Department of Health and Human Services
DEPARTMENTAL APPEALS BOARD
Appellate Division
SUBJECT: New York State Department of Social Services
DATE: October 2, 1995
Docket No. A-95-69
Control No. A-02-93-02000
Decision No. 1537
DECISION
The New York State Department of Social Services (New
York) appealed a decision of the Regional Director,
Region II, Department of Health and Human Services,
disallowing $690,726 in federal financial participation
(FFP) claimed by New York under several federal grant
programs, primarily programs administered by the
Department of Health and Human Services (HHS). This
decision affirmed the determination of the Division of
Cost Allocation (DCA), from which New York appealed
pursuant to 45 C.F.R. Part 75. 1/ The disallowed claims
represented interest incurred for the purchase of
automatic data processing (computer) equipment for the
period April 1, 1987 to March 31, 1993. New York
obtained funds for the purchase by issuing certificates
of participation to the general public. DCA found that
the interest paid on the certificates was not an
allowable cost under the cost principles in Office of
Management and Budget (OMB) Circular A-87.
DCA's determination was based on an audit conducted by
the Office of the Inspector General as a follow-up to
a prior audit of similar costs which resulted in a
disallowance upheld by the Board in New York State Dept.
of Social Services, DAB No. 1417 (1993). That decision
relied on the analysis in an earlier decision, New York
State Dept. of Social Services, DAB No. 1360 (1992),
which also upheld a disallowance of similar costs. 2/ As
discussed in detail below, we conclude that New York has
not raised any arguments which warrant a different result
in this case. Specifically, we conclude that OMB
Circular A-87 need not have been published pursuant to
the notice and comment rulemaking procedures in the
Administrative Procedure Act in order to be binding on
New York. We also conclude that there is no basis for
retroactive application of the recent revision of OMB
Circular A-87, which makes interest on the acquisition of
computer equipment an allowable cost. Finally, New
York's policy arguments are unavailing since, even if the
Board agreed with them (which it does not necessarily),
the Board is bound by all applicable laws and
regulations. Accordingly, we uphold the disallowance
in full.
Analysis
1. OMB Circular A-87 is binding on the states even
though it was not published pursuant to the notice and
comment rulemaking procedures in the Administrative
Procedure Act.
OMB Circular A-87, the cost principles applicable to
state and local governments, was issued by OMB as
guidance for federal agencies. HHS (then the Department
of Health, Education, and Welfare (DHEW)) adopted the
cost principles in OMB Circular A-87 as part of its
general grant regulations on September 19, 1973 (38 Fed.
Reg. 26274). On May 22, 1980, HHS adopted OMB's
revisions to the Circular (which had been redesignated as
Federal Management Circular (FMC) 74-4). 45 Fed. Reg.
34272. However, at neither time did HHS follow the
notice and comment rulemaking procedures in section
553(b) and (c) of the Administrative Procedure Act (APA).
Section 553(b) and (c) require that a substantive agency
rule be published in proposed form in the Federal
Register, and that interested persons be given an
opportunity to participate in rulemaking. Although
section 553(a)(2) specifically exempts from the notice
and comment rulemaking requirement rules relating to
federal grant programs, HHS announced in 1971 that it
would utilize notice and comment rulemaking for rules
relating to its grant programs. 36 Fed. Reg. 2532
(February 5, 1971). HHS' 1973 rule adopting OMB Circular
A-87 invited written comments from interested persons;
however, it was published as a final rule and stated that
DHEW could not "unilaterally deviate" from OMB Circular
A-87. 38 Fed. Reg. 26275. HHS' 1980 rule stated:
Since this amendment to HHS' regulations merely
incorporates changes to Government-wide policy made
by OMB after obtaining public participation, and HHS
has no discretion to modify the policy, proposed
rulemaking procedures are considered unnecessary.
45 Fed. Reg. 34273. New York argued that, in light of
HHS' waiver of the grants exemption, HHS could not
enforce OMB Circular A-87 against the states since HHS
did not adopt the Circular following notice and comment
rulemaking procedures. 3/
We conclude that the lack of notice and comment
rulemaking did not render OMB Circular A-87
unenforceable. In addition to exempting grants from
notice and comment rulemaking procedures, the APA permits
exceptions from these procedures when an agency "for good
cause finds . . . that notice and public procedure
thereon are impracticable, unnecessary, or contrary to
the public interest." Section 553(b)(B). (Indeed, in
the very notice waiving the grants exemption, HHS
contemplated using the good cause exception in
appropriate circumstances.) HHS in effect found that
there was good cause for not using notice and comment
rulemaking when it stated in the preamble to the 1980
rule that proposed rulemaking was unnecessary and cited
the fact that OMB had obtained public participation
before it issued the Circular as well as the fact that
HHS had no discretion to modify the government-wide
policy in the Circular.
New York challenged this finding of good cause, arguing
that OMB had not followed the notice and comment
rulemaking procedures in issuing any of the versions of
OMB Circular A-87. However, public participation in the
formulation of a rule can be obtained in other ways than
through notice and comment rulemaking. HHS determined
that since there had been some form of public
participation in the formulation of OMB Circular A-87, it
was unnecessary for HHS to duplicate that through notice
and comment rulemaking. 4/
New York also argued that, contrary to the statement made
by HHS in the 1980 rule adopting OMB Circular A-87, HHS
did in fact have discretion to modify the cost principles
contained in OMB Circular A-87. New York pointed out
that OMB had recognized that federal agencies must
reinterpret the OMB circulars where those directives
conflict with the enabling legislation for a program
administered by an agency. 5/ New York also asserted
that HHS itself had modified OMB circulars in some
instances. 6/ However, New York did not allege that the
prohibition on interest conflicted with the enabling
legislation for any of the programs in question.
Instead, New York asserted that "modification of OMB
Circular A-87 by DHHS was required because the interest
provision at issue was derived from laws relating to
cost-reimbursement contracts and is inapplicable to the
factual circumstances of grantees." New York brief at
11, n.3.
We do not find this argument persuasive. Since OMB
Circular A-87 was intended specifically for application
to grants to state and local governments, there is no
reason to believe that OMB did not consider the factual
circumstances of grantees in promulgating the Circular.
Thus, the derivation of the rule is irrelevant under the
circumstances here, where the drafters clearly intended
it to be applied in different contexts. See New York
State Dept. of Social Services, DAB No. 1336 (1992), at
23-24. Moreover, whether or not HHS could have deviated
from the OMB Circular, HHS could have reasonably
concluded that it was under greater constraints in
adopting government-wide rules which had been developed
through public participation than under ordinary
circumstances where it promulgates rules implementing
solely HHS program policies.
Accordingly, OMB Circular A-87 was properly adopted by
HHS and was binding on New York.
2. The 1995 revision of OMB Circular A-87 providing for
interest on purchases of computer equipment as an
allowable cost is not retroactively applicable to
interest payments made prior to its effective date.
After the period in question here, OMB Circular A-87 was
revised to make interest on the purchase of computer
equipment an allowable cost. 60 Fed. Reg. 26484, 26499
(May 17, 1995). 7/ The Circular expressly provides that
this change is applicable to costs covered by cost
allocation plans for the governmental fiscal year
beginning on or after September 1, 1995. Id. at 26490,
26499. New York argued, however, that it was
unreasonable not to give this change in policy
retroactive effect. New York asserted that if a cost is
allowable, as OMB has now recognized interest is, the
cost is allowable regardless of when it was incurred.
Thus, New York argued, there was no rational basis for
making the policy change effective only on a prospective
basis.
New York's argument has no merit. As the Supreme Court
stated in Bowen v. Georgetown University Hospital, 488
U.S. 204 (1988), "[r]etroactivity is not favored in the
law. Thus, . . . administrative rules will not be
construed to have retroactive effect unless their
language requires this result." Id. at 208. 8/ In this
case, the language of the revised Circular expressly
provides for a prospective effective date. Moreover, the
allowability of a particular administrative cost is a
matter within the federal government's discretion. As
New York itself pointed out, the Social Security Act
programs under which some of the costs in question here
were claimed typically vest the Secretary of HHS with the
authority to determine what costs are "necessary" for the
proper and efficient administration of the program. See,
e.g., section 403(a)(3) of the Social Security Act. 9/
Thus, the federal government could reasonably decide that
it would pay a share of the cost of acquiring computer
equipment on a prospective basis only. As OMB indicated
in the preamble to the revised Circular, this limitation
is not unfair "[i]n view of the fact that pre-revision
debt was incurred with full knowledge of the cost policy
that was in effect at that time. . . ." 60 Fed. Reg.
26486.
Accordingly, we conclude that the interest in question
here is not allowable under the 1995 revision to the
Circular. This conclusion is consistent with the Board's
holding in DAB No. 1336 that New York was not entitled to
retroactive application of an earlier change in OMB
Circular A-87 to permit rental costs for publicly owned
buildings occupied on or after October 1, 1980. See DAB
No. 1336, at 12, 26-27.
3. New York's policy arguments are unavailing since,
even if the Board agreed with them (which it does not
necessarily), the Board is bound by all applicable laws
and regulations.
New York argued that the Circular's treatment of interest
paid by state governments is arbitrary and capricious
because interest paid by commercial contractors and not-
for-profit organizations under contract to HHS is
allowable under the Federal Acquisition Regulations
(FAR). New York asserted that commercial contractors are
entitled to be paid the "capital cost of money for
facilities," otherwise known as interest. New York
further asserted that not-for-profit contractors are
permitted to be paid a profit by the federal government,
and that these organizations can recover otherwise
unallowable costs, such as interest, from their profit
margin. New York argued that it was arbitrary and
capricious to make the allowability of interest costs
dependent on the classification of the entity which
incurs the costs.
In DAB No. 1360, the Board considered a similar argument
by New York and stated:
The federal government may reasonably have different
policies and provisions when it seeks to do business
with a commercial enterprise than when it deals with
a state or local government. . . .
DAB No. 1360, at 7-8; see also, DAB No. 1336 at 23. The
same response can be made to New York's argument with
respect to not-for-profit contractors. New York
nevertheless took the position that this was not a
satisfactory response since HHS has not shown that it in
fact had reasons for its different policies. We need not
consider this issue further, however. 10/ We know of no
requirement that an agency have reasons justifying its
rules from every conceivable perspective or differing
application. In any event, the Board is bound by all
applicable laws and regulations. 45 C.F.R. 16.14.
There is no dispute that the interest costs are
unallowable under the version of OMB Circular A-87 in
effect when the costs were incurred. Since we concluded
above that OMB Circular A-87 was properly incorporated in
HHS' regulations and that the 1995 revision of the
Circular is not retroactively applicable, we must find
the interest costs unallowable.
New York also argued that this case is distinguishable
from the prior appeals because New York has shown here
that it was not possible to acquire the computer
equipment in question via an outright purchase (which
would obviate the need for interest payments), and also
that the certificates of participation were the most
economical financing mechanism available to New York.
New York submitted as exhibits affidavits from several
state officials stating that the equipment could not be
purchased outright due to a lack of funds to do so, and
that the annual percentage rate for the certificates was
more economical than the vendor financing offered. New
York Exhibits 6, 7 and 8. New York also submitted a copy
of a General Accounting Office report and congressional
testimony on that report which endorsed the use of the
type of financing system used by New York to purchase its
equipment. New York Exhibit 5.
However, the Board's prior decisions did not turn on the
absence of such a showing. Instead, the Board upheld the
disallowances based on its finding that "funding for the
interest at issue here is unallowable under the interest
provision of OMB Cir. A-87, which is made expressly
applicable by the program regulations." DAB No. 1360, at
4. The Board did note in DAB No. 1360 that "the interest
cost could be viewed as an optional financing mechanism
chosen by New York which was neither directly related to
nor necessarily incurred for the program [in that case,
the Social Security Disability Determination program]."
DAB No. 1360, at 5, n. 5. However, the Board
specifically stated that it was not addressing this issue
"since we conclude that the interest charge in any event
is an unallowable cost under the applicable regulatory
framework." Id.
Accordingly, even assuming that New York is correct that
it had no choice but to finance its purchase and that its
financing method was the most economical, the Board could
not find the interest costs allowable since the Board is
bound by the applicable regulations.
Conclusion
For the foregoing reasons, we uphold the disallowance of
$690,726 in interest costs incurred by New York for the
purchase of computer equipment.
___________________________
Cecilia Sparks Ford
___________________________
Norval D. (John) Settle
___________________________
Donald F. Garrett
Presiding Board Member
1.
The costs claimed were allocated among the federal
programs in accordance with New York's approved cost
allocation plan. Since New York received predominantly
HHS grants (see letter from Bamundo to Dowling dated
8/17/94 (DCA's disallowance determination), Attachment
A), HHS was presumably the cognizant federal agency for
purposes of approving New York's cost allocation plan and
determining whether costs were properly charged in
accordance with that plan.
2.
At New York's request, the record for DAB Nos. 1360 and
1417 is incorporated in the record for this decision.
3.
As previously noted, not all of the federal programs to
which the costs in question here were charged were HHS
programs. However, New York limited its argument to HHS,
and did not indicate whether any of the other agencies in
question had waived the grants exemption or had adopted
OMB Circular A-87 using notice and comment rulemaking
procedures. We therefore assume for purposes of this
decision that the Circular was properly applied to the
grants administered by the other agencies.
4.
It is not clear what form of public participation there
was in the formulation of the original version of OMB
Circular A-87. It is likely that drafts were circulated
to states and/or organizations representing state
interests. Most of the revisions to the Circular adopted
by HHS in 1980 were published by OMB in proposed form for
public comment in the Notices section of the Federal
Register prior to the adoption of the final version. 44
Fed. Reg. 37707 (June 28, 1979) (proposed); 45 Fed. Reg.
27363 (April 22, 1980) (final).
5.
New York cited in this connection the common rule
adopted by numerous agencies, including HHS, to implement
revised OMB Circular A-102 (administrative requirements
for grants to state and local governments). The rule
states that all inconsistent grants administration
requirements in existing program regulations are
rescinded except to the extent they are required by
legislation or approved by OMB. See 53 Fed. Reg. 8034,
8035 (March 11, 1988).
6.
The example cited by New York was a proposal by HHS to
simplify OMB Circular A-102. 49 Fed. Reg. 6927 (February
24, 1984). However, HHS specifically stated that "[a]ll
HHS departures from OMB Circular A-102 will require OMB
approval before issuance in final form . . . ," and noted
that its proposal might become unnecessary if OMB itself
revised the Circular (which OMB subsequently did). Id.
at 6928.
7.
The Circular states in pertinent part:
Financing costs (including interest) paid or
incurred on or after the effective date of this
Circular associated with otherwise allowable costs
of equipment is allowable, subject to the conditions
in (1)-(4).
OMB Circular A-87, Attachment B, 26.b.
8.
New York cited Pasadena Hospital Association Ltd. v.
United States, 618 F.2d 728 (Cl. Ct. 1980), for the
proposition that "[t]he standard for determining whether
a rule may be implemented on a retroactive basis is that
retroactivity is permissible so long as it is reasonable
to do so." New York reply brief at 8. However, this
decision merely states that retroactive application of a
regulation is not per se unlawful.
9.
The discretionary nature of the decision whether to
allow an administrative cost is also clear from the fact
that OMB engaged in a cost analysis to determine whether
interest incurred prior to the effective date of the
Circular should be allowable. See 60 Fed. Reg. 26486,
where OMB determined that the cost of pre-revision debt
on computer equipment would likely be greater than the
administrative cost associated with maintaining separate
records to track pre-revision and post-revision debt.
(The preamble indicates that, based on the same analysis,
pre-revision debt for equipment other than computers
should be allowable. 60 Fed. Reg. 26486. However, the
text of the Circular inexplicably does not provide that
such pre-revision debt is allowable.)
New York argued that this analysis was simply not
relevant to the allowability of interest costs, and that
OMB's determination that pre-revision interest costs were
unallowable was therefore arbitrary and capricious. Even
if we agreed with that position (which we do not
necessarily), as discussed in the next section, the Board
is bound by applicable laws and regulations and may not
reverse a disallowance based on such arguments.
10.
We note in any event that, as the Board pointed out in
DAB No. 1360, the FAR allow the capital cost of money for
facilities, not equipment. In addition, 45 C.F.R.
75.81, effective August 25, 1994, provides that "no HHS
funds may be paid as profit to any recipient even if the
recipient is a commercial organization." The regulation
defines "profit" as "any amount in excess of allowable
direct and indirect costs."