OPENING STATEMENT OF CHAIRMAN PETE HOEKSTRA, SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS, COMMITTEE ON EDUCATION AND THE WORKFORCE *

OPENING STATEMENT OF CONGRESSMAN ROBERT SCOTT, SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS, COMMITTEE ON EDUCATION AND THE WORKFORCE *

TESTIMONY OF MARSHALL SMITH, ACTING DEPUTY SECRETARY, U.S. DEPARTMENT OF EDUCATION, WASHINGTON, D.C. *

TESTIMONY OF LORRAINE LEWIS, INSPECTOR GENERAL, U.S. DEPARTMENT OF EDUCATION, ACCOMPANIED BY STEVEN A. McNAMARA, ASSISTANT INSPECTOR GENERAL FOR AUDIT SERVICES, U.S. DEPARTMENT OF EDUCATION, WASHINGTON, D.C. *

TESTIMONY OF GLORIA JARMON, DIRECTOR, HEALTH, EDUCATION AND HUMAN SERVICES ACCOUNTING AND FINANCIAL MANAGEMENT ISSUES, U.S. GENERAL ACCOUNTING OFFICE, WASHINGTON, D.C. *

TESTIMONY OF MICHAEL LAMPLEY, PARTNER, ERNST & YOUNG, LLP, WASHINGTON, D.C. *

APPENDIX A - WRITTEN OPENING STATEMENT OF CHAIRMAN PETE HOEKSTRA, SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS, COMMITTEE ON EDUCATION AND THE WORKFORCE *

APPENDIX B - WRITTEN STATEMENT OF MARSHALL SMITH, ACTING DEPUTY SECRETARY, U.S. DEPARTMENT OF EDUCATION, WASHINGTON, D.C. *

APPENDIX C - WRITTEN STATEMENT OF LORRAINE LEWIS, INSPECTOR GENERAL, U.S. DEPARTMENT OF EDUCATION, WASHINGTON, D.C. *

APPENDIX D - WRITTEN STATEMENT OF GLORIA JARMON, DIRECTOR, HEALTH, EDUCATION AND HUMAN SERVICES ACCOUNTING AND FINANCIAL MANAGEMENT ISSUES, U.S. GENERAL ACCOUNTING OFFICE, WASHINGTON, D.C. *

APPENDIX E - WRITTEN STATEMENT OF MICHAEL LAMPLEY, PARTNER, ERNST & YOUNG, LLP, WASHINGTON, D.C. *

House of Representatives

Subcommittee on Oversight and Investigations

Committee on Education and the Workforce

Washington, D.C.

The Subcommittee met, pursuant to call, at 12:30 p.m., in Room 2261, Rayburn House Office Building, Hon. Peter Hoekstra, Chairman of the Subcommittee, presiding.

Present: Representatives Hoekstra, Schaffer, Scott, and Kind.

Staff Present: Peter Warren, Professional Staff; Faith Cristol, Professional Staff; Jon DeWitte, Staff Assistant; Patrick Lyden, Professional Staff; Sally Stroup, Professional Staff; Deborah Samantar, Office Manager; Mike Reynard, Media Assistant.

Chairman Hoekstra. Good afternoon. A quorum being present, the Subcommittee on Oversight and Investigations will come to order.

The Subcommittee is meeting today to hear testimony on the financial management practices of the Department of Education. Under Rule 12(b) of the Committee, any oral opening statements at hearings are limited to the Chairman and the Ranking Minority Member. This will allow us to hear from our witnesses sooner and help Members keep to their schedules. Therefore, if other Members have statements they can be included in the hearing record.

Without objection, all Members' statements will be inserted in the hearing record. Also without objection, I ask that all documents referenced in the hearing be incorporated into the hearing record.

I will go into my opening statement. First of all, I would like to thank the Members, Mr. Scott I understand is on the way, for coming here during a congressional recess. The Subcommittee is meeting today to assess the financial health of the Department of Education. We could not do this hearing while Congress was in session because the Department's audit was completed just as Congress was adjourning last month. I am talking about their audit for fiscal year 1998, which ended on September 30.

Let me begin by stating what is obvious to many: The primary role of the Department of Education is not to educate our children. The Department does not educate children; teachers and schools and local schools educate the children. The Department does not educate young people at our colleges; colleges and professors educate young men and women.

What the Department of Education does is provide the resources that help our colleges and our local schools accomplish their local education objectives. Another primary focus of the Department of Education is that by its various nature, the Department of Education is a very large financial institution. It has been entrusted with roughly $120 billion of taxpayer money. Just to put this in a little bit of context, $120 billion is about 24 million American families paying taxes of about $5,000. Their annual appropriation is about $35 billion. That is about 7 million American families paying $5,000 in taxes per year. It is a very large number.

It is basically composed of three components. First, there is the discretionary budget, which is the amount that they award to local schools and States and colleges on an annual basis for fiscal year 2000, that is about $38 billion. Second, they also manage a direct loan program. In fiscal year 2000 we are estimating there will be a new loan volume under the direct student loan program of about $16 billion. Finally, they also manage the outstanding student loan volume, the loans that have been given in the past, in the nature of $61 billion. Then they manage the loans that have been subsidized by the Federal Government, but have been managed by the private sector. So it is a very significant organization.

One of the things that we are testing for today is, as they are distributing and managing this money, whether they are doing it in an efficient and reliable manner.

How do we know if they are doing this? Any business executive can tell you that an annual audit is a good place to begin. Some say an audit is like making sure your shoes are tied so as you are running the race, you don't trip. Using this analogy, if the Department's shoes were tied, there is less of a chance that taxpayer dollars are being lost on waste, fraud and abuse.

The report that came out a few weeks ago indicates that the Department's shoes aren't tied. Ernst & Young, independent auditors, found the Department's fiscal year 1998 books to be unauditable. They found discrepancies as large as $6 billion in the financial statements that the Department did not have an explanation for.

The Department officials say that their books could have been fully audited. They indicate that they had run out of time, and that if given more time, more resources, more money, they could have audited the books. But the auditors report that even though they worked 8 months past the March 1 audit deadline, they still could not express an opinion on the books.

It is worth noting that the Department does not tolerate excuses from schools and other grant recipients who fail to meet audit requirements. These grantees are subject to sanctions, including the suspension and termination of their Federal awards.

Why couldn't the Department get an audit opinion?

First, officials did not get their financial statements to the auditors on time. The auditors, according to the documents that we received, wanted to begin their work in May or June of 1998. The Department was not ready. The auditors showed up again in September 1998 as the fiscal year was ending; still, the Department was not ready. The auditors were told to return in February, a month before the report is due, by law.

The second problem is that the Department cannot balance its checkbook. The Treasury Department serves as the bank for all Federal agencies. The Department does not balance its checkbook each month or on any regular basis. As a result, auditor reports have found discrepancies between the Department and Treasury at the end of each recent fiscal year. The interesting thing is that the discrepancy at the end of fiscal year 1998 is not even stated in the current audit report.

The third reason for the unauditability is that the Department purchased a dysfunctional accounting system that does not meet generally accepted standards. As a result, auditors had to dig through the records by hand to come up with end-of-the-year balances that should be produced automatically. But even that process is like trying to get blood from a stone, since a poor accounting system tends to produce garbage in, garbage out. The auditors also found that the accounting system and other information systems are not secure and subject to tampering.

These are only the most prominent items cited in the audit report. Others include a lack of monitoring of student aid programs that has resulted in sizable waste, fraud and abuse. For example, this past June, the Inspector General reported that student loans are being forgiven for people who pretend to be permanently disabled or dead. I am disappointed that I don't have the exact verbiage of the IG's report because it was stated so clearly and so well, but basically what the IG found is that many of those reported as dead were both alive and employed. The IG found almost $77 million in improperly discharged loans. That $77 million could pay for nearly 20,000 new student loans for eligible students.

The IG has also estimated that $177 million in Pell grants were improperly awarded during one recent academic year alone because students who failed to meet the income requirements got the grants anyway. Congress specifically targets Pell grants for students from low-income families; $177 million could buy 88,500 Pell grants for needy students.

In my belief, in all likelihood, this is just the tip of the iceberg. We do not know the full extent of overpayments and other waste.

GAO was recently asked to collect estimates of improper payments made by each Federal agency. But GAO could not report a figure for the Department of Education. I suspect this is because the Department does not know how much waste is occurring.

But that is not surprising in light of the fiscal year 1998 audit results. When your shoelaces are untied, you are going to eventually trip over them. It is not the Department that is getting the scrapes and bruises, though; it is the students who rely on the Federal education dollars and the taxpayers who are paying the price.

Mr. Scott.

WRITTEN OPENING STATEMENT OF CHAIRMAN PETE HOEKSTRA, SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS, COMMITTEE ON EDUCATION AND THE WORKFORCE – SEE APPENDIX A

Mr. Scott. Thank you, Mr. Chairman. I thank the panel that is here before us to explain the situation in the Department of Education's fiscal management practices, and I hope we would engage in an objective, straightforward oversight of the Department of Education's fiscal management practices. We should not ignore the fact that the Department did not receive a clean audit in 1998.

This should be placed in context. Unlike the Reagan and Bush administrations, this administration has made tremendous strides in improving the management and fiscal integrity of the Department's processes. For example, the default rate on student loans has declined for 7 consecutive years and now is at a record low, 8.8 percent. Collections on defaulted loans have more than doubled, from $1 billion in fiscal year 1983, to $2.2 billion in fiscal year 1998.

Data improvement for the National Student Loan Data System has prevented the disbursement of as much as $1 billion in grants and loans to ineligible students.

In addition, the Department of Education is taking appropriate steps to receive a clean audit for fiscal year 1999. I look forward to hearing about the new general ledger system and how the new system requires all disbursed funds to be immediately posted to a grantee's account. I am confident these efforts on the part of the Education Department, coupled with our congressional oversight, will continue to ensure sound fiscal management and ensure the Department of Education fulfills its mission for the improved education of our Nation.

Finally, Mr. Chairman, I want to congratulate you on your slide presentation. There is probably no telling what it costs, but we don't want to spare a dime in making sure that our oversight responsibilities are met.

Thank you, Mr. Chairman. I yield back.

Chairman Hoekstra. Would Mr. Scott like an estimate of the cost?

Mr. Scott. No, Mr. Chairman, I am looking forward to the testimony.

Chairman Hoekstra. Actually, it is amazing what technology can do. This is a presentation developed on Power Point. It is developed with no physical product, so it is simply developed on the screen. It is taking the materials that otherwise would have been used for boards and things like that and just transferring the data electronically to a projector. So there is little, if any, extra cost beyond that of the regular presentations, and we thought it would be a nice way to improve our ability to communicate with the people that are here today.

Mr. Scott. I congratulate you, Mr. Chairman, and I am looking forward to the testimony of the witnesses.

Chairman Hoekstra. Hey, great. Thank you.

I would like to introduce the panel. The first witness that we have with us today is Mr. Marshall Smith, the Acting Deputy Secretary of the U.S. Department of Education. Mr. Smith, welcome back. You have been with us before. It is good to see you here again today.

We also have Ms. Lorraine Lewis, the new Inspector General for the U.S. Department of Education, who assumed those responsibilities back in June of this year. I believe that this is the first opportunity that you have had to with be us. Welcome. We look forward to working with you in the coming years.

We also have Ms. Gloria Jarmon. Welcome. Good to see you. She is the Director of Health, Education and Human Services, Accounting and Financial Management Issues. You get that all on one business card? That is quite a title. But we have enjoyed working with you over the last number of years. Welcome back. Gloria is from the U.S. General Accounting Office.

We also have Mr. Michael Lampley, a partner with Ernst & Young, which is the firm that did the independent audit of the Education Department back in 1998, and is working on the audit for 1999. Welcome. We are looking forward to your testimony as well.

I would ask the panel to please stand and I am going to ask you to take the oath. I think you are familiar with it; that it is unlawful to make a false statement to Congress while under oath.

[Witnesses sworn.]

Chairman Hoekstra. Let me remind the witnesses that under our Committee rules, we would prefer the statement to say they must, but I have had a weak gavel in the past. But to get to the question-and-answer period, I would really prefer that you limit your oral statements to 5 minutes. Your entire statements will be printed in the record. We will also allow the entire panel to testify before the questioning of the witnesses begins.

So, I really would prefer today if we could keep it to the 5 minutes. I have had the opportunity, I believe, to read all of the testimony. I appreciate the panel, I think in all cases, getting us the testimony last week on Friday, so that we could review it over the weekend. I recognize that at least a couple of us, maybe all of us, have had an opportunity to read the entire record. So being discreet with your verbal testimony would be very much appreciated.

Mr. Smith.

Mr. Smith. Mr. Chairman, other Members, I welcome this opportunity to talk about how Secretary Riley and I have worked to strengthen the Federal investment in American education.

Before I begin, let me thank the Chairman for reminding me of the other times I have been here. One of them, as you may recall, was in the Y2K testimony, and very shortly after that, the Department received an "A" from Congress and moved to the highest tier at OMB.

On loan consolidations, again after that testimony, the Department moved to a point where it was consolidating loans, actually consolidated about three-fifths of the total number of loans that have been consolidated over the last year or so, and all within a 60-day time period. So perhaps Mr. Chairman, if this happens, we will get a clean audit this next year.

Let me say at the beginning, just in response, I am sorry that I didn't know you were going to have overheads. I would have brought some along too.

I believe that the money the Department of Education is entrusted with by the Congress reaches its recipients, and one study by an independent group, the GAO in this case, actually looked at whether or not the money reached the recipients. It looked at the 10 largest or 10 of the largest programs in elementary and secondary education and found that 99 percent of the funds reached the States, which were their intended recipients. I think it is also important to note, in response to your comment about waste, fraud and abuse, that in no instance did the independent auditor say that there was any waste, fraud or abuse in the Department on these, in terms of care of these resources.

Shortly after we arrived at the Department in 1993, we were greeted by a General Accounting Office report on the Department's long-standing management problems. The first Secretary of Education had only a few months in which to try to organize the Department before a new administration took office. The next Secretary made dismantling the Department a formal goal, the report read, and did not request a budget for fiscal years 1993 and 1994. Subsequent Secretaries focused on external policy agendas, devoting little attention to departmental management. The report continued, because its financial management system did not provide adequate financial and cannot produce accurate and reliable information, Education cannot ensure that its programs are financially sound. That was written in 1992.

Secretary Riley and I have placed top priority on these issues. Our employees are highly motivated and dedicated to the work and to the Department's missions. I firmly believe that our programs are better managed than ever before.

We began by improving the quality of our data and our financial reporting. The new National Student Loan Data System, required by Congress in the 1992 amendments, was put into place and has begun to pay large dividends. We devoted extra staff and financial resources into the area of the fiscal year 1997 financial statements. Our work, conducted over a period of 20 months, required time-consuming manual data verification. This intense effort ultimately led to a clean bill of health in our 1997 financial systems.

In 1998, our efforts to integrate our stand-alone financial systems culminated in the implementation of a new system, EDCAPS, to perform financial management, contracts and purchasing, and grants and payment management together. However, for fiscal year 1998 the preparation of our financial statement was delayed by four factors:

First, our concentrated effort to support the 1997 audit delayed the 1998 audit by 4 to 5 months. Second, all government agencies were required to provide two new major financial statements for 1998. Third, the Department was using its new standard ledger software, IEFARS, to prepare its financial statements. Fourth, we faced continuing data quality issues that required time-consuming data reviews.

Our delays in preparing financial statements meant that the 1998 process would likely be either more prolonged than it was and could jeopardize our 1999 audit. As a result, we accepted our auditors' recommendation to suspend work on the 1998 audit. This mutual decision by the Inspector General and myself was reached after full consultation with the independent auditors and the Office of Management and Budget. As a result, the Department's auditor did not express an opinion on the 1998 consolidated financial statements.

The difficulties we are experiencing as we work towards stronger financial management are hardly unique. Only 12 of the 24 agencies covered by the Chief Financial Officer's Act received an unqualified opinion in 1998, and while our auditors identified issues that the Department must address, as I said, it did not report that any funds were lost, misallocated or stolen. Our efforts over the past year, working on the fiscal year 1997 audit, were not wasted. They are the foundation for future success.

During fiscal year 1998, we resolved a material weakness involving the data underlying liability estimates for student loan programs. We also made substantial progress in resolving the problems associated with the three material witnesses identified in the 1998 audit.

We have adopted all of our auditors' recommendations to improve financial reporting, including increased staff expertise, new quality assurance and documentation procedures and new software applications. We are improving computer security by hiring new staff with the necessary expertise and by aggressively implementing corrective action plans. We are continuing to strengthen our reconciliation processes with customers, the U.S. Treasury and internal systems.

Prior to 1998, customers such as States or universities, did not identify the use for the Federal funds they requested, but instead certified their use retrospectively at the end of the month or quarter. Today, our new grant system requires that our customers request funds by grant number, creating immediate reconciled data by program on recipients' actual use of funds. Investments in technology have enabled us to move from annual to quarterly reconciliations with Treasury.

In March, we will begin reconciling on a monthly basis. Two years ago, internal reconciliation between the general ledger and student financial assistance programs occurred only annually. Today, we reconcile daily for Pell grants and quarterly for student loans. Further improvements to student loan reconciliation are planned for this spring.

So far this year, we have met our auditors' schedule to complete audited 1999 financial statements by the deadline of March 2000. We have already delivered to our auditors a consolidated general ledger, trial balance and financial statements, 8 months ahead of last year's time line. We have also begun replacing our general ledger system, IEFARS, because it was not capable of automatically producing reports required. However, our IEFARS contractor was purchased, that is, the company was bought and no longer routinely supports IEFARS for Federal clients.

Our new system will improve budget execution, financial reporting, year-end closing, and integration with other financial management modules. It will be in place sometime in the year 2001.

I am proud of our work. The Department's management accomplishments over the past 7 years, including cutting loan defaults in half, doubling collections and enabling the direct student loan program, have achieved billions of dollars in savings, money that could fund our administrative budget many times over, with only two-thirds as many employees that administered our programs in 1980, even though our budget has more than doubled.

A recent GAO report confirmed that over 99 percent of our appropriations for the 10 largest K-to-12 education programs reached the States. We have trimmed one third of our regulations, reduced grant application paperwork and aggressively implemented waiver authority for legal roadblocks to State reform.

We have fully addressed the issues presented by 203 of the 234 audits issued by the GAO and the Inspector General that were still unresolved in 1993, or issued since 1993, and addressed more than half of the issues of the remaining 31. There are less than half as many open audits as there were 6 years ago. Customer service ratings for EDPUBS, our document distribution center, exceed those of premier corporations like Federal Express and Nordstrom.

We have been part of a nationwide team of students, families and educators investing in American education, and the results are beginning to be evident. New high academic standards are in place in all 50 States. For the first time ever, the Nation's reading scores are up in all three grades tested. Math scores are also improved. More high school seniors than ever, 65 percent, are going straight to college.

I would be happy to answer any questions you have.

WRITTEN STATEMENT OF MARSHALL SMITH, ACTING DEPUTY SECRETARY, U.S. DEPARTMENT OF EDUCATION, WASHINGTON, D.C.

SEE APPENDIX B

Chairman Hoekstra. We are generous. We recognize you are leaving the Department of Education in February; is that correct?

Mr. Smith. That is correct.

Chairman Hoekstra. Ms. Lewis.

Ms. Lewis. Mr. Chairman and other Members, I am pleased to testify today.

Chairman Hoekstra. Before we go further, since this is your first time, the green light means you have plenty of time, the yellow light means you are getting close, and if you haven't been here, the red light means, okay, the time is up.

Ms. Lewis. Okay. Will do.

I prepared a longer statement with appendices for the record. I have asked Steve McNamara, the Assistant Inspector General for Audit Services, to be with me today to answer any questions the Subcommittee may have.

We all share the common goals of good government and serving the taxpayer. Promoting sound financial management is clearly an important part of these functions. The Office of Inspector General is responsible for the performance of the financial statements audit.

In 1998, Ernst & Young was engaged to provide independent reports on the Department's financial statements to the Inspector General. Oversight throughout the financial audit process and reporting on the results is one of my highest priorities. I transmitted the final 1998 reports to the Secretary of Education on November 18, 1999. The reports were issued late because the Department's financial statements and records were not ready to be audited to meet the March 1st deadline.

I am committed to meeting the March 1st deadline for the audit of 1999 financial statements and all that follow.

The 1999 engagement resulted in a report from Ernst & Young containing a disclaimer of opinion because they were unable to determine whether the 1998 financial statements were presented fairly in all material respects in accordance with Federal accounting standards. This is because the Department operated under a new financial management software package in 1998. Weaknesses in that package included the inability to perform a year-end closing process or produce automated, consolidated financial statements. These were significant factors in the Department's inability to prepare accurate consolidated financial statements in a timely manner. In addition, the Department did not adequately perform reconciliations on account balances and could not provide sufficient documentation supporting transactions.

Also, a report on internal control documented seven reportable conditions of which the following three are material weaknesses: One, financial reporting needs to be strengthened; two, reconciliations need to be improved; and, three, controls surrounding information systems need enhancement.

The material weaknesses can be attributed to the following: The Department implemented a new financial management software package; there was significant turnover of personnel in the Office of the Chief Financial Officer; and in 1998 OMB imposed additional reporting requirements on Federal agencies, such as increasing the number of required statements by two.

The report on compliance with laws and regulations documented the failure to meet the March 1st statutory deadline and noncompliance with the systems requirements of the Federal Financial Management Improvement Act.

You asked how the findings reported for 1998 compared with previous Department-wide audits. The Department received a disclaimer 3 out of the last 4 years. The clean opinion for 1997 was the result of a lengthy effort to gather audited data from outside the NSLDS.

Overall, the findings identified in the 1998 report on internal control are substantially the same as those reported in prior years. For 1997, financial reporting and controls surrounding information systems were identified as new significant control weaknesses. They were reported again in 1998.

In contrast, in 1998, the Department was able to correct the long-standing internal control weakness related to its failed loan liability estimate.

The Department has made other efforts to improve its financial management. Some areas include the preparation of interim statements, the use of contractors to help prepare statements more timely, and the institution of automated processes to prepare the consolidated trial balance and financial statements.

I would like to take a moment to acknowledge the commitment and effort made by Department staff to try to overcome the difficulties posed by the new financial management software package. They worked very long hours in order to prepare the 1998 financial statements. They have met the internal deadline for producing the 1999 financial statements; and with regard to the issues in the 1998 reports, the Department has indicated it is in general agreement and is developing a comprehensive corrective action plan.

You also asked about recommendations for improvement in monitoring the implementation. The Office of Inspector General and its contract auditors continued to make recommendations for improving financial management. One of the ways this is accomplished is through the financial statement audit report. Since 1995, the internal control reports have included 115 recommendations, of which 88 remain open and 27 are closed. Also the Office of Inspector General internally tracks implementation of corrective actions by management.

Mr. Chairman and Members of the Subcommittee, I am committed to providing timely quality audit services for the Department to enable it to improve financial management and reporting to the Department and Congress on the results of our work. Mr. McNamara and I would be pleased to answer any questions.

Thank you very much.

WRITTEN STATEMENT OF LORRAINE LEWIS, INSPECTOR GENERAL, U.S. DEPARTMENT OF EDUCATION, WASHINGTON, D.C. – SEE APPENDIX C

Chairman Hoekstra. Thank you. Not a bad start. Ms. Jarmon

.

Ms. Jarmon. Mr. Chairman and Members of the Subcommittee, I am pleased to be here today to discuss our review of the auditors' reports of the Department of Education's financial statements covered in fiscal year 1998. The audit results of the agency's financial statements are key indicators of the quality of agents of financial data.

In March of this year, we reported on the results of our financial statement review of the fiscal year 1998 consolidated financial statements of the U.S. Government. Because of serious deficiencies in the government's systems, record-keeping, documentation, financial reporting and controls, we found that amounts reported in the government-wide financial statements do not provide a reliable source of information for decision-making by the government or the public.

Similar outcomes were identified at Education. The auditors' reports reveal that Education has serious internal control and financial management system issues that prevented it from reliably reporting on the results of its operations for fiscal year 1998.

In addition, Education was the last CFO agency to issue its fiscal year 1998 financial statements, releasing them on November 18, over 8 months later than the March 1st, 1999, due date for audited statements.

I would briefly discuss each of the three material internal control weaknesses included in the auditors' report. These weaknesses are: one, weaknesses in the financial reporting process; two, inadequate reconciliations of financial accounting records; and three, inadequate controls over information systems.

First, in regard to financial reporting, the auditors found that the Department does not have adequate internal controls over its financial reporting process to provide reasonable assurance that its principal financial statements are reliable. As a result, Education was unable to prepare reliable financial statements. It could not support material amounts reported on its financial statements, including obligations, grant expenditures and net position.

The Department's new accounting system could not perform an automated year-end closing process and directly produce consolidated financial statements as would normally be expected from such systems. This meant that the Department had to use a costly, labor-intensive and time-consuming manual process to prepare its financial statements. These problems contributed to the significant delay in Education's submitting financial statements to the auditors and to OMB.

Next, in regard to reconciliations, the auditors reported that Education did not properly or promptly reconcile its financial records during fiscal year 1998. It could not provide sufficient documentation to support its financial transactions. Its reported $45 billion in fund balance with Treasury accounts could not be verified. The transactions that Education reported to the Treasury routinely differed from those reported in its general ledger throughout fiscal year 1998. The auditors found that Education made large adjustments that were not fully researched or supported, merely to force records to agree.

Finally, in regard to information systems weaknesses, Education's inadequate controls over its information systems placed critical Education operations, such as financial management and sensitive loan and grant management, at increased risk of unauthorized access and disruption. In addition, sensitive financial transaction data are vulnerable to inadvertent or deliberate misuse, fraudulent use, improper disclosure or destruction, possibly occurring without detection. This is a real concern due to the high volume of transactions that flow through Education's grant administration and payments system, over $20 billion a year.

As a result of these weaknesses, Education cannot be sure that it provides reliable financial information to decision-makers, such as the Congress or the public. With continued dedicated effort from Education's management, Education can address some of these issues in the near term. Others will take longer. Resolving these problems is critical to Education's achieving its mission and meeting its obligations to loan and grant recipients and its responsibilities under law.

Mr. Chairman, this concludes my statement. I will be happy to answer any questions from you or other members of the Subcommittee.

WRITTEN STATEMENT OF GLORIA JARMON, DIRECTOR, HEALTH, EDUCATION AND HUMAN SERVICES ACCOUNTING AND FINANCIAL MANAGEMENT ISSUES, U.S. GENERAL ACCOUNTING OFFICE, WASHINGTON, D.C. – SEE APPENDIX D

Chairman Hoekstra. Thank you very much. Mr. Lampley.

Mr. Lampley. Good afternoon, Mr. Chairman and Members of the Subcommittee. My name is Mike Lampley. I am a partner with Ernst & Young. I have been in public accounting for over 30 years, specializing for the last 10 years in the audit of Federal agencies. At the Committee's request, I will focus on Ernst & Young's process for the FY 1998 audit.

First, I will focus on the process we employ when auditing a typical Federal agency, and then I will comment on our experience with the Department of Education's fiscal year 1999 audit.

The Office of Inspector General at the Department of Education contracted with Ernst & Young on June 24th, 1998, to conduct an audit of the fiscal year 1998 financial statements for the purposes of satisfying the requirements of the Government Management Reform Act. Pursuant to the Act, adequate financial statements must be provided to OMB by March 1 of the year following the fiscal year under audit.

To accomplish this objective, engagement planning typically begins in mid-May of the year to be audited. Interim procedures are performed during the months of June through mid-August with the auditors returning in mid-October after the Federal agency has closed its books. The year-end audit procedures are completed by February of the following fiscal year. Finally, the reporting phase of the audit is completed by March 1.

With respect to the Department of Education, this was the first year we were engaged to conduct the audit of the Department's financial statements. Our initial plan was to conduct the audit in a similar process as described above. Early in the process, however, it became evident that the Department did not believe it could provide information in the time frames needed for Ernst & Young to meet the deadlines and time frames identified in the contract with the Office of Inspector General. We would typically like to have begun our fiscal year 1998 audit procedures by mid-May of 1998, but since our contract was not awarded until June, we couldn't begin the process until July.

In early August, 1998, the then-chief financial officer informed the OIG that the Department's books and records would not be ready for audit until February 1999. As a result, a decision was made to delay the audit and we did not perform additional work related to the Office of the CFO until February of 1999. As a result of the adjusted time frames, it was recognized that the March 1 statutory deadline would not be achieved. Even after March 1 and throughout this process, the Department was unable to provide information in a timely manner.

From February until early June of 1999, Ernst & Young performed testing where possible, while working with the Department to obtain final versions of trial balance, financial statements and notes thereto.

Finally, in July of 1999, as a result of the difficulties the Department was encountering in preparing financial statements, the Department recognized it would not receive an opinion on all of the required statements. Specifically, on July 20th, 1999, a document was delivered by the Deputy CFO and signed by the Deputy Secretary, indicating the Department's decision to conclude the 1998 audit and accept the disclaimers of opinion on all the statements.

As result of the engagement procedures followed and as documented in our report of independent auditors, we were unable to determine whether or not the financial statements presented fairly in all material respects in conformity with Federal accounting standards. Accordingly, E&Y issued a disclaimer of opinion, indicating that we did not express an opinion on the financial statement.

We also issued a report on internal control, documenting seven reportable conditions. Of the seven, three were material weaknesses, the definition of which is included in my written testimony. Two of those three were repeat conditions from the prior year's audit.

The first material weakness indicated that there were significant issues surrounding the Department's financial reporting. Second was the Department's lack of timely account balance reconciliations. The third and final material weakness was the lack of control surrounding the Department of information systems. The remaining reportable conditions are listed in my written testimony.

The weaknesses identified in our report on internal control can be attributed primarily to the following:

First, the Department implemented a new financial management software package that made it more difficult for the Department to prepare the required fiscal year 1998 financial statements.

Second, there was turnover of key personnel in the Office of the Chief Financial Officer during the course of the engagement. As a result, at times there was limited guidance and leadership for individuals in this office.

Third, in fiscal year 1998, OMB bulletin 9701, the form and content of agency financial statements, imposed additional reporting requirements on Federal agencies such as increasing the number of required statements from two to five.

In summary, the Department encountered significant difficulties related to the preparation of its fiscal year 1998 financial statements because the Department lacked adequate financial systems, reports and financial oversights to prepare timely and accurate financial statements. A detailed chronology of key events related to the audit process is attached to Appendix 1 in my written statement.

At this point I would be pleased to answer any questions.

WRITTEN STATEMENT OF MICHAEL LAMPLEY, PARTNER, ERNST & YOUNG, LLP, WASHINGTON, D.C. – SEE APPENDIX E

SUBMITTED FOR THE RECORD, REPORT ON COMPLIANCE WITH LAWS AND REGULATIONS, ERNST & YOUNG, LLP, WASHINGTON, D.C., SEPTEMBER 15, 1999 - SEE APPENDIX F

Chairman Hoekstra. I thank the panel very much. We will now go to Member questioning.

Mr. Lampley, year-end closing the books and auditability is really to give you a picture of what happened within a certain period of time, in this case from October 1 to September 30? Is that correct?

Mr. Lampley. Yes, sir. For our audit, it would have been October 1 of 1997 to September 30 of 1998.

Chairman Hoekstra. Coming out of the private sector, it is important that you capture the data at a beginning date, and that is your base, and you close the books on a specific date, September 30. I came out of the private sector. I worked for a Fortune 500 company; it was very clear, anything that happened after close of business on that close date, in this case it would be September 30 of 1998 for the Education Department, would be moved into the following fiscal year. That is standard accounting procedure; is that correct?

Mr. Lampley. Mr. Chairman, it would typically be correct, yes.

Chairman Hoekstra. That is why I was really captured reading through your report, and this is from your report on internal control, page 15 point D. It is called "Borrowings." "During our testing of Borrowings from Treasury, we noted that many of the principal repayments to Treasury were made after September 30, 1998." I am quoting. "For financial reporting purposes, the Department reflected the repayment of borrowings as if it had occurred by September 30, 1998.", then, "As a result of the principal repayments to Treasury, both Fund Balance with Treasury and Borrowings from Treasury are understated by approximately $1.3 billion as of September 30, 1998."; end of quote.

Now, what I am reading here, tell me if I am reading it right, okay, or you correct me if I am wrong. This says that we passed September 30, 1998, so now we are maybe into October and November. I don't know exactly when. Maybe you know the details behind this, but after September 30th, the Department of Education performed financial transactions.

And then did they, I don't know what the term is, predate or go back into the books to, as it says here, "as if it had occurred by September 30."? Did they do things in October, November and December, and go back into the books and say these things really happened prior to September 30th? Is that what this says?

Mr. Lampley. Mr. Chairman, with respect to this specific item, it was strictly with respect to the borrowings and repayments to the Department of Treasury. There are situations in which Treasury, I guess, allows a period of time my understanding is now, for those payments to be made and recorded as of September 30th. I think many of us, and perhaps including even GAO, believe that should be recorded strictly as of September 30, 1998.

To my knowledge, this would have been the only situation where that would have occurred; that any transactions to my knowledge would have been reflected in October or beyond for '98, that would have been reflected in the '98 statements.

Chairman Hoekstra. Okay. All right. Interesting. Okay.

Also Ms. Jarmon , I am captured by what you talked about in your statement. Page 6, you are talking about "Education Reporting Controls Are Inadequate and Its Financial Management Systems Do Not Comply With FFMIA. As a result, Education (1) was unable to prepare reliable statements and (2) could not support material amounts reported on its financial statements, including obligations, grant expenditures and net position."

You then go on later, on page 8, "In fiscal year 1998, Education reported about $45 billion in Fund Balance with Treasury accounts, but the independent auditors could not determine whether the amount was correct."

I am assuming that that goes along with the point that we made earlier, that I think you mentioned a couple of times. It could not support material amounts reported on its financial statements.

Then you go on, on page 9, "The auditors found that Education made large adjustments which it did not research or support merely to force the records into agreement. In addition, Education did not reconcile its general ledger balance with its subsidiary debt collection system. Instead, Education made unsupported adjustments to the general ledger to align these records with amounts reported in its debt collection system. Furthermore, Education did not reconcile between the loans reported by its guaranty agencies as assigned to Education and those recorded in its debt collection."

Mr. Lampley, that is kind of scary, to be an auditor and go in and find these kinds of numbers and these kinds of conditions. Yes? No? "Scary" is a value word, I recognize. You may use other terminology. It makes it very difficult to go out and do an audit with these types of conditions?

Mr. Lampley. Mr. Chairman, I would have to agree with that. There is no doubt that it makes it difficult to do an audit. I think that the underlying software in the financial management system and the issues and the problems thereto led to some difficult situations for the Department and for us to be able to audit.

Chairman Hoekstra. I mean, the bottom line is, you went in a number of places and asked for backup material to take a look at how these numbers were arrived at, and in many cases you could not be provided with the backup information. Is that correct?

Mr. Lampley. There were certain situations in the case of rent liabilities and obligations and some accounts payable support that we were not able to get sufficient documentation for.

Chairman Hoekstra. I think I have gotten, as we go on, some of the egregious examples of bookkeeping.

Mr. Scott, we will be generous with your time as well, and Mr. Schaffer.

Mr. Scott. And Mr. Kind.

Chairman Hoekstra. Mr. Kind. Welcome.

These are just some of the examples of the egregious things here. There was a $6 billion difference between the Department's undelivered orders balance and the balance reported on the financial statements, a $550 million adjustment posted incorrectly creating an erroneous net difference of approximately $1.1 billion and an adjustment of approximately $400 million that was invalid and had to be reversed.

I mean, the bottom line is, as you went through the records and you took a look and tested these numbers and adjustments, you could not be provided with the background or the backup data that says these numbers are appropriate and they are exactly where they should be. Is that correct, Mr. Lampley?

Mr. Lampley. I think that is a fair assessment. I mean, after a while, it was a matter of the qualitative aspect of the information as well as the quantitative aspect. In certain situations, as you mentioned, the one item that was referred to as the $6 billion difference, if you will, was a result of obtaining a report earlier on in the process. At that point in time, the financial statements had a footnote that reflected a $19 billion item, and the report that we initially received only reflects $13 billion. Subsequently, the footnote was adjusted so that the $19 billion number was no longer disclosed. I believe we sent a letter up too, in an attempt to explain that particular situation. But we never received a further report to explain the difference.

And there were other items, as you indicated, with the $550 million that there was support for, but the $550 million was posted to the financial statements incorrectly. So the documentation existed, but we were the ones that determined that the $550 million had been posted basically in the "wrong direction," for lack of a better term.

Chairman Hoekstra. Just one last question, and then I will go to Mr. Scott.

We also, and I will submit it for the record, during a quick, high-level analysis of the data provided us from DCS, noted a Stafford loan with an balance of approximately $800 million. This was in correspondence and some e-mails. The error in default collection service loan is a Stafford loan with a principal of $800,007,306.28. We will submit it for the record. We will black out the Social Security number of the young person involved or the person involved with the $800 million Stafford loan.

But are you aware of this particular instance or not?

Mr. Lampley. No, sir, to my knowledge, I am not aware of that situation.

Chairman Hoekstra. It is true when you post a number any time in accounting, if it is showing a student with an $800 million loan, it also would be reflected somewhere else as account receivable? Should it be?

Mr. Lampley. It should be. Depending on the circumstances, yes, sir.

Chairman Hoekstra. Okay. We will do a little bit more work. Either this is going to be one of the brightest kids in America; we know it is one of the poorest kids in America at this point. But I want to know where this person went to school to make sure that my kids don't go there. That is one we will do some follow-up on.

Mr. Scott.

Mr. Scott. Thank you, Mr. Chairman.

Mr. Smith, the 1999 audit material is due on March 1st, as I understand it.

Mr. Smith. The culmination is really March 1st or towards the end of March. Materials are due before then.

Mr. Scott. Will the materials be provided on time and in a format that will be auditable?

Mr. Smith. They will be, and they have been. That is, we have submitted most of the materials at this point and done it on the schedule of the auditors and, actually, OMB's schedule.

Mr. Scott. So the material will be provided on time and will be auditable for the 1999 fiscal year?

Mr. Smith. Absolutely.

Mr. Scott. Okay. Now, you were okay in 1997 but in 1998, problems occurred. Was that due to the software package?

Mr. Smith. Part of it was the software package. I think another part of it was the amount of time that the 1997 audit took. There were other reasons as well. But the time was important because what the time did was eat into the time to do the 1998 audit. I think that was a considerable cost. It was important to get the clean audit, but at the same time what happened was that we had put a premium on the time for 1998 and didn't give it as much time as it should have had.

Mr. Scott. You purchased a new software package.

Mr. Smith. We did.

Mr. Scott. Who made the decision that a particular software package was the one that should have be purchased?

Mr. Smith. Well, this was taken directly off a government purchasing office list. It met as many specifications as any software package did for this particular use. So we were completely by the book on this, Mr. Scott. It is sad that this piece of software didn't work out. In fact, the company was sold. And the new company, now the parent company, took this particular part of our overall system and said that they weren't going to support it any longer.

So we made an arrangement with them; a difficult arrangement. They are providing us with some support for it. But the system itself doesn't have the capacity or the capability to produce what we need.

Mr. Scott. Mrs. Jarmon, your office covers more agencies than just the Department of Education, does it not?

Ms. Jarmon. Yes.

Mr. Scott. Do the other agencies have this software problem? Is there something unique about the Department of Education that they needed that particular software package? Isn't there some standard software package that could have been used that would not have produced these problems?

Ms. Jarmon. We don't know. There are other agencies that have had problems with some of the software packages that they have also purchased using the schedule and the GSA requirements that Mr. Smith referred to. There were minimum requirements at that time when the educational financial system software system was purchased in 1995. Since that time, the GSA schedule has been modified, and there is now a group that is called Program Management Office that has been developed that has come up with new standards for systems that I am sure Education will try to follow.

So within the government this has been a problem. And there is an effort with a group called the Joint Financial Management Improvement Program to try to revise the qualifications and improve upon that problem.

Mr. Scott. Does the GAO provide any guidance as to what you would find appropriate for an accounting system?

Mr. Smith. GAO has been working with the new group that has recently been formed, and these new standards really came into effect in fiscal year 1999. So it's relatively new that the new standards have been developed. Right now there are only four firms that have met the requirements of the new standards. So it's kind of an evolving process.

Mr. Scott. Is it your belief that we will not have these problems in the future?

Ms. Jarmon. That is difficult to answer. It is my belief that the process has improved. So it should be a better process when Education tries to purchase their new system. I guess they will be doing that in the next year. So the process has improved, but there are other agencies that have problems.

Mr. Scott. Mr. Smith, speaking of the future, did I understand in your testimony that the new system will be totally in place by 2001?

Mr. Smith. That's right. So we will not be depending upon it for this current audit or the year 2000 audit.

Mr. Scott. Well, what will take place in the year 2000 in terms of record keeping so that we can have some confidence that the information will be auditable?

Mr. Smith. Well, we have learned from our experience. We will work around the problems as far as that particular system creates. I believe that we are going to have a very good shot at a clean audit for fiscal year 1999.

Mr. Scott. Okay. Mrs. Lewis, from the IG's perspective, is there any evidence that money has been lost, misallocated, or stolen?

Ms. Lewis. There was no finding in any of the three reports, in the internal control reports specifically, of lost money or stolen money. Internal control reports did speak to increased vulnerabilities when controls were not in place; vulnerabilities to irregularities. That is the kind of work the Inspector General's Office also does. We do other oversight work in addition to having oversight of the financial statements audit.

We are as well, looking at issues relating to the grants accounts. Any other lead, if we have one, we would follow up on.

Mr. Scott. Are you satisfied now that the new software package and the new procedures will allow you to determine whether money is being lost, misallocated, or stolen?

Ms. Lewis. The current system, IEFARS, will be in place until about 2001. What the Department is doing and what it tried to do in 1998 is to work around that system, literally called work-arounds, or working around the problems. So in other words, the Department had to develop a way to get around the system in order to close the books for the FY 1999 statements.

As I mentioned in my brief testimony, the statements were delivered on time to the independent auditor on December 1st through the work-around process. So that is looking into the future.

Mr. Scott. Do you think the information has been turned over on time and in an auditable format?

Ms. Lewis. It is premature to say. We have noted the improvements that the Department has made through the lessons learned from 1998. But it is premature to say, since we are in the process of reviewing the 1999 statements now.

Mr. Scott. "Auditable" means they can conduct an audit. It doesn't mean an audit is going to render good results. It's auditable that means you can have some confidence in the numbers you are looking at if you have sufficient information to make a decision.

Ms. Lewis. Well, Ernst & Young is currently under contract to the Inspector General Offices doing that review work. And we are monitoring that work. And we have an ability to hear from them in the next few months in terms of the status, but it would be premature for me to say at this point.

Chairman Hoekstra. Let me ask it another way. Do you have any evidence to lead you to believe that it will not be auditable?

Ms. Lewis. Basically I think looking to see that improvements are in place is a major improvement. It is a huge, significant improvement that the financial statements were delivered on time. But beyond that I can't tell.

Mr. Scott. Do you have any reason to believe that the material will not be auditable for the fiscal year 1999?

Ms. Lewis. Congressman, I am looking to see the information from Ernst & Young, because ultimately they are required to provide an independent professional opinion on that and we are looking for them to complete their review. It is December 6th. That information was provided electronically on December 1st. And it is really too soon to say.

Mr. Scott. If I could ask one additional question, Mr. Chairman?

Mr. Smith, reference has been made to a $6 billion glitch. Can you explain what happened so that people can understand what that is about?

Mr. Smith. I don't know the specifics of that, no, Mr. Scott.

Mr. Scott. Does anybody know the specifics of that?

Mr. Smith. Mr. Lampley, you referenced it.

Mr. Lampley. The references are to the fact that probably in the early June time frame, we had financial statements with footnote information that included a $19 billion item. We got a detailed report at that point in time that was for $13 billion. As a result of things that transpired from that point in time on, the Department never provided another report. And, consequently, the $19 billion was removed from the footnotes. So it was a matter that you could never determine whether the $13 billion or the $19 billion was correct.

Mr. Scott. We need a coherent response to this, because you just can't allow a little billion here, a little billion there. We are not going to allow that to be the response. Mr. Smith, if you don't have the answer right now, that is fine, estimate off the top of your head. But if you can provide a coherent answer to what happened in that, we would appreciate it.

Mr. Smith. Let me make one thing clear; that the accounting problems that we are talking about do not reflect on whether or not the money is, in fact, reaching the students and things. I mean, this we need to be absolutely clear about. In fact, our particular system, the GAP system, for example, the grants system, now puts out money on the basis of an account.

So if Harvard University, for example, has 30 different accounts or programs with us, Harvard has to ask for money for each of those programs. Other accounting systems in the Federal Government and in other places, and the accounting system we had before allowed Harvard to just draw down from the bulk system that went to Harvard. So we know on an instantaneous basis, basically, where that money is going, how much is going, and whether or not we exceed or don't exceed the amount of resources that are available. And we don't exceed it. There are controls that cover that.

So I think we need to have that part of it understood. The rest of it is, you know, as is evident, needs a lot of attention. I believe we are giving it that attention.

But this point has to be understood, I think, and that is reflected in the GAO audit.

Mr. Scott. If you could specifically give us a response to that, we would appreciate it. It doesn't have to be right now. I don't expect somebody to know everything. Obviously, you are not familiar with the details of this particular transaction. But we just can't leave the record open on that question.

Mr. Smith. I agree completely.

Chairman Hoekstra. Mr. Scott, I believe you bring out the problem that I think Mr. Lampley and Ernst & Young were finding when they were doing the audit. That is that numbers would change, and they would question why the numbers were changed. And I think it was in Ms. Jarmon's testimony that they couldn't get the accurate documentation, and that was whether it was the $45 billion in the trial balance or the $6 billion in this case or the other numbers that we have referenced. That is that the problem was that numbers would change and change rather dramatically, and no one could quite explain why.

I just want to clarify what we are doing on the accounting systems here. We had an accounting system in 1997 that worked, correct? That was in place? We contracted or the Department of Education contracted for a new system that was in place for 1998, and that is the one that has created the problems that we experienced, right?

Mr. Smith. Mr. Chairman, we had an old accounting system. That old accounting system did not meet the standards that the government was setting.

Chairman Hoekstra. You went to a new accounting system.

Mr. Smith. That new accounting system did not account on the basis of programs, it accounted on the basis of the general accounts. So we really couldn't keep track of where our money was going. A variety of different sources, including the IG and the GAO, I believe, had criticized that system any number of times because it was a set of disparate systems.

We moved to a, quote, state-of-the-art system.

Chairman Hoekstra. That's what we had in 1998.

Mr. Smith. Unfortunately, one part of that state-of-the-art system didn't work, and it doesn't work the way we want it to. So we are trying to replace that right now.

Chairman Hoekstra. Now we are revolving between this system, and hopefully by 2001, will have a third accounting system in place.

Mr. Smith. In the meantime, I believe we can work around the existing system because the other three parts of the existing system are pretty robust.

Chairman Hoekstra. We will talk about the progress that we have made. I don't know whether or not Mr. Schaffer will be talking about the duplicate payments that happened back, in 1997 and 1998, and happened again as recently as last month I think, totaling $123 million. So I mean there were still problems that we were experiencing in 1999, or actually that will be on the fiscal year 2000 books, that we also experienced in 1998.

Mr. Schaffer.

Mr. Schaffer. Thank you, Mr. Chairman. I want to first jump to the GAO report.

Ms. Jarmon, I understand the reluctance to speculate on the 1999 audit report, especially when those you are reviewing are right here. But your written testimony states: "The Department of Education continues to be plagued by serious internal control and system deficiencies that hinder its ability to achieve lasting financial management improvements. While Education has planned and begun implementing many actions to resolve its financial management problems, it is too early to tell whether they will be successful."

Does the GAO stand behind that written testimony?

Ms. Jarmon. Yes.

Mr. Schaffer. Thank you.

Mr. Smith, I want to go to your testimony as well, and particularly the written testimony that I had a chance to go through just a few minutes before the hearing. Because it seems that there is, and in the document that I have reviewed, some difference of the opinion as to really what is the source of delay in the work done in 1998.

On page 9, you say that, right at the top: "Delays in preparing fiscal year 1998 financial statements and the potential of a prolonged 1998 process that would jeopardize our fiscal year 1999 audit ultimately led us to accept our auditors' recommendation to suspend work for the 1998 statements."

Could you expound on that a little bit more? It was the auditors' recommendation that you delay the 1998 financial statements.

Mr. Smith. We sat down and worked with the IG, and we worked with our own internal folks and the auditors. The sense was that we had reached a point where we were going to jeopardize the fiscal year 1999 audit.

Fiscal year 1999 audit, as you know, has taken on a lot of meaning in the Federal Government. And the OMB is looking to really bring everybody in on schedule for the fiscal year 1999 audit. We wanted to make that schedule. We believe that making that schedule would require us to move to the fiscal year 1999 audit while we were actually working on the fiscal year 1998 audit.

As a consequence, we said among ourselves that we wanted to put the resources on 1999 rather than continue them on 1998. We spent quite a bit of time on 1998. We worked through an awful lot of issues. We learned a lot.

I believe the books are, in effect, auditable. The time wasn't there for the auditors to work through it. Had they had much more time, they could have audited those books. But they didn't have the time. And I think all of us agree.

Mr. Schaffer. You didn't have time because you took 5 additional months to get the required documents to the auditor. Am I incorrect?

Mr. Smith. That's exactly right. We were living off the fiscal year 1997 audit.

Mr. Schaffer. I guess I am getting at the decision to delay the 5 months on getting the necessary reports completed. Whose decision was that?

Mr. Smith. I beg your pardon?

Mr. Schaffer. Who decided to wait the extra 5 months?

Mr. Smith. The issue here was we had the fiscal year 1997 audit. The fiscal year 1997 audit took extra time. And it cut into the resources that would have been useful to use in the 1998 audit.

Mr. Schaffer. I understand that.

Mr. Smith. As a consequence, the fiscal year 1998 documents took longer to get in hand.

Mr. Schaffer. But, see, in your statement, you say "led us to accept our auditors' recommendation to suspend work on the 1998 statements." So I take you at your word that the auditors' recommended that you suspend the statements for 1998, but ultimately somebody had to decide.

Ms. Lewis. May I cut in?

Mr. Schaffer. Sure.

Ms. Lewis. To close down the 1998 audit, to cease and desist.

Mr. Schaffer. To stop the audit.

Ms. Lewis. To stop the audit in the summer of 1999. The delay from the fall of 1998 to February of 1999, that is not the period I believe that is at issue in this sentence. I think that the sentence, as I read it, refers to the period in the summer of 1999 that enough work had been done on the 1998 audit.

The 1997 audit was issued on May 29th, 1998. Really, work beginning on the 1998 audit really began late May, early June. By the end of July, it was a mutually agreed upon decision. Ultimately, it is the auditors. It is the OIG decision. But there was a lot of collaboration and consultation. The decision was at that point on July 20th to stop field work or to start to bring the process to closure, which meant reporting on it.

Mr. Schaffer. Ms. Lewis, do you know that the Department of Education's books for 1998 are auditable?

Ms. Lewis. There was a lot of effort put in, a huge amount of effort, some of which took place after I arrived.

Mr. Schaffer. I know. But the report was submitted on the 19th.

Ms. Lewis. To prepare the financial statements working around the huge problems that IEFARS represented, ultimately, it was really a call that, given the amount of extra work it would take to research issues that weren't apparent was not going to help the process. In fact, it was going to jeopardize 1999. It was for that reason primarily that the OIG made a recommendation to the brand-new deputy CFO that it was time to stop work on the 1999 audit and begin its work.

Mr. Schaffer. So am I correct in understanding that, in your opinion, the 1998 books are not auditable?

Ms. Lewis. I can't state it in those terms.

Mr. Schaffer. Are you convinced that those books are auditable?

Ms. Lewis. I think the best terms I can state it in are the terms I expressed just now and in my written statement in terms of why it didn't make any more sense.

Mr. Schaffer. As to the question of whether they were auditable, what was the answer?

Ms. Lewis. I am trying to answer in the best way I can.

Mr. Schaffer. How about yes or no?

Ms. Lewis. The important date is March 1^st. It is the date the audits are due.

Chairman Hoekstra. Will the gentleman yield?

Mr. Schaffer. I would be happy to yield.

Chairman Hoekstra. Ms. Lewis, you gave us another box of documents today. I think this has been an ongoing internal debate between the Office of Inspector General and the Department since probably earlier this year. I received three option letters addressed to Mr. Smith, all of them from Mr. Skelly. I don't have a date on these letters. But after receiving Mr. Don Rappaport's letter to you, he was with the chief financial office, is that correct, dated April 12, 1999, I must say that I am very disappointed at the CFO's fabrication of facts and innuendos.

I think the Department has consistently said you can audit. I think the Inspector General and accounting firm has said you are kidding me. I have got a letter here from Greg Spencer to Steve McNamara or an e-mail or something. In my opinion, all the office of Chief Financial Officer did was finally confirm in front of OIG management, the Ernst & Young partners, and Steve Moore the following. "Even if by intent they misled the Deputy Secretary earlier in the day, they don't have a consolidated T/B", which I am assuming is trial balance, "with fiscal year 1998-only revenues and expense activity that was used to produce F&S." What is that, financial statements? "They will have to go back and write new SQL scripts to produce the necessary trial balance." What is SQL? Mr. Lampley?

Mr. Lampley. That is an inquiry into the database to be able to pull off information.

Chairman Hoekstra. So they are still trying to create the basic documents that you need in March of 1999 for fiscal year 1998. They never checked to see whether the trial balance agreed with the financial statements.

That was 5 months ago and this is 3 weeks after you are supposed to get these documents to the Department, and I think OIG and I think Ernst & Young are still debating.

Then I have got the letter from you, Mr. Smith, and John Higgins, a memo, April 20: "I am compelled to respond in order to correct the record, given the egregious mischaracterizations and factual inaccuracies contained therein. I believe that you are well aware of the facts concerning the CFO's inability to close the books and produce financial statements which culminated in our agreement to delay the start of the audit for 5 months until February and a grade of F from the OMB because the statements could not be produced in time."

Then you go on to May 6th. This must be meeting minutes. It asserts: "Current plan is to have a new set of adjusted statements by mid-May, 2-1/2 months further behind".

You know the reason to come back to these books; even I think these books weren't auditable. You are going back 6, 7 months and trying to recreate history. I think all of the internal documents outline the struggle between Ernst & Young and the Office of Inspector General.

Would the Department say, you know, you are not giving us anything that we can actually go through and check the numbers of?

I will yield back to Mr. Schaffer.

Mr. Schaffer. Thank you. I do have one more question I want to hurry up and sneak in before that light turns red.

The question I have, again, Mr. Smith, is with respect to your testimony. Right off the bat when you started your introductory remarks, you noted again a statement that is mentioned earlier on page 9 of your written testimony: "The auditors identified issues which the Department must address. They did not report any funds were lost, misallocated, or stolen." You also dispute the claim that these funds are unauditable. I would like you to comment on that and elaborate on what you see in these reports that Ms. Lewis and GAO and others, and Members on the Committee are unable to see.

But with respect to the lost, misallocated, or stolen funds, did you see the Inspector General's report on pages 18, 19, and page 18 of the report on internal control? They referenced an earlier Inspector General report from June of 1999 regarding improving the process for forgiving student loans in which it identified control weaknesses of the current system for determining borrower eligibility for the disability or death discharge. It said the report indicated that student loans are being discharged for total and permanent disability and death, even though the borrowers are apparently not totally and personally disabled or deceased.

The Office of Inspector General also found that new loans were being awarded to borrowers who returned to school after previously having loans discharged due to permanent disability.

While Ernst & Young may not have put the words this is waste, fraud, or abuse, I guess I want to ask how can you read the report, read a reference to just one event that I am citing, there are others in here, and not have it fall into the category of waste, fraud, or abuse? And then there are the examples of the unsupported adjustments. How is that anything other than abuse, as has been cited numerous times and not only in the Ernst & Young report?

So I give you two examples that they cite and document in the report. I would like you to reconcile that with your comments that they didn't find any waste or abuse. I don't put either of those two examples in the category of fraud, not on the Department's behalf anyway, but maybe somebody else's. But I fail to see those two examples are anything other than waste and abuse.

Mr. Smith. Mr. Schaffer, as you know, we had a hearing on the death and disability procedures. And, you know, there is no question in my mind that that sort of behavior is either waste, fraud, or abuse. You are never quite sure until you look at the specific case. Or it could be a case of naive mismanagement or a misunderstanding or a variety of other things. That is, of course, why we are trying to track these situations down and we are requiring improved documentation or different documentation in order to eliminate this kind of practice.

Mr. Schaffer. Do you stand behind the statement they issued that they did not report any funds were lost, misallocated, or stolen?

Mr. Smith. I would need to see the report on this.

Ms. Lewis. This? May I?

Mr. Schaffer. I have exceeded the red light, I believe. I am sorry. I appreciate the Committee's indulgence.

Chairman Hoekstra. I think it's Mr. Kind's indulgence. Are you done?

Mr. Schaffer. I'm finished asking. They were asking me to yield to somebody else here. I am kind of at your discretion at this point. I throw the question out. I will let it get answered however you would prefer.

Mr. Smith. I don't want to split hairs on this date. They are citing a report from June 1999 of the Inspector General. They are not saying that they found this. I don't disagree with you. I think that sort of thing shouldn't be done. It is either waste, fraud, or abuse, or it is total misunderstanding.

So I am not going to condone that. What I am saying here is that the independent auditor did not come up and show independently where there was waste, fraud, and abuse. And that doesn't mean they wouldn't have found it if they had more time to audit the books. And if they had more time to audit the books, they could have turned up a variety of other things.

So I am not disagreeing with you, Mr. Schaffer. I think the issue of trying to get at this is what is absolutely critical now. We are taking a variety of steps. We would be delighted to provide you with lots of information about the steps that we are taking to try to remediate this problem and the sets of other problems.

Chairman Hoekstra. The record always stays open for 14 days for additional responses from the panel, or if they want to clarify any of the comments that they have made, or for Members to submit additional comments.

Ms. Lewis, I saw you.

Ms. Lewis. Just one. This was a report that was specifically requested by the program office. In fact, it was the subject of a hearing my very first week on the job. The report had just been issued. Mr. McNamara actually testified before Mr. Mica and that Subcommittee. And the program office and the Office of Inspector General and the guarantee agencies are actually working very hard on this problem. But it was specifically identified, brought to our attention. And I do not know the audit period, or whether we can provide it for the record.

But this is discussed under the reportable condition that monitoring of programs needs to be strengthened, which is one of the sections of the internal control report. So that is frequently where, the independent auditor will take significant reports. This one was released in 1999, and will discuss terms of program monitoring. That is why it appears in this section of the internal control report.

Mr. Schaffer. Thank you.

Chairman Hoekstra. Mr. Kind.

Mr. Kind. Thank you, Mr. Chairman. I’m always happy to indulge. I want to apologize to the panelists for my late entry. I didn't have a chance to listen to your opening statements, but I look forward to reviewing them in more detail when I have a little bit more time.

I just want to shift back as far as the overview of what this hearing is all about because I hate to have any loose ends dangling or have people leaving this room today with any false impressions.

Just so we are clear in our minds, I want to ask you a couple of questions in regards to whether or not you feel, based on your firsthand knowledge of the situation that we are dealing with. Regarding the accounting at the Department of Education, is this just a situation where we have a problematic accounting system at the Department of Education that needs correcting, or if we are looking at some instances of intentional financial mismanagement that may have run in violation of some laws or some regulations? There have been some public allegations that have been floating out there now from even some of my colleagues, perhaps steering people to believe that there may have been some intentional mismanagement taking place at the Department of Education. I think the word "slush funds" has been used already, which conjures up images of Watergate or Iran-Contra slush fund money.

I just want to be clear as far as what the purpose of this hearing is and what we are really trying to get at here. So I want to ask each and every one of you your opinion as to whether or not, based on information that you have been privy to or conversations that you have had with your colleagues working on this situation, is there anything to indicate that there is any evidence that would leave one to believe that someone at the Department may have violated the law or violated some regulations in handling the books over there?

Mr. Lampley, let's start with you.

Mr. Lampley. From my perspective, we have included in compliance with laws and regulations two issues, and one was just the noncompliance with the GMRA, and that was meeting the March 1 deadline. And then we included the noncompliance with FFMIA, the Financial Federal Management Improvement Act. And that was primarily as a result of the systems issues that existed.

We have a chronology that we have included as a part of our written testimony. There were a number of, in my mind, delays with respect to the financial systems. There was an awful lot of work done from the perspective of the financial system not having a closing process as a part of the system that definitely generated a lot of issues and problems for the Department. As we went through, it was extremely difficult at times to get information that we could work with, if you will.

But to directly answer your question, I have no direct knowledge of any mismanagement, financial mismanagement or violation of the law that I could report to you.

Mr. Kind. So there was no intentional financial mismanagement that may have run counter to the law.

Mr. Lampley. No. One of the things that we have to do to as part of an audit process is evaluate the so-called risk factors related to errors or irregularities. And certainly some of those risk factors include the fact that you didn't have a general ledger that the subsidiary records would support, that there was significant delays, that there were reportable conditions that continued from prior years. All of those are reflected in our report on our internal control. But, once again, I do not have any direct knowledge.

Mr. Kind. Thank you. Ms. Jarmon.

Ms. Jarmon. Our statement talks about some of the material weaknesses, and my statement talks about some of the potential effects of those material weaknesses. And the potential is there for some mismanagement, fraud, waste, and abuse. But we didn't have any direct knowledge of any intentional mismanagement.

Mr. Kind. Thank you. Ms. Lewis.

Ms. Lewis. No, not with regard to the preparation and management of the 19998 financial statement. No.

Mr. Kind. Okay. Mr. Smith.

Mr. Smith. No, sir.

Mr. Kind. All right. Well, barring any direct evidence of any intentional misdeeds occurring at the Department of Education, perhaps we just need to focus more on what the problem is and what needs to be done to correct it.

Mr. Lampley, are you confident that the steps that are being taken now in regards to the accounting system at the Department of Education are going to deal with the problem that your firm encountered with the 1998 audit? Or, in short, is everything that can be done being done in order to make future audits credible?

Mr. Lampley. If I may, let me respond. We received, December 1, the financial statements and some support with respect to those financial statements. We are in the process of examining that information at this point in time. At this point, I could not conclude with respect to that because it will depend a lot on the information we have and whether those numbers in the financial statements can be supported. So I cannot really comment with respect to that.

Mr. Kind. Did your firm make any recommendations to the Department on what they needed to do in order to get you the information that you needed to do your job?

Mr. Lampley. Sir, we made a number of recommendations, I think it is in the neighborhood of 25 recommendations. We attended a meeting back in November; I believe it was November 5th, with respect to the presentation to the General Accounting Office and the Office of Management and Budget. And there were action steps being developed. The real key will be do those action steps accomplish it?

Mr. Kind. Do you feel that the Department has been responsive to your recommendations and that they are doing everything in their power to comply with those?

Mr. Lampley. I believe that the Department has been cooperative from the standpoint of accepting the recommendations. I think there are some situations and issues that are going to require a great deal of effort on their part; for example, the new system which, presumably, would not be in place until 2001. Between now and then, there is going to be quite a bit of effort required to support the existing financial management system. But from the standpoint of accepting the recommendations, I would comment yes, that I believe that.

Mr. Kind. Mr. Smith, what priority has the Department given to bringing the accounting system at the Department of Education into compliance so that a firm like Ernst & Young can do their job efficiently?

Mr. Smith. First of all, let me say that we greatly appreciated working with Ernst & Young. They have provided thoughtful, quick turnaround every time we have asked them. And they turn out to be very, very professional.

This is a very high priority for both Secretary Riley and myself. And as I said in my written statement on pages 10 and 11, we have made substantial progress in resolving the problems associated with the three material instances that Ernst & Young pointed out in the 1998 audit.

We are taking a lot of different actions, many of which I outline here and am glad to provide other information about.

Mr. Kind. Thank you, Mr. Chairman. My time has expired.

Chairman Hoekstra. You can have some more time. You are all set?

Mr. Kind. Is this our only chance to interrogate the witness?

Chairman Hoekstra. No. Actually, we wouldn't put it that way. But you can use whatever terminology you would like.

There are just a couple of things that I want to go back to. Ms. Jarmon, I think this is out of your testimony. It might be your last paragraph: "It is also important to recognize that several of the financial management issues that have been raised in reports emanating from reviews of Education's financial statements directly or indirectly affect Education's ability to meet its obligations to its loan grant recipients and responsibilities under law."

I think what you are saying is, you know the commitment here is to help our kids. It is to help those young people who are in college. It is to get money to the local schools and those types of things. And without a proper and well-functioning accounting and financial tracking mechanism, that may not be happening. Is that what you are saying? Or can't we really test that?

Ms. Jarmon. We are saying we don't know. With the problems related to reconciliations that were identified by the auditors, and accounts that weren't reconciled or accounts that we are forced to reconcile, we just don't know in some cases what the overall effect might be or to what the amount should have been in the various appropriation accounts.

Chairman Hoekstra. I can only think of what happened to this poor student who one day got a statement that said you have gotten an $800 million Stafford loan. If you don't have the right controls in place this was the issue we had talked about on one of the trips that we went on to the Education Department. All are the duplicate payments that were sent out of the Education Department, some as recently as October of 1999, meaning they are fiscal year 2000.

Again, without the lack of controls, there is the one that went out on 10/18 and the one that went out on 10/19. I think those two combined, total about $140 million of people getting duplicate checks. It does have an impact on people at the grassroots if we are not managing the money properly here in Washington.

I want to talk a little bit about the account that Mr. Kind brought up, which is the grant-back account. I think this is in some meeting notes with Ernst & Young: "Approximately $500 million is still, in parentheses, the Department's expense accounts, which I believe a client of the Education Department called a slush fund. Some of this money should probably be returned to the Treasury, but the Department has little if any evidence to support how much should be returned."

Mr. Lampley, has the Department since produced solid evidence of who that half million dollars belongs to or where it came from?

Mr. Lampley. Mr. Chairman, to my knowledge, we have not gotten additional information with respect to that.

Chairman Hoekstra. A half a billion dollars and you have not gotten that information?

Mr. Lampley. We have not gotten that information.

Chairman Hoekstra. Ms. Jarmon, you also talked about this grant back account in your testimony. I think it is page 8. You mentioned that this account contained $386 million as of September 30, 1998. How much did they pay back? How much did the Education Department give back to Treasury in 1998?

Ms. Jarmon. Based on the information that was provided to us, it seems like the amount was about $148 million.

Chairman Hoekstra. Okay. You state that the Department estimates the portion of the $386 million that should be returned to Treasury ranges from $15.4 million to over $220 million. That is a gap of over $200 million. And what Mr. Lampley has stated is we don't know where that money is actually, or the documentation isn't there as to where that money belongs. How does GAO respond to an account like this?

Ms. Jarmon. It is our understanding that the $15 to $221 million estimate of how much is to be returned is an additional amount that should be returned in addition to the $148 million that was, according to their records, returned. And as you know, we are looking into this account. So right now the information in our report really is information that was in the report of the auditors. But it is unusual that it is such a large amount and that it is not known at this time how much should go back to Treasury.

Chairman Hoekstra. I think the one thing that we do know about the grant-back account, whether it's $386 million or whether it's $500 million, is only a small portion of that money is actually in that account for the stated reason as to why that money should be there, which is its grant-back money. Is that correct?

Ms. Jarmon. Right. We were told that's about $13 to $15 million.

Chairman Hoekstra. Thirteen to $15 million; so the other $386 million we don't know where it came from.

The audit report states "the transactions the Department reported to the Treasury differed from the transactions posted to the general ledger in every period throughout fiscal year 1998, creating large reconciling differences which were adjusted." I think this is out of the audit report, Mr. Lampley, "creating large reconciling differences, which were adjusted to equal the balance shown by Treasury in the cash reconciliation process."

Knowing how careful accountants are with their use of terms, what is "large"?

Mr. Lampley. Could you repeat the question?

Chairman Hoekstra. The audit report states that, quote, "The transactions the Department reported to Treasury differed from the transactions posted to the general ledger in every period throughout fiscal year 1998, creating large," and they have even got it bold here, "large reconciling differences which were adjusted to equal the balance shown by Treasury in the cash reconciliation process."

I just want to know what "large" is. I mean, I am assuming if it is $100, it wouldn't be large. I just want you to tell me.

Mr. Lampley. In that case, I will have to get back to you, Mr. Chairman. I don't have the specific detail with respect to that.

Chairman Hoekstra. I do believe that we know that for the year-end differences between Education and Treasury, we are in the $140-$150 million range in total. Were there some months where there was a plus and some months where there was a negative or not? Or do you know?

Mr. Lampley. I can't answer that directly. But the big issue here is that the account reconciliations need to be done on a monthly, at least in my opinion, a monthly or quarterly basis, and they are typically not done until the end of the year. And as a result, that causes a much bigger effort to get the reconciliations done.

Chairman Hoekstra. Like balancing your checkbook and taking the bank's credit; is that an analogy?

Mr. Lampley. That is an analogy.

Chairman Hoekstra. Waiting till the end of the year, rather than doing it on a monthly basis.

Mr. Smith or Ms. Lewis, do we know if the Department did monthly reconciliations for 1999, with Treasury?

Mr. Smith. Did we do monthly reconciliations with Treasury?

Chairman Hoekstra. Yes.

Mr. Smith. I think we did a couple of months, but I am not sure. We also did a couple of quarters. Well, we are moving now fully on quarters and then to monthly, as I mentioned, in March. I agree with Mr. Lampley, and we need to move to monthly at the least.

If I could say one thing about the clearing accounts, Mr. Chairman.

Chairman Hoekstra. Yes.

Mr. Smith. Okay. This is not a situation where so-called "slush fund" is an appropriate word to use I believe at all. In fact, it is a clearing account. It is used to hold funds that are pending additional information, such as an appropriate account or the recipient.

In the case of the grant-backs, I will be the first to agree that we shouldn't have taken both the grant-back account, which is for a specific legal piece of legislation, and concluded it with what is generally a clearing account. We did. That was a mistake. And we are waiting now to make sure that GAO takes a good look at it and that our auditor takes a good look at it, and we will clean that up.

On the other hand, I got a report the other day. I asked the question that you have asked: Did these accounts occur in other agencies? And I would be glad to give you the citation on that report. There are literally hundreds of such accounts in I don't know all Federal agencies, but many, many Federal agencies.

Chairman Hoekstra. You know, I am troubled by what some of you are saying. This is not a race to the bottom. I don't really care whether there are 24 departments that have to meet these a