[Federal Register Volume 61, Number 231 (Friday, November 29, 1996)]
[Rules and Regulations]
[Pages 60565-60577]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-30394]


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DEPARTMENT OF EDUCATION

34 CFR Parts 600 and 668

RIN 1840-AC36


Institutional Eligibility and Student Assistance General 
Provisions

AGENCY: Department of Education.

ACTION: Final regulations.

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SUMMARY: The Secretary amends the Student Assistance General Provisions 
regulations by revising requirements for compliance audits and audited 
financial statements, revising the two-year performance exemption to 
the refund reserve requirement, and adding financial responsibility 
standards for foreign schools. These final regulations improve the 
Secretary's oversight of institutions participating in programs 
authorized by title IV of the Higher Education Act of 1965, as amended.
    The final regulations do not contain changes to the general 
standards of financial responsibility, which will be considered further 
by the Secretary.

DATES: Effective date: These regulations take effect July 1, 1997. 
However, affected parties do not have to comply with the information 
collection requirements in Sec. 668.23 until the Department of 
Education publishes in the Federal Register the control number assigned 
by the Office of Management and Budget (OMB) to these information 
collection requirements. Publication of the control number notifies the 
public that OMB has approved these information collection requirements 
under the Paperwork Reduction Act of 1995.

FOR FURTHER INFORMATION CONTACT: Mr. David Lorenzo or Mr. John Kolotos, 
U.S. Department of Education, 600 Independence Avenue, S.W., Room 3045 
ROB-3, Washington, D.C. 20202, telephone (202) 708-7888. Individuals 
who use a telecommunications device for the deaf (TDD) may call the 
Federal Information Relay Service (FIRS) at 1-800-877-8339 between 8 
a.m. and 8 p.m., Eastern standard time, Monday through Friday.

SUPPLEMENTARY INFORMATION: The Student Assistance General Provisions 
regulations (34 CFR part 668) apply to all institutions that 
participate in the student financial assistance programs authorized by 
title IV of the Higher Education Act of 1965, as amended (title IV, HEA 
programs).
    Compliance audits and audited financial statements provide 
information necessary for the Secretary to determine whether an 
institution that participates or seeks to participate in the

[[Page 60566]]

title IV, HEA programs has the resources to deliver its education and 
training programs to students and the extent to which the institution 
complies with applicable statutory and regulatory requirements in its 
administration of the title IV, HEA programs.
    On September 20, 1996, the Secretary published a notice of proposed 
rulemaking (NPRM) for this part in the Federal Register (61 FR 49552-
49574 ). The NPRM included a discussion of the major issues surrounding 
the proposed changes (as well as a summary of the report by the firm of 
KPMG Peat Marwick, LLP) which will not be repeated here. The following 
list summarizes those issues and identifies the pages of the preamble 
to the NPRM on which a discussion of those issues may be found:
    Revisions to the compliance audit requirements that would 
amalgamate the previous requirements for the provision of an audited 
financial statement; the proposed inclusion of a requirement for a 
proprietary institution to disclose the percentage of revenues it 
derives from title IV, HEA programs; audit submission requirements for 
foreign institutions; a clarification of the entity that must submit an 
audited financial statement; and a statement regarding the treatment of 
questionable accounting treatments contained in the required audited 
financial statement (pages 49555-49556).
    The scope and purpose statement of the new Subpart L (page 49556).
    The new ratio standards that comprise the main test of financial 
responsibility; a transition rule; and a proposed modification to an 
exception to the refund letter of credit requirement (pages 49556-
49557).
    A proposal to modify the precipitous closure alternative to 
demonstrating financial responsibility; and a clarification of the 
types of alternatives to demonstrating financial responsibility 
available to new institutions (pages 49557-49558).
    Financial responsibility standards and other requirements for 
institutions undergoing a change of ownership (page 49558).
    Financial responsibility standards for foreign institutions (pages 
49558-49559).
    Past performance standards (page 49559).
    An outline of additional requirements and administrative actions, 
including requirements for institutions that are provisionally 
certified; and an outline of administrative actions taken when an 
institution fails to demonstrate financial responsibility (page 49559).
    The contents of the proposed Appendix F (page 49559).
    The following discussion describes significant changes since the 
publication of the NPRM.

General

    In the September 20, 1996 NPRM, the Secretary indicated that the 
Department intended to publish final regulations by December 1, 1996, 
implementing new financial responsibility standards based on the 
proposed ratio methodology. However, in response to public comment on 
the proposed rules, the Secretary has decided to seek further comment 
and delay publishing final rules implementing these standards.
    In particular, the public expressed concern that there was 
insufficient time for the Department to identify and address any 
possible problems with the proposed methodology and make needed 
technical adjustments. Commenters also asserted that institutions had 
insufficient time to review and provide meaningful comment on the 
methodology. Commenters from private non-profit institutions also 
expressed concern about the sufficiency of data on the effects of 
changed reporting standards that takes place when institutions begin 
reporting under Statement of Financial Accounting Standards 116 and 117 
promulgated by the Financial Accounting Standards Board, and maintained 
that the Secretary should attempt to gather data on the effects of the 
changes and further evaluate the methodological adjustments made to the 
strength factors that are based on the estimated impact of that change. 
Finally, commenters urged the Secretary to consult with more members of 
the community regarding the potential impact of and possible 
improvements to the methodology.
    The Secretary sought to implement the proposed rule effective July 
1, 1997 to benefit institutions that do not satisfy the current 
financial responsibility standards, but could establish their financial 
responsibility under the proposed standards because those standards 
better evaluate the total financial condition of those institutions.
    However, the Secretary is now convinced by commenters to await 
further analysis and consultation. The Secretary is, therefore, 
delaying publication of final regulations establishing a new subpart 
containing new financial responsibility standards and related 
regulations. The Secretary is publishing separately in the Federal 
Register a notice reopening the comment period for those parts of the 
September 20, 1996 NPRM not addressed in these Final Rules, and 
providing further information regarding the Secretary's plans.
    Because the Secretary is delaying publication of final rules 
implementing the proposed changes to the financial responsibility 
standards, the Secretary is not creating a new Subpart L in these Final 
Rules, as was proposed in the September 20, 1996 NPRM. Nor is the 
Secretary removing the current Sec. 668.15, as was also proposed in the 
September 20, 1996 NPRM. Instead, as discussed below, the Secretary is 
amending Sec. 668.15 to add the revised refund reserve performance 
standard, to add the foreign schools financial responsibility 
standards, and to remove the additional submission of an audited 
financial statement. The Secretary is also amending Sec. 668.23 to 
require the simultaneous submission of the audited financial statement 
and compliance audit, both performed on a fiscal year basis, and to 
require notification of 85/15 information as a note to the audited 
financial statement.

Section 600.5--Proprietary Institution of Higher Education

    The Secretary is removing Sec. 600.5(e), since the requirements for 
verifying 85/15 information will now be contained in Sec. 668.23.

Section 668.15--Factors of Financial Responsibility

    Because the Secretary is delaying publication of final regulations 
addressing factors of financial responsibility, Sec. 668.15 is retained 
and amended to include the change in the two-year performance 
alternative to the refund reserve requirement, and to include financial 
responsibility standards for foreign schools. Both changes were 
originally proposed to be included in the new subpart L in the 
September 20, 1996 NPRM.
    The Secretary is also removing Sec. 668.15(e), since the audited 
financial statement will now be required to be submitted with the 
compliance audit under the requirements contained in Sec. 668.23.

Section 668.23--Compliance Audits and Audited Financial Statements

    The Secretary has made several technical changes to the language 
proposed in the September 20, 1996 NPRM. The Secretary is also removing 
the proposed section addressing the treatment of questionable 
accounting treatments.
    As part of the consideration of the comments concerning the 
consolidated audit submissions, the Secretary has also restructured 
some of the regulation

[[Page 60567]]

language to simplify and clarify the requirements. Specifically, a new 
definition of Independent Auditor has been added to 668.23(a) to 
explain that the audits submitted under these regulations may be 
performed by certified public accountants or by government auditors 
that meet certain governmental standards. Similarly, a new section 
668.23(e) has been created that consolidates language from several 
parts of the proposed regulation concerning access to auditor records 
for a school's or servicer's compliance or financial statement audit. 
This section also clarifies that such access includes the ability of 
the Secretary or Inspector General to make copies of such records.
    The Secretary also received substantive comments on the provisions 
in Sec. 668.23 that were formerly contained in Sec. 668.24. While the 
Secretary, as described above, has made technical changes in these 
provisions, the Secretary does not address the commenters' substantive 
concerns here. The Secretary will consider those comments when final 
regulations addressing financial responsibility standards are 
published.

Analysis of Comments and Changes

    In response to the Secretary's invitation in the September 20, 1996 
NPRM, approximately 500 parties submitted comments on the proposed 
regulations. An analysis of the comments on Sec. 668.15 and Sec. 668.23 
and of the changes in the regulations since publication of the NPRM is 
published as an appendix to these final regulations. In that appendix, 
the Secretary responds only to those comments pertaining to the final 
regulations published here. The Secretary will publish responses to all 
other comments when the Secretary publishes final regulations on the 
remainder of the regulatory areas addressed in the September 20, 1996 
NPRM.
    Major issues are grouped according to subject, with appropriate 
sections of the regulations referenced in parentheses. Other 
substantive issues are discussed under the section of the regulations 
to which they pertain. Technical and other minor changes--and suggested 
changes the Secretary is not legally authorized to make under the 
applicable statutory authority--are not addressed.

Executive Order 12866

Assessment of Costs and Benefits

    These final regulations have been reviewed in accordance with 
Executive Order 12866. Under the terms of the order the Secretary has 
assessed the potential costs and benefits of this regulatory action.
    The potential costs associated with the proposed regulations are 
those resulting from statutory requirements and those determined by the 
Secretary to be necessary for administering this program effectively 
and efficiently.
    In assessing the potential costs and benefits--both quantitative 
and qualitative--of these final regulations, the Secretary has 
determined that the benefits of the final regulations justify the 
costs.
    The Secretary has also determined that this regulatory action does 
not interfere unduly with State and local governments in the exercise 
of their governmental functions.

Summary of Potential Costs and Benefits

    The Department has assessed the costs and benefits of the proposed 
regulations. This discussion is contained in the Regulatory Flexibility 
Analysis.

Assessment of Educational Impact

    In the notice of proposed rulemaking, the Secretary requested 
comments on whether the proposed regulations would require transmission 
of information that is being gathered by or is available from any 
agency or authority of the United States.
    Based on the response to the proposed rules and on its own review, 
the Department has determined that the regulations in this document do 
not require transmission of information that is being gathered or is 
available from any other agency or authority of the United States.

Regulatory Flexibility Analysis

    The Secretary has determined that small entities are likely to 
experience economic impacts from this regulation. Thus, the Regulatory 
Flexibility Act (RFA) requires that an Initial Regulatory Flexibility 
Analysis (IRFA) of the economic impacts be performed and that analysis, 
or a summary thereof, be published in the notice of proposed 
rulemaking. The IRFA was performed and a summary was published. This 
Final Regulatory Flexibility Analysis (FRFA) discusses the comments 
received on the IRFA and fulfills the other RFA requirements.

Summary of Significant Issues Raised by the Public Comments on the 
Initial Regulatory Flexibility Analysis (IRFA), a Summary of the 
Assessment of the Department of Such Issues, and a Statement of any 
Changes Made in the Proposed Rule as a Result of Such Comments

    Changes were made in the final rule as a result of public comments. 
These changes are discussed elsewhere. Two commenters replied 
specifically to the IRFA. Their comments are summarized and discussed 
here.
    Comments: Both commenters stated that the IRFA did not explore any 
alternatives.
    Response: As stated in the IRFA, alternatives such as those that 
would establish differing compliance or reporting requirements or 
timetables based upon the size of the institution rather than the type 
of institution, or the use of performance standards rather than 
establishing baseline measures, or an exemption from coverage of the 
rule or any part thereof for small entities, would not adequately 
discharge the Secretary's obligation under section 498(c) of the HEA to 
determine the financial responsibility of institutions and guard the 
Federal fiscal interest. At the time the IRFA was completed, the 
Secretary determined that there were no significant alternatives that 
would satisfy the same legal and policy objectives while minimizing the 
economic impact on small entities. Public comment was received that the 
Secretary has determined requires additional consideration, so the 
comment period for several components of this regulation is being 
reopened. The Secretary welcomes comments that suggest additional 
alternatives consistent with the objectives of the Regulatory 
Flexibility Act.
    Changes: The comment period for several components will be reopened 
to allow for additional public comment.
    Comments: Both commenters stated that the IRFA did not consider 
economic impacts from regulatory provisions that are not addressed in 
these Final Rules. This includes opinions from one or both commenters 
that there may be impacts from: the change of ownership/additional 
location components; underestimation of the cost of obtaining a letter 
of credit; and, the notion that the cost of a letter of credit was not 
considered in the context of applications for new approvals or for 
changes in ownership.
    Response: These comments will be discussed when the reopened 
comment period has closed for the ratio portions

[[Page 60568]]

of the final regulations and the final regulation is published.
    Changes: The comment period for these components has been extended 
to allow for additional public comment.
    Comments: One commenter raised numerous questions about the 
necessity for the rule itself.
    Response: The preamble to the rule discusses the reasons why action 
by the Secretary is needed.
    Changes: None.
    Comments: One commenter stated that the IRFA did not consider the 
cost of changing the audit requirements. This commenter also asked 
questions about possible secondary effects of changing the audit 
requirements.
    Response: The Secretary re-analyzed the component of this rule that 
requires changes in audit requirements. While there may be some slight 
costs associated with the transition to the new audit requirements, 
these costs are not thought to represent a significant economic impact.
    Changes: The final regulatory flexibility analysis acknowledges the 
slight costs that may be associated with a transition to the new audit 
requirements.

Description of the Reasons Why Action by the Department Is Being 
Considered and a Succinct Statement of the Objectives of, and Legal 
Basis for, the Proposed Rule

    The Secretary is directed by section 498(c) of the HEA to establish 
that institutions participating in title IV, HEA student financial 
assistance programs are financially responsible. The Secretary is 
directed by section 498(d) of the HEA to establish that institutions 
participating in the programs have the administrative capability to 
administer federal funds. As part of the regulatory reinvention 
process, the Secretary has analyzed the current standards whereby 
institutions can demonstrate financial responsibility and 
administrative capability and found that improvements can be made. The 
proposed improvements are discussed at length in the preamble to the 
September 20, 1996 NPRM.

Description and Estimate of the Number of Small Entities to Which the 
Proposed Rule Will Apply

    The Secretary has adopted the U.S. Small Business Administration 
(SBA) Size Standards for this analysis. The Regulatory Flexibility Act 
directs that small entities are the sole focus of the Regulatory 
Flexibility Analysis. There are three types of small entities that are 
analyzed here. They are: for-profit entities with total annual revenue 
below $5,000,000; non-profit entities with total annual revenue below 
$5,000,000; and entities controlled by governmental entities with 
populations below 50,000. An estimate of the proportion of entities in 
each of these categories was calculated using the best available data 
from the National Center for Education Statistics IPEDS survey for 
academic year 1993-94. These estimates were applied to Department 
administrative files, where no data element for total revenue is 
available. The estimates are that 1,690 small for-profit entities, 660 
small non-profit entities and 140 small governmental entities will be 
covered by the proposed rule. Where exact data were not available to 
estimate the proportion of small entities, data elements were chosen 
that would have overestimated, rather than underestimated, the 
proportion.

Description of the Projected Reporting, Recordkeeping and Other 
Compliance Requirements of the Rule, Including an Estimate of the 
Classes of Small Entities Which Will Be Subject to the Requirement and 
the Type of Professional Skills Necessary for Preparation of the Report 
or Record

    The components of this final rule that may impose economic impacts 
are those associated with the new compliance audit requirements. The 
new audit requirements change the audit period from the award year to 
the institution's fiscal year. In some circumstances, this may entail a 
somewhat more involved audit if award rules change significantly from 
award year to award year so that the auditor would have to verify 
compliance with both the old and new sets of rules during the fiscal 
year. These changes are expected to cost $2,000 or less for a small 
entity with $5,000,000 in total revenue.
    Changing the 85-15 compliance verification from the current 
attestation standard to a note to the financial statement is not 
expected to represent higher auditor fees. On balance, the amount of 
auditing work is comparable for both standards. Combining the audits is 
expected to reduce the economic cost of audits. While there may be some 
slight costs associated with the transition to the new audit 
requirements, these costs are not expected to represent a significant 
economic impact.
    As discussed above, all small (and large) entities that are 
identified as being covered by the rule will be subject to the new 
audit requirements. The Regulatory Flexibility Act requires a 
discussion of the professional skills required for compliance with this 
rule. All small (and large) entities that participate in the title IV, 
HEA programs are required by statute to provide audits. These audits 
must be prepared by auditors that are qualified to prepare government 
audits. This rule changes the audit requirements, but does not impose a 
significantly new activity upon the entities. Under the current 
regulations, an institution must submit an audited financial statement 
and a compliance audit, but the financial statement was submitted 
twice. Under these new regulations, the institution will still be 
required to submit both the audited financial statement and the 
compliance audit, but the financial statement will only be submitted 
once, at the same time as the compliance audit is submitted. Thus the 
savings to institutions is the marginal savings that is produced by the 
elimination of the extra submission of the audited financial statement.

Description of the Steps the Department Has Taken To Minimize the 
Significant Economic Impact on Small Entities Consistent With the 
Stated Objectives of Applicable Statutes

    This rule reduces the number of audits which must be submitted to 
the Secretary, removing a reporting requirement that overlaps with this 
proposed rule. This should help to reduce the overall reporting costs 
to participating institutions.

A Statement of the Factual, Policy, and Legal Reasons for Selecting the 
Alternative Adopted in the Final Rule and Why Each One of the Other 
Significant Alternatives to the Rule Considered by the Department That 
Affect the Impact on Small Entities Was Rejected

    For the purpose of this regulatory flexibility analysis, the 
significant alternative that was considered by the Secretary and 
rejected was that of ``no action.'' Other alternatives, would not 
adequately discharge the Secretary's obligation under sections 498 (c) 
and (d) of the HEA to determine the financial responsibility and 
administrative capability of participating institutions and guard the 
Federal fiscal interest.
    The Secretary has determined that there are no other significant 
alternatives that would satisfy the same legal and policy objectives 
while minimizing the economic impact on small entities. This 
determination is based, in part, on the extensive consultation that the 
Department performed with small (and large) entities in developing 
these proposed revisions. The alternative ``no action'' was rejected 
because this alternative would not adequately protect the

[[Page 60569]]

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

Conclusion

    The Secretary concludes that a substantial number of small entities 
are likely to experience significant adverse economic impacts from the 
proposed rule. However, the Secretary has concluded that the costs are 
outweighed by the benefits. In this case, the benefits are better 
protection of the Federal fiscal interest as well as improved service 
to students receiving assistance under the title IV, HEA programs.
    The Secretary emphasizes that this conclusion addresses the 
regulations published in this Final Rule. Additional analysis of, and 
conclusions regarding, the other regulatory proposals that were part of 
the September 20, 1996 NPRM will be published when final regulations 
addressing those proposals are published, and will be based on comments 
received during the initial comment period, and those received during 
the reopened comment period.

Paperwork Reduction Act of 1995

    The information collection requirements contained in Sec. 668.23 
have been submitted to the Office of Management and Budget for 
approval.

List of Subjects

34 CFR Part 600

    Colleges and universities, Foreign relations, Grant programs--
education, Loan Programs--education, Reporting and recordkeeping 
requirements, Student aid, Vocational education.

34 CFR Part 668

    Administrative practice and procedures, Colleges and universities, 
Reporting and recordkeeping requirements, Student aid.

(Catalog of Federal Domestic Assistance Number: 84.007, Federal 
Supplemental Educational Opportunity Grant Program; 84.032, Federal 
Family Educational Loan Program; 84.032, Federal PLUS Program; 84.032, 
Federal Supplemental Loans for Students Program; 84.033, Federal Work-
Study Program; 84.038, Federal Perkins Loan Program; 84.063, Federal 
Pell Grant Program; 84.069, State Student Incentive Grant Program, and 
84.268, Direct Loan Program)

    Dated: November 22, 1996.
Richard W. Riley,
Secretary of Education.
    The Secretary amends parts 600 and 668 of title 34 of the Code of 
Federal Regulations as follows:

PART 600--INSTITUTIONAL ELIGIBILITY UNDER THE HIGHER EDUCATION ACT 
OF 1965, AS AMENDED

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

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


Sec. 600.5  [Amended]

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

PART 668--STUDENT ASSISTANCE GENERAL PROVISIONS

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

    Authority: 20 U.S.C. 1085, 1088, 1091, 1092, 1094, 1099c, and 
1141, unless otherwise noted.

    4. Under Sec. 668.15, paragraph (e) is removed and reserved, 
paragraph (g) is revised, and paragraph (h) is added to read as 
follows:


Sec. 668.15  Factors of financial responsibility

* * * * *
    (g) Two-year performance requirement. (1) The Secretary considers 
an institution to have satisfied the requirements in paragraph 
(d)(1)(C) of this section if the independent certified public 
accountant, or government auditor who conducted the institution's 
compliance audits for the institution's two most recently completed 
fiscal years, or the Secretary or a State or guaranty agency that 
conducted a review of the institution covering those fiscal years--
    (i)(A) For either of those fiscal years, did not find in the sample 
of student records audited or reviewed that the institution made late 
refunds to 5 percent or more of the students in that sample. For 
purposes of determining the percentage of late refunds under this 
paragraph, the auditor or reviewer must include in the sample only 
those title IV, HEA program recipients who received or should have 
received a refund under Sec. 668.22; or
    (B) The Secretary considers the institution to have satisfied the 
conditions in paragraph (g)(1)(i)(A) of this section if the auditor or 
reviewer finds in the sample of student records audited or reviewed 
that the institution made only one late refund to a student in that 
sample; and
    (ii) For either of those fiscal years, did not note a material 
weakness or a reportable condition in the institution's report on 
internal controls that is related to refunds.
    (2) If the Secretary or a State or guaranty agency finds during a 
review conducted of the institution that the institution no longer 
qualifies for an exemption under paragraph (d)(1)(C) of this section, 
the institution must--
    (i) Submit to the Secretary the irrevocable letter of credit 
required in paragraph (b)(5) of this section no later than 30 days 
after the Secretary or State or guaranty agency notifies the 
institution of that finding; and
    (ii) Notify the Secretary of the guaranty agency or State that 
conducted the review.
    (3) If the auditor who conducted the institution's compliance audit 
finds that the institution no longer qualifies for an exemption under 
paragraph (d)(1)(C) of this section, the institution must submit to the 
Secretary the irrevocable letter of credit required in paragraph (b)(5) 
of this section no later than 30 days after the date the institution's 
compliance audit must be submitted to the Secretary.
    (h) Foreign institutions. The Secretary makes a determination of 
financial responsibility for a foreign institution on the basis of 
financial statements submitted under the following requirements--
    (1) If the institution received less than $500,000 U.S. in title 
IV, HEA program funds during its most recently completed fiscal year, 
the institution must submit its audited financial statement for that 
year. For purposes of this paragraph, the audited financial statements 
may be prepared under the auditing standards and accounting principles 
used in the institution's home country; or
    (2) If the institution received $500,000 U.S. or more in title IV, 
HEA program funds during its most recently completed fiscal year, the 
institution must submit its audited financial statement in accordance 
with the requirements of Sec. 668.23, and satisfy the general standards 
of financial responsibility contained in this section, or qualify under 
an alternate standard of financial responsibility contained in this 
section.
* * * * *
    5. Section 668.23 is revised to read as follows:


Sec. 668.23  Compliance audits and audited financial statements.

    (a) General. (1) Independent auditor. For purposes of this section, 
the term ``independent auditor'' refers to an independent certified 
public accountant or a government auditor. To conduct an audit under 
this section, a government auditor must meet the Government Auditing 
Standards qualification and independence standards, including

[[Page 60570]]

standards related to organizational independence.
    (2) Institutions. An institution that participates in any title IV, 
HEA program must at least annually have an independent auditor conduct 
a compliance audit of its administration of that program and an audit 
of the institution's general purpose financial statements.
    (3) Third-party servicers. Except as provided under this part or 34 
CFR part 682, with regard to complying with the provisions under this 
section a third-party servicer must follow the procedures contained in 
the audit guides developed by and available from the Department of 
Education's Office of Inspector General. A third-party servicer is 
defined under Sec. 668.2 and 34 CFR 682.200.
    (4) Submission deadline. Except as provided by the Single Audit 
Act, Chapter 75 of title 31, United States Code, an institution must 
submit annually to the Secretary its compliance audit and its audited 
financial statements no later than six months after the last day of the 
institution's fiscal year.
    (5) Audit submission requirements. In general, the Secretary 
considers the compliance audit and audited financial statement 
submission requirements of this section to be satisfied by an audit 
conducted in accordance with the Office of Management and Budget 
Circular A-133, ``Audits of Institutions of Higher Education and Other 
Nonprofit Organizations''; Office of Management and Budget Circular A-
128, ``Audits of State and Local Governments'', or the audit guides 
developed by and available from the Department of Education's Inspector 
General, whichever is applicable to the entity, and provided that the 
Federal student aid functions performed by that entity are covered in 
the submission. (Both OMB circulars are available by calling OMB's 
Publication Office at (202) 395-7332, or they can be obtained in 
electronic form on the OMB Home Page (http://www.whitehouse.gov).
    (b) Compliance audits for institutions. (1) An institution's 
compliance audit must cover, on a fiscal year basis, all title IV, HEA 
program transactions, and must cover all of those transactions that 
have occurred since the period covered by the institution's last 
compliance audit.
    (2) The compliance audit required under this section must be 
conducted in accordance with--
    (i) The general standards and the standards for compliance audits 
contained in the U.S. General Accounting Office's (GAO's) Government 
Auditing Standards. (This publication is available from the 
Superintendent of Documents, U.S. Government Printing Office, 
Washington, DC 20402); and
    (ii) Procedures for audits contained in audit guides developed by, 
and available from, the Department of Education's Office of Inspector 
General.
    (3) The Secretary may require an institution to provide a copy of 
its compliance audit report to guaranty agencies or eligible lenders 
under the FFEL programs, State agencies, the Secretary of Veterans 
Affairs, or nationally recognized accrediting agencies.
    (c) Compliance audits for third-party servicers. (1) A third-party 
servicer that administers title IV, HEA programs for institutions does 
not have to have a compliance audit performed if--
    (i) The servicer contracts with only one institution; and
    (ii) The audit of that institution's administration of the title 
IV, HEA programs involves every aspect of the servicer's administration 
of that program for that institution.
    (2) A third-party servicer that contracts with more than one 
participating institution may submit a compliance audit report that 
covers the servicer's administration of the title IV, HEA programs for 
all institutions with which the servicer contracts.
    (3) A third-party servicer must submit annually to the Secretary 
its compliance audit no later than six months after the last day of the 
servicer's fiscal year.
    (4) The Secretary may require a third-party servicer to provide a 
copy of its compliance audit report to guaranty agencies or eligible 
lenders under the FFEL programs, State agencies, the Secretary of 
Veterans Affairs, or nationally recognized accrediting agencies.
    (d) Audited financial statements. (1) General. To enable the 
Secretary to make a determination of financial responsibility, an 
institution must, to the extent requested by the Secretary, submit to 
the Secretary a set of financial statements for its latest complete 
fiscal year, as well as any other documentation the Secretary deems 
necessary to make that determination. Financial statements submitted to 
the Secretary must be prepared on an accrual basis in accordance with 
generally accepted accounting principles, and audited by an independent 
auditor in accordance with generally accepted government auditing 
standards, and other guidance contained in the Office of Management and 
Budget Circular A-133, ``Audits of Institutions of Higher Education and 
Other Nonprofit Organizations''; Office of Management and Budget 
Circular A-128, ``Audits of State and Local Governments''; or in audit 
guides developed by, and available from, the Department of Education's 
Office of Inspector General , whichever is applicable. As part of these 
financial statements, the institution must include a detailed 
description of related entities based on the definition of a related 
entity as set forth in the Statement of Financial Accounting Standards 
(SFAS) 57. The disclosure requirements under this provision extend 
beyond those of SFAS 57 to include all related parties and a level of 
detail that would enable to Secretary to readily identify the related 
party. Such information may include, but is not limited to, the name, 
location and a description of the related entity including the nature 
and amount of any transactions between the related party and the 
institution, financial or otherwise, regardless of when they occurred.
    (2) Submission of additional financial statements. To the extent 
requested by the Secretary in determining whether an institution is 
financially responsible, the Secretary may also require the submission 
of audited consolidated financial statements, audited full 
consolidating financial statements, audited combined financial 
statements or the audited financial statements of one or more related 
parties that have the ability, either individually or collectively, to 
significantly influence or control the institution, as determined by 
the Secretary.
    (3) Audited financial statements for foreign institutions. A 
foreign institution must submit--
    (i) Audited financial statements prepared in accordance with the 
generally accepted accounting principles of the institution's home 
country, if the institution received less than $500,000 U.S. in title 
IV, HEA program funds during its most recently completed fiscal year; 
or
    (ii) Audited financial statements translated to meet the 
requirements of paragraph (d) of this section, if the institution 
received $500,000 U.S. or more in title IV, HEA program funds during 
its most recently completed fiscal year.
    (4) Disclosure of title IV HEA program revenue. A proprietary 
institution must disclose in a footnote to its financial statement 
audit the percentage of its revenues derived from the title IV, HEA 
program funds that the institution received during the fiscal year 
covered by that audit. The revenue percentage must be calculated in 
accordance with Sec. 600.5(d).

[[Page 60571]]

    (5) Audited financial statements for third-party servicers. A 
third-party servicer that enters into a contract with a lender or 
guaranty agency to administer any aspect of the lender's or guaranty 
agency's programs, as provided under 34 CFR part 682, must submit 
annually an audited financial statement. This financial statement must 
be prepared on an accrual basis in accordance with generally accepted 
accounting principles, and audited by an independent auditor in 
accordance with generally accepted government auditing standards and 
other guidance contained in audit guides issued by the Department of 
Education's Office of Inspector General.
    (e) Access to records. (1) An institution or a third-party servicer 
that has a compliance or financial statement audit conducted under this 
section must--
    (i) Give the Secretary and the Inspector General access to records 
or other documents necessary to review that audit, including the right 
to obtain copies of those records or documents; and
    (ii) Require an individual or firm conducting the audit to give the 
Secretary and the Inspector General access to records, audit work 
papers, or other documents necessary to review that audit, including 
the right to obtain copies of those records, work papers, or documents.
    (2) An institution must give the Secretary and the Inspector 
General access to records or other documents necessary to review a 
third-party servicer's compliance or financial statement audit, 
including the right to obtain copies of those records or documents.
    (f) Notification of questioned expenditures or compliance. (1) As a 
result of a Federal audit or an audit performed at the direction of an 
institution or third-party servicer, if the auditor questions an 
expenditure made by the institution or servicer, or questions the 
institution's or servicer's compliance with an applicable requirement 
(including the lack of proper documentation), the Secretary notifies 
the institution or servicer of the questioned expenditure or 
compliance.
    (2) If the institution or servicer believes that the questioned 
expenditure or compliance was proper, the institution or servicer shall 
notify the Secretary in writing of the institution's or servicer's 
position and the reasons for that position.
    (3) The institution's or servicer's response must be based on an 
attestation engagement performed by the institution's or servicer's 
auditor in accordance with the Standards for Attestation Engagements of 
the American Institute of Certified Public Accountants and must be 
received by the Secretary within 45 days of the date of the Secretary's 
notification to the institution or servicer.
    (g) Determination of liabilities. (1) Based on the audit finding 
and the institution's or third-party servicer's response, the Secretary 
determines the amount of liability, if any, owed by the institution or 
servicer and instructs the institution or servicer as to the manner of 
repayment.
    (2) If the Secretary determines that a third-party servicer owes a 
liability for its administration of an institution's title IV, HEA 
programs, the servicer must notify each institution under whose 
contract the servicer owes a liability of that determination. The 
servicer must also notify every institution that contracts with the 
servicer for the same service that the Secretary determined that a 
liability was owed.
    (h) Repayments. (1) An institution or third-party servicer that 
must repay funds under the procedures in this section shall repay those 
funds at the direction of the Secretary within 45 days of the date of 
the Secretary's notification, unless--
    (i) The institution or servicer files an appeal under the 
procedures established in subpart H of this part; or
    (ii) The Secretary permits a longer repayment period.
    (2) Notwithstanding paragraphs (f) and (g)(1) of this section--
    (i) If an institution or third-party servicer has posted surety or 
has provided a third-party guarantee and the Secretary questions 
expenditures or compliance with applicable requirements and identifies 
liabilities, then the Secretary may determine that deferring recourse 
to the surety or guarantee is not appropriate because--
    (A) The need to provide relief to students or borrowers affected by 
the act or omission giving rise to the liability outweighs the 
importance of deferring collection action until completion of available 
appeal proceedings; or
    (B) The terms of the surety or guarantee do not provide complete 
assurance that recourse to that protection will be fully available 
through the completion of available appeal proceedings; or
    (ii) The Secretary may use administrative offset pursuant to 34 CFR 
part 30 to collect the funds owed under the procedures of this section.
    (3) If, under the proceedings in subpart H, liabilities asserted in 
the Secretary's notification, under paragraph (e)(1) of this section, 
to the institution or third-party servicer are upheld, the institution 
or third-party servicer must repay those funds at the direction of the 
Secretary within 30 days of the final decision under subpart H of this 
part unless--
    (i) The Secretary permits a longer repayment period; or
    (ii) The Secretary determines that earlier collection action is 
appropriate pursuant to paragraph (g)(2) of this section.
    (4) An institution is held responsible for any liability owed by 
the institution's third-party servicer for a violation incurred in 
servicing any aspect of that institution's participation in the title 
IV, HEA programs and remains responsible for that amount until that 
amount is repaid in full.

(Authority: 20 U.S.C. 1088, 1094, 1099c, 1141, and section 4 of Pub. 
L. 95-452, 92 Stat. 1101-1109)

Analysis of Comments and Changes

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

General

    Comments: Many commenters maintained that the 45 day comment period 
was too short for institutions to understand thoroughly the new 
proposals and submit comments on them. Many commenters also maintained 
that the turnaround time between November 4 (the end of the comment 
period) and December 1 (the deadline for publication of final 
regulations in time for implementation for the 1997-1998 award year in 
accordance with the Master Calendar) was too short for Department staff 
to understand the comments that were submitted and to make necessary 
changes in the regulations based on those comments. These commenters 
therefore recommended that the publication of final rules be delayed, 
and the comment period extended.
    Discussion: The Secretary has reviewed these comments and is 
sympathetic to some of the concerns raised that additional time would 
have been desirable for the public to consider some of the proposals in 
more detail. The September 20, 1996 Notice of Proposed Rulemaking 
provided a detailed discussion of the competing concerns at issue given 
the statutory deadline that requires final rules to be published by 
December 1 in order to go into effect by July 1 of the following year. 
The Secretary also notes that many members of the public were able to 
use the allotted time to study the proposed regulation and provide 
detailed comments with constructive suggestions for improving the final 
regulation. These

[[Page 60572]]

comments also identified areas where the proposed regulation may need 
further study and review, particularly with respect to some of the 
components of the financial responsibility ratios calculated under the 
proposed methodology.
    Based in large part on concerns identified in the comments, the 
Secretary is withholding publication of final regulations implementing 
the revised financial responsibility standards at this time, and 
details concerning time frames for additional public comment on that 
proposal will be set out in a separate Federal Register Notice. The 
portions of the September 20 NPRM that are now being incorporated into 
Final Regulations are discussed in detail in the following sections.
    Changes: Certain portions of the proposed regulations that are 
dependent upon the financial responsibility ratio calculations are 
being held back for additional consideration, and the final regulations 
on the remaining portions of the September 20 NPRM are set out and 
discussed below.
    Comments: Several commenters maintained that the current standards 
of financial responsibility could not be changed unless the Department 
engaged in the process of negotiated rulemaking, as specified in 
section 492 of the HEA, or that at least the spirit of that section 
required that the Department enter into further discussions with the 
community on these matters. One commenter alleged that without 
negotiated rulemaking, the Department could not promulgate regulations 
on this subject that would have legal force and effect.
    Discussion: Pursuant to Section 492 of the HEA, the Secretary 
conducted negotiated rulemaking for the regulations that implemented 
parts B, G and H of the HEA as amended by the Higher Education 
Amendments of 1992. The promulgation of those regulations, and the 
procedures specified for those regulations--regional meetings, followed 
by negotiated rulemaking--were subject to a specific time limit set out 
in the statute, tied to the enactment of the 1992 Amendments. The 
requirement to conduct regional meetings and negotiated rulemaking for 
regulations implementing those parts thus did not extend to subsequent 
changes to those regulations. No corresponding time limits or 
procedures were provided in the HEA for any regulations other than the 
ones that were initially required due to the 1992 amendments. The 
Secretary, therefore, disagrees with the suggestions from the 
commenters that negotiated rulemaking would have been required as part 
of the implementation of these regulations.
    Changes: None.

Section 668.15: Factors of Financial Responsibility

    Comments: Many commenters supported the proposed change to the 
performance exception to the refund reserve requirement. These 
commenters also requested that the Department take prompt action to 
approve applications regarding several state tuition recovery funds 
that are still pending. Several of these commenters also suggested that 
the exceptions be expanded to exempt an institution that obtains a 
performance bond as required by a state licensing agency. This 
commenter maintained that such bonds typically provide for refunds to 
students in cases of school closure.
    Several commenters supported the proposed change, but maintained 
that a 10 percent or 15 percent error threshold would be fairer and 
more appropriate, especially for institutions with very few refunds, 
since in those cases even one or two late refunds may exceed the 5 
percent threshold. One of these commenters added that this would take 
into account those refunds paid a day or two late due to payments on a 
30-day cycle. Several commenters noted that a threshold based on the 
number of refunds made late, with no consideration of the amount of 
money that was late in being refunded, was inadequate, because a few 
refunds might be substantial due to the amount of money involved, or, 
conversely, appreciably more refunds than a 5 percent measure could be 
immaterial due to the inconsequential amount of money involve. One 
commenter suggested that a monetary threshold be included in the 
performance requirement, such that the standard be that the institution 
did not make the greater of 5 percent or $5000 of refunds late. One 
commenter suggested that for institutions that make a small number of 
refunds every year, such that one late refund would cause the 
institution to exceed the 5 percent threshold, the Department take 
several years of refund history into account, and, if no pattern of 
late refunds emerges, determine that the institution meets the 
performance standard.
    A commenter representing an accounting firm believed that an 
institution that satisfied the general financial standards should not 
be subject to the refund reserve provisions.
    One commenter requested clarification regarding whether the 5 
percent late refund trigger for the refund reserve requirement would be 
counted at each site for an institution that has additional locations, 
or whether the standard would be applied to the institution as a whole, 
including the additional sites with the main campus.
    Several commenters asked that the refund reserve performance 
exception be clarified to include the results of an appeal process for 
findings regarding late refunds.
    Several commenters requested clarifications of the revised refund 
reserve fund performance standard with regard to the standard being 
linked to the years covered by an auditor or the year during which the 
auditor conducts the audit. One of these commenters asked whether a 
late refund that is split among several programs is counted as one late 
refund or several late refunds. This commenter maintained that the 
former should be the case.
    A commenter from a proprietary institution asked whether the 5 
percent error rate would be based on the refunds examined or an 
extrapolation of the refunds examined. This commenter maintained that 
an extrapolated 5 percent error rate is not indicative of an 
institution that is not financially responsible, nor indicative of a 
reportable condition related to the payment of refunds.
    Several commenters suggested that only FFEL and Direct Loan Program 
refunds be counted as untimely in the refund percentage because only 
late refunds to those programs will have financial consequences to the 
Federal government or the student.
    Discussion: The Secretary appreciates the support this proposal 
generally received from the community. The Secretary, however, is not 
convinced by arguments that the original proposal should be changed 
substantively.
    In particular, the Secretary believes that the only accurate way to 
determine whether an institution is making its refunds under the 
standards contained in Sec. 668.22 is by setting a measure of refunds 
made or not made in a timely fashion. The Secretary does not agree with 
those commenters who believe that a dollar amount should be part of the 
threshold, such that an institution would be allowed to qualify under 
this exemption if the institution makes more than 5 percent of its 
refunds late, but the dollar amount of those refunds is low. This 
performance exemption is premised on providing relief to an institution 
that has created and maintained an efficient system that allows the 
institution to discharge the responsibilities it assumes by 
participating in a title IV, HEA program. In this case, the performance 
of the system must be measured on the basis

[[Page 60573]]

of making refunds. The Secretary does not believe that adding a dollar 
threshold to the 5 percent error threshold would create a better 
measure than the 5 percent threshold alone, since the dollar threshold 
will not yield additional information on how well the system is 
processing refunds. In fact, such a threshold would allow an 
institution to continue using the exemption even though its system 
performed with a significant error rate, so long as the dollar amount 
of each refund made late was low.
    While the Secretary appreciates the position taken by commenters 
who argued the obverse (that an institution that made a few but very 
large refunds late should not qualify for this exemption), the 
Secretary believes that the more appropriate enforcement action in 
cases where an institution inadvertently made a few refunds of large 
amounts late should be taken under the standards set in Sec. 668.22. 
Those standards address the act of making a refund rather than the 
process that controls the making of refunds, and are therefore better 
suited to generate appropriate sanctions, if any, in response to 
deficiencies in the making of a particular refund or refunds.
    The Secretary also disagrees with those commenters who maintained 
that the Secretary should set the error rate at a higher threshold. The 
5 percent threshold was meant to provide relief only in those rare 
instances when, although the institution's system of internal controls 
is generally sound, a few refunds are inadvertently made late. The 
Secretary does not agree that a 10 or 15 percent error threshold would 
capture the intent of the exemption as a performance standard that 
indicates that the institution does, in all but rare situations, make 
refunds in a timely fashion. Rather, the Secretary believes that a 10 
or 15 percent error rate may indicate that serious problems exist with 
the institution's system of internal controls, as well as significant 
compliance problems.
    The Secretary agrees with commenters who asserted that a single 
late refund should not trigger the refund reserve requirement if, due 
to the small number of refunds the institution makes annually, a single 
refund would constitute more than 5 percent of the institution's annual 
refunds. While the Secretary expects institutions that have small 
numbers of refunds to be equally responsible as institutions with large 
numbers of refunds in ensuring that all refunds are paid in a timely 
fashion, the Secretary believes that it is reasonable to allow an 
institution to continue utilizing this exemption if it is found to have 
made only one refund late during its fiscal year, even though that 
single refund represented 5 percent or more of the refunds the 
institution was required to make during that year.
    In promulgating this revision to this exemption, the Secretary 
emphasizes that the 5 percent threshold does not give an institution 
license willfully to make some number of late refunds so long as the 
percentage of late refunds is less than 5 percent. The 5 percent 
threshold is meant to allow institutions to qualify under this 
exemption if the instances in which the institution does not meet the 
regulatory requirements for the payment of all its refunds are rare and 
exceptional. The 5 percent threshold thus allows such institutions to 
qualify for the exemption despite those rare and exceptional instances 
of late payment. But, the Secretary reminds institutions that attempts 
to abuse this exemption by willfully making a percentage of late 
refunds could result in actions taken under Sec. 668.22. In addition, 
the institution's independent auditor is required to make a finding of 
a material weakness in the institution's procedures related to refunds 
if the auditor finds that the institution intentionally or 
systematically made late refunds, and such a finding would result in 
the institution losing the benefit of this exemption.
    The Secretary disagrees with those commenters who asserted that 
only those refunds that contain FFELP or Direct Loan funds should be 
counted as untimely. Refunds made to grant programs must also be made 
in a timely fashion, not only for Federal fiscal reasons, but also 
because those funds may be subsequently used as aid to other needy 
students and should be available to those students as soon as possible. 
Thus, the Secretary includes refunds that do not contain FFELP or 
Direct Loan funds in the measure of refund performance for purposes of 
this exemption.
    In response to other concerns raised by commenters, the Secretary 
wishes to clarify the following. The 5 percent threshold applies to the 
number of refunds made late, not to the number of programs to which 
funds are remitted. Late refunds will be evaluated on the combination 
of a main campus and any additional locations. Evaluations are also 
made for the period of time covered by the auditors or reviewers.
    The Secretary also wishes to clarify that the procedures that occur 
when the letter of credit requirement is triggered are the same as 
current procedures. If the auditor or reviewer finds, in his or her 
examination of a sample of student records, that 5 percent or more of 
the refunds that should have been made to those students in the sample 
were made late, then the institution must immediately submit a letter 
of credit. That letter of credit then remains in place until the final 
report of the reviewer or auditor shows that the institution made fewer 
than 5 percent of its total required refunds late, or until the 
institution can meet the two-year performance exemption based on 
subsequent reviews or audits, or meets one of the other alternatives.
    The Secretary, based on past experience with performance bonds, 
disagrees that they are an acceptable way of meeting the refund reserve 
requirement. The Secretary has found that the terms of coverage and 
conditions for collection on performance bonds are difficult to 
administer consistently, and do not provide the same level of 
protection available under letters of credit.
    The Secretary is currently reviewing several applications regarding 
state tuition recovery funds. Such applications have not conformed to 
the regulatory provisions contained in 668.15(d)(2)(ii). The Secretary 
agrees that such funds are a good way for institutions to meet the 
refund reserve requirements and looks forward to receiving applications 
detailing such state plans that would conform to the regulatory 
provisions.
    Changes: Because the Secretary is delaying the publication of the 
final rules implementing the new proposed standards of financial 
responsibility, Sec. 668.15 is being amended to include this change to 
the two-year performance requirement. Language allowing an institution 
to use this exemption if the auditor or reviewer found that the 
institution made only one late refund has also been added, and 
technical changes to regulatory language have been made to make the 
exemption easier to understand.
    Comments: One commenter agreed that the proposed standards for 
foreign institutions were appropriate.
    Discussion: The Secretary appreciates this support of the proposal. 
The Secretary believes these standards appropriately set levels of 
oversight for foreign institutions given the level of risk represented 
respectively by institutions that receive $500,000 or less annually in 
title IV, HEA program funds, and those that receive more than $500,000 
annually in such funds.
    Changes: None.

[[Page 60574]]

Section 668.23  Compliance Audits and Audited Financial Statements

    Comments: A commenter from a public institution maintained that, 
because of cost, a compliance audit should be required only once every 
two or three years for a public institution, instead of annually. A 
commenter from a public institution maintained that the Single Audit 
Act does not require that the audited financial statements of 
individual public institutions be submitted. One commenter requested 
clarification of the type of audit required of an institution that 
falls below the level of the OMB Circular A-133 audit requirement of 
$300,000.
    Several commenters from accounting firms supported the requirement 
that audited financial statements be included in the compliance audit 
and that the compliance audit be prepared on a fiscal year basis, on 
the grounds that this would result in cost reductions to institutions 
without compromising the ability of the Department to perform its 
oversight responsibilities.
    Many commenters from proprietary institutions and the certified 
public accountant (CPA) community opposed the new requirement. These 
commenters asserted that for those institutions that have a fiscal year 
different from an award year, the change would result in compliance 
audits that cover two different award years, sometimes involving a 
single student's file that would have to be examined under two 
different standards, and that this would add significant costs and 
burdens to institutions. In particular, some commenters also asserted 
that this change would result in audits being prepared during the busy 
season for CPAs, thereby increasing costs; that it might entail using a 
single auditor rather than two different auditors, which would also 
lead to increased costs; and, if the initial audit after the change 
would require the audit of a partial year, this would also increase 
costs. Commenters who opposed changing the reporting year for 
compliance audits from an award year basis to a fiscal year basis 
estimated that time and costs would increase in a range of 40 percent 
to 100 percent.
    A commenter from a proprietary institution opposed the requirement 
that compliance audits be performed on a fiscal year basis, on the 
grounds that information contained on the PMS 272 Report will not match 
information on the final report of expenditures--the Federal Pell Grant 
Statement of Account and the Fiscal Operations Report and Application 
to Participate (FISAP) for campus-based programs. This commenter also 
argued that there will be no mechanism in place for the institution to 
receive an increased authorization to cover additional Pell Grant 
eligibility, since adjustments to award year authorizations must be 
done in the initial audit report.
    One commenter from a Subchapter S corporation asserted that the 
combination of the compliance audit and the audited financial statement 
would not result in more time for an institution to complete its audit, 
because other government agencies require the corporation to provide 
audited financial statements within 120 days of the end of the 
institution's fiscal year. This commenter maintained that creating a 
combined audit requirement meant that the corporation would be required 
to complete both the audited financial statement and the compliance 
audit in that timeframe. This commenter maintained that, therefore, 
this requirement was impossible to meet, because a compliance audit 
typically takes more than five months to complete. This commenter also 
maintained that the combined audit would create problems for a 
corporation with several separate schools when the corporation submits 
an audited financial report to other entities (such as those involved 
in bonding, insurance, and banking), because the combination would 
consist of the financial statement and several different compliance 
audits that are unrelated to the institution for which the report was 
requested. This commenter maintained that the proposed rule does not 
reduce any burden other than that of a separate mailings, since the 
current requirements do not require duplicate information. A commenter 
from a proprietary institution argued that the combined audit would be 
burdensome to some publicly traded corporations because those companies 
are required to prepare an audited financial statement with the 
Security and Exchange Commission within three months of the 
institution's fiscal year end, and this would also be the time period 
in which the institution would be required to complete a compliance 
audit. One commenter recommended either that the Department negotiate 
with the Internal Revenue Service to allow S corporations to change 
their fiscal year from January 1 to December 31, or to change the award 
year to the calendar year.
    Many commenters suggested as an alternative that an institution 
might either combine its audited financial statement with its 
compliance audit, with both covering the same period of time, or allow 
the institution to submit a single audit, with the financial statement 
and compliance audit covering different periods of time (the financial 
statement covering the institution's most recently completed fiscal 
year, and the compliance audit covering the award year). One commenter 
asserted that the combination is not necessary as long as the firm 
conducting the audit of the financial statements is subjected to the 
current Quality Review, and the compliance auditor and the financial 
statement auditor can consult with one another.
    One commenter representing a guarantee agency opposed the combined 
audit on the grounds that the change in the submission deadline from 
four months to six months increased risk to students and taxpayers.
    Several commenters asked for clarification if two separate auditors 
could perform the compliance audit and audit the institution's 
financial statement.
    Several commenters requested more information regarding the time 
period to be covered by the first combined submission and the due date 
for the first combined submission. One of these commenters asked 
whether a compliance audit of less or more than 12 months would be 
acceptable during the transition.
    A commenter from an accounting firm commented that the requirement 
that the audit be prepared according to Generally Accepted Government 
Auditing Standards (GAGAS) would mean higher costs for institutions. 
One commenter maintained that only public institutions should be 
required to use GAGAS, and all other institutions be allowed to use 
Generally Accepted Auditing Standards (GAAS).
    Discussion: It was not the Secretary's intent to preclude the 
preparation of financial statement audits and compliance audits as 
separate reports. The Secretary will accept a financial statement audit 
and a compliance audit performed by different auditors provided that 
both audits are conducted on a fiscal year basis and are submitted 
together as one package. The Secretary is aware that for many 
institutions the award year differs from the fiscal year and that this 
may require that auditors perform audit testing in each of two distinct 
award years, both of which may be subject to different regulatory 
requirements. The Secretary believes that although this may require 
additional planning with respect to developing samples for substantive 
tests of details, the level and complexity of any additional work is 
not substantially greater than would normally be required. Auditors 
would still perform

[[Page 60575]]

reconciliation work and tests of balances relative to the award year 
but would now be required to supplement that work, at fiscal year end, 
with additional reconciliation work and tests of balances. However, the 
nature and extent of those tests and the amount of work associated with 
these activities would be minimal unless year-end testing of internal 
controls indicated a significant change in the reliability of the 
internal control structure. This may result in a modest increase in the 
level of work auditors must perform during peak demand periods, and 
consequently may result in slightly higher audit fees, depending on the 
auditor. Historically, auditors have been required to adapt their 
procedures to accommodate statutory and regulatory changes that have 
occurred at varying periods throughout individual award years. The 
Secretary believes that the benefits associated with consolidating 
multiple regulatory reporting requirements into a single reporting 
package exceed the incremental costs incurred. In addition, auditors 
who perform audits and attest services for participating institutions 
have a responsibility to be aware of changing statutory or regulatory 
requirements, and to develop appropriate plans for accommodating 
changes in those requirements.
    An initial compliance audit covering a partial year will be 
required at the institution's first fiscal year end following the 
effective date of the regulations, and will cover the period of time 
since the institution's last compliance audit. For an institution with 
a fiscal year end of December 31st, an initial compliance audit 
will be required for the period beginning July 1, 1997 and ending 
December 31, 1997. In subsequent years, the compliance audit will be 
prepared on a fiscal year basis and will cover the period of time since 
the institution's last compliance audit. For an institution with a 
December 31st fiscal year end, the next required compliance audit 
and financial audit would be required to be submitted together in a 
single package for the fiscal year ending December 31st, 1998 not 
later than six months following the institution's fiscal year end. 
Although some commenters have suggested that the Secretary allow 
institutions to prepare an initial compliance audit at the end of the 
institution's second fiscal year following the effective date, the 
Secretary believes this creates an unacceptable delay with regard to 
his receiving notification of potentially serious compliance 
violations. Accordingly, the Secretary is requiring institutions to 
prepare a partial year compliance audit at the end of the first fiscal 
year following the effective date of the regulation.
    For many institutions with a December 31st fiscal year end, 
this change will provide the Secretary with more timely information 
with respect to compliance audits. Under previous regulations a 
compliance audit for an award year ending June 30th would not have 
been required to be received by the Secretary until six months 
following a December 31st fiscal year end. By changing the 
requirement that a compliance audit be prepared on an award year basis 
to that of a fiscal year, the Secretary shortens the period in which a 
compliance audit is received to six months instead of nearly a year. 
This may also provide the Secretary with a means of ascertaining the 
potential impact of serious audit liabilities with respect to an 
institution's ability to demonstrate financial responsibility. The 
Secretary further believes that the consistency in reporting periods 
will encourage independent CPAs who perform financial statement audits 
to identify and properly disclose any material contingent liabilities 
that exist as a result of compliance violations.
    In contrast, this change extends the period of time in which 
institutions may submit financial audits from four months under 
previous regulations to six months. This change should prove beneficial 
to institutions. In addition, the Secretary believes that a change in 
the reporting period from the award year to the fiscal year provides 
institutions with an opportunity to consolidate audit services into a 
single engagement rather than to incur the potentially higher costs 
associated with separate engagements .
    The required audit submission is considered to be satisfied by an 
audit under the Single Audit Act and OMB Circular A-128 or OMB Circular 
A-133. However, for institutions that are not required to prepare such 
audits because the total amount of federal financial assistance is less 
than the applicable threshold amount, a financial audit report and a 
compliance audit must be prepared and submitted to the Secretary for 
purposes of complying with the HEA. Guidance in the preparation of the 
compliance audit may be sought from the U.S. Department of Education's 
Office of the Inspector General.
    With regard to the issue of fiscal years for S corporations, the 
Secretary has promulgated a regulation that permits schools to 
synchronize their compliance audit to correspond with their fiscal 
year. The Secretary therefore does not believe it is necessary for an 
institution to be able to switch its fiscal year to correspond to the 
award year, but has rather provided a means for an institution to 
change the period covered by its annual compliance audit so that it 
will correspond to its fiscal year.
    Existing law requires the Inspector General to take appropriate 
steps to assure that any work performed by non-federal auditors 
complies with Generally Accepted Government Auditing Standards (GAGAS). 
This provision reflects a clarification of existing guidance previously 
made available to auditors in publications available from the 
Department of Education's Office of the Inspector General .
    Changes: Several technical changes have been made to Sec. 668.23.
    Comments: Several commenters representing proprietary institutions 
supported the concept of the submission of questionable audit 
statements to the American Institute of Certified Public Accountants 
(AICPA) and other parties for review as part of a fair and impartial 
way of settling disputes between auditors and the Department, but 
questioned the language contained in this proposed rule. One of these 
commenters questioned whether the AICPA would agree to serve in this 
capacity, and asserted that the reference to other parties in the 
proposed rule was unclear. One commenter asserted that the AICPA does 
not have a process for resolving accounting disputes between parties, 
but does have a process, through the Professional Ethics Executive 
Committee, by which parties may be referred for investigation and 
disciplinary action if there is a possible violation of professional 
standards, and a process, through the Accounting Standards Executive 
Committee, for considering whether there is a need for new accounting 
standards.
    Some commenters suggested that it was very important that the 
``other parties'' be familiar with the intricacies of the particular 
sector of higher education involved in the question or dispute, and 
that it was also very important that the Secretary create a process for 
providing notice and soliciting comment from experts in the particular 
sector associated with the question or dispute when the Secretary 
submits a statement for resolution.
    One of these commenters maintained that the proposed procedures 
could be problematic because there are several different legitimate 
ways to reflect similar transactions.
    Discussion: In exercising the Department's statutory oversight 
authority, the Secretary makes every effort to ensure that the 
regulatory standards are applied consistently

[[Page 60576]]

among all participating institutions. One way that the Secretary 
ensures that regulatory provisions are consistently applied is to 
evaluate the accounting principles used in the preparation of financial 
statements. Different representations of similar financial 
circumstances by preparers of those financial statements may lead the 
Secretary to form fundamentally different conclusions about the fiscal 
responsibility of the respective institutions. The Secretary looks to 
the auditor first as a way of ensuring consistent application of 
accounting principles among reporting institutions.
    In proposing the mechanism described in the proposed Sec. 668.23 
(d)(2), the Secretary had intended to establish a formal procedure to 
resolve significant discrepancies that may exist among independent 
auditors in the interpretation of Generally Accepted Accounting 
Principles (GAAP). Notwithstanding this procedure, the Secretary, as 
the principal user of these financial statements, would remain the 
ultimate authority in determining the acceptability of any general 
purpose financial statement for purposes of demonstrating financial 
responsibility. However, several commenters had indicated that the 
procedure proposed in the NPRM was not workable from the standpoint of 
the AICPA, in that the AICPA generally took action to clarify 
accounting principles in the long term rather than to help adjudicate 
particular differences. After reviewing the concerns raised by the 
commenters, the Secretary agrees that the type of assistance the 
Department could procure from the AICPA would not necessitate the 
procedure proposed in the NPRM. The Secretary is, therefore, removing 
this proposal from the final regulations.
    The Secretary, however, reiterates that the Department will 
generally consult with authoritative accounting bodies such as the 
Financial Accounting Standards Board (FASB), The Governmental 
Accounting Standards Board (GASB), and the AICPA when examining audited 
financial statements. If, after consideration of the facts, 
circumstances, and assumptions, the Secretary believes that a departure 
from GAAP exists, the Secretary will notify the institution of the 
finding and may provide the institution with an opportunity to cure. In 
the event the Secretary believes that existing accounting standards 
need to be changed or that existing accounting standards are silent and 
that more guidance is needed, the Secretary will bring the matter to 
the attention of the appropriate accounting standard-setting body or 
bodies for consideration of future changes. However, the Secretary will 
continue to be the final authority in determining the acceptability of 
any specific accounting treatment for purposes of determining the 
financial responsibility of an institution that participates in a title 
IV, HEA program.
    Changes: The provision contained in the proposed Sec. 668.23(d)(2) 
has been removed.
    Comments: Many commenters representing proprietary institutions 
opposed the provision that enables the Secretary to require the 
submission of audited financial statements of related entities, 
consolidated financial statements, or full consolidating financial 
statements, on the grounds of excessive cost and burden. Several of 
these commenters maintained that all necessary information is contained 
in the footnotes to the audited financial statements submitted by 
institutions. One of these commenters maintained that this provision 
would be acceptable only if the requirement was limited to those 
instances in which the Internal Revenue Service requires consolidation. 
Several commenters representing proprietary institutions maintained 
that the provision was unacceptable and should be removed. One 
commenter suggested that the rule read that, if the parent corporation 
is willing to provide a guarantee of the financial obligation of the 
institution, then the financial statements of the parent corporation 
will be considered.
    One commenter argued that a particular definition of ``related'' 
must be promulgated, and that this definition should be constructed so 
as to exclude any entity that does not have a direct and significant 
financial relationship with the institution.
    One commenter representing proprietary institutions opposed the 
proposed regulation in which the Secretary may require full 
consolidating financial statements on the grounds of expense and the 
possible unavailability of financial statements of such entities 
(because they may not be required to prepare them for any other 
purpose). This commenter maintained that the requirement to submit 
audited financial statements be limited to institutions or to an 
institution's parent corporation that intends to sign the institution's 
program participation agreement. This commenter argued that the 
Secretary does not have the statutory authority to require audited 
financial statements of related parties other than at the level of the 
institution, nor does the Secretary have the authority to determine the 
institution's financial responsibility on the basis of a related 
party's financial statement unless the institution is a wholly owned 
subsidiary of the related party. This commenter recommended that the 
proposed regulations be changed to limit the requirement to provide 
this information for related parties only if the Department reasonably 
believes that the related party's performance jeopardizes the financial 
responsibility of the institution, based on a clear financial 
relationship between the entities, and that the requirement be limited 
to the requirement that the related party provide its most recent 
financial statement within six months. Further, this commenter 
recommended that the Department not penalize the institution if the 
related party does not maintain sufficient documentation to support an 
audited financial statement.
    One commenter from a proprietary institution suggested that the 
Department rely on the auditor's judgement, following AICPA guidelines, 
about whether the institution should submit consolidated financial 
statements. A commenter from a public institution maintained that the 
Department should not require a consolidated statement in situations in 
which such statements are not required under GASB standards.
    One commenter maintained that requiring the audited financial 
statement from a related party could result in significant problems, 
stemming from requests after the year end for a period that has not 
been audited (resulting in difficulty in issuing a clean opinion), and 
the presence of inventories and opening balances that may result in 
qualifications. This commenter asserted that, as a result of such 
difficulties, the Department may not receive what it considers 
acceptable audits for these parties, and that institutions may not be 
able to correct the problems for as long as a year.
    A commenter from a proprietary institution maintained that, when an 
institution or institutions are owned by a corporation the financial 
statement of the corporation be the basis for evaluating financial 
responsibility, since all the assets and liabilities of the 
institutions are assets and liabilities of the corporation.
    Discussion: The Secretary requires that an institution provide as 
part of its audited financial statement a detailed disclosure of all 
related parties consistent with the definition of a related party 
established in SFAS 57. The Secretary's intent is to obtain an 
understanding of the relationships that exist among related entities 
that have the ability to exert substantial influence or control. The 
Secretary recognizes that

[[Page 60577]]

the existence of related parties may lead to material transactions that 
are substantially different in terms and conditions from those that 
would occur with unrelated independent entities. The Secretary believes 
that this understanding is necessary in order to take into 
consideration an institution's total financial circumstances. This 
provision is intended to make available to the Secretary information 
important to an analysis of the financial statements that would 
otherwise be difficult to ascertain simply from reviewing the financial 
statements. The Secretary believes that by providing a reference to the 
definitions in SFAS 57 both institutions and their independent auditors 
will have a clear understanding as to the meaning of the term ``related 
party'' under this provision.
    To determine whether an institution is financially responsible, the 
Secretary may also require that the institution submit audited 
consolidated financial statements, audited full consolidating financial 
statements, audited combined financial statements or the audited 
financial statements of one or more related parties that have the 
ability, either individually or collectively, to significantly 
influence or control the institution, as determined by the Secretary. 
This requirement represents a clarification of the existing regulatory 
provisions in 34 CFR 668.15(e) which provides that the Secretary may 
request additional information to the extent necessary to make a 
determination of financial responsibility. The HEA requires that the 
Secretary take into consideration an institution's total financial 
circumstances. The Secretary believes that these additional financial 
statements may be necessary in order to obtain an understanding of the 
economic substance of an institution's financial condition. The 
Secretary further believes that this may constitute a more accurate 
reflection of the institution's total financial circumstances. The 
Secretary also believes that this provision will provide flexibility 
with respect to how an institution demonstrates financial 
responsibility. For example, the existing regulatory language may have 
required several institutions, none of which was individually a 
separate legal entity, to provide individual audited financial 
statements representing each institution despite the fact that all were 
operating divisions of a single corporate entity. Under the new 
standard, the Secretary has explicit flexibility to allow the 
preparation of a single audited financial statement, representing the 
corporate entity only, in lieu of requiring these individual financial 
statements.
    Notwithstanding the Secretary's interest in obtaining an 
understanding of the institution's total financial circumstances, the 
Secretary enters into a program participation agreement with an entity 
that has the legal capacity and financial capability to enter into such 
an agreement for the institution. In the event that the Secretary 
determines that the economic substance of the relationship among 
related parties is such that the institution would not otherwise be 
able to demonstrate financial responsibility on its own, the Secretary 
may require financial guarantees from related parties or co-signatories 
to the program participation agreement. In contrast, should the 
economic relationship among related entities be such that the total 
financial circumstances of the institution indicate an inability to 
demonstrate financial responsibility due to the existence of 
significant liabilities or claims on the assets of the institution, the 
institution shall be deemed not financially responsible. The Secretary 
believes that this requirement will not cause excessive burden or cost 
to any institution that is able to demonstrate financial responsibility 
independently of a related entity. However, the Secretary recognizes 
that for some institutions this provision may be costly. The Secretary 
maintains that the costs are necessary to protect the federal fiscal 
interests.
    Changes: The Secretary clarifies requirements in this area by 
adding the following regulatory language to Sec. 668.23(d)(2): ``The 
disclosure requirements under this provision extend beyond those of 
SFAS 57 to include all related parties and a level of detail that would 
enable the Secretary to readily identify the related party. Such 
information may include but is not limited to the name, location and a 
description of the related entity including the nature and amount of 
any transactions between the related party and the institution, 
financial or otherwise, regardless of when they occurred.''
    Comments: A commenter from a proprietary institution supported the 
requirement that proprietary institutions disclose the proportion of 
revenue the institution received from title IV, HEA program sources.
    Many commenters opposed the requirement. Most of these commenters 
opposed the provision on the grounds that the current provision 
contained in Sec. 600.5 requires only an attestation on the part of the 
CPA firm. Including a disclosure in the audited financial statement 
will increase the work required of the auditor as well as the exposure 
of the auditor, and thus increase the cost of the audit. These 
commenters also asserted that the current procedures provided 
sufficient information for the Department to fulfill its oversight 
responsibility in this area.
    One commenter questioned whether the requirement was that the 
disclosure be separately audited, or based on the attestation 
engagement required by 34 CFR Sec. 600.5. This commenter asserted that, 
should the former be the case, this should be reflected in a change to 
34 CFR Sec. 600.5 and in the Regulatory Flexibility Analysis. One 
commenter maintained that the request for this information suggested 
that the Department intended to use the information for purposes that 
extended beyond Congressional intent.
    Discussion: Previously the Secretary had required an examination 
level ``Compliance Attestation'' to be performed within three months of 
the institution's fiscal year end. The Secretary believes that the 
revised requirement contained in these final regulations will not 
result in significant additional cost as the disclosure will now become 
part of the audit of the general purpose financial statements. The 
corresponding increase in cost associated with adding this disclosure 
is not likely to be significantly greater than the savings resulting 
from the removal of the requirement to perform the ``Compliance 
Attestation.'' Additionally, the independent auditor who performs the 
audit of the institution's general purpose financial statement may be 
able to rely to some extent on the field work of the independent 
auditor who will be conducting the institution's compliance audit for 
the same fiscal period. The Secretary requires this information to 
ensure compliance with provisions of the HEA that stipulate a 
proprietary institution may not receive more than 85 percent of total 
revenues in the form of Title IV program funds.
    Changes: Section 600.5(e) has been removed.

[FR Doc. 96-30394 Filed 11-27-96; 8:45 am]
BILLING CODE 4000-01-P