GAB Decision 401
Docket No. 82-70
March 30, 1983
Kentucky Department for Human Resources;
Garrett, Donald; Teitz, Alexander Settle, Norval
The Kentucky Department for Human Resources (DHR) appealed from a
determination by the Director, Division of Cost Allocation (Agency) for
the Department of Health and Human Services (HHS) that $647,340 of
federal participation (FFP) was unallowable. The disallowance followed
recommendations contained in an Inspector General audit report (Audit
Control Number 04-10254) for the period July 1, 1975 through September
30, 1979 and a subsequent limited review for the period October 1, 1979
through September 30, 1981.
In its Notice of Appeal DHR appealed the following three elements of
the disallowance: (1) $202,262 of excessive central office costs; (2)
$130,886 of costs related to the operation of an employees' credit
union; and, (3) $314,192 of inappropriate Title XX training costs.
During the course of the proceedings, the Agency reduced the amount of
disallowed training costs from $314,192 to $166,567, leaving in dispute
a total of $499,715 FFP for the three elements of the disallowance. The
particulars with respect to the three areas of dispute will be dealt
with separately below.
The Board concludes as follows: (1) to uphold the disallowance of
central office costs, subject to the recalculation explained below; (2)
to uphold the disallowance of credit union expenses; and, (3) to uphold
the disallowance of training costs to the extent of $86,958.81, subject
to further adjustment. This decision is based on briefs and documents
submitted by the parties, the transcript of a hearing conducted by the
Board in this case, and the parties' post-hearing submissions.
I. Central Office Costs
DHR leased office space in the New Capitol Annex Building. The
rental rate was established to liquidate the bond and interest coupons
issued for the construction of the building. The original plan was
that, after the bond issue was retired the rental rate would cease and
the only charge to DHR would be its proportionate share of the
maintenance costs. Therefore, in return for participating at an
accelerated rate (2) in liquidating the bond issue, the Agency would
benefit in reduced office space costs to DHR in later years. The Agency
disallowed $202,262 FFP which represents the federal share of an
adjustment for the cost of office space provided to DHR employees. The
disallowance was based on an audit finding that DHR received FFP at an
accelerated rate for the cost of office space in the New Capitol Annex
Building. The report found, however, that DHR moved from the building
and is charging the Agency for the cost of office space in another
building without recognizing the Agency's "equity" in the New Capitol
Annex Building.
The following facts, except as otherwise specified, are not in
dispute. On July 1, 1950, DHR (then known as the Department of Economic
Security) entered into a lease agreement with the Kentucky State
Property and Buildings Commission for office space in the then proposed
New Capitol Annex Building. The term of the lease was for two years
renewable "at the option of the lessee for additional two-year terms for
a full term of one hundred (100) years." DHR Appeal Brief, Tab 2. The
lease also provided that DHR would pay a rental rate sufficient to
retire the bonds and to pay the maintenance cost of the building. Upon
retirement of the bonds, DHR's rental cost would be limited to the "cost
of maintenance and upkeep of the building." Id.
The bond issue was retired in 1970 and thereafter DHR was provided
with virtually rent-free space in the Capitol Annex building. However,
in the early 1970s, DHR decided for managerial reasons to construct a
new office building and locate DHR operations within it. In July, 1977,
DHR began to occupy office space in the New Human Resources Building.
The Agency approved a rate of $5.87 per square foot for DHR's space in
the new building and DHR claimed this rate for purposes of FFP, but made
no adjustment in recognition of the Agency's prior participation at an
accelerated rate in the cost of office space in the Capitol Annex
building.
The audit report and the disallowance letter cited the provisions of
the Handbook of Public Assistance, Part V, and concluded that an
adjustment was necessary to the rate that DHR received in the new
building to recognize the Agency's accelerated participation in the
Capitol Annex. The Agency noted that section 4532.5 of the HPA states,
in part, that:
if the State agency should vacate a building before the end of the
life expectancy period, an adjustment of the Federal funds that the
agency received will be made if the spread of the cost has been over a
shorter period (3) in accordance with the comparable rental. The amount
of funds that it would have received had the initial cost of the
building actually been spread in accordance with the life of the
building, would need to be determined and an adjustment in the claim for
Federal participation made...
Based on the above provision, the Agency determined that for fiscal
years 1978 through 1981 an adjustment of $202,262 was appropriate. In
addition, the Agency determined that a similar adjustment was necessary
for the next 21 years in order for the Agency to receive its benefit
from providing FFP at an accelerated rate.
The Agency subsequently clarified its basis for the disallowance
stating at the hearing that while it continued to maintain that an
adjustment was necessary, it conceded that "the disallowance is not
based on the mechanics of the HPA." Tr., p. 17. The Agency stated that
the amount of the disallowance was calculated based on the amount of
space DHR occupied rent-free in the Capitol Annex, projecting that
rent-free space in the new building DHR occupied. Id. The Agency
asserted that its position:
is based on the letters of 1951 which (the Agency) believes made
certain promises and representations to the government for the purpose
of receiving federal financial participation in that building at a fast
rate.
Id.
The Agency argued in the alternative that the adjustment could be
computed in accordance with the United States Department of Labor's
Employment Security Manual (ESM). The Agency, while recognizing that
the ESM would not normally be applied to HHS programs, stated that the
ESM was referenced in the 1951 letters and, therefore, "it was
incorporated within the agreement between Kentucky and HHS." Id. at p.
18.
Lastly, the Agency asserted that, despite the fact that the
disallowance did not rely on the HPA, HPA section 4532.5 could be the
basis of an adjustment for DHR's receipt of accelerated FFP.
DHR raised a number of legal and factual arguments contesting the
Agency's claim for an adjustment. In general, DHR argued that there was
no applicable legal requirement for DHR's reimbursing the Agency for
DHR's activities under the two leases and, even assuming there was, the
Agency's calculation of the adjustment was wrong.
(4) In approaching this issue, we first examine below the validity of
the Agency's alternative remedies, and then we examine the calculation
of the adjustment.
A. Whether the Agency Has a Basis for Recovery
1. Whether the 1951 Letters May Be Used as a Basis of Recovery
The Agency contended that two letters written in 1951, prior to DHR's
occupation of the Capitol Annex building, represent a promise by
Kentucky officials to provide 80 years of rent-free office space to DHR
after the bonds were amortized. Agency Response, p. 2. In support of
its argument the Agency cited a March 13, 1951 letter from V. E.
Barnes, Commissioner, DHR, to John L. Craig, Regional Director of the
Bureau of Employment Security, Department of Labor, (DHR Appeal Brief,
Tab. 4) and a July 16, 1951 letter from V. E. Barnes to Irvin Walker of
the U.S. Bureau of Public Assistance (Agency Attch. 1).n1
The Agency argued that these two letters represent binding agreements
between the Agency and DHR and as such DHR owed the Agency the benefit
from DHR's 80 years of rent-free office space. The Agency concluded
that it "paid for the portion that (the Agency) occupied the entire cost
of that building for its useful life" and, therefore, the disallowance
is proper. Tr., p. 18.
We find the Agency's argument unpersuasive. As DHR pointed out in
its brief (see, DHR Reply, p. 2), a close reading of these two letters
show that they contain no promises, but instead contain certain
information pertaining to the leases in question provided in response to
requests by Agency officials. Neither letter contains any substantial
indicia of a binding agreement between the parties, nor did the Agency
provide any evidence which shows that these letters were the basis of
the final agreement between the Agency and DHR or were incorporated into
the final agreement. Without evidence to show that these letters were
sent for reasons other than providing information or as part of a
process of negotiation, we are unable to conclude that these two letters
had the status of binding agreements between DHR and HHS.
Even if these letters arguably were to be considered as unilateral
(5) commitments, it is clear that the letters simply do not say what the
Agency is representing. Both letters state that DHR will have rent-free
space upon retirement of the bonds. The letters also state that DHR has
an option to renew its lease for additional 2-year periods up to a total
of 100 years. The Agency apparently interpreted these two provisions
together to mean that DHR is promised 80 years of rent-free space after
the 20 year period during which the bonds would be retired. However,
there is nothing in these two letters or in the record of this case
which states that DHR is required to exercise the option under the lease
for the entire 100 years, nor are there any statements of conditions
which must exist before DHR could decide to forego the option. The
letters do not guarantee that DHR will exercise the option for the
entire 100 years nor do they provide for any penalty if DHR fails to
exercise the option. Therefore, even assuming that these letters were
binding commitments, we find that they do not provide the promises or
bases for remedy that the Agency alleged.
2. Whether the Provisions of the ESM Can Be Applied to this Case
The Agency contended that the provisions of the ESM could be applied
here to require an adjustment to DHR's rental rate in the new building.
/2/ The Agency again cited the March 13, 1951 letter from V. E. Earnes
to John L. Craig, pointed to a reference in that letter to paragraph
2525 of Part IV of the ESM, and stated that this reference shows that:
Kentucky's V. E. Barnes recognized that the Employment Security
Manual, promulgated by the predecessor agency to the U.S. Department of
Labor, was applicable to the financing of the old building.
Agency Response, pp. 3-4.
The Agency then argued that the ESM was made applicable to DHR's
arrangement with HHS "as it was referenced in the March 13, 1951 letter,
a copy of which was sent to an official of a predecessor agency of HHS."
Id. at p. 4, n. 3.
We find the Agency's position untenable. As stated above, this
letter was written providing certain information in response to a
request (6) by a Department of Labor official. The letter clearly
states that the information was provided "as required by Paragraph 2525
of Part IV" of the ESM. There is absolutely no mention of the
applicability of the ESM to any agreement between the Bureau of Public
Assistance (BPA) (or any other predecessor to HHS) and DHR. To attempt
to bind DHR to the provisions of the ESM merely because the letter and
supporting documents were forwarded to a BPA official is unreasonable.
Although we have no indication in the record of this case of exactly why
the letter was sent to BPA, it is clear from the letter itself that
there is no mention of the BPA being bound by the ESM. Therefore, since
this letter contains no statement binding a HHS predecessor agency to
the provisions of the ESM, and there is no other evidence in the record
to support such a binding effect of the ESM, we find that the Agency has
failed to show that DHR was bound to the provisions of the ESM in
relation to HHS.
3. Whether the Handbook of Public Assistance (HPA) is Applicable to
This Case
a. Whether DHR Was Subject to the HPA
The Agency stated that, contrary to what the audit report and
disallowance letter had first indicated, the proposed adjustment was not
computed in accordance with the HPA. However, the Agency maintained
that DHR was bound by the provisions of the HPA. Agency Response, p. 6.
DHR contended that it was not bound by the provisions of the HPA.
DHR stated that there is no evidence that the HPA ever was included in
the State Plan for public assistance or in the lease agreement. DHR
Reply Brief, p. 8; see also, DHR Appeal Brief, p. 10. DHR argued that
in the absence of a published administrative regulation or evidence of
incorporation of HPA section 4532.5 in the State Plan or other
correspondence between the parties, the Agency "has no basis to apply
the HPA to federal financial participation in rental costs for the
Capitol Annex." DHR Appeal Brief, p. 10. DHR argued further, citing
Morton v. Ruiz, 415 U.S. 199 (1974), that in analogous situations, the
courts have prevented federal agencies from enforcing rules which were
not published under the Administrative Procedure Act (APA), 5 U.S.C.
552, and not otherwise communicated to the party against whom the rule
is sought to be enforced.
DHR subsequently conceded that the HPA was in existence at the time
the leases were executed and that the HPA was transmitted to the
Commonwealth of Kentucky. DHR Reply Brief, p. 10. Under APA section
552(a), publication is not required to bind a party to an Agency policy
where (7) there is actual notice of the policy. /3/ DHR even appeared
to admit in its early briefs that the Agency's communication of the HPA
to Kentucky would be sufficient to bind it to the HPA's terms. See, e.
g., DHR Appeal Brief, p. 10. Accordingly, the Board finds that DHR had
actual notice of the provisions of the HPA and was bound by its terms.
b. Whether HPA Section 4535.5 Can Be Applied Retroactively to DHR
Since DHR had notice of HPA section 4532.5 as of January 7, 1955 it
was bound by its terms as of that date. We now address the question of
whether HPA section 4532.5 can be applied retroactively to 1952, the
first year DHR leased space in the Capitol Annex.
DHR contended that a transmittal, entitled "State Letter #236" (DHR
Reply Brief, Attch. 1) from the Bureau of Public Assistance, dated
December 23, 1954 and apparently received by Kentucky on January 7,
1955, specifically referred to HPA section 4532.5 and stated in part
that:
The revised policy continues to permit the spread of rental charges
for the cost of purchase or construction over a period less than the
life expectancy of the building within the limit of comparable rental.
However, a new condition has been established in this connection. In the
event the state agency vacates a building, an adjustment of the Federal
funds will be required if the rental rate was computed on the basis of a
period shorter than the expected life of the building. The life
expectancy for all buildings will need to be determined when a rental
rate is to be based on the spread of costs in accordance with comparable
rental. (DHR's emphasis)
DHR asserted that this transmittal is evidence that prior to December
23, 1954 there was no federal requirement for an adjustment of funds,
and the transmittal was received after the date that the leases were
entered into for the Capitol Annex. DHR argued that to apply the HPA to
an agreement between DHR and HHS, the HPA would have had to have been
incorporated into the State Plan or the parties would have had to agree
through other correspondence to apply a specific provision of the HPA.
DHR asserted that, otherwise, the agreement between DHR and (8) HHS
could be unilaterally changed by HHS with a subsequent change of the
HPA. DHR argued that such a change would violate DHR's 10th Amendment
Constitutional rights.
The Agency asserted that the publication of HPA section 4532.5 did
not create a new wrong but "provided a more specific remedy for what was
an existing wrong." Tr., p. 21. The Agency argued that analagous
situations under the Medicare program were upheld by the courts and
concluded that the retroactive application of HPA section 4532.5 to DHR
is not unconstitutional. Id. The Agency argued further that even if the
Board finds that HPA section 4532.5 cannot be applied retroactively, it
should be applied to the payments after its communication to DHR, i.e.,
the payments beginning in 1975.
In reviewing the case law concerning the legality of retrospective
application of statutes, rules and regulations, one finds that those
cases in which such an application is held illegal reach that result
essentially on the basis of the undue burden resulting to the
plaintiffs. Thus, where there was justifiable reliance upon an old rule
and a severe financial burden would occur if that reliance were
frustrated, retroactive application of a new rule was not allowed.
Essential Communication Systems Inc. v. AT&T, 446 F. Supp. 1090 (D.N.J.
1978), rev'd on other grounds, 610 F.2d 1114 (1979); Coe v. Sec. of
HEW, 502 F.2d. 1337 (4th Cir. 1974).Retroactivity was not allowed where
it would produce a harsh result and change prior settled law that had
been relied upon. Anderson, Clayton & Co. v. U.S., 562 F.2d. 972 (5th
Cir. 1977), reh. and reh. en banc denied; cert. denied, 436 U.S. 944
(1978).
But many retroactive applications have been upheld by the courts.
Retroactive application has been upheld where the regulation was
curative and the results were not oppressive, Hazelwood Chronic &
Convalescent Hospital v. Weinberger, 543 F.2d 703 (9th Cir. 1976),
vacated on other grounds, 430 U.S. 952 (1977), 434 U.S. 811 (1977);
Summit Nursing Home Inc. v. U.S., 572 F.2d 737 (Ct. Cl. 1978); Daughters
of Miriam Center for the Aged v. Mathews, 590 F.2d 1250 (3d Cir. 1978).
The Ninth Circuit stated that it is reasonable to have ongoing
adjustment in a program that distributes federal subsidies. Hazelwood,
supra, at 708. Other considerations stated by the courts are how the
regulatee's conduct would have differed if the regulation had been
applied originally, Adams Nursing Home of Williamstown Inc. v. Mathews,
548 F.2d. 1077 (1st Cir. 1977); and whether the rule has a rational
basis, Springdale Convalescent Center v. Mathews, 545 F.2d 943 (5th Cir.
1977); Usery v. Turner Elkhorn Mining Co., 428 U.S. 1 (1976).
(9) In applying these factors to the present case, the Board finds
that HPA section 4532.5 may be applied retroactively to the date that
the leases were executed. The retroactive effects of HPA section 4532.5
were limited and reasonable. Its operation was triggered by a
subsequent act: a grantee's leaving a facility prior to providing the
Agency a return for the accelerated payments. If the grantee had
remained in the facility there would have been no recapture of the
accelerated payments. Therefore, the provision was curative and
necessary as it provided the Agency with a remedy against grantees that
took advantage of the accelerated payments but failed to provide the
Agency with a corresponding benefit. See, Hazlewood, supra.
DHR's rights under its agreement with HHS were unaffected. There is
no indication that DHR protested or disagreed with the contents of HPA
section 4532.5 or its possible application to DHR. Nor is there any
evidence that DHR attempted to avoid the recapture provision. In fact,
DHR exercised its option under the lease agreement to renew the lease
every two yers approximately 10 times subsequent to the issuance of
section 4532.5 and while DHR was on notice of its content. There is no
evidence in the record to indicate that DHR was prejudiced or unduly
burdened in any way by the implementation of HPA section 4532.5.
It is also clear that DHR's conduct would not have changed
significantly had section 4532.5 been in effect at the time the lease
agreeements were executed.Over the lifetime of an asset there is little
difference between accelerated and straight-line depreciation; higher
payments generated by the accelerated method in early years are recouped
by reduced payments later. /4/ HPA section 4532.5 is designed to leave
DHR no better - and no worse - off than if DHR had chosen the
straight-line method in the first place.
We also agree with the Agency that section 4532.5 merely codified
what would reasonably be expected if DHR abandoned the Capitol Annex
prior to providing the Agency a return for the accelerated payments, i.
e., payment for excess amounts provided for retirement of the bonds.
/5/
(10) DHR had the benefit of accelerated payments in return for which
the Agency would benefit from virtual rent-free space after retirement
of the bonds. The Agency fulfilled its full share of the agreement but
in return received only the benefit from DHR's five years of rent-free
space. /6/ Basic equity would require that an adjustment is due the
Agency and section 4532.5 recognizes just such an adjustment. It places
the parties in a position as if the accelerated payments were never made
while providing an adequate payment in recognition of the services
provided. We find that such an adjustment is reasonable, fair, and
called for under the facts of this case.
In finding that the HPA may be applied to the facts of this case on a
retroactive basis, we find unpersuasive DHR's argument that this allows
the Agency to effect a unilateral change in an agreement by promulgating
a change in a regulation or issuing a new policy statement. As we
stated in determining whether this provision could be applied
retroactively, courts have allowed a retrospective application where the
substantive rights of the parties are unaffected. However, if the
effect of a new policy is that it changes the agreement the parties are
operating under, the Board will not apply that policy, but will apply
the policy in effect at the time the agreement was consummated. See,
e.g., New Mexico Department of Human Services, Decision No. 211, August
31, 1981. But in this case, we find that DHR's antecedent rights were
unaffected substantially by the application of HPA section 4532.5.
(11) B. Applying HPA Section 4532.5
Having found that HPA section 4532.5 can be applied retroactively to
the facts of this case, it is now necessary to compute the adjustment
provided for in that provision.
Section 4532.5 permits the state agency to:
secure the cost of the building at a more rapid rate than if the cost
were spread on the basis of the life of the building.
It states further that once the cost of the building is defrayed,
only the costs of service and maintenance may be charged. Neither party
argued that DHR did not comply with these two provisions. Indeed the
record shows that DHR received FFP at an accelerated rate sufficient to
retire the bonds and upon payment of the bonds charged the Agency only
for maintenance costs.
It is also not in dispute that DHR vacated the Capitol Annex prior to
the end of its useful life. In such a case section 4532.5 requires an
adjustment of the federal funds that the state agency received. The
adjustment is:
The amount of funds that the State agency received on the comparable
rental basis, as compared to the amount of funds that it would have
received had the initial cost of the building actually been spread in
accordance with the life of the building....
In response to questions raised by the Board, the Agency explained
that the "comparable rental rate" was never established in this case
because there was no comparable rental property in Frankfort, Kentucky -
the location of the Capitol Annex. Agency's June 28, 1982 Memorandum,
p. 5.
The Agency stated that the comparable rental is used as a maximum
rental which the accelerated rate cannot exceed. The Agency stated that
in this case:
the rate established to liquidate the bond and interest coupons was
assumed to be less than the maximum allowable "comparable rental rate."
Id.
(12) Using the Agency's explanation of the "comparable rental rate",
our interpretation of section 4532.5 is that it envisions an adjustment
which would recoup the difference between the amount paid on an
accelerated basis and the amount that would normally be paid on a
straight-line depreciation method.
Although the Agency initially detailed the calculation of the
disallowance and stated that it was calculated in accordance with HPA
section 4532.5 (id. at p. 4.), as we previously stated the Agency later
conceded that this was not the case. Tr., p. 17. However, the Agency
maintained that the adjustment in section 4532.5 requires not only a
calculation based on historic costs but also a calculation of the future
benefits the Agency would have received had DHR continued to occupy the
Capitol Annex. Agency Response, p. 10.
We find that section 4532.5 does not provide for any calculation of
future benefits and that any such calculation would result in a double
penalty to DHR. Section 4532.5 contains no mention of an adjustment
concerning potential benefits to the Agency. The language of section
4532.5 is in the past tense, "an adjustment of the Federal funds that
the agency received" (emphasis added), which necessarily implies that
the adjustment deals solely with historic costs. Indeed an example of
the adjustment is provided which shows a calculation based on historic
costs (see, section 4532.51).
In addition, the Agency's proposed adjustment would result in a
double penalty to DHR. The Agency is requesting an historic adjustment
- placing the parties in a position where straight-line depreciation is
provided and, therefore, no accelerated payment - and a future
adjustment which requires DHR to provide the benefits of rent-free space
even though the Agency seeks to deprive DHR of the benefit of the
accelerated payments. This would result in a windfall to the Agency, a
windfall not supported by the HPA or any other policy statement produced
by the Agency.
DHR presented a calculation of the disallowance which shows DHR owing
the Agency an adjustment of $133,528. This figure differs not only in
amount compared to the Agency's disallowance of $202,262, but also in
that it is a one-time adjustment while the Agency's figure represents a
four year period and would require subsequent adjustments for a period
of 21 years. As we stated above, we find that the one-time adjustment
as proposed by DHR is the adjustment contemplated by the HPA; however,
as discussed below, more information is required to compute the actual
adjustment.
(13) DHR's calculation was as follows:
Cost Cost % Yrs.
Allowance (1) Construction Cost
$6,028,619 2 25 $3,014,310 Additions 1973-74 $
9,282 2 4 $ 743 1974-75 $ 162,286 2
3 $ 9,737 1975-76 $ 149,757 2 2 $
5,990 1976-77 $ 81,323 2 1 $ 1,626 TOTALS
$6,431,267 $3,032,406
(2) Ratio HHS floor space to total floor space (31,041/300,820)
10.32% (3) Use Cost Applicable to HHS programs (1 X 2)
$312,944 (4) HHS participation at 50%
$156,742 (5) Amount of bond retirement cost charged to HHS programs
$290,270 (6) Excess of bond retirement over use allowance
$133,528
DHR Appeal Brief, p. 13.
The Agency did not directly dispute DHR's overall calculation of the
historic portion of the HPA's adjustment. However, the Agency
specifically questioned two of the figures used by DHR in its
calculation: the 31,041 of square feet of office space occupied by
Public Assistance (PA) programs in the Capitol Annex (line 2 of DHR's
calculation above), and the $290,270 of bond retirement cost charged to
the Agency (line 5, supra). We examine these figures separately below.
1. The Amount of Office Space Occupied by PA Programs
The Agency disputed DHR's use of 31,041 square feet as the amount of
area occupied by HHS-supported PA programs. The figure was derived from
a schedule (DHR Appeal Brief, Tab 13) which shows the amount of square
footage occupied by the Labor department component and HHS-funded
programs. The Agency noted, however, that the schedule contains a note
written by Roy Wainscott, an HHS auditor, dated November 9, 1979, which
states:
(14) This schedule is not accurate. Staff percentages (ratios BES
employees to PA employees) has been 50/50 for 20 years.... Therefore,
PA's actual payments were greater than finances (Department of) showed
and conversely BES' payments were less.
The Agency contended that the correct square footage for PA programs
is 58,344. Mr. Wainscott testified that in performing the audit, the
records pertaining to the Capitol Annex were non-existent. Tr., p.
339. Therefore, he used the best evidence available to determine the
occupied space. Mr. Wainscott stated that based on his own experience
from having worked in the Capitol Annex since 1966, and conversations
with DHR employees with regard to the ratio of PA staff to Labor
employees, he concluded that PA occupied 50% of the space. See, e.g.,
Tr., p. 426. He stated that he applied the 50% to the 116,688 figure
contained in the leases to determine the PA occupied space. Id. at p.
454.
The question of which figure is correct is a factual issue in
relation to which the Board had to weigh flawed and conflicting
evidence. Both parties' evidence raised questions which are not well
answered in the record; but on balance, we find the DHR's evidence more
persuasive. The Agency was unable to show that Tab 13 was a fatally
inaccurate assessment of PA occupied space during the critical time
period. Since Tab 13 was compiled from source documents (Tr., p. 205),
we find that this figure is inherently more accurate than the Agency's
inexact and unsupported judgmental method of allocating space based on
the number of employees. Therefore, DHR's figure of 31,041 square feet
should be used in determining the adjustment under the HPA. We review
the parties' evidence separately below.
a. DHR's Calculation of PA Occupied Space
Tab 13 is a schedule which contains a breakdown of the bond
retirement costs of the Capitol Annex. The schedule covers fiscal years
1953-72 and includes the square footage occupied by both PA and BES
(Labor) during those years.
James A. Fleming, Director, Division of Fiscal Services, DHR,
testified that he personally prepared the document known as Tab 13. He
stated that the document was prepared pursuant to a request by James A.
Moore, former head of Fiscal Operations for DHR, for the purpose of
determining "the relative participation in space in the Capitol Annex."
Tr., p. 205. Mr. Fleming testified that in preparing Tab 13 he "used
the source document plus the joint cost books and went back and started
in 1953 and brought it forward to 1972." Id.
(15) The Agency questioned the accuracy of the figures shown on Tab
13. Mr. Wainscott testified that in conducting the audit of DHR for
1975 through 1979, he found DHR's accounting records "so bad that we
could not render an opinion on the reliability of the accounting
records." Tr., p. 399. With regard to the accounting records pertaining
to the Capitol Annex, Mr. Wainscott stated that the records "were not
even in existence." Id.
However, on cross-examination Mr. Wainscott conceded that he could
not express an opinion on DHR's accounting system during the period
covered by Tab 13 since the records were non-existent. Id. at p. 456.
The Agency also produced the testimony of Charles Popp, an Agency
auditor, who testified as to the general reputation of DHR's accounting
records after 1974. Mr. Popp stated that DHR's reputation was of having
"unreliable" records. Tr., p. 381.
DHR objected strenuously concerning the relevance of testimony about
DHR's accounting records after 1970. DHR contended Tab 13 involved
source documents for the years 1953-70 and, therefore, testimony about
events outside that period is irrelevant.
We agree with DHR that the operative years were 1953-70. However,
the Agency was apparently arguing that there was a pattern of poor
accounting practices by DHR and was attempting to show this pattern by
means of the findings in the 1975-79 audit and testimony concerning the
reputation of DHR's accounting records for periods prior to 1975. To
the extent that the Agency could establish such a pattern of poor
accounting practices the evidence was relevant; but since the time
periods of supposed comparison were so different, we are compelled to
give less weight to such evidence than we otherwise might.
We find that the Agency failed to establish a pattern of poor
accounting practices during the years 1953-70 sufficient to condemn
DHR's case. DHR conceded that its accounting records were "unreliable"
for the period of 1975-79. See, e.g., Tr., p. 372. DHR stated that
these problems were the result of a reorganization placing the many
departments under an umbrella organization. Id. at p. 372. The Agency
was unable to produce any substantial evidence of the unreliable nature
of DHR's accounting system during the period 1953-1970. Although the
Agency continually referred to previous audit reports concerning this
period which described DHR's poor accounting system, none as produced.
One Agency witness, Edwin A. Schulz, Associate Regional Representative
in 1965, testified that he reviewed financial audits for that period
(16) and could not recall any "major disallowances during that period."
Tr., p. 499. Since the Agency was unable to produce any substantial
evidence of DHR's allegedly unreliable accounting records during the
period 1953-70, we find that it is unreasonable to assume that poor
accounting practices that existed during the years 1975-79 necessarily
existed for years prior to that period.
The Agency also contended that a grantee has an obligation to
maintain its records. However, those requirements are for a period of
three years or, if an audit has begun, until the completion of the
audit. See, e.g., 45 CFR 205.145 (1975). The Agency did not show that
DHR was required by this provision to maintain the records that are now
admittedly non-existent. In fact, it does not appear that DHR was
required to maintain these records. The records covered the period
1953-70. The Agency did not begin its audit until 1979. The records
were at least 9 years old before the audit began. Since DHR apparently
was not required to maintain these records, the fact that these records
are no longer in existence does not reflect negatively on DHR's
accounting system.
The Agency also asserted that Tab 13 was inconsistent with other
documents in the record and was internally inconsistent. The Agency
noted Mr. Wainscott's handwritten note on the document which states that
the document is inaccurate. See, p. 14 of decision. However, Mr.
Wainscott testified later that when he wrote this note he was not aware
that this schedule was based on any source documents and, therefore, his
observation was based on his belief that the ratio of PA to Labor staffs
was approximately 50/50. Tr., p. 473. Therefore, his statement on the
document was not aimed at the figures themselves or how they were
obtained, but was directed at determining the square footage
attributable to the programs based on the next best evidence, staff
ratios.
The Agency also stated as a basis for believing that Tab 13 was
incorrect that the total square footage shown to be occupied was less
than the 116,688 figure noted in the March 13 letter (DHR Appeal Brief,
Tab 4) as the minimum amount of space to be occupied. Tr., pp. 438-39.
The Agency did not develop this argument beyond this mere statement. In
any event, we fail to see how this bears on the accuracy of the figures
themselves. At most it raises an issue of whether DHR complied with the
terms of its lease agreement. This is not an issue in this dispute.
There was also a great deal of testimony and evidence on the wide
fluctuation in the bond retirement rates during the period 1953-1970.
Even if the Agency's argument were accepted that this variation leads to
questions about the validity of the bond retirement figures, this does
not bear (17) on the question of the accuracy of the square footage
computations. As Agency counsel stated, the bond retirement rates would
bear on the validity of the computation of the $290,270.33 figure given
for the Agency's participation. Tr., p. 260. See discussion at p. 18
below.
b.The Agency's Determination of PA Occupied Space
Mr. Wainscott testified that after he was unable to determine from
source documents the amount of space PA occupied, he used the next best
evidence, i.e., an extrapolation from the ratio of PA employees to Labor
employees. See, e.g., Tr., p. 473. He stated that based on his own
experience and on conversations with DHR staff accountants, the "staff
percentages were 50/50." Id. at p. 453. Mr. Wainscott stated that it
seemed reasonable to him that employees would occupy approximately the
same amount of space. Id. at 452. Therefore, he applied the 50% to the
116,688 to determine that PA programs occupied 58,344 square feet.
DHR argued that Mr. Wainscott misused the staff percentage in that
"staff percentages" is a limited term as used by DHR referring to
staff
who work on more than one program. See, e.g., Tr., pp. 80-82. DHR
produced testimony of numerous DHR accountants which established that
"staff percentages" were used in distributing office space for staff
who
worked on more than one program. Office space occupied by one program
was distributed based on actual space occupied, not staff percentages.
See, Tr., pp. 82, 110, 117.
The Agency contended that Mr. Wainscott used the term "staff
percentages" merely to indicate a ratio of employees of PA to Labor and
not in reference to the percentage of time spent by staff personnel
working on public assistance programs and Labor programs. Agency's
March 4, 1983 Reply, p. 2.
We are not persuaded by the Agency's explanation of Mr. Wainscott's
use of the term "staff percentages." Mr. Wainscott formed his opinion
as
to the ratio of PA employees to Labor employees based largely on
conversations with DHR accountants. In talking with the accountants,
Mr. Wainscott asked them what the staff percentage ratios were. The
accountants replied "50/50". See, e.g., Tr., p. 454. However, Mr.
Wainscott's interpretation of their response was based on a different
definition of staff percentages. He believed it to mean the entire
staff while they responded with regard to staff working on more than one
program. Id. Therefore, the premise for Mr. Wainscott's determination
that PA occupied 58,344 square feet was at least questionable if not
actually incorrect.
(18) The Agency also argued that even assuming that Mr. Wainscott was
incorrect in his understanding of "staff percentages", PA still had
as
many or more employees than Labor (See, DHR Hearing Ex. 5) and,
therefore, Labor could not have occupied twice as much space. Agency's
March 4, 1983 Reply, p. 2. The Agency noted that DHR does not dispute
that PA and Labor had approximately the same number of employees and,
therefore, Mr. Wainscott's basis for determining the square footage,
that employees occupy approximately the same amount of square feet, was
correct.
The document the Agency is relying on to show that PA and Labor
department employees are approximately equal in number (DHR Hearing Ex.
5) also shows square footage figures that support DHR's determination.
The Agency did not offer any support for its figure other than its
deduction that, with everything else being equal, people occupy
approximately the same amount of space. However, the space in question
was not occupied solely by people; the space was also occupied by files
and machines. There was much testimony on both sides on the amount of
files and machines kept by the PA and Labor departments. See, e.g., Tr.,
pp. 150, 424. However, this testimony was not conclusive as it lacked
actual figures and was based merely on perceptions and memories -
relating to a period beginning 30 years ago (although, on balance we are
inclined to find more persuasive the testimony of DHR's own managers
about how DHR occupied its space in the building). The Agency's opinion
evidence, balanced against a document based on source information is
unpersuasive.
2. The Amount of Bond Retirement Costs Charged to HHS Programs
The Agency disputed DHR's use of $290,270.33 (see, line 5 of DHR's
calculation, p. 13 of decision) as the amount of bond retirement costs
charged to the Agency. The Agency stated that DHR was inconsistent in
its claims as to the Agency's share of the bond costs. The Agency
pointed to a letter dated April 5, 1977 from the Executive Director of
DHR to an Agency official (DHR Appeal Brief, Tab 15) and asserted that
the Executive Director represented the Agency's share as $225,343.92.
The Agency asserted that DHR was "uncertain as to the amount of bonds
involved" and in general DHR had problems with "incorrect financial
records." Agency Response, pp. 10-11.
DHR asserted that the correct amount of HHS' share of the bond
retirement costs was $290,270.33 as stated in its briefs and in a letter
from DHR Commissioner Deitz to the Agency's Associate Regional
Commissioner (Agency Response, Attch. 4). DHR stated that this figure
is not inconsistent with the $225,343.92 figure as the latter figure did
not include interest. DHR Reply Brief, p. 12. The Agency did not
address DHR's explanation.
(19) William Esenbock, Manager of Accounting for DHR, testified that
the $290,270.33 figure was derived from Tab 13. Tr., p. 256. Tab 13
supports DHR's assertion by showing the total federal share as
$290,270.33 and, without interest, as $225,343.92. Therefore, there is
no basis in the record for the Agency's claim that DHR was inconsistent
in its representation of the Agency's share of the bond retirement
costs.
However, the Agency also questioned the accuracy of the $290,270.33
figure as shown on Tab 13 on other bases. The Agency's argument
centered on the fluctuation in the figures under the column headed
"Rates Bond Retire" contained in Tab 13. The Agency apparently accepted
DHR's explanation (see, DHR's February 11, 1983 Supplemental Brief),
that this column represents the portion of the rental costs used to
retire the bonds. See, Agency's February 11, 1983 Response Brief. The
Agency asserted, however, that the rental rates shown in Tab 13 are less
than the rental rates charged in accordance with the lease agreements.
Apparently, the Agency meant that DHR computed the $290,270.33 using
rental rates that were lower than the rates actually charged the Agency
in accordance with the lease agreements, which would result in a lower
total for how much the Agency participated at the accelerated rate.
This lower total would in turn result in a smaller dollar adjustment
under the HPA. The Agency did not provide a calculation of what it
believes the federal share was.
DHR contended that the variation in the rental rates shown in Tab 13
was caused by the build-up of a reserve account. DHR's Supplemental
Brief, p. 4. DHR submitted documentation which supports its contention
that an escrow account was formed and that part of the rental charge was
funneled into the account. Id. at Attchs. B-F.
The Agency conceded that an escrow account existed. Agency's
Response, p. 3. Again, it is not exactly clear what the Agency was
arguing, but apparently the Agency contended that DHR's documentation
and explanation of the escrow account is irrelevant because it does not
show that the escrow account was used to reduce the rental rate. Id.
Therefore, the existence of an escrow account does not explain why the
rental rates shown in Tab 13 and used to calculate the amount of federal
participation are less than the rental costs called for in the lease
agreements. The Agency noted that DHR Hearing Exhibit 7 shows that
rental costs charged were those called for in the lease agreements.
The Agency's argument does not affect fiscal years 1953-60. For
those years rental rates shown in Tab 13 correspond to the rental rates
called for in the lease agreements. Beginning in fiscal year 1961,
however, the rental rate shown in Tab 13 drops precipitously. DHR
explained (20) that this decrease occurred because DHR was advised to
use a portion of the escrow account to offset the rental charges. See,
DHR Supplemental Brief, Attch. F. DHR blamed further fluctuations in the
rental charges on changes in the maintenance and operating reserves.
Id. at p. 5.
Since DHR stated that the rental rates were reduced below the $1.50
and $2.00 figures shown in the documents before the Board as the rental
rates in the lease agreements, the question becomes whether these
reduced rates were charged to HHS programs or, as the Agency alleged,
whether HHS continued to reimburse based on the higher amounts.
We find that there in nothing in the record to conclusively answer
this question. The Agency argued that DHR Hearing Exhibit 7, pp. 3-4
supported its position that the Agency was charged the higher rates of
$1.50 and $2.00 as called for in the lease agreements. However, that
document covers the period through 1960 and is consistent with the
figures shown in Tab 13. The Agency also contended that p. 2 of Exhibit
7 shows that total rental paid remained relatively stable for the years
1953-60 and, therefore, there was no drop in the rental rates charged.
Again, however, this is consistent with the figures shown in Tab 13 that
rates remained constant through 1960. It was not until 1961 that the
rental rates dropped noticeably. Therefore, DHR Hearing Exhibit 7 does
not support the Agency's contention that it was charged the higher
rates.
In reviewing the record of this case we find no evidence to suggest
that the Agency was charged a higher rental rate than what is indicated
in Tab 13. In fact, DHR Hearing Ex. 7, p. 7 indicates, as Tab 13 does,
that the Agency was charged rates lower than the $1.50 and $2.00 the
Agency alleged was called for in the lease agreements for the years
1961-70.
As we previously stated (see, p. 14 of decision), Mr. Fleming
testified that Tab 13 was prepared from source documents. Tr., p. 205.
He stated that in his professional opinion the records were reliable.
Id. at p. 206. He also stated that, to his knowledge, the records no
longer exist. Id. However, as we stated above, DHR had no obligation to
retain those records and, therefore, is not responsible for their
production at this time.
Therefore, since Tab 13 was prepared from source documentation, since
the Agency has been unable to produce any substantial contradictory
evidence, and since the Agency has not persuaded us that the figures
contained in Tab 13 are inaccurate, we find that the federal share of
the bond retirement cost was $290,270.33. This figure, should be used
in calculating the amount of the disallowance under the HPA.
(21) C. Summary of Holding and Remand on Central Office Costs
In summary, we have determined that:
(a) HPA section 4532.5 is the applicable standard here;
(b) HPA section 4532.5 calls for a one-time adjustment based on
historic costs; and,
(c) the adjustment should be calculated using 31,041 as the square
footage occupied by PA and $290,270.33 as the federal share of the bond
retirement costs.
Based on the foregoing, we remand this portion of the disallowance to
the Agency to recalculate the amount of the disallowance in accordance
with the HPA.
II. Credit Union Costs
The Agency disallowed $130,836 in FFP for the period July 1, 1974
through June 30, 1979 claimed in relation to the operation of a credit
union on behalf of DHR employees. The Agency stated that the money
represented the salaries of eight employees who operated the credit
union and other various expenses. Agency's June 28, 1982 Memorandum, p.
10.
The audit report found that the credit union had assets in excess of
5 million dollars and paid dividends ranging from 6.6% in 1976 to 8.75%
in 1979. Audit Report, p. 34. The report stated further that these
dividends were treated as a credit union expense and that after their
payment there was no remaining income from which to pay the operating
expenses of the credit union. Id.
The Agency disallowed DHR's claim for the operating expenses stating
that the costs: (1) did not conform to the requirements of 45 CFR Part
74, App. C, II.B.14; and, (2) were not reasonable and necessary for the
proper and efficient administration of the grant program (45 CFR Part
74, App. C, I.C.1.a.). /7/ Agency's June 28, 1982 Memorandum, p. 11.
(22) The Agency asserted that the costs did not meet the requirements
of App. C, II.B.14. That section states:
Employee morale, health, and welfare costs. The costs of health or
first-aid clinics and/or infirmaries, recreational facilities,
employees' counseling services, employee information publications, and
any related expenses incurred in accordance with general State or local
policy are allowable. Income generated from any of these activities
will be offset against expenses.
The Agency argued that this section does not contain a general
"catch-all phrase" and since the costs of a credit union are not listed,
such costs are not allowable. Agency's June 28, 1982 Memorandum, p. 12.