oversight

Audit of the New Jersey Higher Education Student Assistance Authority's (HESAA) monitoring of law firms (special counsels) providing collection services to HESAA.

Published by the Department of Education, Office of Inspector General on 2004-03-03.

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

                                        UNITED STATES DEPARTMENT OF EDUCATION
                                                        OFFICE OF INSPECTOR GENERAL 

                                                              KANSAS CITY OFFICE 


                                                      8930 Ward Parkway. Suile 2401
                                                     Kansas Cily. Missouri 64114-3302

 AVD IT SERVICES                                                                                                                 INVESTIGATION SERV ICES
                                                          Telephone (816) 268-0500
FAX (8 16) 823- 1398                                                                                                                FAX (816) 268-0526
                                                                  MAR 032004
                                                                                                                       ED-OIG/A07-C0032


   Elizabeth Wong. Executive Director
   New Jersey Higher Education Student
    Assistance Authority
   4 Quakerbridge Plaza
   Trenton. J 08625-0540

    Dear Dr. Wong:

    This Filial Alldit Report (Control Number ED-OIG/A07-C0032) presents the results of our
    Audit of the New Jersey Higher Education Student Assistance Authority's (HESAA) monitoring
    of law firms (special counsels) providing co llection services to HESAA. Our objectives were to:
    (i) determine the adequacy of the procedures HESAA had implemented to monitor the activities
    of the special counsels, (ii) determine whether borrowers were only being assessed collection
    costs that were permitted and reasonable, and (iii) assess whether all collections were being
    remitted to HESAA on a timely basis.

                                                                BACKG ROUN D

    HESAA is a stale guaranty agency that provides nearly $1 billion in financial aid annuall y. Each
    year, HESAA programs assist more than 500,000 students with grants, scholarships, loans and
    information resources.

    HESAA has written agreements with 10 special counsels I to provide collection services relating
    to borrowers who had defaulted on Federal Family Education Loan Program (FFELP) loans. At
    the beginning of our fieldwork, there were over 37,000 borrower accounts, worth 5174 million,
    assigned to special counsels and active during OUI audit period. The special counsels ' offices
    were located in Ihe states of New Jersey, New York, Florida, and Pennsylvania. In addition, one
    special counsel, Hayt, Hayt, and Landau (HHL), New Jersey, had affiliates located in 48 states,

    1 Gordin and Berger; Hayt, Hayt. and Landau, New Jersey; Hayt, Hayt, and Landau, New York; Levin,
    Clancy, Foster & Arena; Scott Marcus and Associates; Marvel & Maloney; State of New Jersey, Division
    of Law; Rolfe & Lobello; Schachter Portnoy; and Waters, McPherson and McNeill



               Our mission is to   lnsllrllqltal   access to educaliofl Qlld to promote educatioltal excelltllce t'ITOllS/101I1 the Natio".
Puerto Rico, the Virgin Islands, and Washington, D.C. The borrower account portfolios were
referred to special counsels after HESAA's internal collection staff had been unsuccessful in
their efforts. As the defaulted loans were held by HESAA, it was responsible for monitoring the
special counsels to ensure their compliance with federal laws and regulations, as well as
applicable state law (in the majority of cases, the special counsel obtained judgments from the
applicable state court to enable the attachment of assets).

Prejudgment collection costs and attorney fees were governed and determined by the appropriate
state court, and were normally included in the final judgment amount. HESAA requested that
the court include special counsel fees in the judgment at the rate provided for in the agreement
between HESAA and the special counsel. Postjudgment collection costs and interest rates were
determined by the court. Postjudgment attorney fees assessed to the borrower at a flat rate were
not permitted. Postjudgrnent attorney fees for specific items were allowable if adequately
supported. Postjudgment collection costs (except for the state of Florida) were to be assessed
only after the outstanding balances of principal and interest were cleared.

                                      AUDIT RESULTS

We found that (I) the guaranty agency did not adequately monitor the special counsels to ensure
compliance with applicable laws and regulations and the formal, written agreement that the
agency had with each special counsel, (2) reviews of the special counsels' activities were not
being conducted as required, and (3) all collections were not being remitted to HESAA on a
timely basis.

The agreements between the guaranty agency and its special counsels state,

       Under applicable federal and state law, a guaranty agency is responsible for its
       agent's compliance with all federal and state regulatory and statutory
       requirements. Accordingly, [HESAA] will conduct a review of your student loan
       collection and bankruptcy practices as they pertain to [Office of Student
       Assistance] accounts no less frequently than every three years.

Improper Application of Payments

The State of New Jersey, Division of Law, one of the special counsels, did not apply the
borrowers' payments to judgment balances in the order prescribed by HESAA policy. It was
applying the payments first to outstanding judgment principal, then to postjudgment interest.
This practice is harmful to the federal interest. The guaranty agency informed us that it was
aware of the problem and had requested a reamortization of the accounts in the portfolio.



                                                2

In 21 of25 borrower accounts we reviewed, another special counsel, Waters, McPherson, and
McNeill, added collection costs to the outstanding judgment balance at various times after the
final judgment had been entered, and computed interest on the combined balance. The special
counsel considered these costs as part of the docketing process prior to final judgment. In most
cases, however, special counsels considered collection costs as postjudgment costs (since the
judgment had been previously entered in the lower court) and applied payments to them after the
outstanding balances ofjudgment principal and interest had been cleared. Applying payments to
postjudgment collection costs in this manner is in accordance with HESAA policy and the
special counsel agreement. However, Waters, McPherson, and McNeill did not follow the
established policy. As a result of including collection costs in the outstanding postjudgment
principal balance, we estimated that the total outstanding balances in the account portfolio of
5,699 accounts were overstated by $163,859.

In 4 of20 closed accounts we reviewed from Waters, McPherson, and McNeill, the special
counsel improperly applied payments to the outstanding judgment principal balance before
clearing the outstanding postjudgment interest. This practice violates HESAA policy and the
special counsel agreements, and is harmful to the federal interest. As a result of not applying
payments to interest before principal, we estimated that the 1,296 closed accounts in the portfolio
were erroneously reduced by $9,720.

Improper Computation oflnterest

Gordin and Berger, another special counsel, improperly computed interest at intervals that did
not always coincide with receipt of the borrower' s payments. Because payments must be applied
first to computed interest and then to principal, this methodology is incorrect because the special
counsel failed to compute the anlOunt of interest that had actually accrued on the outstanding
principal balance on the date on which a payment was received and credited to the debt.
Payments were therefore credited against the outstanding principal balance before all computed
interest had been satisfied in full. For five of the six accounts reviewed, interest was erroneously
reduced by an average of$98.48. As a result, the Federal Fund did not receive its share of the
additional interest that would have accrued on principal mistakenly paid by amounts that should
have been credited to computed interest. We estimated that computed interest was erroneously
reduced by $15,461 for the 157 accounts in the portfolio.

Interest was overstated an average of$97.10 for six of seven accounts reviewed that were held
by another special counsel, Scott Marcus and Associates (one of the seven accounts was
erroneously reduced). We could not determine what caused the differences. Interest was




                                                 3

overstated (borrowers were assessed excessive amounts of interest) by an estimated $43,112 for
the 516 accounts in the portfolio.

Improper Remittances

HHL, New Jersey, violated its agreement when it withheld its fees from remittances ofboITower
payments to the guaranty agency. In June 200 I, HESAA discovered this violation and notified
HHL that it must cease and desist this practice immediately. HHL informed HESAA that it
would not comply until HESAA completed a detailed reconciliation. HESAA did not feel it was
under any obligation to do so, but completed tlus reconciliation in November 2001. At that time,
HHL began depositing 100 percent of the collections. As a result ofHHL withholding its fees
from remittances, the Federal Fund at HESAA, which is the property of the federal government,
did not receive its share of interest income-$25,632-that would have been earned on the full
remittance amounts had they been properly deposited into the holding account.

Untimely Deposits

The guaranty agency violated the 48-Hour Rule when it did not ensure that the federal
government received its share of the interest that would have accrued on borrowers' payments
timely deposited into an interest-bearing account. The special counsel agreements required that
payments received from borrowers be deposited into a HESAA-controlled federal collections
escrow (holding account) on a daily basis to comply with the 48-Hour Rule:

       [In accordance with] 34 CFR 682.419(b)(6) and Dear Guaranty Agency Director
       letter G-00-328 ... the United States Department of Education is requiring that we
       deposit funds received by our agent or us, whichever is earlier, within 48 hours of
       receipt of those funds ... into a separate agency-controlled account or an agency­
       controlled escrow account.

On a bimonthly basis, HESAA remitted to the Federal Fund its share of borrower payments
(including interest income from the holding account). Payments received from defaulted
borrowers were not always deposited into the federal interest-bearing escrow account within 48
hours. Halfofthe special counsels had at least one late deposit. As a result of untimely deposits,
we estimated that the Federal Fund lost interest amounting to $4,584. HESAA did not ensure
that the special counsels established uniform procedures for receiving and recording payments.

The guaranty agency did not effectively implement management controls (formal review
procedures) that were in place over the processing and recording of student loan payments
received from defaulted borrowers by the special counsels. HESAA did not conduct reviews of


                                                4

special counsels as required by its agreements with them. As of the date of our field exit
conference, HESAA had conducted four on-site reviews during the period the account portfolios
were held by the special counsels. Our analyses of two of the four reviews found that they
focused on remitting and reporting collections to HESAA, rather than review of the special
counsels' individual systems for applying payments to borrowers' accounts. Informal routine
monitoring of special counsels also focused on attorney fees assessed and collection remittances
toHESAA.

HESAA officials informed us that their agency had decided to shift resources to areas other than
the monitoring of special counsel activities, i.e., required reviews of lenders and schools. They
stated that subsequent to our audit period HESAA had hired new personnel and scheduled
reviews to satisfy their policy on special counsel oversight.

Recommendations

We recommend that the Chief Operating Officer (COO) for Federal Student Aid (FSA) require
thatHESAA

      1. 	 Conduct reviews of all the special counsels as required by the agreements between
          HESAA and the special counsels.
      2. 	 Ensure that adequate management controls are established andlor implemented over the
           special counsels' systems for accounting for borrower collections.
      3. 	 Require that the Division of Law reamortize the applicable accounts in its portfolio to
           properly apply the payments to interest before principal and notify borrowers as
                   .   2
           appropnate.
      4. 	 Remit to the Federal Fund the federa l share of collections for Division of Law accounts
           that were closed prior to the reamortization 3
      5. 	 Require that Waters, McPherson, and McNeill reamortize all active accounts to properly
           exclude postjudgment collection costs from the outstanding principal balances, and to
           apply payments to the outstanding balances of interest, principal, and collection costs in
           the correct order; and notify borrowers as appropriate.
      6. 	 Require that Gordin and Berger reamortize all active accounts to correct the methodology
           used to compute interest and ensure that interest is calculated at the time payment is
           received, and notify borrowers as appropriate'


2   HESAA indicated that reamortization of accounts and borrower notification was in process.
J   HESAA indicated that the Division of Law planned to ask the court to reopen closed accounts.


                                                     5

    7. 	 Require that Scott Marcus and Associates reamortize all active accounts to ensure that
         interest is computed correctly, and notify borrowers as appropriate.
    8. 	 Remit to the Federal Fund $25,632 in imputed interest lost as a result of fees withheld by
         HHL, ew Jersey.s

    9. 	 Require that the special counsels establish uniform procedures for recording the date the
         borrower's payment is received .

    10. Ensure that all payments are deposited into a federa l interest-bearing account within 48
        hours of receipt from the borrower.

HESAA's C omments and OJG Response

HESAA agreed with a majority of our conclusions and recommendations. Its comments (full
text enclosed) specifically addressed the recommendation.s . The following is a summary of
HESAA's comments and our response to the comments.

Con du ct R eviews of All the Special Counsels as R eq u ired bv the Agreemen ts Between
HESAA an d the Special Counsel

HESAA stated that it concurred with this recommendation and, prior to our review, had taken
significant steps to address this issue. HESAA had conducted initial reviews of all ten counsel
that provided a basis for identifying compliance issues and prioritizing full compliance reviews.
HESAA noted that, to date, one review had been completed.

OIG Response

We recognize that some steps may have been taken both prior to and after the start of our review
to address the deficiencies noted during our review. HESAA officials informed us that the
Audits and Quality Assurance Unit had not completed an on-site review in over three years .
HESAA's policy required that this unit conduct biennial reviews focusing on compliance with
collection and bankruptcy practices. In addition, during thcse reviews, the accounting records
were to be reviewed to verify the correct outstanding balances of accounts.



4 On August 28, 2003, HESAA informed us that corrective action had been taken- all active accounts
had been reamortized.
5 HESAA remitted $14,573 to the Federal Fund on March 17,2003. HESAA used the New Jersey Cash
Management Fund rate to calculate the amount of imputed interest. We used the U.S. Treasury Current
Value of Funds rate, which is specified by the Debt Collection Act of 1982 (31 U.S.c. 37 17) as the
minimal rate of interest for debts owed the federal government.



                                                 6
Ensure That Adequate Management Controls Are Established and/or Implemented Over
the Special Counsels' Svstems for Accounting for Borrower Collections

HESAA stated that it did not concur with this recommendation because it implies that adequate
controls were not in place during the audit period. HESAA has in place several effective
management controls that include annual attorney meetings, annual site visits, quarterly
monitoring of attorney collections and core sample review. Core sample review involved testing
sample accounts to ensure the attorney system is accurately recording credits and applying
payments to principal and interest, as well as verifying the accuracy of interest accruals.
Noncompliance is immediately communicated to the special counsel to remedy.

OIG Response

We recognize that HESAA had some controls in place prior to and during our review. As stated
above, no major compliance reviews had been conducted in over three years and noncompliance
issues were not adequately addressed for the period reviewed.

Require That the Division of Law Reamortize the Applicable Accounts in Its Portfolio To
Properlv Applv th e Pavments To Interest Before Principal and Notifv Borrowers As
Appropriate. Remit To the Federal Fund the Federal Share of Collections for Division of
Law Accounts That Were Closed Prior To the Reamortization

HESAA stated that it concurred with these recommendations and had previously directed the
Division of Law to reamortize their portfolio which is scheduled for completion by June 2004.
Borrowers have been and will continue to be notified accordingly. For those accounts closed
subsequent to January I, 1998, HESAA wi ll determine the amount of the Federal share of
collections that must be remittcd to the Federal Fund.

Require That Waters. McPherson. and McNeill Reamortize All Active Accounts To
Properly Exclude Post judgment Collection Costs From the Outstanding Principal
Balances. and to Apply PaYments To the Outstanding Balances of Interest. Principal. and
Collection Costs in the Correct Order~ and Notify Borrowers as Appropriate

HESAA stated that it did not concur with the finding or the recommendation as to the special
counsel's treatment of "postjudgment collection costs", as referenced by the Inspector General.
As described in the Revised Background Section ofHESAA's comments, the costs were part of
the judgment amount entered by the Special Civil Part and then docketed with the Clerk of the
Superior Court. The capitalization of the costs awarded at judgment, and accrual of interest on
those costs is acceptable and routine pursuant to NJ.Ct.R. 4:42-11. The costs were posted to


                                               7

borrowers' accounts subsequent to the final judgment date as a result of an accounting system
conversion. Waters, McPherson, and McNeill did follow established policy when, at HESAA's
request, they converted their accounting system September 25,1996, to include the costs
awarded by the special Civil Part into the judgment balance. This counsel did not overstate the
total outstanding balances in the account portfolio by including these previously awarded fees
and costs in the judgment amount (principal balance).

With respect to the proper app lication of payment [applying payments to principal before
interest] by Waters, McPherson and McNeill, HESAA stated that it concurred with the finding
but disagreed with the recommendation. In October 200 I, the attorney completed reamortization
of active accounts to correct this problem. The remairung small number of closed accounts had
negligible average balances, which fall within the small balance write-off guidelines issued by
USDE. As a result, the finding should note that the active accounts havc already been
reamortized and borrowers notified.

OIG Response

We agree that the costs were incurred prior to fmaljudgment. In most cases, however, other
special counsels followed the policy provided to us by HESAA for postjudgment costs, and
consistently applied them to borrowers' accounts after the outstanding balances of principal and
interest had been cleared. Our review found that the costs were posted to borrowers accounts
held by Waters, McPherson, and McNeill inconsistently at various times. For example, a
judgment was awarded on December 26, 1996, for one borrower; however, the costs included on
the statement for docketing were not added to the account until August 6, 1999, and the account
was paid-in-full on January 25, 2002.

With respect to the application of payments to principal before interest, according to HESAA,
the special counsel has taken corrective action as of October 2001. We recommend that the
Chief Operating Officer for Federal Student Aid determine if further action is necessary.

Require That Gordin and Berger Reamortize All Active Accounts to Correct the
Methodologv Used to Compute Interest and Ensure That Interest Is Calculated at the Time
Payment Is Received, and Notifv Borrowers as Appropriate

HESAA stated that it concurred with the fmding, but disagreed with the number of accounts
included in the erroneous reduction of interest calculation. The special counsel returned the
portfolio and HESAA completed the reamortization of the active accounts. Borrowers were
notified appropriately. As a result, HESAA requested that the erroneous reduction of interest
calculation be limited to 79 closed accounts of the total 157 accounts in the portfolio. Therefore,


                                                 8

HESAA requested that the recommendation be removed, since all active accounts had already
been reamortized.

OIG Response

The erroneous reduction of interest calculation included in the recommendation was based on
total accounts affected at the time of our review, including both active and closed accounts. As
stated in the Objective, Scope, and Methodology section of this report, the estimates presented
assumed that the average error rates found in the samples would be representative of the entire
population of borrower accounts related to a particular sample. However, given the sizes of our
samples, we have no assurance that the samples are representative.

Require That Scott Marcus and Associates Reamortize All Active Accounts to Ensure That
Interest is Computed Correctlv. and Notifv Borrowers as Appropriate

HESAA stated that it concurred with the recommendation that Scott Marcus reamortize all active
accounts and notify borrowers as appropriate. HESAA has also taken additional steps to prevent
borrowers from being assessed incorrect amounts in the future .

Remit To the Federal Fund $25.632 in Imputed Interest Lost As a Result of Fees Withheld
bv HHL. New Jersey

[As stated in our finding, HHL, New Jersey, violated its agreement when it withheld its fees
from remittances of borrower payments to the guaranty agency. As a result ofHHL withholding
its fees from remittances, the Federal Fund at HESAA, which is the property of the federal
government, did not receive its share of interest income.] HESAA stated that it had remitted
$14,573 in imputed interest. HESAA felt that the calculation should be based on the rate of the
New Jersey Cash Management Fund as opposed to the Federal Debt Collection rate and,
therefore, did not feel that it should remit the additional $11,059 to the Federal Fund.

OIG Response

Our review ofHESAA's comments did not change our position. The Treasury Current Value of
Funds rate is specified by the Debt Collection Act of 1982,31 U.S.C. 3717, as the minimal rate
of interest for debts owed the Government.




                                                9

Require That the Special Counsels Establish Uniform Procedures for Recording the Date
the Borrower's Pavment is Received

HESAA stated that it concurred with this recommendation and has taken corrective action.

E nsure That All Pavments Are Deposited Into a' Federal Interest-Bearing Account Within
48 Hours of Receipt From the Borrower

HESAA stated that it concurred with this recommendation and has taken corrective action.

Response To Inspector General's Statement of Management Controls

HESAA disagreed with the statement that the assessment disclosed significant management
control weaknesses. Prior to notification of this audit by the Inspector General, HESAA had
already identified most of the specific problems with the collections portfolios, and had begun
necessary improvements to more effectively administer the portfolios.

OIG Response

At the time of our review, no major compliance reviews had been conducted in over three years.
Borrowers were not always assessed costs that were permitted and reasonable. In addition,
amounts collected from borrowers by the special counsels were not always remitted to HESAA
in a timely manner.

                      OBJECTIVES. SCOPE. AND METHODOLOGY

The objectives of our audit were to (i) determine the adequacy of the procedures the guaranty
agency had implemented to monitor the activities of the special counsels, (ii) determine whether
borrowers were only being assessed collection costs that are permitted and reasonable, and (iii)
assess whether all collections were being remitted to the guaranty agency in a timely manner.
Our audit of timely deposits covered the period July I, 2001, through June 30,2002. Our audit
of collection costs assessed to borrowers extended from the time of referral to a special counsel
or from the date ofjudgment (in effect, a new loan is established at the time ofjudgment)
through July 7,2003. To accomplish OUf objectives, we

    • 	 Reviewed applicable federal laws and regulations.

    • 	 Reviewed state law applicable to judgments against defaulted borrowers obtained from
        state courts.



                                                10 

   • 	 Interviewed guaranty agency staff.

   • 	 Interviewed one special counsel's staff.

   • 	 Reviewed a program review ofHESAA conducted from December 5 through December
       7,2000.

   • 	 Reviewed Retainer Agreements and modifications for the 10 special counsels.

   • 	 Reviewed two internal review reports prepared by HESAA staff.

   • 	 Reviewed quarterly variance reports prepared by HESAA staff.

   • 	 Reviewed the Comprehensive Annual Financial Report of the State of New Jersey,
       prepared by the State Auditor, for the fiscal year ended June 30,2001 .

   • 	 Reviewed the State of New Jersey Single Audit Report, prepared by the State Auditor, for
       the fiscal year ended June 30,2001.

In addition, we randomly selected 50 transactions from a universe of 86,493 transactions and
traced them to bank deposits and remittance reports to determine iflhey were deposited into a
federal interest-bearing account in accordance with the 48-Hour Rule. From the 50 borrower
accounts associated with this sample of transactions, we requested continnations from borrowers
of account information.

From these 50 borrower accounts, we judgrnentally selected a preliminary sample of 40
accounts, and randomly selected an additional 85 borrower accounts from a universe of 7,209
borrower accounts, to verify the accuracy and allowabi lity of costs assessed to borrowers. As the
special counsels' records did not provide outstanding balances of principal, interest, and
collection costs at the time of each payment, it was necessary to recalculate 78 of these accounts.

For the 78 accounts, we reviewed court, HESAA, and special counsel records to verify the
correct outstanding balance at the time ofjudgrnent. We prepared a spreadsheet that
automatically calculated the outstanding balances at the time of each payment. We compared the
ending balances from the special counsels' systems to the ending balance from our spreadsheet.
We traced amounts contained in the special counsels ' systems to amounts reported in HESAA's
system. Throughout the course of OUf fieldwork, we provided HESAA officials with spreadsheet
data on 19 of 78 accounts to obtain additional information and/or their comments. The estimates
presented in the Audit Results section of this report assumed that the average error rates found in
the samples would be representative of the entire population of borrower accounts related to a
particular sample. However, given the sizes of our samples, we have DO assurance that the
samples are representative.




                                                  11 

To achieve our objectives, we relied on data from HESAA 's and the special counsels' electronic
collections systems. To assess the reliability of this data, we relied, to the extent possible, on
work performed by HESAA's staff, and conducted additional tests of the data. We tested the
accuracy, authenticity, and completeness of the data by comparing the data to source records.
We concluded that the data contained in these systems were sufficiently reliable to be used in
meeting the audit's objectives.

We perfonned on-site fieldwork at HESAA's offices from October 17 through October 25, 2002
and March 31 through April 4, 2003, and at the New Jersey Division of Law' s offices on April I,
2003. A field exit conference was held on April 4, 2003. We conducted additional analyses on
borrower accounts in our Kansas City office from Apri l 4 through August 5, 2003, and a final
ex it conference was held on August 28,2003. We conducted the audit in accordance with
generally accepted government auditing standards appropriate to the scope of the audit described
above.

                      STATEMENT ON MA AGEMENT CONTROLS

As part of our review, we assessed the system of management controls, policies, procedures, and
practices applicable to HESAA's monitoring of the special counsels' collections of defaulted
loans. Our assessment was perfonned to determine the level of control risk for detennin.ing the
nature, extent, and timing of our substantive tests to accomplish the audit objectives.

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

    •   Receipt and recording of borrower payments.

    •   Remitting and reporting collections.

    •   HESAA's on-site monitoring of special counsels.

Because of inherent limitations, a study and evaluation made for the limited purpose described
above would not necessarily disclose all material weaknesses in the management controls.
However, our assessment disclosed significant management control weaknesses that allowed for
improper application of payments, improper accrual of interest, improper remittances, and
untimely deposits of collections. These weaknesses and their effects are fully discussed in the
Audit Results section of this report.




                                                 12 

                                ADMINISTRATIVE MATTERS 


If you have any additional comments or information that you believe may have a bearing on the
resolution of this audit, you should send them directly to the following Department of Education
official, who will consider them before taking final Departmental action on the audit.

                                      Theresa S. Shaw
                                      Chief Operating Officer
                                      Federal Student Aid
                                      U.S. Department of Education
                                      Union Center Plaza, Room 112G I
                                      830 First Street, NE
                                      Washington, DC 20202

It is the policy of the U.S. Department of Education to expedite the resolution of audits by
initiating timely action on the findings and recommendations contained therein. Therefore,
receipt of your comments within 30 days would be greatly appreciated.

In accordance with the Freedom of Information Act (5 U.S.C. § 552), reports issued by the
Office of Inspector General are 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.

If you have any questions, or if you wish to discuss the contents of this report, please contact
William Allen at (816) 268-0509. Please refer to the control number in all correspondence
related to the report.

                                              Sincerely,



                                              William Allen
                                              Regional Inspector General
                                               for Audit

Enclosure




                                                 13 

                                                State ofNew Jersey
                                       HIGHER EDUCATION STUDENT ASSISTANCE AUTHORITY
                                                   4 QUAKERBRlDGE PLAZA
                                                           PO Box 540
JAMES   E,   MCGREEVEY                            TRENTON. NJ 08625-0540                              ELIZABETH WONG
        GaoernoT                                       1-800-792-8670                                     E%"""tiv~ Dirocror
                                                          www.hesaa.org




                                                                 January 26, 2004



                   William Allen
                   Regional Inspector General for Audit
                   U.S. Department of Education
                   Office of Inspector General
                   8930 Ward Parkway, Suite 2401
                   Kansas City, MO 64114-3302

                   Dear Mr. Allen:

                        On behalf ofNew Jersey's Higher Education Student Assistance Authority
                   (HESAA). I am responding to the Draft Audit Report (Control Number ED-OIGtA07­
                   C0032).

                          If you have any questions, or if you wish to discuss HESAA's response, please
                   contact Francine Andrea at (609) 588-7702 or Gene Hutchins at (609) 588-4584.

                                                                 Sincerely,


                                                                  a/~#/vL. 

                                                                 E:"e,'h  Wong
                                                                 Executive Director
                                                                                       7

                   EW:jac
                   Enclosure

                   c: 	   Francine Andrea
                          Gene Hutchins
This New Jersey Higher Education Student Assistance Authority ("HESAA'') Response to your
December 15, 2003 Draft Audit Report (Control #EDMOIG/A07·C0032) ("Draft'') presents our
comments and response to the findings and recommendations in the Draft. Our goal is to assist you in
carrying out the objectives ofthe audit, and to ensure that you fully understand the HESAA policies
and procedures already in place, or soon to be implemented. for monitoring law finns (special counsel)
providing collection services. We appreciate your staff's diligent field work. open communication,
constructive criticism, and thoughtful analysis during the audit process over the past year, and greatly
appreciate this opportunity to commend on your Draft before it is finalized.


We begin with brief comments on the Background section of the Draft, with particular reference to
special counsel collection activities which are governed by the New Jersey Court Rules. We then
provide you with specific nwnbered responses to the nwnbered recommendations in the Draft and
some comments on the Statement ofManagement Controls.


HESAA Comments on Draft - "Background"

   In our view, some ofthe special counsel's procedures characterized as "improper" in the Audit
   Results Section of the Draft, result from special counsels' methods for accounting for collection
   costs based on upon procedures peculiar to the New Jersey courts. Therefore, we ask that the final
   paragraph ofthe ''Background'' Section ofthe Report be revised as follows:


   Prejudgment costs and attorney fees are governed and detennined by the appropriate State court,
   and are normally included in the final judgment amount. In. New Jersey, the judgment process in
   many cases is a two·tiered system. The first tier involves obtaining a judgment in the Special Civil
   Part, which is New Jersey's court where disputes under $1 5,000 are adjudicated. The dollar
   threshold for adjudicating claims in this court has been increased over the years. Since the
   promissory notes provide for a defaulted borrower to pay HESAA's attorney fees and collections
   costs. at the Special Civil Part tier, HESAA requests that the court include special counsel feesMin
   the judgment at the same rate provided for in the agreement between HESAA and the special
   counsel /NJ.Ct.R 4:49M9[2.11]). Collections costs including attorneys' fees (if adequately
   supported) are determined by the Special Civil Part in accordance with New Jersey Court Rules
   ("N.J.Ct.R. 6:5Ml; NJ.Ct.R. 4:42M8, .9) and are stated on the transcript of the judgment. Attorney



Control Number ED-OIGfA07--COO32             1
    fees assessed to the borrower at a flat rate are not pennitted.


   After this judgment is awarded by the Special Civil Part, the attorney may then take this judgment
   to the second tier of the system by "docketing" the Special Civil Part judgment with the Clerk of
   New Jersey's Superior Court. Docketing serves to further protect the Secretary's interest by
   creating a statewide lien against any real estate owned by the borrower. This lien enhances
   collectability and helps to facilitate satisfaction of the debt. Once the judgment is docketed, the
   docketed judgment amount will include the principal, interest, costs and attorney fees already
   awarded at the Special Civil Part level, as well as any credits to the borrower. Under State law,
   interest accrues on this docketed judgment amount at the post-judgment interest rate (which is
   adjusted annually based on the State ofNew Jersey Cash Management Fund average rate ofreturn)
   as established in the court rules <N.J.Ct.R 4:42-11).


   As a separate matter, certain collection costs incurred subsequent to the entry ofthe final judgment
   in the Special Civil Part (post-judgment costs) are allowable under the court rules for this tier, if
   adequately supported (N.J.Ct.R. 4:42-8). Collection costs are to be satisfied only after the
   outstanding balance ofprincipal and interest are paid. Again, the docketed judgment balance may
   include principal, pre-judgment interest, costs, and attorney fees. Interest accrues on this docketed
   judgment balance. Additional costs subsequent to docketing do not accrue interest. Subsequent
   collections costs are to be satisfied only after the outstanding docketed judgment balance and post­
   judgment interest are paid.


Response to Recommendations

1. 	 Cooduet reviews of all the speelal couosels as required by the agreements between HESAA
     and the special conDsels.

   HESAA Response 1#1:

       HESAA concurs with this recommendation and in the spring of2002, prior to the Inspector
       General's visit, had taken significant steps to address this issue. HESAA reorganized its Audits
       & Quality Assurance Unit by hiring a new director and additional staff to conduct reviews of
       all special counsel by the end ofcalendar year 2004. Initially, the Audits & Quality Assurance



Control Number ED-OIGfA07-COO32               2
       Unit conducted a survey (Core Sample Review) of all ten special counsel. This survey
       provided a basis for identifYing compliance issues and prioritizing full compliance reviews of
       all special counsel during the current biennium.

       To date, the Audits & Quality Assurance Unit has completed the review of one special counsel
       (Hayt. Hayt & Landau - NJ) and is in process of completing reviews on three other special
       counsels (Waters, McPherson and McNeill; Rolfe & Lobello; and Grodin and Berger).
       Reviews of the remaining six special counsels will be conducted in calendar year 2004 and are
       included in HESAA's 2004 Audit Plan as approved by Higher Education Student Assistance
       Authority Board. All reviews will be completed by December 31, 2004.

       HESAA's Audits & Quality Assurance Unit will continue to conduct biennial reviews of all
       special counsel as provided for in the Special Counsel Retainer Agreements executed between
      HESAA and its special counsels.

2. 	 Ensure that adequate management eontrols are established andlor implemented over the
     special counsels' systems for aecounting for borrower eoUections.

   HESAA Response #2:

       HESAA respectfully does not concur with this recommendation, which implies that adequate
       controls were not in place during the audit period. However, HESAA continues to implement
       additional management controls to improve processes where applicable. HESAA has in place
       several effective management controls that include annual attorney meetings, annual site visits,
       quarterly attorney account reconciliations, monthly review of attorney status reports, quarterly
      monitoring of attorney collections, and core sample review. This last control involves testing
       sample accounts to ensure the attorney system is accurately recording credits and applying
       payments to principal and interest, as well as verifying the accuracy of interest accruals.
       Additionally, irregularities or issues ofnon-compliance are immediately communicated to the
       special counsel to remedy. Continued instances of non-compliance are directed to the Contract
       Administrator and Director of Audits & Quality Assurance for further action. All of the above
       controls represent a good faith effort on behalf ofHESAA to monitor its portfolio in the
       absence of regulatory guidance.



Control Number ED·OIGfA07-COO32              3
       HESAA is working to enhance additional electronic exchanges ofinformation with special
       counsels concerning matters placed with them to reduce manual errors and to improve
       timeliness.


3. 	 Require that the Division of Law re-amortize the appUcable aeeounts in its portfolio to
     properly apply the paymeots to iDterest before priDeipal and notify borrowers as
     appropriate.

4. 	 Remit to the Federal Fuod the federal share of collections for Division of Law accounts that
     were closed prior to the re-amortization.

   HESAA Response #3 aDd #4i

       HESAA concurs with these recommendations and has previously directed the Division of Law
       to re-amortize their portfolio. To date, the Division ofLaw has completed several phases of the
       re-amortization process. The final phase ofthe re-amortization process for active accounts will
       be completed by April 2004. Borrowers have been and will continue to be notified
       accordingly.

       The Division of Law is currently in the process ofre-amortizing the portfolio of accounts
       closed subsequent to January 1, 1998. This task will be completed by June 2004. Based on the
       balance variances, HESAA will determine the amount ofthe Federal share of collections that
       must be remitted to the Federal Fund.

       The Division of Law was advised to return HESAA's defaulted loan portfolio. Upon receipt of
       the portfolio, HESAA will conduct file reviews and reassign the active judgment accounts.


5. 	 Require that Waten, McPherson, and McNeUl re-amortize au active aecounts to properly
     exdude post judgment coUection costs from the ontstandiDg principal balances, and to apply
     payments to the outstandiDg balances of tote rest, principal, and collection costs to the correct
     order; and notify borrowers as appropriate.

   HESAA Response m!i;

       HESAA respectfully does not concur with the :finding or the recommendation as to the special
       counsel's treatment of''postjudgmcnt collection costs", as referenced by the Inspector GeneraL



Control Number ED-OIGIA07-C0032            4
       The special counsel's payment history reflected permissible costs including attorney fees
       originally awarded by the Special Civil Part, which were posted to the borrower's account
       subsequent to the final judgment date as a result of an accounting system conversion by Waters,
       McPherson and McNeill (see Attachment I). As described in the Revised Background
       paragraph above. these costs were part ofthe judgment amount entered by the Special Civil
       Part and then docketed with the Clerk ofthe Superior Court. (See, Attacbment I - Judgment
       amount was $3.377.24 plus Fees and Costs awarded in the amount of $86.54 for a total
       docketed judgment ofS3,463.78 as of 8/06/96). However, it was not until September 25, 1996
       (after the judgment was docketed with the Clerk of the Superior Court), that this special
       counsel's accounting system was updated to include the $86.54 in costs in the principal balance
       upon which post-judgment interest accrues. The capitalization of the attorney fees and costs
       awarded at judgment, and accrual ofpost-judgment interest on those costs is acceptable and
       routine pursuant to N.1.Q.R. 4:42-11. We disagree with the finding on page 3 of the draft,
       which states "Waters, McPherson and McNeill did not follow established policy". Special
       counsel Waters, McPherson. and McNeill did follow established HESAA policy when, at our
       request, they converted their accounting system during 1996 to include the costs awarded by
       the special Civil Part into the judgment balance. This counsel did not overstate the total
       outstanding balances in the account portfolio by including these previously awarded fees and
       costs in the judgment amount (principal balance).

       With respect to the proper application ofpayment by Waters. McPherson and McNeill,
       HESAA concurs with the finding but disagrees with the recommendation. In October 2001, the
       attorney completed a re-amortization of active accounts to correct this problem. The remaining
       small number ofclosed accounts had negligible average balances, which fall within the small
       balance wrire..off guidelines issued by USDE. As a resuit. the findings should note that the
       active accounts have already been re-amortized and borrowers notified. Therefore, HESAA
       respectfully requests that this recommendation #5 be removed.

6. 	 Require that Gordin and Berger re-amortlze aU active accounts to correct the methodology
     used to accrue interest and ensure that interest is calculated at the time payment Is ret:eived,
     aud notify borrowen as appropriate.




Control Number ED-mOlA07·C0032              5
   BESAA Response #6;

       HESAA concurs with the finding, but disagrees with the number of accounts included in the
       understatement of interest calculation. The special counsel returned the portfolio and HESAA
       completed the re-amortization of the active accounts. Borrowers were notified appropriately.
       As a result, we request that the understatement of interest calculation in the finding be limited
       to seventy-nine (79) closed accounts of the total one hundred fifty-seven (157) accounts in the
       portfolio. Therefore, HESAA respectfully requests the removal ofthis recommendation, since
       all active accounts have already been re-amortized.

7. 	 Require that Scott Marcus and Associates re-amortize all active accounts to ensure that
     interest is accrued correctly, and notify borrowers as appropriate.

   HESAA Response to #7;

       HESAA concurs with the recommendation that Scott Marcus and Associates re-amortize all
       active accounts. HESAA has taken the following corrective actions:

       • 	 Annual special counsel meeting - reiterated proper payment allocation method and accrual
          methodology

       • 	 Reviewed sample cases with special counsel to evaluate balance calculations.

       • 	 June 2003, HESAA staff conducted an annual site visit at the special counsel's office to
          review the system records and system calculations of accrued interest. HESAA had
          continued to monitor the system's calculation and has provided additional assistance to the
          special counsel.

       Borrowers are being advised oftheir correct balance subsequent to re-amortizations and
       provided with a statement displaying the balance.

S. 	 Remit to the Federal Fund $25,632 in imputed interest lost as a result of fees withheld by
     BBL, New Jersey.

   HESAA Response to #8;

       HESAA does not concur with this recommendation and respectfully requests its removal from



Control Number ED-OIG/A07-COO32              6
       the report. The Federal debt collection interest rate under 31 U.S.C.A. Sec. 3717 should not
       apply to monies owed to HESAA's Federal Student Loan Reserve Fund (FSLRF) pursuant to
       Title IV ofthe Higher Education Act of 1965, specifically 20 U.S.C.A. 1072(h)(4)(A), as well
       as regulations issued thereunder, specifically 34 CFR part 682.419. HESAA, as a Federal
       Guaranty Agency is authorized to place monies in a restricted account "established. by the
      Agency with the approval ofthe Secretary." HESAA has a long-standing policy of depositing
       these funds in the New Jersey Cash Management Fund. DCL 99-G-316 (Attachment II)
       expressly pennits guaranty agencies "that have invested the Federal reserve funds in 'pooled
       investments' as part of a State investment program" to continue to utilize that investment
       vehicle for the FSLRF without requesting specific approval from the Secretary. The Notice of
      Proposed Rulemaking for the FFELP program, dated August 3, 1999 uses the same language
      when creating rules for the FSLRF. While these funds and investment earnings are
      undisputedly owned by the Federal government, they are under HESAA's fiduciary care, have
       been invested by HESAA in the New Jersey Cash Management Fund, and have historically
       accrued interest at the rate earned. by that fund. Accordingly, any amounts collected by HESAA
       for the FSLRF would have been placed in this account and accrued interest at that rate.
       Therefore, the rate ofthe New Jersey Cash Management Fund should be the appropriate rate
      used to determine the interest due to the FSLRF on any FFELP student loan collection remitted
       by HESAA as opposed to the Federal Debt Collection rate. Based on this rate of return,
      HESAA reimbursed to the FSLRF $14,573, the actual amount of interest that the FSLRF would
      have earned had the special counsel deposited these collections in compliance with the 48-hour
       rule.

       Additionally, all amounts due and owing to the USDE as part ofthe Secretary's equitable share
       of total collections are reported on the Monthly Fonn 2000 and were paid on a timely basis or
       used as an offset against student loan reinsurance amounts due to HESAA from the USDE, as
       appropriate.

9. 	 Require that the special couDsels establish uniform procedures for recording the date the
   borrower's payment Is received.




Control Number ED-CIGIA07-COO32             7
   HESAA Response to #9

   HESAA concurs with this reconunendation and has already instructed the special counsels to
   stamp all checks with the date ofreceipt. Although this is not defined in any federal regulation, we
   agree this is a good business practice.


10. Ensure that all payments are deposited into a federal interest-bearing account witbin 48
    hours of receipt from the borrower.

   HESAA Response to #10

      HESAA concurs with this recommendation and has already taken the following actions to
      further ensure compliance with the federal regulation requiring deposit of student loan
      payments into an interest bearing federal account within 48 hours. These include:


      • 	 HESAA deposit procedures are conununicated to the special counsels on a periodic basis.

      • 	 HESAA requires special counsel to fax the daily deposit ticket and a listing of items being
          deposited. As previously stated above, checks are required to be stamped with the date of
          receipt, and the list of items being deposited must contain borrower infonnation.     This
          provides for a reconciliation between the daily deposit and the remittance report.

      • 	 HESAA monitors daily deposit activity of special counsel.

      • 	 HESAA Finance Division sends an e-mail notification to any attorney for any business day
          when no deposits and no faxes were received indicating there were no deposits, and makes
          the initial phone contact to special counsel personnel if necessary.

      • 	 HESAA Finance Division reports any instances of non -compliance to the program
          administrator and Office of Audits and Quality Assurance for appropriate action.


   Response to Inspector General's Statement On Management Controls:

       HESAA disagrees with the statement that the assessment "disclosed significant management
       control weaknesses". Prior to notification ofthis audit by the Inspector General, HESAA had
       already identified most ofthe specific problems with the collections portfolio, which are
       described in the Audit Results section ofthe Draft, and had begun necessary improvements to



Control Number ED-OIGIA07-COO32             8
       more effectively administer the special counsels' portfolios. To address these concerns,
       HESAA has over the past two years, implemented a series of additional management controls
       to improve and strengthen our special cOWlsels' compliance with program requirements.
       HESAA has taken the following actions:


       • 	 In 2002, HESAA reorganized its Audits & Quality Assurance unit by hiring a new Director.
          Subsequently, additional staffwas hired to facilitate the review of all special counsel.

       • 	 Conducted a survey (Core Sample Review) of all ten special counsel.

       • 	 Conducted and will continue to conduct annual attorney meetings with all special counsel
          to keep special counsel infonned ofnew initiatives, address control weaknesses identified,
          and reiterate federal compliance requirements.

      • 	 Continued site visits to all special counsel by HESAA's Servicing and Collections Unit at
          least once a year to discuss systems and servicing issues identified by HESAA that pertain
          to counsel.

       • 	 HESAA's Audits & Quality Assurance unit is conducting biennial compliance reviews of
          all special counsel. These reviews are included in HESAA's Annual Audit Plans approved
          by the Higher Education Student Assistance Authority Board.

       • 	 HESAA revised the Special Counsel Retainer Agreement in August 2003. The new
          retainer agreement strengthens HESAA's management controls, standardizes special
          counsel receipt and application ofborrower payments, the remittance and reporting of
          collections, and monitoring processes.

       • 	 HESAA continuously reviews and revises its policies and procedures on an ongoing basis
          to ensure accuracy and compliance with federal and state rules and regulations.

       • 	 Continuous monitoring of all special counsels by Servicing and Collections staff and
          HESAA's finance staff: This includes:

              • 	 On~site testing ofspecial counsel system computations

              • 	 Sampling of borrower accounts

              • 	 Reconciliation of cash receipts to remittance reports



Control Number ED-OIGfA07-COO32             9
              •   Reconciliation of the attorney portfolio

              •   Monitoring changes in attorney collection perfonnance

              •   Follow-up on instances of non-compliance.

      We ask that the statement of Management Controls be revised to delete the phrase "significant
      management control weaknesses" and, instead, to state that "our assessment disclosed that
      HESAA has recently improved its management control systems with respect to special counsel
      to better prevent improper application ofpayments, improper accrual ofinterest, improper
      remittances and untimely deposits ofcollections. Such problems as were identified during the
      audit period are fully discussed in the "Audit Results" section ofthis report."



   Conclusion

   In sum, HESAA appreciates the opportunity to review and conunent upon the Draft prior to it
   being finalized, and accepts a majority of the findings and recommendations. We ask that the
   Background, Reconunendations nwnbers 2, 5, 6, & 8, and the Statement ofManagement Controls
   (as noted above) be revised to more accurately described your findings and reconunendations
   concerning the management and collections procedures ofHESAA and its special counsels. Thank
   you for your cooperation and consideration during the entire audit process, which has been a
   valuable leaming experience for all concerned.




Control Number ED-OIGIA07-COO32            10
 ATrAC~ 1                (Cmltrol #ED-OIG/A07-CO03l)
N'EW ,JERSEY HIGHER EDtJCA'..,,,,0.­                  SUPERIOR COUR"... '.i t"    NEW       JERSEY
ASSISTANCE AUTHORITY                                  LAW DIVISION SPECIAL CIVIL PART
                                                                 BERGEN COUNTY

                                                        ON {X) CONTRACT { ) TORT 

PLAINTIFF                                               DOCKET NO. DC-007Q2J-96 

                                                               STATEMENT FOR POCKETINg'
                    vs                                          Plaintiff's Attorney:
                                                               WATERS, MCPHERSON, MCNEILL
                                                               300 LIGHTING WAY
                                                               SECAUCUS, N J 07096

DEFENDANT


Judgment in the above entitled cause was entered in the Bergen county 

Sp@gial CbB Part in favor of the plaintiff Is) and against the defendant Is) . 

An Execution was issued on________               Judgment date 08/00/90
and was returned oon'-_______________                 JUdgment amount             $3377.24

Monies received by Officer $, _______                  Costs & Atty fees $              86,54
                                                                                                           •
                                                                                                           o
Total credits ....••••.•.••.. $_______                1IDD'L costs                $_-

An   Execution was issued on___________
and was returned on___________________                CREDITS, if any             $_­

Monies received by Officer $_________                 TOTAL .••...••.••. $3463.78

Total credits .••.....•....... $________ 


I HEREBY CERTIFY THAT the foregoing reflects               the~udgment           and    cost~_of     record in the
Court, as of this time.


PM
           . . S'Tc.2.9C·jl"'"'"'"-
DATED:-8"o'I3U .                   ___
                                                  ,        \     f    ;Lvh'
                                                                      AKGBLO
                                                                             . C-.~~~~{'~
                                                                                      (k:-.
                                                                                J., CATALDO
                                                                    clerk of .1;be Court     . J/
I, the undersigned (Attorney for the above                      ) 'l'at.al judgment due $ 3463.78­
named Plaintiff) certify that at the present                                                      -0­
time there is due .upon the above mentioned                          Total credits               $_--­
judgment, which is about to be docketed in                                                       $ 3463.78
the SUPERIOR COURT of New Jersey, (TRENTON)                          Subtotal
         I hereby c~r-:fy that the foregoing      Interest              $:__2::'::.:...77:.....­
         is i:l truo copy of tho original on file
         In my office.                            Total due this date $ 3488.55
                ~      . 0.. f"':"l_ n            (being a sum not less than
               ~k.....&It'+-'-11dJG.""            Ten Dollars)
- I certify that th~rOing s-tatements made by me are true. I am aware that i f                                 an}
  of t~-foregoing -~~ts made by me- are willfully false, I am subject to
                     September Z~. 1996                         ,. .'
                                                                      "
                                                                           .           ..             ~.
A'l'TACmmNT 1             (Control #ED-OIG/A07-C003Z)
                                        WAfERS.~MCNEILL
                                        I~T8TATEMENT
                                                 "
FlU! ,Ui&6



             -
-

             011l20/1I'
             0SJ1_
                                         c....
                                            ",00
                                            "'00
                                          $20.00
                                        TAX CREDIT
                                                           lut....1St



                                                             $328.80
                                                                           .......".00
                                                               ...... .......
                                                                $0.00


                                                                               ".00
                                                                                         ~IBaJ . 

                                                                                      $$,377.24
                                                                                      $3.443.78 

                                                                         JUDGEMENT COST
                                                                                            $3,463.78
                                                                                                           InlerntBeL

                                                                                                                 ......
                                                                                                                  "'00


                                                                                                                $333-l4
             DB/1....                     $38.IlO               ".00           ..~O          $3,463.78          $295.74·

             12131199
             12131100
                                        TAX CREDIT
                                            "'-00
                                            $0.00
                                                             $293.85-
                                                             $173.88
                                                                               .. ~
                                                                               ".00
                                                                                             $3,0483.711
                                                                                             t3,4e3.78
                                                                                                                $&89.69
                                                                                                                $763.25
                                                               m211

             _. 

             QO/SOI01                     $112.00                              ".00          $3,483.78          f/29.54
             08/2.101
                                        TAXCAEDIT
                                          $301l00
                                        TAX CREDIT
                                                               ......          ".00          __"",78            $472...

                                          ... ~                118.27          ...do         $3,463.78          $441.13
                                        TAX CREDIT
                                            ".00                               ..m
             12/31101                                          ....83
                                                                               ..m
                                                                                             $3,483.78
                                                                                                                -.60 

                                                                                                                $401.76



             -

             0&l29I02                     $224.00              SM84                          $3.483.78
                                        TAX CREDIT
                                        .819.so'·               $3,"           ".00               $0.00     +     ${J.oo ­
                                 *      TAXCREDIT
                                                         EN)   Of RECORDS-PRJNTED 11JS102
                                                                                         BALANCE $0.00




                               "\"-1-    CA.cd,e         ",c;t.III11I~   ~!Xl.QO                                     •
                                            '('~~¥.tr               A/(ll'eJ _~ '6' PHe..




                                                                                     \




                                                     "




                                                                                                                        ,

  ATTACHMENT II (Control #EDOOIG/A07-COOlZ)
                                                                         . o m e SFA Portal Contacts What', New Fe

                                        SFA Infonnatlon for Financial Aid Professionals
                                                U.S. Department of Education


DCLPublicationDate: 111/99
DCUD: 99-G-316
AwardYear:
Summary: Provisions of the Higher Education Amendment8 of 1998 (Pub. L. 105-244) that
relate to the Federal Fund and Operating Fund uaed by guaranty agencies In the Federal Family
Education Loan Program.


January 27,1999

99-G-316


SUBJECT: Provisions of the Higher Education Amendments of 1998 (Pub. L 105-244) that relate to
the Federal Fund and Operating Fund used by guaranty agencies in the Federal Family Education
Loan Program.


Dear Guaranty Agency Director:

This letter provides the Secretary's initial guidance concerning the two new funds each guaranty
agency Is required to establish under the Higher Education Amendments of 1998 - the "Federal Fund'
and the ·Operating Fund.' The Secretary has' asked that I share this guidance with you. A separate
letter is being prepared about the other provisions of the 1998 Amendments that primarily affect
guaranly agencies and lenders, for example, voluntary flexible agreements, prohibited inducements,
and blanket certificates of guaranty. The Secretary invites your views on those other provisions, which
will be helpful as the next letter is prepared.

We welcome your comments concemlng this initial guidance about the Federal and Operating Funds.
If you have questions about this new legislation, or the guidance in this letter, please call my staff at
(202) 706-8242.

Sincerely.



G,..Woods
Chief Operating Officer
OfIice of Student Financial Assistance Programs



THE FEDERAL FUND

Establishing the Federal Fund

Under §422A of the Higher Education Act of 1965, as amended (the "HEA") each guaranty agency is
required to establish a Federal Student loan Reserve Fund (the "Federal Fund"), within 60 days of
enactment of Pub. L 105-244. The date of enactment of Pub. l. 105-244 was October 7, 1998, the
date it was signed by the President Guaranty agencies were informed during subsequent discussions
that the two new funds m.Jst be established by December 6, 1998.

The Secretary has decided that all of the funds, securities, and other liquid assets in the agency's
   (Control ofED-QIG/A07-COOlZ)

reserve fund as of September 30, 1998, as described in 34 CFR 682.410(a), must be deposited into
the Federal Fund when It is established. The new legislation specifies that the Federal Fund shall be
located in a type of account selected by the agency, with the approval of the Secretary, The new
Federal Fund must be a separate account that contains only funds belonging to the Federal Fund. A
guaranty agency may use Its existing Federal reserve fund account established pursuant to 34 CFR
682.410(a) that satisfies the above requirement as the new Federal Fund simply by notifying the
Secretary in writing. If a different account is desired, the agency must provide a description of the
proposed account and promptly request the Secretary's approval.


ownershjP of the federal fund

The statute stipulates thai the Federal Fund, and nonliquid assets (suCh as buildings or equipment)
developed or purchased by an agency in whole or in part with Federal res8fVe funds, regardless of
who holds or controls the Federal re&elV8 funds or assets, are the property of the United States. The
ownership of assets will be prorated based on the percentage dthe asset developed or purchased
with Federal reserve funds.

Section 422A(d) of the HEA allows the Federal Fund to be used only to pay lender claims and to pay
cfefauH aversion fees into the agency's Operating Fund. Under the statute, these same restrictions
apply to nonliquid assets. The statute also authorizes the Secretary to restrict or regulate the use of
suCh assets to the extent necessary to reasonably protect the Secretary's prorated share oflhe value
of SUCh assets. A strict application of this restriction would prohibit an agency from using nonliquid
assets developed or purchased with Federal Funds for any other purpose and would unnecessarily
burden the agency's performance of Its other responsibilities in the Federal Family EducatiOll Loan
Program. The Secretary recognizes that Federal regulations in effect prior to the amendments
authorized guaranty agencies to use !he Federal portion of nonliquicl assets for other allowable
purposes and wishes to continue that policy. Accordingly, the Secretary hereby authorizes guaranty
agencies to use the Federal portion of nOllliquld assets for activities necessary and appropriate to fulfill
the agencies' guaranty responsibilities as provided in 34 CFR 682.410. In addition, the Federal portion
of nontiquid assets may also be used for activities other than those described in 34 CFR 682.410,
subject to the conditions described in 34 CFR 682.410(a)(6)(i).
Deposjts into the Federal Fund
The statute requires an agency to deposit into the Federal Fund:
1. Default reinsurance payments received from the Secretary, and payments made to the agency by
the Secretary on death, disability, bankruptcy and loan cancellation and discharge Claims;

2. A percenlage of collections equal to the complement of the reinsurance percentage paid on a
defaulted loan, and 100 percent of payments obtained with respect to a loan that the Secretary has
repaid or discharged under §437 of the HEA;

3. Insurance premiums cotlected from borrowers ptATSUant to §428(b){1)(H) and §428H(h) of the
HEA;

4. All amounts received from the Secretary as payment for supplement::!1 preclaims activity
performed OIl or before September 30,1998;

5. 70 percent of amounts received on or after October 1, 1996, as payment for administrative cost
allowances for loans upon which insurance was issued on or before September 30, 1998; and

6. Other receipts as specified in the Departmenfs regulations.

Inyestments of the Federal Fund
The Federal Fund (and amounts in the Operating Fund that are borrowed from the Federal Fund) shall
be invested in securities issued or guaranteed by the United Slates or a State, or with the approval of
the Secretary, in other similarly low-risk securities selected by the guaranty agency. Guaranty
agencies that have invested the Federal reserve funds In "pooled" investments as part of a state
investment program may continue using that investment vehicle for the new Federal Fund without
requesting specific approval from the Secretary. Eamings on the investment of the Federal Fund are
the sole property of the Federal Govemment. Guaranty agenCies shall exercise the level of care
 (Control #ED-OIG/A07-COO3Z)

required of a fiduciary charged with !he duty of investing the money of others. Accordingly, a guaranty
agency may not prepay obligations of the Federal Fund unless it demonstrates, to the satisfaction of
the Secretary, that the prepayment is in the best Interests of the United Stales.

                                        THE OPERATING FUND


Establishing the Operating Fund

Each guaranty agency must establish a fund designated as the "Operating Fund' by December 6,
1998 (within 60 days after the enactment of Pub. L. 105-244.) The Operating Fund must be in an
account that is separate from the Federal Fund. The slaMe requires an agency to deposit into the
Operating Fund:

1. Loan processing and issuance fees;

[Note: Under §428(f) of the HEA, each guaranty agency will be paid a processIng and issuance fee
equal to 0.65 percent of the total principal amount of loans originated during fiscal years 1999 thlOl.lgh
2003 on which suCh agency issued insurance (beginning with fiscal year 2004, the fee drops to 0.40
percent of the principal amount of the loans). No payment may be made for loans for which the
disbursement checks have not been cashed or for which electronic funds transfers have not been
completed. The rea will be paid quarterly. The Secretary has decided to calculate the amount of !he
fee based on aggregates of each guaranty agency's data reported to !he National student Loan Data
System.]
2. 30 percent of administrative cost allowances received after October 1, 1996, for loans upon which
insurance was Issued before October 1, 1998;

3. Account maintenance fees;

[Not.: Under §458 of the HEA, each guaranty agency will receive an account maintenance fee in an
amount equal to 0.12 percent of the original principal balance of guaranteed loans outstanding during
fiscal years 1999 and 2000. During fiscal years 2001 through 2003 the fee shall be 0.10 percent of the
original principal balance of guaranteed loans outstanding during the year. The fee will be paid
quarterly.

The Secretary has decided to calculate the amount of the fee by using the guaranty agency's data
reportsd to the National Student Loan Data System. In order to pay prompUy foHowIng the end of each
quarter, the amounts of the first three quarterly payments for each fiscal year wilt be 0.12 percent of
the original principal balance of loans outstanding at the beginning of the fiscal year, divided by four.
The fourth quarter payment will be calculated by obtaining the sum of the original principal balance of
loans outstanding at the beginning and end of the fiscal year, dividing by two, multiplying the result by
0.12 percent, and subtracting the amounts of the first three quarterly payments.]
4. Default aversion fees;

[Note: Pub. L. 105-244 added a new default aversion fee in §428(1) of the HEA to replace the
supplemental preclairns aSSistance payment made under prior law. Upon receipt of a completed
request for assistance from a lender not earlier !han the 60th day of delinquency, a guaranty agency
must engage in default aversion activities designed to prevent a default by the borrower. For any loan
on which a defatJlt claim is not paid by the guaranty agency as a result of the loan being brought into
current repayment status by the guaranty agency on or before the 360lh day of delinquency, the
guaranty agency shall be paid a default aversion faa. For the purpose of earning the default aversion
fee, !he term 'current repayment status' means that the bolTower is no longer delinquent as a result of
paying all principal and interest on the loan forwhich a payment due date has passed. The fee shall
be equal to 1 percent of the total unpaid principal and accrued interest on the loan at the time the
request for assistance is submitted by the lender.
The default aversion fees eamed may be transferred by the guaranty agency 10 its Operating Fund
from the Federal Fund no more frequentty than monthly. The statute stipulates that the fee may not be
paid more than once on any loan, unless (1) at least 18 months have elapsed between the date the
borrowar entered current repayment status and the date the lender filed a subsequent default aversion
assistance request; and (2) the bolTlJWillr was not more than 30 days past due on any payment of
  (Control #ED-OIG/A07-C0032)

principal and interest during such period.]

5. Amounts remaining from collections of defaulted loans after payment of the Secretary's equitable
share and depositing tile complement of the reinsurance percentage into the Federal Fund;

[Nota: The statute authorizes guaranty agencies to deposit an amount equal to 24 percent of the
payments made by or on behalf of a defaufted borrower into its Operating Fund. Beginning October 1,
2003, the amount of collections an agency may deposit into its Operating Fund is reduced 10 23
percent]
6. Amounts borrowed from the Federal Fund; and

7. Other receipts as specified In the Departmenfs regulations.

Bol"l"OWlng from the Federa! Fund
Under §422A(f) of the HEA, In addition to using the Federal Fund for the purposes described earlier, a
guaranty agency may borrow a limited amount of funds from the Federal Fund to establish the
Operating Fund. Upon receiving the Secretary's approval, an agency may borrow from the Federal
Fund an amount up to the equivalent of 180 days of cash expenses (not including claim payments) for
normal operating expenses for deposit into the agency's Operating Fund. The amount borrowed and
outstanding during the firtrt 3 years after establiShing the Operating Fund may not at any time exceed
the lesser of 180 days cash expenses (not including claim payments), or 45 percent ofthe balance in
the Federal reserve fund as of September 30, 1998.
The statute requires a guaranty agency that wishes to borrow principal or interest from the Federal
Fund to provide the Secretary with a repayment schedule and evidence that it can meet the schedule.
Therefore, prior to borrowing from the Federal Fund, a guaranty agency shall provide the Secretary
with the following:
1. A request for the loan that Identifies the desired amount and the desired tenns of repayment;

2. A projected revenue and expense statement (that must be updated annually during the repayment
period), that demonstrates that the agency will be able to repay the loan within the repayment period
requested;

3. A certification that sufficient funds will remain in the Federal Fund to pay lender claims within the
required time periods, to meet the reserve recall requirements of 1422 of the HEA, and to satisfy the
statutory minimum reserve level of 0.25 percent, as mandated by §428(cX9) of the HEA; and

4. A certification that there are no legal prohibitions to the agency obtaining or repaying the loan.

Borrowing of Interest
Section 422A(f)(2) authorizes the Secretary to permit a limited number of agencies to borrow an
amount greater than 180 days of operating expenses (not including claim payments) in certain limited
cases. Specifically, an agency may be authorized to ~ the 18O-day limit: by the amount of interest
income earned 0f1 the Federal Fund during the 3-year period following the date of enactment. To be
allowed to borrow the interest Income, In addition to Items 1-4 above, the agency must demonstrate to
the Secre~ary that the cash flow in the Operating Fund will be negative without the transfer of such
interest, and the transfer will substantially Improve the financial cln::umstances of the guaranty agency.

The Secretary will respond to a guaranty agency's request 10 borrow from the Federal Fund within two
weeks after receiving the Items described above. All correspondence should be addressed to: Mr.
Larry Oxendine, Director, Guarantor and Lender Oversight Service, U.S. Department of Education,
washington, DC 20202. Guaranty agencies may call Mr. Oxendine's staff at (202) 401-2280 for
Information concerning their requests.



                                                                . The statute        .
                                                                                              ..
                                                                                         In the Operating
 (Control fED-OIG!A07-COO3Z)

Fund.

General usage rule
The statute specifies that the operating Fund shall be used by the guaranty agency to fulfill its
responsibilities under the HEA. In addition to repaying money borrowed from·the Federal Fund,
permissible uses include application processing, loan disbursement, enrollment and repayment status
management, default ave!$ion, collection activities, school and lender training, financial aid awareness
and outreach activities, compliance monitorlng, and other student financial aid related activities, as
selected by the guaranty agency .



             •
     not later than the start of the 4th year                         the
borrowed shall be repaid not later than 5 years after the date the Operating        i established.
Repayment of interest
The statute authorizes the Secretary to extend the period for repayment of interest borrowed under
§422A(f)(2) of the HEA, fi'om 2 years to 5 years If the Secretary determines that the cash flow of the
Operating Fund will be negative If the borrowed interest had to be repaid earlier, or the repayment of
the interest would substantially diminish the financial circumstances of the agency. To receive an
extension, the agency must demonstrate that it will be able to repay all borrowed funds by the end of
the 8th year following the date of establishment of the Operating Fund, and that the agency will be
financially sound upon the completion of repayment Repayment of amounts borrowed from the
Federal Fund pursuant to §422A(f)(2) of the HEA that are repaid during the 6th, 7th, and 8th years
following the establishment of the Operating Fund shall include the amount borrowed, plus any income
eamad after the 5th year from the Invesb'Tlent of the borrowed amount. In detennining the amount of
income eamed on the borrowed amount, the Secretary will use the average investment Income earned
on all the agency's investments.
If an agency fails to make a scheduled repayment to the Federal Fund, the agency may not receive
any other federal funds until the agency becomes current in making all scheduled payments, unless
the Secretary waives this restriction.




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