Management Report
Improvements Are Needed in Internal Control Over Financial Reporting for the Troubled Asset Relief Program Gao ID: GAO-10-743R June 30, 2010The Emergency Economic Stabilization Act of 2008 (EESA) requires that we annually audit the financial statements of the Troubled Asset Relief Program (TARP) which is implemented by the Office of Financial Stability (OFS). On December 9, 2009, we issued our audit report including (1) an unqualified opinion on OFS's financial statements for TARP as of and for the period ended September 30, 2009, and (2) an opinion that OFS maintained effective internal control over financial reporting as of September 30, 2009. We also reported that our tests of OFS's compliance with selected provisions of laws and regulations for the period ended September 30, 2009, disclosed no instances of noncompliance. Our December 9, 2009, audit report concluded that although certain internal controls could be improved, OFS maintained, in all material respects, effective internal control over financial reporting as of September 30, 2009, that provided reasonable assurance that misstatements, losses, or noncompliance material in relation to the financial statements would be prevented or detected and corrected on a timely basis. Our audit report also identified two significant deficiencies in OFS's internal control over financial reporting. This report presents (1) more details concerning underlying specific control deficiencies that contributed to the two significant deficiencies identified in our audit report, (2) other less significant control deficiencies that we identified during our audit, and (3) related recommendations for corrective actions. While the deficiencies we identified are not considered material weaknesses, they warrant management's attention and action. The recommendations presented in this report are in addition to those we have made as part of the series of reports issued on our ongoing oversight of TARP.
We identified two significant deficiencies in OFS's internal control over financial reporting concerning (1) accounting and financial reporting processes and (2) verification procedures over the data used for asset valuations. The significant deficiency concerning accounting and financial reporting processes was the combination of several underlying specific control deficiencies. Specifically, (1) OFS did not effectively implement its review and approval process for preparing its fiscal year 2009 financial statements and related disclosures for TARP; (2) OFS had not finalized its written procedures related to its processes for accounting for certain program transactions, preparing its September 30, 2009, financial statements, and its oversight and monitoring of financial-related services provided to OFS by asset managers and certain financial agents; and (3) OFS did not have proper segregation of duties over a significant accounting database it uses in valuing its assets in that the same individual was responsible for performing both the data entry and the reconciliation of the data output. However, OFS had developed and implemented other controls over TARP transactions and activities that reduced the risk of material misstatements resulting from these deficiencies. With regard to the second significant deficiency, OFS did not effectively implement its verification procedures for certain assumptions and data that were input into the economic and financial credit subsidy models used for the valuation of TARP direct loans, equity investments, and asset guarantees. OFS reduced the risk of misstatements resulting from this data verification deficiency by performing procedures to assess the reasonableness of the model outputs, including comparison of the asset valuations calculated by the model with independently performed valuations. In addition to the two significant deficiencies, we identified other less significant control deficiencies related to (1) tracking executed agreements, (2) recording warrant transactions, and (3) reconciliations of disbursements to and refunds from the TARP custodian. We are making 17 recommendations related to OFS's significant deficiencies and 3 recommendations related to the other less significant control deficiencies. In commenting on a draft of this report, the Assistant Secretary for Financial Stability stated that OFS concurred with the recommendations in our draft report.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Gary T. Engel Team: Government Accountability Office: Financial Management and Assurance Phone: (202) 512-8815GAO-10-743R, Management Report: Improvements Are Needed in Internal Control Over Financial Reporting for the Troubled Asset Relief Program
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GAO-10-743R:
United States Government Accountability Office:
Washington, DC 20548:
June 30, 2010:
The Honorable Herbert M. Allison, Jr.
Assistant Secretary for Financial Stability:
Office of Financial Stability:
Department of the Treasury:
Subject: Management Report: Improvements Are Needed in Internal
Control Over Financial Reporting for the Troubled Asset Relief Program:
Dear Mr. Allison:
The Emergency Economic Stabilization Act of 2008 (EESA)[Footnote 1]
requires that we annually audit the financial statements[Footnote 2]
of the Troubled Asset Relief Program (TARP) which is implemented by
the Office of Financial Stability (OFS).[Footnote 3] On December 9,
2009, we issued our audit report[Footnote 4] including (1) an
unqualified opinion on OFS's financial statements for TARP as of and
for the period ended September 30, 2009, and (2) an opinion that OFS
maintained effective internal control over financial reporting as of
September 30, 2009. We also reported that our tests of OFS's
compliance with selected provisions of laws and regulations for the
period ended September 30, 2009, disclosed no instances of
noncompliance.
Our December 9, 2009, audit report concluded that although certain
internal controls could be improved, OFS maintained, in all material
respects, effective internal control over financial reporting as of
September 30, 2009, that provided reasonable assurance that
misstatements, losses, or noncompliance material in relation to the
financial statements would be prevented or detected and corrected on a
timely basis. Our audit report also identified two significant
deficiencies in OFS's internal control over financial reporting.
[Footnote 5]
This report presents (1) more details concerning underlying specific
control deficiencies that contributed to the two significant
deficiencies identified in our audit report, (2) other less
significant control deficiencies that we identified during our audit,
and (3) related recommendations for corrective actions. While the
deficiencies we identified are not considered material weaknesses,
they warrant management's attention and action. The recommendations
presented in this report are in addition to those we have made as part
of the series of reports issued on our ongoing oversight of TARP.
[Footnote 6]
Results in Brief:
We identified two significant deficiencies in OFS's internal control
over financial reporting concerning (1) accounting and financial
reporting processes and (2) verification procedures over the data used
for asset valuations.
The significant deficiency concerning accounting and financial
reporting processes was the combination of several underlying specific
control deficiencies. Specifically, (1) OFS did not effectively
implement its review and approval process for preparing its fiscal
year 2009 financial statements and related disclosures for TARP; (2)
OFS had not finalized[Footnote 7] its written procedures related to
its processes for accounting for certain program transactions,
preparing its September 30, 2009, financial statements, and its
oversight and monitoring of financial-related services provided to OFS
by asset managers and certain financial agents; and (3) OFS did not
have proper segregation of duties over a significant accounting
database it uses in valuing its assets in that the same individual was
responsible for performing both the data entry and the reconciliation
of the data output. However, OFS had developed and implemented other
controls over TARP transactions and activities that reduced the risk
of material misstatements resulting from these deficiencies.
With regard to the second significant deficiency, OFS did not
effectively implement its verification procedures for certain
assumptions and data that were input into the economic and financial
credit subsidy models used for the valuation of TARP direct loans,
equity investments, and asset guarantees. OFS reduced the risk of
misstatements resulting from this data verification deficiency by
performing procedures to assess the reasonableness of the model
outputs, including comparison of the asset valuations calculated by
the model with independently performed valuations.
In addition to the two significant deficiencies, we identified other
less significant control deficiencies related to (1) tracking executed
agreements, (2) recording warrant transactions, and (3)
reconciliations of disbursements to and refunds from the TARP
custodian.
We are making 17 recommendations related to OFS's significant
deficiencies and 3 recommendations related to the other less
significant control deficiencies.
In commenting on a draft of this report, the Assistant Secretary for
Financial Stability stated that OFS concurred with the recommendations
in our draft report. The Assistant Secretary also stated that OFS
began taking actions related to these recommendations in January 2010
following the release of our audit report and expects to have
implemented corrective actions for all recommendations by September
30, 2010.
Scope and Methodology:
As part of our audit of OFS's fiscal year 2009 financial statements
for TARP, we evaluated the design and operating effectiveness of OFS's
internal control over financial reporting. We tested relevant internal
controls over financial reporting, including those designed to provide
reasonable assurance that (1) transactions are properly recorded,
processed, and summarized to permit the preparation of the financial
statements in conformity with U.S. generally accepted accounting
principles (GAAP), and assets are safeguarded against loss from
unauthorized acquisition, use, or disposition; and (2) transactions
are executed in accordance with the laws governing the use of budget
authority and other laws and regulations that could have a direct and
material effect on the financial statements.
We did not evaluate all internal controls relevant to operating
objectives as broadly established under 31 U.S.C. § 3512(c), (d),
commonly known as the Federal Managers' Financial Integrity Act, such
as those controls relevant to preparing statistical reports and
ensuring efficient operations. We limited our internal control testing
to controls over financial reporting. Because of inherent limitations,
internal control may not prevent or detect and correct misstatements
due to error or fraud, losses, or noncompliance. Additional details on
our audit methodology can be found in our December 2009 audit report.
[Footnote 8]
We performed our audit of OFS's fiscal year 2009 financial statements
for TARP in accordance with U.S. generally accepted government
auditing standards. We believe that our audit provided a reasonable
basis for our conclusions in this report.
We requested comments on a draft of this report from the Assistant
Secretary for Financial Stability. In a letter dated June 17, 2010,
OFS commented on our draft report. OFS's comments are reprinted in
enclosure I.
Background:
Since its inception on October 3, 2008, OFS has implemented numerous
initiatives under TARP that were designed to help ensure overall
stability and liquidity of the financial system and help preserve
homeownership. During fiscal year 2009, OFS primarily made equity
investments in and direct loans to hundreds of entities, including
financial institutions and automotive companies; however, most of the
value of its investments and loans was concentrated in a limited
number of high-dollar transactions. Specifically, during fiscal year
2009, OFS disbursed about $364 billion, of which $318 billion (or 87
percent) was disbursed to 20 TARP participants, such as American
International Group, Inc.; General Motors; Bank of America; and
Citigroup. In addition, while OFS had started to implement its Home
Affordable Modification Program (HAMP) during fiscal year 2009, the
amounts disbursed were less than $1 million through September 30, 2009.
During fiscal year 2009, OFS made significant progress in building a
financial reporting structure for TARP, including developing an
internal control system over TARP activities and transactions and
addressing key accounting and financial reporting issues necessary to
enable it to prepare financial statements for TARP and to receive an
audit opinion on those statements, for the period ended September 30,
2009. However, OFS's financial reporting structure continued to evolve
throughout the year as new TARP programs were implemented,[Footnote 9]
which posed a challenge to OFS's ability to establish a comprehensive
system of internal control while simultaneously reacting to market
events and evolving TARP initiatives and responsibilities.
Significant Deficiencies:
The following sections present additional information concerning the
specific underlying control deficiencies that contributed to the two
significant deficiencies we identified related to (1) accounting and
financial reporting processes and (2) verification procedures over the
data used for asset valuations,[Footnote 10] along with our related
recommendations for corrective actions.
Accounting and Financial Reporting Processes:
While OFS had developed and implemented controls over TARP
transactions and activities, we identified several specific control
deficiencies that collectively represented a significant deficiency in
OFS's internal control over its accounting and financial reporting
processes. Specifically, OFS did not effectively implement its review
and approval process for preparing its financial statements and
related disclosures for TARP. In addition, OFS did not finalize its
written procedures for accounting for certain program transactions,
preparing its September 30, 2009, financial statements, and overseeing
and monitoring financial-related services asset managers and financial
agents provided to OFS. Further, OFS did not have proper segregation
of duties over a significant accounting database it used in valuing
its assets in that the same individual was responsible for performing
both the data entry and the reconciliation of the data output.
However, OFS had developed and implemented other controls over TARP
transactions and activities that reduced the risk of material
misstatements resulting from these deficiencies.
Financial Statements Review and Approval Process:
OFS did not effectively implement its review and approval process for
preparing its fiscal year 2009 financial statements and related
disclosures for TARP. While OFS had draft procedures for the
preparation of year-end financial statements and performed year-end
review and approval processes, we identified incorrect amounts and
inaccurate, inconsistent, and incomplete disclosures in OFS's draft
financial statements, footnotes, and Management's Discussion and
Analysis (MD&A) for TARP that were significant, but not material, and
that were not detected by OFS. Office of Management and Budget (OMB)
Circular No. A-136, Financial Reporting Requirements,[Footnote 11]
requires agencies to ensure that information in the financial
statements is presented in accordance with GAAP for federal entities.
Without an effectively implemented review and approval process for
preparing financial statements and related disclosures, an agency is
at risk of presenting information that is inaccurate, incomplete, or
not in conformity with GAAP.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the Chief Financial Officer (CFO) to establish a mechanism for
the effective implementation of the review and approval process for
preparing the year-end financial statements and related disclosures,
including MD&A, for TARP.
Procedures for Accounting and Financial Reporting:
OFS had developed and implemented written procedures related to many
of its accounting and financial reporting processes, such as
disbursement and receipt processing and asset valuation. However, OFS
had not finalized other procedures related to its processes for
accounting for certain program transactions, preparing its September
30, 2009, financial statements, and its oversight and monitoring of
financial-related services provided to OFS by asset managers and
certain financial agents. As detailed below, procedures were not
finalized either because they were in draft form, did not address
certain specific issues, or had not yet been developed.
Standards for Internal Control in the Federal Government[Footnote 12]
provides that agencies should establish internal controls for all
transactions and other significant events and that these transactions
should be clearly documented, and the documentation should be readily
available for examination. It further provides that documentation
should appear in management directives, administrative policies, or
operating manuals. The 10 accounting and financial reporting areas in
which OFS did not fully comply with these provisions, along with
certain other applicable guidance, relate to:
* modifications of direct loans, equity investments, and asset
guarantees;
* subsequent events;
* contractor's economic and financial model review findings;
* economic and financial model error and warning messages;
* economic and financial model assumptions derived from informed
opinion;
* interest, dividends, and distributions receivable;
* preparing financial statements;
* asset manager data used in the asset valuation process;
* oversight of HAMP financial agents; and,
* estimating the HAMP liability.
* Modifications of direct loans, equity investments, and asset
guarantees. Although OFS performed steps to identify and evaluate
modifications (government actions, such as a change in contract terms,
that alter the cost of a program),[Footnote 13] OFS did not have
specific written procedures necessary to help ensure complete,
accurate, and consistent identification and evaluation of
modifications of direct loans, equity investments, and asset
guarantees. Personnel from OFS's Office of Credit Modeling and
Analysis (OCMA) conducted informal discussions with personnel from
OFS's Office of the Chief Investment Officer (OCIO) to obtain
information on asset-related events that could be modifications, such
as amendments to contracts. While OCMA relied on OCIO to help identify
potential modifications, OFS lacked specific written procedures to
define OCIO and OCMA roles and responsibilities and criteria for OCIO
and OCMA to use to help ensure comprehensive, accurate, and consistent
identification and evaluation of such events. In addition, OFS lacked
specific written procedures requiring documentation of management
review and approval, and OMB approval, of the modification subsidy
cost estimate. However, OFS did maintain documentation of the nature
of the modifications, the cost of the modifications, and OMB's
approval.
The Federal Accounting Standards Advisory Board's (FASAB), Federal
Financial Accounting and Auditing Technical Release 6 (Technical
Release 6),[Footnote 14] calls for management to ensure that
documentation is available for modifications, including the review and
approval process of the modification subsidy cost estimate and the
sign-off procedure within the agency. The lack of written procedures
for the identification and evaluation of modifications increases the
risk that all modifications are not timely identified, evaluated, and
described in the financial statements and related disclosures.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to develop and implement written procedures for
identifying and evaluating modifications of direct loans, equity
investments, and asset guarantees, to include: specific roles and
responsibilities, criteria to identify modifications, documentation of
management review and approval, and:
documentation of OMB approval of the modification subsidy cost
estimate.
* Subsequent events. OFS did not have written procedures to identify
and evaluate subsequent events[Footnote 15] that could require
revisions to its asset valuations or additional disclosures in the
notes to its financial statements. After OFS's year-end, but before
OFS issued its financial statements, we identified certain subsequent
events that could have affected asset valuations and financial
statement disclosures. At our request, OFS developed and implemented
draft procedures to identify and evaluate the effect on OFS's asset
valuation of the failure, such as a bankruptcy, of a TARP participant
subsequent to year-end. As a result of implementing these procedures,
OFS revised certain asset valuations and added additional disclosures
to its financial statements.[Footnote 16] However, a lack of finalized
procedures for consideration of subsequent events in the asset
valuation process increases OFS's risk of not consistently following
procedures from period to period and risk of misstatements and
insufficient disclosures.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to finalize and implement OFS's draft written
procedures for identifying and evaluating any subsequent events that
could have an effect on asset valuations and related disclosures.
* Contractor's economic and financial model review findings. OFS did
not have written procedures for formally tracking the resolution of
findings from independent verification and validation reviews of its
economic and financial models used for valuing TARP direct loans,
equity investments, and asset guarantees. OFS hired a contractor to
perform an independent verification and validation of the technical
accuracy of OFS's economic and financial models. The contractor
provided OFS reports that summarized its review procedures and
findings, including potential errors that could affect the models'
calculations. Although OFS provided information on actions taken to
address the contractor's findings, OFS did not have documentation
linking the actions to the findings and showing the resolution of each
of the contractor's findings. Consequently, OFS faces an increased
risk that model errors were not appropriately resolved. Unresolved
errors in the economic and financial models increase the risk that the
direct loans, equity investments, and asset guarantees may be
misstated in the financial statements.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to develop and implement written procedures for
tracking the resolution of independent verification and validation
findings related to OFS's economic and financial models used for
valuing TARP direct loans, equity investments, and asset guarantees.
* Economic and financial model error and warning messages. OFS's
written asset valuation procedures did not include specific steps for
the identification, resolution, and documentation of error and warning
messages produced by the economic and financial models used for
valuing TARP direct loans, equity investments, and asset guarantees.
The error and warning messages produced by the economic and financial
models alert OFS personnel of potential issues with the model
calculations or data. While OFS provided reasonable explanations
concerning the resolution of the economic and financial model error
and warning messages, OFS did not document these resolutions. Any
unresolved errors in the economic and financial models increase the
risk that the valuation of direct loans, equity investments, and asset
guarantees may be misstated in the financial statements.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to update existing procedures to include procedures for
identifying and resolving economic and financial model error and
warning messages, including requirements to maintain appropriate
supporting documentation regarding the resolution of such instances.
* Economic and financial model assumptions derived from informed
opinion. OFS's written asset valuation procedures did not include
requirements for documenting the use of assumptions derived from
informed opinion[Footnote 17] and OFS did not sufficiently document
its basis for certain assumptions derived from informed opinion. As
part of OFS's valuation of TARP direct loans, equity investments, and
asset guarantees and consistent with FASAB guidance, OFS used informed
opinion to make certain assumptions for use in its economic and
financial models. Although OFS's asset valuation procedures provided
that documentation must discuss all significant assumptions and why
assumptions were selected, OFS's asset valuation procedures did not
specifically require documentation for the use of assumptions derived
from informed opinion. In addition, although OFS documented the
assumptions it used in its economic and financial models and met with
senior officials to review the assumptions and obtain the officials'
approval, OFS did not sufficiently document the basis for certain
assumptions derived from informed opinion. For example, in its
valuation of direct loans, OFS used informed opinion as a basis for
its assumptions of recoveries on defaulted loans. Although OFS
documented its recovery assumption values, it did not sufficiently
document the basis for the opinion on the assumption values. In
another instance, OFS used informed opinion as a basis for its
assumption related to expected prepayments from TARP participants.
However, OFS did not adequately document the basis for the informed
opinion. In both cases, while the opinions were not adequately
documented, OFS was able to sufficiently explain the basis for its
opinions.
FASAB Technical Release 6 states that documentation be provided to
support the assumptions used by the agency in the subsidy calculations
to facilitate the agency's review of the assumptions. The
documentation should be complete such that a knowledgeable independent
person could perform the same steps and replicate the same results
with little or no outside explanation or assistance. In addition,
FASAB Technical Release 6 calls for the basis of the stated opinion to
be articulated and documented in detail when informed opinion is used.
The absence of sufficient supporting documentation of the basis for
certain economic and financial model assumptions derived from informed
opinion may impair management's ability to effectively oversee and
approve assumptions, which increases the risk of misstatements due to
valuation errors.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to update OFS's asset valuation procedures to include
specific requirements for documenting the basis of economic and
financial model assumption values derived from informed opinion
consistent with FASAB Technical Release 6.
* Interest, dividends, and distributions receivable. OFS did not have
written procedures on how income from direct loans and trust preferred
securities should be presented on the Statement of Net Cost, and on
how accrued interest receivable, dividends declared but unpaid, and
distributions receivable should be disclosed in notes to OFS's
financial statements for TARP.[Footnote 18] OFS also did not have
written procedures for the identification of dividends declared but
unpaid as of September 30, 2009.
As of September 30, 2009, OFS had interest receivable relating to
certain direct loans and considered the future cash flows relating to
expected interest payments in valuing its direct loans.[Footnote 19]
OFS evaluated how to present and disclose certain interest-related
accounts. However, OFS did not have written procedures on how to
present interest income on direct loans in the Statement of Net Cost
and disclose any accrued interest receivable in the notes to its
financial statements. According to OMB Circular A-136, management's
method for accruing interest revenue and recording interest receivable
should be disclosed. Also, this circular calls for interest receivable
to be reported as a component of direct loans in the notes to the
financial statements. OFS did not disclose any accrued interest
because it determined that the accrued interest receivable as of
September 30, 2009, was not significant.
Similarly, OFS considered future cash flows relating to expected
dividends from equity securities and expected distributions receivable
from trust preferred securities in valuing such investments. FASAB
standards for credit reform accounting do not contain guidance as to
the presentation in the Statement of Net Cost and disclosure in the
notes to the financial statements of dividends declared but unpaid and
distributions receivable from trust preferred securities. In the
absence of any federal guidance, OFS disclosed in the notes to its
financial statements that it presents in its Statement of Net Cost
dividend revenue when dividends are declared. OFS had not, however,
developed written procedures regarding presentation of income from
trust preferred securities in the Statement of Net Cost. Further,
although OFS took specific steps to determine whether there were any
dividends declared but unpaid as of September 30, 2009, OFS had not
developed written procedures for (1) determining whether such items
existed as of September 30, 2009, or (2) disclosing in the notes to
the financial statements dividends declared but unpaid and, if
applicable, distributions receivable.[Footnote 20]
Without written procedures regarding presentation and disclosure of
the activity and balances discussed above, OFS faces an increased risk
that the financial statements will contain misstatements or will lack
adequate disclosures.
Recommendations for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to develop and implement written procedures for:
* presenting income from direct loans and trust preferred securities
in the Statement of Net Cost,
* identifying any year-end dividends declared but unpaid to OFS from
TARP participants, and:
* disclosing accrued interest receivable, dividends declared but
unpaid, and, if applicable, distributions receivable from trust
preferred securities in OFS's financial statements for TARP.
* Preparing financial statements. OFS had not finalized its draft
procedures for the preparation of the year-end financial statements or
included in its draft procedures all key processes used in the
preparation of the year-end financial statements. While OFS performed
year-end financial statement processes, OFS's written procedures
governing those processes were in varying states of completion. For
example, the processes OFS used in preparing its financial statements,
recording adjusting journal entries after the close of the general
ledger, reconciling general ledger balances, and identifying any
commitments and contingencies were not included in OFS's draft
procedures for financial reporting. OMB Circular No. A-136 provides
that each agency CFO should establish procedures guiding agency fiscal
and management personnel on how to prepare annual financial
statements. Without finalized financial reporting processes, OFS faces
increased risk that the financial statements will contain
misstatements or inadequate disclosures.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to finalize and implement procedures for the
preparation of the year-end financial statements to include all key
preparation processes.
* Asset manager data used in the asset valuation process. While OFS
carried out oversight and monitoring activities, OFS did not have
written procedures detailing how it is to oversee and determine the
reasonableness of the data provided by asset managers and used for
OFS's internally developed TARP asset valuations. OFS contracted
external asset managers to provide, among other things, independently
performed asset valuations and credit scores[Footnote 21] for each
institution. OFS performed specific steps to help ensure consistency
in the methodology applied by the asset managers in preparing their
asset valuations. OFS also analyzed the aggregate valuations and
credit score data provided by the asset managers and explained how
information was used by the asset managers. However, OFS did not
provide documentation of oversight steps performed to determine that
the information provided by the asset managers was reasonable before
using the data in its valuation process. In addition, in connection
with OFS's use of the asset manager valuations to assess the
reasonableness of its internal asset valuations of preferred share
equity investments, OFS investigated differences between OFS's
valuations and those of the asset managers that exceeded a certain
threshold. However, OFS did not document the rationale for the
threshold selected. Without written procedures for overseeing and
assuring the reasonableness of asset manager-provided data, the risk
that misstatements due to valuation errors may not be prevented or
detected and corrected on a timely basis is increased.
Recommendations for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO:
* in coordination with the Chief Investment Officer, to develop and
implement, as part of OFS's oversight and monitoring activities,
written procedures detailing steps to effectively oversee and
determine the reasonableness of data provided by external asset
managers, prior to the use of such data, and:
* to develop and implement written procedures to document the
rationale for established thresholds used in determining whether to
investigate differences between the asset manager valuations and OFS's
internally developed asset valuations.
* Oversight of HAMP financial agents. OFS did not have written
procedures for the oversight and monitoring of its financial agents'--
Federal National Mortgage Association (Fannie Mae) and Federal Home
Loan Mortgage Corporation (Freddie Mac)--administrative and compliance
activities, including internal controls over existence and
completeness of loan data used in determining the HAMP liability. OFS
contracted with Fannie Mae to act as the program administrator and
record keeper of loan data for HAMP and with Freddie Mac to perform
compliance activities related to HAMP servicers.[Footnote 22]Without
clearly documented guidance regarding the specific procedures OFS
should follow to effectively oversee and monitor Fannie Mae and
Freddie Mac, OFS faces an increased risk that the financial
information related to HAMP may not be complete or correct, and OFS
management's ability to identify key risks in this area may also be
impaired. While OFS disbursed less than $1 million during fiscal year
2009 for HAMP, the importance of having written procedures in these
areas will become more significant as HAMP activity increases.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to develop and implement written procedures detailing
steps to be performed in overseeing and monitoring OFS's financial
agents, Fannie Mae and Freddie Mac, including internal controls over
the existence and completeness of loan data used in the determination
of the HAMP liability.
* Estimating the HAMP liability. OFS did not have written procedures
for estimating the HAMP liability. The HAMP liability represents the
liability for payments to servicers and investors and principal
balance reduction payments for the benefit of borrowers under HAMP.
OFS developed a position paper setting out an approach for estimating
the HAMP liability in accordance with SFFAS No. 5, Accounting for
Liabilities in the Federal Government. However, OFS did not document
the specific procedures it used in estimating the HAMP liability.
Without such written procedures, there is an increased risk that
liability amounts will be calculated incorrectly. As of September 30,
2009, the HAMP liability was less than $2 million; however, the
importance of having written procedures in this area will become more
significant as HAMP activity increases.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to develop written procedures for periodically
estimating the HAMP liability.
Segregation of Duties:
OFS did not have proper segregation of duties over a significant
accounting database it uses in valuing certain of its assets. OFS
maintained an accounting database of information that it used for
multiple purposes, including as a source for certain data that were
input into economic and financial models used for the valuation of
TARP direct loans, equity investments, and asset guarantees. OFS
recorded in the accounting database certain institution and
transaction-specific information, such as the name of the institution,
the dollar value of a transaction, and the type of financial
instrument[Footnote 23] involved in the transaction. However, the same
individual was responsible for performing both the data entry and the
reconciliation of the data output.
Specifically, the same OFS staff member performed the incompatible
duties of recording information into the accounting database,
comparing information between the accounting database and reports from
the TARP custodian,[Footnote 24] recording changes in the accounting
database, and reconciling information between the accounting database
and the OFS general ledger.
Consistent with Standards for Internal Control in the Federal
Government, key duties and responsibilities are to be divided or
segregated among different individuals to reduce the risk of error or
fraud. This should include separating the responsibilities for
authorizing transactions, processing and recording them, and reviewing
the transactions. No one individual should control all key aspects of
a transaction or event. Without adequate segregation of duties over
the accounting database, OFS faces an increased risk that error or
fraud related to asset valuation information may occur and not be
detected and corrected on a timely basis.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to develop and implement procedures to segregate the
responsibilities for recording, approving, and reconciling of
information maintained in the accounting database used by OFS in the
asset valuation process.
Verification Procedures over the Data Used for Asset Valuations:
OFS did not effectively implement verification procedures for certain
assumptions and data that were input into the economic and financial
credit subsidy models used for the valuation of TARP direct loans,
equity investments,and asset guarantees. OFS accounts for TARP direct
loans, equity investments, and asset guarantees consistent with the
concepts in SFFAS No. 2, Accounting for Direct Loans and Loan
Guarantees. SFFAS No. 2 requires agencies to value certain assets at
the net present value of estimated future cash flows. Further,
Standards for Internal Control in the Federal Government provides that
control activities help to ensure that all transactions are completely
and accurately recorded. To estimate cash flows for TARP, OFS
developed economic and financial models that use data files, which
include information related to the actual terms of the instruments and
the financial condition of the institutions, as well as assumptions
about future performance. OFS used automated data inputs and a
significant number of manual inputs to create these data files. The
use of manual inputs poses an increased inherent risk of error, and
therefore effective review procedures are needed to reduce such risk.
OFS's established verification procedures related to the valuation of
TARP direct loans, equity investments, and asset guarantees called for
OFS analysts to verify and document that the data files accurately
reflect the data used in the valuation process. However, these
procedures lacked specificity with respect to the steps to follow in
the review of manual inputs that are used in the economic and
financial credit subsidy models. In our audit, we identified data
input errors to the estimation models related to interest and dividend
rates, maturity dates, other instrument-specific terms, and
assumptions related to future performance. Many of the significant
errors we identified related to manual inputs. Significant errors that
we identified were corrected and amounts were properly reflected in
the September 30, 2009, financial statements. OFS did perform
procedures to assess the reasonableness of the model outputs,
including comparison of the asset valuations calculated by the model
with independently performed valuations. These procedures reduced the
risk that management would not detect misstatements resulting from the
data input errors.
However, the lack of effective verification of data inputs used in the
economic and financial credit subsidy models increases the risk that
the asset valuations and related subsidy cost are not completely and
accurately recorded and reliably reported in the financial statements.
Recommendations for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to:
* enhance and implement specific written procedures to verify data
inputs, including manual inputs, used in the economic and financial
models for the valuation of TARP direct loans, equity investments, and
asset guarantees, and help ensure that such verification is clearly
documented, and:
* assess manual inputs used in the economic and financial models for
the valuation of TARP direct loans, equity investments, and asset
guarantees to determine the feasibility of reducing the number of
manual inputs.
Other Control Deficiencies:
In addition to the two significant deficiencies, we identified other
control deficiencies that were not considered material weaknesses or
significant deficiencies, but nevertheless warrant OFS management's
attention and action. Specifically, as discussed in the following
sections, we identified deficiencies concerning OFS controls over:
* tracking executed agreements,
* recording warrant transactions, and:
* reconciliations of disbursements to and refunds from the TARP
custodian.
Tracking Executed Agreements:
OFS lacked a mechanism for tracking the location of TARP executed
agreements including securities purchase agreements for TARP
investments. OFS's contract with the Bank of New York Mellon (BNYM)
established that BNYM is to retain executed agreements and related
legal documentation at a secure facility. According to OFS officials,
after agreements were executed, OFS's legal agents sent executed
agreements and related legal documentation to the BNYM repository, and
BNYM was then responsible for reviewing, sorting, and securely storing
the documents. However, OFS did not have a mechanism for tracking the
location of TARP executed agreements. Our tests revealed that OFS
could not readily locate three agreements. However, in following up on
our tests, OFS ultimately found that the agreements in question were
held by OFS's legal agents.
Standards for Internal Control in the Federal Government provides that
an agency is to establish physical control to secure and safeguard
vulnerable assets. In addition, access to resources and records should
be limited to authorized individuals, and accountability for their
custody and use should be assigned and maintained. Without a mechanism
for reliably tracking the location of TARP executed agreements and
related legal documentation, the records are at risk of loss.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the appropriate personnel to develop, document, and implement a
mechanism to track the location of executed agreements.
Recording Warrant Transactions:
OFS did not have written procedures for recording warrant adjustments
[Footnote 25] and did not properly record certain warrant transactions
in the accounting database used for valuing TARP assets.
The warrant terms stipulate that if a TARP participant declares and
pays a stock dividend,[Footnote 26] the number of shares underlying
the warrant and the price per share is to be adjusted so that Treasury
is entitled to purchase the number of shares of common stock that it
would have been entitled to receive at the exercise price had Treasury
exercised the warrant immediately prior to the effective date[Footnote
27] of the adjustment. However, for the purpose of recording warrant
adjustments related to stock dividends in the accounting database, OFS
incorrectly used the date the shares were distributed to common
shareholders, rather than the effective date of the warrant
adjustment. We also found that OFS did not properly record in the
accounting database certain other warrant adjustments resulting from
events that occurred prior to September 30, 2009. Generally, if a TARP
participant in the Capital Purchase Program issued qualified stock
prior to December 31, 2009, the number of shares underlying the
warrant was to be reduced by half. However, we found that OFS did not
always properly record in the accounting database the transactions to
reduce these warrants by half. These errors in OFS's warrant records,
although not significant, nonetheless resulted in misstatements in
OFS's financial statements for TARP.
Standards for Internal Control in the Federal Government provides that
agencies should have controls in place to provide reasonable assurance
that financial transactions are recorded completely and accurately and
that internal control be clearly documented in management directives,
administrative policies, or operating manuals. Without effective
procedures to reasonably ensure that warrant adjustments are properly
recorded, OFS faces an increased risk of undetected misstatements of
the related TARP assets.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to develop and implement written procedures specifying
detailed steps to be followed to reasonably ensure that warrant
adjustments are properly recorded in the accounting database OFS uses
for valuing TARP assets.
Reconciliations of Disbursements to and Refunds from the TARP
Custodian:
OFS did not always document reconciliations of key documents for
disbursements to and refunds from BNYM, the TARP custodian, and did
not have an effective monitoring process to identify instances where
such reconciliations were not documented. As part of OFS's
disbursement process, BNYM disbursed funds received from OFS to
individual TARP participants. OFS's written procedures require OFS
personnel to reconcile the resulting key documents, such as the
disbursement authorization, payment system voucher, and the BNYM
confirmation notice of funds received. Although OFS documented its
reconciliations in certain instances and maintained records of the key
documents used in the disbursement process, OFS did not always
document such reconciliations as required. OFS disburses funds to BNYM
based on its expectation of the transactions with TARP participants
scheduled to occur on a particular day. However, in some instances,
certain transactions are not completed on the scheduled day and BNYM
refunds the corresponding amounts to OFS. OFS also did not always
document reconciliations related to refunds from BNYM as required.
Standards for Internal Control in the Federal Government specifies
that control activities include approvals, authorizations,
verifications, reconciliations, and the creation and maintenance of
related records that provide evidence of the execution of these
activities as well as appropriate documentation. Although our tests
did not identify any errors in amounts disbursed or refunded, by not
always following established procedures for the documentation of
disbursement-and refund-related reconciliations, OFS faces an
increased risk that it will not timely detect any incorrect
disbursements to or refunds from BNYM.
Recommendation for Executive Action:
We recommend that the Assistant Secretary for Financial Stability
direct the CFO to establish procedures to effectively monitor the
documentation of reconciliations of key documents related to
disbursements to and refunds from BNYM as prescribed in OFS's written
procedures.
Agency Comments:
In commenting on a draft of this report, the Assistant Secretary for
Financial Stability stated that OFS concurred with the recommendations
in our draft report. The Assistant Secretary also stated that OFS
began taking actions related to these recommendations in January 2010
following the release of our audit report and expects to have
implemented corrective actions for all recommendations by September
30, 2010. We plan to follow up to determine the status of corrective
actions taken for these matters during our fiscal year 2010 audit.
This report is intended for use by OFS management. We are sending
copies of this report to interested congressional committees and
members, the Secretary of the Treasury, Inspector General of the
Department of the Treasury, Special Inspector General for TARP,
Congressional Oversight Panel, Financial Stability Oversight Board,
Director of the Office of Management and Budget, and others. In
addition, this report is available at no charge on GAO's Web site at
[hyperlink, http://www.gao.gov].
We acknowledge and appreciate the cooperation and assistance provided
by OFS management and staff during our audit of OFS's fiscal year 2009
financial statements for TARP. If you have questions about this
report, please contact me at (202) 512-3406 or engelg@gao.gov. Contact
points for our Offices of Congressional Relations and Public Affairs
may be found on the last page of this report. GAO staff who made major
contributions to this report are listed in enclosure II.
Sincerely yours,
Signed by:
Gary T. Engel:
Director:
Financial Management and Assurance:
Enclosures - 2:
[End of section]
Enclosure I: Comments from the Office of Financial Stability:
Department Of The Treasury:
Assistant Secretary:
Washington, D.C. 20220:
June 17, 2010:
Mr. Gary T. Engel:
Director, Financial Management and Assurance:
U.S. Government Accountability Office:
Dear Mr. Engel:
We have received a copy of your draft report entitled Management
Report: Improvements Are Needed in Internal Control Over Financial
Reporting for the Troubled Asset Relief Program (GAO-10-743R).
We are pleased that you noted in your report that the Office of
Financial Stability received unqualified opinions on both the OFS FY
2009 financial statements and internal control over financial
reporting and had no identified instances of noncompliance with
selected provisions of laws and regulations.
We have reviewed the detailed recommendations that you have provided
regarding the two significant deficiencies you identified during your
FY 2009 audit and regarding the other less significant control
deficiencies. We concur with your draft recommendations.
Through coordination with your staff and our understanding of the
Matters for Further Consideration that we responded to during the FY
2009 audit, we began taking action on the recommendations in January
2010 immediately after your final audit report was released. We have
made the necessary improvements to our processes and procedures. We
expect to implement the majority of other necessary changes by June
30, 2010 and any remaining changes by September 30, 2010.
Sincerely,
Signed by:
Herbert M. Allison, Jr.
Assistant Secretary:
Office of Financial Stability:
[End of section]
Enclosure II: Staff Acknowledgments:
The following individuals made major contributions to this report:
Marcia L. Carlsen, Lynda E. Downing, and Joseph P. O‘Neill, Assistant
Directors; Janaya D. Davis-Lewis, Vincent Gomes, Diane M. Koch, Steven
M. Koons, Mary V. Osorno, Grant L. Simmons, Anne Y. Sit-Williams, and
Chris G. Yfantis.
[End of section]
Footnotes:
[1] Pub. L. No. 110-343, Div. A, 122 Stat. 3765 (Oct. 3, 2008),
codified in part, as amended, at 12 U.S.C. §§ 5201-5261.
[2] Section 116(b) of EESA, 12 U.S.C. § 5226(b), requires that the
Department of the Treasury (Treasury) annually prepare and submit to
Congress and the public audited fiscal year financial statements for
TARP that are prepared in accordance with generally accepted
accounting principles. Section 116(b) further requires that GAO audit
TARP's financial statements annually in accordance with generally
accepted auditing standards.
[3] Section 101 of EESA, 12 U.S.C. § 5211, established OFS within
Treasury to implement TARP.
[4] GAO, Financial Audit: Office of Financial Stability (Troubled
Asset Relief Program) Fiscal Year 2009 Financial Statements,
[hyperlink, http://www.gao.gov/products/GAO-10-301] (Washington, D.C.:
Dec. 9, 2009).
[5] A significant deficiency is a deficiency, or combination of
deficiencies, in internal control that is less severe than a material
weakness, yet important enough to merit attention by those charged
with governance. A material weakness is a deficiency, or combination
of deficiencies, in internal control such that there is a reasonable
possibility that a material misstatement of the entity's financial
statements will not be prevented, or detected and corrected on a
timely basis. A deficiency in internal control exists when the design
or operation of a control does not allow management or employees, in
the normal course of performing their assigned functions, to prevent,
or detect and correct misstatements on a timely basis.
[6] Section 116(a) of EESA, 12 U.S.C. § 5226(a), requires GAO to
report at least every 60 days on TARP activities and performance.
Products and recommendations related to GAO's oversight of TARP are
available on GAO's Web site at [hyperlink, http://www.gao.gov].
[7] Procedures that had not been finalized were either in draft form,
did not address certain specific issues, or had not yet been developed.
[8] [hyperlink, http://www.gao.gov/products/GAO-10-301].
[9] For example, in October 2008, OFS established the Capital Purchase
Program and purchased $115 billion in preferred stock and warrants; in
December 2008, Treasury announced and began implementing the
Automotive Industry Financing Program; in March 2009, Treasury and the
Federal Reserve announced the launch of the Term Asset-backed
Securities Loan Facility; in August 2009, OFS began to make
disbursements for the Home Affordable Modification Program; and, also
in September 2009, OFS signed commitments to invest in limited
partnerships under the Public-Private Investment Program.
[10] OFS accounts for its equity investments at fair value, defined as
the estimated amount of proceeds OFS would receive if the equity
investments were sold to a market participant. OFS derives fair value
measurements by applying the provisions of Statement of Federal
Financial Accounting Standards (SFFAS) No. 2, Accounting for Direct
Loans and Loan Guarantees, to account for TARP direct loans, equity
investments, and asset guarantees. SFFAS No. 2 requires the
measurement of certain assets at the net present value of the
estimated future cash flows. OFS used economic and financial models to
estimate future cash flows for TARP. The economic and financial models
reflect specific terms and conditions of the program and financial
instruments, technical assumptions regarding the underlying assets,
risk of loss, and other factors, as appropriate.
[11] OMB Circular No. A-136, Financial Reporting Requirements (Revised
June 2009), establishes a central point of reference for federal
financial reporting guidance for executive branch agencies required to
submit audited financial statements.
[12] GAO, Standards for Internal Control in the Federal Government,
[hyperlink, http://www.gao.gov/products/GAO/AIMD-00-21.3.1]
(Washington, D.C.: November 1999), contains the internal control
standards to be followed by executive agencies in establishing and
maintaining systems of internal control as required by 31 U.S.C. §
3512 (c), (d) (commonly referred to as the Federal Managers' Financial
Integrity Act of 1982).
[13] According to OMB Circular No. A-11 §185, Preparation, Submission,
and Execution of the Budget, (Revised November 2009), the term
"modification" means a federal government action, including new
legislation or administrative action that directly or indirectly
alters the estimated subsidy cost and the present value of the asset.
There are situations where it is not clear whether a government action
constitutes a modification. These situations should be judged on a
case-by-case basis by OMB in consultation with the agency involved.
Agencies must have budget authority available to cover the cost of a
modification that increases the subsidy cost before the modification
takes place.
[14] Federal Accounting Standards Advisory Board, Federal Financial
Accounting and Auditing Technical Release 6: Preparing Estimates for
Direct Loan and Loan Guarantee Subsidies under the Federal Credit
Reform Act - Amendments to Technical Release No. 3 Preparing and
Auditing Direct Loan and Loan Guarantee Subsidies under the Federal
Credit Reform Act (January 2004).
[15] According to SFFAS No. 5, Accounting for Liabilities of the
Federal Government, subsequent events are events or transactions that
occur subsequent to the balance sheet date but prior to the issuance
of the financial statements and auditor's report that have a material
effect on the financial statements and therefore require adjustment or
disclosure in the statements.
[16] According to AU Section 560.07, Subsequent Events (American
Institute of Certified Public Accountants Professional Standards),
subsequent events affecting the realization of assets such as
receivables and inventories or the settlement of estimated liabilities
ordinarily will require adjustment of the financial statements because
such events typically represent the culmination of conditions that
existed over a relatively long period of time.
[17] Informed opinion refers to the judgment of agency staff or others
who make subsidy estimates based on their programmatic knowledge,
experience, or both. Informed opinion is considered an acceptable
approach under Technical Release 6 when adequate historical data does
not exist.
[18] Under multiple TARP programs, OFS held direct loans, equity
investments, and trust preferred securities. Direct loans accrue
interest and equity securities generally entitle OFS to receive
periodic dividends if and when dividends are declared by the
corresponding issuer of the securities. Trust preferred securities
generally entitle OFS to receive certain distributions consistent with
the terms of the financial instruments held by the corresponding trust.
[19] OFS applies the provisions of Statement of Federal Financial
Accounting Standards (SFFAS) No. 2, Accounting for Direct Loans and
Loan Guarantees, to account for TARP direct loans, equity investments,
and asset guarantees. SFFAS No. 2 requires the measurement of certain
assets at the net present value of the estimated future cash flows.
OFS includes future dividends and interest in its cash flow estimates.
[20] OFS performed procedures and concluded that there were no
significant dividends declared but unpaid as of September 30, 2009.
[21] The asset managers' credit scores are based on assessments of the
capital adequacy, asset quality, earnings, and liquidity of each
financial institution and represent a forward-looking risk of failure,
which correlates to the likelihood of repayment of TARP funds.
[22] Under HAMP, Treasury enters into contracts with servicers--
financial institutions that commit to modify mortgages and to receive
and make payments in accordance with specified criteria.
[23] Financial instruments include preferred stock, common stock,
warrants for the purchase of common stock, and subordinated debentures.
[24] Bank of New York Mellon (BNYM) functions as the TARP custodian
by, among other things, taking possession of stock certificates,
storing agreements, and generating reports related to TARP
transactions.
[25] A warrant is an option to buy shares of common stock or preferred
stock at a predetermined price (i.e., exercise price) on or before a
specified date. A warrant adjustment is a change to the exercise
price, the number of shares underlying the warrant, or both because of
various events such as stock splits and stock dividends.
[26] A stock dividend is the payment of a dividend on an entity's
shares of common stock in the form of additional shares of common
stock rather than in cash.
[27] The effective date would be the ex-dividend date, which is the
date on which a transaction, such as a stock dividend, is effective
for the party holding the security on that date.
[End of section]
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