University of Kansas Medical Center, DAB No. 530 (1984)

GAB Decision 530
Docket No. 83-267

April 17, 1984

University of Kansas Medical Center;
Ford, Cecilia Sparks; Garrett, Donald Ballard, Judith


The University of Kansas (University) appealed a decision of the
Deputy Assistant Secretary, Finance (Agency), Department of Health and
Human Services (HHS), disallowing $347,978 plus accrued interest. The
disallowed amount represents alleged investment earnings on excess
federal funds drawn down by the University of Kansas Medical Center
(KUMC, a component of the University) under its letter of credit (LOC).
The University argued that it neither invested the excess funds, nor
earned any interest from the funds, and that, in any event, the Agency
had no authority to demand a refund for any interest earned on the
funds.

For the reasons discussed below, we sustain the disallowance.

I. Background

The Agency based its disallowance on an audit report prepared by the
HHS Office of Inspector General Audit Agency. /1/ The stated objective
of the federal audit was to evaluate the "Medical Center's systems and
procedures related to withdrawal and cash accountability under the HHS
letter-of-credit" for the four and one-half year period ended December
31, 1981. University Brief, Tab 2, p. 2


Briefly, the audit determined that the KUMC maintained cash balances
from its LOC in excess of its daily needs. More specifically, the
auditors found that for the fiscal year (2) ended June 30, 1981, KUMC
maintained an average cash balance of about $1.6 million - an amount
equal to expenses for 47 working days or 2.5 calendar months. Id., p.
5. The auditors found further that available records indicated that
"cash balances in excess of $1 million were maintained as far back as
July 1977." Id. With regard to the excess cash, the auditors determined
that:

Most was not disclosed on the required quarterly cash accountability
statements due to inaccurate reporting.

Portions were invested as part of idle funds in the State of Kansas
treasury.

Portions were used to (i) fund certain indirect cost transfers, (ii)
finance direct expenses of sponsored research awards (Federal and
non-federal) not financed under the letter-of-credit system, and (iii)
maintain a minimum deposit in a local bank account.

Id.

The auditors estimated that the earnings on the invested LOC cash
were $347,978 for the four and one-half year period. Id., p. 13. The
University disagreed with the auditors' computation but did not state
why or provide any alternative computation.

The University accepted the audit findings that KUMC, because of
deficient accounting procedures (see University Brief, Tab 2, pp.
7-11), drew down excessive amounts of cash from its LOC. However, the
University contested the auditors' finding that the University earned
interest on the excess cash and disputed the Agency's right to collect
any such alleged interest.

We discuss the University's arguments separately below.

(3) II. Discussion

Section 74.47(b) of 45 CFR (1980) /2,/, in accordance with the
Intergovernmental Cooperation Act of 1968, provides that a state /3/ is
not accountable to the federal government for interest earned where the
income is attributable to "grants-in-aid." The definition of the term
"grants-in-aid" specifically excludes:

. . . (VI) a payment under a research and development (procurement)
contract or grant awarded directly and on similar terms to all
qualifying organizations.

31 U.S.C. 6501(4)(C).

HHS regulations provide that, except to the extent the exemption
under the Act for grants-in-aid to states applies, "grantees shall remit
to the Federal Government any interest or other investment income earned
on advances of HHS grant funds." 45 CFR 74.47(a).

The University did not contest the auditors' determination that the
Agency-sponsored projects involved here were not grants-in-aid. See
University Brief, Tab 2, p. 13. The University also did not contest the
validity of the regulation requiring grantees to remit interest earned
on advances of HHS funds. Since the University's sponsored projects
were not subject to the exemption under the (4) Intergovernmental
Cooperation Act of 1968 and the University agreed that KUMC drew down
excessive amounts from its LOC, we conclude that the University, in
accordance with 45 CFR 74.47(a), must remit the interest or investment
income earned on those excessive balances.

The University presented several collateral arguments contesting the
determination that the University itself earned interest and the
Agency's right to collect any interest earned on the excessive drawdowns
from the University.

A. Whether the University is accountable for interest earned on the LOC
funds

The University contended that KUMC did not invest any of the
premature drawdowns from its LOC, that it did not receive any interest
earned from any investment of the funds, and that it cannot be required
to pay back what it did not receive. University Brief, p. 1.

The University contended that, under 45 CFR 74.10(a), the Agency was
precluded from requiring the University to segregate the drawdowns from
its LOC in a separate account. Absent such a requirement for a separate
account, the University asserted, it was required by Kansas State law to
deposit the federal funds with the State Treasury. State law requires
such deposit except:

where federal laws or regulations of the federal agency making such
funds available to the state prevent certain federal funds from being
deposited, allocated or expended as provided by this act.

K.S.A. 75-3734; see also University Brief, Tab 8.

The University stated that the exception in K.S.A. 75-3734:

expresses the State Legislature's recognition that state agencies
receiving federal funds must have the flexibility to comply with federal
regulations governing the receipt of funds.

University Brief, p. 3.

(5) The University argued, however, that this exception applies only
to those cases where the federal requirements mandate that the federal
funds be placed in a separate acount. In support of this interpretation
of the Kansas law, the University submitted an opinion by the State
Deputy Attorney General. University Brief, Tab 7. The University
argued that the Deputy Attorney General's opinion confirmed that absent
a federal requirement to segregate the funds, "(the University) had no
authority to require such separation and the crediting of interest on
the funds." University Brief, p. 4.

1. Was the University required to deposit the funds with the State?

As discussed below, we conclude that the University is accountable
for the interest earned on federal funds, even though the State earned
the interest and the University may not have benefited from it directly.
Thus, to a certain extent, it is irrelevant whether the University was
or was not required to deposit the funds in the State treasury. Since
the question has some bearing on the fairness of our result, however, we
discuss here why we think that the exception in K. S.A. 75-3734
reasonably could have been applied.

Federal regulations require letter-of-credit recipients to limit cash
advances to an "actual, immediate" need level. Treasury regulations at
31 CFR 205.4(a) /4/ state:

Cash advances to a recipient organization shall be limited to the
minimum amounts needed and shall be timed to be in accord only with the
actual, immediate cash requirements of the recipient organization in
carrying out the purpose of the approved program or project.


(6) The regulation provides further that:

The timing and amount of cash advances shall be as close as is
administratively feasible to the actual disbursements for direct program
costs and the proportionate share of any allowable indirect costs.

Therefore, the University was required by federal regulations to draw
down only levels of funds commensurate with the need to cover the
federal share of allowable program costs. K.S.A. 75-3734 requires that
federal funds deposited in the State Treasury be disbursed upon warrants
and be subject to fiscal controls imposed by the Act. These State
requirements are arguably incompatible with the goals of the federal
LOC. The LOC provides an efficient means of distributing cash to
qualified recipients of grant funds. However, to control the cost to
the federal government, the drawdowns from the LOC are to be timed so as
to minimize the financing costs. /5/ For the University to draw funds
from its LOC and deposit those funds in the State Treasury and then
request warrants from the State Treasury arguably could defeat the
purpose of the LOC's cash availability and greatly increase the elapsed
time between the University's LOC drawdown and its actual payment.
Since the LOC requirements can be considered inconsistent with the State
deposit requirement, the exception to the State law could reasonably be
applied, obviating the need to deposit the funds in the State Treasury.


In reaching this conclusion, we reject the State's contention that
there must be a requirement of a separate account before the exception
applies. K.S.A. 75-3734 contains no such requirement. In addition, the
State Deputy Attorney General's opinion does not support such a
conclusion. The Deputy's opinion was in response to a request whether
the University:

may deposit federal letter-of-credit funds in accounts separate from
the state general fund and attribute to (7) such account any investment
earnings made on those funds.

University Brief, Tab 7.

The University also advised that there was no federal regulation or
other grant requirement that specified that the funds be segregated.
Within this limited scope the Deputy provided his response. The
response did not address the LOC within the context of the exception in
K.S.A. 75-3734. Therefore, we find that the limited opinion does not
provide the broad support the University submitted it for. /6/


2. Does it matter that the State earned the interest?

The University also argued that the regulations governing the
remission of interest contemplate only interest earned by the recipient
of grant funds, citing the description of "program income" at 45 CFR
74.41(a). The University contended that since interest, if any, was
earned by the State, and not the University, the provisions relied on by
the Agency cannot be used to collect the interest from the University.

We are not persuaded by the University's argument. The regulations
contained in 45 CFR Part 74, Subpart F, govern "grant-related income."
The scope section of this subpart states:

This subpart contains policies and requirements relating to (a)
program income and (b) interest and (7) other investment income earned
on advances of grant funds.

45 CFR 74.40.

It is clear from reading this "scope" section that the grant-related
income regulations are intended to address two separate types of income.
While the University may be correct in its assertion that program income
is limited by definition to income earned by the grant recipient, the
section on treatment of interest is not limited to interest earned by
the recipient. The interest provision specifies that "grantees shall
remit to the Federal Government any interest or other investment income
earned on advances of HHS grant funds." 45 CFR 74.47(a) (emphasis
added). Thus, it places an affirmative obligation on a grantee to remit
any interest earned on grant funds, regardless of whether it is earned
by the grantee directly. The University prematurely drew down the LOC
funds, deposited them in the State Treasury, and accessed the funds as
needed for grant expenditures; thus, the University had responsibility
for the funds and is accountable for the interest earned on the funds.
To accept the University's argument that it is not accountable for any
interest earned on the LOC funds, merely because they were on deposit
with the State, would absolve the University of its responsibility to
properly administer its LOC. It would also open the door to further
violations of this reasonable requirement by allowing grantees to
circumvent the regulation by placing grant funds with third parties who
could earn interest on the funds with no accountability to the federal
government.

We also note that this is not a case where the University had paid
the funds to the State for some reason. The State was merely holding
the funds pending disbursement by the University and, in a sense was
merely an agent or de facto trustee for the University. In these
circumstances, it is appropriate to hold the University accountable for
the interest.

B. Whether the Agency has the authority to recover the interest earned
on the LOC funds

The University contended that the Agency was exceeding its authority
in demanding the remittance of interest earned. The University cited
Treasury regulations at 31 CFR 205.7 as (9) providing the exclusive
sanctions for failure to establish proper LOC procedures. The remission
of interest in not included as one of the sanctions.

The Agency asserted that these regulations merely establish proper
procedures for terminating advance methods of grant program funding.
The Agency argued that these regulations do not provide an exclusive
list of sanctions for misuse of an LOC, and, therefore, the Agency did
not exceed its authority in requiring the remission of interest.

As previously stated, the regulations at 45 CFR 74.47(a) require the
remission of interest earned on grant funds to the federal government.
Even assuming that the regulation at 31 CFR 205.7 said what the
University alleged, and we find below that it does not, there is nothing
in the regulation which would pre-empt the requirement in 45 CFR
74.47(a). That regulation does not impose a sanction for failure to
follow LOC procedures. Rather, it imposes a clear condition on all
grants (except grants-in-aid to states), precluding the possibility of a
non-federal party benefiting from interest earned on federal funds,
whatever the circumstances. Based on that regulation, we find that the
University must remit the interest.

In addition, we note that 31 CFR 205.7 addresses merely the situation
where a grantee does not have proper LOC administration procedures in
place. In such a situation, 31 CFR 205.7 provides that the federal
program agency shall terminate the grantee's LOC. The regulation does
not purport to address the treatment of interest. Therefore, the
University's reliance on it is misplaced.

The University also cited proposed HHS regulations which, much like
31 CFR 205.7, provide for certain sanctions for failure to follow
prescribed LOC guidelines. Proposed 45 CFR Part 77, 48 Fed. Reg. 9668
(March 8, 1983). Even assuming the relevance of the proposed
regulations, we are not persuaded by the University's argument. These
proposed regulations simply address a different problem, namely
financial management deficiencies, and how to remedy that problem. In
this case, we are concerned with the treatment of income earned on
advances of federal funds. As as stated above, 45 CFR 74.47(a)
prescribes the treatment of such (10) income, i.e., remission to the
federal government. Therefore, the regulations aimed at treating
management-related deficiencies are inapposite. /7/

(11) C. The amount of interest to be remitted

As stated previously (see page 2 above), the University said that it
did not agree with the auditors' estimation that $347,978 of investment
income was earned on the excessive drawdowns. The University did not
develop this issue further. We note that the auditors' method of
estimating the investment income (average return times average amount of
daily balance invested) appears to be reasonable. University Brief, Tab
2, p. 13. However, the resulting figure is admittedly an estimate.
Consequently, if the University presents to the Agency, within 30 days
of receiving this decision, a more accurate accounting of the amount of
investment income earned on the excessive drawdowns, the Agency should
consider revising the disallowance amount. If the University provides
an accounting and the parties cannot agree on a revised amount, the
University may return to the Board. If the University makes no further
submission regarding the amount, the University must remit the amount
determined by the Agency.

Conclusion

We hold that the University is required to remit the investment
income earned on the excessive drawdowns from its LOC. /1/ "Report on
Audit of the HHS Letter-of-Credit Systems, Procedures, and Cash
Balances for the Period July 1, 1977 through December 31, 1981," Audit
Control Number 07-37021. University Brief, Tab 2. /2/ We note
that the parties cited in support of their respective positions the
provisions of Office of Management and Budget Circular A-110, which
contains uniform administrative requirements for grants and agreements
with institutions of higher education, hospitals, and other nonprofit
organizations. In accordance with A-110, agencies were instructed to
issue implementing regulations. 41 Fed. Reg. 32016 (1976). Part 74 of
45 CFR represents HHS' implementation of that circular. We cite to HHS'
regulations for convenience. /3/ "State" is defined in the Act
to include any agency or instrumentality of a state, and the definition
does not exclude an institution of higher education which is such an
agency or instrumentality. 31 U.S.C. 6501(8). /4/ These
regulations apply, with some exceptions not relevant here, to any
federal program receiving advance funding, e.g., letter-of-credit. 31
CFR 205.2(a). Part 74 of 45 CFR contains similar provisions requiring
grantees to minimize time between withdrawal and payment. 45 CFR 74.92.
/5/ The audit estimated that interest expense to the federal government
on the University's excess drawdowns was $687,000. This is not an issue
in this case. /6/ In some circumstances, the Board will defer to
a state's interpretation of its own law. See, e.g., Florida Department
of Health and Rehabilitative Services, Decision No. 414, April 29, 1983.
Here, however, the applicability of the exception in K.S.A. 75-3734
depends on how federal requirements are interpreted. To the extent that
the question is one of interpreting the scope of the Kansas exception,
the Deputy Attorney General's opinion simply does not support the
University's interpretation that it applies only where segregation of
funds is specifically required. /7/ As the Board was preparing
to issue this decision, the University submitted a packet of materials
concerning implementation by the Office of Management and Budget and the
Department of Treasury of a "pilot program to address some of the
problems arising out of the use of letter of credit and the restrictions
placed on state agency recipients who must comply with various state
statutes." University's letter of April 9, 1984. One of the proposals
in the materials is the option for a state to use a system of drawing
down cash under a letter of credit at the time the State issues checks,
so long as the state pays or credits the U.S. Treasury interest on the
balance of federal cash in the state treasury. The materials also
indicate that the federal government will pay or credit state treasuries
interest on state cash advanced for federal programs. The University
said that this proposal (approved by the Deputy Assistant Secretary,
Finance, HHS) indicates "that various federal offices do recognize the
problems created for state agency recipients of federal funds." Id. As
the University recognized, the materials relate to a pilot program not
in effect during the time period involved in this case. Thus, they do
not directly affect our decision here. We note, however, that the
policies expressed in the materials are consistent with our decision. In
particular, the Joint State/Federal Cash Management Reform Task Force
proposing the pilot projects agreed that underlying policies include
that "the Federal Government is entitled to earnings on cash provided by
the Federal Government to a State government prior to the time such cash
is needed . . ." and that neither government should benefit or suffer
financially as the result of cash transfer in federal assistance
programs. Since there is nothing in the materials which alters our
conclusions here, we did not think it necessary to ask for the Agency's
comments.

NOVEMBER 14, 1984