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U.S. ENVIRONMENTAL PROTECTION AGENCY
OFFICE OF INSPECTOR GENERAL
Catalyst for Improving the Environment
Special Report
Innovative Techniques for State
Monitoring of Revolving Funds Noted
Report No. 08-P-0290
September 29, 2008
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Abbreviations
DHEC Department of Health and Environmental Control (South Carolina)
EPA U.S. Environmental Protection Agency
IFA Indiana Finance Authority
OIG Office of Inspector General
OMB Office of Management and Budget
SRF State Revolving Fund
Cover photo: Service Reservoir #6 in Anchorage, Alaska, for which work was funded by
the State Revolving Fund (photo courtesy Alaska Department of
Environmental Conservation)
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U.S. Environmental Protection Agency
Office of Inspector General
At a Glance
08-P-0290
September 29, 2008
Catalyst for Improving the Environment
Why We Did This Review
We conducted this special
review to determine whether
the States receiving State
Revolving Funds comply with
the subrecipient monitoring
requirements of the Single
Audit Act, Clean Water Act,
and Safe Drinking Water Act.
We also reviewed procedures
the States use to prevent and
detect fraud in the State
Revolving Funds.
Background
The State Revolving Funds are
the U.S. Environmental
Protection Agency's (EPA's)
largest programs, with
approximately $74 billion in
loans and other type of
assistance outstanding as of
June 30, 2007. About
$1.5 billion was awarded in
2008. The goal of subrecipient
monitoring is to ensure projects
meet performance goals and
borrowers spend federal funds
in accordance with the intent of
the laws and regulations.
For further information,
contact our Office of
Congressional and Public
Liaison at (202) 566-2391.
To view the full report,
click on the following link:
www.epa.qov/oiq/reports/2008/
20080929-08-P-0290.pdf
Innovative Techniques for State Monitoring of
Revolving Funds Noted
What We Found
In general, the States we reviewed complied with subrecipient monitoring
requirements. Our review identified several innovative techniques and
procedures some States use to comply with the subrecipient monitoring
requirements of the Single Audit Act, Clean Water Act, and Safe Drinking Water
Act. Two States take advantage of current technology, such as e-mail and the
Internet, to reduce the number of on-site inspections yet are able to track current
construction activity. Two other States analyze subrecipient audit reports not
only to track financial condition but also to make trend and ratio analyses to
project on a subrecipient's ability to repay a loan in the future.
We did note two minor areas EPA should address. Only 59 percent of the States
we reviewed identify the federal award information to the recipient, and EPA's
Annual Performance Evaluation should include an evaluation of the States'
subrecipient monitoring procedures. We suggest that EPA require all States to
notify borrowers of federal award information to assure they can comply with the
Single Audit Act. We also suggest that EPA include a review of how States
monitor borrowers as part of its annual review procedures.
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\ UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
3 WASHINGTON, D.C. 20460
OFFICE OF
INSPECTOR GENERAL
September 29, 2008
MEMORANDUM
SUBJECT: Innovative Techniques for State Monitoring of Revolving Funds Noted
Report No. 08-P-0290
FROM: Stephen J. Nesbitt
Assistant Inspector General for Investigations
TO: Benjamin Grumbles
Assistant Administrator, Office of Water
This is our final report on the subject review conducted by the Office of Inspector General (OIG)
of the U.S. Environmental Protection Agency (EPA). This special report does not contain any
recommendations, but does include matters the OIG has identified that may be of benefit to other
States. This special report represents the opinion of the OIG and the matters contained in this
report do not necessarily represent the final EPA position.
The estimated cost of this report - calculated by multiplying the project's staff days by the
applicable daily full cost billing rates in effect at the time - is $95,076.
Action Required
Because this report contains no recommendations, you are not required to respond to this report.
We have no objections to the further release of this report to the public. This report will be
available at http://www.epa.gov/oig.
If you or your staff has any questions regarding this report, please contact me at (202) 566-0817
or nesbitt.stephen@epa.gov, or William Dayton at 415-947-4509 or davton.william@epa.gov.
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Innovative Techniques for 08-P-0290
State Monitoring of Revolving Funds Noted
Table of Contents
Purpose 1
Background 1
Scope and Methodology 2
States Comply with Subrecipient Monitoring Requirements 3
Best Practices and Noteworthy Achievements 4
Minor Improvements Needed 8
Status of Recommendations and Potential Monetary Benefits 10
Appendix
A Distribution 11
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08-P-0290
Purpose
We conducted this review to determine the extent that States receiving State Revolving Funds
(SRFs) are complying with subrecipient monitoring requirements established by the Clean Water
Act, the Safe Drinking Water Act, and the Single Audit Act. To accomplish that goal, our
review looked at how the States monitor subrecipients of SRF assistance. We also reviewed
other procedures the States use, if any, to prevent and detect fraud at the local level
Background
The Clean Water Act of 1987 created the Clean Water SRF, while the Safe Drinking Water Act
Amendments of 1996 created the Drinking Water SRF. The SRFs are permanent funds for the
States that provide low-cost financing to local governments. Approximately 95 percent of the
financial assistance made by the SRF's is in the form of loans or guarantees for construction of
traditional wastewater or drinking water facilities. The U.S. Environmental Protection Agency
(EPA) provides the initial funding through capitalization grants. Both programs require the
States to provide matching funds of 20 percent of the capitalization grant amount.
The SRFs represent EPA's largest program (about 50 percent of all assistance awards made by
EPA), with 2008 funding levels of approximately $1.5 billion. As of June 2007, the Clean Water
SRF had provided approximately $62.9 billion in financial assistance to local communities and
the Drinking Water SRF approximately $11.0 billion. EPA has the responsibility to oversee the
States, and ensure that States operate the SRF programs to meet the intent of the Clean Water
Act and Safe Drinking Water Act.
Bribery
4%
Wire Fraud
1
Conflict of
I nterest
6%
In response to a risk assessment conducted by the EPA Office of Inspector General's (OIG)
Office of Investigations,1 EPA identified several areas of potential risk in the grants area. Major
concerns included false claims, false statements, cost mischarging, product substitution, lack of
proper oversight, and lack of
internal controls. As shown in Figure 1: Grant Fraud Allegations
Figure 1, false statements, false
claims, embezzlement, and financial
theft accounted for 81 percent of
grant fraud allegations. As of Fiscal
Year 2006, over 31 percent of all
assistance agreement investigations
the Office of Investigations
conducted involved SRFs. State
and EPA personnel involved in the
SRF are the front-line defense
against fraud to the extent that they
can recognize and report potential
fraud. 0 ._.„ . .
Source: OIG analysis.
False
Statements
18%
An ti -Trust
4%
Mail Fraui
2%
Embezzlement
16%
>iracy
Financial Fraud Criminal Risk Assessment, July 1, 2007.
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08-P-0290
The community is responsible for all aspects of the project, from concept, design, construction,
and operations. Successful completion of a project requires the community to have procedures
to manage and review all aspects of the project. One of the objectives of a system of internal
controls is to safeguard the assets of an entity against loss and ensure that transactions are valid.
Single Audit Act Established Subrecipient Monitoring
Congress passed the Single Audit Act to improve auditing and management of federal
funds provided to State and local governments. The Single Audit Act requires an
organization-wide financial audit that includes all federal programs and an audit of the
entity's compliance with laws and regulations of each major federal program if the entity
spends more than $500,000 in federal funds during the year.
Office of Management and Budget (OMB) Circular A-133, "Audits of States, Local
Governments, and Non-Profit Organizations," sets audit and reporting standards for
single audit reports. OMB's Compliance Supplement, Part 3, identifies State
responsibilities, monitoring activities typically performed, audit objectives, and suggested
audit procedures.
States are required to:
• Identify the federal award information and applicable compliance requirements to
the subrecipient.
• Monitor the subrecipient's use of federal awards through reporting, site visits,
regular contact, or other means.
• Ensure that subrecipients expending $500,000 or more in federal awards during
the year have met the audit requirements of OMB Circular A-133.
EPA Annual Reviews
EPA's responsibility for subrecipient monitoring is to oversee the States. EPA needs to
understand how the States monitor the subrecipients, and determine whether the States
comply with the subrecipient monitoring requirements of the Single Audit Act. The
Clean Water Act and Safe Drinking Water Act require EPA to conduct an annual review
to assess how a State meets the program objectives. The primary objectives of EPA's
annual review are to determine how the State meets the intent of the Clean Water Act and
Safe Drinking Water Act, and evaluate the State's performance.
Scope and Methodology
We conducted this performance audit in accordance with generally accepted government
auditing standards. Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions
based on our audit objectives. We believe that the evidence obtained provides a reasonable basis
for our findings and conclusions based on our audit objectives.
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08-P-0290
We conducted our audit field work from December 2007 to September 2008 in EPA
Headquarters and Regions 4, 5, and 9. We sent a survey to all EPA regional SRF coordinators.
We also prepared a survey that we sent to nine States to determine what specific procedures
States used to monitor subrecipients. We received 13 responses to our State questionnaires. We
also conducted site visits in four other States to determine how the particular State documented
its subrecipient monitoring procedures. We interviewed several SRF coordinators and State
personnel.
We reviewed State-wide single audit reports for 26 States for fiscal years ended 2005 and 2006
(the latest available) to determine how many of those States included audit findings on
subrecipient monitoring. We also reviewed audits for States that conduct separate audits of the
SRF program.
We reviewed 87 investigative files for all investigations completed by the Office of Investigations
between October 1, 2003, and September 30, 2007, that dealt with SRFs. These investigations
included allegations against the community, a subcontractor, and various other matters.
We issued a prior report that addressed SRF Best Practices, South Carolina State Revolving Fund
Subrecipient Loan Monitoring (Report No. 2001-S-000745-000001), on October 12, 2000.
States Comply with Subrecipient Monitoring Requirements
In general, the States we reviewed complied with the subrecipient monitoring requirements of
the Single Audit Act. As shown in Table 1, at least 82 percent of the States reviewed met the
most critical elements of subrecipient monitoring, with the exception of identifying the federal
award information. The States
reviewed have systems and Table 1: Critical Monitoring Elements
procedures in place that
provide reasonable assurance
to prevent or detect fraud or
other irregularities.
Element
Award identification
During the award monitoring:
Regular contact and monitoring
Review reimbursement requests
Engineer/contractor certifications
Site visits/project inspections
Subrecipient audits
Audit of State SRF
States
10
16
17
16
14
17
14
Percentage
59
94
100
94
82
100
82
Source: OIG analysis
EPA's annual review only
checks to see if the States
require an annual audit as part
of the subrecipient monitoring
process. All States surveyed
and visited require SRF
borrowers to conduct financial
statement audits. One of the most important functions of an audit is to review and test the
controls in place. The auditor's report on internal controls provides assurance that the controls
are adequate, and the State can rely on the financial information presented by the community.
While a financial statement audit may not prevent fraud, current auditing standards2 require that
audits consider the possibility of fraud when planning the audit and designing audit tests.
Statement on Auditing Standards No. 99, Consideration of Fraud in a Financial Statement Audit.
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08-P-0290
States perform several tasks that EPA's annual review does not review. Monitoring a project is
an on-going process, and there are many different methods of monitoring besides requiring an
annual audit (for example, how States reimburse borrowers). States we reviewed require that the
borrowers submit invoices, contractor billings, and other documentation to support the request.
The project manager then reviews the contractor and engineering billings for the technical
aspects of the request, and must approve them before reimbursing the community. These
procedures protect SRF assets and make sure the borrower and its contractors are progressing as
planned, using specified materials, and billing for work actually completed.
Best Practices and Noteworthy Achievements
Our review disclosed several practices that may be of benefit to other States. These practices
address common issues and concerns. Some of these practices deal with the technical or project
side of the SRF, such as monitoring construction projects. Others deal with the financial end of
the SRF, such as reviewing and analyzing financial reports. These practices help provide the
States with the assurances that projects are being constructed according to the intent of the SRF,
and that the subrecipients maintain the means to repay the loans according to the terms. The
States that developed and implemented these "Best Practices" have offered to provide other
interested States with whatever assistance they may need to implement similar procedures.
Technical Best Practices
A common comment in our surveys and site visits concerned project inspections. Several
States cited the lack of personnel and limited travel funds as the main reasons they cannot
conduct regular inspections. Rising fuel costs have increased airfares and vehicle costs
dramatically, plus have reduced the number of flights or eliminated them altogether,
especially to smaller market areas. The only alternative is to travel by car, which can
involve hundreds miles and extensive travel hours, especially in the larger States.
Adding in costs for lodging and several days to inspect just one project, some States
stated it is not cost effective to send an engineer to inspect a project. Thus, the challenge
facing States is how to cost effectively ensure that projects are completed according to
the plans and specifications, as well as complying with monitoring requirements.
The solution California and Alaska developed is to use technology in innovative ways
that allow them to comply with the subrecipient monitoring requirements. California and
Alaska use e-mail and the Internet to ensure that communities complete their projects
according to the approved plans and specifications while limiting personnel and travel
costs.
California
A project engineer in California developed a "Construction Report" several years ago that
communities were required to complete on a monthly basis. These reports are generally
in electronic form, and the community sends the report to the project manager via e-mail.
While the Construction Report does not take the place of an actual on-site project
inspection, it does provide detailed information so that the project manager can keep
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08-P-0290
abreast of construction progress, identify potential problems, and track time schedules.
The Construction Report includes:
• A summary of progress to date, including a detailed description of progress since
the last report.
• The percentage of construction that is complete, the percentage the contractor has
billed, and the percentage of the schedule that has elapsed.
• A listing of change orders, including amount of the change order, description of
work performed, change in contract amount, and changes in the time schedule.
• A discussion of problems encountered and proposed resolutions, a schedule for
resolution of the problems, and an update on the status of previous problems.
The resident engineer generally completes the Construction Report on behalf of the
borrower. Most construction reports include photographs of the construction as
completed. For example, photo 1, which was included in a recent Construction Report,
shows workers finishing the - - • ™-»_
bottom of a secondary , ^ _, - '*'"""
clarifier at the Ellis Creek
Water Recycling Facility,
City of Petaluma, California.
The photograph allows the
project manager to see the
construction activity in
progress and the
construction techniques and
methods used. The project
manager can then make an
assessment on the
percentage completed, and
compare to progress
payments made to date.
Photo 1: Construction of secondary clarifier, City of Petaluma,
California (photo courtesy City of Petaluma).
Whether the project is across town or across the State, the efficiency of the Construction
Report is apparent. This report has allowed project managers to track the progress of a
project without incurring any additional costs in personnel or travel. Due to the success
of the Construction Report, California includes the requirement to prepare and submit
such reports in its loan agreements for all borrowers. The report documents work
performed, and can help prevent potential problems in the future. Further, the project
manager can request additional information if the manager has questions or concerns
noted in the report. Using the Internet, the project manager can get the information
within minutes instead of waiting until the next inspection.
Several California communities also include progress and details of current construction
projects on the Internet. For example, the City of Lompoc updates the progress of its
wastewater plant upgrade monthly, and includes updates from March 2007 to the current
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08-P-0290
month. The following is a sample of construction projects posted on official community
internet Websites:
http ://www. cityoflompoc. com/departments/utilities/wastewater.htm
http://www.reedley.com/publicworks/wastewater.htm
http://www.citvofpetaluma.net/waterrecycling/construction.html
Alaska
While Alaska performs regular inspections, the size of Alaska, plus the fact that many
locations are not accessible by road, severely limits how often Alaska conducts project
inspections. Alaska project managers communicate with borrowers frequently by
telephone, but Alaska officials said the development of e-mail has made the biggest
difference in being able to track
remote projects. Photo 2 shows
construction activity at the Nome
Water and Sewer Project, over 1,100
miles from the project manager in
Juneau. Alaska can obtain such
information almost instantly by
e-mail, and can address questions and
problems quickly and efficiently. The
ability to obtain written status reports
quickly with attached documentation
and photographs has minimized the
need to travel into the field for
inspections. Alaska uses these
e-mails, documentation, and
photographs as part of the official
State files.
Financial Best Practices
Photo 2: Nome Water and Sewer Project, Nome,
Alaska (photo courtesy Alaska Department of
Environmental Conservation).
All States included in our surveys require borrowers to conduct a single audit and submit
the audit reports to the State. While States are expected to review the audit reports, the
level of review varies widely among the States. Two States we reviewed (South Carolina
and Indiana) perform extensive analyses of subrecipient financial statements and pro-
actively use the financial information to help manage their loan portfolios. While the two
States have different approaches to monitoring the financial aspects of the SRFs, they
have common elements in that they both:
• Take a pro-active role in reviewing and analyzing audits of subrecipients;
• Use historical information to predict and prevent future problems from occurring;
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08-P-0290
• Contact the communities when the reviews show that key ratios are in danger of
falling below State minimums, and
• Actively work with communities to address potential problems.
South Carolina
South Carolina's SRF program is jointly administered by the State's Department of
Health and Environmental Control (DHEC) and the South Carolina Water Quality
Revolving Fund Authority, through the State Budget and Control Board's Office of Local
Government. DHEC is responsible for administering the technical and program activities
of the SRF program, and the Office of Local Government is responsible for all financial
and management functions, including credit approval and loan monitoring. This joint
administration of the SRF maximizes the strengths and expertise of both DHEC and the
Office of Local Government. We had issued a Best Practices report on South Carolina's
subrecipient monitoring practices in October 2000 (Report No. 2001-S-000745-000001).
Revenues generated by the utility systems are the sole security for most SRF loans in
South Carolina. Therefore, making good credit decisions and actively monitoring loans
is particularly important for South Carolina's SRF program. Credit decisions begin with
an analysis for the loan approval process and end with the loan repayment. The process
involves the following major stages:
• Credit analysis: Determining the current and future financing needs of the
borrower, how to meet these needs, how the borrower can repay the loan, and the
key factors critical to repayment.
• Loan Structuring: Determining how to structure the loan to meet the borrower's
needs while meeting SRF legal requirements and minimizing risks to the SRF.
• Loan Monitoring: Designing a system to monitor and control the credit risk
factors throughout the life of the loan.
The Office of Local Government uses various means to monitor loan recipients. It
analyzes the audited financial statements to make sure that the community still meets the
established debt coverage, and that nothing has changed that would affect the
community's ability to repay the loan. A financial database is prepared that calculates
and tracks a variety of key ratios and financial trends for each borrower. They also use a
database to make projections for the next 4 years and, when they receive the actual
information, compares to the projections.
By continuously monitoring the financial condition of the borrower and making
projections, program management can anticipate how potential changes may affect the
borrower's ability to repay the loan. Such projections help provide sufficient time to
meet with the community and discuss possible courses of actions that will prevent
problems in meeting the obligation.
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08-P-0290
Indiana
The Indiana Finance Authority (IF A) operates Indiana's SRF program. IF A has
established a monitoring program that tracks all financial aspects of loans to ensure that
borrowers conduct audits, maintain required debt coverage ratios, and can make
scheduled loan payments according to the loan agreement. As IFA awards a new loan, it
enters the loan information into a database to track when audits are due and notes the
most recent loan closing date, status of the loan, date of most recent financial statements,
and the auditor's opinion on the most recent financial statements.
IFA also has a system for ensuring that borrowers conduct audits when required. IFA
sends a list to the Indiana State Board of Accounts (the State auditor), who will perform
audits of communities at least every 3 years if they do not conduct an annual audit. IFA
also tracks the amount of federal funds in each disbursement so the community, as well
as IFA, can track when the OMB Circular A-133 threshold of $500,000 is met. They will
also audit private borrowers under the Drinking Water SRF if requested.
As IFA receives the financial statements, key financial information is entered and various
ratios calculated. IFA analyzes net operating income, debt service (interest and
principal), current ratios, user charges, and cash flow to see if the community is
maintaining the required coverage. IFA also encourages new applicants to set up their
debt service reserve with IFA's trustee. As a result, IFA is able to monitor communities
on a monthly basis. Moreover, IFA contacts all borrowers at least annually to ensure that
borrowers maintain their debt service reserve balances. If the debt service ratio drops
below IFA requirements, IFA will call the community and discuss options to get the ratio
up to the agreed minimum coverage ratio. The options discussed may include reducing
expenses, rate increases, or other means. In some cases, IFA may require that the
community move its debt service funds to IFA's trustee bank so it can have some control
over any disbursements.
Minor Improvements Needed
Even though the States generally comply with the subrecipient monitoring requirements of the
Single Audit Act, Clean Water Act, and Safe Drinking Water Act, certain improvements can be
made, as discussed below.
Award Identification
The Single Audit Act requires that States inform assistance recipients of the Catalogue of
Federal Domestic Assistance title and number, award name and number, award year, and
name of federal agency. Only 10 of the 17 States surveyed include this required
information in loan documents. While all States reviewed require subrecipients to
conduct annual audits, the intent of this requirement is to ensure that SRF recipients are
aware of when a single audit is required, and specific requirements imposed on them by
federal laws, regulations, and grant provisions.
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08-P-0290
EPA Annual Review
The purpose of EPA's Annual Review is to assess how each State is meeting the intent of
the Clean Water Act and Safe Drinking Water Act, and whether the State complies with
applicable laws and regulations. EPA's Annual Review guidance includes eight required
program elements, nine financial elements, and three required elements for the set-aside
funds in Drinking Water SRF. However, none of these required elements addresses the
States' subrecipient monitoring process.
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08-P-0290
Status of Recommendations and
Potential Monetary Benefits
POTENTIAL MONETARY
RECOMMENDATIONS BENEFITS (in $OOOs)
Planned
Rec. Page Completion Claimed Agreed To
No. No. Subject Status1 Action Official Date Amount Amount
No recommendations
0 = recommendation is open with agreed-to corrective actions pending
C = recommendation is closed with all agreed-to actions completed
U = recommendation is undecided with resolution efforts in progress
10
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Appendix A
Distribution
Office of the Administrator
Assistant Administrator, Office of Water
Agency Follow-up Official (the CFO)
Agency Follow-up Coordinator
Office of General Counsel
Associate Administrator for Congressional and Intergovernmental Relations
Associate Administrator for Public Affairs
Audit Follow-up Coordinator, Office of Water
Deputy Inspector General
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