 of 1,573 sampled entities were  to be reviewed. Field offices sought and received waivers for 966 entities  primarily because the entities were previously reviewed or the farming  operation involved only a husband and wife. According to FSA  headquarters officials, the sampling process was developed in the mid- 1990s and it can be improved and better targeted.
Second, field offices do not always conduct compliance reviews in a  timely manner. Only 9 of 38 FSA state offices responsible for conducting  compliance reviews for 2001 completed the reviews and reported the  results to FSA headquarters within 12 months, as FSA policy requires.  FSA headquarters selected the 2001 sample on March 27, 2002, and  forwarded the selections to its state offices on April 4, 2002. FSA  headquarters required the state offices to conduct the compliance reviews  and report the results by March 31, 2003. Six of the 26 FSA state offices  that failed to report the results to headquarters had not yet begun these  reviews for 470 farming operations as of summer 2003: Arkansas,  California, Colorado, Louisiana, Ohio, and South Carolina. Until we  brought this matter to their attention in July 2003, FSA headquarters staff  were unaware that these six states had not conducted compliance reviews  for 2001. Similarly, they did not know the status of the remaining 20 states.  Because of this long delay, FSA cannot reasonably assess the level of  recipients’ compliance with the act and may be missing opportunities to  recapture payments that were made to ineligible recipients if a farming  operation reorganizes or ceases operations.
Third, FSA staff do not use all available tools to assess compliance. For  one-half of the case files we reviewed for 2001, field offices did not use all  available tools to determine whether persons are actively engaged in  farming. FSA compliance review policy requires field staff to interview  persons asserting that they are actively engaged in farming before making  a final eligibility decision, unless the reason for not interviewing the  person is obvious and adequately justified in writing. Indeed, 83 percent  of the field offices responding to our survey indicated that interviews are  helpful in conducting compliance reviews. However, in 27 of the 86 case  files we reviewed in six states, field staff did not interview these persons  and did not adequately document why they had not done so. In one of the  states we visited, field staff had not conducted any interviews. We also  found that some field offices do not obtain and review certain key  financial information regarding the farming operation before making final  eligibility decisions. For example, our review of case files indicated that  for one-half of the farming operations, field staff did not use financial  records, such as bank statements, cancelled checks, or accounting  records, to substantiate that capital was contributed directly to the  farming operation from a fund or account separate and distinct from that  of any other individual or entity with an interest in the farming operation,  as required by FSA’s policy. Instead, FSA staff often rely on their personal  knowledge of the individuals associated with the farming operation to  determine whether these individuals meet the requirement for active  engagement in farming.
Fourth, FSA does not consistently collect and analyze monitoring data.  FSA has not established a methodology for collecting and summarizing  compliance review data so that it can (1) reliably compare farming  operations’ compliance with the actively engaged in farming requirements  from year to year and (2) assess its field offices’ conduct of compliance  reviews. Under Office of Management and Budget Circular A-123, agencies  must develop and implement management controls to reasonably ensure  that they obtain, maintain, report, and use reliable and timely information  for decision-making. Because FSA has not instituted these controls, it  cannot determine whether its staff are consistently applying the payment  eligibility requirements across states and over time.
Finally, these problems are exacerbated by a lack of periodic training for  FSA staff on the payment limitations and eligibility rules. Training has  generally not been available since the mid-1990s.
In conclusion, the Farm Program Payments Integrity Act of 1987, while  enacted to limit payments to individuals and entities actively engaged in  farming, allows farming operations to maximize the receipt of federal farm  payments as long as all recipients meet eligibility requirements. However,  we found cases where payment recipients may have developed methods to  circumvent established payment limitations. This seems contrary to the  goals of the 1987 Act and was caused by weaknesses in USDA’s regulation  and oversight. The regulations need to better define what constitutes a  significant contribution of active personal management and clarify  whether fraudulent intent is necessary to find that someone has adopted a  scheme or device. Without specifying measurable standards for what  constitutes a significant contribution of active personal management, FSA  allows individuals who may have had limited involvement in the farming  operation to qualify for payments. Moreover, FSA is not providing  adequate oversight of farm program payments under its current  regulations and policies.
In our report to you, we made eight recommendations to the Secretary of  Agriculture for improving FSA’s oversight of compliance with the 1987  Act, including: developing measurable requirements defining a significant  contribution of active personal management; clarifying regulations and  guidance as to what constitutes a scheme or device; improving its  sampling method for selecting farming operations for review; and  developing controls to ensure all available tools are used to assess  compliance with the act. USDA agreed to act on most of our  recommendations. However, USDA stated that its current regulations are  sufficient for determining active engagement in farming and assessing  whether operations are schemes or devices to evade payment limitations.
Mr. Chairman, this concludes my prepared statement. We would be happy  to respond to any questions that you or other Members of the Committee  may have.
For further information about this testimony, please contact Lawrence J.  Dyckman, Director, Natural Resources and Environment, (202) 512-3841,  or by email at dyckmanl@gao.gov. Ron Maxon, Thomas Cook, Cleofas  Zapata, Carol Herrnstadt Shulman, and Amy Webbink made key  contributions to this statement.
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