Institutional Eligibility and Student Assistance General Provisions

DEPARTMENT OF EDUCATION

34 CFR Parts 600 and 668

RIN 1840-AC36

Institutional Eligibility and Student Assistance General

Provisions

AGENCY: Department of Education.

ACTION: Final regulations.

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SUMMARY: The Secretary amends the Student Assistance General Provisions

regulations by revising requirements for compliance audits and audited

financial statements, revising the two-year performance exemption to

the refund reserve requirement, and adding financial responsibility

standards for foreign schools. These final regulations improve the

Secretary's oversight of institutions participating in programs

authorized by title IV of the Higher Education Act of 1965, as amended.

The final regulations do not contain changes to the general

standards of financial responsibility, which will be considered further

by the Secretary.

DATES: Effective date: These regulations take effect July 1, 1997.

However, affected parties do not have to comply with the information

collection requirements in Sec. 668.23 until the Department of

Education publishes in the Federal Register the control number assigned

by the Office of Management and Budget (OMB) to these information

collection requirements. Publication of the control number notifies the

public that OMB has approved these information collection requirements

under the Paperwork Reduction Act of 1995.

FOR FURTHER INFORMATION CONTACT: Mr. David Lorenzo or Mr. John Kolotos,

U.S. Department of Education, 600 Independence Avenue, S.W., Room 3045

ROB-3, Washington, D.C. 20202, telephone (202) 708-7888. Individuals

who use a telecommunications device for the deaf (TDD) may call the

Federal Information Relay Service (FIRS) at 1-800-877-8339 between 8

a.m. and 8 p.m., Eastern standard time, Monday through Friday.

SUPPLEMENTARY INFORMATION: The Student Assistance General Provisions

regulations (34 CFR part 668) apply to all institutions that

participate in the student financial assistance programs authorized by

title IV of the Higher Education Act of 1965, as amended (title IV, HEA

programs).

Compliance audits and audited financial statements provide

information necessary for the Secretary to determine whether an

institution that participates or seeks to participate in the

[[Page 60566]]

title IV, HEA programs has the resources to deliver its education and

training programs to students and the extent to which the institution

complies with applicable statutory and regulatory requirements in its

administration of the title IV, HEA programs.

On September 20, 1996, the Secretary published a notice of proposed

rulemaking (NPRM) for this part in the Federal Register (61 FR 49552-

49574 ). The NPRM included a discussion of the major issues surrounding

the proposed changes (as well as a summary of the report by the firm of

KPMG Peat Marwick, LLP) which will not be repeated here. The following

list summarizes those issues and identifies the pages of the preamble

to the NPRM on which a discussion of those issues may be found:

Revisions to the compliance audit requirements that would

amalgamate the previous requirements for the provision of an audited

financial statement; the proposed inclusion of a requirement for a

proprietary institution to disclose the percentage of revenues it

derives from title IV, HEA programs; audit submission requirements for

foreign institutions; a clarification of the entity that must submit an

audited financial statement; and a statement regarding the treatment of

questionable accounting treatments contained in the required audited

financial statement (pages 49555-49556).

The scope and purpose statement of the new Subpart L (page 49556).

The new ratio standards that comprise the main test of financial

responsibility; a transition rule; and a proposed modification to an

exception to the refund letter of credit requirement (pages 49556-

49557).

A proposal to modify the precipitous closure alternative to

demonstrating financial responsibility; and a clarification of the

types of alternatives to demonstrating financial responsibility

available to new institutions (pages 49557-49558).

Financial responsibility standards and other requirements for

institutions undergoing a change of ownership (page 49558).

Financial responsibility standards for foreign institutions (pages

49558-49559).

Past performance standards (page 49559).

An outline of additional requirements and administrative actions,

including requirements for institutions that are provisionally

certified; and an outline of administrative actions taken when an

institution fails to demonstrate financial responsibility (page 49559).

The contents of the proposed Appendix F (page 49559).

The following discussion describes significant changes since the

publication of the NPRM.

General

In the September 20, 1996 NPRM, the Secretary indicated that the

Department intended to publish final regulations by December 1, 1996,

implementing new financial responsibility standards based on the

proposed ratio methodology. However, in response to public comment on

the proposed rules, the Secretary has decided to seek further comment

and delay publishing final rules implementing these standards.

In particular, the public expressed concern that there was

insufficient time for the Department to identify and address any

possible problems with the proposed methodology and make needed

technical adjustments. Commenters also asserted that institutions had

insufficient time to review and provide meaningful comment on the

methodology. Commenters from private non-profit institutions also

expressed concern about the sufficiency of data on the effects of

changed reporting standards that takes place when institutions begin

reporting under Statement of Financial Accounting Standards 116 and 117

promulgated by the Financial Accounting Standards Board, and maintained

that the Secretary should attempt to gather data on the effects of the

changes and further evaluate the methodological adjustments made to the

strength factors that are based on the estimated impact of that change.

Finally, commenters urged the Secretary to consult with more members of

the community regarding the potential impact of and possible

improvements to the methodology.

The Secretary sought to implement the proposed rule effective July

1, 1997 to benefit institutions that do not satisfy the current

financial responsibility standards, but could establish their financial

responsibility under the proposed standards because those standards

better evaluate the total financial condition of those institutions.

However, the Secretary is now convinced by commenters to await

further analysis and consultation. The Secretary is, therefore,

delaying publication of final regulations establishing a new subpart

containing new financial responsibility standards and related

regulations. The Secretary is publishing separately in the Federal

Register a notice reopening the comment period for those parts of the

September 20, 1996 NPRM not addressed in these Final Rules, and

providing further information regarding the Secretary's plans.

Because the Secretary is delaying publication of final rules

implementing the proposed changes to the financial responsibility

standards, the Secretary is not creating a new Subpart L in these Final

Rules, as was proposed in the September 20, 1996 NPRM. Nor is the

Secretary removing the current Sec. 668.15, as was also proposed in the

September 20, 1996 NPRM. Instead, as discussed below, the Secretary is

amending Sec. 668.15 to add the revised refund reserve performance

standard, to add the foreign schools financial responsibility

standards, and to remove the additional submission of an audited

financial statement. The Secretary is also amending Sec. 668.23 to

require the simultaneous submission of the audited financial statement

and compliance audit, both performed on a fiscal year basis, and to

require notification of 85/15 information as a note to the audited

financial statement.

Section 600.5--Proprietary Institution of Higher Education

The Secretary is removing Sec. 600.5(e), since the requirements for

verifying 85/15 information will now be contained in Sec. 668.23.

Section 668.15--Factors of Financial Responsibility

Because the Secretary is delaying publication of final regulations

addressing factors of financial responsibility, Sec. 668.15 is retained

and amended to include the change in the two-year performance

alternative to the refund reserve requirement, and to include financial

responsibility standards for foreign schools. Both changes were

originally proposed to be included in the new subpart L in the

September 20, 1996 NPRM.

The Secretary is also removing Sec. 668.15(e), since the audited

financial statement will now be required to be submitted with the

compliance audit under the requirements contained in Sec. 668.23.

Section 668.23--Compliance Audits and Audited Financial Statements

The Secretary has made several technical changes to the language

proposed in the September 20, 1996 NPRM. The Secretary is also removing

the proposed section addressing the treatment of questionable

accounting treatments.

As part of the consideration of the comments concerning the

consolidated audit submissions, the Secretary has also restructured

some of the regulation

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language to simplify and clarify the requirements. Specifically, a new

definition of Independent Auditor has been added to 668.23(a) to

explain that the audits submitted under these regulations may be

performed by certified public accountants or by government auditors

that meet certain governmental standards. Similarly, a new section

668.23(e) has been created that consolidates language from several

parts of the proposed regulation concerning access to auditor records

for a school's or servicer's compliance or financial statement audit.

This section also clarifies that such access includes the ability of

the Secretary or Inspector General to make copies of such records.

The Secretary also received substantive comments on the provisions

in Sec. 668.23 that were formerly contained in Sec. 668.24. While the

Secretary, as described above, has made technical changes in these

provisions, the Secretary does not address the commenters' substantive

concerns here. The Secretary will consider those comments when final

regulations addressing financial responsibility standards are

published.

Analysis of Comments and Changes

In response to the Secretary's invitation in the September 20, 1996

NPRM, approximately 500 parties submitted comments on the proposed

regulations. An analysis of the comments on Sec. 668.15 and Sec. 668.23

and of the changes in the regulations since publication of the NPRM is

published as an appendix to these final regulations. In that appendix,

the Secretary responds only to those comments pertaining to the final

regulations published here. The Secretary will publish responses to all

other comments when the Secretary publishes final regulations on the

remainder of the regulatory areas addressed in the September 20, 1996

NPRM.

Major issues are grouped according to subject, with appropriate

sections of the regulations referenced in parentheses. Other

substantive issues are discussed under the section of the regulations

to which they pertain. Technical and other minor changes--and suggested

changes the Secretary is not legally authorized to make under the

applicable statutory authority--are not addressed.

Executive Order 12866

Assessment of Costs and Benefits

These final regulations have been reviewed in accordance with

Executive Order 12866. Under the terms of the order the Secretary has

assessed the potential costs and benefits of this regulatory action.

The potential costs associated with the proposed regulations are

those resulting from statutory requirements and those determined by the

Secretary to be necessary for administering this program effectively

and efficiently.

In assessing the potential costs and benefits--both quantitative

and qualitative--of these final regulations, the Secretary has

determined that the benefits of the final regulations justify the

costs.

The Secretary has also determined that this regulatory action does

not interfere unduly with State and local governments in the exercise

of their governmental functions.

Summary of Potential Costs and Benefits

The Department has assessed the costs and benefits of the proposed

regulations. This discussion is contained in the Regulatory Flexibility

Analysis.

Assessment of Educational Impact

In the notice of proposed rulemaking, the Secretary requested

comments on whether the proposed regulations would require transmission

of information that is being gathered by or is available from any

agency or authority of the United States.

Based on the response to the proposed rules and on its own review,

the Department has determined that the regulations in this document do

not require transmission of information that is being gathered or is

available from any other agency or authority of the United States.

Regulatory Flexibility Analysis

The Secretary has determined that small entities are likely to

experience economic impacts from this regulation. Thus, the Regulatory

Flexibility Act (RFA) requires that an Initial Regulatory Flexibility

Analysis (IRFA) of the economic impacts be performed and that analysis,

or a summary thereof, be published in the notice of proposed

rulemaking. The IRFA was performed and a summary was published. This

Final Regulatory Flexibility Analysis (FRFA) discusses the comments

received on the IRFA and fulfills the other RFA requirements.

Summary of Significant Issues Raised by the Public Comments on the

Initial Regulatory Flexibility Analysis (IRFA), a Summary of the

Assessment of the Department of Such Issues, and a Statement of any

Changes Made in the Proposed Rule as a Result of Such Comments

Changes were made in the final rule as a result of public comments.

These changes are discussed elsewhere. Two commenters replied

specifically to the IRFA. Their comments are summarized and discussed

here.

Comments: Both commenters stated that the IRFA did not explore any

alternatives.

Response: As stated in the IRFA, alternatives such as those that

would establish differing compliance or reporting requirements or

timetables based upon the size of the institution rather than the type

of institution, or the use of performance standards rather than

establishing baseline measures, or an exemption from coverage of the

rule or any part thereof for small entities, would not adequately

discharge the Secretary's obligation under section 498(c) of the HEA to

determine the financial responsibility of institutions and guard the

Federal fiscal interest. At the time the IRFA was completed, the

Secretary determined that there were no significant alternatives that

would satisfy the same legal and policy objectives while minimizing the

economic impact on small entities. Public comment was received that the

Secretary has determined requires additional consideration, so the

comment period for several components of this regulation is being

reopened. The Secretary welcomes comments that suggest additional

alternatives consistent with the objectives of the Regulatory

Flexibility Act.

Changes: The comment period for several components will be reopened

to allow for additional public comment.

Comments: Both commenters stated that the IRFA did not consider

economic impacts from regulatory provisions that are not addressed in

these Final Rules. This includes opinions from one or both commenters

that there may be impacts from: the change of ownership/additional

location components; underestimation of the cost of obtaining a letter

of credit; and, the notion that the cost of a letter of credit was not

considered in the context of applications for new approvals or for

changes in ownership.

Response: These comments will be discussed when the reopened

comment period has closed for the ratio portions

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of the final regulations and the final regulation is published.

Changes: The comment period for these components has been extended

to allow for additional public comment.

Comments: One commenter raised numerous questions about the

necessity for the rule itself.

Response: The preamble to the rule discusses the reasons why action

by the Secretary is needed.

Changes: None.

Comments: One commenter stated that the IRFA did not consider the

cost of changing the audit requirements. This commenter also asked

questions about possible secondary effects of changing the audit

requirements.

Response: The Secretary re-analyzed the component of this rule that

requires changes in audit requirements. While there may be some slight

costs associated with the transition to the new audit requirements,

these costs are not thought to represent a significant economic impact.

Changes: The final regulatory flexibility analysis acknowledges the

slight costs that may be associated with a transition to the new audit

requirements.

Description of the Reasons Why Action by the Department Is Being

Considered and a Succinct Statement of the Objectives of, and Legal

Basis for, the Proposed Rule

The Secretary is directed by section 498(c) of the HEA to establish

that institutions participating in title IV, HEA student financial

assistance programs are financially responsible. The Secretary is

directed by section 498(d) of the HEA to establish that institutions

participating in the programs have the administrative capability to

administer federal funds. As part of the regulatory reinvention

process, the Secretary has analyzed the current standards whereby

institutions can demonstrate financial responsibility and

administrative capability and found that improvements can be made. The

proposed improvements are discussed at length in the preamble to the

September 20, 1996 NPRM.

Description and Estimate of the Number of Small Entities to Which the

Proposed Rule Will Apply

The Secretary has adopted the U.S. Small Business Administration

(SBA) Size Standards for this analysis. The Regulatory Flexibility Act

directs that small entities are the sole focus of the Regulatory

Flexibility Analysis. There are three types of small entities that are

analyzed here. They are: for-profit entities with total annual revenue

below $5,000,000; non-profit entities with total annual revenue below

$5,000,000; and entities controlled by governmental entities with

populations below 50,000. An estimate of the proportion of entities in

each of these categories was calculated using the best available data

from the National Center for Education Statistics IPEDS survey for

academic year 1993-94. These estimates were applied to Department

administrative files, where no data element for total revenue is

available. The estimates are that 1,690 small for-profit entities, 660

small non-profit entities and 140 small governmental entities will be

covered by the proposed rule. Where exact data were not available to

estimate the proportion of small entities, data elements were chosen

that would have overestimated, rather than underestimated, the

proportion.

Description of the Projected Reporting, Recordkeeping and Other

Compliance Requirements of the Rule, Including an Estimate of the

Classes of Small Entities Which Will Be Subject to the Requirement and

the Type of Professional Skills Necessary for Preparation of the Report

or Record

The components of this final rule that may impose economic impacts

are those associated with the new compliance audit requirements. The

new audit requirements change the audit period from the award year to

the institution's fiscal year. In some circumstances, this may entail a

somewhat more involved audit if award rules change significantly from

award year to award year so that the auditor would have to verify

compliance with both the old and new sets of rules during the fiscal

year. These changes are expected to cost $2,000 or less for a small

entity with $5,000,000 in total revenue.

Changing the 85-15 compliance verification from the current

attestation standard to a note to the financial statement is not

expected to represent higher auditor fees. On balance, the amount of

auditing work is comparable for both standards. Combining the audits is

expected to reduce the economic cost of audits. While there may be some

slight costs associated with the transition to the new audit

requirements, these costs are not expected to represent a significant

economic impact.

As discussed above, all small (and large) entities that are

identified as being covered by the rule will be subject to the new

audit requirements. The Regulatory Flexibility Act requires a

discussion of the professional skills required for compliance with this

rule. All small (and large) entities that participate in the title IV,

HEA programs are required by statute to provide audits. These audits

must be prepared by auditors that are qualified to prepare government

audits. This rule changes the audit requirements, but does not impose a

significantly new activity upon the entities. Under the current

regulations, an institution must submit an audited financial statement

and a compliance audit, but the financial statement was submitted

twice. Under these new regulations, the institution will still be

required to submit both the audited financial statement and the

compliance audit, but the financial statement will only be submitted

once, at the same time as the compliance audit is submitted. Thus the

savings to institutions is the marginal savings that is produced by the

elimination of the extra submission of the audited financial statement.

Description of the Steps the Department Has Taken To Minimize the

Significant Economic Impact on Small Entities Consistent With the

Stated Objectives of Applicable Statutes

This rule reduces the number of audits which must be submitted to

the Secretary, removing a reporting requirement that overlaps with this

proposed rule. This should help to reduce the overall reporting costs

to participating institutions.

A Statement of the Factual, Policy, and Legal Reasons for Selecting the

Alternative Adopted in the Final Rule and Why Each One of the Other

Significant Alternatives to the Rule Considered by the Department That

Affect the Impact on Small Entities Was Rejected

For the purpose of this regulatory flexibility analysis, the

significant alternative that was considered by the Secretary and

rejected was that of ``no action.'' Other alternatives, would not

adequately discharge the Secretary's obligation under sections 498 (c)

and (d) of the HEA to determine the financial responsibility and

administrative capability of participating institutions and guard the

Federal fiscal interest.

The Secretary has determined that there are no other significant

alternatives that would satisfy the same legal and policy objectives

while minimizing the economic impact on small entities. This

determination is based, in part, on the extensive consultation that the

Department performed with small (and large) entities in developing

these proposed revisions. The alternative ``no action'' was rejected

because this alternative would not adequately protect the

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Federal fiscal interest, as discussed above and in the appendix to the

final rule.

Conclusion

The Secretary concludes that a substantial number of small entities

are likely to experience significant adverse economic impacts from the

proposed rule. However, the Secretary has concluded that the costs are

outweighed by the benefits. In this case, the benefits are better

protection of the Federal fiscal interest as well as improved service

to students receiving assistance under the title IV, HEA programs.

The Secretary emphasizes that this conclusion addresses the

regulations published in this Final Rule. Additional analysis of, and

conclusions regarding, the other regulatory proposals that were part of

the September 20, 1996 NPRM will be published when final regulations

addressing those proposals are published, and will be based on comments

received during the initial comment period, and those received during

the reopened comment period.

Paperwork Reduction Act of 1995

The information collection requirements contained in Sec. 668.23

have been submitted to the Office of Management and Budget for

approval.

List of Subjects

34 CFR Part 600

Colleges and universities, Foreign relations, Grant programs--

education, Loan Programs--education, Reporting and recordkeeping

requirements, Student aid, Vocational education.

34 CFR Part 668

Administrative practice and procedures, Colleges and universities,

Reporting and recordkeeping requirements, Student aid.

(Catalog of Federal Domestic Assistance Number: 84.007, Federal

Supplemental Educational Opportunity Grant Program; 84.032, Federal

Family Educational Loan Program; 84.032, Federal PLUS Program; 84.032,

Federal Supplemental Loans for Students Program; 84.033, Federal Work-

Study Program; 84.038, Federal Perkins Loan Program; 84.063, Federal

Pell Grant Program; 84.069, State Student Incentive Grant Program, and

84.268, Direct Loan Program)

Dated: November 22, 1996.

Richard W. Riley,

Secretary of Education.

The Secretary amends parts 600 and 668 of title 34 of the Code of

Federal Regulations as follows:

PART 600--INSTITUTIONAL ELIGIBILITY UNDER THE HIGHER EDUCATION ACT

OF 1965, AS AMENDED

1. The authority citation for part 600 continues to read as

follows:

Authority: 20 U.S.C. 1088, 1091, 1094, 1099b, 1099c, and 1141,

unless otherwise noted.

Sec. 600.5 [Amended]

2. Under Sec. 600.5, paragraph (e) is removed and reserved.

PART 668--STUDENT ASSISTANCE GENERAL PROVISIONS

3. The authority citation for part 668 continues to read as

follows:

Authority: 20 U.S.C. 1085, 1088, 1091, 1092, 1094, 1099c, and

1141, unless otherwise noted.

4. Under Sec. 668.15, paragraph (e) is removed and reserved,

paragraph (g) is revised, and paragraph (h) is added to read as

follows:

Sec. 668.15 Factors of financial responsibility

* * * * *

(g) Two-year performance requirement. (1) The Secretary considers

an institution to have satisfied the requirements in paragraph

(d)(1)(C) of this section if the independent certified public

accountant, or government auditor who conducted the institution's

compliance audits for the institution's two most recently completed

fiscal years, or the Secretary or a State or guaranty agency that

conducted a review of the institution covering those fiscal years--

(i)(A) For either of those fiscal years, did not find in the sample

of student records audited or reviewed that the institution made late

refunds to 5 percent or more of the students in that sample. For

purposes of determining the percentage of late refunds under this

paragraph, the auditor or reviewer must include in the sample only

those title IV, HEA program recipients who received or should have

received a refund under Sec. 668.22; or

(B) The Secretary considers the institution to have satisfied the

conditions in paragraph (g)(1)(i)(A) of this section if the auditor or

reviewer finds in the sample of student records audited or reviewed

that the institution made only one late refund to a student in that

sample; and

(ii) For either of those fiscal years, did not note a material

weakness or a reportable condition in the institution's report on

internal controls that is related to refunds.

(2) If the Secretary or a State or guaranty agency finds during a

review conducted of the institution that the institution no longer

qualifies for an exemption under paragraph (d)(1)(C) of this section,

the institution must--

(i) Submit to the Secretary the irrevocable letter of credit

required in paragraph (b)(5) of this section no later than 30 days

after the Secretary or State or guaranty agency notifies the

institution of that finding; and

(ii) Notify the Secretary of the guaranty agency or State that

conducted the review.

(3) If the auditor who conducted the institution's compliance audit

finds that the institution no longer qualifies for an exemption under

paragraph (d)(1)(C) of this section, the institution must submit to the

Secretary the irrevocable letter of credit required in paragraph (b)(5)

of this section no later than 30 days after the date the institution's

compliance audit must be submitted to the Secretary.

(h) Foreign institutions. The Secretary makes a determination of

financial responsibility for a foreign institution on the basis of

financial statements submitted under the following requirements--

(1) If the institution received less than $500,000 U.S. in title

IV, HEA program funds during its most recently completed fiscal year,

the institution must submit its audited financial statement for that

year. For purposes of this paragraph, the audited financial statements

may be prepared under the auditing standards and accounting principles

used in the institution's home country; or

(2) If the institution received $500,000 U.S. or more in title IV,

HEA program funds during its most recently completed fiscal year, the

institution must submit its audited financial statement in accordance

with the requirements of Sec. 668.23, and satisfy the general standards

of financial responsibility contained in this section, or qualify under

an alternate standard of financial responsibility contained in this

section.

* * * * *

5. Section 668.23 is revised to read as follows:

Sec. 668.23 Compliance audits and audited financial statements.

(a) General. (1) Independent auditor. For purposes of this section,

the term ``independent auditor'' refers to an independent certified

public accountant or a government auditor. To conduct an audit under

this section, a government auditor must meet the Government Auditing

Standards qualification and independence standards, including

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standards related to organizational independence.

(2) Institutions. An institution that participates in any title IV,

HEA program must at least annually have an independent auditor conduct

a compliance audit of its administration of that program and an audit

of the institution's general purpose financial statements.

(3) Third-party servicers. Except as provided under this part or 34

CFR part 682, with regard to complying with the provisions under this

section a third-party servicer must follow the procedures contained in

the audit guides developed by and available from the Department of

Education's Office of Inspector General. A third-party servicer is

defined under Sec. 668.2 and 34 CFR 682.200.

(4) Submission deadline. Except as provided by the Single Audit

Act, Chapter 75 of title 31, United States Code, an institution must

submit annually to the Secretary its compliance audit and its audited

financial statements no later than six months after the last day of the

institution's fiscal year.

(5) Audit submission requirements. In general, the Secretary

considers the compliance audit and audited financial statement

submission requirements of this section to be satisfied by an audit

conducted in accordance with the Office of Management and Budget

Circular A-133, ``Audits of Institutions of Higher Education and Other

Nonprofit Organizations''; Office of Management and Budget Circular A-

128, ``Audits of State and Local Governments'', or the audit guides

developed by and available from the Department of Education's Inspector

General, whichever is applicable to the entity, and provided that the

Federal student aid functions performed by that entity are covered in

the submission. (Both OMB circulars are available by calling OMB's

Publication Office at (202) 395-7332, or they can be obtained in

electronic form on the OMB Home Page (http://www.whitehouse.gov).

(b) Compliance audits for institutions. (1) An institution's

compliance audit must cover, on a fiscal year basis, all title IV, HEA

program transactions, and must cover all of those transactions that

have occurred since the period covered by the institution's last

compliance audit.

(2) The compliance audit required under this section must be

conducted in accordance with--

(i) The general standards and the standards for compliance audits

contained in the U.S. General Accounting Office's (GAO's) Government

Auditing Standards. (This publication is available from the

Superintendent of Documents, U.S. Government Printing Office,

Washington, DC 20402); and

(ii) Procedures for audits contained in audit guides developed by,

and available from, the Department of Education's Office of Inspector

General.

(3) The Secretary may require an institution to provide a copy of

its compliance audit report to guaranty agencies or eligible lenders

under the FFEL programs, State agencies, the Secretary of Veterans

Affairs, or nationally recognized accrediting agencies.

(c) Compliance audits for third-party servicers. (1) A third-party

servicer that administers title IV, HEA programs for institutions does

not have to have a compliance audit performed if--

(i) The servicer contracts with only one institution; and

(ii) The audit of that institution's administration of the title

IV, HEA programs involves every aspect of the servicer's administration

of that program for that institution.

(2) A third-party servicer that contracts with more than one

participating institution may submit a compliance audit report that

covers the servicer's administration of the title IV, HEA programs for

all institutions with which the servicer contracts.

(3) A third-party servicer must submit annually to the Secretary

its compliance audit no later than six months after the last day of the

servicer's fiscal year.

(4) The Secretary may require a third-party servicer to provide a

copy of its compliance audit report to guaranty agencies or eligible

lenders under the FFEL programs, State agencies, the Secretary of

Veterans Affairs, or nationally recognized accrediting agencies.

(d) Audited financial statements. (1) General. To enable the

Secretary to make a determination of financial responsibility, an

institution must, to the extent requested by the Secretary, submit to

the Secretary a set of financial statements for its latest complete

fiscal year, as well as any other documentation the Secretary deems

necessary to make that determination. Financial statements submitted to

the Secretary must be prepared on an accrual basis in accordance with

generally accepted accounting principles, and audited by an independent

auditor in accordance with generally accepted government auditing

standards, and other guidance contained in the Office of Management and

Budget Circular A-133, ``Audits of Institutions of Higher Education and

Other Nonprofit Organizations''; Office of Management and Budget

Circular A-128, ``Audits of State and Local Governments''; or in audit

guides developed by, and available from, the Department of Education's

Office of Inspector General , whichever is applicable. As part of these

financial statements, the institution must include a detailed

description of related entities based on the definition of a related

entity as set forth in the Statement of Financial Accounting Standards

(SFAS) 57. The disclosure requirements under this provision extend

beyond those of SFAS 57 to include all related parties and a level of

detail that would enable to Secretary to readily identify the related

party. Such information may include, but is not limited to, the name,

location and a description of the related entity including the nature

and amount of any transactions between the related party and the

institution, financial or otherwise, regardless of when they occurred.

(2) Submission of additional financial statements. To the extent

requested by the Secretary in determining whether an institution is

financially responsible, the Secretary may also require the submission

of audited consolidated financial statements, audited full

consolidating financial statements, audited combined financial

statements or the audited financial statements of one or more related

parties that have the ability, either individually or collectively, to

significantly influence or control the institution, as determined by

the Secretary.

(3) Audited financial statements for foreign institutions. A

foreign institution must submit--

(i) Audited financial statements prepared in accordance with the

generally accepted accounting principles of the institution's home

country, if the institution received less than $500,000 U.S. in title

IV, HEA program funds during its most recently completed fiscal year;

or

(ii) Audited financial statements translated to meet the

requirements of paragraph (d) of this section, if the institution

received $500,000 U.S. or more in title IV, HEA program funds during

its most recently completed fiscal year.

(4) Disclosure of title IV HEA program revenue. A proprietary

institution must disclose in a footnote to its financial statement

audit the percentage of its revenues derived from the title IV, HEA

program funds that the institution received during the fiscal year

covered by that audit. The revenue percentage must be calculated in

accordance with Sec. 600.5(d).

[[Page 60571]]

(5) Audited financial statements for third-party servicers. A

third-party servicer that enters into a contract with a lender or

guaranty agency to administer any aspect of the lender's or guaranty

agency's programs, as provided under 34 CFR part 682, must submit

annually an audited financial statement. This financial statement must

be prepared on an accrual basis in accordance with generally accepted

accounting principles, and audited by an independent auditor in

accordance with generally accepted government auditing standards and

other guidance contained in audit guides issued by the Department of

Education's Office of Inspector General.

(e) Access to records. (1) An institution or a third-party servicer

that has a compliance or financial statement audit conducted under this

section must--

(i) Give the Secretary and the Inspector General access to records

or other documents necessary to review that audit, including the right

to obtain copies of those records or documents; and

(ii) Require an individual or firm conducting the audit to give the

Secretary and the Inspector General access to records, audit work

papers, or other documents necessary to review that audit, including

the right to obtain copies of those records, work papers, or documents.

(2) An institution must give the Secretary and the Inspector

General access to records or other documents necessary to review a

third-party servicer's compliance or financial statement audit,

including the right to obtain copies of those records or documents.

(f) Notification of questioned expenditures or compliance. (1) As a

result of a Federal audit or an audit performed at the direction of an

institution or third-party servicer, if the auditor questions an

expenditure made by the institution or servicer, or questions the

institution's or servicer's compliance with an applicable requirement

(including the lack of proper documentation), the Secretary notifies

the institution or servicer of the questioned expenditure or

compliance.

(2) If the institution or servicer believes that the questioned

expenditure or compliance was proper, the institution or servicer shall

notify the Secretary in writing of the institution's or servicer's

position and the reasons for that position.

(3) The institution's or servicer's response must be based on an

attestation engagement performed by the institution's or servicer's

auditor in accordance with the Standards for Attestation Engagements of

the American Institute of Certified Public Accountants and must be

received by the Secretary within 45 days of the date of the Secretary's

notification to the institution or servicer.

(g) Determination of liabilities. (1) Based on the audit finding

and the institution's or third-party servicer's response, the Secretary

determines the amount of liability, if any, owed by the institution or

servicer and instructs the institution or servicer as to the manner of

repayment.

(2) If the Secretary determines that a third-party servicer owes a

liability for its administration of an institution's title IV, HEA

programs, the servicer must notify each institution under whose

contract the servicer owes a liability of that determination. The

servicer must also notify every institution that contracts with the

servicer for the same service that the Secretary determined that a

liability was owed.

(h) Repayments. (1) An institution or third-party servicer that

must repay funds under the procedures in this section shall repay those

funds at the direction of the Secretary within 45 days of the date of

the Secretary's notification, unless--

(i) The institution or servicer files an appeal under the

procedures established in subpart H of this part; or

(ii) The Secretary permits a longer repayment period.

(2) Notwithstanding paragraphs (f) and (g)(1) of this section--

(i) If an institution or third-party servicer has posted surety or

has provided a third-party guarantee and the Secretary questions

expenditures or compliance with applicable requirements and identifies

liabilities, then the Secretary may determine that deferring recourse

to the surety or guarantee is not appropriate because--

(A) The need to provide relief to students or borrowers affected by

the act or omission giving rise to the liability outweighs the

importance of deferring collection action until completion of available

appeal proceedings; or

(B) The terms of the surety or guarantee do not provide complete

assurance that recourse to that protection will be fully available

through the completion of available appeal proceedings; or

(ii) The Secretary may use administrative offset pursuant to 34 CFR

part 30 to collect the funds owed under the procedures of this section.

(3) If, under the proceedings in subpart H, liabilities asserted in

the Secretary's notification, under paragraph (e)(1) of this section,

to the institution or third-party servicer are upheld, the institution

or third-party servicer must repay those funds at the direction of the

Secretary within 30 days of the final decision under subpart H of this

part unless--

(i) The Secretary permits a longer repayment period; or

(ii) The Secretary determines that earlier collection action is

appropriate pursuant to paragraph (g)(2) of this section.

(4) An institution is held responsible for any liability owed by

the institution's third-party servicer for a violation incurred in

servicing any aspect of that institution's participation in the title

IV, HEA programs and remains responsible for that amount until that

amount is repaid in full.

(Authority: 20 U.S.C. 1088, 1094, 1099c, 1141, and section 4 of Pub.

L. 95-452, 92 Stat. 1101-1109)

Analysis of Comments and Changes

(Note: This appendix will not be codified in the Code of Federal

Regulations)

General

Comments: Many commenters maintained that the 45 day comment period

was too short for institutions to understand thoroughly the new

proposals and submit comments on them. Many commenters also maintained

that the turnaround time between November 4 (the end of the comment

period) and December 1 (the deadline for publication of final

regulations in time for implementation for the 1997-1998 award year in

accordance with the Master Calendar) was too short for Department staff

to understand the comments that were submitted and to make necessary

changes in the regulations based on those comments. These commenters

therefore recommended that the publication of final rules be delayed,

and the comment period extended.

Discussion: The Secretary has reviewed these comments and is

sympathetic to some of the concerns raised that additional time would

have been desirable for the public to consider some of the proposals in

more detail. The September 20, 1996 Notice of Proposed Rulemaking

provided a detailed discussion of the competing concerns at issue given

the statutory deadline that requires final rules to be published by

December 1 in order to go into effect by July 1 of the following year.

The Secretary also notes that many members of the public were able to

use the allotted time to study the proposed regulation and provide

detailed comments with constructive suggestions for improving the final

regulation. These

[[Page 60572]]

comments also identified areas where the proposed regulation may need

further study and review, particularly with respect to some of the

components of the financial responsibility ratios calculated under the

proposed methodology.

Based in large part on concerns identified in the comments, the

Secretary is withholding publication of final regulations implementing

the revised financial responsibility standards at this time, and

details concerning time frames for additional public comment on that

proposal will be set out in a separate Federal Register Notice. The

portions of the September 20 NPRM that are now being incorporated into

Final Regulations are discussed in detail in the following sections.

Changes: Certain portions of the proposed regulations that are

dependent upon the financial responsibility ratio calculations are

being held back for additional consideration, and the final regulations

on the remaining portions of the September 20 NPRM are set out and

discussed below.

Comments: Several commenters maintained that the current standards

of financial responsibility could not be changed unless the Department

engaged in the process of negotiated rulemaking, as specified in

section 492 of the HEA, or that at least the spirit of that section

required that the Department enter into further discussions with the

community on these matters. One commenter alleged that without

negotiated rulemaking, the Department could not promulgate regulations

on this subject that would have legal force and effect.

Discussion: Pursuant to Section 492 of the HEA, the Secretary

conducted negotiated rulemaking for the regulations that implemented

parts B, G and H of the HEA as amended by the Higher Education

Amendments of 1992. The promulgation of those regulations, and the

procedures specified for those regulations--regional meetings, followed

by negotiated rulemaking--were subject to a specific time limit set out

in the statute, tied to the enactment of the 1992 Amendments. The

requirement to conduct regional meetings and negotiated rulemaking for

regulations implementing those parts thus did not extend to subsequent

changes to those regulations. No corresponding time limits or

procedures were provided in the HEA for any regulations other than the

ones that were initially required due to the 1992 amendments. The

Secretary, therefore, disagrees with the suggestions from the

commenters that negotiated rulemaking would have been required as part

of the implementation of these regulations.

Changes: None.

Section 668.15: Factors of Financial Responsibility

Comments: Many commenters supported the proposed change to the

performance exception to the refund reserve requirement. These

commenters also requested that the Department take prompt action to

approve applications regarding several state tuition recovery funds

that are still pending. Several of these commenters also suggested that

the exceptions be expanded to exempt an institution that obtains a

performance bond as required by a state licensing agency. This

commenter maintained that such bonds typically provide for refunds to

students in cases of school closure.

Several commenters supported the proposed change, but maintained

that a 10 percent or 15 percent error threshold would be fairer and

more appropriate, especially for institutions with very few refunds,

since in those cases even one or two late refunds may exceed the 5

percent threshold. One of these commenters added that this would take

into account those refunds paid a day or two late due to payments on a

30-day cycle. Several commenters noted that a threshold based on the

number of refunds made late, with no consideration of the amount of

money that was late in being refunded, was inadequate, because a few

refunds might be substantial due to the amount of money involved, or,

conversely, appreciably more refunds than a 5 percent measure could be

immaterial due to the inconsequential amount of money involve. One

commenter suggested that a monetary threshold be included in the

performance requirement, such that the standard be that the institution

did not make the greater of 5 percent or $5000 of refunds late. One

commenter suggested that for institutions that make a small number of

refunds every year, such that one late refund would cause the

institution to exceed the 5 percent threshold, the Department take

several years of refund history into account, and, if no pattern of

late refunds emerges, determine that the institution meets the

performance standard.

A commenter representing an accounting firm believed that an

institution that satisfied the general financial standards should not

be subject to the refund reserve provisions.

One commenter requested clarification regarding whether the 5

percent late refund trigger for the refund reserve requirement would be

counted at each site for an institution that has additional locations,

or whether the standard would be applied to the institution as a whole,

including the additional sites with the main campus.

Several commenters asked that the refund reserve performance

exception be clarified to include the results of an appeal process for

findings regarding late refunds.

Several commenters requested clarifications of the revised refund

reserve fund performance standard with regard to the standard being

linked to the years covered by an auditor or the year during which the

auditor conducts the audit. One of these commenters asked whether a

late refund that is split among several programs is counted as one late

refund or several late refunds. This commenter maintained that the

former should be the case.

A commenter from a proprietary institution asked whether the 5

percent error rate would be based on the refunds examined or an

extrapolation of the refunds examined. This commenter maintained that

an extrapolated 5 percent error rate is not indicative of an

institution that is not financially responsible, nor indicative of a

reportable condition related to the payment of refunds.

Several commenters suggested that only FFEL and Direct Loan Program

refunds be counted as untimely in the refund percentage because only

late refunds to those programs will have financial consequences to the

Federal government or the student.

Discussion: The Secretary appreciates the support this proposal

generally received from the community. The Secretary, however, is not

convinced by arguments that the original proposal should be changed

substantively.

In particular, the Secretary believes that the only accurate way to

determine whether an institution is making its refunds under the

standards contained in Sec. 668.22 is by setting a measure of refunds

made or not made in a timely fashion. The Secretary does not agree with

those commenters who believe that a dollar amount should be part of the

threshold, such that an institution would be allowed to qualify under

this exemption if the institution makes more than 5 percent of its

refunds late, but the dollar amount of those refunds is low. This

performance exemption is premised on providing relief to an institution

that has created and maintained an efficient system that allows the

institution to discharge the responsibilities it assumes by

participating in a title IV, HEA program. In this case, the performance

of the system must be measured on the basis

[[Page 60573]]

of making refunds. The Secretary does not believe that adding a dollar

threshold to the 5 percent error threshold would create a better

measure than the 5 percent threshold alone, since the dollar threshold

will not yield additional information on how well the system is

processing refunds. In fact, such a threshold would allow an

institution to continue using the exemption even though its system

performed with a significant error rate, so long as the dollar amount

of each refund made late was low.

While the Secretary appreciates the position taken by commenters

who argued the obverse (that an institution that made a few but very

large refunds late should not qualify for this exemption), the

Secretary believes that the more appropriate enforcement action in

cases where an institution inadvertently made a few refunds of large

amounts late should be taken under the standards set in Sec. 668.22.

Those standards address the act of making a refund rather than the

process that controls the making of refunds, and are therefore better

suited to generate appropriate sanctions, if any, in response to

deficiencies in the making of a particular refund or refunds.

The Secretary also disagrees with those commenters who maintained

that the Secretary should set the error rate at a higher threshold. The

5 percent threshold was meant to provide relief only in those rare

instances when, although the institution's system of internal controls

is generally sound, a few refunds are inadvertently made late. The

Secretary does not agree that a 10 or 15 percent error threshold would

capture the intent of the exemption as a performance standard that

indicates that the institution does, in all but rare situations, make

refunds in a timely fashion. Rather, the Secretary believes that a 10

or 15 percent error rate may indicate that serious problems exist with

the institution's system of internal controls, as well as significant

compliance problems.

The Secretary agrees with commenters who asserted that a single

late refund should not trigger the refund reserve requirement if, due

to the small number of refunds the institution makes annually, a single

refund would constitute more than 5 percent of the institution's annual

refunds. While the Secretary expects institutions that have small

numbers of refunds to be equally responsible as institutions with large

numbers of refunds in ensuring that all refunds are paid in a timely

fashion, the Secretary believes that it is reasonable to allow an

institution to continue utilizing this exemption if it is found to have

made only one refund late during its fiscal year, even though that

single refund represented 5 percent or more of the refunds the

institution was required to make during that year.

In promulgating this revision to this exemption, the Secretary

emphasizes that the 5 percent threshold does not give an institution

license willfully to make some number of late refunds so long as the

percentage of late refunds is less than 5 percent. The 5 percent

threshold is meant to allow institutions to qualify under this

exemption if the instances in which the institution does not meet the

regulatory requirements for the payment of all its refunds are rare and

exceptional. The 5 percent threshold thus allows such institutions to

qualify for the exemption despite those rare and exceptional instances

of late payment. But, the Secretary reminds institutions that attempts

to abuse this exemption by willfully making a percentage of late

refunds could result in actions taken under Sec. 668.22. In addition,

the institution's independent auditor is required to make a finding of

a material weakness in the institution's procedures related to refunds

if the auditor finds that the institution intentionally or

systematically made late refunds, and such a finding would result in

the institution losing the benefit of this exemption.

The Secretary disagrees with those commenters who asserted that

only those refunds that contain FFELP or Direct Loan funds should be

counted as untimely. Refunds made to grant programs must also be made

in a timely fashion, not only for Federal fiscal reasons, but also

because those funds may be subsequently used as aid to other needy

students and should be available to those students as soon as possible.

Thus, the Secretary includes refunds that do not contain FFELP or

Direct Loan funds in the measure of refund performance for purposes of

this exemption.

In response to other concerns raised by commenters, the Secretary

wishes to clarify the following. The 5 percent threshold applies to the

number of refunds made late, not to the number of programs to which

funds are remitted. Late refunds will be evaluated on the combination

of a main campus and any additional locations. Evaluations are also

made for the period of time covered by the auditors or reviewers.

The Secretary also wishes to clarify that the procedures that occur

when the letter of credit requirement is triggered are the same as

current procedures. If the auditor or reviewer finds, in his or her

examination of a sample of student records, that 5 percent or more of

the refunds that should have been made to those students in the sample

were made late, then the institution must immediately submit a letter

of credit. That letter of credit then remains in place until the final

report of the reviewer or auditor shows that the institution made fewer

than 5 percent of its total required refunds late, or until the

institution can meet the two-year performance exemption based on

subsequent reviews or audits, or meets one of the other alternatives.

The Secretary, based on past experience with performance bonds,

disagrees that they are an acceptable way of meeting the refund reserve

requirement. The Secretary has found that the terms of coverage and

conditions for collection on performance bonds are difficult to

administer consistently, and do not provide the same level of

protection available under letters of credit.

The Secretary is currently reviewing several applications regarding

state tuition recovery funds. Such applications have not conformed to

the regulatory provisions contained in 668.15(d)(2)(ii). The Secretary

agrees that such funds are a good way for institutions to meet the

refund reserve requirements and looks forward to receiving applications

detailing such state plans that would conform to the regulatory

provisions.

Changes: Because the Secretary is delaying the publication of the

final rules implementing the new proposed standards of financial

responsibility, Sec. 668.15 is being amended to include this change to

the two-year performance requirement. Language allowing an institution

to use this exemption if the auditor or reviewer found that the

institution made only one late refund has also been added, and

technical changes to regulatory language have been made to make the

exemption easier to understand.

Comments: One commenter agreed that the proposed standards for

foreign institutions were appropriate.

Discussion: The Secretary appreciates this support of the proposal.

The Secretary believes these standards appropriately set levels of

oversight for foreign institutions given the level of risk represented

respectively by institutions that receive $500,000 or less annually in

title IV, HEA program funds, and those that receive more than $500,000

annually in such funds.

Changes: None.

[[Page 60574]]

Section 668.23 Compliance Audits and Audited Financial Statements

Comments: A commenter from a public institution maintained that,

because of cost, a compliance audit should be required only once every

two or three years for a public institution, instead of annually. A

commenter from a public institution maintained that the Single Audit

Act does not require that the audited financial statements of

individual public institutions be submitted. One commenter requested

clarification of the type of audit required of an institution that

falls below the level of the OMB Circular A-133 audit requirement of

$300,000.

Several commenters from accounting firms supported the requirement

that audited financial statements be included in the compliance audit

and that the compliance audit be prepared on a fiscal year basis, on

the grounds that this would result in cost reductions to institutions

without compromising the ability of the Department to perform its

oversight responsibilities.

Many commenters from proprietary institutions and the certified

public accountant (CPA) community opposed the new requirement. These

commenters asserted that for those institutions that have a fiscal year

different from an award year, the change would result in compliance

audits that cover two different award years, sometimes involving a

single student's file that would have to be examined under two

different standards, and that this would add significant costs and

burdens to institutions. In particular, some commenters also asserted

that this change would result in audits being prepared during the busy

season for CPAs, thereby increasing costs; that it might entail using a

single auditor rather than two different auditors, which would also

lead to increased costs; and, if the initial audit after the change

would require the audit of a partial year, this would also increase

costs. Commenters who opposed changing the reporting year for

compliance audits from an award year basis to a fiscal year basis

estimated that time and costs would increase in a range of 40 percent

to 100 percent.

A commenter from a proprietary institution opposed the requirement

that compliance audits be performed on a fiscal year basis, on the

grounds that information contained on the PMS 272 Report will not match

information on the final report of expenditures--the Federal Pell Grant

Statement of Account and the Fiscal Operations Report and Application

to Participate (FISAP) for campus-based programs. This commenter also

argued that there will be no mechanism in place for the institution to

receive an increased authorization to cover additional Pell Grant

eligibility, since adjustments to award year authorizations must be

done in the initial audit report.

One commenter from a Subchapter S corporation asserted that the

combination of the compliance audit and the audited financial statement

would not result in more time for an institution to complete its audit,

because other government agencies require the corporation to provide

audited financial statements within 120 days of the end of the

institution's fiscal year. This commenter maintained that creating a

combined audit requirement meant that the corporation would be required

to complete both the audited financial statement and the compliance

audit in that timeframe. This commenter maintained that, therefore,

this requirement was impossible to meet, because a compliance audit

typically takes more than five months to complete. This commenter also

maintained that the combined audit would create problems for a

corporation with several separate schools when the corporation submits

an audited financial report to other entities (such as those involved

in bonding, insurance, and banking), because the combination would

consist of the financial statement and several different compliance

audits that are unrelated to the institution for which the report was

requested. This commenter maintained that the proposed rule does not

reduce any burden other than that of a separate mailings, since the

current requirements do not require duplicate information. A commenter

from a proprietary institution argued that the combined audit would be

burdensome to some publicly traded corporations because those companies

are required to prepare an audited financial statement with the

Security and Exchange Commission within three months of the

institution's fiscal year end, and this would also be the time period

in which the institution would be required to complete a compliance

audit. One commenter recommended either that the Department negotiate

with the Internal Revenue Service to allow S corporations to change

their fiscal year from January 1 to December 31, or to change the award

year to the calendar year.

Many commenters suggested as an alternative that an institution

might either combine its audited financial statement with its

compliance audit, with both covering the same period of time, or allow

the institution to submit a single audit, with the financial statement

and compliance audit covering different periods of time (the financial

statement covering the institution's most recently completed fiscal

year, and the compliance audit covering the award year). One commenter

asserted that the combination is not necessary as long as the firm

conducting the audit of the financial statements is subjected to the

current Quality Review, and the compliance auditor and the financial

statement auditor can consult with one another.

One commenter representing a guarantee agency opposed the combined

audit on the grounds that the change in the submission deadline from

four months to six months increased risk to students and taxpayers.

Several commenters asked for clarification if two separate auditors

could perform the compliance audit and audit the institution's

financial statement.

Several commenters requested more information regarding the time

period to be covered by the first combined submission and the due date

for the first combined submission. One of these commenters asked

whether a compliance audit of less or more than 12 months would be

acceptable during the transition.

A commenter from an accounting firm commented that the requirement

that the audit be prepared according to Generally Accepted Government

Auditing Standards (GAGAS) would mean higher costs for institutions.

One commenter maintained that only public institutions should be

required to use GAGAS, and all other institutions be allowed to use

Generally Accepted Auditing Standards (GAAS).

Discussion: It was not the Secretary's intent to preclude the

preparation of financial statement audits and compliance audits as

separate reports. The Secretary will accept a financial statement audit

and a compliance audit performed by different auditors provided that

both audits are conducted on a fiscal year basis and are submitted

together as one package. The Secretary is aware that for many

institutions the award year differs from the fiscal year and that this

may require that auditors perform audit testing in each of two distinct

award years, both of which may be subject to different regulatory

requirements. The Secretary believes that although this may require

additional planning with respect to developing samples for substantive

tests of details, the level and complexity of any additional work is

not substantially greater than would normally be required. Auditors

would still perform

[[Page 60575]]

reconciliation work and tests of balances relative to the award year

but would now be required to supplement that work, at fiscal year end,

with additional reconciliation work and tests of balances. However, the

nature and extent of those tests and the amount of work associated with

these activities would be minimal unless year-end testing of internal

controls indicated a significant change in the reliability of the

internal control structure. This may result in a modest increase in the

level of work auditors must perform during peak demand periods, and

consequently may result in slightly higher audit fees, depending on the

auditor. Historically, auditors have been required to adapt their

procedures to accommodate statutory and regulatory changes that have

occurred at varying periods throughout individual award years. The

Secretary believes that the benefits associated with consolidating

multiple regulatory reporting requirements into a single reporting

package exceed the incremental costs incurred. In addition, auditors

who perform audits and attest services for participating institutions

have a responsibility to be aware of changing statutory or regulatory

requirements, and to develop appropriate plans for accommodating

changes in those requirements.

An initial compliance audit covering a partial year will be

required at the institution's first fiscal year end following the

effective date of the regulations, and will cover the period of time

since the institution's last compliance audit. For an institution with

a fiscal year end of December 31st, an initial compliance audit

will be required for the period beginning July 1, 1997 and ending

December 31, 1997. In subsequent years, the compliance audit will be

prepared on a fiscal year basis and will cover the period of time since

the institution's last compliance audit. For an institution with a

December 31st fiscal year end, the next required compliance audit

and financial audit would be required to be submitted together in a

single package for the fiscal year ending December 31st, 1998 not

later than six months following the institution's fiscal year end.

Although some commenters have suggested that the Secretary allow

institutions to prepare an initial compliance audit at the end of the

institution's second fiscal year following the effective date, the

Secretary believes this creates an unacceptable delay with regard to

his receiving notification of potentially serious compliance

violations. Accordingly, the Secretary is requiring institutions to

prepare a partial year compliance audit at the end of the first fiscal

year following the effective date of the regulation.

For many institutions with a December 31st fiscal year end,

this change will provide the Secretary with more timely information

with respect to compliance audits. Under previous regulations a

compliance audit for an award year ending June 30th would not have

been required to be received by the Secretary until six months

following a December 31st fiscal year end. By changing the

requirement that a compliance audit be prepared on an award year basis

to that of a fiscal year, the Secretary shortens the period in which a

compliance audit is received to six months instead of nearly a year.

This may also provide the Secretary with a means of ascertaining the

potential impact of serious audit liabilities with respect to an

institution's ability to demonstrate financial responsibility. The

Secretary further believes that the consistency in reporting periods

will encourage independent CPAs who perform financial statement audits

to identify and properly disclose any material contingent liabilities

that exist as a result of compliance violations.

In contrast, this change extends the period of time in which

institutions may submit financial audits from four months under

previous regulations to six months. This change should prove beneficial

to institutions. In addition, the Secretary believes that a change in

the reporting period from the award year to the fiscal year provides

institutions with an opportunity to consolidate audit services into a

single engagement rather than to incur the potentially higher costs

associated with separate engagements .

The required audit submission is considered to be satisfied by an

audit under the Single Audit Act and OMB Circular A-128 or OMB Circular

A-133. However, for institutions that are not required to prepare such

audits because the total amount of federal financial assistance is less

than the applicable threshold amount, a financial audit report and a

compliance audit must be prepared and submitted to the Secretary for

purposes of complying with the HEA. Guidance in the preparation of the

compliance audit may be sought from the U.S. Department of Education's

Office of the Inspector General.

With regard to the issue of fiscal years for S corporations, the

Secretary has promulgated a regulation that permits schools to

synchronize their compliance audit to correspond with their fiscal

year. The Secretary therefore does not believe it is necessary for an

institution to be able to switch its fiscal year to correspond to the

award year, but has rather provided a means for an institution to

change the period covered by its annual compliance audit so that it

will correspond to its fiscal year.

Existing law requires the Inspector General to take appropriate

steps to assure that any work performed by non-federal auditors

complies with Generally Accepted Government Auditing Standards (GAGAS).

This provision reflects a clarification of existing guidance previously

made available to auditors in publications available from the

Department of Education's Office of the Inspector General .

Changes: Several technical changes have been made to Sec. 668.23.

Comments: Several commenters representing proprietary institutions

supported the concept of the submission of questionable audit

statements to the American Institute of Certified Public Accountants

(AICPA) and other parties for review as part of a fair and impartial

way of settling disputes between auditors and the Department, but

questioned the language contained in this proposed rule. One of these

commenters questioned whether the AICPA would agree to serve in this

capacity, and asserted that the reference to other parties in the

proposed rule was unclear. One commenter asserted that the AICPA does

not have a process for resolving accounting disputes between parties,

but does have a process, through the Professional Ethics Executive

Committee, by which parties may be referred for investigation and

disciplinary action if there is a possible violation of professional

standards, and a process, through the Accounting Standards Executive

Committee, for considering whether there is a need for new accounting

standards.

Some commenters suggested that it was very important that the

``other parties'' be familiar with the intricacies of the particular

sector of higher education involved in the question or dispute, and

that it was also very important that the Secretary create a process for

providing notice and soliciting comment from experts in the particular

sector associated with the question or dispute when the Secretary

submits a statement for resolution.

One of these commenters maintained that the proposed procedures

could be problematic because there are several different legitimate

ways to reflect similar transactions.

Discussion: In exercising the Department's statutory oversight

authority, the Secretary makes every effort to ensure that the

regulatory standards are applied consistently

[[Page 60576]]

among all participating institutions. One way that the Secretary

ensures that regulatory provisions are consistently applied is to

evaluate the accounting principles used in the preparation of financial

statements. Different representations of similar financial

circumstances by preparers of those financial statements may lead the

Secretary to form fundamentally different conclusions about the fiscal

responsibility of the respective institutions. The Secretary looks to

the auditor first as a way of ensuring consistent application of

accounting principles among reporting institutions.

In proposing the mechanism described in the proposed Sec. 668.23

(d)(2), the Secretary had intended to establish a formal procedure to

resolve significant discrepancies that may exist among independent

auditors in the interpretation of Generally Accepted Accounting

Principles (GAAP). Notwithstanding this procedure, the Secretary, as

the principal user of these financial statements, would remain the

ultimate authority in determining the acceptability of any general

purpose financial statement for purposes of demonstrating financial

responsibility. However, several commenters had indicated that the

procedure proposed in the NPRM was not workable from the standpoint of

the AICPA, in that the AICPA generally took action to clarify

accounting principles in the long term rather than to help adjudicate

particular differences. After reviewing the concerns raised by the

commenters, the Secretary agrees that the type of assistance the

Department could procure from the AICPA would not necessitate the

procedure proposed in the NPRM. The Secretary is, therefore, removing

this proposal from the final regulations.

The Secretary, however, reiterates that the Department will

generally consult with authoritative accounting bodies such as the

Financial Accounting Standards Board (FASB), The Governmental

Accounting Standards Board (GASB), and the AICPA when examining audited

financial statements. If, after consideration of the facts,

circumstances, and assumptions, the Secretary believes that a departure

from GAAP exists, the Secretary will notify the institution of the

finding and may provide the institution with an opportunity to cure. In

the event the Secretary believes that existing accounting standards

need to be changed or that existing accounting standards are silent and

that more guidance is needed, the Secretary will bring the matter to

the attention of the appropriate accounting standard-setting body or

bodies for consideration of future changes. However, the Secretary will

continue to be the final authority in determining the acceptability of

any specific accounting treatment for purposes of determining the

financial responsibility of an institution that participates in a title

IV, HEA program.

Changes: The provision contained in the proposed Sec. 668.23(d)(2)

has been removed.

Comments: Many commenters representing proprietary institutions

opposed the provision that enables the Secretary to require the

submission of audited financial statements of related entities,

consolidated financial statements, or full consolidating financial

statements, on the grounds of excessive cost and burden. Several of

these commenters maintained that all necessary information is contained

in the footnotes to the audited financial statements submitted by

institutions. One of these commenters maintained that this provision

would be acceptable only if the requirement was limited to those

instances in which the Internal Revenue Service requires consolidation.

Several commenters representing proprietary institutions maintained

that the provision was unacceptable and should be removed. One

commenter suggested that the rule read that, if the parent corporation

is willing to provide a guarantee of the financial obligation of the

institution, then the financial statements of the parent corporation

will be considered.

One commenter argued that a particular definition of ``related''

must be promulgated, and that this definition should be constructed so

as to exclude any entity that does not have a direct and significant

financial relationship with the institution.

One commenter representing proprietary institutions opposed the

proposed regulation in which the Secretary may require full

consolidating financial statements on the grounds of expense and the

possible unavailability of financial statements of such entities

(because they may not be required to prepare them for any other

purpose). This commenter maintained that the requirement to submit

audited financial statements be limited to institutions or to an

institution's parent corporation that intends to sign the institution's

program participation agreement. This commenter argued that the

Secretary does not have the statutory authority to require audited

financial statements of related parties other than at the level of the

institution, nor does the Secretary have the authority to determine the

institution's financial responsibility on the basis of a related

party's financial statement unless the institution is a wholly owned

subsidiary of the related party. This commenter recommended that the

proposed regulations be changed to limit the requirement to provide

this information for related parties only if the Department reasonably

believes that the related party's performance jeopardizes the financial

responsibility of the institution, based on a clear financial

relationship between the entities, and that the requirement be limited

to the requirement that the related party provide its most recent

financial statement within six months. Further, this commenter

recommended that the Department not penalize the institution if the

related party does not maintain sufficient documentation to support an

audited financial statement.

One commenter from a proprietary institution suggested that the

Department rely on the auditor's judgement, following AICPA guidelines,

about whether the institution should submit consolidated financial

statements. A commenter from a public institution maintained that the

Department should not require a consolidated statement in situations in

which such statements are not required under GASB standards.

One commenter maintained that requiring the audited financial

statement from a related party could result in significant problems,

stemming from requests after the year end for a period that has not

been audited (resulting in difficulty in issuing a clean opinion), and

the presence of inventories and opening balances that may result in

qualifications. This commenter asserted that, as a result of such

difficulties, the Department may not receive what it considers

acceptable audits for these parties, and that institutions may not be

able to correct the problems for as long as a year.

A commenter from a proprietary institution maintained that, when an

institution or institutions are owned by a corporation the financial

statement of the corporation be the basis for evaluating financial

responsibility, since all the assets and liabilities of the

institutions are assets and liabilities of the corporation.

Discussion: The Secretary requires that an institution provide as

part of its audited financial statement a detailed disclosure of all

related parties consistent with the definition of a related party

established in SFAS 57. The Secretary's intent is to obtain an

understanding of the relationships that exist among related entities

that have the ability to exert substantial influence or control. The

Secretary recognizes that

[[Page 60577]]

the existence of related parties may lead to material transactions that

are substantially different in terms and conditions from those that

would occur with unrelated independent entities. The Secretary believes

that this understanding is necessary in order to take into

consideration an institution's total financial circumstances. This

provision is intended to make available to the Secretary information

important to an analysis of the financial statements that would

otherwise be difficult to ascertain simply from reviewing the financial

statements. The Secretary believes that by providing a reference to the

definitions in SFAS 57 both institutions and their independent auditors

will have a clear understanding as to the meaning of the term ``related

party'' under this provision.

To determine whether an institution is financially responsible, the

Secretary may also require that the institution submit audited

consolidated financial statements, audited full consolidating financial

statements, audited combined financial statements or the audited

financial statements of one or more related parties that have the

ability, either individually or collectively, to significantly

influence or control the institution, as determined by the Secretary.

This requirement represents a clarification of the existing regulatory

provisions in 34 CFR 668.15(e) which provides that the Secretary may

request additional information to the extent necessary to make a

determination of financial responsibility. The HEA requires that the

Secretary take into consideration an institution's total financial

circumstances. The Secretary believes that these additional financial

statements may be necessary in order to obtain an understanding of the

economic substance of an institution's financial condition. The

Secretary further believes that this may constitute a more accurate

reflection of the institution's total financial circumstances. The

Secretary also believes that this provision will provide flexibility

with respect to how an institution demonstrates financial

responsibility. For example, the existing regulatory language may have

required several institutions, none of which was individually a

separate legal entity, to provide individual audited financial

statements representing each institution despite the fact that all were

operating divisions of a single corporate entity. Under the new

standard, the Secretary has explicit flexibility to allow the

preparation of a single audited financial statement, representing the

corporate entity only, in lieu of requiring these individual financial

statements.

Notwithstanding the Secretary's interest in obtaining an

understanding of the institution's total financial circumstances, the

Secretary enters into a program participation agreement with an entity

that has the legal capacity and financial capability to enter into such

an agreement for the institution. In the event that the Secretary

determines that the economic substance of the relationship among

related parties is such that the institution would not otherwise be

able to demonstrate financial responsibility on its own, the Secretary

may require financial guarantees from related parties or co-signatories

to the program participation agreement. In contrast, should the

economic relationship among related entities be such that the total

financial circumstances of the institution indicate an inability to

demonstrate financial responsibility due to the existence of

significant liabilities or claims on the assets of the institution, the

institution shall be deemed not financially responsible. The Secretary

believes that this requirement will not cause excessive burden or cost

to any institution that is able to demonstrate financial responsibility

independently of a related entity. However, the Secretary recognizes

that for some institutions this provision may be costly. The Secretary

maintains that the costs are necessary to protect the federal fiscal

interests.

Changes: The Secretary clarifies requirements in this area by

adding the following regulatory language to Sec. 668.23(d)(2): ``The

disclosure requirements under this provision extend beyond those of

SFAS 57 to include all related parties and a level of detail that would

enable the Secretary to readily identify the related party. Such

information may include but is not limited to the name, location and a

description of the related entity including the nature and amount of

any transactions between the related party and the institution,

financial or otherwise, regardless of when they occurred.''

Comments: A commenter from a proprietary institution supported the

requirement that proprietary institutions disclose the proportion of

revenue the institution received from title IV, HEA program sources.

Many commenters opposed the requirement. Most of these commenters

opposed the provision on the grounds that the current provision

contained in Sec. 600.5 requires only an attestation on the part of the

CPA firm. Including a disclosure in the audited financial statement

will increase the work required of the auditor as well as the exposure

of the auditor, and thus increase the cost of the audit. These

commenters also asserted that the current procedures provided

sufficient information for the Department to fulfill its oversight

responsibility in this area.

One commenter questioned whether the requirement was that the

disclosure be separately audited, or based on the attestation

engagement required by 34 CFR Sec. 600.5. This commenter asserted that,

should the former be the case, this should be reflected in a change to

34 CFR Sec. 600.5 and in the Regulatory Flexibility Analysis. One

commenter maintained that the request for this information suggested

that the Department intended to use the information for purposes that

extended beyond Congressional intent.

Discussion: Previously the Secretary had required an examination

level ``Compliance Attestation'' to be performed within three months of

the institution's fiscal year end. The Secretary believes that the

revised requirement contained in these final regulations will not

result in significant additional cost as the disclosure will now become

part of the audit of the general purpose financial statements. The

corresponding increase in cost associated with adding this disclosure

is not likely to be significantly greater than the savings resulting

from the removal of the requirement to perform the ``Compliance

Attestation.'' Additionally, the independent auditor who performs the

audit of the institution's general purpose financial statement may be

able to rely to some extent on the field work of the independent

auditor who will be conducting the institution's compliance audit for

the same fiscal period. The Secretary requires this information to

ensure compliance with provisions of the HEA that stipulate a

proprietary institution may not receive more than 85 percent of total

revenues in the form of Title IV program funds.

Changes: Section 600.5(e) has been removed.

[FR Doc. 96-30394 Filed 11-27-96; 8:45 am]

BILLING CODE 4000-01-P