Financial Management: Improvements Needed in NIH's Controls Over Royalty
Income (Letter Report, 07/21/2000, GAO/AIMD-00-210).

Poor internal controls have affected the monitoring of licensees and the
completeness and accuracy of royalty income received by the National
Institutes of Health (NIH). In fiscal year 1999, NIH's Office of
Technology Transfer (OTT) did not follow up--with one exception--on the
biennial audits of licensees' sales to ensure that licensees with sales
that exceed $2 million had been properly audited. In the audited
exception, GAO found that there were $9.4 million in uncollected royalty
payments, with another $1.2 million projected. OTT also did not exercise
its right to designate auditors to conduct reviews and verifications of
semiannual royalty reports and royalty payments that could provide OTT
assurance that royalty income received from its licensees is based on
accurate sales amounts. Additionally, OTT did not enforce its collection
policies and procedures to ensure timely payment of royalty fees. NIH's
Office of Financial Management system to track royalty payments is not
integrated with OTT, making monthly reconciliation labor-intensive.
Delays in recording royalty income in its own general ledger increase
the risk that financial and budgetary reports to Treasury may be
inaccurate and delay distribution of funds.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-00-210
     TITLE:  Financial Management: Improvements Needed in NIH's
	     Controls Over Royalty Income
      DATE:  07/21/2000
   SUBJECT:  Royalty payments
	     Internal controls
	     License agreements
	     Accounting procedures
	     Technology transfer
	     Financial management
	     Research and development

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GAO/AIMD-00-210

Accounting and Information
Management Division

B-285582

July 21, 2000

The Honorable Tom Bliley
Chairman
Committee on Commerce
House of Representatives

The Honorable Fred Upton
Chairman, Subcommittee on Oversight
and Investigations
Committee on Commerce
House of Representatives

In our November 22, 1999 letter1 to your office, we summarized the results
of our work in response to your request that we (1) determine the extent of
and reasons for the differences between the number of the National
Institutes of Health (NIH) research inventions licensed under cooperative
research and development agreements (CRADA) compared to inventions licensed
under other intramural research projects and (2) review NIH's internal
controls that ensure proper accountability for royalty income resulting from
these licenses. While carrying out our work on these objectives, we
identified deficiencies in NIH's internal controls over royalty income that
is distributed to institutes and inventors. For fiscal year 1999, NIH
reported $45 million in royalty income from its licensees. As agreed with
your office, we continued our work to review NIH's internal controls, and
this report provides the results of that review.

Although NIH has established policies and procedures for administering its
royalty income, we identified deficiencies in internal controls that affect
the monitoring of licensees and the completeness and accuracy of royalty
income received. Specifically, with the exception of one licensee, the
Office of Technology Transfer (OTT) did not follow up on the biennial audits
of licensees' sales to ensure that licensees with sales that exceed $2
million had been properly audited. OTT's follow-up on one licensee yielded
previously uncollected royalty payments of $9.2 million and the expectation
that another $1.2 million would be collected. Given the experience with this
licensee, it would seem reasonable for OTT to obtain assurances that the net
sales from these more lucrative licensees be routinely and timely audited.
Also, OTT did not exercise its right to designate auditors to conduct
reviews and verifications of semiannual royalty reports and royalty payments
for the majority of its licensees. These biennial audits and verifications
of semiannual royalty payments could provide OTT assurance that royalty
income received from licensees is based on accurate sales amounts. We also
found that OTT did not enforce its collection policies and procedures to
ensure timely payment of royalty fees. As a result, institutes and inventors
may not be receiving their share of royalty income in a timely manner.

In addition, NIH's systems and processes hampered proper management of
royalty income. The systems maintained by the Office of Financial Management
(OFM) and OTT that are used to account for royalty income were not
integrated.2 As a result, the monthly royalty income reconciliation process
was labor-intensive and was not always performed in a timely manner.

Licensees are instructed to remit payments to a Treasury lockbox
administered by a commercial bank. OFM, which receives payment information
from the Treasury lockbox, did not record royalty income received from
licensees in its general ledger in a timely manner. Rather, OFM records such
receipts in a Treasury suspense account until it identifies the licensee,
institute, and inventor. Delays in recording royalty income in its own
general ledger increase the risk that financial and budgetary reports to
Treasury will be inaccurate and may tend to delay distribution of funds. In
its fiscal year 1999 financial audit report on internal controls, the
independent public accountant (IPA) responsible for the financial statement
audit of NIH noted a reportable condition related to posting of royalty
income transactions. The IPA reported that NIH did not post royalty income
to its general ledger in a timely manner. Timely posting of royalty income
to its general ledger could help provide assurance that royalty income is
properly accounted for and reported.

We are making recommendations to help NIH strengthen its internal controls
over the administration of royalty income. In comments on a draft of this
report, NIH agreed with four of our six recommendations and disagreed with
two, stating that the areas in which we are making recommendations are areas
where improvements can be, and are being, made.

NIH, an operating division of the Department of Health and Human Services,
is made up of 25 institutes and centers with a combined fiscal year 2000
appropriation of $17.8 billion. One of NIH's primary missions is to promote
new knowledge through basic and applied biomedical research that directly
benefits public health. It performs biomedical research through both
extramural and intramural projects. Extramural projects, which accounted for
about $13 billion in funding in fiscal year 1999, are carried out through
grants and contracts with nonfederal organizations, such as universities and
other nonprofit research organizations, and for-profit corporations.
Intramural projects, which accounted for about
$1.5 billion in funding in fiscal year 1999, are primarily conducted within
NIH laboratories.

Federal research performed under extramural and intramural projects can
result in inventions. If the invention is developed under an extramural
project, the contractor or grantee generally retains title to and profits
from the invention, subject to certain terms and conditions. If the
invention is developed under an intramural project, the federal agency
normally retains title to the invention and can license it to others who may
then commercialize it. The federal government receives royalty income from
inventions it licenses. This royalty income can be in various forms
including execution fees, minimum annual fees, patent fees, and earnings
based on sales. These fees are negotiated with the licensees and are
included in the licensing agreement.

Licensees pay a one-time execution fee to NIH for execution of the licensing
agreement. The minimum annual fee is what the licensee pays to NIH for
maintaining the license agreement, and the patent fees are paid for

patent filings.3 Earnings are based on net sales of the licensed product or
licensed processes and are computed by the licensees based on an agreed-upon
rate specified in the license agreement. For fiscal year 1999, NIH reported
$45 million in royalty receipts from its licensees. It currently has a
reported 1,204 license agreements with approximately 516 licensees.
Licensees' sales information is subject to a biennial audit by an
independent auditor.4

NIH management is responsible for establishing an internal control system to
properly account for royalty income. In November 1999, we updated our
Standards for Internal Control in the Federal Government. These standards,
which are issued pursuant to the Federal Managers' Financial Integrity Act,
provide the overall framework for establishing and maintaining internal
control in the federal government.5 In implementing these standards,
management is responsible for developing the detailed policies, procedures,
and practices to fit their agency's operations and to ensure that they are
built into and an integral part of operations. To comply with the
Comptroller General's Standards, NIH needs to implement procedures for (1)
monitoring licensees, (2) receiving, recording, and reconciling royalty
income received, and (3) distributing royalty income to institutes and
inventors. Primarily, two offices within NIH manage royalty income received
from licensees: the Office of Technology Transfer (OTT) and the Office of
Financial Management (OFM). Figure 1 depicts how royalty income is received,
reconciled, and distributed.

OTT is responsible for administering and maintaining the licensing
agreements and for billing licensees for royalty income when it is due. OTT
is also responsible for the oversight and monitoring of licensees that have
entered into license agreements with NIH. OTT's oversight includes the
review of biennial audit reports and the enforcement of royalty collection
policies and procedures. OFM, which comprises the General Ledger Branch
(GLB) and the Government Accounts Section (GA), is responsible for receiving
information on licensees' payments and distributing royalty income to
institutes and inventors. The GLB receives advices of royalty payments from
licensees through a Treasury lockbox at Mellon Bank. The GA is responsible
for reconciling royalty income with OTT monthly to ensure that (1) the
amounts to be distributed to institutes and inventors agree with royalty
income received from licensees and (2) payments are made to the correct
institute and inventor. The Federal Technology Transfer Act of 1986 (FTTA)
provides for the distribution of royalty income received by federal
agencies. To fulfill the act's requirements in this regard, NIH royalty
policy requires OFM to distribute inventor royalty payments twice a year, in
the early summer and early winter. Inventors' share of royalty income
includes the first $2,000 of royalties received under the license, 15
percent of receipts between $2,000 and $50,000, and 25 percent of receipts
over $50,000. An inventor may not receive more than $150,000 of royalty
receipts in a given year unless specifically approved by the President. Even
if their employment is terminated with the government, inventors are still
entitled to their share of royalty income. After the inventors have received
their share of the royalty income, the remaining royalties are allocated to
the institute from which the patents originated. However, before royalty
income can be allocated to institutes, it must be apportioned by OMB.

To determine the controls that NIH has in place to ensure proper
accountability for royalty income, we obtained an understanding of the
royalty receipt and disbursement process by interviewing officials in OTT,
OFM, and two of NIH's largest institutes--the National Cancer Institute and
the National Institute of Allergy and Infectious Diseases. To gain an
understanding of license requirements, we reviewed the contents of license
agreements. We reviewed and analyzed monthly reconciliations for June,
September, and November 1999 to determine the accuracy of royalty receipts.
To determine whether royalty receipts were properly accounted for and
reported, we selected and tested a statistical sample of fiscal year 1999
royalty receipts from OTT's Invention Tracking System.6 We tracked the
sample of receipts from the Invention Tracking System to the related license
agreements. Because of the confidence level provided by the statistical
sample, which showed no discrepancies, we randomly selected 10 different
license agreements from OTT's files and tracked pertinent data from these
agreements to the Invention Tracking System. We reviewed the audit work
performed by the independent public accountant responsible for the fiscal
year 1999 financial statement audit of NIH and reviewed the pertinent laws
and regulations related to royalty income. We also reviewed NIH policies and
procedures related to the collection of royalty income.

We conducted our work from January 2000 through June 2000 in accordance with
generally accepted government auditing standards. We requested comments on a
draft of this report from the Acting Director of NIH or her designee. These
comments are reprinted in appendix I.

NIH also provided technical comments, which we incorporated into this report
where appropriate but have not included in the appendix.

OTT did not adequately monitor its licensees to ensure accurate payments of
royalty fees because its monitoring controls over licensees were
insufficient. Monitoring controls are key internal controls for ensuring
that NIH receives accurate amounts of royalty income from licensees. The
Comptroller General's Standards for Internal Control in the Federal
Government states that internal controls should generally be designed to
assure that ongoing monitoring occurs in the course of normal operations.
The standards also state that ongoing monitoring activities include
comparisons and reconciliations to identify inaccuracies or exceptions that
alert management to any internal control problems. OTT's monitoring controls
include biennial audits of licensees' sales information, semiannual
verifications of royalty reports and royalty payments, and enforcement of
collection policies and procedures. We found that OTT did not follow up on
the biennial audits of licensees' sales and did not exercise its right to
designate accountants and auditors to conduct reviews and verifications of
licensees' semiannual royalty reports and royalty payments. In addition, OTT
did not enforce its royalty collection policies and procedures to ensure
that licensees made royalty payments in a timely manner and did not assess
interest and penalties on delinquent licensees.

In 1997, OTT identified 14 licensees with annual sales over $2 million and
sent letters to them requesting that an audit be performed.7 The letters
specified areas that the auditors should address during the audit and report
on in the audit report to provide NIH a basis for determining if licensees
submit accurate amounts of royalty income. These areas included determining
(1) the amount of gross sales for each year covered by the audit, (2) the
amount of funds owed to the federal government for each license agreement,
and (3) whether the amounts owed the federal government had been paid and
were reflected in the licensee's records.

Upon completion of the audits, the licensees were asked to submit the audit
reports to OTT. However, OTT did not specify a time frame for submitting the
audit reports but indicated that the audit reports should be submitted in a
timely manner. In 1998, the 14 licensees submitted audit reports to OTT
covering calendar years 1995 and 1996. According to OTT officials, while the
licensees' independent public accountants (IPA) properly performed 4 of the
14 audits covering calendar years 1995 and 1996, the remaining 10 were not
properly performed in accordance with the guidelines specified in OTT's
letters. The IPAs did not disclose in the 10 audit reports the gross sales
amount and related expenses used to arrive at net sales, which is the basis
for calculating royalty fees.

In addition, OTT officials told us that 1 of the above 10 licensees
submitted its audit report much later than others did. As a result, OTT
compared the licensee's sales information to similar information reported to
the Securities and Exchange Commission as an alternative means for
determining if the licensee had reported accurate sales amounts.8 Based on
this comparison, OTT found discrepancies and, in 1998, sent an auditor to
review and verify the licensee's sales and royalties reports. As a result,
in 1999 OTT recovered $9.2 million in unpaid royalty fees from this licensee
and is anticipating the collection of an additional $1.2 million.

At the time of our review, the sales and royalty reports had not been
verified for the remaining nine licenses for which OTT had questions about
their audit reports. OTT officials indicated that although letters
requesting an audit were sent to the 14 licensees, the audits were voluntary
because the audit requirement was not included in license agreements
executed prior to 1997. Therefore, according to OTT officials, it did not
have a basis for requiring the remaining 9 licensees to have additional
audit work performed. They told us that the institutes would have to finance
those audit costs. Given the amount of royalty income collected from the 1
licensee in which follow-up was performed, it would appear to have been in
the government's best interest to follow up on the nine audits.

OTT is still facing the same problem today. Starting with license agreements
executed in 1997, OTT requires the licensee to have an audit of sales and
related royalties conducted by an independent auditor at least every 2 years
if annual sales of the licensed product or the licensed processes exceeded
$2 million. Currently there are 13 licensees with annual sales over $2
million. However, only 1 is required to have a biennial audit because the
audit requirement is not applicable to license agreements executed prior to
1997. OTT did not separately contract for audits for the remaining 12
licensees and did not require audits for the licensees with annual sales
that were $2 million and under.

OTT personnel told us that its licensing specialists performed some
monitoring of licensees' semiannual sales reports that were submitted to
OTT. According to OTT, this monitoring included following up with licensees
that had sales significantly lower or higher than those submitted on a prior
semiannual sales report. In some instances, the follow-up resulted in the
licensees submitting a corrected sales report. However, OTT could not
provide supporting documentation of how it monitored licensees. Without
better-defined processes and documentation of what OTT says it does, it
cannot be assured that royalty receipts submitted by licensees are accurate
and reliable.

In addition to the biennial audits, the license agreements require the
licensee to submit a semiannual royalty report that shows the amount of the
licensed products sold, the net sales, and the amount of royalty fees due.
The license agreement further states that the licensee's records should be
made available during normal business hours for inspection by an accountant
or other designated auditor selected by OTT for the sole purpose of
verifying reports and royalty payments. While licensees submitted the
required semiannual sales and royalty reports, OTT had not exercised its
right to have auditors review and verify these reports. Because the majority
of the licensees were not required to have biennial audits, the semiannual
reviews and verifications of sales information could be a compensating
control. Further, the reviews and verifications of royalty reports and
payments could help to ensure the accuracy of sales used to determine
royalty fees and the receipt of proper amounts of royalty income from
licensees.

In addition, OTT did not enforce its collection policy to ensure timely
payment of royalty fees. According to OTT's collection policies and
procedures, if a royalty payment is not received within 90 calendar days of
the original due date, a letter should be sent to the licensee to terminate
the license agreement. Our test results showed that 1 licensee owing
$125,000 as of February 2000 in overdue royalty fees had not made payments
to OTT since January 1998. However, OTT did not send the required
termination letter to the licensee until January 2000--2 years after the
payments became delinquent. At the time of our review, the licensee had made
a payment of $100,000 of the $125,000 overdue royalty fee.

We identified 78 of the 1,204 license agreements in which the licensees were
over 90 days delinquent in making royalty payments as of April 2000, which
was the most recent data available at the time of our review. The delinquent
royalty payments for these 78 license agreements, which cover 36 licensees,
amounted to $864,302. OTT allowed licensees to exceed the 90 days
delinquency in certain instances where public health considerations were
involved. For example, according to OTT officials, a licensee that has
invented a drug for AIDS treatment would not be terminated and would be
allowed to exceed the 90-day delinquency because of the impact AIDS has on
public health and the urgent need for effective drugs to combat the disease.

Also, NIH did not assess interest and penalty fees on licensees that were
delinquent in making their royalty payments. The licensing agreement states
that NIH may assess interest and penalties on any overdue payment. We
determined that delinquent debt was not referred to OFM. OTT plans to refer
future delinquent debt to OFM to assess interest and penalties. The timely
submission of royalty fees is an equity issue that has a direct impact on
NIH inventors and institutes that should receive a distributed share of
royalty income. If licensees do not submit royalty fees on a timely basis,
inventors payments are also delayed. Further, the institutes do not receive
their share of royalty income to support research laboratory operations and
for payment of related administrative expenses.

According to the CFO Act, agencies should develop and maintain an integrated
accounting and financial management system that complies with federal
requirements and provides for complete, reliable, consistent, and timely
information that is responsive to the financial information needs of the
agency. An integrated financial system coordinates a number of functions to
improve overall efficiency and control. Two key NIH offices that are
responsible for reconciling royalty income records maintained separate,
nonintegrated systems. As a result, the monthly royalty income
reconciliation process was labor-intensive and was not always performed in a
timely manner. OTT recently changed its plans to develop and implement a new
system to replace its current Invention Tracking System when available funds
for the contract ran out. OTT now has plans to upgrade the Invention
Tracking System. However, the planned upgrade would not facilitate the
royalty income reconciliation process performed by offices in OTT and OFM.

OFM's, General Ledger Branch (see figure 1) receives information on
licensees' payments and forwards separate copies of original royalty receipt
documents to OTT and OFM's Government Accounts Section so that they can
determine whether NIH received proper amounts. Because NIH does not have an
integrated system to account for royalty income, each of the three offices
maintains royalty income in separate systems. OTT maintains royalty income
data in the Invention Tracking System, and the two OFM offices maintain
royalty income data on separate Lotus spreadsheets. At the end of each
month, personnel from these offices perform reconciliations of royalty
income receipts recorded in each of their systems. Reconciliation procedures
are a control necessary to ensure accurate reporting of royalty income
received. At the same time, the clerical effort involved in entering the
same data into different systems is not efficient and introduces the
possibility of errors.

We found that OTT's royalty income records were not always promptly
reconciled with OFM's records. Of the royalty reconciliations we reviewed,
we found that the June 1999 royalty reconciliation was not completed until
October 1999, 3 months after the end of the accounting period. OTT officials
told us that the delay in the reconciliation process resulted from licensees
(1) submitting checks without proper identification such as the license
number and (2) making multiple payments with a single check. The Comptroller
General's Standards for Internal Control in the Federal Government states
that internal control activities help ensure that management's directives
are carried out. These activities include approvals, authorizations,
verifications, reconciliations, and maintenance of related records that
provide evidence of execution of these activities as well as appropriate
documentation. Performing monthly reconciliations of royalty income
information within 30 days could provide assurance that reported royalty
income is accurate and complete, available faster for use by the institutes,
and distributed in a timely manner to inventors.

We also found that the reconciliations we reviewed were prepared and
approved by the same individuals and lacked indication of supervisory
review, which further increases the risk of inaccurate and incomplete
royalty income. The Comptroller General's Standards for Internal Control in
the Federal Government states that key duties and responsibilities should be
divided or segregated among different people to reduce the risk of error or
fraud. This includes separating the responsibilities for authorizing
transactions, processing and recording them, reviewing the transactions, and
handling any related assets.

OTT and OFM could more efficiently record, retrieve, and reconcile royalty
income data if the OTT and OFM systems were integrated and the data shared
among those needing the information. In our November 1999 correspondence, we
reported that OTT planned to replace its Invention Tracking System with a
new system, the Technology Transfer Information Management System (TTIMS).
In July 1997, OTT contracted for the development of TTIMS. However, after
available funds for the contract ran out, OTT did not retain the contractor.
According to OTT officials, after spending about $414,000, OTT terminated
the contractor because it did not produce an adequate system. OTT could not
provide us with the analysis it said it performed as a basis for
discontinuing TTIMS.

OTT now plans to upgrade the current Invention Tracking System. However, OTT
could not tell us how the upgrade to the Invention Tracking System would
improve the efficiency of its overall operations. The Clinger-Cohen Act
requires agencies to establish a process to assess the value and risks of
information technology investments, including specific quantitative and
qualitative criteria for comparing and prioritizing alternative information
technology projects. Only by comparing the costs, benefits, and risks of a
full range of technical options can agencies ensure that the best approaches
are selected.

OFM did not promptly record royalty income in its general ledger when it was
received from licensees. Rather, royalty income was recorded outside of the
general ledger on a Lotus spreadsheet. Recording transactions in the general
ledger in a timely manner can facilitate accurate reporting to Treasury. The
Comptroller General's Standards for Internal Control in the Federal
Government states that transactions should be promptly recorded to maintain
their relevance and value to management in controlling operations and making
decisions.

When licensees make royalty payments, the funds are deposited in a Treasury
lockbox. Treasury requires agencies to submit monthly cash collection and
disbursement transaction reports that identify the appropriation account in
which Treasury should record the funds. However, OFM prepares the monthly
cash collections and disbursement transaction reports and instructs Treasury
to post its royalty income received to a suspense account. The Treasury
suspense account is an account that maintains transactions that cannot be
readily identified. Although Treasury allows agencies to record transactions
in a suspense account, these agencies are expected to clear the account in a
timely manner by transferring the receipts to the proper appropriation
account. According to OFM personnel, it generally takes 2 to 4 months to
research royalty income and for OFM and OTT to reconcile this income. After
the royalty income research process and the reconciliations are complete,
receipts are transferred out of Treasury's suspense account and also
recorded in the NIH general ledger. However, we found that about
$50 million in royalty income had remained in the Treasury suspense account
since December 1998 and was not transferred to the proper appropriation
account until April 2000. In addition, only a portion of the
$50 million was recorded in the NIH general ledger in a timely manner. As a
result, the royalty receipts in NIH's general ledger may not be complete and
accurate, resulting in inaccurate reporting in NIH's financial statements
and other external reports sent to the Office of Management and Budget (OMB)
and the Treasury.

The IPA responsible for the fiscal year 1999 financial statement audit of
NIH identified the same issue as an example in support of a reportable
condition in its internal control report. The IPA reported that the
financial accounting systems at NIH do not have the appropriate controls in
place to ensure that transactions are posted to the general ledger in a
timely manner. Specifically, the IPA reported that royalty receipts were not
posted to the NIH general ledger in a timely manner.

Were Approved

NIH submitted its fiscal years 2000-2001 royalty income apportionment
request to OMB on March 21, 2000, and the request was approved in April
2000.9 However, 3 months before OMB approved the apportionment

request, NIH sent advice of allotments to its institutes.10 The distribution
of royalty income should not be made to NIH institutes until the royalty
apportionment request is approved by OMB. We found that in January 2000, the
NIH budget office provided one of the institutes an approved advice of
allotment that gave it the authority to obligate royalty income funds from
the first allotment for fiscal years 2000 and 2001. According to institute
officials, based on this allotment, it obligated royalty income.

NIH budget office officials told us that they notified some of the
institutes verbally and by electronic mail in March 2000 that they had
prematurely issued advice of allotments in January 2000 in error. The
officials also told us that they requested that the allotments not be
disbursed until the fiscal year 2000 apportionment had been approved. We
were not able to verify that notifications had been sent to the institutes
because the NIH budget office officials could not provide support. Timely
submission and approval of apportionment requests could ensure that the use
of royalty income is properly authorized prior to issuance of allotments to
institutes.

As a result of insufficient internal controls over its administration of
royalty income, NIH cannot ensure that reported sales and related royalty
amounts are reliable. In addition, by not adhering to collection policies
and procedures, NIH may be foregoing royalty income due to it. Further,
NIH's lack of an integrated computerized system to process royalty income
transactions has hampered its ability to process and record royalty income
in a timely and efficient manner. As a result, a significant amount of time
and effort is spent on tasks such as reconciliations.

To strengthen controls over the royalty receipt process, we recommend that
the Acting Director of NIH

ï¿½ review and revise NIH policies and procedures for monitoring activities to
include (1) the use of biennial audits for all licensees with sales over $2
million, (2) periodic reviews of the accuracy of semiannual royalty sales
reports, including those under $2 million, and (3) specific due dates for
the submission of biennial audit reports;

ï¿½ impose and collect interest and penalties on licensees delinquent in
submitting royalty payments;

ï¿½ discontinue the practice of recording royalty income in the Treasury
suspense account when received--instead, record royalty income in the NIH
general ledger when it is received;

ï¿½ prepare timely royalty income reconciliations and ensure proper
supervisory review and approval of these reconciliations;

ï¿½ develop and implement a centralized database system that integrates data
used by OFM and OTT to facilitate the reconciliation process; and

ï¿½ ensure that royalty income apportionment requests are approved prior to
issuance of advice of allotments to institutes.

In written comments (see appendix I) on a draft of this report, NIH agreed
in principle with four of our six recommendations and did not concur with
two. NIH stated that our recommendations addressed current management
weaknesses and that it was aware of and addressing many of these problems.
It expressed disagreement with our overall observations and conclusions
concerning the problems encountered and reported on during our review. NIH
also said that, had we conducted a benchmark study of organizations that
license their technologies, it would have surfaced as a leader in the level
of sophistication of its monitoring activities.

First, regarding the scope of our evaluative work, we evaluated NIH's
processes against commonly accepted business practices and expectations. As
noted in our report, our overarching conclusion is that NIH systems,
processes, and disciplines imposed internally and on its licensee community
were not adequate to meet what would be considered reasonable expectations
for achieving financial accountability as well as for fulfilling NIH's
fiduciary role to its inventor community, which shares the royalty proceeds.

Regarding the two recommendations with which it did not concur, NIH tended
to mischaracterize and misconstrue the thrust of our proposed managerial
enhancements. NIH agreed that appropriate and timely monitoring activities
are necessary but said it did not concur with particular aspects of our
recommendation related to biennial audits, periodic reviews of the accuracy
of semiannual sales reports, and specified due dates for submission of the
biennial audit reports. However, in discussing its perception of what we
were asking it to do, NIH's comments presumed a much more intensive effort
than we had contemplated or which could be justified by the circumstances
involved.

The intent of this recommendation was to help ensure that royalty income due
to NIH is collected in a timely and efficient manner. Performing biennial
audits for all licensees with sales over $2 million and periodic reviews of
the accuracy of semiannual sales reports are mechanisms to ensure that
accurate amounts of royalty income are received. NIH expressed the view that
it would not be cost-effective to audit sales data for all 1,200 licenses
because for many licensees, the cost of the audit would exceed the royalty
income owed. This was not our intent. An appropriate approach would entail
evaluating the risk of understatement of sales in semiannual reports,
selecting and reviewing those licensees with sales data that exhibit a risk
of understatement, and sampling the remaining licensees for review. NIH also
contends that OTT provided several letters as evidence of the outcome of its
monitoring activities. We requested support as evidence of OTT's monitoring
of semiannual sales reports throughout our review. However, this support has
never been provided.

Further, specifying due dates for OTT to receive audit reports would help to
ensure that NIH receives royalty income on a timely basis and that its
institutes and inventors in turn receive their royalty income in a timely
manner. As NIH stated in its comments, it is not practical to require a
single due date for all licensees. We were not suggesting a single due date,
but rather that NIH set a time frame for audit reports to be submitted to
OTT--for example, a specified number of months after a licensee has met the
$2 million threshold or within a specified period after the close of the
licensee's fiscal year. Merely asking that the audit reports be submitted
timely is not specific enough to ensure consistent submission of audit
reports from licensees.

NIH did not concur with our recommendation to discontinue the practice of
recording royalty income in the Treasury suspense account when received and
instead to record royalty income in its general ledger as received. In its
comments, NIH stated that when licensees make payments, many do not provide
sufficient data to allow proper recording of the receipts to the appropriate
accounts in a timely manner. Specifically, it noted that it is obligated to
acknowledge the receipt of the funds within its Treasury Agency Location
Code by classifying the receipts in a suspense account until it can be
properly classified to another specific account. We understand that the
varying types of payments and the data or lack thereof accompanying
licensees payments create accounting and recording problems, making
resolution both time consuming and expensive. Therefore, it is incumbent
upon NIH to change its expectations concerning the completeness and accuracy
of licensees' submissions. It is reasonable for NIH business practices and
policies to reflect an expectation that any accounting and receipt questions
be consistently resolved within 30 days.

NIH also said that if all receipts were recorded as royalty income, the
potential for overstating income and budgetary resources would be high. We
are not suggesting that all receipts be recorded as royalty income. NIH
currently enters royalty receipts on Lotus spreadsheets but not in its
accounting records until questions are resolved. Our point is that this
practice means that receipt data is not being controlled by the accounting
system and therefore poses a risk of lost data. Royalty receipts should be
recorded in the general ledger when received, possibly in a suspense account
there until resolved.

Related to royalty income reconciliations, NIH states that our report
inaccurately portrays the reconciliation process as an internal control
issue and that we do not present evidence or analysis to document the
vulnerability. Reconciliations are a critical part of any entity's internal
control activities. Reconciliation procedures are a control necessary to
ensure accurate reporting of royalty income received. Also, while NIH said
it was not aware of any instances where payments to inventors were delayed
or missed because of a problem in the manner in which records were
reconciled between OTT and OFM, officials told us that inventors and
institutes cannot receive their share of royalty income until this process
is complete.

We are sending copies of this report to Representative John D. Dingell,
Ranking Minority Member, House Committee on Commerce; Representative Ron
Klink, Ranking Minority Member, Subcommittee on Oversight and
Investigations, House Committee on Commerce. We are also sending copies of
this report to the Honorable Donna Shalala, Secretary of the Department of
Health and Human Services; Dr. Ruth Kirschstein, the Acting Director of the
National Institutes of Health; and the Honorable Jacob J. Lew, Director of
the Office of Management and Budget. Copies will also be made available to
others upon request. Please contact me at

(202) 512-4476 if you or your staff have any questions concerning this
report. Key contributors to the assignment were Chinero Nwaigwe, Rosa Ricks
Harris, Godwin Nwosu, and Debra Rucker.

Gloria L. Jarmon
Director, Health, Education, and Human Services
Accounting and Financial Management Division

Comments From the National Institutes of Health

1. During a meeting with an OTT official, future plans for OTT's operations
were discussed. However, OTT did not provide a written plan of its business
activities for our review.

2. Discussed in "Agency Comments and Our Evaluation" section of this report.

3. This report has been revised to reflect that these audits are to be
conducted every 2 years, namely, "biennially."

4. As stated in the report, it appears that it would have been in the
government's best interest to follow up on other voluntary audits. Although
a firm under one of the voluntary audits paid NIH $9 million, NIH stated
that the firm did so under protest and that the case is now in litigation in
federal court. We do not believe that the threat of a lawsuit should be a
factor in determining if an audit should be performed.

5. In its comments, NIH stated that because many of its routine processes
have been delegated to highly qualified staff, it is not convinced that much
value would be added to having reconciliations reviewed and approved by
another supervisory layer. Contrary to NIH's comment that the OTT staff that
signs the reconciliation supervises the staff that prepares the
reconciliation, our review of NIH royalty income reconciliations for 3
months showed that the reconciliations were signed by the preparer without
supervisory review and approval. Supervisory review and approval of royalty
income reconciliations could offer additional assurance that royalty income
is accurate and complete.

(916310)

1. Financial Management: National Institutes of Health Research Invention
Licenses and Royalties (GAO/AIMD-00-44R, November 1999).

2. Federal financial system requirements define an integrated financial
system as one that coordinates a number of previously unconnected functions
to improve overall efficiency and control. Characteristics of such a system
include (1) standard data classifications for recording financial events,
(2) common processes for processing similar transactions, (3) consistent
internal controls over data entry, transaction processing, and reporting,
and (4) a system design that eliminates unnecessary duplication of
transaction entry.

3. Patents are property rights authorized by the U.S. Constitution and
statutes enacted pursuant thereto. An issued patent gives the owner the
right to exclude others from making, using, selling, or importing the
claimed invention.

4. Beginning in fiscal year 1997 executed license agreements required
licensees with sales that exceeded $2 million to have a biennial audit
performed. This requirement was not applicable to license agreements
executed prior to 1997. License agreements also require licensees to submit
semiannual sales reports to OTT.

5. Under the Federal Managers' Financial Integrity Act of 1982, managers are
responsible for ensuring that adequate systems of internal controls are
developed and implemented.

6. The Invention Tracking System is used by NIH's OTT to maintain data on
federal inventions and the licenses and royalties resulting from them.

7. The letters sent to the 14 licensees stated that OTT requires licensees
to have compliance audits conducted of license agreements as a part of the
company's annual audit by an independent audit firm. However, OTT officials
told us that they viewed these audits as voluntary because the audit
requirement was not applicable to license agreements executed prior to 1997.

8. The Federal Securities Act of 1934 requires companies whose stock is
publicly traded to include sales information in financial reports submitted
to the Securities and Exchange Commission.

9. NIH submits a 2-year apportionment request to OMB. Under the Federal
Technology Transfer Act of 1986, as amended, an agency may generally retain
royalties for 2 years after the fiscal year in which the royalties were
received.

10. An advice of allotment provides an institute the authority to obligate
royalty funds.
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