Applicants with Defaulted Student Loans Continue to Receive Financial Aid.

Published by the Department of Education, Office of Inspector General on 1998-06-23.

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

      Applicants With Defaulted
      Student Loans Continue To
        Receive Financial Aid

                                 FINAL AUDIT REPORT

                                 Audit Control Number 06-70004
                                           June 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                                 Dallas, TX
                                   OFFICE OF INSPECTOR GENERAL
                                           1999 Bryan Street, Suite 2630
                                           DALLAS, TEXAS 75201-6817

June 23, 1998


TO        :     David Longanecker
                Assistant Secretary
                Office of Postsecondary Education

FROM       :    Daniel J. Thaens
                Western Area Manager
                Dallas, Texas

                Audit Control Number 06-70004

You have been designated primary action official for this report. Please provide the Office of the
Chief Financial Officer - Audit Follow-up Branch and the Office of Inspector General - Advisory
and Assistance Team, Student Financial Assistance with semiannual reports on corrective actions
until all such actions have been completed or continued follow-up is unnecessary.

In accordance with the Freedom of Information Act (Public Law 90-23), reports issued by the
Office of Inspector General are made available, if requested, to members of the press and general
public to the extent information contained 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

We appreciate the cooperation given us during our review. If you have any questions concerning
this report, please call me at 214-880-3031.

                   TABLE OF CONTENTS

EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

AUDIT RESULTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

HOW THE CURRENT PROCESS WORKS . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

GAO REPORTED THE ISSUE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3


MORE NEEDS TO BE DONE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

RECOMMENDATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6



BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

OBJECTIVE, SCOPE, AND METHODOLOGY . . . . . . . . . . . . . . . . . . . . . . . . 8

STATEMENT ON MANAGEMENT CONTROLS . . . . . . . . . . . . . . . . . . . . . . 9


Students who are ineligible because they have defaulted loans continue to be
awarded student financial aid. Applications for financial aid are not rejected
although Department records show an applicant has defaulted on a student
loan or received a grant overpayment. Instead, applicants’records are flagged
and school officials are responsible for taking the appropriate action. This
reliance on schools has not always prevented ineligible students from
receiving additional aid. We estimate that 3,278 ineligible students received
$11.9 million of award year 1996-97 student financial aid.

The Department took action after our audit period to improve controls and has
plans to provide additional guidance to schools about how to resolve the
eligibility of applicants with flagged records. We are recommending that the
Department implement planned additional actions and monitor the
effectiveness of these actions on at least an annual basis. If the actions are
not effective, we recommend the Department take stronger action to include
rejecting applications for financial aid for all applicants who are identified as
having a defaulted loan or grant overpayment.

The Department agreed that its procedures may have been inadequate in the
past and that the primary cause of the problem was inappropriate and
incomplete documentation obtained by schools. However, the Department
disagreed with our original recommendation to reject flagged applications.
Officials stated that rejecting applications is premature given the additional
steps taken and planned to address the problem. We changed our
recommendations to give the Department additional time to evaluate the
effectiveness of its actions. If ineligible students continue to receive aid, the
Department should then consider rejecting flagged applications. The
Department’s response is summarized following our recommendations and
included in total as an appendix to the report.
Audit Control Number 06-70004                                                                Page 2

                                  AUDIT RESULTS
Our review disclosed that some students in default continued to receive additional student
financial aid (SFA). Based on our review of 250 student records at 18 schools visited for the
1994-95 award year, school officials either took no action or the action taken was inadequate to
resolve defaulted loan flags for 32 percent of the students. The General Accounting Office
(GAO) also reported in July 1995 and the Department determined from a review in September
1995 that this problem existed. The Department made changes that took effect in the 1995-96
award year to enhance the process. However, additional steps are still needed because our review
of 400 students for the 1996-97 award year disclosed that 56 students (14 percent) who were in
default continued to receive SFA.

HOW THE CURRENT                      Students apply for SFA by submitting a Free Application for
 PROCESS WORKS                       Federal Student Aid to the Central Processing System
                                     (CPS). The end result of the application process is a
                                     Student Aid Report (SAR) which is mailed to the student or
                                     an Institutional Student Information Record (ISIR) which a
                                     school can obtain electronically. For an otherwise eligible
                                     student to receive aid, the school must receive a SAR/ISIR
                                     that contains an eligible Expected Family Contribution
                                     (EFC) amount. Rejected SARs/ ISIRs do not contain an
                                     EFC and cannot be used to award aid.

                                     Section 484 of the Higher Education Act of 1965, as
                                     amended, states that applicants who default on a student
                                     loan or receive a grant overpayment are ineligible for
                                     additional financial aid. The CPS uses the National Student
                                     Loan Data System (NSLDS) to screen applicants for
                                     defaults and overpayments. If an applicant has a default or
                                     overpayment according to NSLDS data, a SAR/ISIR is
                                     issued which may contain an eligible EFC along with a flag
                                     alerting the school that the applicant is not eligible for aid
                                     until the default or overpayment issue is resolved.

                                     Regulation 34 CFR 668.16 (f) requires schools have a
                                     system for determining if students are eligible for SFA.
                                     Department guidance in SFA handbooks and Dear
                                     Colleague letters require schools to resolve default and
                                     overpayment flags by obtaining documentation that shows
                                     students have repaid the defaulted loans or taken other
Audit Control Number 06-70004                                                            Page 3

                                appropriate action prior to awarding SFA. If the school
                                determines students are eligible, it can award SFA based on
                                the initial SARs/ISIRs received.

                                Our review at the 18 schools disclosed that 80 (32 percent)
                                of the 250 students whose 1994-95 SAR/ISIR had a loan
                                default or grant overpayment flag were ineligible to receive
                                $96,868 of Pell Grants. We did not determine the amount
                                of loans awarded to the students. The schools either took
                                no action to resolve the flags even though they were made
                                aware of the students’default status prior to disbursing aid,
                                or the actions taken were inadequate. Inadequate actions by
                                the schools included accepting copies of one or more
                                canceled checks or letters received in a prior year as
                                evidence of the applicants’eligibility.

   GAO REPORTED                 The GAO issued a report in July 1995, Student Financial
                                Aid: Data Not Fully Utilized to Identify Inappropriately
                                Awarded Loans and Grants, which concluded that the
                                default screening process was aimed only at identifying
                                ineligible students and had not effectively prevented them
                                from getting additional aid. GAO reported that the number
                                of loans to ineligible students with prior defaults increased
                                from 10,450 in fiscal year 1990 (before the screening) to
                                12,134 in fiscal year 1993 (after the screening was
                                implemented). The 12,134 loans totaled $33 million (the
                                Pell Grant amount for the students was not identified).
                                GAO noted that Department officials advised that the
                                NSLDS match, which should provide for more timely
                                identification of defaulters, would not prevent all ineligible
                                students from receiving aid because schools would still be
                                responsible for ensuring compliance.

 THE DEPARTMENT                 A Department review of defaulters who received new loans
                                in August and September 1995 disclosed that simply
                                flagging applicant records was not always effective. The
  ISSUE AND TOOK                Department reviewed a sample of 59 students from a
      ACTION                    universe of 6,811 loan recipients and found that 12 (20
                                percent) students with flagged records were ineligible to
                                receive $102,172 in new loans. Five of the 12 ineligible
                                students received $28,900 of loans in the following year.
Audit Control Number 06-70004                                                           Page 4

                                The Department concluded that the institutions did not
                                perform proper verification to ensure that the students were
                                eligible for additional financial aid. Action taken to improve
                                the process included identifying defaulted loans on the
                                SARs/ISIRs and clarifying instructions to schools regarding

     MORE NEEDS                 There have been improvements to the screening process
                                since our review of the 1994-95 award year data at the 18
                                schools. For example, beginning in 1995-96 the
                                Department began listing defaulted loans on the SAR/ISIR.
                                However, the process has not changed in one important
                                respect. The flagged SAR/ISIR is not rejected, it still may
                                contain a valid EFC and an award can be made without
                                certification that the flagged transaction was resolved. As a
                                result, the Department continued to rely on school officials
                                to prevent ineligible students from receiving additional SFA.

                                Our review of the nationwide sample of 400 recipients from
                                a universe of 23,412 Pell Grant recipients whose 1996-97
                                SAR/ISIR identified a default or overpayment disclosed that
                                56 (14 percent) were ineligible. The 23,412 recipients were
                                awarded $108.4 million in SFA, including $40.1 million in
                                Pell Grants and $68.3 million in guaranteed student loans.
                                We estimated 3,278 ineligible recipients received $11.9
                                million in aid by projecting the sample results to the
                                universe of 23,412 recipients. We are 90 percent confident
                                that the amount of aid that ineligible recipients received
                                would not be less than $8.4 million or more than $15.4

                                Most of the 56 ineligible students were awarded aid because
                                the schools had not taken appropriate action to resolve
                                defaulted loans listed on the students’SARs/ISIRs. We
                                contacted the 54 schools that awarded aid to the 56
                                ineligible students to determine what actions the schools
                                took to resolve the defaults. Most of the schools provided
                                either no documentation of action taken before aid was
                                awarded (14 students) or the documentation was inadequate
                                (35 students). Inadequately documented actions included
                                resolving only one of several defaulted loans of a student,
Audit Control Number 06-70004                                                               Page 5

                                    accepting documentation on other loans that were not in
                                    default (e.g., a previously defaulted loan that was paid in
                                    full, loans in repayment, etc.), and using financial aid
                                    transcripts as a basis for concluding the defaulted loans did
                                    not exist.

                                    The schools for the remaining 7 students obtained
                                    documentation of the students’eligibility as required. The
                                    documentation showed the students had regained eligibility
                                    by making timely, consecutive payments on their defaulted
                                    loans. However, we found the students had become
                                    ineligible before the schools awarded the aid because they
                                    stopped making payments on their defaulted loans after
                                    providing documentation of their eligibility to the schools.
                                    The Department implemented a post-screening process in
                                    March 1998 that should help prevent these types of errors
                                    from occurring in the future. The process includes
                                    identifying students who default on loans after their initial
                                    applications have been processed and reporting that
                                    information to the schools. The schools will have more
                                    current information on the default status of students and
                                    should be able to make more accurate eligibility

                                    We found that 86 percent of the sample students were
                                    eligible even though their records were flagged with a
                                    default. The records were flagged because NSLDS data
                                    was not current or contained duplicates. Many of the
                                    students’defaulted loans were paid in full or consolidated.
                                    Duplicates existed for some students because defaulted
                                    loans were consolidated with other loans but the NSLDS
                                    retained separate records for the defaulted loans.

                                    An effort began in December 1996 to reconcile NSLDS
                                    data with guarantee agency data to eliminate duplicates and
                                    update student loan data on the NSLDS. The effort should
                                    result in more accurate NSLDS data. It should also
                                    increase the likelihood that flagged SARs/ISIRs are for
                                    ineligible applicants.

We recommend that the Department:
Audit Control Number 06-70004                                                                     Page 6

1)     Implement additional actions planned to prevent students with loan defaults or grant
       overpayments from receiving additional SFA as discussed below and conduct an analysis
       at least annually of the effectiveness of the actions.

2)     If this analysis discloses that the actions already taken are not effective, the Department

       a) Reject applications for financial aid for all applicants who are identified as having
       defaulted loans or grant overpayments;

       b) Establish a procedure for schools to override the rejected applications if they
       subsequently determine the applicants are eligible; and

       c) Require schools to provide a certification to the CPS at the time they perform the
       override that they have obtained documentation that shows the applicant has appropriately
       resolved the default or overpayment and regained eligibility for SFA.

Department officials agreed that its procedures to prevent students with defaulted loans or grant
overpayments from receiving additional financial aid may not have been adequate in the past. The
primary cause of the problem was inappropriate and incomplete documentation obtained by
schools to determine if students had a defaulted loan or grant overpayment. Department officials
disagreed with our recommendation to reject applications which were flagged as having a prior
defaulted loan or grant overpayment. The response stated that rejecting applications is premature
given the size and nature of the problem and the additional steps already taken and planned to
address the issue.

Department officials stated that they have recognized the problem and taken decisive action.
Actions mentioned included improvements in the accuracy of default data maintained in the
NSLDS, implementation of the post-screening process in March 1998, and the issuance of
additional guidance to schools. In addition, the response noted that additional guidance for
schools was planned that would strongly and precisely emphasize that schools must take proper
action to resolve default or overpayment flags before disbursing aid. The Department said the
planned guidance would address the immediate cause of the problem, i.e., schools’failure to take
appropriate action and to obtain complete and appropriate documentation that a default or
overpayment has been resolved. Further, the Department said that it expected these actions to
reduce disbursements of additional aid to students with defaults and overpayments and that it
would continue to monitor the issue to ensure that adequate progress was being made.
Audit Control Number 06-70004                                                                   Page 7

Officials also stated that the size of the problem must be kept in perspective when it comes to
identifying and implementing appropriate remedies and sanctions. The response noted that only
.09 percent of the total 1996-97 Pell Grant recipients were ineligible as a result of a prior loan
default or grant overpayment, and that this amount was not materially significant.

The full text of the Department’s response is included as an Appendix to this report.

We agree that the actions taken and planned by the Department should help prevent students with
loan defaults and grant overpayments from receiving additional aid. As a result, we have changed
our recommendation regarding rejecting applications to give the Department additional time to
evaluate the effectiveness of these actions. We remain concerned, however, that the actions will
not eliminate the problem and are recommending that the Department conduct an analysis for
each award year to determine the extent to which schools are disbursing aid to students with
defaults or overpayments. If this analysis discloses that ineligible students continue to receive aid,
the Department should consider rejecting flagged applications.

We do not agree with the Department’s assertion that the percent of ineligible recipients was not
materially significant. Our estimate of 14 percent or 3,278 ineligible recipients is based on the
universe of the 23,412 recipients whose 1996-97 SAR/ISIR identified a default or overpayment.
The Department’s calculation of a .09 percent error rate is based on the universe of 3.8 million
Pell Grant recipients in the award year. Only 23,412 of the 3.8 million recipients’records had
been flagged. Since our report only addressed how schools resolved flagged records, we believe
our estimate of a 14 percent error rate is appropriate. In any event, we remain concerned that
schools were able to award an estimated $11.9 million of Pell Grants to ineligible students when
the Department had information that those students had a defaulted loan.
Audit Control Number 06-70004                                                                 Page 8

Applicants are ineligible for SFA if they have defaulted on a federally guaranteed student loan or
received a grant overpayment and have not taken appropriate action to resolve the default or
overpayment. The CPS uses the NSLDS to screen all financial aid applications for prior defaults
and overpayments. Schools are alerted through the SAR/ISIR if the NSLDS finds a default or
overpayment. The applications are not rejected. The Department relies on school financial aid
administrators (FAAs) to take appropriate steps to determine the applicants’eligibility for SFA.
For award year 1996-97, schools awarded $108.4 million of SFA ($40.1 million in Pell Grants
and $68.3 million in student loans) to 23,412 students whose SAR/ISIR was flagged because the
NSLDS screen identified a prior default or overpayment.

The objective of our audit was to determine if FAAs appropriately determined eligibility when
applicants’SARs/ISIRs contained default or overpayment flags. The audit period covered July 1,
1994 through June 30, 1995, for the 250 student records reviewed at the 18 schools and July 1,
1996 through June 30 1997, for the 400 students in our nationwide sample.

To accomplish our objective, we judgmentally selected 18 schools that received Pell Grant
funding in 11 states (see Appendix for location of schools and review results). The 18 schools
included 10 proprietary, 4 private nonprofit, and 4 public institutions. Five of the schools were
selected because they had a high percentage of Pell Grant recipients whose records contained
default or overpayment flags. The other 13 schools were selected for other reasons, such as type
of school, location, etc. Our audit work at the 18 schools included a review of student records
for all 250 Pell Grant recipients whose SAR/ISIR contained a default or overpayment flag. We
interviewed school staff and reviewed the schools’student financial aid records.

Our audit also included using the Pell Grant Recipient Financial Management System to identify
23,412 Pell Grant recipients in 1996-97 whose records were flagged as having a default or
overpayment. We used statistical sampling to select 400 students from the 23,412 universe and
obtained loan data for the students from the NSLDS. We contacted guaranty agencies, the
Department, and schools to determine if these students were eligible to receive Title IV aid in the
1996-97 award year. We also obtained documentation from the 54 schools that they used as
justification for awarding aid to the 56 ineligible students.
Audit Control Number 06-70004                                                                 Page 9

We relied on computer generated data obtained from the CPS, NSLDS, and the Pell Grant
Recipient Financial Management System for background data and to identify the nationwide
universes of Pell Grant recipients whose records contained default/overpayment flags. The data
was also the basis for our selection of the five schools that had a high percent of recipients with
default/overpayment flags in award year 1994-95 and the recipients whose SARs/ISIRs contained
the flags in both years. Based on our tests of the 250 student records at the 18 schools and
review of the 400 sample students, we believe the data was reliable for the purposes of this audit.

We reviewed relevant provisions of the Higher Education Act of 1965, as amended, regulations,
and guidance the Department provided to schools in SFA Handbooks, Counselor’s Handbooks,
Dear Colleague letters, and other documents. We also interviewed Department officials.
Fieldwork was performed at the Department’s Office of Postsecondary Education in Washington,
D.C., and at the 18 schools between September 1995 and January 1997. Review of the 400
sample students was done between March 1997 and May 1998. Our review was conducted in
accordance with generally accepted government auditing standards appropriate to the scope
described above.

As part of our review we assessed the system of management controls, policies, procedures, and
practices relating to eligibility determinations for applicants whose SARs/ISIRs identified a
defaulted loan or grant overpayment. Our assessment was performed to determine the level of
control risk for determining the nature, extent, and timing of our substantive tests to accomplish
the audit objective.

For the purpose of this report, we assessed and classified the significant management controls into
the following categories:

--     identifying students with a prior defaulted loan or grant overpayment, and

--     preventing students with a prior defaulted loan or grant overpayment from receiving
       additional financial assistance.

Because of inherent limitations, a study and evaluation made for the limited purpose described
above would not necessarily disclose all material weaknesses in management controls. However,
our assessment identified weaknesses which are discussed in the Audit Results section of this
                                  REVIEWED FOR AWARD YEAR 1994-95

       SCHOOL                     RECIPIENTS WITH
                                                                    INELIGIBLE STUDENTS
#     LOCATION (1)              FLAGGED RECORDS (2)
                                                                    NUMBER            PERCENT

1     Baton Rouge, LA                         22                         2                 9%

2     Kansas City, KS                         25                        17                68%

3      New York, NY                           28                         7                25%

4     East St. Louis, IL                      50                        26                52%

5           Detroit, MI                       17                         0                 0%

6           Albany, NY                         6                         1                17%

7           Cahokia, IL                        2                         0                 0%

8           Canton, MA                         2                         0                 0%

9      Milwaukee, WI                           3                         0                 0%

10          Hialeah, FL                        2                         0                 0%

11          Austin, TX                         4                         0                 0%

12    New Orleans, LA                         43                        22                51%

13         Merrillville, IN                    1                         0                 0%

14         Santurce, PR                        9                         4                44%

15    Kansas City, KS                          8                         0                 0%

16          Austin, TX                         5                         0                 0%

17    Kansas City, KS                          9                         0                 0%

18     New York, NY                           14                         1                 7%

             TOTALS                           250                       80                32%

                              DISTRIBUTION SCHEDULE
                              Audit Control Number 06-70004

Action Official

         David A. Longanecker, Assistant Secretary
         Office of Postsecondary Education
         Department of Education
         ROB-3, Room 4082
         7th and D Streets, SW
         Washington, DC 20202-5101                                    1

Other ED Offices

         Diane Rogers, Deputy Assistant Secretary for
          Student Financial Assistance Programs, OPE                  1

         Linda Paulsen, Service Director
         Accounting and Financial Management Service, OPE             1

         Secretary’s Regional Representative, Region VI               1

         Inspector General                                            1
         Deputy Inspector General                                     1
         Assistant Inspector General for Audit                        1
         Assistant Inspector General for Investigation                1
         Assistant Inspector General for Operations Western Area      1
         Special Counsel to IG                                        1
         Regional Inspector General for Investigation                 1
         RIGA Regions 2, 3, 4, 5, 7, 9                                6


         Jamienne S. Studley, General Counsel (A)
         Office of General Counsel
         Department of Education
         600 Independence Ave. SW
         Room 5400
         Washington, DC 20202-2100                                    1