[Congressional Record Volume 141, Number 45 (Friday, March 10, 1995)]
[Senate]
[Pages S3814-S3818]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]


                   STUDENT LOAN CONFLICTS OF INTEREST

 Mr. SIMON. Mr. President, my colleagues from Massachusetts, 
Senator Kennedy, yesterday recited a long list of items where the new 
Congress has declared war on working Americans.
  One item that he mentioned is the attack on student financial aid: 75 
percent of all college student aid comes from the Federal Government, 
much of that in the form of loans. The only significant Federal student 
aid subsidy that reaches middle-class families is the Federal payment 
of interest while students are in school. Now, it seems that this 
benefit is in danger in the House of Representatives.
  Mr. President, I have argued that as far as student aid is concerned, 
we should not be balancing the budget on the backs of students while 
banks and middlemen continue to receive excessive subsidies in the 
Student Loan Program.
  Two weeks ago, a letter I wrote to the Washington Post made the point 
that the Guaranteed Student Loan Program is not the private sector 
system that its proponents would have us believe it is, and that it is 
riddled with dangerous conflicts of interest.
  In a response that appeared in yesterday's Washington Post, Roy 
Nicholson, the chairman of USA Group, charges me with vilifying and 
``attempt[ing] to silence'' him, while ignoring ``the substance of the 
debate'' on student loans.
  Ironically, Nicholson does not respond to the substance of the 
inspector general's concern, raised in my letter, that ``billions of 
dollars of the Nation's [student loan] portfolio are at risk because 
many guaranty agencies * * * have a clear conflict of interest.''
  Mr. President, I ask that the two letters and the inspector general 
report be printed in the Record at the conclusion of my remarks.
  Guaranty agencies like USA Group are supposed to act as bank 
regulators on behalf of the U.S. Government. Since banks have little 
financial incentive to put serious effort into collecting payments on 
Government-backed student loans, it is the guarantors' responsibility 
to ensure that--before taxpayers reimburse banks for a default--the 
bank actually did try to collect.
  But what if, as in the case of USA Group, the guarantor works not 
just for the Government, but for the banks, too? Clearly, this is a 
case of the shepherd moonlighting for the wolf. The inspector general 
provides a number of examples of how these arrangements put taxpayer 
dollars at great risk.
  Last year, a specific incident involving USA Group made this conflict 
painfully clear. In an effort to address the default problem, Congress 
2 years ago directed the Education Department to oversee the loan 
collectors. But last June, when the Department tried to implement the 
new rules--something that guarantors, as protectors of the taxpayers, 
should support--USA Group sued to stop the rules, arguing that it was 
not fair to them as contractors for the banks.
  The student loan industry has decided that the only way to keep their 
entitlements in the face of President Clinton's money-saving reforms to 
the Student Loan Program is to portray the reforms as big Government, 
in contrast to the current private sector system.
  Don't be fooled. It is not a private sector system when the 
Government takes virtually all the risk of default through entities it 
backs with the full faith and credit of the United States.
  Mr. President, taking a closer look at what is really going on in the 
Guaranteed Student Loan Program is not ``the politics of vilification'' 
or an ``attempt to silence.'' It is what the substance of the debate 
should be. It should come as no surprise to my colleagues that people 
do try to take advantage of Federal programs. I do not consider it out-
of-bounds to describe the structures and perverse incentives that lead 
to abuse.
  [[Page S3815]] President Clinton has proposed that the costly and 
risky Guarantee Program be phased out and replaced by the Direct 
Student Loan Program, which is working remarkably well at the first 104 
colleges involved this year. He is also proposing that guaranty 
agencies return $1.1 billion in excess Federal reserves over the next 5 
years.
  These money-saving proposals should be seriously considered by 
Congress. Yet committee chairmen in both Houses are talking only about 
ways to put brakes on the Direct Loan Program.
  Mr. President, we cannot afford to ignore the enormous abuses in the 
Guarantee Program. I urge my colleagues to take a closer look at both 
the Guaranteed and Direct Student Loan Programs, and to focus our 
efforts on providing assistance to students and taxpayers.
  The material follows:
               [From the Washington Post, March 2, 1995]

            Conflict of Interest in the Student Loan Program

       In opposing President Clinton's money-saving reforms of the 
     student loan program [``Clinton, GOP Split Over Student 
     Loans,'' front page, Feb. 14], USA Group argues that it 
     supports the ``competition'' in the current ``private-public 
     partnership.''
       Ironically, the only things ``private sector'' about USA 
     Group are its salaries.
       As a guarantor responsible for helping to oversee banks' 
     roles in the student loan program, USAG has no private 
     investors or contributors. Every penny of the $141,087,845 
     that USAG had in the bank in 1993 came from federal 
     entitlements set by lobbying Congress, not through private-
     sector competition.
       Furthermore, USAG has taken those taxpayer funds and used 
     them to start other businesses, including becoming lenders--
     putting USAG in the position of regulating its own banking 
     activity. The Education Department's inspector general has 
     called this a ``clear conflict of interest,'' putting 
     ``billions of dollars of the nation's [student loan] 
     portfolio as risk.''
       USAG paid its chairman $527,833 plus benefits in 1992, even 
     though it is a ``charitable'' organization and its employees 
     are essentially public servants.
       Taxpayers and students can do without ``partners'' like 
     these.
     Paul Simon
                                                                    ____


               [From the Washington Post, March 9, 1995]

                     The Debate About Student Loans

       Sen. Paul Simon's March 2 letter--which responds to The 
     Post's Feb. 14 front-page story about the issue of direct 
     government loans for college students--ignores the substance 
     of the debate and instead levels an attack on USA Group Inc., 
     the nation's leading guarantor-administrator of student 
     loans.
       Sen. Simon's letter continues an unfortunate pattern in 
     which the proponents of government lending try to discredit 
     those who disagree with them, and he recklessly disregards 
     the facts about USA Group.
       USA Group is proud of its public service to millions of 
     American students, but that work doesn't make us public 
     employees. The company was established as a nonprofit 
     corporation in 1960, five years before enactment of the 
     Higher Education Act, which created the guaranteed student 
     loan program. From its inception, a major portion of revenues 
     has derived from non-guarantor activities serving higher 
     education.
       USA Group affiliates annually open their books for numerous 
     independent audits, including those undertaken by federal 
     agencies. Contrary to Sen. Simon's unsubstantiated assertion, 
     USA Group has never taken taxpayer funds to start other 
     businesses, and these audits clearly demonstrate our 
     compliance with the highest fiduciary standards.
       USA Group's voice of experience, which Sen. Simon attempts 
     to silence, is warning the nation's thoughtful policymakers--
     and there are many on both sides of the aisle--about the 
     pitfalls they risk by accelerating government lending before 
     we know whether the government can effectively operate a $25 
     billion to $30 billion a year consumer loan program.
       The politics of vilification has no place in the debate. 
     Let's hope that reason and fact prevail in determining 
     whether government lending is in the best long-term interests 
     of students, schools and taxpayers.
     Roy A. Nicholson,
       Chairman and Chief Executive Officer, USA Group.
                                                                    ____

                                 U.S. Department of Education,

                                San Francisco, CA, March 15, 1993.
     Re Management Improvement Report No. 93-02.

     To: Maureen McLaughlin, Acting Assistant Secretary for 
         Postsecondary Education.
     From: Regional Inspector General for Audit, region IX.
     Subject: ED Should Prohibit Conflicts of Interest Between 
         Guaranty Agencies and Affiliated Organizations.

       The purpose of this Management Improvement Report is to 
     advise you of an opportunity to improve the administration of 
     the Federal Family Education Loan Program (FFELP) by 
     prohibiting conflicts of interest between guaranty agencies 
     and affiliated organizations that the guaranty agencies are 
     required to monitor.
       Affiliations with a FFELP loan servicer, secondary market, 
     or other FFELP service provider compromise a guaranty 
     agency's impartiality in administering the loan insurance 
     program, and ensuring that lenders exercise due diligence in 
     collecting insured loans. Currently, billions of dollars of 
     the nation's FFELP portfolio are at risk because many 
     guaranty agencies are affiliated with FFELP loan servicers, 
     secondary markets, and other FFELP service providers, and 
     thus have a clear conflict of interest.


         billions of dollars of the ffelp portfolio are at risk

       We obtained data from 12 guaranty agencies that represent 
     about $59 billion in total loan guarantees (approximately $42 
     billion in loans in repayment, and $17 billion in loans in 
     deferment). In fiscal year 1991, the 12 guarantors we 
     contacted accounted for approximately 68 percent of the new 
     FFELP loan volume. Nine of the 12 guaranty agencies, with 
     approximately $40 billion in loan guarantees, are affiliated 
     with organizations that they are required to monitor. Of the 
     $40 billion in loan guarantees, we have identified 
     approximately $11 billion that are at risk due to the 
     potential conflicts of interest. The schedule in Attachment A 
     of this report illustrates the potential dollars at risk. The 
     matrix in Attachment B of this
      report illustrates the various affiliations that may result 
     in a conflict of interest. The notes to Attachment B 
     explain the criteria we used to determine whether an 
     affiliation exists. Where specific guaranty agencies are 
     named in the body of this report, their designations 
     correspond to those listed in the attachments to this 
     report.


              the affiliations cause a number of problems

       The affiliations take many forms. For example, Guaranty 
     Agency B was so closely affiliated with a profit-making FFELP 
     service provider that its CPA firm issued consolidated 
     financial statements. Often, the guaranty agency acts as a 
     parent corporation, with nonprofit and profit subsidiaries 
     providing it with various services. In fact, Guaranty Agency 
     G and a FFELP loan servicer functioned as divisions within a 
     larger corporation. In other cases, the firms are legally 
     separate, but are controlled by common management. In almost 
     every affiliation, the firms share board members, corporate 
     officers, management and employees. The firms also share 
     assets, such as buildings, office space, computer equipment, 
     and furniture.
       The affiliations between guaranty agencies, FFELP loan 
     servicers, secondary markets, and other FFELP service 
     provides create many conflicts of interest. We interviewed ED 
     and General Accounting Office (GAO) officials and reviewed ED 
     OIG audit reports and guaranty agency program reviews 
     performed by both Regional and Headquarters staff of the 
     Office of Student Financial Assistance (OSFA). Each official 
     we interviewed expressed concern that the conflicts could 
     seriously impair the effectiveness of the FFELP. Similar 
     concerns were expressed in the audit reports and program 
     reviews. The concerns relate primarily to the guaranty 
     agencies' loss of independence, the integrity of FFELP 
     electronic data, the preferential treatment of affiliates, 
     and the weakened financial condition of guaranty agencies. 
     These concerns are discussed in the following paragraphs.


               affiliations cause a loss of independence

       Guaranty agencies play a critical oversight role in the 
     FFELP. When a guaranty agency is affiliated with an 
     organization that it is required to monitor, it may lack the 
     independence necessary to objectively administer the program. 
     Conflicting internal priorities may place undue pressure on 
     the guaranty agency to make decisions that are not in the 
     best interest of the taxpayer.
       In one state, for example, the secondary market was 
     instrumental in founding Guaranty Agency I. Later, the 
     guarantor and the secondary market joined forces to create a 
     new management company. As a result of this reorganization, 
     the guaranty agency and the secondary market came under 
     common management. Additionally, the secondary market has 
     provided the guaranty agency with $3.5 million in loans and 
     is committed to provide an additional $10 million line of 
     credit.
       In such cases, the guaranty agency may be unable to deal 
     impartially with a corporation that is actively involved in 
     its management and is a major source of its funding. If the 
     guaranty agency disallows claims submitted by the secondary 
     market, it hurts the finances of one of the guaranty agency's 
     major funding sources.
       The area of lender due diligence further demonstrates how 
     important it is for the guaranty agency to remain independent 
     of an organization it is required to monitor. Basically, 
     lender due diligence regulations stipulate that the guaranty 
     agency must ensure that the lender has taken all the required 
     steps to collect the loan before it pays a default claim. In 
     this case the lender can be the original lender, a secondary 
     market, or a loan service acting on behalf of a lender. 
     Therefore, the guaranty agency must review the collection 
     activity of the lender or its agent to determine compliance 
     with Federal due diligence requirements.
       [[Page S3816]] There is an obvious conflict of interest 
     when a guaranty agency reviews the due diligence practices of 
     its affiliated secondary market or loan servicer. In such 
     cases, the guaranty agency's findings affect its own 
     financial position. The close relationships between the FFELP 
     service providers pose a significant risk that due diligence 
     irregularities. could occur and go unreported.
       A Guaranty Agency Failed To Remain Independent. In one 
     state, a guaranty agency that was not one of the twelve 
     included in our review, contractually delegated all of its 
     duties and functions to its affiliated secondary market. In 
     February 1989, OSFA conducted a review of the guaranty agency 
     and requested the refund of over $1 million because the 
     agency failed to follow due diligence requirements. The 
     guaranty agency appealed OSFA's findings and requested that 
     the Secretary waive the right to repayment because the 
     financial cost would ruin its affiliated secondary market. ED 
     denied the appeal and stated that the guarantor's regulatory 
     violations were a matter between the guaranty agency and ED, 
     regardless of the relationship between the guarantor and the 
     secondary market.
       The guaranty agency's appeal was clearly designed to 
     protect the financial condition of its affiliated secondary 
     market. It also demonstrates how the financial health of an 
     affiliate may influence the decision-making of the guaranty 
     agency.
       The conflict was even more apparent in June 1990, when the 
     same guaranty agency completed a lender review of its 
     affiliated secondary market and reported numerous areas of 
     noncompliance, including due diligence violations. However, 
     the guaranty agency neither required the appropriate 
     repayments resulting from the violations nor took action to 
     ensure future corrective action. The guaranty agency's 
     actions were even more egregious because it had contracted 
     with the secondary market to review the secondary market's 
     own claims and determine whether the guaranty agency should 
     pay them.
       About eight months later, in February 1991, OSFA conducted 
     a review of the same secondary market. OFSA found that the 
     guaranty agency's prior review had not been appropriately 
     resolved, and compelled the secondary market to formally 
     address the
      findings. Only after OSFA's intervention did the guaranty 
     agency assess a liability of over $1.1 million against its 
     affiliate. In our opinion, the guaranty agency's 
     reluctance to enforce the Federal regulations clearly 
     demonstrates that the interests of the taxpayers and those 
     of its affiliate where in direct conflict.


   Affiliations Compromise the Integrity of the FFELP Electronic Data

       The administration of the FFELP requires a great amount of 
     electronic data to pass between the lenders, the FFELP 
     service providers, the guaranty agencies, and ED. This 
     electronic data provides the basis for computing virtually 
     all of the costs associated with the FFELP. It also provides 
     ED with its primary means of monitoring the effectiveness of 
     the program as a whole. Therefore, the integrity of the 
     electronic data is essential to achieving the program's 
     overall goals.
       An important mission of the guaranty agency is to conduct 
     lender and servicer reviews to ensure that there are adequate 
     internal controls over computer generated data, and that the 
     data is accurately transferred between entities. The guaranty 
     agencies also review the accuracy and reasonableness of the 
     fees and expenses computed by the automated systems.
       ED and GAO have reported numerous problems with the 
     accuracy and the completeness of the FFELP database. We 
     believe that the conflicts of interest have contributed to 
     the lack of integrity of the database because the guaranty 
     agencies often have disincentives to identify and resolve 
     systemic problems with the automated systems.
       First, identifying the causes of the problems can be costly 
     and often involves reviewing a system that the agency itself 
     designed for its affiliate. Second, implementing the changes 
     needed to improve the integrity of the data may place a 
     financial burden on its affiliate. Consequently, the guaranty 
     agency may conduct only cursory reviews of its affiliates in 
     order to satisfy the Federal requirements, and ignore the 
     underlying causes of the problems. In such cases, the 
     guaranty agency may continue to accept and forward data of 
     questionable accuracy in order to avoid the costly 
     expenditures needed to ensure accurate and complete 
     electronic data.
       For example, ED OIG auditors conducted an assist audit of 
     Guaranty Agency B for GAO. ED OIG auditors concluded that the 
     guaranty agency's computer system was less accurate than the 
     agency claimed it to be. When the auditors requested the 
     guaranty agency to provide the dollar amount of loans in 
     repayment, it initially computed the amount to be $2.4 
     billion. Later, it revised the amount to $2.2 billion, and 
     finally to $2.3 billion. The auditors concluded that the 
     guaranty agency's revisions will impact future trigger 
     figures. At the time, approximately 40 percent of the loans 
     in question were serviced by the guaranty agency's affiliated 
     loan servicer.
           affiliations may result in preferential treatment

       FFELP service providers contract with guaranty agencies and 
     lenders to provide a myriad of services such as loan 
     origination, loan servicing, collections, litigation, and 
     other administrative functions. Often the service providers 
     are for-profit corporations that are subsidiaries or 
     affiliates of the guaranty agencies. The potential for abuse 
     exists in such arrangements.
       Guaranty Agencies May Give Their Affiliates Unfair 
     Advantages. The guaranty agency is in the position to spin-
     off specialized companies and then provide the new company 
     with a level of sales that increases its odds for success. 
     For instance, a guaranty agency could exert undue pressure on 
     its affiliated secondary market to use the services of its 
     new for-profit loan servicer.
       Approximately 42 percent of Guaranty Agency C's $7.9 
     billion portfolio is handled by its servicing arm. Similarly, 
     about 32 percent of Guaranty Agency A's $9.1 billion 
     portfolio is serviced by one of its affiliates. About 45 
     percent of Guaranty Agency G's $4.1 billion portfolio is 
     serviced by its affiliated loan servicer.
       In another example, the Treasurer of Guaranty Agency B 
     informed ED OIG auditors that it was successful in starting a 
     new for-profit subsidiary without the infusion of capital. 
     The guaranty agency was able to provide its new subsidiary 
     with immediate cash flows from rent resulting from a building 
     management agreement and from loan origination fees. 
     According to the treasurer, the guaranty agency also 
     permanently transferred some of its employees to the 
     subsidiary.
       Later, the same guaranty agency's CPA firm asserted in its 
     working papers that the volume of transactions between the 
     agency and its newly formed subsidiary was ``excessive.'' The 
     working papers also noted that the IRS may view the condition 
     as undue favoritism towards a for-profit subsidiary. Such a 
     relationship makes it more difficult for unaffiliated FFELP 
     service providers to enter the market and compete.
       Officers and Employees May Use Their Positions For Personal 
     Gain. The guaranty agency's officers and senior management 
     have direct control over how the guaranty agency delegates 
     certain functions to outside companies. They also must 
     determine the reasonableness of the fees charged by outside 
     contractors for their services. In the same way a guaranty 
     agency may exert pressure on an affiliate to use the services 
     of another affiliate, officers may use their positions to 
     exert pressure on the guaranty agency to use the services of 
     certain companies that benefit the officers' financial 
     positions.
       For example, Guaranty Agency I joined forces with a 
     secondary market to establish a management company. The 
     guaranty agency and secondary market transferred all of their 
     employees to the management company, and entered into a 
     management services agreement with the new company. The 
     Chairman of the Board for the management company that 
     oversees the guaranty agency is also the President of the 
     secondary market. This same officer is also 100% owner of a 
     for-profit company that provided services to the guaranty 
     agency and the secondary market. The President's personal 
     corporation was paid over $150,000 by the guaranty agency and 
     over $750,000 by the secondary market during the fiscal year 
     ended September 30, 1991.
       Although the President's corporation claims that it 
     provides its services to the guaranty agency and secondary 
     market at cost, it receives free rent in the building owned 
     by the guaranty agency's management company and is allowed to 
     bill unproductive time to the management company. With these 
     benefits, the President's company has been able to 
     successfully market its services in three other states.
       Guaranty Agencies May Misuse Federal Funds. As long as 
     guaranty agencies are allowed to start and operate FFELP 
     service companies, there is a risk that Federal funds may be 
     used for purposes for which they were not intended. For 
     example, a guaranty agency that was not one of the twelve 
     included in our review improperly used $3.1 million of its 
     reserve fund to start and operate an affiliated, for-profit 
     loan servicing operation. An ED OIG audit report concluded 
     that the guaranty agency had misused the reserve fund and 
     recommended that it refund the $3.1 million to the reserve 
     fund.
       Guaranty Agencies May Absorb the Costs of For-Profit 
     Affiliates. Guaranty agencies can also support affiliates by 
     paying some of their expenses. As previously noted, guaranty 
     agencies and their affiliates often share buildings, office 
     space, computer equipment, furniture, and even employees. 
     This allows the affiliates to incur owner expenses and to 
     increase profits.
       For example, from 1989 to 1991, Guaranty Agency B paid 
     approximately $768,000 in software development cost incurred 
     by an affiliate that provided a specific service for the 
     guaranty agency. Its agreement with that affiliate states the 
     guaranty agency will continue to absorb the cost for the 
     computer hardware, software, maintenance and enhancements 
     incurred by its affiliate while performing this service. The 
     affiliate is a for-profit corporation which earned 
     approximately $1.4 million by providing this and other 
     services to the guaranty agency.
         affiliations may weaken guaranty agencies financially

       As guaranty agencies subcontract more activities to 
     affiliates, they could become shell corporations with fewer 
     financial assets. 
     [[Page S3817]] Such an occurrence has many negative 
     implications for guaranty agency reserves. Furthermore, ED 
     may find it more difficult to recover misspent funds from the 
     guaranty agencies if their revenue flows have been diverted 
     to affiliates. Fees and income designated for the guaranty 
     agencies assist them in continuing to carry out their mission 
     and increasing their reserves. When these income streams are 
     diverted to affiliates through subcontracting, the guaranty 
     agencies' reserves may be reduced and the agencies' overall 
     financial condition may be weakened.
       For example, Guaranty Agency B delegated escrow account 
     services to an affiliate. Federal regulations (34 CFR 
     682.408) allow the guaranty agency to act as an escrow agent 
     for receiving FFELP proceeds and transmitting them to the 
     borrower. In return, the guaranty agency may invest the 
     proceeds of the loans and retain the interest that it earns 
     on the float. This interest assists the guaranty agency to 
     build up its reserves. The guaranty agency delegated the 
     escrow function to a for-profit affiliate and allowed the 
     affiliate to retain the interest on the float. The guaranty 
     agency paid over $400,000 of the costs incurred by its 
     affiliate for operating the escrow system, but allowed its 
     affiliate to retain over $1 million in interest earned on the 
     float.


                 conflict of interest rules are common

       Every organization needs to be confident that its employees 
     are acting in the organization's best interest. To achieve 
     this, many entities restrict their employees' activities in 
     order to prevent those employees from having a conflict of 
     interest.
       In the Federal government, for example, Executive Order 
     11222 requires agencies to issue regulations governing 
     standards of conduct for their employees. ED has issued its 
     regulations under 34 CFR Part 73. Section 73.11(a)(1) states 
     that an employee may not:
       ``Have a direct or indirect financial interest that 
     conflicts, or appears to conflict, substantially with the 
     employee's official duties and responsibilities * * *.''
       Further, Section 73.20 prohibits an employee from accepting 
     gifts or favors from any person who conducts business or 
     financial operations that are regulated by the Department or 
     whose business or financial interests may be substantially 
     affected by the employee's official duties.
       State and local governments have similar prohibitions. For 
     example, under California law:
       ``No public official at any level of state or local 
     government shall make, participate in making or in any way 
     attempt to use his official position to influence a 
     governmental decision in which he knows or has reason to know 
     he has a financial interest.''
       Professional organizations such as the American Bar 
     Association, and the American Institute of Certified Public 
     Accountants (AICPA) have adopted rules prohibiting their 
     members from becoming entangled in business relationships 
     that result in, or give the appearance of, a conflict of 
     interest. Such rules are needed because much of their work 
     involves issues of public trust.
       An example of these conflict of interest rules is found in 
     the AICPA's Code of Professional Conduct. That code requires 
     accountants to maintain personal and professional business 
     relationships that do not compromise their integrity and 
     objectivity (Rule of Conduct 102). The AICPA has concluded 
     that any member that holds a material financial interest in 
     the client that is being reviewed has violated the principle 
     of independence (Rule of Conduct 101).
       The Securities and Exchange Commission (SEC), which relies 
     on the accountant's independence when reviewing certain 
     financial statements, has adopted related regulations that 
     state:
       ``* * * an accountant will be considered not independent 
     with respect to any person or any of its parents, its 
     subsidiaries, or other affiliates (1) in which, during the 
     period of his professional engagement to examine the 
     financial statements, * * * his firm, or a member of his firm 
     had, or was committed to acquire, any direct financial 
     interest or any material indirect financial interest * * *.'' 
     (17 CFR 210.2-01(b))
       The AICPA and the SEC have concluded that both the 
     accountant and the accounting firm lose the independence 
     necessary to render an objective opinion when the accountant 
     has a material financial interest, or actively participates 
     in the management of the client being reviewed.
       Organizations that prohibit conflicts of interest do not 
     assume that their employees or members are dishonest. Rather, 
     they recognize that persons who are responsible for interests 
     of more than one party are often placed in untenable 
     situations. First, they have no clear guideline as to which 
     of the conflicting interests should have priority. Second, 
     even the appearance of a conflict of interest reduces public 
     confidence in their actions. In the case of governmental 
     employees or representatives, public confidence is essential.
       ED relies on guaranty agencies to review the compliance 
     practices of other organizations that do business with ED. 
     The results of the guaranty agency reviews may significantly 
     impact taxpayer funds. If ED prohibits its employees from 
     having financial interests that create conflicts of interest, 
     or even the appearance of a conflict of interest, it should 
     place similar prohibitions on agencies that have 
     responsibility for ensuring appropriate actions in regard to 
     billions of dollars of Federally insured student loans.


 1992 amendments allow ed to require reporting of individual conflicts 
                              of interest

       ED is aware of the problems caused by the conflicts of 
     interest between guaranty agencies and their affiliates. In 
     fact, ED's recommendations for the Higher Education 
     Amendments of 1992 (HEA) included language that would 
     prohibit the officers and employees of guaranty agencies
      from having a financial interest in organizations that the 
     agency is required to monitor. However, ED's 
     recommendations did not prevail. Instead, the final 
     version of the HEA only included a new reporting 
     requirement. The provision requires certain paid officials 
     of guaranty agencies, eligible lenders, and loan servicing 
     agencies to report to the Secretary, if the Secretary 
     should so require, any financial interest held in other 
     institutions that participate in the FFELP.
       The new provision indicates Congress's interest in 
     identifying conflicts of interest, but it needs to be 
     strengthened.
       First, the new reporting requirement significantly 
     increases the oversight responsibilities of the Department by 
     requiring it to monitor the financial holdings of hundreds of 
     officers and employees. ED officials informed us that the 
     Office of Postsecondary Education is not in a position to 
     handle the increased workload that the new provision requires 
     without increasing staffing levels. Consequently, the new 
     reporting requirement may not be implemented in the near 
     future.
       Second, the new provision stops short of prohibiting 
     financial holdings that cause conflicts of interest.
       Third, the new reporting requirement deals with only the 
     financial holdings of individual officers and employees. The 
     provision does not address the conflicts that arise when 
     guaranty agencies have a financial interest in the 
     institutions that they are required to monitor.
       We believe that conflicts of interest could adversely 
     impact the administration of the FFELP, regardless of whether 
     the conflicts occur with individual officers and employees, 
     or with affiliated agencies. In our opinion, prohibiting all 
     affiliations, as described in the Recommendations section of 
     this report, provides the best method of eliminating the 
     potential conflicts of interest in the FFELP. It would also 
     reduce the oversight burden of the new reporting requirement.


                                summary

       The nation's guaranty agencies provide a critical oversight 
     function on behalf of the Federal government. They must 
     administer the FFELP objectively and efficiently. By 
     affiliating with FFELP loan servicers, secondary markets, and 
     other FFELP service providers, guaranty agencies often place 
     themselves in the position of choosing between the interests 
     of the taxpayers or their affiliates. The resulting conflicts 
     of interest place billions of dollars of the FFELP portfolio 
     at risk of mismanagement, waste, and abuse.
       For many years professional organizations, Federal, state, 
     and local governments have utilized conflict of interest 
     rules to guard the public trust. ED prohibits its employees 
     from having financial interests that create conflicts of 
     interest, or even the appearance of a conflict of interest.
      We believe that ED should place similar prohibitions on 
     guaranty agencies that are responsible for ensuring 
     appropriate actions in regard to billions of dollars of 
     Federally insured student loans.


                            Recommendations

       We recommend that the Department amend its regulations, or, 
     if necessary, seek legislative change to:
       1. Prohibit guaranty agencies or their officers and 
     employees from having any affiliation with an entity that is 
     a participant or a service provider in the FFELP. 
     Participants in the FFELP include the guaranty agencies, 
     lenders, secondary markets, and eligible postsecondary 
     institutions. FFELP service providers include entities that 
     provide services that support the originating, servicing, and 
     collecting of Federally insured loans.
       2. Develop timetables for the guaranty agencies and their 
     officers and employees to divest themselves of their current 
     holdings or to legally separate the guaranty agency from its 
     affiliates.


                             Other Matters

       This memorandum was prepared in accordance with those GAO 
     standards which the Inspector General has determined to be 
     applicable to Management Improvement Reports. The work 
     conducted on this issue does not constitute an audit.
       We would appreciate your views and comments concerning our 
     recommendations within 30 days of the date of this report. If 
     you have any questions, or would like to discuss the report, 
     please call me.
                                                    Sefton Boyars.
                              Attachment B


                      criteria for an affiliation

       We contacted twelve guaranty agencies and requested that 
     they provide us with information about their relationships 
     with loan servicers, secondary markets, and other FFELP 
     service providers. Additionally, we contacted officials from 
     ED and GAO, and reviewed numerous reports prepared by ED and 
     independent CPA firms. Of the 12 agencies that we selected 
     for review, 9 were affiliated with FFELP firms that they are 
     required to 
     [[Page S3818]] monitor, and thus, have a potential conflict 
     of interest. For the purposes of this review, we defined an 
     affiliation as:
       An organizational setting where, regardless of each firm's 
     legal structure, a loan servicer, secondary market, other 
     FFELP service provider, or any combination thereof, reported 
     to the same senior management staff or board of directors (or 
     its equivalent) as the guaranty agency.
       An organizational setting where, regardless of each firm's 
     legal structure, a loan servicer, secondary market, other 
     FFELP service provider, or any combination thereof, shared at 
     least one of its senior management staff or board of 
     directors (or its equivalent) with the guaranty agency.
       An instance where the guaranty agency, its parent, or 
     management company held an ownership interest in, or was a 
     member of (in the case of a nonprofit corporation), a loan 
     servicer, secondary market, or any other organization that 
     provided services to the FFELP.
       An instance where an official of the guaranty agency, its 
     parent, or management company held an ownership interest in 
     any organization that provided services to the FFELP.
       We recognize that some organizations that have a potential 
     conflict of interest manage to prevent the conflict from 
     harming the FFELP. However, our discussions with program 
     officials revealed that those organizations that successfully 
     manage the potential conflicts generally do so because of the 
     efforts of key managers and employees. Consequently, 
     replacing these key individuals with less conscientious 
     managers and employees may significantly increase the risk of 
     abuse.


                 specific affiliations that we observed

       The following paragraphs briefly discuss the organizational 
     environment that exists at each guaranty agency we reviewed. 
     Since the organizational structures are often very 
     complicated, we have limited our discussion to a general 
     overview. The guaranty agencies discussed in the following 
     paragraphs correspond to those listed in the schedule found 
     in Attachment A and the matrix shown above.
                           guaranty agency a

       This guaranty agency has a parent corporation that operates 
     the guaranty agency, a loan servicer, and a secondary market 
     as separate corporations under its umbrella. Each of the four 
     corporations has a separate board of directors. However, at 
     least one individual serves on all four boards, and several 
     individuals serve on three of the four boards. Additionally, 
     at least two individuals serve as officers in all four 
     corporations, and several individuals serve as officers in 
     three of the four corporations.
       Until November, 1992, the secondary market activity was a 
     departmental function of the guaranty agency. In November 
     1992, the secondary market was incorporated as one of the 
     above mentioned companies. The guaranty agency plans to 
     transfer some of its employees to its newly formed secondary 
     market.
       Approximately 84 percent of the secondary market's 
     portfolio, and 79 percent of the loan servicer's portfolio 
     are guaranteed by their affiliated guarantor.


                           guaranty agency b

       This guaranty agency underwent sweeping organizational 
     changes in 1992. At the time of our review the changes were 
     not completely finalized. Generally, the end result will be a 
     management company which operates 1) a guaranty agency, 2) a 
     nonprofit FFELP service provider that provides supporting 
     services such as account management, litigation services, and 
     loan disbursement services to the guarantor, and 3) a for-
     profit FFELP service provider that provides some of the same 
     supporting services to the guarantor as its nonprofit 
     counterpart. The new management company owns all of the stock 
     of the for-profit FFELP service provider, and the two 
     corporations share at least one board member.
       The above corporations work very closely with three other 
     organizations that were previously founded by the guaranty 
     agency. These three firms are 1) a loan servicer, 2) a 
     secondary market, and 3) an educational resource firm. 
     Although the secondary market and the educational resource 
     firm were legally separated from the guaranty agency, they 
     continue to share common board members with the new 
     management company mentioned above. The management company 
     holds 25 percent of the stock of the loan servicer, and the 
     two corporations share board members.
       Approximately 55 percent of the secondary market's 
     portfolio, and 69 percent of the loan servicer's portfolio 
     are guaranteed by their affiliated guarantor.


                           guaranty agency c

       This guarantor, along with a loan servicer and secondary 
     market, is operated as a division of a larger agency. There 
     is no separate legal structure for the guarantor, loan 
     servicer, or secondary market. All three divisions report to 
     the same senior management and board of directors.
      Approximately 71 percent of the secondary market's 
     portfolio, and 60 percent of the loan servicer's portfolio 
     are guaranteed by their affiliated guarantor.


                           guaranty agency d

       This guaranty agency is operated by a state commission that 
     is appointed by the Governor. The State Commission, along 
     with its Executive Director, is responsible for operating the 
     guaranty agency and the secondary market. The State 
     Commission has only one board of commissioners to oversee the 
     guaranty agency and the secondary market.
       Approximately 99 percent of the secondary market's 
     portfolio is guaranteed by its affiliated guarantor.


                           guaranty agency e

       This guaranty agency is a component of a state authority 
     that manages all the Federal and state student loan programs. 
     A separate state authority operates the secondary market. 
     However, the management and board of the two authorities are 
     the same.
       Approximately 100 percent of the secondary market's 
     portfolio is guaranteed by its affiliated guarantor.


                           guaranty agency f

       This guaranty agency is housed together with a loan 
     servicer at the same state agency. There is only one board of 
     commissioners for the guaranty agency and the loan servicer, 
     and both are served by the same senior management staff.
       Approximately 100 percent of the loan servicer's portfolio 
     is guaranteed by its affiliated guarantor.


                           guaranty agency g

       This guaranty agency is a division of a larger corporation. 
     The corporation has a guaranty agency division and a FFELP 
     servicing division. The guarantor and servicer are managed by 
     separate corporate vice presidents. The president of the 
     corporation also holds the offices of Chairman of the Board 
     of Directors, Chief Executive Officer, and Treasurer.
       Approximately 100 percent of the loan servicer's portfolio 
     is guaranteed by its affiliated guarantor.
                           Guaranty Agency H

       This guaranty agency provides FFELP servicing to 
     participating lenders and secondary markets. The loan 
     servicer is part of a division of the guaranty agency that 
     reported to the Senior Vice President of Operations. The 
     guaranty agency claims that it began phasing-out its loan 
     servicing activities in the spring of 1989. However, it still 
     retains a significant servicing portfolio.
       Approximately 95 percent of the loan servicer's portfolio 
     is guaranteed by its affiliated guarantor.


                           Guaranty Agency I

       This guaranty agency has a parent company that is the sole 
     member (or shareholder) of both the guaranty agency and the 
     secondary market. In this case, all three organizations are 
     separate nonprofit corporations. The parent company is the 
     employer with respect to virtually all of the staff of the 
     guaranty agency and the secondary market, and provides the 
     staff to its subsidiaries under a management contract.
       The three companies have separate boards. However, the two 
     presidents of the guaranty agency and the secondary market 
     also serve on the board of the parent company. In fact, the 
     Chairman of the Board of the parent company is also the 
     president of the secondary market. This same person is the 
     100% owner of a for-profit company that was paid 
     approximately $900,000 in 1991 to provide services to the 
     guaranty agency and the secondary market.
       Approximately 52 percent of the secondary market's 
     portfolio is guaranteed by its affiliated guarantor.


                      Guaranty Agencies J, K, & L

       Our inquiries did not lead us to conclude that the above 
     guarantors were affiliated with a loan servicer, secondary 
     market, or other FFELP service provider.
     

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