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'V pfl0^ OFFICE OF INSPECTOR GENERAL
Catalyst for Improving the Environment
Audit Report
Reported Outlays Under
EPA Grant R828112-01
Health Effects Institute
Report No. 2005-4-00054
March 31, 2005
This audit report contains findings that describe problems the Office of Inspector General (OIG) has
identified and corrective actions the OIG recommends. The report represents the opinion of the OIG,
and findings contained in this report do not necessarily represent the final EPA position. Final
determinations on matters in this report will be made by EPA managers in accordance with established
audit resolution procedures.
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Report Contributors:
Keith Rei chard
Richard Valliere
Clem Cantil
Abbreviations
CFR
EPA
OIG
OMB
Recipient
Code of Federal Regulations
Environmental Protection Agency
Office of Inspector General
Office of Management and Budget
Health Effects Institute
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U.S. Environmental Protection Agency
Office of Inspector General
At a Glance
2005-4-00054
March 31, 2005
Catalyst for Improving the Environment
Why We Did This Review
We conducted this
examination to express an
opinion on the reported
outlays on the Federal Cash
Transactions Reports, and
determine whether the
recipient was managing its
EPA grant in accordance with
applicable requirements.
Background
EPA awarded grant
R828112-01 to the recipient
on November 14, 2000. The
agreement was authorized
under section 103 of the Clean
Air Act, as amended. This
agreement provided
$18,750,000 to the recipient to
identify and help the broader
science community plan for
new research in air toxics,
accountability, and the health
effects of emerging fuels and
technologies.
Reported Outlays Under EPA Grant R828112-01
Health Effects Institute
What We Found
We questioned $2,009,473 of reported outlays because the Health Effects Institute
did not maintain the necessary documentation to fully support the reported costs, as
required by Federal regulations. Employee time sheets did not specifically identify
the EPA grant as a chargeable activity and were not used as the basis for charging
labor and related costs to the grant. The recipient charged time for specific
employees even though the employees might have worked on other non-grant
activities. In addition, the recipient charged travel and other costs to the grant
without determining the allocable benefit of such costs.
The Health Effects Institute did not agree with our conclusions. The Institute stated
that it had only one final cost objective and all of its cost were allocable to the EPA
grant. This position is inconsistent with the Institute's accounting records which
identified two cost objectives, one for the EPA grant and one for industry. Besides
the automotive industry, the Institute received funds from several other sources.
What We Recommend
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/2005/
20050331 -2005-4-00054.pdf
We recommend that EPA (1) obtain sufficient documentation to support the outlays
of $2,009,473 in accordance with EPA regulations or disallow the costs from
Federal grant participation; (2) place the recipient on a cost reimbursement payment
basis and review the supporting documentation for all claims prior to payment until
such time as the recipient can demonstrate that it has addressed its financial
management weaknesses; and (3) ensure the recipient's indirect cost rate proposal
includes information for identifying direct and indirect costs, and an explanation of
how these costs are accounted for in the accounting system.
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I '% UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
3 o WASHINGTON, D.C. 20460
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OFFICE OF
INSPECTOR GENERAL
March 31, 2005
MEMORANDUM
SUBJECT: Reported Outlays Under EPA Grant R828112-01
Awarded to Health Effects Institute, Boston, MA
Report No. 2005-4-00054
FROM: Michael A. Rickey /s/ 'WUcfael/I. IQc&ey
Director, Assistance Agreement Audits
TO: Richard Kuhlman
Director, Grants Administration Division
This is the final report to express on opinion on the outlays reported through December 31, 2003,
by the Health Effects Institute under grant R828112-01. The grant was authorized under Section
103 of the Clean Air Act. Our opinion does not extend to the recipient's financial statements
taken as a whole, nor does it extend to the quality or results of the funded research. In addition,
our conclusions are qualified subject to EPA's acceptance of the work upon completion of the
grant.
We have questioned over $2 million because the recipient did not have sufficient documentation
to support the allocation of these costs to the EPA grant in accordance with the terms and
conditions of the grant. The report represents the opinion of the Office of Inspector General
(OIG), and the findings contained in this report do not necessarily represent the final EPA
position. The OIG has no objection to the release of this report to any member of the public upon
request.
On November 23, 2004, we issued a draft report to the recipient for review and comment. The
recipient did not agree with the reported findings. We have included the recipient's response to
the draft report in Appendix B (we did not include the recipient's attachments but they are
available upon request). The response is also summarized after each finding with our comments.
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Action Required
In accordance with EPA Manual 2750, the action official is required to provide this office with a
proposed management decision within 120 days of the date of this transmittal memorandum. The
proposed management decision must address each finding and recommendation. Where you
disagree with a finding or recommendation, please provide alternative actions and support or
precedence for your position
If you have questions concerning this report, please contact Keith Reichard, at (312) 886-3045.
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Table of C
At a Glance
Background 1
Independent Auditor's Report 2
Schedule of Reported Outlays and Results of Audit for Grant R828112-01 4
Report of Non-Compliance 9
Appendices
A Scope and Methodology 12
B Recipient's Response 14
C Distribution 34
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Background
The U.S. Environmental Protection Agency (EPA) awarded grant R828112-01 to the recipient on
November 14, 2000. The recipient is an independent nonprofit corporation chartered to conduct
and evaluate research and testing related to the health effects of emissions from motor vehicles
and other environmental pollutants. Its mission is to provide independent, unbiased, timely, and
high quality scientific results of this research to the public and interested Government agencies.
To support the recipient's mission and its 5-year strategic plan, a number of organizations both in
the United States and in Europe provide funding to support the recipient's research. These
organizations include EPA, the motor vehicle industry, the California Air Resources Board, the
European Commission, the German Automobile Manufacturers Association, the European
Chemical Industry Council, the Chemical Manufacturers Association, and the American
Petroleum Institute. The following table provides some basic information about the authorized
project period and the funds awarded under the agreement covered by this audit.
Total
Recipient's
Federal
Project
Award
Share
Share
Period
$18,750,000
$0
$18,750,000
04/01/2000 - 03/31/2005
The agreement was authorized under section 103 of the Clean Air Act, as amended. This
agreement provides for the recipient to identify and help the broader science community plan for
new research in air toxics, accountability, and the health effects of emerging fuels and
technologies.
Although this grant does not have a cost-matching requirement, the recipient indicated that the
automobile industry provided the recipient funding in an amount equal to the Government
funding level.
To assist the reader in obtaining an understanding of the report, key terms are defined below:
Reported Outlays: Program expenses or disbursements claimed by the recipient
on the Federal cash transaction report.
Questioned Outlays: Outlays that are (1) contrary to a provision of a law,
regulation, agreement, or other documents governing the
expenditure of funds, (2) not supported by adequate
documentation, or (3) not approved by a responsible Agency
official.
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Independent Auditor's Report
We have examined the total outlays reported by the recipient through December 31, 2003 under
the EPA grant R828112-01, as shown below:
Federal Cash Transaction Reports
Date
Submitted
Period
Ending
Federal Share of
Outlays
Reported
01/11/01
12/31/00
$1,500,903
07/12/01
06/30/01
$3,710,458
01/15/02
12/31/01
$1,995,199
07/15/02
06/30/02
$293,440
01/15/03
12/31/02
$3,509,473
07/15/03
06/30/03
$0
03/03/04
12/31/03
$1,000,000
Total
$12,009,473
The recipient certified that the outlays reported on the Federal Cash Transaction Reports,
Standard Form 272, were correct and for the purposes set forth in the agreement. The preparation
and certification of the claim are the responsibility of the recipient. Our responsibility is to
express an opinion on the reported outlays based on our examination.
Our examination was conducted in accordance with the Government Auditing Standards issued
by the Comptroller General of the United States, and the attestation standards established for the
United States by the American Institute of Certified Public Accountants. We examined, on a test
basis, evidence supporting the reported outlays, and performed such other procedures as we
considered necessary in the circumstances (see Appendix A for details). We believe that our
examination provides a reasonable basis for our opinion. Our scope and conclusions are qualified
because the work under the grant was not complete, and EPA has not yet accepted the research
projects.
We questioned $2,009,473 of the $12,009,473 in outlays reported because the recipient did not
maintain sufficient documentation to support the allocation of these costs to the EPA grant in
accordance with the terms and conditions of the grant. The recipient also needs to improve some
of its accounting practices to ensure compliance with Federal requirements.
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In our opinion, because of the effects of the questioned outlays discussed in the preceding
paragraph, the reported Federal outlays on the Federal Cash Transaction Reports do not present
fairly, in all material respects, the allowable outlays incurred in accordance with the terms and
conditions of the grant and applicable EPA regulations. Details of our audit are included in the
Schedule of Reported Outlays and Results of Audit for Grant R828112-01 and the Report of Non-
Compliance that follows.
/ s/ "Keit& IReicAand fan
Office of the Inspector General
U.S. Environmental Protection Agency
September 1, 2004
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Schedule of Reported Outlays and Results of Audit for
Grant R828112-01
Description
Reported
Outlays
Questioned
Outlays
Note
Payroll
$1,138,677
$1,138,677
1
Fringe Benefits
$192,556
$192,556
1
Travel
$61,500
$61,500
2
Other Costs
$616,740
$616,740
2
Research Contracts
$10,000,000
$0
3
Totals
$12,009,473
$2,009,473
Note 1: We questioned payroll and fringe benefit outlays of $1,138,677 and $192,556,
respectively. The recipient did not use employee time sheets to distribute labor
costs to the grant, and the time sheets did not identify the EPA grant or specific
grant activity as the final cost objective. As a result, we were unable to determine
whether the reported outlays were allowable for Federal grant purposes.
Title 40 CFR 30.27 provide that non-profit organizations shall follow the
provisions of OMB Circular A-122 for determining allowable costs. That
Circular, Attachment B, subparagraphs 7.m (1) and (2), requires that:
...the distribution of salaries and wages to awards
must be supported by personnel activity
reports....Reports reflecting the distribution of
activity of each employee must be maintained for all
staff members (professionals and nonprofessionals)
whose compensation is charged, in whole or in part,
directly to awards....Reports maintained by
non-profit organizations to satisfy these
requirements must meet the following standards:
(a) the reports must reflect an after-the-fact
determination of the actual activity of each
employee. Budget estimates (i.e., estimates
determined before the services are performed) do not
qualify as support for charges to awards.
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(b) Each report must account for the total activity
for which employees are compensated and which is
required in fulfillment of their obligations to the
organization.
(c) The reports must be signed by the individual
employee, or by a responsible supervisory official
having firsthand knowledge of the activities
performed by the employee, that the distribution of
activity represents a reasonable estimate of the actual
work performed by the employee during the periods
covered by the reports.
(d) The reports must be prepared at least monthly
and must coincide with one or more pay periods....
The recipient did not maintain sufficient documentation to distribute labor costs to
the EPA grant. The recipient's employees documented their daily attendance and
hours worked on biweekly time sheets. However, these time sheets were not used
to distribute labor costs to the EPA grant, and did not identify the grant or
specifically identified unique grant activity as a final cost objectives. The
recipient's time sheets distributed time to a functional areas such as "study review"
or "science publications." These functional areas were not specifically identified
with the EPA grant.
Because the recipient used functional areas rather than the grant as a final cost
objective and did not use the time sheets to distribute labor costs to the grant, the
recipient selected six employees to charge to the grant. These six employees did
not necessarily work full-time on the grant. For example, the recipient charged all
the salary for the Director of Finance and Administration to the grant although she
stated that she worked on other tasks unrelated to the grant.
OMB Circular A-122, Attachment A, provides that only allocable costs are
allowable grant costs. Since the recipient did not maintain sufficient records to
properly identify the actual labor costs incurred for the grant, the reported outlays
are unallowable for Federal grant participation.
Recipient's Response
The recipient stated that it had only one final cost objective during the period
audited, therefore, 100 percent of staff time was tied directly to that final cost
objective. All costs, both direct and indirect, are allocable to that final cost
objective. The recipient required all employees to fill out weekly or bi-weekly
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time sheets. Those time sheets comply with OMB Circular A-122, Attachment B,
(1) and are filled out after-the-fact, (2) record total activity, (3) are signed by the
employee and approved by a supervisor and (4) are prepared at least monthly.
OIG's Comments
We disagree with the recipient that it had only one final cost objective during the
audit period and that the time records met the requirements of OMB Circular A-
122. The recipient received funding from both EPA and the auto industry, and
established two final costs objectives in its accounting system for these two
sources of funding. However, the recipient did not identify and allocate labor
costs to these two cost objectives on its time sheets in accordance with OMB
Circular A-122. The recipient received additional funding from the U.S. Agency
for International Development, the William and Flora Hewlett Foundation, the
California Air Resources Board, and other domestic and foreign organizations.
Further, employee time sheets were not used to distribute the labor charges to the
final cost objectives. According to the OMB Circular, the distribution of salaries
and wages to awards must be supported by personnel activity reports and reflect an
after-the-fact determination of the activity of each employee. The recipient's time
records and accounting practices did not meet these requirements.
Note 2: We questioned travel and other outlays of $61,500 and $616,740, because the
recipient could not demonstrate that the outlays were allocable to the EPA grant.
According to the recipient, outlays for travel and fees paid to various scientific
review committees were split equally between the EPA grant and other non-
Federal work. Similarly, 100 percent of the outlays for such items as telephones
and photocopying were charged to the grant. The recipient does not have
sufficient documentation to show that these practices meet the allocability
requirements in OMB Circular A-122.
OMB Circular A-122, Attachment A, subparagraph 4 states that a cost is allocable
to the grant in accordance with the relative benefits received and is treated
consistently with other costs incurred for the same purpose in like circumstances.
An allocable cost can be incurred specifically for the grant or incurred for the grant
as well as other work. The recipient does not have documentation to show that the
reported outlays for travel and other outlays were allocable to the EPA grant.
Consequently, the reported outlays are not allowable for Federal participation.
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Recipient's Response
The recipient states the questioned costs for scientific experts, their travel, and
administrative expenses were expended only in support of the recipient's sole final
cost objective - the EPA grant. The recipient stated that expenses such as
telephone, photocopying, office supplies, computer technical support, insurance,
audit, and utilities were charged to the grant. However, other expenses necessary
to support the recipient's activities such as postage, rent, maintenance and printing,
were charged to industry sponsors. Given this, and that the reasonableness, nature,
or amount of such costs are not in question, the expense should be fully allowable.
OIG's Comments
We disagree that the recipient had only one final cost objective during the period
of our audit. The recipient received funding from EPA and industry and
established two final cost objectives in its accounting system. The recipient also
received funding from other sources.
Since the recipient had more than one final cost objective, we were unable to
determine if the costs charged to the EPA grant were allocable to the grant in
accordance with the relative benefits received because the recipient did not have
sufficient documentation to support distribution of costs. Costs are allocable to a
final cost objective if the costs (1) are incurred specifically for the award, (2)
benefits both the award and other work and can be distributed in reasonable
proportion to the benefits received, and (3) is necessary to the overall operation of
the organization, although a direct relationship to any particular cost objective
cannot be shown. When an organization has multiple cost objectives, costs that
can be specifically identified with the final cost objective should be charged direct
to that final cost objective. If a direct relationship to any particular cost objective
cannot be shown, and the costs are necessary and allowable, then the costs are
generally allocated to the benefitting cost objective using an equitable allocation
basis.
The recipient has not demonstrated that the reported outlays are allocable to the
EPA grant in accordance with OMB Circular A-122. Accordingly, the travel and
other costs charged to the grant are not allowable for Federal participation.
Note 3: The outlays for the research contracts are subject to EPA review and acceptance
upon completion of the grant.
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Recommendation 1
We recommend that EPA obtain sufficient documentation to support the outlays of
$2,009,473, in accordance with EPA regulations, or disallow the costs from Federal grant
participation.
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Report of Non-Compliance
Financial management practices did not meet all the requirement of 40 CFR 30.21 because
the recipient did not (1) always maintain the source documentation needed to allocate the
costs to the Federal grant, (2) identify the grant or specific grant activities as the final cost
objective, and (3) develop written procedures for identifying direct and indirect costs.
Title 40 CFR 30.21 requires that the recipient have a system of procedures in place to
provide for (1) accurate, current, and complete disclosure of the financial results;
(2) records that identify adequately the source and application of funds for federally
sponsored activities; (3) effective control over and accountability for all funds; (4)
accounting records including cost accounting records that are supported by source
documents; (5) written procedures for determining the reasonableness, allocability, and
allowability of costs.
As discussed earlier in this report, the recipient did not maintain the documentation
required to support the allocation of labor, fringe benefits, travel, and other costs to the
EPA grant. The recipient charged labor costs to the grant for specific staff although the
staff sometimes worked on non-grant activities. In addition, the recipient did not have the
records to adequately identify the application of funds for federally sponsored activities
because the recipient had not identified the grant or related tasks as a final cost objective.
The lack of sufficient controls and accountability over the funds caused the recipient to
report erroneous financial information resulting in questioning reported outlays of
$2,009,473.
The recipient has not developed written procedures for identifying direct and indirect
costs, the basis for allocating such costs to projects. These written procedures would
provide a consistent and verifiable basis for the treatment of direct and indirect costs and
serve as the basis for preparing an indirect cost rate proposal. Since the recipient has not
developed these procedures, the proposed indirect cost rate submitted for fiscal year 2002
is not sufficient to negotiate a indirect cost rate.
Recipient's Response
The recipient had only one final cost objective jointly funded by EPA and industry during
the period audited. Thus, all expenses were incurred in support of and were allocable to
that cost objective. Further, the recipient had in place a financial accounting system in
which all expenses, including labor, were directly traceable from source documents,
through the books and records to the grant and that the accounting system was compliant
with Federal requirements. Within this full set of allocable costs, 50 percent were charged
to EPA and 50 percent to industry. The fact that twice as much costs were incurred for
grant activities than was claimed for Federal reimbursement means as a practical matter,
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unless costs questioned amount to more than one-half of the total expenditures, there is no
adverse impact to the Government.
The recipient acknowledges that it does not have fully written procedures for calculation
of indirect costs and is prepared to immediately address this issue as part of the resolution
of this audit.
OIG's Comments
We disagree that the recipient had only one final cost objective during the period of our
audit. The recipient received equal funding from both EPA and the auto industry, and
established two final costs objectives in its accounting system for these two sources of
funding. In addition, as previously mentioned, the recipient also received funding from
other entities. Under the recipient's supposition that there was only one final cost
objective, all funding sources should have been allocated a proportional share of
allowable costs. Therefore, EPA's share would have been less than 50 percent.
With respect to developing written accounting procedures, the recipient should develop a
complete cost policy statement. This document should identify the bases for
accumulating, and distributing allowable direct and indirect costs to cost objectives. The
plan should also identify the allocation methods used to distribute costs to final cost
objectives.
Recommendation 2
We recommend that EPA use the authority granted under 40 CFR 30.14 to place the
recipient on a cost reimbursement payment basis and review the supporting
documentation for all claims prior to payment until such time as the recipient can
demonstrate that it has addressed its financial management weaknesses. At a minimum,
the recipient must demonstrate that its accounting practices are consistent with 40 CFR
30.21 and must:
a. Ensure that financial results are current, accurate, and complete.
b. Include records that adequately identify source and application of funds for
federally sponsored programs.
c. Include cost accounting records that are supported by adequate source
documentation.
d. Include an adequate time distribution system that meets the requirements of
OMB Circular A-122, Attachment B, paragraph 7. The system should
account for total hours worked and leave taken, and identify the specific
activities and final cost objectives that the employees work on during the
pay period. It should also serve as the basis for charging labor costs to
Federal grants.
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Recommendation 3
We recommend that EPA ensure the recipient's indirect cost rate proposal includes
information for identifying direct and indirect costs, and an explanation of how these costs
are accounted for in the accounting system.
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Appendix A
Scope and Methodology
We performed our examination in accordance with Government Auditing Standards, and the
attestation standards established for the United States by the American Institute of Certified
Public Accountants. We also followed the guidelines and procedures established in the OIG
Project Management Handbook dated November 5, 2002.
We conducted this examination to express an opinion on the reported outlays on the Federal Cash
Transactions Reports, and determine whether the recipient was managing its EPA grant in
accordance with applicable requirements. To meet these objectives, we asked the following
questions:
1. Is the recipient's financial management system adequate to account for grant funds in
accordance Title 40 CFR 30.21?
2. Does the recipient maintain an adequate labor distribution system that conforms to
requirements of OMB Circular A-122?
3. Does the recipient's procurement procedures for contractual services comply with
Title 40 CFR 30.40 to 30.48?
4. Is the recipient properly drawing down grant funds in accordance with Title 40 CFR
30.22?
5. Is the recipient complying with its reporting requirements under Title 40 CFR 30.51
and 30.52?
6. Are the outlays reported under the grant adequately supported and eligible for
reimbursement under the terms and conditions of the grant, OMB Circular A-122, and
applicable regulations?
In conducting our examination, we reviewed the project files and obtained the necessary grant
information for our examination. We interviewed EPA's grant specialist and project staff to
determine whether any concerns needed to be addressed during our examination. We also
interviewed the recipient's personnel to understand the accounting system and the applicable
internal controls as they relate to the reported costs. We obtained and reviewed the single audit
reports and an on-site report prepared by EPA to determine whether any reportable conditions and
recommendations were addressed in those reports.
We reviewed management's internal controls and procedures specifically related to our
objectives. Our examination included reviewing the recipient's compliance with OMB Circular
A-122, Title 40 CFR Part 30, and the terms and conditions of the grant. We also examined the
reported costs on a test basis to determine whether the costs were adequately supported and
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eligible for reimbursement under the terms and conditions of the grant and Federal regulations.
We conducted our field work from June 1, 2004, to September 1, 2004.
After understanding the recipient's financial management system, we reconciled the claimed
outlays to the recipient's accounting records. Based on our judgment, we performed a review of
contract costs reported by the recipient, which represents approximately 83 percent of the costs.
We limited our review of the remaining outlays reported because the recipient claimed these costs
on a predetermined allocation of budgeted items.
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Appendix B
Recipient's Response Heaith Effects
Institute
Chariest own Navy Yard
120 Second Avenue
Boston MA 02129-4533 USA
+1-617-886-9330
January 7, 2005 fay +i
Mr. Keith Reichard
Mr. Richard Valliere
EPA-OIG
1 Congress Street
Boston, MA 02114
Dear Mr. Reichard and Mr. Valliere:
Attached please find the response of the Health Effects Institute (HEI) to the November 23, 2004 Office
of Inspector General Draft Report "Health Effects Institute Reported Outlays Under EPA Grant R828112-
01" (assignment No. 2004-000963). The response provides comments on the factual accuracy of
information in the draft report and includes supplemental documentation to support our position.
Thank you for the opportunity to provide these comments. As an institution that has worked for over 25
years to establish the organizational integrity necessary to ensure the credibility of our scientific results,
and as frequent auditors in the scientific arena ourselves, we recognize the value of the audit process to
ensure sound procedures. HEI was founded in 1980 by mutual agreement of EPA Administrator Douglas
Costle and the Chairmen of the worldwide motor vehicle industry as a unique organization to provide
credible science to inform and support federal regulations. Both sides agreed to support a specialized,
independent Institute to provide a single common product that would be credible to all: high quality and
relevant science to understand the health effects of air pollution.
Because funding is often seen as a source of bias in the conduct of research, HEI was jointly and equally
funded by EPA and industry in pursuit of this common product. The "HEI Model" has succeeded,
doubling the federal investment by leveraging private sector funds, and producing research that has been
at the core of challenging national air quality regulations and that has been sought by EPA, the White
House Science Office, the Office of Management and Budget, industry and many others.
We have prepared a comprehensive and point by point response to the Draft Report that: provides
additional information to clarify several issues raised; respectfully differs with the Draft Report's findings
in several key areas, and proposes constructive approaches throughout to further strengthen what we
believe to be HEI's comprehensive and compliant financial management systems. Of the many points
addressed in our response to the Draft Report several are most important:
-During the period audited, HEI had only one final cost objective (i.e. the grant) and all
scientific and administrative expenses were incurred in support of and were allocable to that
objective. During this time, HEI had only one final cost objective jointly funded by EPA and industry as
the cornerstone of its operation encompassing a specific unified plan of research planning, selection,
oversight, reanalysis peer review and related activities, The Health Effects of Air Pollution Program. This
single unified plan of research was identified in the HEI Strategic Plan 2000-2005, incorporated both
directly in the text of the grant application and in its entirety as an attachment, and approved and
incorporated by reference in the Grant Agreement.
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directly in the text of the grant application and in its entirety as an attachment, and approved and
incorporated by reference in the Grant Agreement
-Given that all research planning, oversight, review and related administrative costs
necessary to implement the Health Effects of Air Pollution Program were allocable to that cost
objective, and that the reasonableness and nature of the costs questioned in the Draft Report are
not at issue, those costs were, in our view, allowable. The detailed response also illustrates that with
respect to segregation of costs between EPA and industry, twice as much cost was incurred for grant
activities than was claimed for federal reimbursement. Thus, as a practical matter, unless questioned costs
amount to more than one half of the total expenditure for the cost objective, which these clearly do not,
there is no adverse impact on the federal government.
-HEI's financial management system specifically and accurately tracks all costs back to the
one final cost objective. HEI had in place a financial accounting system in which all expenses, including
individual employee after-the-fact and approved time sheets, are directly traceable from source
documents, through the books and records of the Institute to the grant. This system has been the subject
of extensive, independent audits over several years and by different firms and has been found to be in
compliance with relevant federal regulations.
-In our response, HEI also responds specifically to the details of the questioned costs, the
need for annual financial reports, and the correctness of its recent Indirect Cost Proposal We look
forward to working with EPA and the Office of Inspector General to resolve any remaining questions in
these areas.
Looking Ahead
In summary, we believe that all of the expenditures claimed are reimbursable under the grant and we
document this in the submission that follows. At the same time we identify several areas going forward
where HEI can further enhance its financial management procedures and look forward to reviewing those
areas with the EPA OIG.
As we have indicated earlier, we would ask for the opportunity to meet with you at your earliest
convenience to ensure that we can minimize any misunderstandings, answer all questions, and bring this
audit to a mutually satisfactory conclusion. We stand ready to provide any additional explanations that
you might require to support costs incurred and will continue to improve our financial management
systems as necessary to maintain compliance with our regulatory responsibilities.
We look forward to working with EPA-OIG to resolve any outstanding administrative issues.
Daniel Greenbaum
President, Health Effects Institute
cc: Michael A. Rickey, EPA
Richard Kuhlman, EPA
Emmanuel Ekwo, EPA
Gail Robarge, EPA
Richard Celeste Chair, HEI Board of Directors
Sincerely
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January 7, 2005
RESPONSE OF THE HEALTH EFFECTS INSTITUTE
To
Health Effects Institute Reported Outlays Under EPA Grant R828112-01
Draft Report of the Office of Inspector General
U.S. Environmental Protection Agency
(Draft Dated November 23, 2004)
I. INTRODUCTION.
The Health Effects Institute ("HEI") is a not-for-profit research institute founded in 1980 by
mutual agreement of EPA (through its Administrator, Douglas Costle) and major motor vehicle and truck
engine manufacturing companies (through their respective chairmen), for the purpose of planning,
implementing, and reporting on a program of original research on the health effects of emissions from
motor vehicles and other sources in the environment (Tab 1). Both sides agreed to support a specialized,
independent HEI to provide a single common product that would be credible to all: high quality and
relevant science to understand the health effects of air pollution. A more detailed description of HEI is
included in Appendix I (and related Tabs).
Because funding is often seen as a source of bias in the conduct of research, HEI was jointly and
equally funded by EPA and industry in pursuit of this common product. The "HEI Model" has succeeded,
doubling the federal investment by leveraging private sector funds, producing research that has been at
the core of challenging national air quality regulations and that has been sought by EPA, the White House
Science Office, the Office of Management and Budget, industry and many others.
As an institution that has worked for over 25 years to establish the organizational integrity
necessary to ensure the credibility of our scientific results, and as frequent auditors in the scientific arena
ourselves, we recognize the value of the audit process to ensure sound procedures. HEI has prepared a
comprehensive and point by point response to the Draft Report of the U.S. EPA Office of Inspector
General (EPA OIG) that: provides additional information to clarify several issues raised; respectfully
differs with the Draft Report's findings in several key areas, and proposes constructive approaches
throughout to further strengthen what we believe to be HEI's comprehensive and compliant financial
management systems now and during the audited period. We look forward to working with the EPA OIG
and EPA to resolve this audit in a mutually satisfactory way.
II. DETAILED RESPONSE TO DRAFT AUDIT REPORT.
FINANCIAL MANAGEMENT SYSTEM
Draft Report Finding: Inadequate Financial Management (Page 7)
The Draft Report (P. 7, Paragraph 2) states: "The recipient's financial management system was
inadequate to determine that reported outlays were allocable, and thus allowable under the EPA grant.
The requirements of Title 40 CFR 30.27 provide that non-profit organizations shall follow the provisions
of OMB Circular A-122 for determining allowable costs. To be allowable under the grant, the provisions
of OMB Circular A-122, Attachment A, provide that costs must be allocable to the grant. A cost is
allocable to a grant if it is treated consistently with other costs incurred for the same purpose in like
circumstances and is incurred specifically for the grant." Within this broader statement, the Draft Report
finds that HEI's Labor Distribution System did not accumulate employee time "by final cost objective."
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HEI Response
HEIhad in place for all of the period audited by the EPA OIG a single final cost objective - the
Health Effects of Air Pollution Program - that is funded jointly and equally by EPA and industry to
produce a single common product: high quality and relevant science to understand the health effects of
air pollution.
A. That final cost objective was submitted to and approved by EPA in the Grant Application
process and was incorporated by reference in the grant.
B. Given that all of HEI's scientific and administrative activity during the period audited
supported only this one final cost objective, all of HEI's expenses were allocable to that final
cost objective (i.e. the grant).
C. HEI also had in place during the period audited a financial management system which
tracked all expenses to that single final cost objective.
A. HEI's Final Cost Objective
It appears that many of the core findings in the Draft Report may have occurred either as a result
of mis communication on the part of HEI or of misunderstanding by EPA OIG of HEI's single final cost
objective during the time period audited: the Health Effects of Air Pollution Program1.
1. HEI Has a Single Final Cost Objective with Core Funding Jointly and Equally
from EPA and Industry.
As described and documented in the Introduction and Appendix I, core funds for HEI are
provided, by longstanding agreement of HEI's sponsors in EPA and industry, jointly and equally by EPA
and the motor vehicle industry2.
To ensure that funding of any specific scientific research or report by HEI could not be viewed as
having been funded solely by either EPA or the industry, the HEI Health Effects of Air Pollution Program
was established as a single final cost objective encompassing a specific unified and comprehensive plan
of scientific activities - including research planning, research and investigator selection and oversight,
reanalysis, peer review, and other scientific activities.
The specific plan of activities for the grant period subject to this audit was identified in HEI's
Strategic Plan 2000-2005 (Tab 5).
2. HEI Submitted Its Single Final Cost Objective to EPA in the Grant Award
Process, and EPA Approved It.
HEI described this specific, unified, and comprehensive plan of scientific activities in the HEI
Strategic Plan 2000-2005 and submitted the plan to EPA as an attachment to and in the text of the Grant
1 Although HEI had a single final cost objective during the period audited, and has had that same final cost objective
since its inception, the name of that final cost objective has been revised over the years from The Health Effects of
Motor Vehicle Emissions Program to the Health Effects of Air Pollution Program in recognition that all of the
pollutants emitted from motor vehicles are emitted from other sources as well.
2 The industry sponsors are the 28 companies that make or market motor vehicles or truck engines in the United
States. Payments to HEI for the Health Effects of Air Pollution Program by the individual companies are based on
their relative sales in the U.S. market and are made in expectation that a similar amount will be contributed by EPA.
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Application for Grant R828112-01 (dated January 31, 2000 and revised final version dated August 7,
2000) (Tabs 14 and 15), and in each annual renewal application forthe grant in 2001, 2002, 2003, and
2004 (Tabs 16, 17, 18, 19).
The plan was subjected to independent Peer Review organized by EPA's National Center for
Environment Research, and was approved by EPA in its Grant Agreement dated November 14, 2000 (Tab
20). Specifically, the Grant Agreement incorporates, by reference, the full Grant Application, which
describes the specific, unified, and comprehensive plan of scientific activities that make up the Health
Effects of Air Pollution Program. The Grant Agreement describes the award as being "for the support of
approved budget period effort described in application (including all application modifications) cited in
the Project Title and description above, signed 01/31/2000 included herein by reference." (Tab 20)
In sum HEI's single final cost objective - the Health Effects of Air Pollution Program - is a
unified and comprehensive set of scientific activities that (i) is funded by longstanding design jointly by
EPA and industry in order to ensure the highest possible quality and acceptance of HEI scientific findings,
and (ii) was explicitly submitted to and approved as the grant by EPA in the award process. HEI looks
forward to working with the EPA OIG and EPA to clarify any miscommunications or misunderstandings
about the HEI final cost objective.
B. Allocability of Costs
Total allowable and reimbursable costs consist of both allocable direct and indirect costs. The
complete text of Circular A-122, General Principles, A.4.a is: "4. Allocable Costs, a. A cost is allocable to
a particular final cost objective, such as a grant, contract, project, service, or other activity, in
accordance with the relative benefits received. A cost is allocable to a Federal award if it is treated
consistently with other costs incurred for the same purpose in like circumstances and if it: (I) Is incurred
specifically for the award. (2) Benefits both the award and other work and can be distributed in
reasonable proportion to the benefits received, or (3) Is necessary to the overall operation of the
organization, although a direct relationship to any particular final cost objective cannot be shown. " As
described, above, during the period covered by the audit and Draft Report, HEI had only one final cost
objective; therefore, all costs of the organization, whether direct or indirect, were allocable to the final
cost objective (i.e. the grant).
Within this full set of allocable costs of the Health Effects of Air Pollution Program, 50% overall
are charged to EPA, and 50% to industry. Although within this segregation of costs, certain costs are
precluded from federal funding (in accordance with Circular A-122 Attachment B) the overall system
thus assures that each side pays an equal share in support of the extensive benefits of the Health Effects of
Air Pollution Program described in Appendix I. Indeed, EPA gains substantial benefit even from those
expenses charged to industry: for example, although EPA funds a substantial part of the specific research
activities conducted by HEI, the expenses forthe publication and dissemination of the results of those
research activities - an essential part of the Health Effects of Air Pollution Program - are charged to the
industry. (Similarly, the industry reaps benefits from those components of the program for which the
expenses are charged to EPA.).
Overall, the fact that twice as much cost was incurred for grant activities than was claimed for
federal reimbursement means that as a practical matter, unless costs questioned amount to more than one-
half of the total expenditures, there is no adverse impact to the government.
C. Financial Management System
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Draft Report Finding: Adequacy of Financial Management System
The Draft Report states (P.7, paragraph 3): "In order to properly account for allowable costs, the
recipient was required to maintain an adequate financial management system that complied with the
provisions of Title 40 CFR 30.21. These provisions require that the recipient's financial management
system provide for: (1) accurate, current, and complete disclosure of the financial results; (2) records that
identify adequately the source and application of funds for federally sponsored activities, (3) effective
control over and accountability for all funds, and (4) accounting records including cost accounting records
that are supported by source documents. As discussed in Notes 1 and 2 of the Schedule of Reported
Outlays and Results of Audit for Grant Number R828112-01 on pages 4 and 5, the recipient's accounting
system did not meet any of these four requirements."
HEI Response:
HEI has had in place a financial accounting system in which all expenses are directly traceable
from source documents through the books and records of the Institute to charges to the single HEI final
cost objective - the Health Effects of Air Pollution Programfi.e. the grant). In total, this system, which is
described in detail in Appendix II, meets or exceeds each of these requirements.
1. Specifically, HEI's accounting system is compliant with each of these requirements
(1) "Accurate, current and complete disclosure of the financial results of each federally-
sponsored project or program in accordance with the reporting requirements set forth in
30.52." (emphasis added). Appendix II describes the detailed system HEI has in place to
fully meet these standards for the only "federally-sponsored project or program" that it had in
place during the period audited.
(2) "Records that identify adequately the source and application of funds for federally-sponsored
activities." Appendix II describes the specific accounting codes used in HEI's Chart of
Accounts to accomplish this.
(3) "Effective control over and accountability for all funds, property and other assets." Control
and approval processes described in Appendix II.
(4) "Accounting records including cost accounting records that are supported by source
documentation." These are described in detail in Appendix II.
2. Further, all costs charged to EPA from among the full universe of allocable costs
described above were submitted to and approved by EPA.
These costs were set forth in HEI's application to EPA for the full grant and in HEI's submissions
in connection with the annual reviews, and they were thus known to EPA and were approved by EPA (see
Tab 15 (Revised Grant Application, Itemized Budget)). As described in Appendix II, these costs were
tracked throughout the HEI accounting system and, as described below, subject to annual independent
audit.
3. Finally, this accounting system has been subjected to annual independent audits for both
financial compliance, and compliance with Federal Regulation (in accordance with OMB
Circular A-133).
HEI's financial management system has been the subject of annual financial and Circular A-133
single audits by HEI's independent outside auditors, which, during the past decade, for example, have
included two separate audit firms and a number of different individual auditors. As described in the audit
statements, these audits included examining, on a test basis, evidence about the Institute's compliance
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with all applicable federal standards. These auditors have routinely selected a sample of financial
transactions of their choosing and tracked them back through the HEI financial management system to the
core final cost objective and the source of funds. (See Tabs 27 - 31 attached audit reports for fiscal years
ending June 30, 2000 through 2004).
Each year, the HEI financial management system has received unqualified financial opinions
from the financial audits, and the A-133 Single Audits have consistently found "no matters involving
material weaknesses in the internal control over financial reporting and operation," and that the "Institute
complied, in all material respects, with the requirements referred to above that are applicable to each of its
federal programs"(i.e. Government Auditing Standards and OMB Circular A-133). (See, for example,
Tab 17; FY 2002 Audit, p. 15.)
In addition, in 2002 in an audit that covered some of the same time period audited by the EPA IG ,
EPA's Office of Administration and Resources Management conducted a set of detailed independent tests
of relevant financial transactions and was able to track detailed HEI expenditures charged to the grant
from the financial management cost accounting records to the source documents. That audit found that
"at the time of our review, HEI had in place rigorous internal management systems that in most cases far
exceeded the general regulation requirements." (Tab 32)
D. HEI's Revised Financial Management System Subsequent to the Period Audited by
the EPA OIG
Although the Health Effects of Air Pollution Program (i.e. the EPA grant) was the sole final cost
objective of HEI during the entire period audited by the EPA OIG, one source of possible
misunderstanding during the audit may have been the fact that changed circumstances subsequent to that
period occasioned substantial revisions to HEI's accounting system to ensure continued future compliance.
These changes included entering into a cooperative agreement with the U.S. Agency for International
Development (US-AID) for work on the Health Effects of Air Pollution in Asia and a 2002 audit of HEI's
financial management system by EPA's Office of Administration and Resources Management (EPA
OARM).
Beginning in HEI fiscal year 2003, HEI received funding from another federal agency, US-AID,
for work on the health effects of air pollution in Asia. Consequently HEI had a second final cost objective.
Before any work was performed on the US-AID project, we were audited by the EPA OARM.
As a result of discussions with the auditors, we agreed that, for future periods, we would need to allocate
administrative costs between different federal final cost objectives by using an appropriately developed
indirect cost rate. This agreement was referred to in their report; in our response, we committed to
implement the agreement; and we submitted our Indirect Cost Proposal to EPA on March 13, 2003 (Tab
33).
In all budget submissions made to EPA subsequent to the initiation of the US-AID award and to
the submission of the Indirect Cost Proposal, HEI has included only direct and indirect costs that are
properly allocable to the EPA grant in accordance with all applicable requirements (e.g., Tab 18; 2003
submission).Thus, in order to ensure that scientific staff time spent on a different federally-funded
objective was not charged to EPA, HEI began charging scientific salary expenses to the EPA grant only
for those scientists who are assigned exclusively to work on EPA-funded activities and only for those
hours recorded in their labor distribution records spent on the oversight and review of research. In
addition, administrative salary and expenses are no longer charged directly to the grant but are recovered
only through the Indirect Cost Rate.
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This change may have contributed inadvertently to an important misreporting in the Draft Report
concerning the work of the HEI Director of Administration and Finance. The Draft Report, at p. 5 states:
"For example, the Director of Finance and Administration3 charged 100 percent of her labor charges to
the EPA grant; however, she told the OIG auditors that she worked on other tasks unrelated to the grant"
(emphasis added). In fact, for the time period audited by the EPA OIG, HEI had only one final cost
objective - the Health Effects of Air Pollution Program - to which all HEI costs were allocable; and the
Director of Administration and Finance did not work on any tasks unrelated to that final cost objective (i.e
the grant). After the initiation of the second final cost objective with funding from US-AID, the Director
of Finance and Administration did work on tasks unrelated to the EPA grant and the Health Effects of Air
Pollution Program. However, at that point her labor charges (and all other administrative expense) were
no longer charged directly to the EPA grant, but only through HEI's Indirect Cost Rate submitted in
response to the EPA OARM audit.
QUESTIONED COSTS
Draft Report Finding: Questioned Costs
The Draft Report (P. 4-6) questions $2, 009,473 of expenses charged to the grant. This includes a
total of $1,138,677 for salaries and $192,556 for fringe benefits, as well as $616,740 of Other Expenses
and $61,500 for Travel. The Draft Report states (P. 5) that "the recipient did not maintain a labor
distribution system for recording and accumulating employees' final time and effort by final cost
objective," and that the Personnel and Fringe expenses are "unallowable without adequate records to
support that the costs were allocable to the EPA grant." For the Other and Travel expenses it states that
"the recipient has not demonstrated that the reported outlays for travel and other outlays were allocable to
the EPA grant."
HEI Response:
As indicated in the prior response, HEI had only one final cost objective during the time period
audited by the EPA OIG. Therefore, all costs, both direct and indirect, are allocable to that final cost
objective (i.e. the grant). In addition, HEI has maintained for many years an after-the-fact labor
distribution system that tracks all employee time back to that single final cost objective in compliance
with applicable federal requirements. Thus, since all costs were tracked appropriately and are allocable
to the final cost objective (i.e. the grant), and neither the nature nor the amounts incurred and paid are at
issue, these costs are allowable. More specific responses to the questioned costs are provided below for
A. Personnel and Fringe, and B. Travel and Other Costs.
A. Personnel and Fringe
1. HEI Has a Labor Distribution System that Complies with All Applicable Requirements.
For many years, HEI has required employees to fill out weekly or bi-weekly time sheets. Those
timesheets, as per Circular A-122, Attachment B, paragraph 7, (1) are filled out after-the-fact, (2) record
total activity, (3) are signed by the employee and approved by a supervisor and (4) are prepared at least
monthly (Tab 35: sample time sheet).
3 This quote is also inadvertently incorrect in another way - during the period audited by the EPA OIG, the position
of Director of Finance and Administration was held by another person - Howard Garsh - who has since retired from
HEI. He also worked 100% of his time on the implementation of the Health Effects of Air Pollution Program.
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Since all time worked by employees for the period audited was for the same final cost objective,
the Health Effects of Air Pollution Program, all charges recorded in those time sheets are allocable to that
final cost objective (i.e. the grant). In addition, all employees who implement HEI's scientific program
must track their time to specific scientific or administrative areas - e.g., "research planning and study
selection", "research management", "study review" - in accordance with established written definitions of
these terms and activities (Tab 34 Time tracking guidance). These functional areas are all sub-categories
of activities carried out in support of the Health Effects of Air Pollution Program. This labor distribution
and tracking system then ties directly to the programmatic categories in the audited financial statements
(See Appendix II and, for example, Tab 29).
Each year, as part of our OMB Circular A-133 audit, a sample (of the auditors' choosing) of the
payroll costs for employees charged to the EPA grant are traced from the timesheets to HEI's ADP
journals to the general ledger. Those amounts are also traced from the general ledger back to the cash
disbursement journals to the ADP journals, and are reconciled with the amounts charged to the EPA grant.
2. All of the questioned Personnel and Fringe Costs ($1,138,677 of salary and $192,556 of
fringe benefits) were expended in support of HEI's sole final cost objective, and therefore
are allocable to that final cost objective (i.e. the grant), and allowable.
In practice, when either a member of the HEI Scientific Staff or Administrative Staff spent time
on either scientific or administrative matters under the Health Effects of Air Pollution Program, that time
was recorded in the labor distribution system. Because, until very recently, the Health Effects of Air
Pollution Program was the only final cost objective for all HEI activities, 100% of staff time was tied
directly to that final cost objective (i.e. the grant).
Within those salary expenditures, scientific staff salaries and fringe benefits were charged to the
grant for a subset of members of the HEI Scientific Staff. All members of the HEI Scientific Staff were
involved - during the time audited in the Draft report, in research planning, selection and oversight of
specific research projects, peer review of the reports of these projects, and/or writing of commentaries on
the results solely in support of the Health Effects of Air Pollution Program.
For example, Dr. Maria Costantini, a Principal Scientist whose salary and fringe benefits were
charged to the EPA Grant (and are part of the questioned costs), was assigned to work 100% of her time
on a series of specific scientific projects within the Health Effects of Air Pollution Program (and all
specifically described in HEI's EPA Grant Application), including managing a number of specific
research projects in HEI's Particulate Matter Research Program, implementing and maintaining the
Particulate Matter Research Activities website, researching and writing a monograph on the emerging fuel
additive cerium, and other related activities. She recorded that activity on a series of after-the-fact labor
distribution (time) sheets, which she signed and her supervisor, the Director of Science, approved (Tab 35:
sample time sheets).
Similar summaries of activities and time tracking - illustrating the connection of all scientific
staff work to the Health Effects of Air Pollution Program - are available for all HEI scientific employees
whose salaries and fringe benefits are charged to the EPA grant (and included in the questioned costs).
Administrative salary and fringe expense was also charged to the grant for a subset of
Administrative Staff members. During the time audited by the EPA OIG, all administrative staff
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members were dedicated solely to administration of the Health Effects of Air Pollution Program. As such
their time was fully allocable and reimbursable.4
In one specific example, the Draft Report states (at p. 5): "the Director of Finance and
Administration charged 100 percent of her labor charges to the EPA grant." That statement is not quite
accurate, because during the time audited the position of Director of Finance and Administration was
filled by another person who has since retired - Mr. Howard Garsh. He did, in fact, spend 100% of his
time on activities related to implementation and administration of the sole HEI final cost objective - the
Health Effects of Air Pollution Program. Those activities included development, implementation, and
review and approval of payment for all research contracts with research institutions selected to conduct
HEI-funded research on the health effects of air pollution; administration of personnel, salary, benefits,
and other administrative systems for all HEI staff (all of whom were working to implement the Health
Effects of Air Pollution program); oversight of all outside audits of HEI financial management systems,
and other activities. Mr. Garsh's activities were recorded on a series of after-the-fact labor distribution
(time) sheets, which he signed and which his supervisor approved. (Tab 36: sample time sheets).
Similar summaries of activities and time tracking are available for all HEI administrative
employees charged to the EPA grant (and included in the questioned costs).
In sum, HEI has had for many years an after-the-fact labor distribution system that complies with
Circular A-l 22 and can track specific employees' time back to their work on implementation of the HEI's
sole final cost objective, the Health Effects of Air Pollution Program, and are therefore fully allocable to
that final cost objective (i.e. the grant). Given this, and that the reasonableness, nature or amount of such
costs are not in question, the expenses are fully allowable.
B. Travel and Other Expenses
1. $381,209for support of expert scientists engaged in HEI's scientific committees and their
related travel expense (i.e., $319,709 of the $616,740for the professional time of HEI
scientific committee members and $61,500for travel by those experts to and from
meetings and site visits)
The expenses to support HEI expert scientists ($319,709 for professional services and $61,500 for
travel were for scientific consulting services and associated travel by experts in medicine, toxicology,
epidemiology, air chemistry, biostatistics, engineering, and other disciplines. These experts serve on HEI
Committees (see the Introduction above) and in other expert capacities. These services were necessary to
plan HEI research, to review and select specific research projects, to conduct peer review of the reports of
those projects, and to write scientific commentaries on these and other related scientific results in the
broader literature. The activities in which these experts engaged were explicitly described in the HEI
grant application, and all of them supported and were allocable to the Health Effects of Air Pollution
Program.
For example, during the period audited by the EPA OIG, HEI charged to EPA consulting
expenses for Dr. Jonathan Samet, Chair of the Epidemiology Department at the Bloomberg School of
4
This was also in compliance with HEI's independent audits. In the first Circular A-133 Single audit of HEI
performed for the fiscal year ended June 30, 1992 the outside auditors at that time, Arthur Andersen, LLP,
determined that, since HEI had only one federal financial assistance program, an indirect cost rate was not required.
(Tab 26). This has continued to be the case until institution of an Indirect Cost Rate.
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Public Health at Johns Hopkins University and a member of the HEI Research Committee. These
expenses are among those questioned in the Draft Report. In his role for HEI, Dr. Samet participated in
planning new research on diesel exhaust, air toxics, and accountability, participated in oversight of a
number of current HEI studies of the health effects of particulate matter, and chaired two key panels of
experts for HEI, who wrote major research planning monographs on accountability (or the measuring of
the health impact of regulations) and exposure to emerging diesel technologies. All of these activities,
including the two research planning activities, were explicitly identified in HEI's Strategic Plan and in its
grant application to EPA as priority topics within the Health Effects of Air Pollution Program. As
described above, all professional compensation also was charged to EPA only at approved federal rates
for such compensation (Tabs 5 and 14).
Similar descriptions and documentation are available for all other experts who participated in
HEI's Health Effects of Air Pollution Program and were among the questioned expenses charged to the
EPA grant.
2. $297,031 (the remainder of the questioned $616,740) for a set of administrative expenses.
The remaining questioned amount is $297,031 for administrative expenses. As described above,
these expenses were all expended in support of the single HEI final cost objective, were all allocable to
that final cost objective (i.e. the grant), were submitted and approved in the applications to EPA for the
grant, and represent a subset of the administrative expenses necessary to support the scientific activities
of HEI, including telephone, photocopying, office supplies, computer technical support, insurance, audit,
and utilities. The remainder of the administrative expenses necessary to support HEI's activities,
including other categories such as postage, rent, maintenance and printing, were charged to HEI's
industrial sponsors, who also contributed to support of the Health Effects of Air Pollution Program.
In sum, the questioned costs for scientific experts, their travel, and administrative expenses were
expended only in support of HEI's sole final cost objective, the Health Effects of Air Pollution Program,
and are therefore fully allocable to that final cost objective (i.e. the grant). Given this, and that the
reasonableness, nature or amount of such costs are not in question, the expenses are fully allowable.
ANNUAL FINANCIAL REPORTING
Draft Report Finding: Annual Financial Reports
The Draft Report (p. 8) states that HEI "did not submit any of its financial status reports as
required by Title 40 CFR 30.52 (a)(l)(iii)."
HEI Response
The conditions of HEI's Grant Award, required the submission of one Financial Status Report
(SF 269) at the end of the grant period (i.e., after 5 years); and 40 CFR 30.52 authorizes EPA to not
require annual reports when the same information is already provided on other forms. HEI actually
submitted the same information to EPA on a more frequent basis (every 6 months); HEI would of course
be willing to provide annual reports should EPA determine they are also necessary.
The EPA Grant Agreement for this grant requires, at p. 4 (Tab 20), the submission of a final
Financial Status Report (SF 269) to the EPA Financial Management Center in Las Vegas, Nevada "within
90 days after the end of the budget period," and does not require submission of annual Financial Status
reports.
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HEI has actually submitted the same information that would have been submitted on an annual
Financial Status Report to EPA more frequently than each year (every six months) in the form of the
Federal Cash Transaction Report (SF-272).(e.g. Tab 25) Thus, HEI has always provided the necessary
information to track funds expended on the grant. These submissions are cited in the Draft Report at p. 2.
EPA's requirement for a final Financial Status Report, and not interim Financial Status Reports,
is consistent with 40 C.F.R. § 30.52(a)(l)(i), which states: "EPA has the option of not requiring the SF-
269 or SF-269A when the SF-270, Request for Advance or Reimbursement, or SF-272 Report of Federal
Cash Transactions, is determined to provide adequate information to meet its needs, except that a final
SF-269 or SF269A shall be required at the completion of the project when the SF-270 is used only for
advances." The decision by EPA to require a report only at the end of the five-year cycle can readily be
interpreted as EPA's exercising of the option provided in 40 C.F.R. § 30.52, given that EPA was aware
that we were also required to submit the same information at six-month intervals.
Although submission of an annual form was not required by the grant, HEI made the extra effort
- as indicated in the Draft Report - to inquire of the EPA Financial Management Center in Las Vegas
whether we were required to submit these reports annually, and we were advised orally that a Financial
Status Report should be filed only at the end of the grant period (five years).
INDIRECT COST RATE PROPOSAL
Draft Report Finding: Indirect Cost Rate Proposal
The Draft Report (p.9) states: "The recipient did submit an indirect cost rate allocation plan to
EPA based on its fiscal year 2002 costs. However, the proposed direct and indirect labor costs used in the
recipient's indirect cost allocation plan were based on unsupported estimates. The recipient's estimates
were calculated based on interviews with employees who estimated the amount of time spent on direct
and indirect activities. Further, the recipient has not developed written procedures for identifying direct
and indirect costs, and the basis for allocating such costs to projects, as required by Title 40 CFR 30.21."
HEI Response:
The finding in the Draft Report appears to flow from a misinterpretation of Schedule B-2 of
HEI's submitted Indirect Cost Proposal. As described above, HEI submitted its Indirect Cost Proposal in
order to comply with all applicable federal requirements, and believes that, when the submission is fully
explained, it provides an accurate presentation of these costs. HEI acknowledges, however, that it does
not have fully written procedures for future calculation of indirect costs. Therefore, HEI is prepared to
move immediately as a part of the resolution of this audit to address this.
As describe above, beginning in HEI fiscal year 2003, HEI for the first time received funding
from another federal agency, US-AID, for work on the health effects of air pollution in Asia. Before any
work was performed on the US-AID project, we were audited by the EPA Administration and Resources
Management group. We discussed the new project with the auditors and agreed that, for future periods,
we would need to allocate administrative costs between different federal final cost objectives. This
agreement was identified in their report (Tab 32).
Subsequent to their visit, and at their suggestion, HEI engaged qualified outside accounting
experts from the firm of Ernst and Young to prepare on its behalf an indirect cost rate proposal to EPA in
order to be able to charge indirect costs between EPA and any other federally-funded final cost objectives.
That proposal was submitted on March 12, 2003. (Tab 33)
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Since HEI's major functions benefit from its indirect costs to approximately the same degree, it
was possible to calculate an indirect cost rate using the Simplified Allocation Method, based on
separating the organization's costs for the base period as either direct or indirect. Although allocation of
salaries between direct and indirect costs based on budgeted amounts is discussed in EPA's guide,
Preparing Indirect Cost Rate Proposals for Grants and Contracts, HEI did not use budgeted or estimated
amounts, but rather, as described below, used actual recorded employee time.
The questioned Schedule B-2 Headcount Allocation Ratios - Fiscal Year 2002 in the Indirect
Cost Proposal presents the ratio of staff indirect and direct time for all of HEI's 20 employees. In contrast
to the finding in the Draft Report at Page 9 that these labor "estimates were calculated based on
interviews with employees who estimated the amount of time spent on direct and indirect activities" these
estimates were based, with a few exceptions, on after-the-fact recorded allocations of employees time
from the existing HEI labor distribution system described below.
a. Note 1 in Schedule B-2 presents the "Recorded Allocations" from HEI FY02 Timesheets in
the HEI Labor Distribution System.
b. Note 2 in Schedule B-2 presents the "Estimated Allocations to be applied prospectively to the
calculation of the Indirect Cost rate.
c. As is evident from Schedule B-2, 15 of the 20 employee "Estimated Allocations" are
identical to those in the "Recorded Allocations," an additional 3 of the 20 involved minor
adjustments to reflect the fact that the employees had recorded no indirect time (an
impossibility), and only two of the "Estimated Allocations" involved substantial adjustments,
reflecting the fact that the work of those two employees had to be reconsidered in light of
future application of an indirect cost rate.5
d. Thus, with minor and justifiable exceptions, the employee allocations included in the Indirect
Cost Proposal are based on actual recorded time distributions, and not on estimates based on
employee interviews.
In all budget submissions made to EPA subsequent to the initiation of the US-AID award and to
the submission of the indirect cost proposal (e.g. Tab 30), HEI has only included direct and indirect costs
that can be allocated to the EPA grant in accordance with all applicable requirements and regulations.
a) HEI's indirect cost proposal has now been received by EPA as a provisional indirect cost rate
and is awaiting review. The application of this indirect cost rate is, of course, subject to audit
in HEI's independent annual audit, based on actual implementation of the indirect cost rate.
b) In submitting the proposal, HEI chose voluntarily to limit it indirect costs sought to 30 %
(despite the fact that the proposal could support an indirect rate of 41.2%) in keeping with
HEI's own policy of limiting recovery of indirect costs by its own research contractors to
30%.
c) As a result of these actions, and in order to ensure that scientific staff time spent on other
federally-funded objectives was not charged to EPA, HEI began charging scientific salary
expenses to the EPA grant only for those scientists who are assigned exclusively to work on
EPA-funded projects and only for those hours recorded in their labor distribution records
spent on the oversight and review of research.
5 In contrast to the interpretation that might be applied to Footnote 2 of Schedule B-2, the adjustments were not
given by the individual employees themselves but were a result of estimates provided to HEFs qualified indirect
cost consultants by HEI senior employees in order to make these adjustments.
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d) In addition, administrative salary and expenses are no longer charged directly to the grant but
are only recovered through the Indirect Cost Rate at 30% of Direct Costs.
Although HEI's Indirect Cost Proposal was submitted to EPA in compliance with all applicable
regulations, we acknowledge that this process would benefit in future implementation from the
development of detailed written procedures for assessing and revising the Indirect Cost Rate, and are
prepared to work expeditiously to put those procedures into place.
III. CONCLUSION
HEI looks forward to working with EPA OIG and EPA to bring this audit to a mutually
satisfactory resolution. HEI has diligently sought, over many years, to conduct its financial management
in compliance with all relevant federal requirements. We also believe, however, that there are always
areas where an organization such as HEI can reconsider and improve its financial management system,
and as noted above we have already identified several such areas and are prepared to move forward on
them immediately.
HEI has a proven track record of addressing audit findings expeditiously. In the case of the EPA
OARM audit of 2002, HEI received the report of the audit on November 7, 2002; received a final
approval of our Compliance Plan by December 27, 2002, and submitted the major item of that Plan - our
indirect Cost Rate Proposal - to EPA on March 12, 2003.
The Draft Report recommends two sanctions that are not, in our view, supported by the facts of
the HEI financial management system and, if implemented, would prevent HEI from continuing to
produce high-quality science to inform air quality and public health decision-making.
First, given that, as described above, all questioned costs were tracked appropriately and are
allocable to the final cost objective (i.e. the grant); and that their reasonableness, nature nor the
amounts incurred and paid are at issue, these costs are allowable. Thus, recovery of the costs - as
suggested in Recommendation One of the Draft Report - is not supportable and HEI would ask
that it be withdrawn.
Second, given HEI's clear final cost objective (i.e. the grant) and its history of responding
appropriately and expeditiously to audit findings, suspending the grant - as suggested in
Recommendation Two - is a sanction we would suggest that has ramifications out of balance with
the nature and extent of the questions under discussion in this audit. Suspension of the grant
would require HEI to suspend research programs at several dozen universities and seriously
impede HEI's ability to meet the time-sensitive deadlines sought by its sponsors for producing
key pieces of air pollution and health research. HEI asks that Recommendation Two be
withdrawn.
HEI is prepared to follow a rapid schedule to resolve any final issues identified in this audit and
to produce the written procedures identified in the detailed response above. We stand ready to provide
any additional explanations or documentation that you might require to support costs incurred and will
continue to improve our financial management systems as necessary to maintain compliance with our
regulatory responsibilities.
We look forward to working with EPA-OIG to resolve any outstanding administrative issues.
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APPENDIX I
THE HEALTH EFFECTS INSTITUTE
The Health Effects Institute ("HEI") is a not-for-profit research institute founded in 1980
by mutual agreement of EPA (through its Administrator, Douglas Costle) and major motor vehicle and
truck engine manufacturing companies (through their respective chairmen), for the purpose of planning,
implementing, and reporting on a program of original research on the health effects of emissions from
motor vehicles and other sources in the environment. (Tab 1). This unique organization was created
largely to alleviate ongoing conflict between EPA and the motor vehicle industry over the credibility of
the science used to underpin environmental regulation. Rather than industry and EPA each funding
research not credible to the other (or to other interested parties, including the Congress, public interest
groups, and the press), the two sides agreed to support the establishment of a new, independent, and
highly specialized institute that would receive equal funding from the industry and EPA to provide a
single common product that would be credible to all: high quality science relevant to understanding the
health effects of motor vehicle emissions.
Currently, the industry sponsors are the 28 companies that make or market motor vehicles
or truck engines in the United States. Payments to HEI by the individual companies are divided based on
their relative sales in the U.S. market and are made in expectation that a similar amount will be
contributed by EPA.
A. HEI Is Structured for Quality and Independence.
HEI's design was the result of extended negotiations between EPA and the industry to
create an institution that is structured to ensure quality and independence in leadership and scientific
activities, so as to provide results that would be credible to the often adversarial sponsors and to other
stakeholders at the science-policy interface.
In response to the critical need for a leader of HEI with absolute integrity and national
stature, the original sponsors selected Archibald Cox, the former Professor at Harvard Law School,
Solicitor General of the United States, and Watergate Special Prosecutor as the founding Chairman of
HEI's Board. Professor Cox held that position for over twenty years until 2001, when he was succeeded
by Richard Celeste, a Rhodes Scholar, former Governor of Ohio, Director of the Peace Corps and
Ambassador to India, and currently President of Colorado College.
Beyond leadership, HEI is also uniquely structured among all science organizations to
ensure independence and quality (Tab 2: HEI Bylaws):
• Because the sources of funding are a cause of real or perceived bias in the conduct of research,
HEI was specifically designed to be funding-neutral, i.e., with joint and equal core funding to
be provided by EPA and the motor vehicle industry.
• HEI is led by an independent Board of Directors of stature whose members must be approved,
in accordance with HEI's Bylaws (Tab 2), by the Administrator of the EPA and by a majority
of the motor vehicle sponsors (Tab 7: list of current members).
• The Board appoints and oversees two separate bodies of internationally renowned scientists
who serve for specific terms and must meet specified eligibility requirements designed to
ensure impartiality (Tab 2):
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o The HEI Research Committee (Tab 8: list current members, with biographical
summaries), which identifies research needs, competitively solicits, selects, and
actively oversees HEI's program of original scientific research, which is entirely
extramural (generally at university laboratories); and
o The HEI Review Committee (Tab 9: list of current members, with biographical
summaries), an entirely separate body of scientists, whose responsibility is to provide
independent peer review of reports of HEI-funded studies and to comment on, and
provide scientific context for, such reports with a view to their consideration in
connection with environmental regulation.
This uniquely funded and structured partnership has, for nearly 25 years, maintained the
impartiality of the institution and its work and has been instrumental in leading to the widespread
acceptance of HEI research results as the basis for informing regulatory decisions. Indeed, because of its
joint funding, rigorous scientific standards, and carefully guarded impartiality, HEI has at times been seen
as the only highly credible source of health science to inform contentious national air quality policy
decisions.
B. HEI's Scientific Output Is Distinguished and Widely Sought.
To provide scientific studies that are relevant to the needs of EPA and the industry, HEI
relies on the HEI Strategic Plan for the Health Effects of Air Pollution, which is the product of extensive
discussions with EPA, industry and the larger scientific community. The 2000-2005 plan (Tab 5),
submitted in conjunction with HEI's grant application to EPA and to the industry, has constituted the
basis for HEI's scientific activities during the past five years.
HEI recently summarized its progress on implementing the HEI Strategic Plan 2000-2005
in its new final draft Strategic Plan 2005-2010 (Tab 6). During 2000-2005, HEI initiated 59 studies of air
pollution, health and exposure and published 59 Research Reports on HEI-funded studies. In addition,
for the audience of environmental policy-makers, HEI issued 9 major documents concerning research
needs and priorities, scientific methods, and science interpretation in priority areas outlined in the
Strategic Plan. These topics cover some of the nation's most challenging and controversial environmental
science-policy issues during the last 5 years, including:
o the health effects of Particulate Matter (PM), and other criteria pollutants in the
context of evaluating new National Ambient Air Quality Standards;
o the carcinogenicity of diesel exhaust and air toxics in the context of new non-
road vehicle rules and mobile source air toxics standards;
o the health effects of emerging technologies and fuels, such as manganese (a key
ingredient in the fuel additive MMT) and MTBE added to gasoline; and
o establishment of a new program to assess the effectiveness of environmental
regulations in improving public health (the "Accountability Project"), through a
comprehensive audit-like research approach.
Specifically because of its unique EPA-industry funding model and established reputation
for providing independent, high quality, and credible science, HEI has often been called on separately by
EPA, Congress, the Executive Office of the President, the Office of Management and Budget ("OMB"),
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industry, and others to lead scientific efforts relating to especially controversial public-policy issues. For
example:
o The White House Science Office and EPA called on HEI to lead an independent
review of the health effects of inhaled MTBE and Ethanol in Fuel (Tab 10).
o EPA, Congress, and industry called on HEI to conduct a landmark reanalysis of
the key studies most at the core of the PM ambient air quality standards, the
"Harvard Six Cities " and the "American Cancer Society" studies, which
following the HEI reanalysis have been cited in key Regulatory Impact Analyses
(e.g., Tab 11: Analysis of the Costs and Benefits of the EPA Heavy Duty
Highway Diesel Rule).
o OMB and EPA recently called on HEI to undertake a major multi-stakeholder
national study to understand the health effects of Particulate Matter from
different sources (Tab 4: exchange of OMB and EPA letters).
Beyond the sheer number of publications and major reports, the fact that HEI is jointly
and equally funded by EPA and industry to produce a common body of science has, over the years, led to
greater willingness of all interested parties to act on the results of HEI's scientific studies than would have
been the case with respect to scientific studies funded solely by one side. Indeed, due to HEI's success,
its organizational approach to the design and conduct of scientific research has been much studied and has
become known as "the HEI Model" (e.g., Tab 3).
Taken together, the HEI Model of an independent institute, with joint financial support
by EPA and industry to achieve a common goal, led by distinguished members of the scientific and policy
communities, structured to ensure credibility and quality of results, and producing science that is highly
relevant to the needs of policy-makers and other stakeholders has been highly successful. In the words of
an independent Peer Review Panel for HEI's January 2000 Grant Application: "HEI has grown to a level
of high visibility and impact in the minds of decision makers in both government and industry" (Tab 12).
C. Learning from Audits.
As an organization that routinely conducts scientific audits of those we fund, HEI well
appreciates and supports the value of the audit process. It has always been HEI's policy to approach
those we audit in a positive and constructive spirit, and to use audits as learning experiences for all. We
have had almost universally positive responses from our many audited entities post audit; they often cite
improvements in their technical procedures and overall quality as a result. (Tab 13).
HEI's management and its Board of Directors have also viewed the periodic independent
financial audits of its own operations as essential to ensuring the transparency and accountability of its
financial management system to all of its sponsors, and have always welcomed those audits and any
others that may occur, as opportunities to ensure that it is meeting applicable standards and to learn how
we can enhance our procedures.
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APPENDIX II
HEI'S FINANCIAL MANAGEMENT SYSTEM
HEI has had in place a financial accounting system in which all expenses are directly traceable
from source documents through the books and records of the Institute to charges to the single HEI final
cost objective - the Health Effects of Air Pollution Program - (i.e. the grant). In total, this system meets
or exceeds all applicable requirements.
1. EPA Expenses are specifically Accounted for in the HEI Financial
Management System as a Subset of all Costs Allocable to the Health Effects
of Air Pollution Program.
Using the approved EPA budget as a guide, HEI coded the EPA costs for the Health Effects of
Air Pollution Program in the general ledger by using a 2-digit ending, as follows (Tab 37: Chart of
Accounts):
10 - EPA Salaries
11 - EPA Benefits
12 - EPA Travel
13 - EPA, Other
14 - EPA Research Contracts
In addition, the general ledger tracks all industry costs back to: 15 - Industry Costs. (The industry
funding does not require the same level of accounting specificity. All use of industry funds is subject to
audit, however; and all audited results are available to the industrial sponsors.)
Under the HEI financial management system, an invoice is received and approved by the
individual who authorized the expense. Invoices are then coded with the proper general ledger account
(according to the Chart of Accounts, Tab 37) by the accounting assistant. The coding is verified and
approved by the Director of Finance and Administration.
Invoices are then entered into the MAS 90 Accounting System, through the Accounts Payable
Invoice Register by using the approved general ledger code, and are further cost-coded as EPA Salary,
Benefits, Travel, Other, or Research Contracts, or as industry expenses (Tab 38: printout from MAS 90).
The information from the Accounts Payable Invoice Register is transferred through the MAS 90
system to the general ledger.
The information from the Accounts Payable Invoice Register, including the cost-coding, is
recorded in the Accounts Payable Check Register when the invoices are paid. The cost-coded amounts
from the Accounts Payable Check Register are then compiled on a spreadsheet and are charged to the
EPA grant.
Thus, all charges can be traced from the EPA grant request back through the Accounts Payable
Check Register to the general ledger and to the source document to verify the charges. All amounts
drawn from the EPA grant are also reconciled to the budget approved by EPA with the grant application.
(Tabs 39-42).
2. An Additional HEI Financial Control System, Tailored to Processing of
Payroll, Tracks All Payroll Expenses.
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Timesheets for individual employees charged to the grant, as per Circular A-122, Attachment B,
paragraph 7, (1) are filled out after-the-fact, (2) record total activity, (3) are signed by the employee and
approved by a supervisor and (4) are prepared at least monthly (Tab 35: sample timesheet).
All time worked by employees for the period audited was for the same "final cost objective",
Health Effects of Air Pollution Program. All programmatic employees must track their time to specific
scientific or administrative areas - e.g., "research planning and study selection", "research management",
"study review" - in accordance with established written definitions of these terms and activities. These
functional areas are all sub-categories of activities carried out in support of the Health Effects of Air
Pollution Program. This labor distribution and tracking system then ties directly to the programmatic
categories in the audited financial statements (e.g. Tab 29).
Information recorded on the timesheets is processed by ADP, HEI's payroll processing agent.
Salaries charged to the grant have codes different from those not charged to the grant. The
amounts from the ADP journals are recorded in the general ledger, with separate accounts for EPA and
industry charges.
In this manner, labor distribution charges are tracked - as they are in many companies and other
organizations - through HEI's payroll processing company (ADP) and directly into the general ledger.
Each year, as part of our OMB Circular A-133 audit, a sample (of the auditors' choosing) of the
payroll costs for employees charged to the EPA grant are traced from the timesheets to the ADP journals
to the general ledger. Those amounts are also traced from the general ledger back to the cash
disbursement journals to the ADP journals, and are reconciled with the amounts charged to the EPA grant.
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List of Attachments for IG Response (Provided in Hard Copy-available from the OIG upon request)
HEI Background and description
1 Articles of Incorporation
2 Bylaws
3 Anderson Article (Bob)
4 Graham/Whitman Exchange of letters
5 HEI Strategic Plan 2000-2005
6 HEI Plan 2005-2010
7 List of Board Members
8 List of Research Committee Members
9 List of Review Committee Members
10 Review of MTBE and Ethanol in Fuel
11 Analysis of Costs and Benefits of EPA Heavy Duty Highway Diesel Rule
12 January 2000 Peer Review Panel
13 HEI QA/QC Audit Procedures
HEI EPA Grant Applications and Amendments
14 EPA Grant Application 2000-2005 Grant No. R828112-01
15 Revised 2000 -2005 Grant Application
16 Renewal 2001
17 Renewal 2002
18 Renewal 2003
19 Renewal 2004
20 EPA Grant Agreement
21 Amendment # 1
22 Amendment #2
23 Amendment #3
24 Amendment #4
25 Federal Cash Transaction Report (Sample)
HEI Audits and responses
26 Audit Report 1992
27 Audit Report 2000
28 Audit Report 2001
29 Audit Report 2002
30 Audit Report 2003
31 Audit Report 2004
32 Letter from EPA OARM audit, HEI response, EPA OARM reply
33 Indirect Cost Rate Proposal
HEI Financial procedures
34 Guidance for payroll timetracking
35 sample timesheet (Maria Costantini)
36 sample timesheet (Howard Garsh)
37 Chart of Accounts
38 sample general ledger printout
39 sample Accounts Payable Invoice Register
40 sample Accounts Payable Check Register
41 sample travel expense invoice
42 grant drawdown spreadsheet
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Appendix C
Distribution
EPA Headquarters
Office of the Administrator
Director, Grants Administration Division (Action Official)
(Responsible for report distribution to recipient)
Director, Office of Grants and Debarment
Audit Followup Coordinator, Office of Grants and Debarment
Assistant Administrator for Air and Radiation
Assistant Administrator for Research and Development
Agency Followup Official (the CFO)
Agency Audit Followup Coordinator
Associate Administrator for Congressional and Intergovernmental Relations
Associate Administrator for Public Affairs
General Counsel
Inspector General
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