Gab Decision 118
September 30, 1980 University of California -- General Purpose Equipment
Docket No. 78-156 Coster, Clarence; Przybylinski, Donald Settle, Norval
Panel Chairman
The University of California (grantee) appealed a decision by the
National Institutes of Health (NIH) Grant Appeals Board, sustaining a
disallowance of $47,370 in costs claimed under Federal research
projects. The Public Health Services (PHS), constituent agency for
purposes of review of the NIH decision, was requested to respond to the
appeal, and, in particular, to respond to a number of specific questions
concerning the disallowance. Based in part on failure by PHS to be
responsive to these questions, the Board Chairman issued an Order
directing PHS to show cause why the disallowance should not be reversed
on the grounds set forth in the Order.
The two major substantive issues addressed in the Order were 1)
whether two portable freezers, included by auditors in a sample of
equipment items purchased by grantee with Federal funds, should have
been classified as "general purpose" equipment, and 2) whether PHS
properly determined the total costs of general purpose equipment
purchased without required approval by using a statistical projection.
In addition, the Order questioned Board jurisdiction over part of the
disallowance, since PHS had stated that the projected disallowance
included costs associated with contracts.
The PHS responxse to the Order has clarified the way in which the
sample findings were used to calculate the projected disallowance but
has failed to persuade us that the statistical method used in this
instance was reliable. In reaching this conclusion, we reject grantee's
position that a disallowance may not be projected from a sample. As
discussed below, sampling is a generally accepted audit technique, and
that technique may be applied, in certain circumstances, to establish
the amount of unallowable costs incurred by a grantee. On the other
hand, we have a duty to inquire into the validity of the particular
technique used and how it was used in each specific instance and may
determine, as here, that the technique as used does not provide a
reliable factual basis for a decision.
For reasons stated below, we also reverse the disallowance of the
costs of the portable freezers. We do not reach the jurisdictional
question raised in the Order since that question is rendered moot by our
decision on the substantive issues.
Background
The NIH Grant Appeals Board decision resulted from an appeal of a
determination by the Financial Advisory Services Branch (FASB), Division
of Contracts and Grants, NIH, based on an HEW (now HHS) Audit Agency
Report dated August 9, 1976. The auditors had selected a sample from a
listing of equipment purchased by grantee from July 1, 1973 to June 30,
1975 (FY'74 and FY'75) with funds from Federal research grants and
contracts. The listing consisted of 2,363 items in classifications with
significant proportions of items considered to be "general purpose"
equipment. In the sample of 172 items, the auditors identified 123
general purpose items and determined that grantee did not obtain
required approval for the purchase of 16 of these items. The auditors
estimated with a claimed probability of 90 percent that grantee had
purchased general purpose equipment costing at least $57,801 without
proper approval during FY'74 and FY'75, with the single most likely
estimate being $84,999, and recommended that grantee refund at least
$57,801.
Of the 16 sample items questioned by the auditors, 10 were acquired
with HEW funds. The FASB, NIH, first determined that 9 of these 10 were
unallowable and disallowed $53,676 based on an Audit Agency projection
that this was the single most likely estimate of unallowable costs for
all HEW projects for the audit period. The assurance factor for this
projection was stated to be 95 percent.
FASB later agreed that one of the 9 items was incorrectly identified
by the auditors as unallowable. The Audit Agency revised the figures,
concluding, with a stated assurance factor of 90 percent, that the
single most likely estimate of unallowable costs was $47,370. The NIH
Board upheld the disallowance in this amount. Since grantee has
accepted disallowance of the costs of six of the HEW items in the
sample, totalling $2,764, the actual amount in dispute is $44,606
($47,370-$2,764).
The NIH Board decision was based on two policy statements: a 1972
NIH Policy Statement, Grants for Research Projects, DHEW Publication No.
(NIH) 72-8, July 2, 1972, applicable only to NIH grants for research
projects, and a 1974 PHS Grants Policy Statement, DHEW Publication No.
(OS) 76-50,000, July 1, 1974. The 1974 Policy Statement was intended to
apply to "all transactions occurring after the date of publication"
with
respect to "grants made by . . . the Public Health Service." (p. 2.)
Grantee refers to Federal Management Circular (FMC) 73-8, Attachment A
(Principles for Determining Costs Applicable to Research and Development
Under Grants and Contracts with Educational Institutions), implemented
by HEA at 45 CFR Part 74, Appendix D, Part I, 38 FR 26275, September 19,
1973.
The 1972 Policy Statement discuses research and general purpose
equipment as follows:
Research equipment -- Allowable. Indiviual items costing $1,000 or
more must have been in the grant budget approved by the NIH or will
require prior approval . . .
General purpose equipment -- Allowable with prior approval by the NIH
awarding unit for items costing $200 or more. General purpose equipment
is defined as items which are usable for activities of the institution
other than research, i.e. office equipment and furnishings, air
conditioning, reproduction equipment, automatic data processing
equipment, etc. (p. 18.)
Paragraph J.13. of Part I of Appendix D to Part 74 (parallel to FMC
73-8) defines "permanent equipment" as "an item of property which
has an
acquisition cost of $200 or more and has an expected service life of one
year or more" and provides that --
a. General purpose equipment. Approval must be obtained to acquire
with Government funds any general purpose permananet equipment, i.e.
any items which are usable for activities of the institution other than
research, such as office equipment and furnishings, air conditioning,
reproduction, or printing equipment, motor vehicles, etc., or any
automatic data processing equipment.
b. Research equipment. Approval must be obtained to acquire with
Government funds any item of permanent research equipment costing $1,000
or more.
The 1974 Policy Statement refers to "project-specific" rather than
"research" equipment and (under the heading of "Costs")
states, "Prior
approval is required for project specific equipment purchases in excess
of $1,000 . . . and for general purpose equipment in excess of $300" (p.
14). Under "Property Management Standards" the following appears:
(1) Project-specific equipment refers to equipment which directly
facilitates the purposes of and is an integral part of the
grant-supported programs, such as laboratory research equipment.
(2) General purpose equipment refers to items of equipment that are
generally usable for activities in the institution other than the
technical, specialized activities supported by the grant, e.g. office
equipment, air conditioning, office furniture, reproduction equipment,
etc. (p. 51.)
It is unclear from the record which approval requirements were
applied by the auditors. The Audit Report cites FMC 73-8 as providing
that general purpose equipment is "any item usable for activities other
than research" and refers to the "Federal policy generally" that
such
equipment costing $200 or more must receive approval prior to purchase.
The Report does not specify how that policy was binding on grantee with
respect to all of its projects. The Report also cites the 1974 PHS
Policy Statement for the proposition that "HEW agencies increased the
minimum cost requiring approval to $300 . . . ." The NIH Board decision
relied on the 1972 NIH Policy Statement and the 1974 PHS Policy
Statement. In response to a question in the Board's Order relating to
whether PHS had approval for a deviation from FMC 73-8, arguably
required because PHS required advance written approval and FMC-73-8 does
not (see, FMC 73-7), PHS stated that this was irrelevant since the basis
for the disallowance was failure to obtain approval to acquire the
equipment. This appears to be contradicted, however, by Audit Agency
statements submitted with the PHS response, explaining that the
"guidance in FMC Circular 73-8 was used for all agencies, but was
supplemented by more specific criteria when appropriate." Lack of
consistency on this point does not affect our decision on classification
of the two freezers, as we find that none of the statements requires
that these freezers be classified as "general purpose equipment."
However, this lack does contribute to our doubt about the fairness of
projecting the auditor's sample findings to all of grantee's HEW
projects.
General Purpose Equipment
Grantee argues that the two portable freezers in the audit sample
should not have been classified as general purpose equipment requiring
approval because actual use of the freezers for research rendered them
unfit for general use. Grantee's documentation shows that one of the
freezers was used to store "specimens" and the other was used to store
"scientific specimens (antiserums, antigens)" and that each would
require expensive decontamination before being diverted to non-research
use. PHS does not dispute this, but argues that, since prior approval
must be obtained "to acquire" general purpose equipment, it is clear
that the question controlling classification of equipment is whether it
can be used for general purposes at the time acquired. We do not think
that this necessarily follows, however. The classification of the
equipment is separate from the timing of the approval process. None of
the policy statements cited by PHS, except statements not in effect
during the relevant time period, gives any specific guidance as to how
to treat equipment which is usable for general purposes at the time
acquired but which would not be usable for general puposes once
committed to a project.
Furthermore, as grantee has pointed out, one reason that the policy
statements are ambiguous is that some items of equipment, such as these
freezers, potentially fall into either the general pupose category or
the research/project-specific category. The policy statements do not
provide guidance as to which prior approval requirements apply to these
items.
The Board has, in several previous decisions, construed prior
approval requirements in favor of a grantee, on grounds that advance
approval requirements not plainly warranted by the nature of the case
should not be read into ambiguous provisions. St. Landry Parish School
Board, DGAB Docket No. 75-4, Decision No. 17, May 28, 1976; See, also,
Point Park College, DGAB Docket No. 75-12, Decision No. 16, May 20,
1976. Whether construing the prior approval requirements to include
these freezers is plainly warranted depends in part on the perceived
purpose of the requirement. There is no guidance in the PHS policy
statements or in the preamble to Part 74 as to what the authors of the
approval requirement intended. Grantee's position is that "only
equipment acquired with Federal funds which could later be used by an
institution for non-Federal activities outside the research functions,
is intended to be covered." (Application for Review, p. 3.) In light of
this, grantee suggests that the test for whether equipment is general
purpose rests on the established pattern of usage within the
institution. Grantee has stated, and PHS has not disputed, that
grantee's primary use of portable freezers is for activities which are
technical, specialized and research-related.
PHS "believes that the reason for the (approval) requirement is that
the Government does not want to supply items of general purpose
equipment to grantee/contractors . . . (because) they should have this
type of equipment on hand and ready for use prior to receipt of grant/
contract awards." This is, perhaps, one possible purpose of the
requirement. On the other hand, PHS has not shown that grantee did have
or should have had portable freezers ready for use on these projects
and, indeed, other portable freezers used for similar purposes might
also be contaminated. Thus, given the ambiguity of the policy
statements, and the circumstances of this case, we conclude that these
portable freezers were not general purpose equipment. Accordingly, we
reverse the disallowance of $684 in costs for the two freezers.
The Validity of Projection
Grantee does not challenge the validity of statistical sampling as an
audit technique in general but questions the propriety of basing a
disallowance on a projection from a sample. The NIH Grant Appeals
Board, with respect to use of extrapolation from a sample as a basis for
a disallowance, noted the "HEW practice which generally utilizes this
statistical sampling technique." (p.3.) The only authority cited on this
point was Chapter 6-70 of the HEW Grants Administration Manual,
Projection of Cost Disallowances Resulting from Systems Deficiencies
Reported by Audit. Chapter 6-70 dated April 20, 1978, was, as PHS now
admits, not applicable during the time period in question and is,
furthermore, intended solely as internal instructions to Department
staff. 6-70-40.
An Audit Agency letter, submitted with the PHS response to the Order,
cited Audit Instruction A-18, dated February 28, 1973, for the
proposition that the "HEW Audit Agency has long had a formal policy of
recommending financial adjustments on the basis of statistical samples."
(p.1.) That instruction was not, however, directed to, or binding on,
grantee and, moreover, was not a long-standing policy at the time the
affected grants were awarded.
Lack of specific provision, in the terms of grantee's research
agreements, for establishing cost disallowances through projection is
not necessarily grounds for reversing this disallowance, however. As
the Audit Agency points out, statistical sampling has been accepted, in
certain circumstances, as a basis for determining adjudicative facts.
Thus, the matter may be viewed as an evidentiary issue rather than as a
question of applicability of agency policy. The PHS position on this
has been somewhat inconsistent. While arguing that statistical sampling
could be used to establish an amount of unallowable costs, PHS took the
position in its response to the appeal that use of a sampling technique
was within the Department's audit responsibility and that, therefore,
the technique was not reviewed by the NIH Board. If an agency disallows
an amount determined through use of this audit technique, however, that
agency must accept responsibility for explaining the technique and
defending its validity as used in a particular case.
Grantee's Arguments
Grantee not only questioned in general the use of a projection from a
sample as a basis for disallowance but argued, in particular, that 1)
the legal effect of a refund to the Federal Government of the funds
disallowed would be that grantee was purchasing the equipment and the
projection provides an inadequate basis for determining what specific
equipment grantee would be acquiring title to; and 2) since the costs
are not identified to specific research agreements, grantee is not
afforded the opportunity to demonstrate that the costs are in fact
allowable.
As pointed out in the Board's Order, grantee's first argument fails
to consider that, generally, title to equipment purchased with grant
funds vests in grantee and grantee's accountability for equipment
purchased with Federal funds has for the most part been waived (see 45
CFR 74.134 (1974)). Furthermore, PHS agreed to pay grantee an equipment
use allowance calculated on the amount of the projected disallowance.
Thus, the effect of failure to identify what specific equipment grantee
would be "purchasing" with any refund would be minimal.
Grantee's second argument fails to consider that an adjustment was
made to the sample for costs which grantee demonstrated to be allowable
subsequent to the audit and that an adjustment to the projection was
also made. Assuming the sample to be representative of the universe and
the adjustment to the projection to be statistically sound, grantee
would not be harmed by the failure to identify the projected costs to
specific research agreements. Thus, our decision here is not based on
the lack of identification of costs to the specific agreements.
Grantee's arguments did, however, raise some question as to the
fairness of the technique and emphasize the need for determining whether
the sample was representative and the projection statistically sound.
The Sampling Technique
In response to the Order, PHS submitted an Audit Agency letter which
described the sampling technique as follows:
We selected an unrestricted random sample of 172 items in equipment
classifications which contained significant proportions of general
purpose equipment. All items which were not general purpose equipment
were not audited and treated as acceptable . . . . Eight of the 98 items
charged to HEW projects were found to be both general purpose equipment
and unapproved. In accordance with acceptable statistical procedures
for projecting the amount of unallowable costs in such cases, the total
unacceptable amount for the 8 cases was divided by 172 (the number of
sample cases) to determine the average amount of unacceptable cost per
item. This average amount was then multiplied by the 2,363 items in the
equipment classifications selected to arrive at the most likely estimate
of unacceptable costs. Standard statistical techniques were utilized to
determine the upper and lower limits at given levels of confidence.
(Audit Agency Letter, pp. 4-5.)
While this description clarified to a certain extent the manner in
which the sample was used, the letter failed to provide the detail,
specifically requested in the Order, regarding the method used to
calculate the disallowance and to make adjustments to the projection.
On the issue of whether the sample was truly representative of the
universe, PHS responded with a conclusory statement that the sample was
representative, unsupported by any analysis discussing sufficiency of
the sample size or the adequacy of an unrestriced random sample for
measuring these costs.
There are other considerations which support reversal here. This is
not a disallowance of costs associated with one particular project but
an extrapolation to all of grantee's HEW grant and contract projects
over a two-year period. There is nothing to clarify whether comparable
requirements applied to all of the projects in a binding way. The PHS
policy statements which applied to at least some of the projects
contained, as discussed above, ambiguous provisions. We note, in this
connection, that all of the disallowed sample items related to PHS
projects.
Further, as the projection was adjusted for questioned items
subsequently determined to be allowable, the given assurance factor
changed from 90 percent to 95 percent, then back to 90 percent.
Certainly, the assurance factor is critical in applying any statistical
evaluation. The fact that the assurance factor here varied casts
suspicion on the validity of the statistical technique used. A further
inconsistency arises from the fact that the Audit Agency recommended
disallowance of the minimum projected amount but PHS disallowed the
"most likely single estimate." PHS was specifically asked whether
this
was an acceptable accounting practice but responded only with vague
statements that it thought the choice of this figure was "reasonable and
fair."
Court Cases Distinguished
As discussed above, in certain circumstances, statistical sampling
may be used to establish an adjudicative fact. The cases cited by PHS
on this point are, however, distinguishable from this case.
In Georgia v. Califano, 446 F. Supp. 404 (D.Ga. 1977), a case in
which a Medicaid disallowance of excess physician fees was upheld, the
District Court concluded that the agency's use of statistical samples
there was not arbitrary and capricious, stating that "statistical
methods are well recognized as reliable and acceptable evidence in
determining adjudicative facts." 446 F. Supp. at 409. The Court further
stated, however, that --
. . . to find that statistics may be admitted as evidence of a
proposition is not to say that the statistical model will always be
conclusive. The weight which must be given to such statistical evidence
is necessarily one which must be considered by the fact finders in light
of the practical difficulties of obtaining a claim by claim review. In
the instant case, statistical sampling was the only feasible method of
audit (of) many thousands of claims submitted each month by each state .
. . . the State could present evidence to challenge the statistical
samples of HEW. The State maintains a copy of each physician's actual
claim. 466 F. Supp. at 410.
It appears that it would have been difficult for HEW to audit with
respect to each item of equipment purchased by grantee. Use of the
sampling method here may nonetheless be distinguished from its use in
the circumstances presented in Georgia. First, the sample items in
Georgia all related to the same program. Here, a number of types of
projects are involved and different policies applied to different types
and to the two grant years involved. In addition, the nature of the
factor audited is distinguishable. The burden of disproving an average
amount of physician overcharges is much less than the burden of
disproving, by actual documentation, an allegation of failure to obtain
approval for purchases of general purpose equipment, particularly where
the definition of "general purpose" is less than clear.
It should also be noted that in Georgia the Court's function was not
the same as that of this Board, which must make findings of facts.
Also, the State had failed to challenge the HEW sample during
administrative reconsideration of the disallowance. Grantee here
contested the use of the sample during the informal appeals process.
In the case of Rosado v. Wyman, 322 F. Supp. 1173 (D.E.D.N.Y. 1970),
the Court also qualified its reliance on statistical sampling, stating:
Statisticians can tell us with some assurance what the reliability
factors and probabilities are. Only the law can decide, as a matter of
procedural and substantive policy, what probabilities will be required
before the courts will change the status quo by granting a remedy. 322
F. Supp. at 118.
In Rosado, the Court accepted the statistical sample as valid but did
so partly on the basis that all parties had agreed that the results from
the sample would be treated as a uniform result for the entire universe.
PHS has not disputed grantee's statement here that it agreed to the use
of a sample only as a basis for recognizing managment deficiencies, not
as a basis for projecting the amount of a cost disallowance.
The Board decision in California State Department of Health, DGAB
Docket No. 78-69-CA-HC, Decision No. 55, May 14, 1979, is also
inapposite. That decision, like Georgia, involved Medicaid overpayments
and was based in part on the reasonableness in that situation of placing
a burden on the grantee of presenting evidence of actual claims. In the
California case, both sides agreed that it would be proper to utilize
projections from a sample (taken by the State). Therefore, that
decision is not controlling in this case where grantee challenges the
Audit Agency projection.
Conclusion
For the reasons stated above, grantee's appeal is sustained. The
holding does not, of course, preclude PHS from reauditing the costs
involved. In view of the length of time which has passed since these
costs were incurred, however, any further audit should be performed
promptly.
OCTOBER 04, 1983