The final regulations establish a new human capital system for DHS that is intended to assure its ability to attract, retain, and reward a workforce that is able to meet its critical mission. Further, the human capital system is to provide for greater flexibility and accountability in the way employees are to be paid, developed, evaluated, afforded due process, and represented by labor organizations while reflecting the principles of merit and fairness embodied in the statutory merit systems principles. Predictable with any change management initiative, the DHS regulations have raised some concerns among employee groups, unions, and other stakeholders because they do not have all the details of how the system will be implemented and impact them. We have reported that individuals inevitably worry during any change management initiative because of uncertainty over new policies and procedures. A key practice to address this worry is to involve employees and their representatives to obtain their ideas and gain their ownership for the initiative. Thus, a significant improvement from the proposed regulations is that now employee representatives are to be provided with an opportunity to remain involved. Specifically, they can discuss their views with DHS officials and/or submit written comments as implementing directives are developed, as outlined under the “continuing collaboration” provisions. This collaboration is consistent with DHS’s statutory authority to establish a new human capital system, which requires such continuing collaboration. Under the regulations, nothing in the continuing collaboration process is to affect the right of the Secretary to determine the content of implementing directives and to make them effective at any time. In addition, the final regulations state that DHS is to establish procedures for evaluating the implementation of its human capital system. High- performing organizations continually review and revise their human capital management systems based on data-driven lessons learned and changing needs in the environment. Collecting and analyzing data is the fundamental building block for measuring the effectiveness of these systems in support of the mission and goals of the agency. We continue to believe that many of the basic principles underlying the DHS regulations are generally consistent with proven approaches to strategic human capital management. Today, I will provide our observations on the following elements of DHS’s human capital system as outlined in the final regulations—pay and performance management, adverse actions and appeals, and labor-management relations. Last year, we testified that the DHS proposal reflects a growing understanding that the federal government needs to fundamentally rethink its current approach to pay and better link pay to individual and organizational performance. To this end, the DHS proposal takes another valuable step towards modern performance management. Among the key provisions is a performance-oriented and market-based pay system. We have observed that a competitive compensation system can help organizations attract and retain a quality workforce. To begin to develop such a system, organizations assess the skills and knowledge they need; compare compensation against other public, private, or nonprofit entities competing for the same talent in a given locality; and classify positions along levels of responsibility. While one size does not fit all, organizations generally structure their competitive compensation systems to separate base salary—which all employees receive—from other special incentives, such as merit increases, performance awards, or bonuses, which are provided based on performance and contributions to organizational results. According to the final regulations, DHS is to establish occupational clusters and pay bands that replace the current General Schedule (GS) system now in place for much of the civil service. DHS may, after coordination with OPM, establish occupational clusters based on factors such as mission or function, nature of work, qualifications or competencies, career or pay progression patterns, relevant labor-market features, and other characteristics of those occupations or positions. DHS is to document in implementing directives the criteria and rationale for grouping occupations or positions into clusters as well as the definitions for each band’s range of difficulty and responsibility, qualifications, competencies, or other characteristics of the work. As we testified last year, pay banding and movement to broader occupational clusters can both facilitate DHS’s movement to a pay for performance system and help DHS to better define occupations, which can improve the hiring process. We have reported that the current GS system as defined in the Classification Act of 1949 is a key barrier to comprehensive human capital reform and the creation of broader occupational job clusters and pay bands would aid other agencies as they seek to modernize their personnel systems.Today’s jobs in knowledge-based organizations require a much broader array of tasks that may cross over the narrow and rigid boundaries of job classifications of the GS system. Under the final regulations, DHS is to convert employees from the GS system to the new system without a reduction in their current pay. According to DHS, when employees are converted from the GS system to a pay band, their base pay is to be adjusted to include a percentage of their next within-grade increase, based on the time spent in their current step and the waiting period for the next step. DHS stated that most employees would receive a slight increase in salary upon conversion to a pay band. This approach is consistent with how several of OPM’s personnel demonstration projects converted employees from the GS system. The final DHS regulations include other elements of a modern compensation system. For example, the regulations provide that DHS may, after coordination with OPM, set and adjust the pay ranges for each pay band taking into account mission requirements, labor market conditions, availability of funds, pay adjustments received by other federal employees, and any other relevant factors. In addition, DHS may, after coordination with OPM, establish locality rate supplements for different occupational clusters or for different bands within the same cluster in the same locality pay area. According to DHS, these locality rates would be based on the cost of labor rather than cost of living factors. The regulations state that DHS would use recruitment or retention bonuses if it experiences such problems due to living costs in a particular geographic area. Especially when developing a new performance management system, high- performing organizations have found that actively involving employees and key stakeholders, such as unions or other employee associations, helps gain ownership of the system and improves employees’ confidence and belief in the fairness of the system. DHS recognized that the system must be designed and implemented in a transparent and credible manner that involves employees and employee representatives. A new and positive addition to the final regulations is a Homeland Security Compensation Committee that is to provide oversight and transparency to the compensation process. The committee—consisting of 14 members, including four officials of labor organizations—is to develop recommendations and options for the Secretary’s consideration on compensation and performance management matters, including the annual allocation of funds between market and performance pay adjustments. While the DHS regulations contain many elements of a performance-based and market-oriented pay system, there are several issues that we identified last year that DHS will need to continue to address as it moves forward with the implementation of the system. These issues include linking organizational goals to individual performance, using competencies to provide a fuller assessment of performance, making meaningful distinctions in employee performance, and continuing to incorporate adequate safeguards to ensure fairness and guard against abuse. Consistent with leading practice, the DHS performance management system is to align individual performance expectations with the mission, strategic goals, organizational program and policy objectives, annual performance plans, and other measures of performance. DHS’s performance management system can be a vital tool for aligning the organization with desired results and creating a “line of sight” showing how team, unit, and individual performance can contribute to overall organizational results. However, as we testified last year, agencies struggle to create this line of sight. DHS appropriately recognizes that given its vast diversity of work, managers and employees need flexibility in crafting specific performance expectations for their employees. These expectations may take the form of competencies an employee is expected to demonstrate on the job, among other things. However, as DHS develops its implementing directives, the experiences of leading organizations suggest that DHS should reconsider its position to merely allow, rather than require, the use of core competencies that employees must demonstrate as a central feature of its performance management system. Based on our review of others’ efforts and our own experience at GAO, core competencies can help reinforce employee behaviors and actions that support the department’s mission, goals, and values and can provide a consistent message to employees about how they are expected to achieve results. For example, an OPM personnel demonstration project—the Civilian Acquisition Workforce Personnel Demonstration Project—covers various organizational units within the Department of Defense and applies core competencies for all employees, such as teamwork/cooperation, customer relations, leadership/supervision, and communication. Similarly, as we testified last year, DHS could use competencies—such as achieving results, change management, cultural sensitivity, teamwork and collaboration, and information sharing—to reinforce employee behaviors and actions that support its mission, goals, and values and to set expectations for individuals’ roles in DHS’s transformation. By including such competencies throughout its performance management system, DHS could create a shared responsibility for organizational success and help assure accountability for change. High-performing organizations seek to create pay, incentive, and reward systems that clearly link employee knowledge, skills, and contributions to organizational results. These organizations make meaningful distinctions between acceptable and outstanding performance of individuals and appropriately reward those who perform at the highest level. The final regulations state that DHS supervisors and managers are to be held accountable for making meaningful distinctions among employees based on performance, fostering and rewarding excellent performance, and addressing poor performance. While DHS states that as a general matter, pass/fail ratings are incompatible with pay for performance, it is to permit use of pass/fail ratings for employees in the “Entry/Developmental” band or in other pay bands under extraordinary circumstances as determined by the Secretary. DHS is to require the use of a least three summary rating levels for other employee groups. We urge DHS to consider using at least four summary rating levels to allow for greater performance rating and pay differentiation.