Internal Controls: FMS' Monitoring of Lockbox Bank Operations Needs Improvement

Published by the Government Accountability Office on 1999-08-20.

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

                  United States General Accounting Office

GAO               Report to the Commissioner, Financial
                  Management Service, Department of the

August 1999

                  FMS’ Monitoring of
                  Lockbox Bank
                  Operations Needs

United States General Accounting Office                                                             Accounting and Information
Washington, D.C. 20548                                                                                   Management Division

                                    B-282987                                                                                        Letter

                                    August 20, 1999

                                    Mr. Richard L. Gregg
                                    Commissioner, Financial Management Service
                                    Department of the Treasury

                                    Dear Mr. Gregg:

                                    We recently reported on the U.S. government’s financial statements for
                                    fiscal year 1998.1 In connection with fulfilling our requirement to audit
                                    these statements, we performed audit procedures to evaluate the internal
                                    controls over cash receipts processed by the Department of the Treasury’s
                                    Financial Management Service (FMS) on behalf of the federal government.2
                                    Our audit included testing the effectiveness of FMS’ internal controls over
                                    lockbox collections. The purpose of this report is to provide the results of
                                    our work in this area and our recommendations for improvement.

                                    On behalf of federal agencies, FMS enters into lockbox service agreements
                                    with commercial banks to collect certain payments made to the federal
                                    government. FMS uses two lockbox networks: the general lockbox
                                    network for all payments except federal taxes and the Internal Revenue
                                    Service (IRS) lockbox network for federal tax payments.3 Both networks
                                    use the same banks but are under separate lockbox service agreements
                                    with FMS. The banks establish post office boxes and electronic accounts
                                    to receive payments and are responsible for safeguarding and processing
                                    the funds collected in accordance with their agreements with FMS and the
                                    federal agencies. In fiscal year 1998, FMS reported that about $259 billion
                                    was collected through these banks, of which $242 billion was federal tax
                                    payments in the IRS lockbox network and $17 billion was nontax payments
                                    in the general lockbox network. Because funds collected through lockbox
                                    banks go directly to the banks, FMS must ensure that the banks establish
                                    and maintain adequate internal controls over the collections they process.
                                    Thus, FMS’ monitoring of lockbox banks’ operations is intended to be a key

                                      Financial Audit: 1998 Financial Report of the United States Government (GAO/AIMD-99-130, March 31,
                                        31 U.S.C. 331 (e) (1994).
                                        Network is the term used by FMS to describe the group of banks that provide lockbox services.

                   Leter            Page 1                                                       GAO/AIMD-99-219 Lockbox Collections

                      internal control for ensuring that the funds collected are protected against
                      fraud, waste, and mismanagement.

Results in Brief      FMS needs to improve its monitoring of lockbox bank operations to ensure
                      that federal collections are adequately safeguarded and properly
                      processed. We found weaknesses in FMS’ monitoring of lockbox bank
                      operations related to on-site reviews and lockbox bank audits. Specifically,
                      we and other auditors found that on-site reviews performed by FMS at IRS
                      lockboxes were not always effective in detecting certain internal control
                      weaknesses at the banks. Also, FMS did not perform periodic on-site
                      reviews of the general lockbox bank operations prescribed in its internal
                      policies and procedures and authorized by its agreements with the banks.
                      In addition, FMS did not have a policy to and did not obtain and review the
                      results of the internal and external audits of general lockbox bank
                      operations, even though these audits were required under the agreements
                      with the banks. Further, FMS did not include any audit requirements in its
                      IRS lockbox agreements.

                      Without performing these key monitoring activities, FMS is not assured of
                      timely identifying and resolving internal control weaknesses at lockbox
                      banks. Such weaknesses increase the risk of loss of federal collections.
                      We and other auditors recently reported on weaknesses in internal controls
                      and instances of actual theft of federal tax payments by employees of
                      banks that provide IRS lockbox services.4 These problems emphasize the
                      importance of establishing adequate controls and effectively monitoring
                      lockbox banks to timely identify and resolve internal control weaknesses
                      that otherwise put billions of dollars of government collections and
                      taxpayer data at risk.

Background            The lockbox program was established to collect a variety of payments to
                      federal agencies through commercial banks (sometimes called federal
                      depositaries but hereafter referred to as lockbox banks), including income
                      taxes, customs duties, fees, licenses, and payments for goods and services
                      the agencies provide. Lockbox banks establish post office boxes or
                      electronic accounts to receive payments made to agencies, process the

                        Financial Audit: IRS’ Fiscal Year 1998 Financial Statements (GAO/AIMD-99-75, March 1, 1999) and
                      Review of the Effectiveness of Using Commercial Bank Lockboxes for Federal Income Tax Payments
                      (Treasury OIG-98-097, August 20, 1998).

              Leter   Page 2                                                  GAO/AIMD-99-219 Lockbox Collections

              payments, transfer funds to the Treasury General Account at the New York
              Federal Reserve Bank, submit collection reports to the federal agencies,
              and report collection data to FMS. FMS is responsible for the overall
              management of the lockbox program and currently has agreements with
              four banks to provide lockbox services. Each of the four banks provides
              general and IRS lockbox services and has multiple lockbox sites. There are
              a total of 11 lockbox sites nationwide.

              FMS enters into agreements (called lockbox depositary agreements) with
              the lockbox banks to provide lockbox services for federal agencies. These
              agreements set forth the general terms and conditions for lockbox
              operations and FMS’ rights to examine and audit those operations. FMS,
              lockbox banks, and each of the federal agencies for whom the lockbox
              services are to be provided, also establish memorandums of understanding.
              These three-party agreements set forth procedures for processing
              collections that are designed to meet the specific processing and reporting
              requirements of the individual federal agencies.

              Under these agreements, the banks are required to maintain books,
              records, reports, and other evidence to support collections processing and
              deposit activity; FMS has the right to inspect, at all times, all parts of the
              lockbox bank facilities engaged in performing lockbox services; and the
              banks are required to have security controls such as security cameras,
              access logs, and employee identification badges. In addition, the general
              lockbox agreements require banks to obtain semiannual internal and
              biannual external audits that cover internal controls over lockbox
              operations and to submit these audit reports to FMS upon request. FMS
              did not include this type of requirement in the IRS lockbox agreements.
              For IRS lockboxes, FMS and IRS monitor and oversee bank operations
              through regular on-site reviews during peak collection periods (such as in
              April when individual tax payments are processed) and quarterly
              performance reviews of the lockbox banks.

Scope and     To meet our objective of evaluating the effectiveness of FMS’ internal
              controls over lockbox operations, we reviewed FMS’ policies and
Methodology   procedures for monitoring lockbox bank operations and discussed these
              with FMS officials. We also reviewed the standard lockbox depositary
              agreements for both the general lockbox network and the IRS lockbox
              network. In addition, we reviewed the related memorandum of
              understanding for one lockbox bank to identify provisions related to
              safeguarding lockbox collections. As part of our audit of IRS’ fiscal year

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                        1998 financial statements, we observed physical safeguards and
                        segregation of duties over receipts and related taxpayer data processed at
                        two lockbox bank sites. In addition, we reviewed a Treasury Office of
                        Inspector General (OIG) report on IRS’ lockbox operations to determine if
                        the auditors had identified any internal control problems. We performed
                        our work in accordance with generally accepted government auditing
                        standards as part of our audit of the government’s fiscal year 1998
                        consolidated financial statements for which our audit report was issued on
                        March 31, 1999. We requested comments on a draft of this report from the
                        Commissioner of the Financial Management Service. The Commissioner’s
                        comments are reprinted in appendix I.

Improvements Are        FMS needs to improve its monitoring of lockbox banks’ operations to
                        ensure that federal collections are adequately safeguarded and properly
Needed in FMS’          processed. The Comptroller General’s Standards for Internal Control in the
Monitoring of Lockbox   Federal Government require that management establish policies and
                        procedures to provide reasonable assurance that assets are safeguarded
Bank Operations         against loss from unauthorized use or disposition and transactions are
                        executed accurately and timely in accordance with management
                        directives.5 We found weaknesses in FMS’ monitoring of lockbox banks’
                        operations related to on-site reviews and lockbox bank audits.

On-site Reviews         On-site reviews are designed to assist FMS in evaluating the effectiveness
                        of the lockbox banks’ internal controls. FMS’ Regional Financial Center
                        (RFC) customer assistance staff are responsible for and are performing
                        on-site reviews at the IRS lockbox bank sites (6 in 1997 and 30 in 1998).
                        However, because the scope did not include all security-related matters,
                        these reviews did not detect problems that existed such as the following
                        internal control weaknesses we and other auditors identified.

                        In our audit of IRS’ fiscal year 1998 financial statements, we found that
                        internal controls related to receipts and related taxpayer data at certain
                        lockbox bank sites did not adequately safeguard collections. For example,

                         These requirements, along with proposed standards that supersede the standards we issued in 1983,
                        are included in our exposure draft Standards for Internal Control in the Federal Government
                        (GAO/AIMD-99-21.3.1) issued May 1999.

                        Page 4                                                   GAO/AIMD-99-219 Lockbox Collections

                      we reported that lockbox banks were using unarmed couriers to transport
                      checks and taxpayer data, and bank personnel whose background checks
                      had not been completed were helping process the checks and taxpayer
                      data. We also reported that in fiscal years 1997 and 1998, IRS’ internal
                      investigation unit had identified numerous cases involving employee theft
                      of hundreds of thousands of dollars of federal funds at lockbox banks.

                      The Treasury OIG also has identified the need for improvements in internal
                      controls related to IRS lockbox receipts and related taxpayer data. In
                      August 1998, after finding that 5 of the 10 IRS lockbox bank sites it visited
                      were not complying with required security measures outlined in the
                      memorandums of understanding, the OIG recommended that FMS ensure
                      banks’ compliance with agreed-upon security measures by making
                      unannounced security inspections.

                      FMS has begun unannounced security inspections at IRS lockbox bank
                      sites in response to the OIG’s recommendation. Specifically, as of March
                      1999, FMS had completed unannounced inspections at 2 IRS lockbox sites,
                      with a schedule in place to complete reviews at all 10 sites. FMS’
                      inspection team leader told us that they found instances of noncompliance
                      at both sites visited. For example, one of the banks had not fully tested its
                      contingency and disaster recovery plans. While the bank had tested the
                      automated procedures, it had not tested the process and related controls
                      for transporting checks and related taxpayer data to another location for

                      FMS’ Financial Services Division (FSD) is responsible for performing
                      on-site reviews at the general lockbox bank sites and has established a goal
                      of visiting each bank every 2 years. However, we found that FSD did not
                      perform any on-site reviews in fiscal year 1998 and performed only one
                      on-site review in fiscal year 1997. FSD officials said that on-site reviews
                      were planned for fiscal year 1998 but were canceled when travel funds
                      were diverted to another project.

Lockbox Bank Audits   Reviewing the results of audits of lockbox operations is another way for
                      FMS to determine if the banks’ controls are adequate. However, we found
                      that FMS did not require internal and external audits of lockbox operations
                      in its IRS lockbox agreements and was not obtaining and reviewing the
                      results of internal and external audits required by the general lockbox
                      agreements. An FSD official told us that instead of requiring audits of IRS
                      lockbox operations, FSD relied on the monitoring and oversight performed

                      Page 5                                      GAO/AIMD-99-219 Lockbox Collections

                  by IRS and FMS’ RFC staff through their on-site reviews and quarterly
                  performance reviews. However, in its August 1998 report on lockboxes,
                  the Treasury OIG reported that IRS did not always submit the results of
                  on-site security reviews to FMS timely because there was no regulation in
                  place requiring this. The OIG also reported that IRS had not been timely
                  monitoring the performance of the lockboxes.

                  For the general lockboxes, FSD was relying on bank officials’ verbal
                  assurances that the required semiannual internal audits were being
                  performed but was not requiring the banks to submit audit reports to FSD.
                  Regarding the external audits of these lockboxes, we found that three of
                  the four lockbox banks had not obtained the required biannual audit of
                  their lockbox operations as stipulated in their agreements with FMS. We
                  also found that the agreements do not include the specific type or scope of
                  audit to be performed. This is important because professional standards
                  provide for several different types of audits or other services.

Conclusion        Without effective monitoring of lockbox bank operations through on-site
                  reviews and review of internal and external audits of such operations, FMS
                  does not know whether the banks are adequately safeguarding and
                  properly processing collections. Also, unless FMS provides the banks with
                  specific guidance as to the type and scope of external audits required, FMS
                  cannot be assured that these audits are consistent as to the level of work
                  being performed. Inadequate monitoring of lockbox bank operations could
                  result in problems like those found in our IRS audit and the OIG review
                  going undetected and unresolved for long periods, thus increasing the risk
                  of the loss of federal collections.

Recommendations   To correct the internal control weaknesses we identified with lockbox
                  operations, we recommend that you direct the Assistant Commissioner for
                  Federal Finance to ensure that the Financial Services Division

                  • performs the periodic on-site reviews of general lockbox banks as
                    prescribed in its internal policies and procedures;
                  • requires banks to obtain semiannual internal and biannual external
                    audits of their IRS lockbox operations;
                  • develops and provides to the banks specific guidance as to the type and
                    scope of the external audits or other services;

                  Page 6                                     GAO/AIMD-99-219 Lockbox Collections

                  • enforces the requirement for banks to obtain internal and external
                    audits in compliance with their lockbox depositary agreements with
                    FSD; and
                  • develops and implements a policy to obtain and review audit results
                    including procedures to follow up with banks and agencies on any
                    weaknesses identified in lockbox operations to ensure that the
                    problems are corrected.

                  We also recommend that you direct the Assistant Commissioner of Federal
                  Finance to monitor FSD’s efforts in this area and take steps to ensure

Agency Comments   In commenting on a draft of this report, the Commissioner of FMS
                  concurred with our findings and noted that FMS has or would be taking
                  actions to address the issues raised. Specifically, the Commissioner
                  indicated that FMS has already implemented an aggressive schedule of
                  on-site reviews. In addition, he stated that FMS intends to strengthen the
                  requirements to receive lockbox bank audits to ensure that FMS is fully
                  apprised of internal and external findings and their subsequent successful
                  closure. We will follow up on these matters during our audit of the federal
                  government’s fiscal year 1999 consolidated financial statements.

                  This report contains recommendations to you. The head of a federal agency
                  is required by 31 U.S.C. 720 to submit a written statement on actions taken
                  on these recommendations to the Senate Committee on Governmental
                  Affairs and the House Committee on Government Reform within 60 days of
                  the date of the report. A written statement also must be sent to the House
                  and Senate Committees on Appropriations with the agency's first request
                  for appropriations made more than 60 days after the date of this report.

                  We are sending copies of this report to Senator Fred Thompson, Chairman,
                  and Senator Joseph Lieberman, Ranking Minority Member, Senate
                  Committee on Governmental Affairs; Representative Dan Burton,
                  Chairman, and Representative Henry Waxman, Ranking Minority Member,
                  House Committee on Government Reform; the Honorable Lawrence
                  Summers, Secretary of the Treasury; Donald Hammond, Fiscal Assistant
                  Secretary, Department of the Treasury; Lawrence W. Rogers, Acting
                  Inspector General, Department of the Treasury; and the Honorable Jacob J.
                  Lew, Director, Office of Management and Budget. Copies will be made
                  available to others upon request.

                  Page 7                                     GAO/AIMD-99-219 Lockbox Collections

If you have any questions regarding this report, please contact me or
Christine Robertson at (202) 512-3406. Other key contributors to this
assignment were Suzanne Murphy, Jerry Marvin, and Carolyn Voltz.

Sincerely yours,

Gary T. Engel
Associate Director
Governmentwide Accounting and
 Financial Management Issues

Page 8                                     GAO/AIMD-99-219 Lockbox Collections
Page 9   GAO/AIMD-99-219 Lockbox Collections
Appendix I

Comments From the Financial Management
Service                                                       AppenIx

             Page 10        GAO/AIMD-99-219 Lockbox Collections
Appendix I
Comments From the Financial Management

Page 11                                  GAO/AIMD-99-219 Lockbox Collections
                  Appendix I
                  Comments From the Financial Management

(919375)   Letr   Page 12                                  GAO/AIMD-99-219 Lockbox Collections
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