oversight

Review of the Department's Oversight of Schools Participating in the William D. Ford Federal Direct Loan Program.

Published by the Department of Education, Office of Inspector General on 1998-09-25.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                          Review of the Department’s
                     Oversight of Schools Participating in the
                            William D. Ford Federal
                              Direct Loan Program




                                 FINAL AUDIT REPORT




                                Audit Control Number 04-70016
                                        September 1998




Our mission is to promote the efficient                     U.S. Department of Education
and effective use of taxpayer dollars                       Office of Inspector General
in support of American education                            Atlanta, GA
                              NOTICE

Statements that management practices need improvement, as well as other
conclusions and recommendations in this report, represent the opinions of
the Office of Inspector General. Determination of corrective action to be
taken will be made by appropriate Department of Education officials. This
report may be released to members of the press and general public under
the Freedom of Information Act.
                UNITED STATES DEPARTMENT OF EDUCATION
                              OFFICE OF INSPECTOR GENERAL
                                 61 FORSYTH STREET, Room 18T71
                                  ATLANTA, GEORGIA 30303

                                         September 25, 1998


MEMORANDUM

TO:            Marshall Smith
               Acting Deputy Secretary
               Office of the Deputy Secretary


FROM:          Carol S. Lynch
               Regional Inspector General for Audit

SUBJECT:       FINAL AUDIT REPORT
               Review of the Department’s Oversight of Schools Participating in the William D.
               Ford Federal Direct Loan Program
               Audit Control Number: 04-70016


Attached is our subject report presenting the findings and recommendations resulting from our
review of the Department’s Oversight of Schools Participating in the William D. Ford Federal
Direct Loan Program.

Please provide us with your final response to each recommendation within 60 days of the date of
this report, indicating what corrective actions you have taken or planned, and related milestone
dates.

In accordance with Office of Management and Budget Circular A-50, we will keep this audit
report on the OIG list of unresolved audits until all open issues have been resolved. Any reports
unresolved after 180 days from the date of issuance will be shown as overdue in the OIG’s
Semiannual Report to Congress.

Please provide the Supervisor, Post Audit Group, Financial Improvement, Receivable and Post
Audit Operations, Office of Chief Financial Officer and the Office of Inspector General, Planning,
Analysis and Management Services with semiannual status reports on promised corrective actions
until all such actions have been completed or continued follow-up actions are unnecessary.

In accordance with the Freedom of Information Act (Public Law 90-23), reports issued by the
Office of Inspector General are available, if requested, to members of the press and general public
to the extent information therein is not subject to exemptions in the Act. Copies of this audit
report have been provided to the offices shown on the distribution list enclosed in the report.

We appreciate the cooperation given us during the review. If you have any questions concerning
the report, please contact me at (404) 562-6462. Please refer to Audit Control Number 04-70016
in all correspondence relating to this report.



Attachment
                                 TABLE OF CONTENTS


EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i

REVIEW RESULTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Finding 1       The Department Does Not Have Sufficient Data to Effectively
                 Monitor Schools Participating in the Direct Loan Program . . . . . . . . . . . . . . . . . . 1

                     Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Finding 2       The Department Needs to Improve Its Approach to Monitoring
                Direct Loan Schools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

                    Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Finding 3       Lack of Loan Level Matches Decreases Control Over Data Reliability . . . . . . . . . . 15

                    Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19


OBJECTIVES OF REVIEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

SCOPE AND METHODOLOGY                           . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

STATEMENT ON MANAGEMENT CONTROLS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

APPENDICES:

Appendix A - Student Financial Assistance Programs:
             Components with Oversight Responsibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Appendix B - Proposed Method for Evaluating Cash Positions . . . . . . . . . . . . . . . . . . . . . . . . 25
Appendix C - Year 5 Reconciliation Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

EXHIBIT 1: Department’s Initial Comments to the Draft Report . . . . . . . . . . . . . . . . . . . . . 28

EXHIBIT 2: Department’s Additional Comments to Finding No. 3 . . . . . . . . . . . . . . . . . . . . 42
 The Department’s Oversight
of Direct Loan Schools                     Final Report                           ACN 04-70016


                         EXECUTIVE SUMMARY
 The Department has not adequately monitored the performance of schools participating in the
 Direct Loan program. Without effective monitoring, the Department is not able to identify and
 correct problems as they arise. The Office of Inspector General report, Administration of the
 William D. Ford Federal Direct Loan Program by Schools, indicated that schools have problems
 which could impact program accountability. If the problems are not corrected, the Department’s
 financial statement reporting could be materially affected. For award year 1994 through award
 year 1997, approximately $20 billion in direct student loans have been disbursed. As of
 November 1997, approximately 1,300 schools were full program participants. The Department
 needs to ensure that Direct Loan schools receive the oversight necessary to protect its assets and
 ensure data integrity.

 Beginning in March 1997, a new Loan Origination Systems contractor began working with the
 Department. The contractually required management information reports, which had been
 routinely provided by the prior contractor, were not forthcoming. From March 1997 until
 January 1998, the Department did not have sufficient data to adequately oversee schools
 participating in the Direct Loan program. Currently, the primary cash management reports do not
 contain accurate data. Further, the Department does not have the needed on-line capability to
 query the Direct Loan data base. Although the Department is now receiving most of the
 management information reports, we are recommending that the Chief Financial Officer and the
 Assistant Secretary take the necessary actions to ensure that the Loan Origination contractor
 fulfills its contractual obligations to provide accurate reports and that the query capability is
 brought expeditiously on-line.

 The Department needs to improve its approach for monitoring Direct Loan school performance.
 Although the Department has in place processes to monitor schools’Direct Loan program
 administration, those processes need improvement. In particular, we identified weaknesses in two
 important monitoring processes: cash management and compliance monitoring. Cash monitoring
 by individual components has been arbitrary and limited, with the potential for duplication of
 efforts. In some instances, guidance is needed to distinguish between technical assistance and
 compliance efforts. The number and scope of program reviews have been limited. In addition,
 schools’loan origination levels had not been periodically and routinely reviewed when additional
 data became available. We are recommending actions the Department can take to improve the
 effectiveness of its current monitoring processes and assure that adequate coverage is provided to
 Direct Loan schools.

 The Department has eliminated the loan level reconciliation process which required a data match
 between school records and the loan origination center records, retroactive to Years 2 and 3 of
 the Direct Loan program. Data matching is important because processing omissions and
 problems are identified and the accuracy of records at the loan origination center and the schools
 is improved. By eliminating data matching, individual student records with errors may not be
 identified on a timely basis. We are recommending that periodic data verification be conducted on
 an interim basis until the Department has assurances that their new process is adequate and that

                                                 i
 The Department’s Oversight
of Direct Loan Schools                      Final Report                            ACN 04-70016

 disbursements to borrowers be tied to school drawdowns.

 Department’s Reply

 On June 11, 1998, the Department provided a written response to our initial draft report. The
 Department noted that the report contains some useful suggestions for improvement, but
 expressed the concern that some statements were inaccurate or misleading. Their response
 describes actions taken or planned to strengthen management controls relating to monitoring the
 Direct Loan Program.

 For Findings 1 and 2, the Department generally agreed with our recommendations or indicated
 that it was already performing the suggested actions. However, the Department stated that the
 OIG misunderstood its actions towards changing origination levels and cited supporting statistics.

 For Finding 3, the Department was most concerned about the OIG’s contention that data
 matching was an integral part of program controls. The Department did not concur with our
 recommendation to reinstate data matching. The Department believes that its new process, the
 Direct Loan School Account Statement, for controlling direct loan data will enhance controls and
 provide more effective monitoring over drawdown and disbursement activity. Prior reconciliation
 processes only confirmed that the Loan Origination Center received what the school transmitted.

 Further, the Department disagreed with the idea of tying disbursements to drawdowns as an
 incentive for schools to provide timely and accurate reporting of disbursements. They indicated
 that OPE is moving toward a common origination and disbursement system that would tie
 drawdowns by schools to specific actual disbursements reported by the institutions. The Year 6
 origination and disbursement process is being developed to support a “just-in-time” draw down
 process that will be supported by specific or actual disbursements reported by schools.

 On September 4, 1998, the Department provided additional comments to our revisions to Finding
 3. In these comments (Exhibit 2), the Department proposes to include steps in the program
 review process for the comparison between loan-level information at a school and the Direct Loan
 Servicer. In addition, the Department reiterated their disagreement with the OIG that a
 reconciliation process needs to be developed to associate cash draw downs to specific
 disbursements.

 OIG Response

 We have carefully considered the Department’s initial comments to the report and the additional
 comments to the revisions to Finding 3. Appropriate changes have been made where deemed
 necessary. Other than the changes to Finding 3, this final report remains basically unchanged
 from the draft version.

 During the course of the review, the School Selection staff and the Direct Loan Task Force
 indicated that routine reevaluations of origination levels were not performed - partly due to lack
 of staff. In addition, neither group routinely received information, such as audit submissions or

                                                  ii
 The Department’s Oversight
of Direct Loan Schools                       Final Report                            ACN 04-70016

 provisional certifications, which could be considered for reevaluating origination levels.

 As noted in Finding 3, we are not convinced that the new Direct Loan School Account Statement
 will provide the necessary means to ensure accurate data. Loan level data integrity will not be
 assured without a verification process that the Department can monitor on a current basis. We
 revised recommendation number 3.1 to recommend that the Department institute an interim
 measure for data verification until the new process is proven to provide adequate assurances that
 schools’loan level data is being transmitted accurately to the loan servicer. The Department is
 proposing to include steps in the program review process to cover data accuracy. When fully
 implemented this proposal should help in this area. However, our concern is whether this will be
 enough. As we have reported, past program reviews at Direct Loan schools have been limited in
 number.

 Five different groups, including the OIG, have cited the need for tying disbursements to
 drawdowns as a vital control for the Direct Loan program. Without a data verification element or
 the tying of disbursements to specific drawdowns, the Department does not have the assurance
 that the loan information held by the loan servicer is correct. Furthermore, the Department
 indicated in its September 4, 1998 response the funding to support the “just-in-time” process was
 not included in the systems budget for Fiscal Year 1999 as earlier indicated. The seriousness of
 the problem is noted in the Administration of the William D. Ford Federal Direct Loan Program
 by Schools report, which cited error rates of 68 percent for loan disbursement and adjustment
 dates and 8 to 10 percent for loan balance data.

 This report includes, after each recommendation or finding, a summary of the Department’s
 comments. We have addressed areas where we disagree or where further clarification was
 needed. Copies of the Department’s complete comments are included as Exhibits 1 and 2.




                                                  iii
 The Department’s Oversight
of Direct Loan Schools                        Final Report                           ACN 04-70016


                                    REVIEW RESULTS

                              The Department’s Student Financial Assistance Program office has not
      Finding 1               had sufficient data to effectively oversee schools participating in the
   The Department             Direct Loan program. From March 1997 until January 1998, the
    Does Not Have             Department’s new loan origination system contractor (contractor) did
   Sufficient Data to         not provide the contractually required management information reports.
      Effectively             As of June 1998, the on-line data query capability was still not
   Monitor Schools            available. Thus, the Student Financial Assistance Program office has
    Participating in          been operating without adequate data in the critical areas of loan
    the Direct Loan           origination, unbooked disbursements, school cash activity, and loan
        Program               reconciliation. As a result, the Student Financial Assistance Program
                              office has only limited assurance that schools are administering the
                              Direct Loan Program adequately. Although other data sources were
                              available, they often were not shared. The Student Financial Assistance
                              Program office needs to take immediate action to correct the lack of
                              accurate management information and to better share information
                              currently available.

                              Federal regulations (34 CFR 685) identify the following areas that the
                              Department should use to evaluate schools participating in the Direct
                              Loan Program:

                              <   Timeliness of reporting;
                              <   Completeness and accuracy of origination records, disbursement
                                  records, and promissory notes;
                              <   Reconciliation process; and
                              <   Cash management.

                              In March 1997, a new contractor took over operational responsibility
 Key Reports
                              for the Direct Loan program loan origination system. The contract and
 were not
                              subsequent modifications require the new contractor to provide
 Available
                              management information reports which had been provided by the prior
                              contractor. From March through August 1997, the only contractor data
                              available to the Department for monitoring school performance from the
                              contractor was a report on promissory notes. As of September 17,
                              1997, the following are examples of reports which were not available to
                              the Department:




                                                    1
 The Department’s Oversight
of Direct Loan Schools                        Final Report                             ACN 04-70016

                              <   Loan Origination Summary
                              <   School Cash Activity
                              <   Monthly Cash Statement
                              <   Disbursement Summary for Unbooked Loans
                              <   Nightly Reconciliation Report
                              <   School Reconciliation and Aging Report


                              On October 8, 1997, a Direct Loan Task Force official stated that the
  More Reports
                              Department could not determine the number of schools that had
  Are Now
                              disbursed funds for the Direct Loan program. On December 17, 1997,
  Available
                              a Department official indicated that they had the loan origination
                              summary, the school cash activity report, and the disbursement
                              summary for unbooked loans. Although these reports will provide
                              data, the remaining reports are still needed. In its June 11, 1998 reply,
                              the Department noted that the Loan Origination contractor was
                              providing most required reports. However, because two cash
                              management reports (school cash activity report and the monthly cash
                              statement) contain inaccurate data, the Department cannot correctly
                              calculate school cash balances.

                              Without the information provided by accurate management information
                              reports, the Department can not adequately evaluate school
                              performance as required by the regulations. In addition, the
                              Department has been hindered in its ability to identify potential
                              problems and to proactively assist schools with problems.

                              Additionally, the Department originally contracted for query capability
  Query
                              using a specific vendor’s software. Because the originally proposed
  Capability is
                              query software was not the same as the query software for the
  Limited
                              Department’s new accounting system, the Department requested a
                              vendor change and the contractor agreed. Although the contractor
                              has not yet delivered data query capability, it agreed to provide a
                              person to perform queries at an additional cost. As of November 30,
                              1997, the contractor had a person in place to perform queries.
                              However, as of June 1998, the on-line query capability was not
                              available to Departmental personnel. The Department still needs the
                              on-line query capability as agreed to in the contract, so that the Direct
                              Loan staff can have current data in order to provide technical
                              assistance to the schools and resolve problems.




                                                    2
 The Department’s Oversight
of Direct Loan Schools                       Final Report                           ACN 04-70016

                              Although the contractor is the Department’s primary source of Direct
  Available                   Loan data on newly originated and consolidated loans, some
  Data Needs                  information is available from other sources. School cash drawdown
  to be Better                data is available from the Department’s Payment Management System
  Shared                      and some booked loan reports are available from the Central Data
                              System. While these reports are available to some Headquarters staff,
                              they are not routinely shared with the regional Client Account
                              Managers who provide technical assistance to schools. Client Account
                              Managers told us that the cash draws and booked loan reports would
                              help them to assist schools.

                              Different Student Financial Assistance Program data bases contain
                              information that is used to assist various components in the school
                              monitoring process. These data bases included: the School Activity
                              Monitoring System and the Tracking Summary reports used by the
                              Accountability and Reconciliation Team (part of the Accounting and
                              Financial Management Service); the Client Account Managers (part of
                              the Policy, Training, and Analysis Service) tracking system; and the
                              School Selection Team (part of the Institutional Participation and
                              Oversight Service) data base. Although these data bases contain
                              information that could be useful to other components, they are not
                              always shared.

                              Department officials agreed that, because of the insufficient data
                              provided by the contractor, they could not adequately monitor schools
                              in the Direct Loan program. They also agreed that they need to better
                              share available data.




   Recommendations


                 We recommend that the Chief Financial Officer:

                 1.1     Enforce or modify the contract to obtain the required management
                         information reports and query capabilities.

                 1.2     Require the contractor to either provide query capabilities to Departmental
                         personnel or to provide sufficient personnel to handle all of the
                         Department’s query needs. This should entail no additional cost to the
                         Department.



                                                   3
 The Department’s Oversight
of Direct Loan Schools                      Final Report                           ACN 04-70016

                 We recommend that the Assistant Secretary for Postsecondary Education:

                 1.3     Provide management information reports to all components having
                         oversight responsibility, once the reports are available.

                 1.4     Conduct an inventory of Direct Loan data bases and determine which are
                         needed and how the data might be combined and shared.



 Department’s Reply

         Although the Department stated in its response that OPE used alternative reports to
         monitor cash activity, they generally agreed to the findings and recommendations for
         Finding Number 1. In several instances, the Department indicated that the suggested
         actions are already being performed. See Exhibit 1 for the full text of the Department’s
         response to this finding.




                                                 4
 The Department’s Oversight
of Direct Loan Schools                        Final Report                           ACN 04-70016

                              The Department needs to improve its approach for monitoring Direct
      Finding 2               Loan school performance. Although the Department has in place
   The Department             processes to monitor schools’Direct Loan program administration, the
      Needs to                processes need improvement. In particular, we identified weaknesses
     Improve Its              in two important monitoring processes: cash management and
    Approach to               compliance monitoring.
     Monitoring
     Direct Loan              Cash monitoring by individual components has been arbitrary and
       Schools                limited, with the potential for duplication of efforts. Compliance
                              monitoring, particularly program reviews, have been limited; and
                              origination levels have not been systematically reviewed. In some
                              instances, guidance is needed in distinguishing between technical
                              assistance and compliance efforts. Without effective cash and
                              compliance monitoring, the Department is not able to identify and
                              correct problems as they arise.

                              Oversight responsibilities are divided among the four organizational
                              components charged with establishing management controls for the
                              Direct Loan program. (See Background and Appendix A for
                              additional descriptions of the components.) However, these
                              components lack formal lines of communication and coordination to
                              routinely share data and information related to Direct Loan schools.
                              The Department should take immediate action to establish an effective
                              and coordinated approach for monitoring Direct Loan school
                              performance.


                              Cash Management Monitoring
                              The Accounting and Reconciliation Team, which was transferred to the
  Lack of Data
                              Accounting and Financial Management Service, is responsible for
  and Staff
                              monitoring Direct Loan school cash management. Draft documents
  Inhibit Cash
                              provided by the Accounting and Financial Management Service and
  Management
                              discussions with the Accounting and Reconciliation Team (Team)
  Monitoring
                              leader indicate that the Team will be monitoring schools and providing
                              technical assistance much as it did under the Direct Loan Task Force.
                              However, since April 1997, the Team has been unable to monitor
                              schools because of the lack of management information data. Further,
                              the Accounting and Reconciliation Team staffing has not been
                              approved.




                                                    5
 The Department’s Oversight
of Direct Loan Schools                        Final Report                           ACN 04-70016

                              Past monitoring activities performed by the Team were inconsistent,
  Past Monitoring
                              inadequate, and not fully documented. These problems may have been
  Inconsistent,
                              caused by the Team’s lack of written policies and procedures. In many
  Inadequate, and
                              instances, it was not possible to determine why the Team ceased
  Not Fully
                              monitoring or failed to monitor schools with indicated problems.
  Documented
                              Schools would appear on the Tracking Summary Report, a report
                              developed to document all the Team’s monitoring activities, for several
                              months and then be dropped with no indication of problem resolution.

                              Using the Team’s benchmarks and February 28, 1997 data (the last
                              data available from the loan origination system), we identified 184
                              schools that should have been monitored. We reviewed the Tracking
                              Summary Report and found that only 114 of the 184 schools were
                              monitored. The last documented monitoring by the Team was in April,
                              1997.

Benchmarks Not                The primary benchmarks used by the Team to track schools were the
Totally                       school’s adjusted cash balance and a ratio of disbursements to cash
Representative of             drawdowns. An adjusted cash balance of more than $1 million
School Cash                   indicated a school with a potential cash management problem.
Position                      However, the calculations are not the most representative of a school’s
                              cash position, because the calculations understate cash balances during
                              periods of higher drawdowns and overstate them during periods of
                              lower drawdowns. To provide a more accurate measure of a school’s
                              ability to manage cash, we have proposed a variation of the current
                              analysis. Accounting and Financial Management Service and Direct
                              Loan Task Force officials agree that the proposed analysis should be
                              used in conjunction with their other benchmarks. (An abbreviated
                              comparison of the current and proposed methods is illustrated in
                              Appendix B.)

  No Site Visit               The Team and the Client Account Managers have various reports
                              which provide information on schools’cash management. However,
  Procedures for
  Testing Cash                neither group has procedures which indicate when or if they should
  Balances                    make site visits to determine whether schools are maintaining excess
                              cash. In our opinion, without performing cash analysis on site, it is
                              often difficult to be certain of a school’s cash position.




                                                    6
 The Department’s Oversight
of Direct Loan Schools                                         Final Report                                               ACN 04-70016



  Potential For                        While the Client Account Managers staff have developed a benchmark
  Duplication Of                       plan that includes analysis of the same indicators used by the Team,
  Effort Among                         there are currently no plans by the Team to include Client Account
  Units Monitoring                     Managers in cash monitoring. The Direct Loan Task Force and the
  Cash                                 Accounting and Financial Management Service acknowledge the
                                       potential for duplication of effort between the Team and the Client
                                       Account Managers and state that they will work to prevent it.
                                       However, none of the plans we reviewed or our interviews with
                                       officials showed how this issue will be addressed. Coordination will
                                       need to occur between the Direct Loan Task Force, the Accounting
                                       and Financial Management Service, and Policy, Training, and Analysis
                                       Service to prevent duplication of effort.


                                       Compliance Monitoring

  Program Reviews                      For the three award years, July 1994 through June 1997, the
  Limited                              Institutional Participation and Oversight Service performed reviews of
                                       the Direct Loan program at 23 schools. As of the end of this period,
                                       there were 1,300 participating schools with a cumulative loan portfolio
                                       of $20 billion. The Director of the Institutional Participation and
                                       Oversight Service said that the limited number of reviews was due to
                                       the newness of the program. 1

  Risk Analysis                        The Institutional Participation and Oversight Service developed the
  System Does                          Risk Analysis System to assist in prioritizing its work load. Direct
  Not Contain                          Loan funding data was not included in the Risk Analysis System
  Direct Loan                          because the contractor could not develop trend analyses due to the late
  Funding Data                         and incomplete data submitted by Direct Loan staff. Direct Loan staff
                                       were only able to provide total, not school level, funding data for
                                       award years 1994/95 and 1995/96. The next scheduled enhancement to
                                       the Risk Analysis System is expected to be completed by the end of
                                       calendar year 1998. At that time, Institutional Participation and
                                       Oversight Service officials believe that school level Direct Loan funding
                                       data will be available for incorporation into the Risk Analysis System.

                                       Data Management and Analysis staff said they believe that until the
                                       enhancement is complete, the monitoring module, which includes data
                                       collected from audits and program reviews, will be adequate to provide
                                       the case management teams with information on Direct Loan schools.


         1
             Program reviews of all Title IV programs have been limited. For the 8 months ending May 31, 1997, Institutional Participation and
         Oversight Service performed only 61 program reviews.


                                                                        7
 The Department’s Oversight
of Direct Loan Schools                         Final Report                             ACN 04-70016

                              Two Office of Inspector General surveys showed that, in the last fiscal
                              year, program reviews have been limited and a serious backlog exists in
                              the processing of the annual compliance and financial statement audits.
                              Further, the lack of adequate management information reports from
                              the Loan Origination contractor and the poor communication between
                              components responsible may mean that the case management teams will
                              have insufficient data to identify Direct Loan schools which may pose
                              risks.

                              Once a school’s origination level has been established, neither the
 No Systematic                Direct Loan Task Force nor the Institutional Participation and
 Review of                    Oversight Service require that it be reassessed, unless the school
 Origination Levels           requests a change. The Direct Loan School Selection Team in the
                              Institutional Participation and Oversight Service is responsible for
                              establishing school origination levels and any subsequent review of the
                              origination levels. The regulations at 34 CFR 685.402 allow the
                              Secretary to lower the origination level of Direct Loan schools “... to
                              ensure program integrity or if the school fails to meet the criteria and
                              performance standards established by the Secretary.”

                              School origination levels are initially determined on the basis of specific
                              criteria applied by the School Selection Team. For example, a school
                              which has a Perkins default rate greater than 30 % or was overdue on
                              required financial and compliance audits, would be allowed to be a
                              Direct Loan participant only at the lowest origination level (standard).
                              Cash management is more controlled for Option 1 and Standard
                              Origination schools. (See Background for additional information.)

                              From available data, we identified 125 schools (74 at the highest
                              origination level) that had not submitted 1994-1995 audit reports and
                              190 (134 at the highest origination level) schools which were
                              provisionally certified. Although these conditions could impact
                              program integrity, Department officials stated that information on
                              school certification status, audit report submission, and audit resolution
                              was not routinely shared with various components needing




                                                     8
 The Department’s Oversight
of Direct Loan Schools                         Final Report                            ACN 04-70016

                              the information. Institutional Participation and Oversight Service
                              officials indicated that even if they had the data, the School Selection
                              Team does not have sufficient staff to perform reevaluations.

                              Information provided by the Direct Loan Task Force showed that it had
                              changed the loan origination level of only one school during the first
                              three years of the program. However, in its response, the Department
                              provided data which indicated that 26 schools loan origination levels
                              were reduced after being placed on reimbursement. An additional 29
                              provisionally recertified schools loan origination levels were lowered.

                              Client Account Managers, who have been integrated into the Policy,
  Guidance Needed
                              Training, and Analysis Service, generally will not become involved in
  on Reporting
                              compliance issues because as their procedures manual states: “the
  Compliance Issues
                              Account Managers’role does not and will not include oversight
                              authority.” Client Account Managers were instructed to report any
                              problems found only to the regional leads, headquarters Client Account
                              Manager staff, or to the Direct Loan Task Force. The Client Account
                              Managers are not provided with guidance on when a problem at a
                              particular school should no longer be treated as an issue requiring
                              technical assistance and should instead be reported to offices having
                              compliance and enforcement authority, such as the Institutional
                              Participation and Oversight Service, Accounting and Financial
                              Management Service, or Office of Inspector General.

  Quality Assurance           The Department’s initial quality assurance guide has expired; and
  Program Not                 schools are no longer required to report on quality assurance activities
  Emphasized                  even though a quality assurance program is required by Federal law and
                              regulations. Since the Department has established quality assurance
                              contacts within the Client Account Manager regional office staff, the
                              Client Account Managers should take the lead in reemphasizing the
                              need for implementing quality assurance programs. This role would be
                              in line with their philosophy of providing proactive, technical
                              assistance.

                              Without an effective approach to monitoring, the Department runs the
                              risk of not being able to identify and correct problems as they arise.
                              The OIG report, Administration of the William D. Ford Federal Direct
                              Loan Program by Schools, indicated that schools have problems which
                              could impact program accountability. If the problems are not
                              corrected, the Department’s financial statement reporting could be
                              materially affected and may cause potential loses. The Department
                              needs to take immediate action to correct the lack of management
                              information. In addition, the Department needs to ensure that Direct
                              Loan schools receive the necessary oversight.


                                                     9
 The Department’s Oversight
of Direct Loan Schools                       Final Report                           ACN 04-70016

 -------------------------------------------------

                   The Department generally agreed with our recommendations or indicated that it
                   was already performing the recommended actions. After each recommendation
                   is a synopsis of the Department’s reply. In those areas where disagreements
                   exist or further clarification is needed, we have provided a response. See
                   Exhibit 1 for the full text of the Department’s response to this finding.




   Recommendations


                 We recommend that the Assistant Secretary for Postsecondary Education:

                 2.1     Clearly define and disseminate the Direct Loan program responsibilities for
                         all components.

                 Department’s Reply: The Department agreed with the recommendation. See
                 Exhibit 1 for details of actions taken.

                 2.2     Provide the Accounting and Financial Management Service with adequate
                         staff to monitor Direct Loan cash management.

                 Department’s Reply: The functions of the Direct Loan Task Force
                 Accountability and Reconciliation Team were transferred to AFMS in the fall of
                 1997. OPE management made the determination that it was unable to divert
                 resources from other critical SFAP activities to support the monitoring of Direct
                 Loan cash management. Because additional staff will not be forthcoming, the
                 AFMS cash management function will remain understaffed.

                 OIG Response: Without additional staff to monitor Direct Loan school’s cash
                 management, AFMS may not be able to adequately follow up, in a timely manner,
                 on potential problems.




                                                     10
 The Department’s Oversight
of Direct Loan Schools                       Final Report                          ACN 04-70016


                 2.3     Incorporate the proposed cash analysis methodology, in Appendix B, into
                         the Accounting and Reconciliation Team’s monitoring process.

                 Department’s Reply: The AFMS Program Operations Team will evaluate
                 various cash balance calculations, including the proposed methodology included in
                 Appendix B of the draft report. A reasoned cash balance calculation will be
                 incorporated into the guidelines and procedures the AFMS Program Operations
                 Team uses to monitor cash management activities.

                 2.4     Develop standards indicating when a cash analysis should be performed on
                         site at a school and by whom.

                 Department’s Reply: The Department agreed with the recommendation. See
                 Exhibit 1 for details of actions taken.

                 2.5     Require the responsible components to establish policies and procedures
                         governing how the Client Account Managers and the Accountability and
                         Reconciliation Team interact.

                 Department’s Reply: The Department agreed with the recommendation. See
                 Exhibit 1 for details of actions taken.

                 2.6     Require the responsible components to develop guidelines as to when
                         technical assistance ends and compliance becomes the issue.

                 Department’s Reply: The Department agreed with the recommendation. See
                 Exhibit 1 for details of actions taken.

                 2.7     Reestablish the Direct Loan Quality Assurance Program guidance and
                         make the program a priority.

                 Department’s Reply: Although a quality assurance (QA) system (not
                 program) is required by law, the law does not require or specify that schools must
                 report on their QA activities. The law gives the Secretary discretion to define
                 what the system will be. From the inception of the Direct Loan Program, the
                 Department has taken a non-prescriptive approach to the QA requirement.
                 Although the initial QA guide has expired, the Department has updated it annually
                 and offered it as one of several options a school may choose to meet the statutory
                 requirement.

                 OIG Response: The OIG believes that the Quality Assurance program could be
                 the vehicle through which schools could readily identify and correct any problems.
                 The current, non-prescriptive approach needs rethinking, with a redirection


                                                  11
 The Department’s Oversight
of Direct Loan Schools                       Final Report                           ACN 04-70016

                 towards a more proactive involvement of the CAMs.

                 2.8     Train Client Account Managers to be quality assurance program
                         consultants who can provide hands-on assistance to schools.

                 Department’s Reply: We do not concur with the recommendation as stated,
                 as we believe the CAMs are currently able to provide such assistance. CAMs
                 assist schools with process improvement in the course of providing on-site
                 technical assistance to schools and assist schools with quality assurance program
                 implementation upon request. The Department will continue to provide overall
                 leadership in the development of the system, but believes overall improvement of
                 data quality and system enhancements are a more cost effective use of limited
                 resources.

                 OIG Response: CAMs are not proactively involved in assisting schools to
                 implement a Quality Assurance program. We believe that a Departmental
                 emphasis on quality assurance will lead to improvements in data quality and system
                 enhancements.

                 2.9     Require the Institutional Participation and Oversight Service to develop a
                         method for assuring that Direct Loan schools receive adequate coverage by
                         the case management teams.

                 Department’s Reply: It should be noted that the new case management
                 approach for school oversight in OPE has strengthened compliance management
                 significantly, allowing OPE to focus on-site compliance activities on cases where
                 the need for strong scrutiny exists. Although program reviews were limited, the
                 Department noted that, during FY 1997, IPOS recertified 1,222 of the 1,395
                 Direct Loan schools which drew down funds. Mostly through recertification,
                 IPOS reviewed all schools in some manner. OPE does not agree that more
                 program reviews need to be done by IPOS just for the sake of doing reviews, but
                 agrees that IPOS will do program reviews where data analysis tells us they are
                 needed. In the future, the Risk Management System will allow IPOS to target
                 Direct Loan schools most in need of review.

                 OIG Response: Program reviews should not be done without a valid concern,
                 but Direct Loan schools must be evaluated in the same fashion as all other schools.
                 Adding the Direct Loan data to the Risk Management System should result in
                 more effective targeting of schools for review. We are currently assessing IPOS’
                 operations, which includes the case management approach and recertification
                 efforts.

                 2.10    Require the Institutional Participation and Oversight Service to expedite
                         inclusion of school level Direct Loan funding data into the risk analysis
                         system.

                                                  12
 The Department’s Oversight
of Direct Loan Schools                       Final Report                            ACN 04-70016

                 Department’s Reply: The AFMS Program Operations Team will be providing
                 financial data to IPOS for inclusion into the Risk Management System. In
                 November 1997, the Data Management and Analysis Division (DMAD) met with
                 AFMS, and obtained Direct Loan gross commitments for all participants since
                 inception, as well as the 790 report data (school cash activity) for the period
                 3/1/97-11/30/97. DMAD will continue to work with others in SFA on the
                 enhancement of the Risk Management System for Direct Loans.

                 2.11    Require the Institutional Participation and Oversight Service to develop a
                         systematic process to periodically review origination levels of Direct Loan
                         schools as data becomes available. This process should define the data
                         elements and the sources of data that would enable the Department to take
                         the necessary actions to review origination levels. Assure that sufficient
                         staffing is available to perform these reevaluations.

                 Department’s Reply: School Selection staff in IPOS already routinely perform
                 reviews of origination levels of Direct Loan schools, and will continue these
                 automatic reviews to ensure that new information which may affect the origination
                 levels of currently participating schools is analyzed. IPOS has developed triggers
                 which will result in reviews of origination levels. Current triggers include those
                 cases where schools go on reimbursement, have an ownership change, or request
                 an origination level change. Future triggers will encompass the cohort default
                 rates, scores from the Risk Management System, provisional certifications, missing
                 audits, and issues from the Direct Loan Cross-cutting Issues Workgroup.

                 The Department stated that the OIG misunderstood its actions towards changing
                 origination levels and cited statistics to support its case. During the first three
                 years of the program, 26 schools placed on reimbursement had their origination
                 levels reduced to Standard Origination. In program Year 2, at least 29
                 provisionally certified schools were notified that their loan origination levels
                 changed from Level 1 to Level 2. An undetermined number of schools with high
                 Perkins default rates also had their origination levels lowered.

                 OIG Response: During the time of our review, the School Selection staff did
                 not routinely perform reviews of origination levels of schools participating in the
                 Direct Loan program - partly due to lack of staff. However, the staff did review
                 data, such as Perkins default rates and lack of audits, for all new schools which
                 were requesting entry into the Direct Loan program or for schools requesting an
                 origination level change. When schools went on reimbursement or had an
                 ownership change, the change in origination level was triggered by an IPOS action
                 or receipt of information, not a routine review by the School Selection staff. OPE
                 must ensure that the information required for analysis of the triggers mentioned
                 above is routinely disseminated to the School Selection staff.




                                                  13
 The Department’s Oversight
of Direct Loan Schools                        Final Report                            ACN 04-70016

                              The Department has eliminated the loan level reconciliation process
      Finding 3               which required a match between school records and the Loan
    Lack of Loan              Origination Center (LOC) records for each cash and loan transaction.
   Level Matches              In Year 5, the Loan Origination Center will generate a monthly
     Decreases                statement containing a summary of the month’s transactions and detail
    Control Over              of drawdowns and excess cash returns. Schools will be expected to
   Data Reliability           match the monthly statement’s ending cash balance with its internal
                              records. For Year 5, the loan level data matching between the school’s
                              record and the Loan Origination Center records will be optional. (See
                              Appendix C for a description of the new process.) In addition, there
                              is no loan level reconciliation or data matching between schools and
                              the Direct Loan Servicer. The lack of loan level reconciliation or data
                              matching between schools and either the Loan Origination Center or
                              the Direct Loan Servicer, diminishes the control over data accuracy and
                              completeness.

                              During Year 4 (1997-1998), once the initial disbursement had been
                              made and the initial obligation to repay had been created, schools were
                              not required to perform any further loan detail data matching on
                              subsequent changes to the student’s account. Once the Loan
                              Origination Center accepted additional disbursements, adjustments, and
                              cancellations, those transactions were also considered reconciled. In
                              our opinion, not matching subsequent account activity may have
                              already weakened the Department’s ability to identify individual student
                              records with errors or omissions.

                              For Years 1 to 3, schools were required to match each cash and loan
                              record with the Loan Origination Center on a monthly basis.
                              Unreconciled records were tracked and aged and schools were
                              encouraged to follow through and correct the records. This process
                              enabled the Department to identify schools with potential problems and
                              provided a measure of accuracy between the Loan Origination Center
                              and each school. Theoretically, the detail records between schools and
                              the Loan Origination Center should automatically match, but this has
                              not always been the case. The OIG’s report, Administration of the
                              William D. Ford Federal Direct Loan Program by Schools, cited error
                              rates of 68 percent for loan disbursement and adjustment dates and 8 to
                              10 percent for loan balance data.

                              For a loan program to operate effectively, it must have accurate loan
                              balances and activity dates. Inaccurate data can lead to asset loss and




                                                   14
 The Department’s Oversight
of Direct Loan Schools                        Final Report                            ACN 04-70016

                               problems in servicing the loans. Without a data verification process,
                              data reliability problems will continue to exist.

                              The Department believes its new process, the Direct Loan School
                              Account Statement (DLSAS), for controlling Direct Loan data will
                              enhance controls. They have stated that the problem with the prior
                              data match process was that it compared only those records that the
                              schools sent to the LOC; it did not identify those records that the
                              school did not send, or those records whose dates or amounts were
                              reported incorrectly. As a result, the data match process could not
                              ensure that the school accurately submitted all disbursement records on
                              its system

                              With the new DLSAS reconciliation process, schools will receive a
                              monthly summary of all transaction activity, as well as an ending cash
                              balance which will be reconciled to the Department*s general ledger
                              account identifying Direct Loan advances to schools. Using this
                              information a school will be able to compare its internal records with
                              the information provided and perform accurate reconciliations. To
                              augment the DLSAS process, there are plans to provide an
                              infrastructure for Certified Public Accountants (CPAs) to allow them to
                              obtain confirmations from the Direct Loan Servicing System on loan
                              activity when they are performing compliance audits, and to require the
                              CPAs to review the school*s reconciliation process.

                              We still have concerns as to whether the Department’s proposed
                              reconciliation/cash management processes will provide adequate
                              assurances that loan level data will be accurate. The Department’s own
                              Internal Quality Control Unit reports indicate that problems exist with
                              both the timeliness and accuracy of school data input. Not only are
                              schools still attempting to process a significant number of Year 2 and 3
                              disbursement records, even though they may have made the
                              disbursements to students long ago, but also there are substantial
                              rejection rates for apparently inaccurate data.

                              The DLSAS process places complete reliance on the schools for
                              reconciling cash balances on a monthly basis. Furthermore, the
                              Department will not know, until some time after the fact, whether the
                              schools have reconciled their statements with their internal records.
                              Presently, no process exists to verify that schools have performed
                              internal reconciliations. The requirement for CPAs to verify school
                              data with the Direct Loan Servicing System and to review schools’




                                                   15
 The Department’s Oversight
of Direct Loan Schools                        Final Report                             ACN 04-70016

                              internal reconciliation practices will add necessary controls, but these
                              processes are not likely to be implemented in the near future.

                              In our draft report, we recommended that the Department reinstate the
                              data matching requirement for all transactions for each loan. We have
                              revised this recommendation. We are now recommending that the
                              Department institute an interim measure for data verification purposes
                              until it has assurance from the CPAs’school audits that the data is
                              accurate and schools are performing internal reconciliations. The
                              Department needs to perform extended loan level data verification by
                              comparing schools’and the Direct Loan servicer’s data. Schools could
                              be selected on a random and/or perceived risk basis. Implementation of
                              our revised recommendation would identify disbursements that the
                              schools did not send to the Loan Origination Center. This would help
                              to minimize the Department’s risk with regard to students’outstanding
                              loan balances.

                              Furthermore, in our opinion, not only does the Department need to
                              maintain a loan level data verification requirement, it also needs to tie
                              individual student disbursements to specific cash drawdowns and
                              excess cash activities. From the inception of the Direct Loan program,
                              this recommendation has been made by: the Department’s independent
                              auditors; an independent consultant; the Advisory Committee on
                              Student Financial Assistance; and the Office of Inspector General. In
                              December 1997, an official in the Office of the Chief Financial Officer
                              agreed that disbursements should be tied directly to drawdowns. As
                              the independent consultant stated, the only way to provide an incentive
                              to the schools for timely, accurate reporting of disbursements is to tie
                              disbursements to drawdowns.


 ----------------------------------------------

                 Department’s Reply: The Department did not concur with our initial
                 recommendation to reinstate data matching. The Department believes its new
                 process, the Direct Loan School Account Statement (DLSAS), for controlling
                 Direct Loan data will enhance controls. The DLSAS will provide a
                 summarization of all drawdown and disbursement activity, as well as an ending
                 cash balance. In its response to the revision of this finding, the Department
                 believes loan-level verification is unnecessary if a school is able to reconcile its
                 data using DLSAS. However, in response to recommendation 3.1, the
                 Department proposes to include steps in the program review process for the
                 comparison between loan-level information at a school and the Direct Loan
                 Servicer. When the Case Management Teams select a Direct Loan school for an
                 onsite program review, the reviewer will ascertain whether the information


                                                    16
 The Department’s Oversight
of Direct Loan Schools                       Final Report                            ACN 04-70016

                 contained in the Direct Loan Servicer’s records is supported by the schools
                 records for selected students.

                 In addition, the Department disagrees with recommendation 3.2 to develop a
                 reconciliation process. In its initial response, the Department indicated that OPE is
                 moving toward a common origination and disbursement system that would tie
                 drawdowns by schools to specific actual disbursements reported by the
                 institutions. The Year 6 origination and disbursement process is being developed
                 to support a “just-in-time” draw down process that will be supported by specific or
                 actual disbursements reported by schools. In its subsequent response, the
                 Department indicated that the process would place a burden on Direct Loan
                 schools under the current funding options and EDExpress software. Funding was
                 not available to support the “just-in-time” process in the systems budget for FY
                 1999. See Exhibits 1 and 2 for the full text of the Department’s replies.


                 OIG Response: We still have concerns as to whether the Department’s
                 proposed reconciliation/cash management processes will provide adequate
                 assurances that loan level data will be accurate. We have revised recommendation
                 3.1 to suggest that the Department institute an interim measure for data
                 verification assurances. The Department’s proposal in its September 4th
                 comments, when fully implemented, should help in this area. However, our
                 concern is whether this will be enough. As we have reported, past program
                 reviews at Direct Loan schools have been limited in number.

                 We believe that the recommendation that the Department develop a reconciliation
                 process which will associate each cash draw down to specific disbursement and
                 excess cash activities is still valid. Furthermore, the Department indicated in its
                 September 4th response that the funding to support the “just-in-time” process was
                 not included in the systems budget for Fiscal Year 1999 as earlier indicated. Five
                 different groups, including the OIG, have cited the need for tying disbursements to
                 drawdowns as an important control for the Direct Loan program. Matching
                 specific drawdowns with specific disbursements does not seem unrealistic. In our
                 prior report (noted above) on direct loan schools, we suggested such a process
                 that would afford better cash management while still giving schools the flexibility
                 needed.




                                                  17
 The Department’s Oversight
of Direct Loan Schools                      Final Report                           ACN 04-70016




   Recommendations


                 We recommend that the Assistant Secretary for Postsecondary Education:

                 3.1     Conduct periodic (i.e., every six months) data verification for all
                         transactions by comparing selected school’s loan level information with
                         that of the Direct Loan Servicer. This data verification process should be
                         used as an interim measure until OPE has assurance from the CPAs’school
                         audits that the loan level data is accurate and schools are performing
                         internal reconciliations.

                 3.2     Develop a reconciliation process which will associate each cash drawdown
                         to specific disbursement and excess cash activities.




                                                 18
 The Department’s Oversight
of Direct Loan Schools                      Final Report                            ACN 04-70016


 OBJECTIVES OF REVIEW

 The objectives of this review were to examine the Department’s processes for monitoring school
 administration of the Direct Loan program and to identify areas where improvements could be
 made. This review is a follow on to the OIG work performed for the report titled, Administration
 of the William D. Ford Federal Direct Loan Program by Schools, (Audit Control Number 03-
 60009). The Direct Loan school report summarized the results of OIG audits performed at 16
 Direct Loan schools and made many recommendations for improving Departmental oversight of
 Direct Loan schools.

 BACKGROUND

 The William D. Ford Federal Direct Loan program (Direct Loan program) was enacted by
 Congress to improve the Federal student loan system for student and parent borrowers,
 institutions, taxpayers and the Federal government. The primary goals of the Direct Loan
 program are to provide borrowers and participating schools with greater flexibility and more
 efficient service within a simpler, more automated, and accountable system than is available under
 the Federal Family Education Loan Program (FFELP).

 The Direct Loan program consists of the borrower, the school, and the U. S. Department of
 Education (Department). The Department contracts with the private sector to provide
 origination, servicing, accounting systems and related services. Contracts are negotiated and
 monitored by the Contracts and Purchasing Operations group, a section under the Office of the
 Chief Financial Officer.

 For the first year of the program, the Secretary of Education selected 103 schools to participate,
 representing approximately 7% of new federal student loan volume. By Year 2, approximately
 1150 schools, representing 30% of new federal student loan volume, were participating in the
 program. Year 3 had more than 1300 participating schools, representing 32% of new federal
 student loan volume.

 Schools can participate in the program under one of three options:

 ! Option 1 schools perform all functions except for drawdowns, which are performed by the
   Loan Origination Center.

 ! Option 2 schools perform all school functions, including loan origination, preparation and
   collection of signed promissory notes, drawdown, and disbursement of funds to students.

 ! Standard Origination schools have drawdowns and preparation and collection of promissory
   notes performed by the Loan Origination Center.

 The Department’s management controls over Direct Loan schools are the responsibility of
 Student Financial Assistance Programs (SFAP). The Department relies on four of its major

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 The Department’s Oversight
of Direct Loan Schools                      Final Report                          ACN 04-70016

 components within SFAP for management control as outlined in the following chart. (See
 Appendix A for additional information.)


    SFAP Components with Direct Loan Management Control Responsibility

  Component                         Management Control               How Performed
                                    Responsibility
   Direct Loan Task Force           Overall Responsibility for the   Coordinates Direct Loan
  (DLTF)                            Direct Loan Program              Activities
  Accounting and Financial          Financial Management/Cash        Accounting and
  Management Service (AFMS)         Management                       Reconciliation Team (ART)
                                                                     and Program Operations
                                                                     Team
  Policy, Training, and Analysis    Technical Assistance to          Client Account Managers
  Service (PTAS)                    Schools                          (CAMs)
  Institutional Participation and   Institutional Compliance with    Case Management and Risk
  Oversight Service (IPOS)          Regulations                      Analysis System


 The Office of Management and Budget’s Circular A-123, “Management Accountability and
 Control,” defines management controls for Federal executive agencies. Management controls are
 defined as the organization, policies and procedures used by agencies to reasonably ensure that: (
 i) programs achieve their intended results; (ii) resources are used consistently with agency
 mission; (iii) program resources are protected from waste, fraud, and mismanagement; (iv) laws
 and regulations are followed; and (v) reliable and timely information is obtained, maintained,
 reported and used for decision making.




                                                  20
 The Department’s Oversight
of Direct Loan Schools                        Final Report                             ACN 04-70016

 SCOPE AND METHODOLOGY

 To achieve an understanding of the Department’s controls and processes relating to the oversight
 of Direct Loan schools, we focused on the monitoring activities of the Direct Loan Task Force;
 the Client Account Management (CAM) Group; the Accountability & Reconciliation Team
 (ART); Accounting and Financial Management Service (AFMS); and Institutional Participation &
 Oversight Service (IPOS). We interviewed Office of Student Financial Assistance Program
 officials, reviewed related procedures, policies, and regulations, examined available data bases,
 analyzed IPOS data on monitoring, and reviewed files as necessary. For issues relating to
 management information reports, we interviewed Program Systems Service (PSS) officials and
 reviewed the reporting requirements of the Loan Origination System contract. We also reviewed
 work associated with the Department’s fiscal year 1996 financial statement audit.

 To achieve an understanding of the regional Client Account Managers’roles, we interviewed
 selected individuals in Washington, D.C.; Philadelphia, Pennsylvania; Atlanta, Georgia; Dallas,
 Texas; and San Francisco, California. We talked with a cross-section of staff in order to better
 understand their responsibilities, particularly as they related to technical assistance and training.

 Our review focused on current and future monitoring controls and processes. We performed
 fieldwork at selected regional offices and at the headquarters of Student Financial Assistance
 Programs during the period August 4, 1997 through October 1, 1997. On October 17, 1997, we
 discussed our review results with the Department; and on December 17 and 18, 1997, we
 performed a limited update on information previously provided to us. On August 5, 1998, a
 follow up exit conference was held with Department officials to discuss the draft report and the
 revision to Finding 3. Our review was performed in accordance with generally accepted
 government auditing standards appropriate to the scope of the review described above.


 STATEMENT ON MANAGEMENT CONTROLS

 In order for the management control process to be effective, the process must be monitored and
 modifications made as needed. As a part of our review, we assessed the Department’s monitoring
 of schools participating in the Direct Loan program. Our assessment was performed to determine
 the type and level of monitoring performed by the various component offices in the Office of
 Student Financial Assistance Programs, which is responsible for oversight of the Direct Loan
 program. (See Appendix A for a description.) For the purposes of this review, we evaluated the
 monitoring activities in the following SFAP components:

 C   Direct Loan Task Force
 C   Accounting and Financial Management Service
 C   Policy, Training, and Analysis Service
 C   Institutional Participation and Oversight Service

 Because of inherent limitations, a study and evaluation made for the limited purpose described
 above would not necessarily disclose all material weaknesses. Our review identified weaknesses

                                                   21
 The Department’s Oversight
of Direct Loan Schools                    Final Report                         ACN 04-70016

 in the cash management and compliance monitoring processes performed by the above
 components. Monitoring was also impacted by the lack of management information data. These
 weaknesses and their effects are fully discussed in the REVIEW RESULTS section of this report.




                                               22
 The Department’s Oversight
of Direct Loan Schools                       Final Report                            ACN 04-70016

                                                                                      APPENDIX A


                          Student Financial Assistance Programs
                         Components with Oversight Responsibility

 Direct Loan Task Force. The Direct Loan Task Force, depicted as an unofficial organization on
 the Office of Postsecondary Education organizational chart dated June 1997, has the ultimate
 responsibility for Direct Loan program administration. The Task Force reports directly to the
 Office of the Deputy Assistant Secretary for Student Financial Assistance Programs. Its most
 recent focus has been on the loan origination system, consolidations, and outreach to attract new
 schools. School monitoring is spread among the other components.

 Policy, Training and Analysis Service. The Client Account Managers, also an unofficial
 organization, operate as part of the Policy, Training and Analysis Service. Mostly located in the
 regions, they provide technical assistance and training to Direct Loan schools. They act as
 proactive program advocates who generally do not become involved in compliance issues.

 Accounting and Financial Management Service. In the simplest terms, Accounting and
 Financial Management Service has the responsibility for cash and will monitor Direct Loan
 schools’cash management. When data is available, this team will be able to analyze daily cash
 activities and contact schools needing assistance.

 Institutional Participation and Oversight Service. Institutional Participation and Oversight
 Service has several different components which provide many varied functions. The case
 management divisions are responsible for institutional recertification, financial statement analysis,
 audit resolution, and program reviews of all Title IV participants, including Direct Loan schools.
 The Data Management and Analysis Division operates the document control central where school
 audits are received and conducts risk analysis to target high risk schools for oversight. The
 Performance Improvement and Procedures Division has the responsibility for approving schools
 to participate in the Direct Loan program and for setting the schools’origination levels.

 Program System Service. Although Program System Service does not have school monitoring
 obligations, it oversees the EDS Loan Origination System contract. As part of the LOS contract,
 EDS is obligated to provide management information reports which could be used to monitor
 schools.




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 The Department’s Oversight
of Direct Loan Schools                         Final Report                                 ACN 04-70016

                                                                                            APPENDIX B
                                                                                              Page 1 of 2
                              Proposed Method for Evaluating Cash Positions

 The Accountability and Reconciliation Team’s benchmarks for monitoring school performance
 included analysis of adjusted cash balances in excess of $1 million, and analysis of school’s ratio
 of disbursements to drawdowns (90% or less considered problematic). They calculated adjusted
 cash balance as:

     Cash Balance (based on drawdowns from ED/Payment Management System and
            disbursements received and booked at the Loan Origination Center (LOC)
     (Minus) Drawdowns within the last 30 days (from ED/PMS data)
     (Minus) Unbooked Disbursements (from the LOC)
     = Adjusted Cash Balance

 ART calculates the ratio of disbursements to drawdowns as:

       Cumulative Disbursements (booked and unbooked, from the LOC)
     Cumulative Drawdowns (excluding drawdowns within the last 30 days)

 In calculating adjusted cash balances and the ratio of disbursements to drawdowns, ED staff
 remove the most recent 30 days’drawdowns and add any unbooked disbursements into the
 cumulative disbursements as shown above. ED staff explained that these adjustments account for
 the 30 days schools are allowed to report disbursements. We believe that these adjustments do
 not give the Department the most accurate picture of the school cash balances. Instead, we
 suggest that the Department use cash balances and ratios after allowing 30 days for processing,
 i.e., reviewing data through September 30 as of October 31. Consider the following example:

                                                         Total Value of    Total Value of    Total Value of
                       Total Value     Total Value of          Records           Records           Records
                        of Records           Records       Received by       Received by       Received by
                      Received by        Received by           LOC in            LOC in            LOC in
                      LOC in July     LOC in August         September            October        November

  Drawdowns                     $0        $1,000,000          $2,000,000        $200,000          $250,000

  Disbursements                 $0        A $200,000       A $500,000         A $200,000        A $100,000
                                                           S $400,000       S $1,000,000        S $200,000
                                                          Ttl $900,000        O $100,000         O $50,000
                                                                           Ttl $1,300,000       N $150,000
                                                                                              Ttl $500,000
 In the disbursements row, “A” signifies disbursements dated in August; “S” , disbursements dated in
 September; “O”, disbursements dated in October; and “N”, disbursements dated in November.




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 The Department’s Oversight
of Direct Loan Schools                    Final Report                          ACN 04-70016

                                                                                  APPENDIX B
                                                                                    Page 2 of 2

 In the illustration above, the school began participating in the Direct Loan program in August,
 with no previous Direct Loan cash balance. In August, the school drew down $1,000,000.
 Disbursements totaling $200,000 relating to the August drawdown had been received at the LOC
 by the end of August. In September, the school drew down $2,000,000. Disbursements totaling
 $500,000, dated in August and relating to the August drawdown, were received by the LOC in
 September, as well as $400,000 of disbursements dated in September, relating to the September
 drawdown, and so on.

                                                     ED Calculation         Proposed Calculation

  August:                                       Calculated August 31     Calculated September 30
   Adjusted Cash Balance                                  ($200,000)                    $300,000
   Disbursement/Drawdown Ratio                      Cannot calculate                       70%

  September:                                Calculated September 30        Calculated October 31
   Adjusted Cash Balance                                  ($100,000)                    $700,000
   Disbursement/Drawdown Ratio                                110%                         77%

  October:                                     Calculated October 31      Calculated November 30
   Adjusted Cash Balance                                    $600,000                     450,000
   Disbursement/Drawdown Ratio                                 80%                         86%


 As demonstrated above, the Department’s calculations understate cash balances during periods of
 higher drawdowns and overstate cash balances during periods of lower drawdowns. While still
 allowing 30 days for reporting, the proposed calculation more closely matches drawdowns to
 disbursements and provides the Department with a more accurate view of school cash balances.
 The proposed method should clearly indicate whether the school has excess cash or meets the 30
 day disbursement reporting requirement.

 We provided this proposed methodology to DLTF and AFMS officials for comment. They
 indicated that it would be a useful tool to supplement their current analyzes.




                                               25
 The Department’s Oversight
of Direct Loan Schools                      Final Report                             ACN 04-70016

                                                                                      APPENDIX C


                                Year 5 Reconciliation Process

 C At the end of each month, the Loan Origination Center (LOC) will generate a “Direct Loan
   School Account Statement” and send the electronic file to the schools. This statement will
   include transactions processed during the period. Additional reports listing detail records
   recorded on the Department’s data base will be available upon request. Schools will import
   the file and a report may be printed. All reconciliation will be done as of the end of the month,
   rather than having the schools choose reconciliation end dates as is currently done.

 C The Direct Loan School Account Statement will contain beginning and ending cash balances
   and totals for categories of booked items processed during the period. Unbooked transactions
   will be listed on the report, in total, after the ending cash balance. The school will also receive
   a file which shows detail for all cash items, and upon request, one for loan detail.

 C Since all cash balances will be as of the end of the month, the cash balances will tie to the
   Financial Accounting and Reporting System (FARS) balances.

 C Using the statement and detail file(s) received, the school will be responsible for reconciling to
   their internal records. Three options will exist to assist schools in doing this: (1) new tools in
   EDExpress will help analyze differences for EDExpress users; (2) schools can use their own
   software to analyze differences; and (3) schools can send a file to the LOC for analysis and the
   LOC will generate an exception report of transactions which do not match.

 C The data matching component of reconciliation will be eliminated. Schools will no longer
   have a reconciliation status flag for each transaction. Loan elements will have a status code
   indicating whether the loan has booked.

 C The responsibility for reconciliation will be the school’s. ED will have no report by which to
   determine whether schools are reconciling.




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 The Department’s Oversight
of Direct Loan Schools                      Final Report                           ACN 04-70016

                                                                                       EXHIBIT 1

                                           June 11, 1998

 Carol S. Lynch
 Regional Inspector General for Audit
 U.S. Department of Education
 100 Alabama Street, Room 18T71
 Atlanta, Georgia 30303

 Dear Ms. Lynch:

 Thank you for the opportunity to review and comment on the Office of Inspector General’s draft
 report entitled, “Review of the Department’s Oversight of Schools Participating in the William D.
 Ford Federal Direct Loan Program.” The objectives of the audit, as stated in the report, were to
 examine the Department’s processes for monitoring school administration of the Direct Loan
 Program and to identify areas where improvements could be made.

 While the report contains some useful suggestions for improvement, we are concerned that some
 statements in it are inaccurate or misleading. Further, some of the current efforts to address
 issues raised in the report are not reflected. This response describes actions taken or planned to
 strengthen management controls related to the Direct Loan Program both in our responses to
 individual OIG findings and recommendations in the Appendix and in the paragraphs below.

 Although the Office of Postsecondary Education’s (OPE) new Loan Origination System
 contractor did not provide management information reports or data query capability from March
 through November 1997, OPE used alternative reports to monitor cash activity. OPE has been
 able to determine drawdown activity for schools using the Payment Management System. In
 addition, OPE could obtain detailed information about school disbursement activity, including
 number, date, and amount of transactions through ad hoc queries from the Loan Origination
 contractor. Steps are being taken to ensure that financial management reports related to Direct
 Loan schools are shared with Institutional Participation and Oversight Service (IPOS) and the
 Client Account Management Group (CAMG).

 OPE has been committed to a coordinated approach to monitoring the performance of schools
 participating in the Direct Loan Program for several years. As the program has matured in the
 last year, the areas of OPE responsible for oversight activities (the Accounting and Financial
 Management Service (AFMS), IPOS and CAMG) have developed a coordinated approach for
 monitoring cash management and school performance. As part of this coordinated approach,
 OPE has established two workgroups. The AFMS Program Operations Team and the CAMG
 workgroup monitors and improves cash management at schools and the Direct Loan Cross-
 cutting Issues workgroup handles school compliance and performance issues. In addition, it
 should be noted that the new case management approach to school oversight in IPOS has
 strengthened compliance management significantly. Plans are also underway to add additional
 Direct Loan data to the Risk Management System to improve the analysis for Direct Loan schools


                                                 27
 The Department’s Oversight
of Direct Loan Schools                       Final Report                                ACN 04-70016

 where the Direct Loan data might indicate there is a problem.

 Two of the statements in the report, both regarding the review of schools’origination levels, do
 not provide an accurate understanding of changes made in schools’origination levels. The report
 states that “Once a school’s origination level has been established, neither the Direct Loan Task
 Force nor the Institutional Participation and Oversight Service require that it be reassessed, unless
 the school requests a change.” The report also states that “ Information provided by the Direct
 Loan Task Force showed that it has changed the loan origination level of only one school during
 the first three years of the program.” We identified over 50 Direct Loan Schools whose loan
 origination level was reduced during the first 3 years of the Direct Loan program by school
 selection staff, some while the staff were part of the Direct Loan Task Force and others after the
 staff were transferred to IPOS. Problems were identified in at least 25 schools that were
 designated Level 1 or Level 2 at the time, and the schools’origination levels were reduced and
 the schools placed on the reimbursement system of payment. Other schools’origination levels
 were reviewed and reduced when the schools were provisionally recertified because they
 underwent a change in ownership.

 We are also concerned with the underlying premise of the OIG’s finding related to the data
 matching issue. After analyzing both data transmittal and processes in use during the first four
 years of the program, we have developed alternative controls to data matching which will provide
 for much more effective monitoring by both schools and OPE. OPE is not eliminating controls
 over data. To the contrary, OPE is enhancing controls over drawdown and disbursement activity.
 Under the new reconciliation process, the schools will receive a monthly statement summarizing
 all drawdown and disbursement activity and a beginning and ending cash balance. The cash
 amount held at the school will be reconciled to the Department’s general ledger account
 identifying the Direct Loan cash advanced to schools. This is a clear improvement over the
 present process that gives the school only confirmation of what the Loan Origination Center
 received from the school, and the CFO is fully supportive of this change.

 Again, we appreciate the opportunity to review and comment on the draft report and we will take
 appropriate steps to address the issues identified in the report. The attached Appendix
 summarizes the Office of Inspector General’s (OIG) findings and corresponding
 recommendations. General comments have been included after each finding, where applicable,
 followed by specific comments to each recommendation.

                                        Sincerely,

                                        (Signed copy of Letter on File in Area Office)

                                        Marshall S. Smith
                                        Acting Deputy Secretary

 Enclosure
 cc:    David A. Longanecker
        Donald Rappaport


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 The Department’s Oversight
of Direct Loan Schools                      Final Report                            ACN 04-70016


                                            APPENDIX

 Finding 1

 The Department does not have sufficient data to effectively monitor schools participating in
 the Direct Loan Program.

 Response to Recommendations:

 Recommendation 1.1. Enforce or modify the contract to obtain the required management
 information reports and query capabilities.

 Response. The key management information reports cited in the OIG report are listed in the loan
 origination contract Master Billing Table as the following deliverables:

         Loan Origination Summary - Deliverable 25
         Monthly Cash Activity - Deliverable 52
         Disbursement Summary of Unbooked Loans - Deliverable 55
         School Reconciliation and Aging Report - Deliverable 34

 Since January 1998, the Loan Origination contractor has been compliant in the timely submission
 of deliverables 25, 52, and 55. The Nightly Reconciliation Report and the School Reconciliation
 and Aging Report will no longer be required by the Department due to the changes in the
 reconciliation process, which became effective in February 1998. The School Cash Activity
 Report is provided to the Department by the Direct Loan Servicing contractor and is not a
 required deliverable under this contract.

 The contracting officer will work with OPE in identifying all required management information
 reports to be incorporated into the contract; and enforce the timely submission of all deliverables
 as specified.

 Recommendation 1.2. Require the contractor to either provide query capabilities to
 Departmental personnel or to provide sufficient personnel to handle all of the Department*s
 query needs. This should entail no additional cost to the Department.

 Response. The Department made the decision to use the Departmental standard querying
 software in lieu of the contractor*s originally proposed query software. The contractor will
 continue to provide manual querying capability support until the Department*s selected software
 is in production. The pilot to provide and test query capabilities of Departmental personnel is
 currently scheduled for April 1998.

 Recommendation 1.3. Provide management information reports to all components having
 oversight responsibility, once the reports are available.



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 The Department’s Oversight
of Direct Loan Schools                      Final Report                           ACN 04-70016

 Response. As indicated in the draft audit report, OPE has not had sufficient reports to oversee
 schools participating in the Direct Loan Program effectively. The primary reports for monitoring
 school cash activity are the School Cash Activity Report and the Monthly Cash Statement. While
 these reports are currently being delivered to the Department, neither report contains accurate
 data which is necessary to correctly calculate school cash balances. AFMS is working with
 Program Systems Service (PSS) and the Loan Origination contractor to ensure that the Loan
 Origination Center (LOC) provides the Department with accurate and timely financial information
 that is necessary for the AFMS Program Operations Team to monitor school cash activity.

 Once the AFMS Program Operations Team begins to receive accurate financial data, it will
 coordinate the distribution of the data to IPOS and the Client Account Managers. This should
 ensure that all parties have the same information and should prevent any duplication of effort.
 The information will also be available to the Direct Loan Task Force and other Department
 components on request.

 Recommendation 1.4. Conduct an inventory of Direct Loan data bases and determine which are
 needed and how the data might be combined and shared.

 Response. We will inventory all existing data bases, determine the extent to which they are still
 useful, and assess whether they can be made readily available to additional staff. We note that
 two of the data bases mentioned in the report, the School Activity Monitoring System, developed
 and maintained by the Accounting and Financial Management Service (ART) and the Client
 Account Managers* (CAMs) tracking system are no longer being used. The School Selection
 System (SSS) is still being used for internal tracking. We are looking at whether the Direct Loan
 module in PEPS, which is available to regional as well as Headquarters staff, can be expanded to
 house additional information currently maintained in SSS or whether SSS should be upgraded and
 revamped to provide for retention of historical records, better query capability and access by
 regional and Headquarters staff.

In addition to its responsibility for ensuring the accuracy of financial data produced by the LOC,
the AFMS Program Operations Team is also responsible for coordinating the dissemination of
financial data to all components having oversight responsibility. The AFMS Program Operations
Team is working together with all oversight components to ensure that financial data is being
shared and not duplicated.




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 The Department’s Oversight
of Direct Loan Schools                      Final Report                             ACN 04-70016

 Finding 2

 The Department Needs an Effective Approach To Monitoring Direct Loan Schools

 General Comments

 Program Reviews Limited

 While the number of on-site program reviews was limited during this period, IPOS actually
 reviewed more schools than ever through the recertification process. Over 3,300 schools were
 reviewed during FY 1997. With respect to Direct Loan schools specifically, during Fiscal Years
 1995, 1996 and 1997, of the 1,395 schools that drew down Direct Loan funds, 1,222 were
 recertified by IPOS. Thus, it is incorrect to conclude that because the number of on-site program
 reviews at Direct Loan schools has not been high, that these schools received inadequate
 oversight. Through the recertification process and case management, we have reviewed all Direct
 Loan schools in some manner. Recertification involved analyzing schools* annual financial
 statements, compliance audits, default rates and available program review reports, as well as the
 information provided on the recertification application itself. Conducting an on-site program
 review is only one of many options available to IPOS for monitoring schools.

 Risk Analysis System Does Not Contain Direct Loan Funding Data

 In reference to the comment in the first sentence of this section, that IPOS developed the Risk
 Management System to assist in prioritizing its work load, we note that the system does more
 than prioritize work; it helps IPOS target institutions most in need of oversight.

 No periodic Review of Origination Levels

 We are concerned about two statements in the report related to origination levels. The report
 states that “Once a school*s origination level has been established, neither the Direct Loan Task
 Force nor the Institutional Participation and Oversight Service require that it be reassessed, unless
 the school requests a change.” Secondly, it states that “Information provided by the DLTF
 showed that it has changed the loan origination level of only one school during the first three
 years of the program.” We are not sure what the source of these statements was, but we can state
 that the DLTF reviewed schools* origination levels automatically in at least three different
 situations: (1) Beginning in June 1995, when a school was placed on reimbursement, if the school
 were a Level 1 or Level 2 school, it was automatically and immediately reduced to Level 3. (2)
 For the first two years of the program, when a school underwent a change in ownership, and was
 reapproved for participation in Title IV programs under provisional certification, the school*s
 origination level was reviewed and was reduced to Level 2, if the school had been a Level 1
 school. (Beginning with the 1996-97 year, the regulations did not reference provisional
 certification as a criterion for determining origination level; hence, no changes were made
 routinely to a school*s origination level based on its being recertified provisionally.) (3) For the
 1995-96 year, the regulations specified that a school with a Perkins Loan default rate above 30%
 could participate at a Level 2, at most. In subsequent years, a Perkins Loan default rate in excess


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 The Department’s Oversight
of Direct Loan Schools                      Final Report                             ACN 04-70016

 of 30% was deemed to be indicative of a severe performance deficiency. Beginning with 1996-
 97, initial participants with such rates were assigned Level 3 or standard origination. In 1996,
 current Direct Loan participating schools were rereviewed, and their origination levels reduced to
 Level 3 or standard origination level if they had previously been participating at a Level 1 or 2.

 We queried the PEPS Direct Loan module and identified twenty-six schools during the first three
 years of the program whose origination level was reduced to Level 3/Standard origination when
 the school was placed on reimbursement. Further, Direct Loan records indicate that in Year 2 of
 the program, at least 29 schools that were provisionally certified were notified that their loan
 origination levels changed from Level 1 to Level 2. Schools with high Perkins Loan default rates
 were notified that their Direct Loan origination level was being reduced as a result of the default
 rate; records reflect action taken on appeals of the revised origination level. The SSS also
 indicates DLTF action to reduce origination levels, but the actions are reflected only in the
 “notes” section and we were therefore not able to run a query to determine the total number of
 such actions.

 The draft audit report states that the auditors identified 125 schools that had not submitted 1994-
 95 audit reports, but there is no information given on the origination level of these schools.
 Although we recognize the importance of schools submitting required audit reports, we must
 point out that: (1) The criteria for loan origination levels in effect for 1995-96 provided that a
 school with missing audits could participate at a Level 2 or Level 3/Standard origination; and (2)
 Beginning with 1996-97, the regulations provide that for a school to originate loans, it must be
 current on audits "for the 12-month period immediately preceding the date of application to
 participate in the Direct Loan Program.” A school that was not current could still participate as a
 Standard origination school. Thus, treatment of missing audits is explicit in the regulations.
 Failure to submit 1994-95 audits would have had an impact on determination of 1996-97
 origination levels for new schools; the DLTF solicited information on audit report submission and
 resolution as part of its school screening process, and IPOS provided the information, and it was
 used accordingly to determine origination levels.

 The report also notes that 134 schools were provisionally certified, but the report indicates neither
 the time period covered nor the origination level assigned to such schools. For 1995-96, the
 regulations specify that a provisionally certified school could not be designated as a Level 1
 school, but there was nothing to preclude assigning it a Level 2 or Level 3/Standard origination
 level. Beginning with 1996-97, the regulations are silent with respect to using provisional
 certification status as a criterion for assigning origination levels.

 Quality Assurance (QA) Program Not Emphasized

 The draft audit report says that schools are no longer required to report on quality assurance
 activities. We note that while a QA system (not program) is required by law, the law does not
 require or specify that schools must report on their QA activities. The law gives the Secretary
 discretion to define what the system will be.

 Response to Recommendations:


                                                  32
 The Department’s Oversight
of Direct Loan Schools                      Final Report                           ACN 04-70016

 Recommendation 2.1. Clearly define the Direct Loan program responsibilities for all
 components.

 Response. We have defined the program responsibilities for all components.

 The AFMS Program Operations Team has the primary responsibility for ensuring that loan
 origination operations of the Direct Loan Program result in correct information being transmitted
 to the Department's Financial Management Support System (FMSS). The AFMS Program
 Operations Team has the responsibility for ensuring that all financial data produced by the Loan
 Origination System (LOS) is complete and accurate and that the data provided by schools to the
 LOS is complete and accurate. AFMS is also responsible for the cash management and
 reconciliation activities previously performed by the DLTF Accountability and Reconciliation
 Team.

 IPOS treats Direct Loan schools the same way it treats schools that do not participate in the
 Direct Loan Program. It provides monitoring, oversight, and technical assistance to insure
 compliance with Title IV legislation and regulations and takes compliance actions when
 warranted.

 The CAM function is customer service, which includes providing training and technical assistance.
 The AFMS Program Operations Team will provide financial data to the CAMs which they will
 use to target those schools whose cash balance gives the appearance of a potential performance
 issue. CAMs will then contact those schools and provide training and other assistance as
 necessary to address performance issues.

 Recommendation 2.2. Provide the Accounting and Financial Management Service with
 adequate staff to monitor Direct Loan cash management.

 Response. For fiscal year 1998, the FTE ceiling for OPE was reduced by 18 FTE. This reduction
 made it necessary to reduce the FTE ceiling for the Student Financial Assistance Programs
 (SFAP) by 14 FTE. The reduction of 14 FTE left SFAP with very little flexibility to provide
 additional FTE for cash management activities.

 The functions of the Direct Loan Task Force Accountability and Reconciliation Team were
 transferred to AFMS in the fall of 1997. OPE management made the determination that it was
 unable to divert resources from other critical SFAP activities to support the monitoring of Direct
 Loan cash management. Thus, no FTE slots have been transferred to AFMS for this purpose, and
 the function is not adequately staffed. However, some efforts were made to accommodate this
 activity, including the transfer of two Direct Loan Task Force employees to AFMS to help
 support the AFMS Direct Loan Program operational coordination and management activities,
 including monitoring cash activity. Prior to their transfer, these two employees were extensively
 involved in and provided leadership to the Direct Loan Task Force for cash management and
 reconciliation activities.

 Recommendation 2.3. Incorporate the proposed cash analysis methodology, in Appendix B,


                                                 33
 The Department’s Oversight
of Direct Loan Schools                     Final Report                            ACN 04-70016

 into the Accounting and Reconciliation Team*s monitoring process.

 Response. The AFMS Program Operations Team will evaluate various cash balance calculations,
 including the proposed methodology included in Appendix B of the draft report. A reasoned cash
 balance calculation will be incorporated into the guidelines and procedures the AFMS Program
 Operations Team uses to monitor cash management activities.

 Recommendation 2.4. Develop standards indicating when a cash analysis should be performed
 on site at a school and by whom.

 Response. AFMS will work with IPOS to develop standards to determine when a cash analysis
 should be performed on site and procedures for IPOS to use during a site visit to analyze a
 school*s cash position.

 Recommendation 2.5. Require the responsible components to establish policies and procedures
 governing how the Client Account Managers and the Accountability and Reconciliation Team
 interact.

 Response. The AFMS Program Operations Team and the CAMG meet weekly to discuss and
 evaluate school performance issues. Policies and procedures are being developed in this and the
 Direct Loan Cross-cutting Issues Workgroup forums. (See response to Recommendation 2.6
 below).

 Recommendation 2.6. Require the responsible components to develop guidelines as to when
 technical assistance ends and compliance becomes the issue.

 Response. The areas in OPE responsible for oversight activities have worked together for several
 years to monitor school performance. As the program has matured in the last year, and many
 functions have been reintegrated into other parts of SFA from the DLTF, these units have been
 working together in a routine manner on performance monitoring. The Direct Loan Cross-cutting
 Issues Workgroup, with representatives from the CAMs, the AFMS Program Operations Team
 and IPOS, will serve as the forum in which guidelines will be developed to determine when
 technical assistance ends and compliance action is needed. This group will develop procedures
 for coordinating the handling of school compliance and performance issues, both among the
 various functional areas at ED and with the contractors involved in the origination and servicing
 of Direct Loans. The AFMS Program Operations Team and IPOS will meet regularly to discuss
 specific schools that may need IPOS review.

 Recommendation 2.7. Reestablish the Direct Loan Quality Assurance (QA) Program guidance
 and make the program a priority.

 Response. From the inception of the Direct Loan Program, the Department has taken a non-
 prescriptive approach to the QA requirement. Given that many quality controls were inherent in
 the structure of the program, such as edits built into EDExpess, and operating on the knowledge
 that costs to schools would rise if they did not do things right and have adequate tools to track


                                                 34
 The Department’s Oversight
of Direct Loan Schools                      Final Report                           ACN 04-70016

 performance, the Department opted to provide tools and guidance, but make their use voluntary.
 Although the initial QA guide has expired, the Department has updated it annually and offered it
 as one of several options a school may choose to meet the statutory requirement. This specific
 guidance was provided to Direct Loan institutions in DL Bulletin 97-13, April 1997. The DLTF
 plans to reissue this guidance for the 1998-99 award year (Year 5). The draft of the Direct Loan
 Training materials and school guide have been updated accordingly for Year 5. The OIG*s draft
 report entitled “Administration of the William D. Ford Federal Direct Loan Program in Schools,”
 contained a related finding (Finding No. 8, Schools Did Not Implement A system of Quality
 Assurance). OPE has provided, and will continue to provide, guidance in this area.

 Recommendation 2.8. Train Client Account Managers to be quality assurance program
 consultants who can provide hands-on assistance to schools.

 Response. We do not concur with the recommendation as stated, as we believe the CAMs are
 currently able to provide such assistance.

 The CAMs currently provide hands on assistance to schools on all aspects of the Direct Loan
 Program. They are familiar with the Direct Loan QA requirements and the Direct Loan QA
 guidance furnished to the schools by the Department. CAMs provide training to schools on
 Direct Loan QA requirements and the QA Guide at Direct Loan EDExpress sessions. CAMs
 assist schools with process improvement in the course of providing on-site technical assistance to
 schools and assist schools with quality assurance program implementation upon request.

 The Department will continue to provide overall leadership in the development of the system, but
 believes overall improvement of data quality and system enhancements are a more cost effective
 use of limited resources.

 Recommendation 2.9. Require the Institutional Participation and Oversight Service to develop
 a method for assuring that Direct Loan schools receive adequate coverage by the case
 management teams.

 Response. It should be noted that the new case management approach for school oversight in
 OPE has strengthened compliance management significantly, allowing OPE to focus on-site
 compliance activities on cases where the need for strong scrutiny exists.

 The inclusion of Direct Loan data into the Risk Management System will help focus attention on
 Direct Loan schools where the Direct Loan data indicates there is a problem. Also, the Cross-
 cutting Issues Workgroup is a step in ensuring appropriate oversight for Direct Loan schools.
 OPE does not agree that more program reviews need to be done by IPOS just for the sake of
 doing reviews, but we do agree that IPOS will do program reviews where data analysis tells us
 they are needed.

 Recommendation 2.10. Require the Institutional Participation and Oversight Service to
 expedite inclusion of school level Direct Loan funding data into the risk analysis system.



                                                 35
 The Department’s Oversight
of Direct Loan Schools                       Final Report                            ACN 04-70016

 Response. The AFMS Program Operations Team will be providing financial data to IPOS for
 inclusion into the Risk Management System.

 In November 1997, the Data Management and Analysis Division (DMAD) met with AFMS, and
 obtained Direct Loan gross commitments for all participants since inception, as well as the 790
 report data (school cash activity) for the period 3/1/97-11/30/97. For reasons cited in the OIG
 draft report, DMAD was not able to obtain complete school reconciliation and/or cash
 management data. The data that were provided were forwarded to the DMAD contractor for
 analysis. Independently, the Direct Loan gross commitments were provided to the case
 management teams for use in researching cases. DMAD will continue to work with others in SFA
 on the enhancement of the Risk Management System for Direct Loans.

 Recommendation 2.11. Require the Institutional Participation and Oversight Service to
 develop a process to periodically review origination levels of Direct Loan schools as data
 becomes available. This process should define the data elements and the sources of data that
 would enable the Department to take the necessary actions to review origination levels.

 Response. IPOS already has some triggers in place that result in a review of and changes in
 origination levels (see “A” below), and there are plans to expand these triggers (see “B” below).


 A. CURRENT TRIGGERS/REVIEWS

 School Selection staff in IPOS already routinely perform reviews of origination levels of Direct
 Loan schools, and will continue these automatic reviews to ensure that new information which
 may affect the origination levels of currently participating schools is analyzed. The following are
 examples of established triggers for origination level reviews:

 1) When a school that participates in the Direct Loan Program is placed on reimbursement
    School Selection staff automatically change the school to standard origination if it is currently
    participating under full origination.

 2) When a Direct Loan school undergoes a change-in-ownership (CIO), School Selection staff
    review the school's origination level. Since the beginning of FY 98, School Selection has
    reviewed 42 Direct Loan Program schools which have undergone a CIO.

 3) When the AFMS Program Operations Team determines that a school*s origination level
    should be reduced, based on a review of the school*s cash management, the School Selection
    staff takes action.

 4) When schools request a review of their origination level School Selection staff research to
    determine if level changes are warranted. During the past 15 months, School Selection staff
    have performed special origination level reviews on approximately 100 schools. Of these, 62
    schools have had their levels changed, 32 schools were kept at their existing level, and 6 are
    pending further review.


                                                  36
 The Department’s Oversight
of Direct Loan Schools                       Final Report                            ACN 04-70016

 B. EXPANSION OF TRIGGERS/TARGETING

 1) IPOS School Selection staff plan to match all Direct Loan Program schools against the new
    FY 95 cohort default rates (CDRS) to ensure that any Option 2 school with a high default rate
    is changed to standard origination. The threshold level has not been determined, but the plan
    is to factor in the FY 95 CDR with the FY 94 and 93 rates.)

 2) School Selection staff are exploring the use of the newly developed IPOS Risk Management
    System to determine if any Direct Loan Program schools score high on the risk analysis factor
    list. School Selection staff will ask IPOS Case Management Teams for more specific
    information on the schools in question. Also, if a Case Management Team determines that
    any Option 2 school has a serious problem, based on available data and analysis, School
    Selection will, at minimum change the origination level to standard. School Selection staff
    recently took risk analysis training to better understand how Case Teams use the Risk
    Management System.

 3) School Selection staff are also planning to examine schools in the Direct Loan Program that
    recently have been provisionally recertified by Case Teams. If any Option 2 schools fall into
    this category, they will be reevaluated and the origination level changed to standard if
    appropriate.

 4) School Selection staff plan to request a list of all Direct Loan Program schools which have
    current missing audits; if a full origination school has a current missing audit, School Selection
    staff will reevaluate that school's origination level.

 5) School Selection staff participate in the Direct Loan Cross-cutting Issues Workgroup. This
    group determines effective courses of action for ED to pursue for those Direct Loan schools
    that have problems/issues. It is establishing standard procedures for determining when school
    problems should be referred to IPOS for action, including changing a school*s origination
    level.




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 The Department’s Oversight
of Direct Loan Schools                       Final Report                            ACN 04-70016

 Finding 3

 Eliminating Controls Over Data May Cause Future Problems

 General Comments

 The auditors* assessment that the reconciliation process that will be in effect for the 1998-99
 processing year will eliminate controls over data is invalid. In fact, it is OPE and the CFO*s belief
 that the new process will enhance controls. On a monthly basis, schools will receive the Direct
 Loan School Account Statement (DLSAS) which will provide a summarization of all drawdown
 and disbursement activity, as well as an ending cash balance. The DLSAS will also provide detail
 information for disbursement and drawdown activity. Schools will be required to reconcile this
 information to their internal records. The new process will not add any burden to the schools, as
 schools will be provided with the necessary information and tools to assist in the reconciliation
 process.

 The total of the ending cash balances provided to all schools on all DLSASs is designed to agree
 with Department*s general ledger advance account cash balance. When fully staffed, the AFMS
 Program Operations Team will use this information to monitor schools* cash management by
 reviewing cash balances on a regular basis and addressing consistently high balances.

 The report stated that the detail records between the schools and the LOC do not always match,
 but there were no examples presented in the finding and the magnitude of the problem was not
 addressed. Nor did the report address the cause of the problem. We have not identified any
 instances where the acknowledgment record from the LOC did not match the record submitted.

 We disagree with the premise that the only way to provide an incentive to schools for timely,
 accurate reporting of disbursements is to tie disbursements to drawdowns. The DLSAS will
 provide this incentive by reflecting the school*s ending cash balance and requiring that schools
 reconcile their internal records to the DLSAS. The AFMS Program Operations Team will be
 monitoring these cash balances. Schools with consistently high cash balances will have the
 necessary corrective action taken by either the AFMS Program Operations Team or IPOS. This
 will provide schools with the incentive to make sure their internal records reconcile to the
 DLSAS. Additionally, in order for schools to close out an award year, schools must ensure that
 they have a zero ending balance on their DLSAS.

 Response to Recommendations:

 Recommendation 3.1. Reinstate the data matching requirement for all transactions for each
 loan.

 Response. We do not concur with this recommendation. The problem with the data match
 process is that it compares only those records that the schools sent to LOC; it cannot identify
 those records that the school did not send, or those records whose dates or amounts were
 reported incorrectly. As a result, the data match process cannot ensure that the school accurately


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 The Department’s Oversight
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 submitted all disbursement records on its system. The data match process is basically a
 verification of data that the school has already sent to the LOC and which has been previously
 verified through the acknowledgment process. The acknowledgment includes not only
 affirmation of the acceptance of the record by the LOC but also provides to the school verification
 of the amount disbursed to date on each loan. The acknowledgment process provides the quality
 assurance check referred to in the Department*s 1996 financial statement audit.

 OPE and the CFO believe that the reconciliation process that has been developed for 1998-1999
 provides more appropriate financial controls for the Department and more useful information to
 assist the Department and schools in managing Direct Loan funds. With the new DLSAS
 reconciliation process schools will receive a monthly summary of all transaction activity, as well
 as an ending cash balance which will be reconciled to the Department*s general ledger account
 identifying Direct Loan advances to schools. Using this information a school will be able to
 compare its internal records with the information provided and perform accurate reconciliations.
 Using these tools, a school would be able to quickly identify those situations that require it to
 provide additional documentation to the Department or return excess cash. In addition, the
 Department will be better able to focus its resources on cash management activities because it will
 not have to provide support for an ineffective process.

 Coupled with the plan to provide an infrastructure for Certified Public Accountants (CPAs) to
 allow them to obtain confirmations from the Direct Loan Servicing System on loan activity when
 they are performing compliance audits, and the requirement for the CPA to review the school*s
 reconciliation process, we believe that this new process will provide the assurance that all
 disbursements have been recorded against the advance amounts for which schools are responsible.

 Recommendation 3.2. Develop a reconciliation process which will associate each cash
 drawdown to specific disbursement and excess cash activities.

 Response. At this time, SFA does not plan to make changes to implement this recommendation
 for all schools. The finding does not contain any specific evidence which supports the need to
 implement the new process described in this recommendation. However, it is important to note
 that SFA is moving toward a common origination and disbursement system that would tie
 drawdowns by schools to specific actual disbursements reported by the institutions. This is also
 part of the EASI vision. In addition, the Year 6 origination and disbursement process is being
 developed to support a Just-in-Time drawdown process that will be supported by specific or
 actual disbursements reported by schools.

 The current plans are to continue to support an advance funding mechanism, and we believe that
 the ending cash balance on the DLSAS will reflect whether the school has accounted for all
 drawdowns during that monthly period through the submission of disbursement records or the
 return of excess cash. In essence, the DLSAS will tie total drawdowns to disbursements on a
 monthly basis, and it should provide much more meaningful information to the Department than
 could be accomplished if the reconciliation process required disbursements to be tied to specific
 drawdowns.



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 The Department’s Oversight
of Direct Loan Schools                     Final Report                           ACN 04-70016

 The Direct Loan Schools Account Statement will clearly indicate to a school its ending cash
 balance and the monthly transactions that result in that balance. By the monthly reconciling of a
 school*s internal records to the DLSAS, a school will be able to determine those situations where
 it needs to submit disbursement records or return excess cash.




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 The Department’s Oversight
of Direct Loan Schools                      Final Report                            ACN 04-70016

                                                                                        EXHIBIT 2

                                         September 4, 1998


 Carol S. Lynch
 Regional Inspector General for Audit
 U.S. Department of Education
 100 Alabama Street, Room 18T71
 Atlanta, Georgia 30303

 Dear Ms. Lynch:

 Thank you for the opportunity to review and comment on the Office of Inspector General’s
 (OIG’s) revision of Finding 3 and accompanying recommendations that were included in your
 draft report entitled, Review of the Department’s Oversight of Schools Participating in the
 William D. Ford Federal Direct Loan Program (ACN 04-70016), dated July 1998. We also found
 the discussion with you and other OIG staff on August 5, 1998, to discuss revised Finding 3 and
 the Department’s approach to a responsive solution, to be beneficial. As you requested at that
 meeting, we are providing a written response to the revised finding.

 In the draft audit report, Finding 3 was entitled, “Eliminating controls over data may cause future
 problems.” Recommendations included with the finding were:

     3.1         Reinstate the data matching requirement for all transactions for each loan.

     3.2         Develop a reconciliation process which will associate each cash draw down to
                 specific disbursement and excess cash activities.

 The revised title for Finding 3 is, “Lack of loan level matches decreases control over data
 reliability.” The revised Recommendation 3.1 is as follows:

     3.1         “Conduct periodic (i.e., every six months) data verification for all transactions by
                 comparing selected school’s loan level information with that of the Direct Loan
                 Servicer. This data verification process should be used as an interim measure
                 until OPE has assurance from the CPAs’school audits that the loan level data is
                 accurate and schools are performing internal reconciliations.”

 I appreciate the time and effort you and your colleagues have expended to research the issues and
 listen to our comments and concerns. As we discussed at our recent meeting, in order to address
 the revised Recommendation 3.1, the Department proposes to include steps in the program
 review process for the comparison between loan-level information at a school and the Direct Loan
 Servicer. Thus, when the Case Management Teams select a Direct Loan school for an on-site
 program review, the institutional reviewer will ascertain whether the information contained



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 The Department’s Oversight
of Direct Loan Schools                      Final Report                            ACN 04-70016

 Page 2 - Carol S. Lynch

 in the Direct Loan Servicer’s records is supported by and accurately reflects information in the
 school’s records for selected students.

 Recommendation 3.2, which was not revised, follows:

     3.2         Develop a reconciliation process which will associate each cash drawdown to
                 specific disbursement and excess cash activities.

 As we have indicated previously, we do not agree that we need to develop such a reconciliation
 process. It would place a great and unnecessary burden on Direct Loan schools under the current
 funding options and EDExpress software. Further, a Just-in-Time funding process is being
 discussed under Project EASI and will be an option in the future, although funding was not
 available to support this new process in the systems budget for FY 1999. Such a process will
 relate disbursements to drawdowns: we will not need another reconciliation process.

 We do have some additional, remaining concerns. First, based on language in the title of the
 finding and in the finding itself, OIG continues to believe the Department needs to maintain a
 school-to-Department loan level verification requirement. We believe loan-level verification is
 unnecessary if a school is able to reconcile its data using the Direct Loan School Account
 Statement (DLSAS). If a school is having difficulty reconciling, it has the option of requesting
 loan-level data from the Direct Loan Origination Center. Second, we note that Year 2/3 closeout
 information provided in the report is inaccurate; we are working with accounting for less than 0.2
 percent of all drawdowns for Years 2 and 3. Further, the revised finding cites a 68 percent
 disbursement and adjustment date error rate contained in a related OIG audit report,
 “Administration of the William D. Ford Federal Direct Loan Program in Schools”, issued in
 October 1997. That error rate is due to schools not reconciling their student accounts to the
 system or software that sends Direct Loan records to the Loan Origination Center. Data
 matching never caught those kinds of errors.

 Again, thank you for the opportunity to provide additional comments. We believe our approach
 will ensure both accountability of public funds and the best use of resources. If you have any
 questions, please contact Linda Paulsen at (202) 708-4664.

                                       Sincerely,

                                       (Signed Letter on file in Area office)

                                       Diane E. Rogers
                                       Acting Deputy Assistant Secretary

 cc. Robert Seabrooks
     Pat Howard



                                                    42
                                REPORT DISTRIBUTION LIST
                              AUDIT CONTROL NUMBER 04-70016



Action Officials                                              No. Of Copies
Primary
Marshall Smith                                                            1
Acting Deputy Secretary
Office of the Deputy Secretary

Collateral - OPE
Dr. David A. Longanecker                                                  1
Assistant Secretary for Postsecondary Education

Collateral - OCFO
Donald Rappaport                                                          1
Chief Financial Officer

Other OPE Officials
Deputy, Assistant Secretary, OPE                                          1
Direct Loan Task Force                                                    1
Accounting and Financial Management Service                               1
Policy, Training and Analysis                                             1
Institutional Participation and Oversight Service                         1
Program Systems Service                                                   1
Audit Liaison Official, OPE                                               1

Other ED Officials
Office of the General Counsel                                             3
Supervisor, Post Audit Group                                              1
  Office of the Chief Financial Officer
Office of Public Affairs                                                  1
Office of the Under Secretary                                             1

ED-OIG Officials
Acting, Inspector General                                                  1
Acting, Deputy Inspector General                                           1
Acting, Assistant Inspector General for Audit                              1
Assistant Inspector General for Investigation                              1
Assistant Inspector General for Operations - Eastern Area                  1
Director, Advisory and Assistance, SFA                                     1
Counsel to the Inspector General                                           1
Director, PAMS                                                  Electronic 1
Other Area Audit Managers                                              1 EA