[Federal Register Volume 82, Number 152 (Wednesday, August 9, 2017)]
[Rules and Regulations]
[Pages 37177-37181]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-16765]


=======================================================================
-----------------------------------------------------------------------

LEGAL SERVICES CORPORATION

45 CFR Part 1629


Bonding Requirements for Recipients

AGENCY: Legal Services Corporation.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: This final rule revises the Legal Services Corporation's (LSC 
or the Corporation) regulation about bonding requirements for LSC 
recipients. It requires recipients to bond all their employees and to 
ensure that third parties who handle recipients' funds have bond 
coverage, allows recipients to use other forms of insurance similar to 
fidelity bonds, raises the minimum level of coverage, and allows 
recipients to use LSC funds to pay for bonding costs. This final rule 
updates regulations to reflect current insurance practices and 
simplifies the language in the rule to reduce confusion.

[[Page 37178]]


DATES: This final rule is effective September 8, 2017. LSC recipients 
and subrecipients must comply with the rule no later than December 31, 
2017.

FOR FURTHER INFORMATION CONTACT: Stefanie K. Davis, Assistant General 
Counsel, Legal Services Corporation, 3333 K Street NW., Washington, DC 
20007; (202) 295-1563 (phone), (202) 337-6519 (fax), or [email protected].

SUPPLEMENTARY INFORMATION: 

I. Regulatory Background

    LSC created part 1629 in 1984 after several situations in which 
recipients lost LSC funds through the dishonest behavior of persons 
associated with the recipient. 49 FR 28717, July 16, 1984. While the 
recipient recovered the funds in some cases, in others, the recipient 
had to absorb the loss. Id.
    Before enacting part 1629, LSC recommended that recipients have 
fidelity coverage as a basic internal control. See LSC Audit and 
Accounting Guide for Recipients and Auditors, revised June 1977, p. 3-
3. LSC intended part 1629 to ``make mandatory [this] important 
protection for the limited funds available to serve eligible clients.'' 
49 FR 23396, June 6, 1984. LSC originally proposed requiring programs 
to obtain fidelity bond coverage at a minimum level equal to 25% of the 
recipient's annualized LSC funding. Id. Based on comments received in 
response to the proposed rule, LSC decreased the required coverage 
level to 10%. 49 FR 28717, July 16, 1984. LSC also set a $50,000 
minimum coverage level ``in response to the recognition that a loss to 
a small program is proportionally greater in effect than a similar one 
to a large program.'' Id.
    LSC added rulemaking on part 1629 to its annual rulemaking agenda 
in April 2016. Regulatory action is justified for three reasons.
    First, the regulation is outdated. LSC has not revised part 1629 
since it was adopted in 1984, and LSC should update it to reflect 
current insurance practices.
    Second, the regulation was derived from a source that does not 
provide the optimal model for a federally funded grant-making entity 
today. The original rule was based on fidelity bonding provisions found 
in the Employee Retirement Income Security Act of 1974 (ERISA). See 
Section 412 of Pub. L. 93-406, and related regulations at 29 CFR 
2550.412-1 and 29 CFR part 2580. ERISA concerns minimum standards for 
retirement plans in private industry. LSC no longer believes that this 
is an appropriate model for LSC to follow, and that instead LSC should 
look to current regulations governing similar grant-making entities and 
to reflect current insurance practices.
    Third, the current regulation is in some respects unclear or 
ambiguous. LSC has received requests for guidance on how to interpret 
certain provisions in part 1629, particularly those sections about the 
form and extent of coverage required by the rule. LSC does not believe 
that the language in part 1629 provides sufficiently clear guidance to 
LSC recipients or to LSC staff. LSC proposed an approach that is 
tailored to LSC's needs and that simplifies the language in the rule.
    On October 17, 2016, the Operations and Regulations Committee 
(Committee) of LSC's Board of Directors (Board) voted to recommend that 
the Board authorize rulemaking on part 1629. On October 19, 2016, the 
Board authorized LSC to begin rulemaking. On April 23, 2017, the 
Committee voted to recommend that the Board approve publication of a 
Notice of Proposed Rulemaking (NPRM) in the Federal Register for notice 
and public comment. On April 24, 2017, the Board accepted the 
Committee's recommendation and voted to approve publication of the NPRM 
in the Federal Resister. 82 FR 20555, May 3, 2017. On July 21, 2017, 
the Committee recommended publication of this final rule to the Board. 
On July 22, 2017, the Board voted to publish this final rule.
    Material about this rulemaking is available in the open rulemaking 
section of LSC's Web site at http://www.lsc.gov/about/regulations-rules/open-rulemaking. After the effective date of this rule, those 
materials will appear in the closed rulemaking section of LSC's Web 
site at http://www.lsc.gov/about/regulations-rules/closed-rulemaking.

II. Section-by-Section Discussion of Comments

    LSC received one comment during the public comment period from 
Legal Action of Wisconsin, Inc. (Legal Action), an LSC recipient. Legal 
Action generally supported LSC's proposed changes but expressed concern 
about the inclusion of ``volunteers'' as among the persons required to 
be bonded. Legal Action also asked that LSC allow recipients to charge 
bonding costs as ``direct'' costs to their LSC grant. These comments 
and LSC's response will be discussed in more detail below.

Section 1629.1 Purpose

    Part 1629 currently does not have a purpose section. LSC proposed 
to add a purpose section stating who must be covered under the bond and 
what losses the bond must protect against.
    LSC received one comment on this section which will be addressed in 
the response to the comment on Sec.  1629.3 of the proposed rule. LSC 
does not propose to make any changes to this section in the final rule.

Section 1629.2 Definitions

    LSC proposed to define annualized funding level to include the 
amount of the Basic Field Grant and special purpose grant funds a 
recipient receives annually from LSC. LSC believes it is necessary to 
include ``special purpose grants'' of LSC funds, such as Technology 
Initiative Grants, Pro Bono Innovation Fund grants, and emergency 
relief grants in the definition of annualized funding level to ensure 
that the maximum amount of LSC funds are protected.
    LSC received no comments on this section of the proposed rule. LSC 
will adopt the language as proposed in the final rule.

Section 1629.3 Who must be bonded?

    LSC currently requires recipients to bond ``[e]very director, 
officer, employee and agent of a program who handles funds or property 
of the program . . . .'' 45 CFR 1629.2(a) (emphasis added). LSC 
considers the term ``handles'' to include access to funds or other 
recipient property or ``decision-making powers with respect to funds or 
property which can give rise to [] risk of loss.'' Id. Through a review 
of recipient insurance policies, LSC has found that most grantees have 
fidelity coverage for all their employees. This common practice exceeds 
the current minimum requirements of part 1629. When employees who were 
not required to be bonded under part 1629 have misappropriated LSC 
funds, grantees that exceeded the minimum part 1629 coverage have 
typically been protected from loss. LSC believes this common practice 
is desirable and proposes to require that recipients carry coverage for 
all employees, regardless of whether the employees ``handle'' program 
funds.
    LSC does not believe that requiring coverage for all employees will 
impose more costs on the recipients. LSC examined 136 recipient 
policies from 2015-2017, including recipients that are no longer 
receiving an LSC grant, and only one recipient had a schedule policy 
covering a select number of individuals. LSC compared that schedule 
policy to blanket policies purchased by grantees of similar size and 
determined that the schedule policy was more expensive than the blanket 
policies of the other recipients. This analysis supports the conclusion 
that LSC is not imposing costs that the

[[Page 37179]]

recipients do not already bear, and that the proposed update to the 
regulation is consistent with recipients' existing practices.
    LSC currently requires grantees to bond ``agents'' who handle funds 
or property of the program. 45 CFR 1629.2(a). But LSC has found that 
most recipients' policies do not cover the dishonest or fraudulent 
actions of agents and independent contractors. In fact, many policies 
explicitly exclude agents and independent contractors from the 
definition of ``covered employee.'' This exclusion is problematic, as 
LSC recipients are now turning to third parties to handle payroll 
functions. See Legal Services Corporation Board of Directors, 
Operations and Regulations Committee, Transcript of Rulemaking 
Workshop, Wednesday, May 18, 2016, pp. 82-84 (comments of Diana White). 
This means that LSC funds are handled by persons outside of the 
recipient's control and insurance coverage. In areas where there are 
few insurers to choose from, it may be impossible for recipients to get 
insurance that covers ``agents'' or ``independent contractors.''
    To address these issues and adequately protect LSC funds from 
misappropriation by recipients and third parties, LSC proposed three 
changes to the existing rule. First, LSC proposed to require that 
recipients' bonds cover volunteers, in addition to directors, officers, 
employees, and agents of the recipient. Second, LSC proposed to require 
recipients to ensure that third parties who provide payroll, billing, 
and collection services to the recipient have fidelity bond coverage or 
similar insurance. The recipient may accomplish this either by 
extending its own insurance to the third party or by ensuring that the 
third party has its own fidelity bond coverage sufficient to protect 
LSC funds in the third party's hands. Finally, LSC proposed to include 
language allowing recipients to either cover subrecipients through 
their own fidelity policies or ensure that the subrecipients have 
policies adequate to protect subgranted funds.
    Comments: Legal Action provided three comments about this section. 
First, Legal Action expressed support for LSC's proposal to extend the 
coverage requirement under Sec.  1629.3(b) to third parties that only 
provide payroll, billing, or collection services. Legal Action believed 
that it would not need to buy more insurance coverage to comply with 
this requirement.
    Legal Action also expressed concern, however, about the proposal to 
require recipients to bond ``volunteers.'' Legal Action stated that 
this will make obtaining coverage more difficult because its current 
policy covers directors, officers, and employees, but not volunteers. 
Per Legal Action's insurance agent and its carrier's underwriting 
staff, Legal Action will need to purchase a stand-alone crime policy 
with an added endorsement to broaden its coverage to include 
``volunteers.'' Legal Action's agent believes this could increase 
annual premiums by 26%.
    Because of the increased premiums, Legal Action asked LSC to drop 
``volunteers'' from the proposed rule in Sec. Sec.  1629.1 & 1629.3(a). 
Legal Action also suggested that if LSC decided to keep ``volunteers'' 
in the proposed rule, then LSC should define ``volunteers.'' Legal 
Action suggested that LSC limit the requirement to volunteers who have 
access to LSC funds and exclude volunteer attorneys who accept cases 
referred from Legal Action.
    Finally, Legal Action asked that LSC drop the requirement under 
Sec.  1629.3(c)(1) that subrecipients supply coverage for volunteers. 
Legal Action expressed concern that subrecipients also would likely 
incur additional costs to meet this requirement. Legal Action stated 
this requirement may discourage potential subrecipients from partnering 
with LSC recipients in cases where the subgrant is small and the cost 
of compliance is high.
    Response: LSC will retain the language from the proposed rule. For 
most recipients, the proposed rule will not impose additional costs. 
This is because most recipients' policies already include 
``volunteers'' in the definition of a covered ``employee.'' In those 
policies, ``volunteers'' are limited to those who are subject to the 
recipient's direction and control and who perform services for the 
recipient.
    LSC reviewed the policies of six recipients similar in size to 
Legal Action who have policies that include ``volunteers'' as employees 
covered by the policy. Policies ranged in amount from $250,000 to $1 
million in coverage, with deductibles ranging from $2,500 to $10,000, 
and annual premiums ranging from $1,124 to $3,628. From this analysis, 
it appears that insurers offer policies Legal Action could consider 
purchasing that would provide coverage for the actions of volunteers 
without additional expense.
    As to the requirement that subrecipients also provide coverage for 
volunteers, LSC will retain the proposed language. Anytime a recipient 
delegates tasks to another entity, often with less capacity and/or 
fewer controls than the recipient itself has, that recipient runs the 
risk that LSC funds may be misappropriated. Because most subgrantee 
agreements may entail a greater risk, LSC thinks it would be imprudent 
to relax the requirements proposed in the NPRM.

Section 1629.4 What forms of bonds can recipients use?

    Current Sec.  1629.5 allows recipients to choose different forms of 
bonds, such as individual, blanket, or schedule. 45 CFR 1629.5. Section 
1629.5 currently does not address whether recipients may choose types 
of insurance other than a fidelity bond that achieve the same purpose 
as a fidelity bond. Most LSC recipients now protect against employee 
dishonesty through riders to their standard commercial crime policies. 
Few grantees obtain separate fidelity bonds.
    In 1999, LSC issued an external opinion permitting recipients to 
use employee dishonesty insurance to satisfy the bonding requirements 
of part 1629 if the recipient could show that the policy gives the same 
level of protection as a fidelity bond. See External Opinion 1999-10-
26, Part 1629 Purchase of Employee Dishonesty Insurance in Lieu of a 
Fidelity Bond (October 26, 1999). To reflect this long-standing LSC 
policy, LSC proposed revising part 1629 to expressly allow recipients 
to substitute employee dishonesty policies or other methods of coverage 
for fidelity bonds. This revision would give recipients greater 
flexibility to choose the most readily available and cost-effective 
methods of insuring LSC funds. The revision also would make clear that 
the substance and amount of coverage is more important than the form.
    LSC received no comments on this section of the proposed rule. LSC 
will adopt the language as proposed in the final rule.

Section 1629.5 What losses must the bond cover?

    Current Sec.  1629.4 requires recipients to have bonds that protect 
them against ``all those risks of loss that might arise through 
dishonest or fraudulent acts in the handling of funds[.]'' The strict 
language--``all those risks of loss''--implies that recipients must be 
completely covered in the event of a loss, and that policies with 
deductibles would not be acceptable under current part 1629. This is 
because if a recipient has LSC funds stolen, and the policy requires 
the recipient to absorb a portion of that loss by paying a deductible, 
then the recipient's policy did not cover against ``all those risks of 
loss.'' Such strict language makes sense under ERISA statutes and 
regulations, as they are designed to protect retirees' pension funds. 
But such language may

[[Page 37180]]

prevent recipients from obtaining policies that will protect LSC funds 
adequately if policies without deductibles are prohibitively expensive.
    In the NPRM, LSC proposed to simplify the language about the types 
of losses that the bond must cover and revise the rule to allow 
recipients to purchase policies that require payment of deductibles. 
LSC proposed revising the definition to state simply that the ``bond 
must provide recovery for loss caused by such acts as: Fraud, 
dishonesty, larceny, theft, embezzlement, forgery, misappropriation, 
wrongful abstraction, wrongful conversion, willful misapplication, or 
any other fraudulent or dishonest act committed by an employee, 
officer, director, agent, or volunteer.''
    LSC received no comments on this section of the proposed rule. LSC 
will adopt the language as proposed in the final rule.

Section 1629.6 What is the required minimum level of coverage?

    Under the existing rule, recipients must maintain bond coverage 
equal to at least 10% of the recipient's annualized LSC funding or of 
the initial grant if the program is a new grantee. 45 CFR 1629.1(a). 
The minimum level of coverage may never be less than $50,000. Id. In 
the NPRM, LSC proposed to increase the minimum coverage level, which 
has remained unchanged since 1984. Based on a sampling of current 
recipients' policies, most recipients already exceed the $50,000 
minimum level of coverage. In fact, most policies provided coverage in 
excess of $100,000. For those recipients that currently have a $100,000 
policy limit, the average annual premium was $561. Because the common 
practice among recipients already is to insure recipient funds above 
the minimum amount required by current Sec.  1629.1(a), LSC believes it 
is reasonable for LSC to raise the minimum coverage level to $100,000. 
LSC does not propose to change the minimum percentage for coverage.
    LSC received no comments on this section of the proposed rule. LSC 
will adopt the language as proposed in the final rule.

Section 1629.7 May LSC funds be used to cover bonding costs?

    Part 1629 currently is silent as to which costs associated with 
fidelity bond coverage--deductibles, premiums, rates, and single loss 
retention--are allowable using LSC funds. To improve clarity on this 
point, LSC proposed to allow recipients to use LSC funds to pay for the 
costs of bonding under this part if they are (1) consistent with 45 CFR 
part 1630, (2) in accordance with sound business practice, and (3) 
reasonable. This proposed rule is based on the Uniform Guidance, which 
allows for such costs. See 2 CFR 200.427.
    LSC considered limiting the amount of deductibles that LSC would 
consider reasonable in the proposed rule. During the process of 
drafting this proposed rule, LSC examined a sample of recipients' 
current fidelity bonds and found that most of those recipients' 
policies have deductibles ranging from $1,000 to $5,000. LSC could not 
determine, based on research of external sources, whether there are 
current best practices in the nonprofit insurance world that would help 
LSC establish a reasonable limit on deductibles. LSC determined that it 
would need more data to set deductible limits and has therefore chosen 
to allow recipients the flexibility to consider the losses they are 
willing to absorb when deciding the appropriate deductibles, if the 
deductibles are consistent with part 1630, in accordance with sound 
business practice, and reasonable.
    Comments: Legal Action suggested that LSC allow recipients to 
charge bonding costs to the LSC grant as either direct or indirect 
costs. Legal Action reasoned that some recipients may not utilize 
``indirect'' cost allocation or may not have an approved ``indirect'' 
cost rate.
    Response: LSC will retain the language from the NPRM in the final 
rule. LSC does not think it should make an exception to the standard 
principle set out in the Uniform Guidance that the costs of bonding 
required by non-Federal entities in the general conduct of their 
operations are allowable as an indirect cost.

List of Subjects in 45 CFR Part 1629

    Fidelity bond, Grant programs-law, Insurance.


    For the reasons set forth in the preamble, the Legal Services 
Corporation revises 45 CFR part 1629 to read as follows:

PART 1629--BONDING REQUIREMENTS FOR RECIPIENTS

Sec.
1629.1 Purpose.
1629.2 Definitions.
1629.3 Who must be bonded?
1629.4 What forms of bonds can recipients use?
1629.5 What losses must the bond cover?
1629.6 What is the required minimum level of coverage?
1629.7 Can LSC funds be used to cover bonding costs?

    Authority: 42 U.S.C. 2996e(1)(A) and 2996f(3).


Sec.  1629.1  Purpose.

    This part is intended to protect LSC funds by requiring that 
recipients be bonded or have similar insurance coverage to indemnify 
recipients against losses resulting from fraudulent or dishonest acts 
committed by one or more employees, officers, directors, agents, 
volunteers, and third-party contractors who handle LSC funds.


Sec.  1629.2  Definitions.

    Annualized funding level means the amount of:
    (1) Basic Field Grant funds (including Agricultural Worker and 
Native American) and (2) Special grants of LSC funds, including 
Technology Initiative Grants, Pro Bono Innovation Fund grants, and 
emergency relief grants, awarded by LSC to the recipient for the fiscal 
year included in the recipient's annual audited financial statements.


Sec.  1629.3  Who must be bonded?

    (a) A recipient must supply fidelity bond coverage for all 
employees, officers, directors, agents, and volunteers.
    (b) If a recipient uses a third party for payroll, billing, or 
collection services, the recipient must either supply coverage covering 
the third party or ensure that the third party has a fidelity bond or 
similar insurance coverage.
    (c) For recipients with subgrants:
    (1) The recipient must extend its fidelity bond coverage to supply 
identical coverage to the subrecipient and the subrecipient's 
directors, officers, employees, agents, and volunteers to the extent 
required to comply with this Part; or
    (2) The subrecipient must supply proof of its own fidelity bond 
coverage that meets the requirements of this Part for the 
subrecipient's directors, officers, employees, agents, and volunteers.


Sec.  1629.4  What forms of bonds can recipients use?

    (a) A recipient may use any form of bond, such as individual, name 
schedule, position schedule, blanket, or any combination of such forms 
of bonds, as long as the type or combination of bonds secured 
adequately protects LSC funds.
    (b) A recipient may use similar forms of insurance that essentially 
fulfill the same purpose as a fidelity bond.


Sec.  1629.5  What losses must the bond cover?

    The bond must provide recovery for loss caused by such acts as 
fraud, dishonesty, larceny, theft,

[[Page 37181]]

embezzlement, forgery, misappropriation, wrongful abstraction, wrongful 
conversion, willful misapplication, or any other fraudulent or 
dishonest act committed by an employee, officer, director, agent, or 
volunteer.


Sec.  1629.6  What is the required minimum level of coverage?

    (a) A recipient must carry fidelity bond coverage or similar 
coverage at a minimum level of at least ten percent of its annualized 
funding level for the previous fiscal year.
    (b) If a recipient is a new recipient, the coverage must be at a 
minimum level of at least ten percent of the initial grant.
    (c) Notwithstanding paragraphs (a) and (b) of this section, 
recipients must not carry coverage under this part at a level less than 
$100,000.


Sec.  1629.7  Can LSC funds be used to cover bonding costs?

    Costs of bonding required by this part are allowable if expended 
consistent with 45 CFR part 1630. Costs of bonding such as rates, 
deductibles, single loss retention, and premiums, are allowable as an 
indirect cost if such bonding is in accordance with sound business 
practice and is reasonable.

    Dated: August 3, 2017.
Mark Freedman,
Senior Associate General Counsel.
[FR Doc. 2017-16765 Filed 8-8-17; 8:45 am]
 BILLING CODE 7050-01-P