Financial Management: Poor Internal Controls Expose Department of
Education to Improper Payments (28-SEP-01, GAO-01-1151).	 
								 
Internal control weaknesses in the Department of Education's	 
payment processes make the department vulnerable to improper	 
payments. GAO focused on three types of disbursements made from  
May 1998 through September 2000--grants and loans totaling $181.4
billion, third party drafts totaling $55 million, and government 
purchase card transactions totaling $22 million. In the grant and
loan area, certain edit checks and other key controls were	 
missing from Education's payment system. For example, Education's
student aid application processing system lacked an automated	 
edit check that would identify students that were much older than
expected. There were several internal control weaknesses that	 
made the third party draft payment process susceptible to	 
improper payments. GAO found 268 instances totaling about $8.9	 
million where Education employees circumvented a system control  
designed to avoid duplicate payments. While analyzing Education's
use of government purchase cards, GAO also found several internal
control weaknesses, including serious deficiencies in the	 
department's process for reviewing and approving purchase card	 
transactions. Over one-third of the 903 purchase cardholders'	 
monthly statements reviewed lacked proper review and approval for
payment. GAO summarized this report in testimony before Congress;
see Financial Management: Poor Internal Control Exposes 	 
Department of Education to improper payments by Linda M. Calbom, 
Director of Financial Management and Assurance, before the Select
Education Subcommittee, House Committee on Education and the	 
Workforce. GAO-01-997T, July 24, 2001.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-1151					        
    ACCNO:   A02037						        
  TITLE:     Financial Management: Poor Internal Controls Expose      
Department of Education to Improper Payments			 
     DATE:   09/28/2001 
  SUBJECT:   Erroneous payments 				 
	     Financial management systems			 
	     Fraud						 
	     Internal controls					 
	     Pell Grant 					 

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GAO-01-1151
     
Report to the Chairman, Subcommittee on Select Education, Committee on
Education and the Workforce, House of Representatives

United States General Accounting Office

GAO

September 2001 FINANCIAL MANAGEMENT

Poor Internal Controls Expose Department of Education to Improper Payments

GAO- 01- 1151

Page 1 GAO- 01- 1151

September 28, 2001 The Honorable Pete Hoekstra Chairman Subcommittee on
Select Education Committee on Education and the Workforce House of
Representatives

Dear Mr. Chairman: On July 24, 2001, we testified before your subcommittee
on our ongoing review of the Department of Education?s payment processes and
how the existing internal control weaknesses we have noted thus far make the
department vulnerable to, and in some cases have resulted in, improper
payments. 1 This letter briefly summarizes our testimony and formalizes
specific recommendations made to the Secretary of Education in our
testimony. We performed our work from August 2000 through July 2001, in
accordance with generally accepted government auditing standards as well as
with investigative standards established by the President?s Council on
Integrity and Efficiency. Further details on our objectives, scope, and
methodology are included in appendix I. Our testimony, which includes our
detailed findings, is reprinted in appendix II.

Our work has focused on three types of disbursements made from May 1998
through September 2000- grants and loans totaling $181.4 billion, third
party drafts totaling $55 million, and government purchase card transactions
totaling $22 million. The results of our work thus far in each of these
areas is summarized below.

In the grant and loan area, we found that certain edit checks and other key
controls were missing from Education?s payment system. For example,
Education?s student aid application processing system lacked an automated
edit check that would identify students that were much older than expected.
Following up on our tests that identified schools with

1 Financial Management: Poor Internal Control Exposes Department of
Education to Improper Payments (GAO- 01- 997T, July 24, 2001).

United States General Accounting Office Washington, DC 20548

Summary of the Testimony

Page 2 GAO- 01- 1151

unusual concentrations of older students, our Office of Special
Investigations, in coordination with Education?s Inspector General,
identified four schools that disbursed as much as $3.4 million in Pell
Grants to ineligible students. These students were ineligible because they
were not participating in a degree program or determined to need English
language instruction in order to utilize their existing knowledge and
skills. Rather, these students were primarily studying English as a second
language. The investigation disclosed that at least one of the schools
generated fraudulent student admissions documents to create the appearance
that students were participating in a degree program. We and the department
have identified a number of other schools with similar disbursement patterns
that warrant further investigation. However, the department currently does
not have a systematic approach for identifying and following up on unusual
disbursement patterns of this nature.

During our analysis of Education?s third party draft payment process, we
identified several internal control weaknesses that made this process
susceptible to improper payments. For example, we found 268 instances
totaling about $8.9 million where Education employees circumvented a key
systems application control designed to avoid duplicate payments. Education
officials are researching and providing supporting documentation for these
transactions, which we will then test to determine if duplicate or over
payments have actually occurred. In response to a letter from the
subcommittee following the earlier April 3, 2001, hearing the subcommittee
held related to our ongoing review, 2 the department acted to eliminate the
use of these third party drafts.

While analyzing Education?s use of government purchase cards, we also found
several internal control weaknesses, including serious deficiencies in the
department?s process for reviewing and approving purchase card transactions.
Over one- third of the 903 purchase cardholders? monthly statements we
reviewed lacked proper review and approval for payment.

In at least two instances, we noted that these internal control weaknesses
precluded Education from detecting the improper use of purchase cards. In
one case, we found that a cardholder made several purchases from two
pornographic Internet sites and, in another case, we found that an employee
used the card to pay for a training course totally unrelated to the

2 Financial Management: Internal Control Weaknesses Leave Department of
Education Vulnerable to Improper Payments (GAO- 01- 585T, April 3, 2001).

Page 3 GAO- 01- 1151

activities of the department. Proper supervisory review and approval of
these transactions should have identified them as improper payments. In
addition, Education is not using management reports available from its
contractor for government purchase cards to monitor purchases nor is it
blocking Merchant Category Codes (MCCs) 3 to reduce the possibility of
cardholders purchasing from inappropriate vendors.

We also found that some employees may have been splitting purchases into
multiple transactions to circumvent the department?s limits on individual
purchases. The department is currently researching a list of 124 instances
totaling about $600,000 where this circumvention of control may have exposed
it to improper payments.

Also in response to your letter from the subcommittee following the April 2,
2001, hearing, the department acted to reduce the number of purchase cards
held by employees and lowered the maximum monthly spending limits on the
remaining cards. However, these actions do not address the issue of split
purchases or the lax approval process.

It is critical that Education management give top priority to improving
internal control to minimize the agency?s vulnerability to improper
payments. The Secretary?s actions to respond to issues related to using
third party drafts and purchase cards are important first steps. At the same
time, there are other important steps that need to be taken to minimize the
department?s exposure to improper Pell Grants and purchase card
disbursements.

The following are our recommendations thus far to address the key findings
that are discussed in our testimony. We may have additional recommendations
after we complete our work later this fall.

To help ensure that Pell Grants are not disbursed to ineligible students and
to reduce the likelihood that improper purchases are made with government
purchase cards, we recommend that the Secretary of Education:

3 The MCC relates to the types of supplies or services that a vendor
provides. The MCC for the Government Purchase Card consists of 11 retail
categories. Agencies have the ability to prohibit cardholders from
purchasing certain supplies or services by blocking specific MCCs.
Conclusions

Recommendations

Page 4 GAO- 01- 1151

 Establish appropriate edit checks to identify unusual grant and loan
disbursement patterns.

 Design and implement a formal, routine process to investigate unusual
disbursement patterns identified by the edit checks.

 Reiterate to all employees established policies regarding the appropriate
use of government purchase cards.

 Strengthen the process of reviewing and approving purchase card
transactions, focusing on identifying split purchases and other
inappropriate transactions.

 Expand the use of MCCs to block transactions with certain vendors. In oral
comments on a draft of this report, Education?s officials agreed with our
findings, conclusions, and recommendations.

As we arranged with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
its date. At that time, we will send copies to the Ranking Minority Member
of your subcommittee, the Secretary of Education, and other interested
parties. We will make copies available to others upon request.

Please contact me at (202) 512- 9508 if you or your staff have any questions
on this report. I can also be reached by e- mail at calboml@ gao. gov. Key
contributors to this assignment are acknowledged at the conclusion of our
testimony.

Sincerely yours, Linda M. Calbom Director Financial Management and Assurance
Agency Comments

and Our Evaluation

Appendix I: Objectives, Scope, and Methodology

Page 5 GAO- 01- 1151

Our objectives were to (1) identify Education?s payment processes, (2)
determine what internal controls existed over these processes, (3) assess
whether the internal controls were designed to provide reasonable assurance
that improper payments would not occur or would be detected in the normal
course of business, (4) identify additional controls that should be
implemented to provide reasonable assurance that improper payments will not
occur, and (5) use various computer auditing techniques to identify
potential improper payments made by Education during the period May 1998
through September 2000.

To identify Education?s payment processes and determine what internal
controls existed over these disbursements as well as to assess whether the
internal controls were designed to provide reasonable assurance that
improper payments would not occur or would be identified promptly, we
interviewed officials and staff in the various offices of Education,
reviewed Education?s policies, and performed walk- throughs of the various
disbursement processes.

To identify potential and actual improper payments, we developed various
computerized auditing techniques, referred to as ?forensic auditing?
techniques, which identified data anomalies that could be indicative of
improper payments. These techniques included database searches, file
comparisons, computer matches, and various other analyses to identify
unusual transactions and unusual payment patterns. Using this approach, we
identified questionable payments - for example, payments to closed schools
or to older students not expected to be enrolled in a degree program. We
then reviewed additional supporting data provided by Education that was
intended to support the propriety of these payments. As necessary, our
Office of Special Investigations investigated selected potential improper
payments that appeared to be fraudulent to further assess their propriety.
Based on the results of these investigations, instances of improper payments
were referred to the Department of Education Inspector General for
appropriate action.

Based on our analysis of the additional supporting data provided by
Education for the potential improper payments we identified, we further
assessed the existing internal control structure to identify additional
internal controls that, if implemented, would have prevented these payments.
We also met with department officials to discuss these additional controls
and to obtain their views. Appendix I: Objectives, Scope, and

Methodology

Appendix I: Objectives, Scope, and Methodology

Page 6 GAO- 01- 1151

We requested comments from the Secretary of Education or his designee on a
draft of this report. We obtained oral comments from cognizant Education
officials who generally concurred with our findings, conclusions and
recommendations. We performed our work from August 2000 through July 2001,
in accordance with generally accepted government auditing standards as well
as with investigative standards established by the President?s Council on
Integrity and Efficiency.

Appendix II: GAO?s July 24, 2001, Testimony Page 7 GAO- 01- 1151

Appendix II: GAO?s July 24, 2001, Testimony

Appendix II: GAO?s July 24, 2001, Testimony Page 8 GAO- 01- 1151

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Appendix II: GAO?s July 24, 2001, Testimony Page 25 GAO- 01- 1151 (190029)

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