[Federal Register: November 29, 1996 (Volume 61, Number 231)]
[Rules and Regulations]
[Page 60565-60577]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
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DEPARTMENT OF EDUCATION
34 CFR Parts 600 and 668
RIN 1840-AC36
Institutional Eligibility and Student Assistance General
Provisions
AGENCY: Department of Education.
ACTION: Final regulations.
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SUMMARY: The Secretary amends the Student Assistance General Provisions
regulations by revising requirements for compliance audits and audited
financial statements, revising the two-year performance exemption to
the refund reserve requirement, and adding financial responsibility
standards for foreign schools. These final regulations improve the
Secretary's oversight of institutions participating in programs
authorized by title IV of the Higher Education Act of 1965, as amended.
The final regulations do not contain changes to the general
standards of financial responsibility, which will be considered further
by the Secretary.
DATES: Effective date: These regulations take effect July 1, 1997.
However, affected parties do not have to comply with the information
collection requirements in Sec. 668.23 until the Department of
Education publishes in the Federal Register the control number assigned
by the Office of Management and Budget (OMB) to these information
collection requirements. Publication of the control number notifies the
public that OMB has approved these information collection requirements
under the Paperwork Reduction Act of 1995.
FOR FURTHER INFORMATION CONTACT: Mr. David Lorenzo or Mr. John Kolotos,
U.S. Department of Education, 600 Independence Avenue, S.W., Room 3045
ROB-3, Washington, D.C. 20202, telephone (202) 708-7888. Individuals
who use a telecommunications device for the deaf (TDD) may call the
Federal Information Relay Service (FIRS) at 1-800-877-8339 between 8
a.m. and 8 p.m., Eastern standard time, Monday through Friday.
SUPPLEMENTARY INFORMATION: The Student Assistance General Provisions
regulations (34 CFR part 668) apply to all institutions that
participate in the student financial assistance programs authorized by
title IV of the Higher Education Act of 1965, as amended (title IV, HEA
programs).
Compliance audits and audited financial statements provide
information necessary for the Secretary to determine whether an
institution that participates or seeks to participate in the
[[Page 60566]]
title IV, HEA programs has the resources to deliver its education and
training programs to students and the extent to which the institution
complies with applicable statutory and regulatory requirements in its
administration of the title IV, HEA programs.
On September 20, 1996, the Secretary published a notice of proposed
rulemaking (NPRM) for this part in the Federal Register (61 FR 49552-
49574 ). The NPRM included a discussion of the major issues surrounding
the proposed changes (as well as a summary of the report by the firm of
KPMG Peat Marwick, LLP) which will not be repeated here. The following
list summarizes those issues and identifies the pages of the preamble
to the NPRM on which a discussion of those issues may be found:
Revisions to the compliance audit requirements that would
amalgamate the previous requirements for the provision of an audited
financial statement; the proposed inclusion of a requirement for a
proprietary institution to disclose the percentage of revenues it
derives from title IV, HEA programs; audit submission requirements for
foreign institutions; a clarification of the entity that must submit an
audited financial statement; and a statement regarding the treatment of
questionable accounting treatments contained in the required audited
financial statement (pages 49555-49556).
The scope and purpose statement of the new Subpart L (page 49556).
The new ratio standards that comprise the main test of financial
responsibility; a transition rule; and a proposed modification to an
exception to the refund letter of credit requirement (pages 49556-
49557).
A proposal to modify the precipitous closure alternative to
demonstrating financial responsibility; and a clarification of the
types of alternatives to demonstrating financial responsibility
available to new institutions (pages 49557-49558).
Financial responsibility standards and other requirements for
institutions undergoing a change of ownership (page 49558).
Financial responsibility standards for foreign institutions (pages
49558-49559).
Past performance standards (page 49559).
An outline of additional requirements and administrative actions,
including requirements for institutions that are provisionally
certified; and an outline of administrative actions taken when an
institution fails to demonstrate financial responsibility (page 49559).
The contents of the proposed Appendix F (page 49559).
The following discussion describes significant changes since the
publication of the NPRM.
General
In the September 20, 1996 NPRM, the Secretary indicated that the
Department intended to publish final regulations by December 1, 1996,
implementing new financial responsibility standards based on the
proposed ratio methodology. However, in response to public comment on
the proposed rules, the Secretary has decided to seek further comment
and delay publishing final rules implementing these standards.
In particular, the public expressed concern that there was
insufficient time for the Department to identify and address any
possible problems with the proposed methodology and make needed
technical adjustments. Commenters also asserted that institutions had
insufficient time to review and provide meaningful comment on the
methodology. Commenters from private non-profit institutions also
expressed concern about the sufficiency of data on the effects of
changed reporting standards that takes place when institutions begin
reporting under Statement of Financial Accounting Standards 116 and 117
promulgated by the Financial Accounting Standards Board, and maintained
that the Secretary should attempt to gather data on the effects of the
changes and further evaluate the methodological adjustments made to the
strength factors that are based on the estimated impact of that change.
Finally, commenters urged the Secretary to consult with more members of
the community regarding the potential impact of and possible
improvements to the methodology.
The Secretary sought to implement the proposed rule effective July
1, 1997 to benefit institutions that do not satisfy the current
financial responsibility standards, but could establish their financial
responsibility under the proposed standards because those standards
better evaluate the total financial condition of those institutions.
However, the Secretary is now convinced by commenters to await
further analysis and consultation. The Secretary is, therefore,
delaying publication of final regulations establishing a new subpart
containing new financial responsibility standards and related
regulations. The Secretary is publishing separately in the Federal
Register a notice reopening the comment period for those parts of the
September 20, 1996 NPRM not addressed in these Final Rules, and
providing further information regarding the Secretary's plans.
Because the Secretary is delaying publication of final rules
implementing the proposed changes to the financial responsibility
standards, the Secretary is not creating a new Subpart L in these Final
Rules, as was proposed in the September 20, 1996 NPRM. Nor is the
Secretary removing the current Sec. 668.15, as was also proposed in the
September 20, 1996 NPRM. Instead, as discussed below, the Secretary is
amending Sec. 668.15 to add the revised refund reserve performance
standard, to add the foreign schools financial responsibility
standards, and to remove the additional submission of an audited
financial statement. The Secretary is also amending Sec. 668.23 to
require the simultaneous submission of the audited financial statement
and compliance audit, both performed on a fiscal year basis, and to
require notification of 85/15 information as a note to the audited
financial statement.
Section 600.5--Proprietary Institution of Higher Education
The Secretary is removing Sec. 600.5(e), since the requirements for
verifying 85/15 information will now be contained in Sec. 668.23.
Section 668.15--Factors of Financial Responsibility
Because the Secretary is delaying publication of final regulations
addressing factors of financial responsibility, Sec. 668.15 is retained
and amended to include the change in the two-year performance
alternative to the refund reserve requirement, and to include financial
responsibility standards for foreign schools. Both changes were
originally proposed to be included in the new subpart L in the
September 20, 1996 NPRM.
The Secretary is also removing Sec. 668.15(e), since the audited
financial statement will now be required to be submitted with the
compliance audit under the requirements contained in Sec. 668.23.
Section 668.23--Compliance Audits and Audited Financial Statements
The Secretary has made several technical changes to the language
proposed in the September 20, 1996 NPRM. The Secretary is also removing
the proposed section addressing the treatment of questionable
accounting treatments.
As part of the consideration of the comments concerning the
consolidated audit submissions, the Secretary has also restructured
some of the regulation
[[Page 60567]]
language to simplify and clarify the requirements. Specifically, a new
definition of Independent Auditor has been added to 668.23(a) to
explain that the audits submitted under these regulations may be
performed by certified public accountants or by government auditors
that meet certain governmental standards. Similarly, a new section
668.23(e) has been created that consolidates language from several
parts of the proposed regulation concerning access to auditor records
for a school's or servicer's compliance or financial statement audit.
This section also clarifies that such access includes the ability of
the Secretary or Inspector General to make copies of such records.
The Secretary also received substantive comments on the provisions
in Sec. 668.23 that were formerly contained in Sec. 668.24. While the
Secretary, as described above, has made technical changes in these
provisions, the Secretary does not address the commenters' substantive
concerns here. The Secretary will consider those comments when final
regulations addressing financial responsibility standards are
published.
Analysis of Comments and Changes
In response to the Secretary's invitation in the September 20, 1996
NPRM, approximately 500 parties submitted comments on the proposed
regulations. An analysis of the comments on Sec. 668.15 and Sec. 668.23
and of the changes in the regulations since publication of the NPRM is
published as an appendix to these final regulations. In that appendix,
the Secretary responds only to those comments pertaining to the final
regulations published here. The Secretary will publish responses to all
other comments when the Secretary publishes final regulations on the
remainder of the regulatory areas addressed in the September 20, 1996
NPRM.
Major issues are grouped according to subject, with appropriate
sections of the regulations referenced in parentheses. Other
substantive issues are discussed under the section of the regulations
to which they pertain. Technical and other minor changes--and suggested
changes the Secretary is not legally authorized to make under the
applicable statutory authority--are not addressed.
Executive Order 12866
Assessment of Costs and Benefits
These final regulations have been reviewed in accordance with
Executive Order 12866. Under the terms of the order the Secretary has
assessed the potential costs and benefits of this regulatory action.
The potential costs associated with the proposed regulations are
those resulting from statutory requirements and those determined by the
Secretary to be necessary for administering this program effectively
and efficiently.
In assessing the potential costs and benefits--both quantitative
and qualitative--of these final regulations, the Secretary has
determined that the benefits of the final regulations justify the
costs.
The Secretary has also determined that this regulatory action does
not interfere unduly with State and local governments in the exercise
of their governmental functions.
Summary of Potential Costs and Benefits
The Department has assessed the costs and benefits of the proposed
regulations. This discussion is contained in the Regulatory Flexibility
Analysis.
Assessment of Educational Impact
In the notice of proposed rulemaking, the Secretary requested
comments on whether the proposed regulations would require transmission
of information that is being gathered by or is available from any
agency or authority of the United States.
Based on the response to the proposed rules and on its own review,
the Department has determined that the regulations in this document do
not require transmission of information that is being gathered or is
available from any other agency or authority of the United States.
Regulatory Flexibility Analysis
The Secretary has determined that small entities are likely to
experience economic impacts from this regulation. Thus, the Regulatory
Flexibility Act (RFA) requires that an Initial Regulatory Flexibility
Analysis (IRFA) of the economic impacts be performed and that analysis,
or a summary thereof, be published in the notice of proposed
rulemaking. The IRFA was performed and a summary was published. This
Final Regulatory Flexibility Analysis (FRFA) discusses the comments
received on the IRFA and fulfills the other RFA requirements.
Summary of Significant Issues Raised by the Public Comments on the
Initial Regulatory Flexibility Analysis (IRFA), a Summary of the
Assessment of the Department of Such Issues, and a Statement of any
Changes Made in the Proposed Rule as a Result of Such Comments
Changes were made in the final rule as a result of public comments.
These changes are discussed elsewhere. Two commenters replied
specifically to the IRFA. Their comments are summarized and discussed
here.
Comments: Both commenters stated that the IRFA did not explore any
alternatives.
Response: As stated in the IRFA, alternatives such as those that
would establish differing compliance or reporting requirements or
timetables based upon the size of the institution rather than the type
of institution, or the use of performance standards rather than
establishing baseline measures, or an exemption from coverage of the
rule or any part thereof for small entities, would not adequately
discharge the Secretary's obligation under section 498(c) of the HEA to
determine the financial responsibility of institutions and guard the
Federal fiscal interest. At the time the IRFA was completed, the
Secretary determined that there were no significant alternatives that
would satisfy the same legal and policy objectives while minimizing the
economic impact on small entities. Public comment was received that the
Secretary has determined requires additional consideration, so the
comment period for several components of this regulation is being
reopened. The Secretary welcomes comments that suggest additional
alternatives consistent with the objectives of the Regulatory
Flexibility Act.
Changes: The comment period for several components will be reopened
to allow for additional public comment.
Comments: Both commenters stated that the IRFA did not consider
economic impacts from regulatory provisions that are not addressed in
these Final Rules. This includes opinions from one or both commenters
that there may be impacts from: the change of ownership/additional
location components; underestimation of the cost of obtaining a letter
of credit; and, the notion that the cost of a letter of credit was not
considered in the context of applications for new approvals or for
changes in ownership.
Response: These comments will be discussed when the reopened
comment period has closed for the ratio portions
[[Page 60568]]
of the final regulations and the final regulation is published.
Changes: The comment period for these components has been extended
to allow for additional public comment.
Comments: One commenter raised numerous questions about the
necessity for the rule itself.
Response: The preamble to the rule discusses the reasons why action
by the Secretary is needed.
Changes: None.
Comments: One commenter stated that the IRFA did not consider the
cost of changing the audit requirements. This commenter also asked
questions about possible secondary effects of changing the audit
requirements.
Response: The Secretary re-analyzed the component of this rule that
requires changes in audit requirements. While there may be some slight
costs associated with the transition to the new audit requirements,
these costs are not thought to represent a significant economic impact.
Changes: The final regulatory flexibility analysis acknowledges the
slight costs that may be associated with a transition to the new audit
requirements.
Description of the Reasons Why Action by the Department Is Being
Considered and a Succinct Statement of the Objectives of, and Legal
Basis for, the Proposed Rule
The Secretary is directed by section 498(c) of the HEA to establish
that institutions participating in title IV, HEA student financial
assistance programs are financially responsible. The Secretary is
directed by section 498(d) of the HEA to establish that institutions
participating in the programs have the administrative capability to
administer federal funds. As part of the regulatory reinvention
process, the Secretary has analyzed the current standards whereby
institutions can demonstrate financial responsibility and
administrative capability and found that improvements can be made. The
proposed improvements are discussed at length in the preamble to the
September 20, 1996 NPRM.
Description and Estimate of the Number of Small Entities to Which the
Proposed Rule Will Apply
The Secretary has adopted the U.S. Small Business Administration
(SBA) Size Standards for this analysis. The Regulatory Flexibility Act
directs that small entities are the sole focus of the Regulatory
Flexibility Analysis. There are three types of small entities that are
analyzed here. They are: for-profit entities with total annual revenue
below $5,000,000; non-profit entities with total annual revenue below
$5,000,000; and entities controlled by governmental entities with
populations below 50,000. An estimate of the proportion of entities in
each of these categories was calculated using the best available data
from the National Center for Education Statistics IPEDS survey for
academic year 1993-94. These estimates were applied to Department
administrative files, where no data element for total revenue is
available. The estimates are that 1,690 small for-profit entities, 660
small non-profit entities and 140 small governmental entities will be
covered by the proposed rule. Where exact data were not available to
estimate the proportion of small entities, data elements were chosen
that would have overestimated, rather than underestimated, the
proportion.
Description of the Projected Reporting, Recordkeeping and Other
Compliance Requirements of the Rule, Including an Estimate of the
Classes of Small Entities Which Will Be Subject to the Requirement and
the Type of Professional Skills Necessary for Preparation of the Report
or Record
The components of this final rule that may impose economic impacts
are those associated with the new compliance audit requirements. The
new audit requirements change the audit period from the award year to
the institution's fiscal year. In some circumstances, this may entail a
somewhat more involved audit if award rules change significantly from
award year to award year so that the auditor would have to verify
compliance with both the old and new sets of rules during the fiscal
year. These changes are expected to cost $2,000 or less for a small
entity with $5,000,000 in total revenue.
Changing the 85-15 compliance verification from the current
attestation standard to a note to the financial statement is not
expected to represent higher auditor fees. On balance, the amount of
auditing work is comparable for both standards. Combining the audits is
expected to reduce the economic cost of audits. While there may be some
slight costs associated with the transition to the new audit
requirements, these costs are not expected to represent a significant
economic impact.
As discussed above, all small (and large) entities that are
identified as being covered by the rule will be subject to the new
audit requirements. The Regulatory Flexibility Act requires a
discussion of the professional skills required for compliance with this
rule. All small (and large) entities that participate in the title IV,
HEA programs are required by statute to provide audits. These audits
must be prepared by auditors that are qualified to prepare government
audits. This rule changes the audit requirements, but does not impose a
significantly new activity upon the entities. Under the current
regulations, an institution must submit an audited financial statement
and a compliance audit, but the financial statement was submitted
twice. Under these new regulations, the institution will still be
required to submit both the audited financial statement and the
compliance audit, but the financial statement will only be submitted
once, at the same time as the compliance audit is submitted. Thus the
savings to institutions is the marginal savings that is produced by the
elimination of the extra submission of the audited financial statement.
Description of the Steps the Department Has Taken To Minimize the
Significant Economic Impact on Small Entities Consistent With the
Stated Objectives of Applicable Statutes
This rule reduces the number of audits which must be submitted to
the Secretary, removing a reporting requirement that overlaps with this
proposed rule. This should help to reduce the overall reporting costs
to participating institutions.
A Statement of the Factual, Policy, and Legal Reasons for Selecting the
Alternative Adopted in the Final Rule and Why Each One of the Other
Significant Alternatives to the Rule Considered by the Department That
Affect the Impact on Small Entities Was Rejected
For the purpose of this regulatory flexibility analysis, the
significant alternative that was considered by the Secretary and
rejected was that of ``no action.'' Other alternatives, would not
adequately discharge the Secretary's obligation under sections 498 (c)
and (d) of the HEA to determine the financial responsibility and
administrative capability of participating institutions and guard the
Federal fiscal interest.
The Secretary has determined that there are no other significant
alternatives that would satisfy the same legal and policy objectives
while minimizing the economic impact on small entities. This
determination is based, in part, on the extensive consultation that the
Department performed with small (and large) entities in developing
these proposed revisions. The alternative ``no action'' was rejected
because this alternative would not adequately protect the
[[Page 60569]]
Federal fiscal interest, as discussed above and in the appendix to the
final rule.
Conclusion
The Secretary concludes that a substantial number of small entities
are likely to experience significant adverse economic impacts from the
proposed rule. However, the Secretary has concluded that the costs are
outweighed by the benefits. In this case, the benefits are better
protection of the Federal fiscal interest as well as improved service
to students receiving assistance under the title IV, HEA programs.
The Secretary emphasizes that this conclusion addresses the
regulations published in this Final Rule. Additional analysis of, and
conclusions regarding, the other regulatory proposals that were part of
the September 20, 1996 NPRM will be published when final regulations
addressing those proposals are published, and will be based on comments
received during the initial comment period, and those received during
the reopened comment period.
Paperwork Reduction Act of 1995
The information collection requirements contained in Sec. 668.23
have been submitted to the Office of Management and Budget for
approval.
List of Subjects
34 CFR Part 600
Colleges and universities, Foreign relations, Grant programs--
education, Loan Programs--education, Reporting and recordkeeping
requirements, Student aid, Vocational education.
34 CFR Part 668
Administrative practice and procedures, Colleges and universities,
Reporting and recordkeeping requirements, Student aid.
(Catalog of Federal Domestic Assistance Number: 84.007, Federal
Supplemental Educational Opportunity Grant Program; 84.032, Federal
Family Educational Loan Program; 84.032, Federal PLUS Program; 84.032,
Federal Supplemental Loans for Students Program; 84.033, Federal Work-
Study Program; 84.038, Federal Perkins Loan Program; 84.063, Federal
Pell Grant Program; 84.069, State Student Incentive Grant Program, and
84.268, Direct Loan Program)
Dated: November 22, 1996.
Richard W. Riley,
Secretary of Education.
The Secretary amends parts 600 and 668 of title 34 of the Code of
Federal Regulations as follows:
PART 600--INSTITUTIONAL ELIGIBILITY UNDER THE HIGHER EDUCATION ACT
OF 1965, AS AMENDED
1. The authority citation for part 600 continues to read as
follows:
Authority: 20 U.S.C. 1088, 1091, 1094, 1099b, 1099c, and 1141,
unless otherwise noted.
Sec. 600.5 [Amended]
2. Under Sec. 600.5, paragraph (e) is removed and reserved.
PART 668--STUDENT ASSISTANCE GENERAL PROVISIONS
3. The authority citation for part 668 continues to read as
follows:
Authority: 20 U.S.C. 1085, 1088, 1091, 1092, 1094, 1099c, and
1141, unless otherwise noted.
4. Under Sec. 668.15, paragraph (e) is removed and reserved,
paragraph (g) is revised, and paragraph (h) is added to read as
follows:
Sec. 668.15 Factors of financial responsibility
* * * * *
(g) Two-year performance requirement. (1) The Secretary considers
an institution to have satisfied the requirements in paragraph
(d)(1)(C) of this section if the independent certified public
accountant, or government auditor who conducted the institution's
compliance audits for the institution's two most recently completed
fiscal years, or the Secretary or a State or guaranty agency that
conducted a review of the institution covering those fiscal years--
(i)(A) For either of those fiscal years, did not find in the sample
of student records audited or reviewed that the institution made late
refunds to 5 percent or more of the students in that sample. For
purposes of determining the percentage of late refunds under this
paragraph, the auditor or reviewer must include in the sample only
those title IV, HEA program recipients who received or should have
received a refund under Sec. 668.22; or
(B) The Secretary considers the institution to have satisfied the
conditions in paragraph (g)(1)(i)(A) of this section if the auditor or
reviewer finds in the sample of student records audited or reviewed
that the institution made only one late refund to a student in that
sample; and
(ii) For either of those fiscal years, did not note a material
weakness or a reportable condition in the institution's report on
internal controls that is related to refunds.
(2) If the Secretary or a State or guaranty agency finds during a
review conducted of the institution that the institution no longer
qualifies for an exemption under paragraph (d)(1)(C) of this section,
the institution must--
(i) Submit to the Secretary the irrevocable letter of credit
required in paragraph (b)(5) of this section no later than 30 days
after the Secretary or State or guaranty agency notifies the
institution of that finding; and
(ii) Notify the Secretary of the guaranty agency or State that
conducted the review.
(3) If the auditor who conducted the institution's compliance audit
finds that the institution no longer qualifies for an exemption under
paragraph (d)(1)(C) of this section, the institution must submit to the
Secretary the irrevocable letter of credit required in paragraph (b)(5)
of this section no later than 30 days after the date the institution's
compliance audit must be submitted to the Secretary.
(h) Foreign institutions. The Secretary makes a determination of
financial responsibility for a foreign institution on the basis of
financial statements submitted under the following requirements--
(1) If the institution received less than $500,000 U.S. in title
IV, HEA program funds during its most recently completed fiscal year,
the institution must submit its audited financial statement for that
year. For purposes of this paragraph, the audited financial statements
may be prepared under the auditing standards and accounting principles
used in the institution's home country; or
(2) If the institution received $500,000 U.S. or more in title IV,
HEA program funds during its most recently completed fiscal year, the
institution must submit its audited financial statement in accordance
with the requirements of Sec. 668.23, and satisfy the general standards
of financial responsibility contained in this section, or qualify under
an alternate standard of financial responsibility contained in this
section.
* * * * *
5. Section 668.23 is revised to read as follows:
Sec. 668.23 Compliance audits and audited financial statements.
(a) General. (1) Independent auditor. For purposes of this section,
the term ``independent auditor'' refers to an independent certified
public accountant or a government auditor. To conduct an audit under
this section, a government auditor must meet the Government Auditing
Standards qualification and independence standards, including
[[Page 60570]]
standards related to organizational independence.
(2) Institutions. An institution that participates in any title IV,
HEA program must at least annually have an independent auditor conduct
a compliance audit of its administration of that program and an audit
of the institution's general purpose financial statements.
(3) Third-party servicers. Except as provided under this part or 34
CFR part 682, with regard to complying with the provisions under this
section a third-party servicer must follow the procedures contained in
the audit guides developed by and available from the Department of
Education's Office of Inspector General. A third-party servicer is
defined under Sec. 668.2 and 34 CFR 682.200.
(4) Submission deadline. Except as provided by the Single Audit
Act, Chapter 75 of title 31, United States Code, an institution must
submit annually to the Secretary its compliance audit and its audited
financial statements no later than six months after the last day of the
institution's fiscal year.
(5) Audit submission requirements. In general, the Secretary
considers the compliance audit and audited financial statement
submission requirements of this section to be satisfied by an audit
conducted in accordance with the Office of Management and Budget
Circular A-133, ``Audits of Institutions of Higher Education and Other
Nonprofit Organizations''; Office of Management and Budget Circular A-
128, ``Audits of State and Local Governments'', or the audit guides
developed by and available from the Department of Education's Inspector
General, whichever is applicable to the entity, and provided that the
Federal student aid functions performed by that entity are covered in
the submission. (Both OMB circulars are available by calling OMB's
Publication Office at (202) 395-7332, or they can be obtained in
electronic form on the OMB Home Page (http://www.whitehouse.gov).
(b) Compliance audits for institutions. (1) An institution's
compliance audit must cover, on a fiscal year basis, all title IV, HEA
program transactions, and must cover all of those transactions that
have occurred since the period covered by the institution's last
compliance audit.
(2) The compliance audit required under this section must be
conducted in accordance with--
(i) The general standards and the standards for compliance audits
contained in the U.S. General Accounting Office's (GAO's) Government
Auditing Standards. (This publication is available from the
Superintendent of Documents, U.S. Government Printing Office,
Washington, DC 20402); and
(ii) Procedures for audits contained in audit guides developed by,
and available from, the Department of Education's Office of Inspector
General.
(3) The Secretary may require an institution to provide a copy of
its compliance audit report to guaranty agencies or eligible lenders
under the FFEL programs, State agencies, the Secretary of Veterans
Affairs, or nationally recognized accrediting agencies.
(c) Compliance audits for third-party servicers. (1) A third-party
servicer that administers title IV, HEA programs for institutions does
not have to have a compliance audit performed if--
(i) The servicer contracts with only one institution; and
(ii) The audit of that institution's administration of the title
IV, HEA programs involves every aspect of the servicer's administration
of that program for that institution.
(2) A third-party servicer that contracts with more than one
participating institution may submit a compliance audit report that
covers the servicer's administration of the title IV, HEA programs for
all institutions with which the servicer contracts.
(3) A third-party servicer must submit annually to the Secretary
its compliance audit no later than six months after the last day of the
servicer's fiscal year.
(4) The Secretary may require a third-party servicer to provide a
copy of its compliance audit report to guaranty agencies or eligible
lenders under the FFEL programs, State agencies, the Secretary of
Veterans Affairs, or nationally recognized accrediting agencies.
(d) Audited financial statements. (1) General. To enable the
Secretary to make a determination of financial responsibility, an
institution must, to the extent requested by the Secretary, submit to
the Secretary a set of financial statements for its latest complete
fiscal year, as well as any other documentation the Secretary deems
necessary to make that determination. Financial statements submitted to
the Secretary must be prepared on an accrual basis in accordance with
generally accepted accounting principles, and audited by an independent
auditor in accordance with generally accepted government auditing
standards, and other guidance contained in the Office of Management and
Budget Circular A-133, ``Audits of Institutions of Higher Education and
Other Nonprofit Organizations''; Office of Management and Budget
Circular A-128, ``Audits of State and Local Governments''; or in audit
guides developed by, and available from, the Department of Education's
Office of Inspector General , whichever is applicable. As part of these
financial statements, the institution must include a detailed
description of related entities based on the definition of a related
entity as set forth in the Statement of Financial Accounting Standards
(SFAS) 57. The disclosure requirements under this provision extend
beyond those of SFAS 57 to include all related parties and a level of
detail that would enable to Secretary to readily identify the related
party. Such information may include, but is not limited to, the name,
location and a description of the related entity including the nature
and amount of any transactions between the related party and the
institution, financial or otherwise, regardless of when they occurred.
(2) Submission of additional financial statements. To the extent
requested by the Secretary in determining whether an institution is
financially responsible, the Secretary may also require the submission
of audited consolidated financial statements, audited full
consolidating financial statements, audited combined financial
statements or the audited financial statements of one or more related
parties that have the ability, either individually or collectively, to
significantly influence or control the institution, as determined by
the Secretary.
(3) Audited financial statements for foreign institutions. A
foreign institution must submit--
(i) Audited financial statements prepared in accordance with the
generally accepted accounting principles of the institution's home
country, if the institution received less than $500,000 U.S. in title
IV, HEA program funds during its most recently completed fiscal year;
or
(ii) Audited financial statements translated to meet the
requirements of paragraph (d) of this section, if the institution
received $500,000 U.S. or more in title IV, HEA program funds during
its most recently completed fiscal year.
(4) Disclosure of title IV HEA program revenue. A proprietary
institution must disclose in a footnote to its financial statement
audit the percentage of its revenues derived from the title IV, HEA
program funds that the institution received during the fiscal year
covered by that audit. The revenue percentage must be calculated in
accordance with Sec. 600.5(d).
[[Page 60571]]
(5) Audited financial statements for third-party servicers. A
third-party servicer that enters into a contract with a lender or
guaranty agency to administer any aspect of the lender's or guaranty
agency's programs, as provided under 34 CFR part 682, must submit
annually an audited financial statement. This financial statement must
be prepared on an accrual basis in accordance with generally accepted
accounting principles, and audited by an independent auditor in
accordance with generally accepted government auditing standards and
other guidance contained in audit guides issued by the Department of
Education's Office of Inspector General.
(e) Access to records. (1) An institution or a third-party servicer
that has a compliance or financial statement audit conducted under this
section must--
(i) Give the Secretary and the Inspector General access to records
or other documents necessary to review that audit, including the right
to obtain copies of those records or documents; and
(ii) Require an individual or firm conducting the audit to give the
Secretary and the Inspector General access to records, audit work
papers, or other documents necessary to review that audit, including
the right to obtain copies of those records, work papers, or documents.
(2) An institution must give the Secretary and the Inspector
General access to records or other documents necessary to review a
third-party servicer's compliance or financial statement audit,
including the right to obtain copies of those records or documents.
(f) Notification of questioned expenditures or compliance. (1) As a
result of a Federal audit or an audit performed at the direction of an
institution or third-party servicer, if the auditor questions an
expenditure made by the institution or servicer, or questions the
institution's or servicer's compliance with an applicable requirement
(including the lack of proper documentation), the Secretary notifies
the institution or servicer of the questioned expenditure or
compliance.
(2) If the institution or servicer believes that the questioned
expenditure or compliance was proper, the institution or servicer shall
notify the Secretary in writing of the institution's or servicer's
position and the reasons for that position.
(3) The institution's or servicer's response must be based on an
attestation engagement performed by the institution's or servicer's
auditor in accordance with the Standards for Attestation Engagements of
the American Institute of Certified Public Accountants and must be
received by the Secretary within 45 days of the date of the Secretary's
notification to the institution or servicer.
(g) Determination of liabilities. (1) Based on the audit finding
and the institution's or third-party servicer's response, the Secretary
determines the amount of liability, if any, owed by the institution or
servicer and instructs the institution or servicer as to the manner of
repayment.
(2) If the Secretary determines that a third-party servicer owes a
liability for its administration of an institution's title IV, HEA
programs, the servicer must notify each institution under whose
contract the servicer owes a liability of that determination. The
servicer must also notify every institution that contracts with the
servicer for the same service that the Secretary determined that a
liability was owed.
(h) Repayments. (1) An institution or third-party servicer that
must repay funds under the procedures in this section shall repay those
funds at the direction of the Secretary within 45 days of the date of
the Secretary's notification, unless--
(i) The institution or servicer files an appeal under the
procedures established in subpart H of this part; or
(ii) The Secretary permits a longer repayment period.
(2) Notwithstanding paragraphs (f) and (g)(1) of this section--
(i) If an institution or third-party servicer has posted surety or
has provided a third-party guarantee and the Secretary questions
expenditures or compliance with applicable requirements and identifies
liabilities, then the Secretary may determine that deferring recourse
to the surety or guarantee is not appropriate because--
(A) The need to provide relief to students or borrowers affected by
the act or omission giving rise to the liability outweighs the
importance of deferring collection action until completion of available
appeal proceedings; or
(B) The terms of the surety or guarantee do not provide complete
assurance that recourse to that protection will be fully available
through the completion of available appeal proceedings; or
(ii) The Secretary may use administrative offset pursuant to 34 CFR
part 30 to collect the funds owed under the procedures of this section.
(3) If, under the proceedings in subpart H, liabilities asserted in
the Secretary's notification, under paragraph (e)(1) of this section,
to the institution or third-party servicer are upheld, the institution
or third-party servicer must repay those funds at the direction of the
Secretary within 30 days of the final decision under subpart H of this
part unless--
(i) The Secretary permits a longer repayment period; or
(ii) The Secretary determines that earlier collection action is
appropriate pursuant to paragraph (g)(2) of this section.
(4) An institution is held responsible for any liability owed by
the institution's third-party servicer for a violation incurred in
servicing any aspect of that institution's participation in the title
IV, HEA programs and remains responsible for that amount until that
amount is repaid in full.
(Authority: 20 U.S.C. 1088, 1094, 1099c, 1141, and section 4 of Pub.
L. 95-452, 92 Stat. 1101-1109)
Analysis of Comments and Changes
(Note: This appendix will not be codified in the Code of Federal
Regulations)
General
Comments: Many commenters maintained that the 45 day comment period
was too short for institutions to understand thoroughly the new
proposals and submit comments on them. Many commenters also maintained
that the turnaround time between November 4 (the end of the comment
period) and December 1 (the deadline for publication of final
regulations in time for implementation for the 1997-1998 award year in
accordance with the Master Calendar) was too short for Department staff
to understand the comments that were submitted and to make necessary
changes in the regulations based on those comments. These commenters
therefore recommended that the publication of final rules be delayed,
and the comment period extended.
Discussion: The Secretary has reviewed these comments and is
sympathetic to some of the concerns raised that additional time would
have been desirable for the public to consider some of the proposals in
more detail. The September 20, 1996 Notice of Proposed Rulemaking
provided a detailed discussion of the competing concerns at issue given
the statutory deadline that requires final rules to be published by
December 1 in order to go into effect by July 1 of the following year.
The Secretary also notes that many members of the public were able to
use the allotted time to study the proposed regulation and provide
detailed comments with constructive suggestions for improving the final
regulation. These
[[Page 60572]]
comments also identified areas where the proposed regulation may need
further study and review, particularly with respect to some of the
components of the financial responsibility ratios calculated under the
proposed methodology.
Based in large part on concerns identified in the comments, the
Secretary is withholding publication of final regulations implementing
the revised financial responsibility standards at this time, and
details concerning time frames for additional public comment on that
proposal will be set out in a separate Federal Register Notice. The
portions of the September 20 NPRM that are now being incorporated into
Final Regulations are discussed in detail in the following sections.
Changes: Certain portions of the proposed regulations that are
dependent upon the financial responsibility ratio calculations are
being held back for additional consideration, and the final regulations
on the remaining portions of the September 20 NPRM are set out and
discussed below.
Comments: Several commenters maintained that the current standards
of financial responsibility could not be changed unless the Department
engaged in the process of negotiated rulemaking, as specified in
section 492 of the HEA, or that at least the spirit of that section
required that the Department enter into further discussions with the
community on these matters. One commenter alleged that without
negotiated rulemaking, the Department could not promulgate regulations
on this subject that would have legal force and effect.
Discussion: Pursuant to Section 492 of the HEA, the Secretary
conducted negotiated rulemaking for the regulations that implemented
parts B, G and H of the HEA as amended by the Higher Education
Amendments of 1992. The promulgation of those regulations, and the
procedures specified for those regulations--regional meetings, followed
by negotiated rulemaking--were subject to a specific time limit set out
in the statute, tied to the enactment of the 1992 Amendments. The
requirement to conduct regional meetings and negotiated rulemaking for
regulations implementing those parts thus did not extend to subsequent
changes to those regulations. No corresponding time limits or
procedures were provided in the HEA for any regulations other than the
ones that were initially required due to the 1992 amendments. The
Secretary, therefore, disagrees with the suggestions from the
commenters that negotiated rulemaking would have been required as part
of the implementation of these regulations.
Changes: None.
Section 668.15: Factors of Financial Responsibility
Comments: Many commenters supported the proposed change to the
performance exception to the refund reserve requirement. These
commenters also requested that the Department take prompt action to
approve applications regarding several state tuition recovery funds
that are still pending. Several of these commenters also suggested that
the exceptions be expanded to exempt an institution that obtains a
performance bond as required by a state licensing agency. This
commenter maintained that such bonds typically provide for refunds to
students in cases of school closure.
Several commenters supported the proposed change, but maintained
that a 10 percent or 15 percent error threshold would be fairer and
more appropriate, especially for institutions with very few refunds,
since in those cases even one or two late refunds may exceed the 5
percent threshold. One of these commenters added that this would take
into account those refunds paid a day or two late due to payments on a
30-day cycle. Several commenters noted that a threshold based on the
number of refunds made late, with no consideration of the amount of
money that was late in being refunded, was inadequate, because a few
refunds might be substantial due to the amount of money involved, or,
conversely, appreciably more refunds than a 5 percent measure could be
immaterial due to the inconsequential amount of money involve. One
commenter suggested that a monetary threshold be included in the
performance requirement, such that the standard be that the institution
did not make the greater of 5 percent or $5000 of refunds late. One
commenter suggested that for institutions that make a small number of
refunds every year, such that one late refund would cause the
institution to exceed the 5 percent threshold, the Department take
several years of refund history into account, and, if no pattern of
late refunds emerges, determine that the institution meets the
performance standard.
A commenter representing an accounting firm believed that an
institution that satisfied the general financial standards should not
be subject to the refund reserve provisions.
One commenter requested clarification regarding whether the 5
percent late refund trigger for the refund reserve requirement would be
counted at each site for an institution that has additional locations,
or whether the standard would be applied to the institution as a whole,
including the additional sites with the main campus.
Several commenters asked that the refund reserve performance
exception be clarified to include the results of an appeal process for
findings regarding late refunds.
Several commenters requested clarifications of the revised refund
reserve fund performance standard with regard to the standard being
linked to the years covered by an auditor or the year during which the
auditor conducts the audit. One of these commenters asked whether a
late refund that is split among several programs is counted as one late
refund or several late refunds. This commenter maintained that the
former should be the case.
A commenter from a proprietary institution asked whether the 5
percent error rate would be based on the refunds examined or an
extrapolation of the refunds examined. This commenter maintained that
an extrapolated 5 percent error rate is not indicative of an
institution that is not financially responsible, nor indicative of a
reportable condition related to the payment of refunds.
Several commenters suggested that only FFEL and Direct Loan Program
refunds be counted as untimely in the refund percentage because only
late refunds to those programs will have financial consequences to the
Federal government or the student.
Discussion: The Secretary appreciates the support this proposal
generally received from the community. The Secretary, however, is not
convinced by arguments that the original proposal should be changed
substantively.
In particular, the Secretary believes that the only accurate way to
determine whether an institution is making its refunds under the
standards contained in Sec. 668.22 is by setting a measure of refunds
made or not made in a timely fashion. The Secretary does not agree with
those commenters who believe that a dollar amount should be part of the
threshold, such that an institution would be allowed to qualify under
this exemption if the institution makes more than 5 percent of its
refunds late, but the dollar amount of those refunds is low. This
performance exemption is premised on providing relief to an institution
that has created and maintained an efficient system that allows the
institution to discharge the responsibilities it assumes by
participating in a title IV, HEA program. In this case, the performance
of the system must be measured on the basis
[[Page 60573]]
of making refunds. The Secretary does not believe that adding a dollar
threshold to the 5 percent error threshold would create a better
measure than the 5 percent threshold alone, since the dollar threshold
will not yield additional information on how well the system is
processing refunds. In fact, such a threshold would allow an
institution to continue using the exemption even though its system
performed with a significant error rate, so long as the dollar amount
of each refund made late was low.
While the Secretary appreciates the position taken by commenters
who argued the obverse (that an institution that made a few but very
large refunds late should not qualify for this exemption), the
Secretary believes that the more appropriate enforcement action in
cases where an institution inadvertently made a few refunds of large
amounts late should be taken under the standards set in Sec. 668.22.
Those standards address the act of making a refund rather than the
process that controls the making of refunds, and are therefore better
suited to generate appropriate sanctions, if any, in response to
deficiencies in the making of a particular refund or refunds.
The Secretary also disagrees with those commenters who maintained
that the Secretary should set the error rate at a higher threshold. The
5 percent threshold was meant to provide relief only in those rare
instances when, although the institution's system of internal controls
is generally sound, a few refunds are inadvertently made late. The
Secretary does not agree that a 10 or 15 percent error threshold would
capture the intent of the exemption as a performance standard that
indicates that the institution does, in all but rare situations, make
refunds in a timely fashion. Rather, the Secretary believes that a 10
or 15 percent error rate may indicate that serious problems exist with
the institution's system of internal controls, as well as significant
compliance problems.
The Secretary agrees with commenters who asserted that a single
late refund should not trigger the refund reserve requirement if, due
to the small number of refunds the institution makes annually, a single
refund would constitute more than 5 percent of the institution's annual
refunds. While the Secretary expects institutions that have small
numbers of refunds to be equally responsible as institutions with large
numbers of refunds in ensuring that all refunds are paid in a timely
fashion, the Secretary believes that it is reasonable to allow an
institution to continue utilizing this exemption if it is found to have
made only one refund late during its fiscal year, even though that
single refund represented 5 percent or more of the refunds the
institution was required to make during that year.
In promulgating this revision to this exemption, the Secretary
emphasizes that the 5 percent threshold does not give an institution
license willfully to make some number of late refunds so long as the
percentage of late refunds is less than 5 percent. The 5 percent
threshold is meant to allow institutions to qualify under this
exemption if the instances in which the institution does not meet the
regulatory requirements for the payment of all its refunds are rare and
exceptional. The 5 percent threshold thus allows such institutions to
qualify for the exemption despite those rare and exceptional instances
of late payment. But, the Secretary reminds institutions that attempts
to abuse this exemption by willfully making a percentage of late
refunds could result in actions taken under Sec. 668.22. In addition,
the institution's independent auditor is required to make a finding of
a material weakness in the institution's procedures related to refunds
if the auditor finds that the institution intentionally or
systematically made late refunds, and such a finding would result in
the institution losing the benefit of this exemption.
The Secretary disagrees with those commenters who asserted that
only those refunds that contain FFELP or Direct Loan funds should be
counted as untimely. Refunds made to grant programs must also be made
in a timely fashion, not only for Federal fiscal reasons, but also
because those funds may be subsequently used as aid to other needy
students and should be available to those students as soon as possible.
Thus, the Secretary includes refunds that do not contain FFELP or
Direct Loan funds in the measure of refund performance for purposes of
this exemption.
In response to other concerns raised by commenters, the Secretary
wishes to clarify the following. The 5 percent threshold applies to the
number of refunds made late, not to the number of programs to which
funds are remitted. Late refunds will be evaluated on the combination
of a main campus and any additional locations. Evaluations are also
made for the period of time covered by the auditors or reviewers.
The Secretary also wishes to clarify that the procedures that occur
when the letter of credit requirement is triggered are the same as
current procedures. If the auditor or reviewer finds, in his or her
examination of a sample of student records, that 5 percent or more of
the refunds that should have been made to those students in the sample
were made late, then the institution must immediately submit a letter
of credit. That letter of credit then remains in place until the final
report of the reviewer or auditor shows that the institution made fewer
than 5 percent of its total required refunds late, or until the
institution can meet the two-year performance exemption based on
subsequent reviews or audits, or meets one of the other alternatives.
The Secretary, based on past experience with performance bonds,
disagrees that they are an acceptable way of meeting the refund reserve
requirement. The Secretary has found that the terms of coverage and
conditions for collection on performance bonds are difficult to
administer consistently, and do not provide the same level of
protection available under letters of credit.
The Secretary is currently reviewing several applications regarding
state tuition recovery funds. Such applications have not conformed to
the regulatory provisions contained in 668.15(d)(2)(ii). The Secretary
agrees that such funds are a good way for institutions to meet the
refund reserve requirements and looks forward to receiving applications
detailing such state plans that would conform to the regulatory
provisions.
Changes: Because the Secretary is delaying the publication of the
final rules implementing the new proposed standards of financial
responsibility, Sec. 668.15 is being amended to include this change to
the two-year performance requirement. Language allowing an institution
to use this exemption if the auditor or reviewer found that the
institution made only one late refund has also been added, and
technical changes to regulatory language have been made to make the
exemption easier to understand.
Comments: One commenter agreed that the proposed standards for
foreign institutions were appropriate.
Discussion: The Secretary appreciates this support of the proposal.
The Secretary believes these standards appropriately set levels of
oversight for foreign institutions given the level of risk represented
respectively by institutions that receive $500,000 or less annually in
title IV, HEA program funds, and those that receive more than $500,000
annually in such funds.
Changes: None.
[[Page 60574]]
Section 668.23 Compliance Audits and Audited Financial Statements
Comments: A commenter from a public institution maintained that,
because of cost, a compliance audit should be required only once every
two or three years for a public institution, instead of annually. A
commenter from a public institution maintained that the Single Audit
Act does not require that the audited financial statements of
individual public institutions be submitted. One commenter requested
clarification of the type of audit required of an institution that
falls below the level of the OMB Circular A-133 audit requirement of
$300,000.
Several commenters from accounting firms supported the requirement
that audited financial statements be included in the compliance audit
and that the compliance audit be prepared on a fiscal year basis, on
the grounds that this would result in cost reductions to institutions
without compromising the ability of the Department to perform its
oversight responsibilities.
Many commenters from proprietary institutions and the certified
public accountant (CPA) community opposed the new requirement. These
commenters asserted that for those institutions that have a fiscal year
different from an award year, the change would result in compliance
audits that cover two different award years, sometimes involving a
single student's file that would have to be examined under two
different standards, and that this would add significant costs and
burdens to institutions. In particular, some commenters also asserted
that this change would result in audits being prepared during the busy
season for CPAs, thereby increasing costs; that it might entail using a
single auditor rather than two different auditors, which would also
lead to increased costs; and, if the initial audit after the change
would require the audit of a partial year, this would also increase
costs. Commenters who opposed changing the reporting year for
compliance audits from an award year basis to a fiscal year basis
estimated that time and costs would increase in a range of 40 percent
to 100 percent.
A commenter from a proprietary institution opposed the requirement
that compliance audits be performed on a fiscal year basis, on the
grounds that information contained on the PMS 272 Report will not match
information on the final report of expenditures--the Federal Pell Grant
Statement of Account and the Fiscal Operations Report and Application
to Participate (FISAP) for campus-based programs. This commenter also
argued that there will be no mechanism in place for the institution to
receive an increased authorization to cover additional Pell Grant
eligibility, since adjustments to award year authorizations must be
done in the initial audit report.
One commenter from a Subchapter S corporation asserted that the
combination of the compliance audit and the audited financial statement
would not result in more time for an institution to complete its audit,
because other government agencies require the corporation to provide
audited financial statements within 120 days of the end of the
institution's fiscal year. This commenter maintained that creating a
combined audit requirement meant that the corporation would be required
to complete both the audited financial statement and the compliance
audit in that timeframe. This commenter maintained that, therefore,
this requirement was impossible to meet, because a compliance audit
typically takes more than five months to complete. This commenter also
maintained that the combined audit would create problems for a
corporation with several separate schools when the corporation submits
an audited financial report to other entities (such as those involved
in bonding, insurance, and banking), because the combination would
consist of the financial statement and several different compliance
audits that are unrelated to the institution for which the report was
requested. This commenter maintained that the proposed rule does not
reduce any burden other than that of a separate mailings, since the
current requirements do not require duplicate information. A commenter
from a proprietary institution argued that the combined audit would be
burdensome to some publicly traded corporations because those companies
are required to prepare an audited financial statement with the
Security and Exchange Commission within three months of the
institution's fiscal year end, and this would also be the time period
in which the institution would be required to complete a compliance
audit. One commenter recommended either that the Department negotiate
with the Internal Revenue Service to allow S corporations to change
their fiscal year from January 1 to December 31, or to change the award
year to the calendar year.
Many commenters suggested as an alternative that an institution
might either combine its audited financial statement with its
compliance audit, with both covering the same period of time, or allow
the institution to submit a single audit, with the financial statement
and compliance audit covering different periods of time (the financial
statement covering the institution's most recently completed fiscal
year, and the compliance audit covering the award year). One commenter
asserted that the combination is not necessary as long as the firm
conducting the audit of the financial statements is subjected to the
current Quality Review, and the compliance auditor and the financial
statement auditor can consult with one another.
One commenter representing a guarantee agency opposed the combined
audit on the grounds that the change in the submission deadline from
four months to six months increased risk to students and taxpayers.
Several commenters asked for clarification if two separate auditors
could perform the compliance audit and audit the institution's
financial statement.
Several commenters requested more information regarding the time
period to be covered by the first combined submission and the due date
for the first combined submission. One of these commenters asked
whether a compliance audit of less or more than 12 months would be
acceptable during the transition.
A commenter from an accounting firm commented that the requirement
that the audit be prepared according to Generally Accepted Government
Auditing Standards (GAGAS) would mean higher costs for institutions.
One commenter maintained that only public institutions should be
required to use GAGAS, and all other institutions be allowed to use
Generally Accepted Auditing Standards (GAAS).
Discussion: It was not the Secretary's intent to preclude the
preparation of financial statement audits and compliance audits as
separate reports. The Secretary will accept a financial statement audit
and a compliance audit performed by different auditors provided that
both audits are conducted on a fiscal year basis and are submitted
together as one package. The Secretary is aware that for many
institutions the award year differs from the fiscal year and that this
may require that auditors perform audit testing in each of two distinct
award years, both of which may be subject to different regulatory
requirements. The Secretary believes that although this may require
additional planning with respect to developing samples for substantive
tests of details, the level and complexity of any additional work is
not substantially greater than would normally be required. Auditors
would still perform
[[Page 60575]]
reconciliation work and tests of balances relative to the award year
but would now be required to supplement that work, at fiscal year end,
with additional reconciliation work and tests of balances. However, the
nature and extent of those tests and the amount of work associated with
these activities would be minimal unless year-end testing of internal
controls indicated a significant change in the reliability of the
internal control structure. This may result in a modest increase in the
level of work auditors must perform during peak demand periods, and
consequently may result in slightly higher audit fees, depending on the
auditor. Historically, auditors have been required to adapt their
procedures to accommodate statutory and regulatory changes that have
occurred at varying periods throughout individual award years. The
Secretary believes that the benefits associated with consolidating
multiple regulatory reporting requirements into a single reporting
package exceed the incremental costs incurred. In addition, auditors
who perform audits and attest services for participating institutions
have a responsibility to be aware of changing statutory or regulatory
requirements, and to develop appropriate plans for accommodating
changes in those requirements.
An initial compliance audit covering a partial year will be
required at the institution's first fiscal year end following the
effective date of the regulations, and will cover the period of time
since the institution's last compliance audit. For an institution with
a fiscal year end of December 31st, an initial compliance audit
will be required for the period beginning July 1, 1997 and ending
December 31, 1997. In subsequent years, the compliance audit will be
prepared on a fiscal year basis and will cover the period of time since
the institution's last compliance audit. For an institution with a
December 31st fiscal year end, the next required compliance audit
and financial audit would be required to be submitted together in a
single package for the fiscal year ending December 31st, 1998 not
later than six months following the institution's fiscal year end.
Although some commenters have suggested that the Secretary allow
institutions to prepare an initial compliance audit at the end of the
institution's second fiscal year following the effective date, the
Secretary believes this creates an unacceptable delay with regard to
his receiving notification of potentially serious compliance
violations. Accordingly, the Secretary is requiring institutions to
prepare a partial year compliance audit at the end of the first fiscal
year following the effective date of the regulation.
For many institutions with a December 31st fiscal year end,
this change will provide the Secretary with more timely information
with respect to compliance audits. Under previous regulations a
compliance audit for an award year ending June 30th would not have
been required to be received by the Secretary until six months
following a December 31st fiscal year end. By changing the
requirement that a compliance audit be prepared on an award year basis
to that of a fiscal year, the Secretary shortens the period in which a
compliance audit is received to six months instead of nearly a year.
This may also provide the Secretary with a means of ascertaining the
potential impact of serious audit liabilities with respect to an
institution's ability to demonstrate financial responsibility. The
Secretary further believes that the consistency in reporting periods
will encourage independent CPAs who perform financial statement audits
to identify and properly disclose any material contingent liabilities
that exist as a result of compliance violations.
In contrast, this change extends the period of time in which
institutions may submit financial audits from four months under
previous regulations to six months. This change should prove beneficial
to institutions. In addition, the Secretary believes that a change in
the reporting period from the award year to the fiscal year provides
institutions with an opportunity to consolidate audit services into a
single engagement rather than to incur the potentially higher costs
associated with separate engagements .
The required audit submission is considered to be satisfied by an
audit under the Single Audit Act and OMB Circular A-128 or OMB Circular
A-133. However, for institutions that are not required to prepare such
audits because the total amount of federal financial assistance is less
than the applicable threshold amount, a financial audit report and a
compliance audit must be prepared and submitted to the Secretary for
purposes of complying with the HEA. Guidance in the preparation of the
compliance audit may be sought from the U.S. Department of Education's
Office of the Inspector General.
With regard to the issue of fiscal years for S corporations, the
Secretary has promulgated a regulation that permits schools to
synchronize their compliance audit to correspond with their fiscal
year. The Secretary therefore does not believe it is necessary for an
institution to be able to switch its fiscal year to correspond to the
award year, but has rather provided a means for an institution to
change the period covered by its annual compliance audit so that it
will correspond to its fiscal year.
Existing law requires the Inspector General to take appropriate
steps to assure that any work performed by non-federal auditors
complies with Generally Accepted Government Auditing Standards (GAGAS).
This provision reflects a clarification of existing guidance previously
made available to auditors in publications available from the
Department of Education's Office of the Inspector General .
Changes: Several technical changes have been made to Sec. 668.23.
Comments: Several commenters representing proprietary institutions
supported the concept of the submission of questionable audit
statements to the American Institute of Certified Public Accountants
(AICPA) and other parties for review as part of a fair and impartial
way of settling disputes between auditors and the Department, but
questioned the language contained in this proposed rule. One of these
commenters questioned whether the AICPA would agree to serve in this
capacity, and asserted that the reference to other parties in the
proposed rule was unclear. One commenter asserted that the AICPA does
not have a process for resolving accounting disputes between parties,
but does have a process, through the Professional Ethics Executive
Committee, by which parties may be referred for investigation and
disciplinary action if there is a possible violation of professional
standards, and a process, through the Accounting Standards Executive
Committee, for considering whether there is a need for new accounting
standards.
Some commenters suggested that it was very important that the
``other parties'' be familiar with the intricacies of the particular
sector of higher education involved in the question or dispute, and
that it was also very important that the Secretary create a process for
providing notice and soliciting comment from experts in the particular
sector associated with the question or dispute when the Secretary
submits a statement for resolution.
One of these commenters maintained that the proposed procedures
could be problematic because there are several different legitimate
ways to reflect similar transactions.
Discussion: In exercising the Department's statutory oversight
authority, the Secretary makes every effort to ensure that the
regulatory standards are applied consistently
[[Page 60576]]
among all participating institutions. One way that the Secretary
ensures that regulatory provisions are consistently applied is to
evaluate the accounting principles used in the preparation of financial
statements. Different representations of similar financial
circumstances by preparers of those financial statements may lead the
Secretary to form fundamentally different conclusions about the fiscal
responsibility of the respective institutions. The Secretary looks to
the auditor first as a way of ensuring consistent application of
accounting principles among reporting institutions.
In proposing the mechanism described in the proposed Sec. 668.23
(d)(2), the Secretary had intended to establish a formal procedure to
resolve significant discrepancies that may exist among independent
auditors in the interpretation of Generally Accepted Accounting
Principles (GAAP). Notwithstanding this procedure, the Secretary, as
the principal user of these financial statements, would remain the
ultimate authority in determining the acceptability of any general
purpose financial statement for purposes of demonstrating financial
responsibility. However, several commenters had indicated that the
procedure proposed in the NPRM was not workable from the standpoint of
the AICPA, in that the AICPA generally took action to clarify
accounting principles in the long term rather than to help adjudicate
particular differences. After reviewing the concerns raised by the
commenters, the Secretary agrees that the type of assistance the
Department could procure from the AICPA would not necessitate the
procedure proposed in the NPRM. The Secretary is, therefore, removing
this proposal from the final regulations.
The Secretary, however, reiterates that the Department will
generally consult with authoritative accounting bodies such as the
Financial Accounting Standards Board (FASB), The Governmental
Accounting Standards Board (GASB), and the AICPA when examining audited
financial statements. If, after consideration of the facts,
circumstances, and assumptions, the Secretary believes that a departure
from GAAP exists, the Secretary will notify the institution of the
finding and may provide the institution with an opportunity to cure. In
the event the Secretary believes that existing accounting standards
need to be changed or that existing accounting standards are silent and
that more guidance is needed, the Secretary will bring the matter to
the attention of the appropriate accounting standard-setting body or
bodies for consideration of future changes. However, the Secretary will
continue to be the final authority in determining the acceptability of
any specific accounting treatment for purposes of determining the
financial responsibility of an institution that participates in a title
IV, HEA program.
Changes: The provision contained in the proposed Sec. 668.23(d)(2)
has been removed.
Comments: Many commenters representing proprietary institutions
opposed the provision that enables the Secretary to require the
submission of audited financial statements of related entities,
consolidated financial statements, or full consolidating financial
statements, on the grounds of excessive cost and burden. Several of
these commenters maintained that all necessary information is contained
in the footnotes to the audited financial statements submitted by
institutions. One of these commenters maintained that this provision
would be acceptable only if the requirement was limited to those
instances in which the Internal Revenue Service requires consolidation.
Several commenters representing proprietary institutions maintained
that the provision was unacceptable and should be removed. One
commenter suggested that the rule read that, if the parent corporation
is willing to provide a guarantee of the financial obligation of the
institution, then the financial statements of the parent corporation
will be considered.
One commenter argued that a particular definition of ``related''
must be promulgated, and that this definition should be constructed so
as to exclude any entity that does not have a direct and significant
financial relationship with the institution.
One commenter representing proprietary institutions opposed the
proposed regulation in which the Secretary may require full
consolidating financial statements on the grounds of expense and the
possible unavailability of financial statements of such entities
(because they may not be required to prepare them for any other
purpose). This commenter maintained that the requirement to submit
audited financial statements be limited to institutions or to an
institution's parent corporation that intends to sign the institution's
program participation agreement. This commenter argued that the
Secretary does not have the statutory authority to require audited
financial statements of related parties other than at the level of the
institution, nor does the Secretary have the authority to determine the
institution's financial responsibility on the basis of a related
party's financial statement unless the institution is a wholly owned
subsidiary of the related party. This commenter recommended that the
proposed regulations be changed to limit the requirement to provide
this information for related parties only if the Department reasonably
believes that the related party's performance jeopardizes the financial
responsibility of the institution, based on a clear financial
relationship between the entities, and that the requirement be limited
to the requirement that the related party provide its most recent
financial statement within six months. Further, this commenter
recommended that the Department not penalize the institution if the
related party does not maintain sufficient documentation to support an
audited financial statement.
One commenter from a proprietary institution suggested that the
Department rely on the auditor's judgement, following AICPA guidelines,
about whether the institution should submit consolidated financial
statements. A commenter from a public institution maintained that the
Department should not require a consolidated statement in situations in
which such statements are not required under GASB standards.
One commenter maintained that requiring the audited financial
statement from a related party could result in significant problems,
stemming from requests after the year end for a period that has not
been audited (resulting in difficulty in issuing a clean opinion), and
the presence of inventories and opening balances that may result in
qualifications. This commenter asserted that, as a result of such
difficulties, the Department may not receive what it considers
acceptable audits for these parties, and that institutions may not be
able to correct the problems for as long as a year.
A commenter from a proprietary institution maintained that, when an
institution or institutions are owned by a corporation the financial
statement of the corporation be the basis for evaluating financial
responsibility, since all the assets and liabilities of the
institutions are assets and liabilities of the corporation.
Discussion: The Secretary requires that an institution provide as
part of its audited financial statement a detailed disclosure of all
related parties consistent with the definition of a related party
established in SFAS 57. The Secretary's intent is to obtain an
understanding of the relationships that exist among related entities
that have the ability to exert substantial influence or control. The
Secretary recognizes that
[[Page 60577]]
the existence of related parties may lead to material transactions that
are substantially different in terms and conditions from those that
would occur with unrelated independent entities. The Secretary believes
that this understanding is necessary in order to take into
consideration an institution's total financial circumstances. This
provision is intended to make available to the Secretary information
important to an analysis of the financial statements that would
otherwise be difficult to ascertain simply from reviewing the financial
statements. The Secretary believes that by providing a reference to the
definitions in SFAS 57 both institutions and their independent auditors
will have a clear understanding as to the meaning of the term ``related
party'' under this provision.
To determine whether an institution is financially responsible, the
Secretary may also require that the institution submit audited
consolidated financial statements, audited full consolidating financial
statements, audited combined financial statements or the audited
financial statements of one or more related parties that have the
ability, either individually or collectively, to significantly
influence or control the institution, as determined by the Secretary.
This requirement represents a clarification of the existing regulatory
provisions in 34 CFR 668.15(e) which provides that the Secretary may
request additional information to the extent necessary to make a
determination of financial responsibility. The HEA requires that the
Secretary take into consideration an institution's total financial
circumstances. The Secretary believes that these additional financial
statements may be necessary in order to obtain an understanding of the
economic substance of an institution's financial condition. The
Secretary further believes that this may constitute a more accurate
reflection of the institution's total financial circumstances. The
Secretary also believes that this provision will provide flexibility
with respect to how an institution demonstrates financial
responsibility. For example, the existing regulatory language may have
required several institutions, none of which was individually a
separate legal entity, to provide individual audited financial
statements representing each institution despite the fact that all were
operating divisions of a single corporate entity. Under the new
standard, the Secretary has explicit flexibility to allow the
preparation of a single audited financial statement, representing the
corporate entity only, in lieu of requiring these individual financial
statements.
Notwithstanding the Secretary's interest in obtaining an
understanding of the institution's total financial circumstances, the
Secretary enters into a program participation agreement with an entity
that has the legal capacity and financial capability to enter into such
an agreement for the institution. In the event that the Secretary
determines that the economic substance of the relationship among
related parties is such that the institution would not otherwise be
able to demonstrate financial responsibility on its own, the Secretary
may require financial guarantees from related parties or co-signatories
to the program participation agreement. In contrast, should the
economic relationship among related entities be such that the total
financial circumstances of the institution indicate an inability to
demonstrate financial responsibility due to the existence of
significant liabilities or claims on the assets of the institution, the
institution shall be deemed not financially responsible. The Secretary
believes that this requirement will not cause excessive burden or cost
to any institution that is able to demonstrate financial responsibility
independently of a related entity. However, the Secretary recognizes
that for some institutions this provision may be costly. The Secretary
maintains that the costs are necessary to protect the federal fiscal
interests.
Changes: The Secretary clarifies requirements in this area by
adding the following regulatory language to Sec. 668.23(d)(2): ``The
disclosure requirements under this provision extend beyond those of
SFAS 57 to include all related parties and a level of detail that would
enable the Secretary to readily identify the related party. Such
information may include but is not limited to the name, location and a
description of the related entity including the nature and amount of
any transactions between the related party and the institution,
financial or otherwise, regardless of when they occurred.''
Comments: A commenter from a proprietary institution supported the
requirement that proprietary institutions disclose the proportion of
revenue the institution received from title IV, HEA program sources.
Many commenters opposed the requirement. Most of these commenters
opposed the provision on the grounds that the current provision
contained in Sec. 600.5 requires only an attestation on the part of the
CPA firm. Including a disclosure in the audited financial statement
will increase the work required of the auditor as well as the exposure
of the auditor, and thus increase the cost of the audit. These
commenters also asserted that the current procedures provided
sufficient information for the Department to fulfill its oversight
responsibility in this area.
One commenter questioned whether the requirement was that the
disclosure be separately audited, or based on the attestation
engagement required by 34 CFR Sec. 600.5. This commenter asserted that,
should the former be the case, this should be reflected in a change to
34 CFR Sec. 600.5 and in the Regulatory Flexibility Analysis. One
commenter maintained that the request for this information suggested
that the Department intended to use the information for purposes that
extended beyond Congressional intent.
Discussion: Previously the Secretary had required an examination
level ``Compliance Attestation'' to be performed within three months of
the institution's fiscal year end. The Secretary believes that the
revised requirement contained in these final regulations will not
result in significant additional cost as the disclosure will now become
part of the audit of the general purpose financial statements. The
corresponding increase in cost associated with adding this disclosure
is not likely to be significantly greater than the savings resulting
from the removal of the requirement to perform the ``Compliance
Attestation.'' Additionally, the independent auditor who performs the
audit of the institution's general purpose financial statement may be
able to rely to some extent on the field work of the independent
auditor who will be conducting the institution's compliance audit for
the same fiscal period. The Secretary requires this information to
ensure compliance with provisions of the HEA that stipulate a
proprietary institution may not receive more than 85 percent of total
revenues in the form of Title IV program funds.
Changes: Section 600.5(e) has been removed.
[FR Doc. 96-30394 Filed 11-27-96; 8:45 am]
BILLING CODE 4000-01-P