DAB Decision No. 1580: Lake County Economic Opportunity Council, Inc.

The Department of Appeals upheld the decision by ACF to terminate the grant awarded to Lake County Economic Opportunity Council, Inc. Grantees will benefit from reviewing this decision to avoid non-compliance with applicable federal laws and regulations. Lake County Economic Opportunity Council, Inc. failed to comply with the required reporting requirements and meet the performance standards for operating its Head Start program.

Department of Health and Human Services

DEPARTMENTAL APPEALS BOARD

Appellate Division

SUBJECT:

Lake County Economic Opportunity Council, Inc.
Docket No. A-95-66
Decision No. 1580

DATE:

June 12, 1996

DECISION

Lake County Economic Opportunity Council, Inc. (LCEOC) appealed a January 13, 1995 determination by the Administration for Children and Families (ACF) denying refunding for LCEOC's Head Start Program. This action was taken pursuant to 45 C.F.R. 1303.15(c), which provides that refunding may be denied for "any or all of the reasons . . . set forth in [45 C.F.R.] 1303.14(b)." ACF set out four general grounds for its determination --

LCEOC's failure to submit timely annual audit reports that meet Office of Management and Budget (OMB) Circular A-133 requirements for 1989, 1990, 1991, 1992, and 1993;
LCEOC's failure to document making cost of living adjustments or salary increases specifically funded in grant awards in 1990, 1991, 1992, and 1993;
LCEOC's failure to enter into written, approved delegate agreements for its nine delegates;
LCEOC's failure to demonstrate full compliance with program requirements, as documented in April 1993 and May 1994 on-site reviews.

ACF Exhibit (Ex.) 1 at 2-11.¹

LCEOC contested each basis of ACF's determination and requested a hearing pursuant to the Head Start Act, 42 U.S.C. 9841. A four-week hearing was held during the months of June and September 1995.

We have carefully considered the record in this case. Although we found LCEOC's witnesses credible and its counsel able, the overwhelming weight of the evidence established that LCEOC has been out of control fiscally for several years. During this time, LCEOC was receiving millions of dollars of federal money, yet it did not provide timely audited statements meeting OMB requirements and showing how the basic Head Start funds it received were spent or whether supplemental funds provided for cost of living adjustments or salary increases during the period 1990-1993 were spent as promised and required. When LCEOC finally produced a long-overdue audited statement at the end of this proceeding, that statement showed that during 1993 and 1994, LCEOC had overspent its budget by over two million dollars. For several years LCEOC ran a program involving nine delegates using, instead of written, approved delegate agreements, one-page letters effectively freezing funding at outdated levels and failing to establish any of the required parameters of the grantee-delegate relationship. In addition, LCEOC failed to demonstrate compliance with many other significant program requirements, despite being given notice and ample opportunity to correct those deficiencies.

For the reasons discussed below, we conclude that LCEOC has materially failed to --

comply with the required fiscal or program reporting requirements;
meet the performance standards for operation of its Head Start program;
comply with Head Start grants administration requirements;
comply with the requirements of the Head Start Act; and
abide by other terms and conditions of its grant and applicable laws or regulations.

Accordingly, we find that denial of refunding is warranted pursuant to 45 C.F.R. 1303.14(b)(3), (4),(6), (7) and (9).²

I. Background

A. Overview of the applicable law and regulations

The Head Start program is designed to deliver comprehensive health, educational, nutritional, social and other services to economically disadvantaged children and their families. See 42 U.S.C. 9831 and 45 C.F.R. 1304.1-3. ACF provides funds to grantees to serve as Head Start agencies within designated communities. See generally 42 U.S.C. 9836. The Head Start Act requires grantees to keep records that will "fully disclose the amount and disposition" of federal funds and "facilitate an effective audit." 42 U.S.C. 9842(a). Head Start agencies may operate part of their funded programs through delegate agencies. 42 U.S.C. 9837. The law requires that a Head Start agency utilize --

accountability in matters governed by law, regulations, or agency policy . . . .

42 U.S.C. 9839(a); see also 45 C.F.R. 1301.30.

In the mid-70s, the Secretary promulgated program performance standards covering the education, health (including medical, dental, mental health and nutrition), social services, and parent involvement component areas of Head Start. See 45 C.F.R. Part 1304. When the regulations were first promulgated, the preamble to the final rule explained that the standards had been developed based on seven years experience with the program, had been field tested, and were considered reasonable and attainable. 40 Fed. Reg. 27,562 (June 30, 1975). The program performance standards covering services for children with disabilities were later published as 45 C.F.R. Part 1308.

Generally, each grantee is required to develop, with the advice and concurrence of its Policy Council, a written plan to implement the performance standards for each component area, and to review it at least annually and revise and update it as necessary. 45 C.F.R. 1304.1-4. Congress has provided that Head Start projects must be operated consistent with the performance standards, and that the "extent to which such standards have been met shall be considered in deciding whether to renew" funding. 42 U.S.C. 9846(b).

ACF is required to conduct a full review of each Head Start agency at least once during each three-year period. 42 U.S.C. 9836a(c)(1)(A). The performance standard regulations require a 90-day opportunity for corrective action on deficiencies in meeting performance standards. See 45 C.F.R. 1304.1-5(b); see also Campesinos Unidos, Inc., DAB No. 1518 at 14 (1995).

Head Start regulations list nine grounds for which a Head Start grantee agency may be terminated or have its refunding denied. As applicable here, refunding may be denied when a grantee has failed to comply with the required fiscal or program reporting requirements; failed to meet the performance standards for operation of its Head Start program; failed to comply with grants administration requirements; failed to comply with the requirements of the Head Start Act; or failed to abide by any other terms and conditions of its grant or applicable laws or regulations. 45 C.F.R. 1303.14(b)(3), (4), (6), (7) and (9), made applicable by 45 C.F.R. 1303.15(c).

The Head Start Act at 42 U.S.C. 9841(a)(3) and corresponding regulations at 45 C.F.R. 1303.15 provide that a grantee denied refunding shall have an "opportunity for a full and fair hearing" on whether refunding should be denied. Procedures for the conduct of a hearing are set forth at 45 C.F.R. 1303.16. The Board is authorized to act on behalf of the Secretary to provide this opportunity for hearing. 57 Fed. Reg. 59,260 (December 14, 1992). The Board's procedural regulations at 45 C.F.R. Part 16 apply to these proceedings insofar as they are not inconsistent with Part 1303. 45 C.F.R. 1303.15(b)(1).

B. Burden of Proof and Materiality

As we have held earlier in these proceedings, the provisions of 45 C.F.R. 1303.14 require ACF to make a prima facie case that there exists sufficient evidence to satisfy the regulatory standards for termination or denial of refunding. See Rulings on Burden of Proof, Materiality, and Jurisdiction Under 45 C.F.R. Part 1303 (May 19, 1995) (Rulings). See also Richmond Community Action Programs, Inc., DAB No. 1571 at 6 (1996). Once ACF has set forth legally adequate reasons to support a denial of refunding or termination, and has provided sufficient specificity for the grantee to respond to the substance of individual findings, the regulations require the appellant to respond.

This process has practical underpinnings. A grantee always bears the burden to demonstrate that it has operated its federally funded program in compliance with the terms and conditions of its grant and the applicable regulations. See, e.g., Meriden Community Action Agency, Inc., DAB No. 1501 at 41 (1994); Rural Day Care Association of Northeastern North Carolina, DAB No. 1489 at 8; 16 (1994), aff'd No. 2:94-CV-40-BO (E.D.N.C., Dec. 19, 1995); see also 45 C.F.R. 74.53(b) and (g). Moreover, a grantee is clearly in a better position to establish that it did comply with applicable requirements than ACF is to establish that it did not. Therefore, once presented with a prima facie case, a grantee must present evidence sufficient to challenge ACF's case or risk summary disposition.

Regarding the question of how the Board should analyze the record developed under Part 1303 in conjunction with Part 16, the appropriate standard to be applied to competing evidence is preponderance of the evidence. That standard requires "evidence which is of greater weight or more convincing than the evidence which is offered in opposition to it; that is, evidence which as a whole shows that the fact sought to be proved is more probable than not." Black's Law Dictionary 1182 (6th ed. 1990). This is the commonly accepted standard for administrative proceedings. See Rulings at 3.

Further, the concept of "materiality" found in 45 C.F.R. Part 74 is read into 45 C.F.R. Part 1303 because the Department-wide grants administration regulations in Part 74 apply to the extent that they are consistent.³ Given the general statutory preference for continuing funding to existing grantees (42 U.S.C. 9836(c)(1)) and, where appropriate, permitting a grantee the opportunity to correct deficiencies (42 U.S.C. 9836a(d)(1)(B)), it is consistent to read materiality into 45 C.F.R. 1303.14(b), which lists the bases for termination or denial of refunding actions. Certainly, ACF should not seek to end a grantee's Head Start participation on a mere technicality.

C. Factual Background

LCEOC is a community service corporation operating a variety of Federal, State and locally funded social service programs throughout a six-county area in Northwest Indiana. LCEOC has been a Head Start grantee since 1965. LCEOC's Head Start Program is administered through nine delegate agencies serving approximately 1,200 children.⁴ The service area covers just over 1,330 square miles and consists of industrialized urban and sparsely populated rural areas. See LCEOC Motion to Dismiss, Attachment (Att.) A (LCEOC Head Start Grant Application, November 1, 1994); ACF Ex. 10 (February 1, 1994 - January 31, 1995 Grant Award).

In April 1993, LCEOC's Head Start Program was subject to a federal On-Site Program Review (OSPRI). The 1993 OSPRI revealed a number of deficiencies in the following program component areas: Education, Nutrition, Social Services, Parent Involvement, Disabilities and Administration. See ACF Ex. 15. The OSPRI also found that LCEOC's fiscal management system was in such disarray that the program component involving Accounting Standards could not be meaningfully reviewed. Moreover, the reviewers also received indications that various supplemental funding awards (meant to increase salary and fringe benefits for LCEOC personnel) which LCEOC had received in the years immediately preceding the OSPRI had not been paid as directed. Having been alerted to these problems, LCEOC was given an opportunity to take corrective action.

On February 16, 1994, ACF notified LCEOC that LCEOC's audit reports for the periods ending January 31, 1990, 1991 and 1992, as well as its audited financial status reports (SF-269s) were overdue. See ACF Ex. 28.

In May 1994, federal reviewers conducted a follow-up to the 1993 OSPRI. Again, they found numerous instances of noncompliance, both repeat and new, with various program components. See ACF Ex. 16. The reviewers also examined LCEOC's performance under the accounting standards and found many instances of noncompliance. Further, the reviewers determined that the supplemental grant funding earmarked for salary increases had not been properly disbursed.

On May 10, 1994, ACF placed LCEOC on "High-Risk" status based on its determination that LCEOC was an organization "whose management practices raise serious concerns about its ability to assure proper programmatic use and financial stewardship of grant funds." ACF Ex. 2. ACF recounted that it had, on numerous occasions, expressed concern to LCEOC regarding the management and functioning of LCEOC's Head Start grant. ACF based its concern on LCEOC's failure to correct programmatic and administrative noncompliance; LCEOC's failure to provide requested and required information; the frequent lateness of LCEOC's applications and other submissions as well as the recurrent inadequacy of those documents. ACF Ex. 2 at 3.

LCEOC sought reconsideration of its High-Risk status. See ACF Ex. 3. On June 24, 1994, ACF denied LCEOC's request that its High-Risk designation be withdrawn. ACF did leave open the possibility that LCEOC could cure its problems with the appropriate corrective action. See ACF Ex. 4. ACF concluded that corrective action was not forthcoming, and issued its Denial of Refunding on January 13, 1995.

II. Analysis

Our analysis of the grounds for denial of refunding is set out below. Part A examines the various issues underlying LCEOC's fiscal mismanagement. Part B contains an analysis of the salary enhancement and cost of living adjustment issues. Part C examines the OSPRI issues. Part D contains an analysis of the delegate agreement issues.

A. LCEOC's Fiscal Mismanagement

During the three-year period prior to ACF's denial of refunding determination, LCEOC received total federal awards of about $13.6 to $14.6 million, with Head Start grants comprising $3.1, $4.2, and $3.8 million in 1992, 1993, and 1994 respectively. In assessing LCEOC's fiscal management of these funds the central instruments examined by ACF were -- a combined audit report for the fiscal years ending December 31, 1989-1991 (CA-1) (LCEOC Ex. 83) and OSPRIs for 1993 and 1994 (LCEOC Exs. 155 (1993) and 129 (1994)). During the course of this appeal, LCEOC finally produced a long-overdue audit for the fiscal years ending December 31, 1992-1994 (CA-2).⁵

In this proceeding, ACF maintained that LCEOC was so disorganized for so many years that ACF was unable to assess LCEOC's fiscal stewardship of the millions of dollars awarded it each year for its Head Start program. A key element was that LCEOC was consistently delinquent in conducting and filing audits by periods ranging from almost two to four years. Further, LCEOC was not filing its semiannual SF-269s. LCEOC conceded its untimeliness on both counts. See LCEOC Ex. 83 at 26 (Response to Finding No. 11); LCEOC Ex. 159, Part 3 at 23 (Response to Finding No. 4); LCEOC Post-Hearing Brief (PHBr.) at Appendix (App.) 3 (Failure to file timely SF-269s). Thus, LCEOC was unable to provide ACF with timely or contemporaneous assurances that Head Start funding was being properly spent. Moreover, since LCEOC remained delinquent in providing annual audits even after CA-1 was submitted, ACF had no assurance that the numerous deficiencies identified by the auditors in CA-1 had been addressed. In addition, ACF's on-site reviewer in April 1993 found LCEOC's financial records in such disarray that she was unable to perform a review. The situation was only marginally better when an ACF reviewer followed up in May 1994. Below we discuss each of these indicators of LCEOC's fiscal disarray.

1. Timeliness of Required Financial Reports

The Head Start Act requires grantees to keep records that will "fully disclose the amount and disposition" of federal funds and "facilitate an effective audit." 42 U.S.C. 9842(a). More specific requirements are set out in 45 C.F.R. Part 74 and the ACF Grants Administration Manual (ACF/GAM)⁶, both of which were incorporated specifically in LCEOC's annual Notices of Grant Award. See, e.g., ACF Ex. 9 (Award for 1993-94) at 5-6 (unnumbered).

Two key elements to ACF's ongoing oversight of Head Start grantees' fiscal management are: the SF-269, which is an unaudited statement required to be filed semiannually to report the status of funds for all nonconstruction grants; and the annual independent audit required by the Single Audit Act of 1984, 31 U.S.C. 7501-7507, and 45 C.F.R. 1301.12. SF-269s report on several elements essential to federal oversight of a grantee's expenditures, including the grantee's total federal and non-federal outlays, unliquidated obligations, and unobligated balance of federal funds. The final report for a grantee's Head Start grant year is due 90 days after the end of each budget period. The HDS/GAM warns grantees that failure to file an overdue report can result in suspension or termination of a grant, withholding of additional awards, or other more severe action. HDS/GAM Chapter (Ch.) 6, C. This warning was also incorporated into the terms and conditions of LCEOC's grant award. See, e.g., ACF Ex. 9 (Award for 1993-94) at 7 (unnumbered).

The annual independent audit of Head Start grantees is governed by Office of Management and Budget Circular A-133 (OMB A-133). Independent auditors are required to determine whether:

The financial statements of the grantee present fairly its financial position and the results of its operations in accordance with generally accepted accounting principles;
The grantee has an internal control structure to provide reasonable assurance that the grantee is managing federal awards in compliance with applicable laws and regulations, and controls that ensure compliance with the laws and regulations that could have a material impact on the financial statements; and
The grantee has complied with laws and regulations that may have a direct and material effect on its financial statement amounts and on each major federal program.

OMB A-133, 12.b. OMB A-133 is codified at 45 C.F.R. Part 74, Appendix I, which was incorporated as a term and condition of LCEOC's grant awards for the relevant period.

OMB A-133 requires grantees to provide for audits to be submitted no later than thirteen months after the end of the audited fiscal year. OMB A-133, 14.h. In early 1994, LCEOC informed ACF that the overdue audit reports for fiscal years (FYs) ending 12/31/89, 12/31/90, 12/31/91 and 12/31/92 would be filed by April 30, 1994. They were not. ACF cited the absence of these reports as a critical concern in its May 10, 1994 high risk designation letter to LCEOC, warning that LCEOC's management practices raised serious concerns about its ability to assure proper programmatic use and financial stewardship of grant funds. ACF Ex. 2 at 1. LCEOC responded with an assurance that the audits for FYs 89-91 would be ready for submission by July 15, 1994. ACF Ex. 3 at 3.

On December 16, 1994, LCEOC finally submitted CA-1, the combined audit for fiscal years 1989-1991. See LCEOC Ex. 83. The individual audits for those three years were 47, 35 and 23 months late, respectively.⁷ Moreover, CA-1 found 26 reportable conditions, the majority of which were related to Head Start. Among those findings was a finding that LCEOC had not submitted timely SF-269s during those three years, a finding that was repeated in the audit covering the following three fiscal years and in the April 1994 follow-up on-site review.

LCEOC offered numerous arguments regarding the untimeliness of CA-1. LCEOC asserted that it was only required to submit audits every two years. LCEOC Notice of Appeal (Appeal) at 7. LCEOC's arguments supporting this assertion are unpersuasive, as neither the regulation or OMB A-133 can reasonably be read to permit audits every two years. The Head Start regulation entitled "Annual audit of Head Start programs" provides: "An audit of the Head Start program covering the prior budget period of each Head Start agency and its delegate agencies, if any, shall be made by an independent auditor . . . ." 45 C.F.R. 1301.12(a). Additionally, OMB A-133 provides: "Audits shall usually be performed annually but not less frequently than every two years." OMB A-133, 7. LCEOC's reliance on this sentence as permitting an audit every two years is misplaced. In context, the two-year period is clearly an outside parameter, a worst case scenario, rather than a routine option. Finally, we note that the record contains the Notices of Grant Award for LCEOC's program years 1990 through 1994. See ACF Exs. 6-10. Each award document includes an "Attachment 3," which specifically calls for an audit of the 12-month period for which funding is awarded. See, e.g., ACF Ex. 6 (1990 Award) at 6 (unnumbered).

In its response to CA-1, LCEOC also blamed CA-1's untimeliness on the absence of a "designated state cognitive agency." Further, LCEOC contended that Indiana's prescribed auditor selection process also delayed completion of its audits. See LCEOC Ex. 83 at 26. However, LCEOC did not develop these arguments to show that they somehow excused its failure to comply with the regulatory audit requirements.

LCEOC did extensively develop its contention that CA-1's and the SF-269s' untimeliness were attributable to various uncontrollable computer problems. Computer changeover, incompatible/inadequate systems, and "head crashes" were recurring themes throughout LCEOC's discussion of this issue. During this period, however, LCEOC claimed that it maintained a manual set of records. Hearing Transcript (Tr.) at 3880-81. LCEOC never explained why, if it indeed had an alternative method of keeping its accounts current, it failed to file SF-269s or annual audits for several years. Moreover, Charlotte Pitts, the ACF financial specialist for this grant who was responsible for the financial part of the 1993 OSPRI, testified that she was concerned when she visited LCEOC that there were no manual books kept concurrently (Tr. at 1641), and was told by LCEOC staff that LCEOC had not kept concurrent books. Id. at 1642. Consequently, she found herself totally unable to review LCEOC's fiscal performance in April 1993 and informed LCEOC management of this conclusion. Id. at 1648. Accepting LCEOC's assertions that its problems were chiefly due to its computerization project, she gave LCEOC the benefit of the doubt, resolving to return six months later. Id. at 1647. Circumstances intervened so that LCEOC actually had a full year to resolve its problems before the next ACF visit. However, as we discuss below, LCEOC's accounting system was still not functional by the May 1994 follow-up review or, indeed, by December 31, 1994, the end of the period covered by CA-2. Thus, the evidence here confirms that, computer problems aside, LCEOC was fiscally mismanaged.

The consistent delinquency of LCEOC's audits was a disservice to the program participants, ACF and itself. Had the audits been submitted timely, both ACF and LCEOC would have had a more current objective assessment of LCEOC's fiscal condition. Neither ACF nor LCEOC's management had any assurance from an independent examiner during that time that the numerous problems identified in earlier audits were being properly addressed and corrected. As a practical example, had LCEOC submitted a timely audit for FY 12/31/92 (i.e., by March 1994), ACF could have determined, at the time of the May 1994 OSPRI, what steps, if any, LCEOC had taken to address the numerous reportable conditions cited in CA-1. We note that CA-2 found that many of the reportable conditions stated in CA-1 were addressed by December 31, 1994. However, since CA-2 was once again an audit covering multiple years, there is no indication as to when many of the corrections were finally made, i.e., for how many more years after CA-1 was issued LCEOC's internal controls remained deficient.

At the time ACF finally decided to deny refunding (January 1995), ACF had been placed in a position of consistently having to review financial management documentation almost two years, at a minimum, after it was due. Although ACF did not have the benefit of CA-2 at the time it made its decision, that document confirms that ACF's concerns about LCEOC's fiscal management were indeed well-founded. According to CA-2, LCEOC ended 1994 with an overall deficit of approximately $2,175,000. Specifically, the independent auditor reported in the combined financial statements that LCEOC experienced significant operating losses in 1993 and 1994, when funding available for needed programs and services was insufficient to support the level of expenditures LCEOC incurred. LCEOC Ex. 159, Part 2, at 10-11. See also Tr. at 1701-02 (LCEOC would be unable to perform budget comparisons without a current general ledger); Tr. at 1684 (general ledger necessary to maintain control over current operations).

Based on LCEOC's persistent, unexcused failure over many years to provide timely financial reports and independent audits we conclude that: LCEOC failed to comply with fiscal reporting requirements applicable to grantees in the Head Start program; failed to comply with the Head Start grants administration requirements set forth in 45 C.F.R. Part 1301; and materially breached the express terms and conditions of its Head Start awards of financial assistance. Thus, we conclude that denial of refunding is warranted under 45 C.F.R. 1303.14(b)(3), (6), and (9).

2. Independent Audit Findings

ACF also based its January 1995 denial of refunding on LCEOC's failure to establish that it had addressed 26 findings of deficiencies in LCEOC's fiscal management identified in CA-1, 17 of which were allegedly related to Head Start, according to ACF.⁸ LCEOC challenged these findings both in number, asserting only 16 related to Head Start, and materiality, contending only four were material.

Both by direct testimony and in its Post-Hearing Brief,ACF contended that LCEOC still had not addressed the findings of deficiencies. As noted above, the untimeliness of this first audit and LCEOC's continued failure to provide timely audits for the next two fiscal years frustrated ACF's attempts to determine if LCEOC was using federal funds for their intended purpose. Had the subsequent audits been timely, there might have been some solid evidence in the record to determine the corrective actions taken to remedy problems arising in 1991, at the earliest. Rather, due to a combination of the lack of documentary evidence as well as the passage of time, LCEOC's case before the Board consisted of generally self-serving testimony. Moreover, even the majority of the corrective actions cited in the testimony of LCEOC's Chief Financial Officer were alleged to have occurred in 1994 (or early 1995) and were based on LCEOC's assertion that its problem-ridden computer program was finally producing a timely, accurate general ledger. Tr. at 3963-65. However, CA-2 found that LCEOC still did not have a currently posted general ledger as late as December 1994. LCEOC Ex. 159, Part 1, Att. at 17.

The audit which we have identified as CA-2 reexamined the 26 findings cited in CA-1 and was finally submitted to ACF in January 1996. CA-2 revealed that although some earlier problems had been corrected, numerous problems still existed. Obviously, ACF did not have the benefit of this independent analysis of LCEOC's fiscal management at the time it made its denial of refunding decision. However, this absence of information regarding LCEOC's corrective action has no bearing on the validity of ACF's determination to deny refunding. The Board has ruled irrelevant evidence of efforts to improve program operations after the follow up to the initial on-site review, here the 1994 OSPRI. See Springfield Action Commission, Inc., DAB No. 1547 at 13 (1995); Meriden at 6-7. This is because ACF is entitled to take such an action whenever it determines that the regulatory criteria still have not been met. Although the Head Start Act permits the Secretary to give grantees an opportunity to correct deficiencies in meeting program standards, 42 U.S.C. 9836a(d)(1)(B), it also directs the Secretary to terminate refunding to programs that are unable to correct. 42 U.S.C. 9836a(d)(1)(C). Thus, the Board has ruled that it will not in effect give a grantee an open-ended period of correction by accepting evidence attempting to show that correction has occurred after ACF made its findings. To do otherwise would hamstring ACF in its program oversight and encourage grantees to seek protracted delays in appeal proceedings. See Springfield at 13.

In this case, it is clear that ACF was eminently reasonable in basing its denial of refunding decision in part on LCEOC's failure to provide convincing evidence that it had corrected the serious financial management deficiencies identified by CA-1 by January 1995. In fact, in addition to LCEOC's missing audits, ACF also had the follow-up OSPRI findings that as of May 1994, LCEOC still did not have a fully functional accounting system. However, rather than engaging in an exhaustive discourse on all 17 of CA-1's Head Start-related findings, we have decided to focus on the five that still remain, in the opinion of CA-2's auditors, and only briefly outline the other findings.

a. Uncorrected Reportable Conditions

11 -- Untimely Submission of Required Reports

⁹

14 -- General Ledger Account Reconciliation

Accurate and current general ledgers are essential to a determination that a grantee is accurately accounting for federal funds. The May 1994 OSPRI found that the most current available general ledger was from May 1992. In September 1995, LCEOC's Vice-President of Finance testified to the existence of general ledger accounts up to March 1994 (printed on June 27, 1994). Tr. at 3754. A long-time LCEOC consultant testified that LCEOC's system was set up so "that you have to close a month to open the next month and you can't close a month . . . and print your financials until everything is there . . . ." Tr. at 3444-45. The Vice-President of Finance indicated that LCEOC's reconciliation process includes reviewing the reasonableness of a transaction at the end of the accounting period and ensuring that it is properly recorded. Id. at 3980; see also LCEOC PHBr. at 55. He testified that LCEOC had been reconciling general ledger accounts (e.g., cash accounts, accounts receivable, fixed assets, intercompany accounts, et al.) since "fall of 1994." Tr. at 3980-81. LCEOC's consultant also stated that LCEOC was up to date printing reports in September 1994. Tr. at 3450.

LCEOC's testimony is unsupported by evidence in the record and does not ameliorate the overall findings regarding the general ledgers. Moreover, this testimony is contradicted by CA-2, which was included in the record for this case at LCEOC's request. See LCEOC Ex. 159, Part 1, Att. at 17. The testimony as well as LCEOC's arguments on this point are generally reflective of the fiscal disarray described by ACF. There is a great deal of confusion regarding when ledgers were current or how close to current they might have been at any given time. (See discussion of financial OSPRI findings below.) However, at the time of the May 1994 OSPRI and the subsequent period covered by CA-2 (ending 12-31-94), LCEOC did not have current reconciled general ledgers.

17 -- Cash Reconciling Items

LCEOC relied on the previously cited testimony of its Vice-President of Finance regarding the reconciliation of general ledger accounts as proof that this situation had been corrected. As with the general ledger account, this logic fails. First, the only evidence of correction is LCEOC's self-serving testimony. The most recent independent audit, CA-2, presents an opposite conclusion. Moreover, even if LCEOC had been reconciling these items as of September 1994, that would not be a mitigating factor showing sound fiscal management. This problem had gone unresolved for the previous five years, up to and including the May 1994 OSPRI upon which, in part, the denial of refunding was based.

18 -- Unrecorded Cash Accounts

In its direct response to this finding, LCEOC indicated that each of its entities (presumably delegate agencies) had their own procedures which had to be addressed before closing or consolidating accounts. LCEOC Ex. 83 at 31. LCEOC contended that each delegate required a general fund account and "functional accounts, such as receiving accounts at one or two locations which would either be a checking or cash account." Tr. at 4000-02. Additionally, here were about 30 to 40 nutrition depository accounts that LCEOC contended were required by applicable regulations. Id. Thus, LCEOC argued, a minimum of 80 cash bank accounts are needed at any one time. LCEOC PHBr. at 56.

LCEOC's responses are evasive. Admittedly, LCEOC does cover a rather divergent geographical area, such that centralized "one-stop" banking might not be a viable alternative. However, LCEOC has done nothing more than flatly state that it has 30 to 40 nutrition depository accounts. LCEOC never stated explicitly what program regulations required this proliferation of accounts. Moreover, LCEOC's earlier response (issued shortly after CA-1) that consolidation or closing of accounts would be dictated by each entities' procedural process begs the question. Both audits consistently cited this situation as a poor business practice. LCEOC cannot shift the blame for this situation to its delegates.

20 -- Fixed Asset Policies and Procedures

The CA-2 auditors noted, as did ACF's financial specialist, that such records are extremely important for providing effective control over such assets, and are also helpful for insurance, tax, and other accounting purposes.¹⁰ See LCEOC Ex. 159, Att. 1 at 9; Tr. at 1761-62. It is demonstrative of LCEOC's continued fiscal malfeasance that, two years after CA-1 identified the problem, there was still no detailed fixed asset ledger.

b. Other CA-1 Findings

The CA-2 auditors determined that the other CA-1 findings had been corrected by the end of the audited period, December 31, 1994. For the most part, the auditors did not state when, during the three-year period covered by CA-2, the corrections were made. Moreover, ACF's financial specialist testified that a number of these corrections would be dependent upon the timeliness and accuracy of the general ledger (which, as previously discussed, CA-2 found was not reconciled on a timely basis). In any event, as there are ample other grounds supporting this denial of refunding, we have decided to simply summarize CA-1's findings so that the reader may see the additional, apparently uncorrected, internal control problems that ACF considered in deciding to deny refunding.

4 -- Head Start - Incorrect Grant Period

CA-1 revealed that LCEOC charged three 1988 Head Start expenditures (totaling $2,650) to the incorrect grant period (1989). LCEOC Ex. 83 at 22.

5 -- Head Start - Unallowable Costs

CA-1 revealed that LCEOC charged unallowable costs ($291) to the Head Start grant. LCEOC Ex. 83 at 22-23.

10 -- Cost Allocation Plan

CA-1 revealed that LCEOC did not properly allocate costs to appropriate programs because LCEOC did not have a cost allocation plan. LCEOC Ex. 83 at 25.

12 -- Grant Close-Out Forms

CA-1 revealed that grant close-out forms were not accurate. LCEOC Ex. 83 at 26.

16 -- Accounting Policies and Procedures Manual and Staff Training

CA-1 revealed that LCEOC did not have a formalized policies and procedures manual nor did it have a formalized training program for the accounting staff. LCEOC Ex. 83 at 29.

19 -- Control of Cash Receipts

CA-1 reported that LCEOC did not restrictively endorse cash receipts immediately upon receipt and that the review of deposit slips or validated deposit tickets was undocumented. LCEOC Ex. 83 at 31.

21 -- Intercompany Receivables and Payables

The CA-1 auditors found that LCEOC did not maintain a detailed listing of significant intercompany receivable and payable accounts which reconciled to the general ledger. LCEOC Ex. 83 at 33.

22 -- Accounts Payable Cut-Off Procedures

CA-1 reported that LCEOC did not have adequate procedures in place to ensure that all liabilities are recorded at the end of the year. LCEOC Ex. 83 at 33.

23 -- Cash Disbursement Controls

CA-1 reported that paid invoices were not consistently marked "Paid." LCEOC Ex. 83 at 33-34.

24 -- Payroll Policies and Procedures

CA-1 reported that payroll policies were not consistently followed. LCEOC Ex. 83 at 34.

25 -- Review of Consulting Contracts

CA-1 reported that two LCEOC consultants were married. The auditors recommended that LCEOC's Board of Directors review this situation and get approval from ACF. LCEOC Ex. 83 at 34-35.

26 -- Improving the Audit Process

CA-1 reported that LCEOC did not provide items requested during the audit on a timely basis. Consequently, LCEOC incurred increased audit fees and the audits took almost 18 months to complete. LCEOC Ex. 83 at 35.

3. OSPRI Findings Related to Financial Management

Charlotte Pitts, ACF's financial specialist assigned to LCEOC's grant, was responsible for reviewing LCEOC's accounting practices during the 1993 OSPRI. Ms. Pitts testified that LCEOC's financial records were too disorganized to review meaningfully. Tr. at 1645-47. In order to give LCEOC time to complete its computerization project, she planned to return to LCEOC to complete her review in six months. However, no one from ACF revisited this issue until the follow-up OSPRI in May 1994. Tr. at 1651-53; ACF PHBr at 204-5.¹¹

Maria Michalski, an experienced Certified Public Accountant, was the peer reviewer responsible for reviewing this component in the 1994 OSPRI. She testified that while she was aware of the 1993 OSPRI, she did not review it prior to conducting her review. Tr. at 3838. Ms. Michalski found LCEOC in compliance with several of the OSPRI items in dispute here. Ms. Pitts was responsible for reviewing Ms. Michalski's findings and making the final determinations for ACF as to whether each item was in compliance. Ms. Pitts examined Ms. Michalski's findings in conjunction with her own understanding of LCEOC's condition in 1993 and consequently reversed some of Ms. Michalski's findings of compliance and noncompliance. ACF concluded in the 1994 OSPRI that LCEOC was out of compliance with eight accounting requirements.

a. Undisputed OSPRI Findings

LCEOC conceded noncompliance with two OSPRI findings and contested the remainder. The two items LCEOC conceded are discussed separately below.

OSPRI 225 Financial data and records were used in preparing the SF-269's for the budget period.

This was a repeat finding from the 1993, as well as a 1988, OSPRI. Tr. at 1681. We have already outlined above the regulatory and grant award requirements underlying this review item. Both Ms. Pitts and Ms. Michalski found LCEOC out of compliance. Ms. Michalski noted that "forms 269 are not available for two current two [sic] required periods 7-31-93 & 1-31-94 & general ledger is not available." ACF Ex. 70, OSPRI at 114. ACF maintained that because LCEOC's financial records were neither accurate nor current, it would be impossible for LCEOC to show that its SF-269s corresponded with its accounting records. ACF PHBr. at 211. LCEOC conceded this finding of noncompliance. See LCEOC PHBr. at App. 3. We have already stated above that this noncompliance is a material failure to comply with program requirements, and will not belabor the point here.

OSPRI 245 The grantee has a system in place to return interest earnings to the Federal Government.

Grantees are required by 45 C.F.R. 74.47 to remit to the federal government any interest income earned on advances of Department of Health and Human Services (DHHS) funds. See also HDS/GAM Ch. 4, D.1; and 45 C.F.R. 74.24. Both the 1993 and 1994 OSPRIs found LCEOC out of compliance with this Item. Ms. Michalski wrote that she was "not able to verify return of interest to fed govt," (LCEOC Ex. 70, OSPRI at 119) and wrote the following on the cover sheet for the overall Administration/Financial/Property Management component summary page (Component Summary) --

Although the funds are sometimes drawn after expenditures are made, DHHS funds remain in the interest bearing money market account for a period of time. A standard procedure should be developed to calculate the amount of interest to be returned to DHHS.

Id. at 1 (unnumbered).

Ms. Michalski's statement makes it clear that this noncompliance had an actual monetary impact. LCEOC was evidently keeping money that it should have returned to the federal government, even though it had received notice of this deficiency as part of the 1993 OSPRI findings. This deficiency provides convincing support for ACF's determination that LCEOC's lax financial management put federal funds at risk. LCEOC conceded this finding of noncompliance. LCEOC PHBr. at App. 3.

b. Disputed OSPRI Findings

We now turn to the 1994 OSPRI findings of noncompliance which LCEOC contested. Many of LCEOC's arguments are based on its contention that Ms. Pitts erroneously reversed Ms. Michalski's findings. Many of Ms. Pitts' reversals were based on her conclusion that LCEOC still did not have a general ledger at the time of Ms. Michalski's on-site visit. LCEOC focused on what it characterized as Ms. Pitts' misinterpretation of Ms. Michalski's notes, and attempted to elicit testimony from Ms. Michalski to support its contention that LCEOC's computerized accounting system was producing a general ledger at the time Ms. Michalski was on-site. Since the parties focused so much of their arguments on this issue, and since it was pivotal for many of Ms. Pitts' findings of noncompliance, we next examine the evidence concerning it.

In her testimony, Ms. Michalski stated that she did not see a current, printed general ledger during her on-site review. Nevertheless, she concluded that LCEOC had a currently posted general ledger because: (1) it was meeting its payroll; (2) it was paying its bills; and (3) a coreviewer was able to retrieve from the LCEOC computer system any of the transactions Ms. Michalski wished to examine. Tr. at 3791-92. She testified that when she noted (ACF Ex. 70 at 70-1) that "General ledgers and operating statements should be printed monthly," she believed that the general ledger existed but could not be printed due to computer problems. Tr. at 3791. At no time during these proceedings did LCEOC produce general ledgers that Ms. Michalski could have seen at the time of her review. The most recent one available to her was for August 1993 and was printed October 31, 1993. It is clear that Ms. Michalski's assumption as to the existence of general ledgers was erroneous because --

Paying employees does not necessarily mean that general ledgers were currently posted. While it is true that the general ledger could not be currently posted if a subsidiary ledger such as payroll was not current, there was no evidence that the payroll ledger was even current. In fact, as we note above, the CA-2 auditors found that during this period LCEOC was incurring expenditure obligations in excess of available funds. LCEOC Ex. 159, Part 1, Att. at 1.
ACF provided testimony which indicated that, during this period, LCEOC was not paying its bills timely. LCEOC was seriously in arrears in reimbursing at least two of its delegate agencies, Lake Ridge and Hammond. Tr. at 976-83; 1039-41. Since Ms. Michalski testified that she did not review accounts payable to delegate agencies (Tr. at 3823), she was unaware of this situation.
The fact that some transactions were in the computer system does not mean that the entire general ledger was current. While Ms. Michalski asserted that her coreviewer was able to locate records for all of the transactions Ms. Michalski reviewed, she never looked at the computer screen herself. Tr. at 3818. Thus, she never actually reviewed the general ledger system in operation. Since, for example, she conceded that she did not examine accounts payable to delegate agencies, she could not know if those accounts payable were properly posted to the general ledger. Additionally, she testified that bank reconciliations were not reconciled to the general ledger, but to internal records. Tr. at 3833.

Ms. Michalski's hand-written comment (that general ledger should be printed monthly) was the source of considerable controversy in this proceeding. Ms. Pitts read Ms. Michalski's comment as stating that general ledgers should be "posted." This buttressed her conclusion that LCEOC did not have a currently posted general ledger. Our examination of the record, confirmed by Ms. Michalski's testimony, indicates that the word was "printed," not "posted." Regardless, the other evidence examined by Ms. Pitts supported her conclusion that LCEOC still did not actually have current general ledgers. Among other Michalski comments that Ms. Pitts had for review were --

We recommend that the general ledger & budget comparison statements should get priority treatment in bringing the new computer system on line. ACF Ex. 70 at 1 (unnumbered) (Component Summary).
Forms SF-269 for 7-31-93 & 1-31-94 were not available for review & the general ledger was not available for comparison. Id. at 3 (Data Sheet).

We find that Ms. Pitts' conclusion that LCEOC did not have a currently posted general ledger in May 1994 was correct. LCEOC's witnesses testified that LCEOC's general ledgers were not current until Fall or September 1994, four months after the OSPRI. See Tr. at 3981; 3450. The second independent auditors' report (CA-2) found that the general ledger was still inadequate as of December 31, 1994. While we found Ms. Michalski overall to be a competent, professional reviewer, she was unaware of Ms. Pitts' 1993 findings and therefore inappropriately excused LCEOC's failures as being due to a new computer system. Ms. Pitts knew the history of LCEOC's problems, however, and appropriately concluded that leniency was no longer due.

Having concluded that Ms. Pitts correctly determined that LCEOC still did not have an accurate, current general ledger in May 1994, we next consider whether the evidence supports her conclusions concerning the financial requirements measured by the six OSPRI items that she found out of compliance.

We quote each OSPRI Item before discussing it.

OSPRI 220 There is a method so that budgeted costs are compared to actual costs.

These two OSPRI items test a grantee's compliance with the financial management systems and audits requirements of 45 C.F.R. Part 74, Subpart H, which is incorporated by reference in the Notice of Grant Award. Item 218 contains a series of indicators which are assessed by the reviewer to help determine a grantee's compliance. Ms. Michalski examined an array of documents in her evaluation of these indicators. Tr. 3784-88. Based on that review, she determined that LCEOC was in compliance with Item 218.

Ms. Michalski testified that she examined LCEOC's budget expenditure comparison statements before determining that LCEOC was in compliance with Item 220. Tr. at 3801. Ms. Pitts reversed both findings because an essential component for compliance with these Items would be a "current and accurate" general ledger. Tr. at 1644-47; 1681-85.

Regarding Item 218, the most "current" general ledger available to Ms. Michalski was for August 1993. Without a current, accurate general ledger, LCEOC did not have a financial management system that ensures budget management, maintains control over current operations, and provides timely, accurate, current, and complete disclosure of financial matters. For example, as ACF noted, while Ms. Michalski might have looked at operating statements, those statements were inherently untrustworthy given the absence of a general ledger. LCEOC's continued reliance on a faulty computer system made it impossible for LCEOC to maintain a timely and accurate general ledger which, in turn, tainted the accuracy of the fiscal reconciliations necessary to LCEOC's position that it had adequate fiscal management.

In terms of her review of Item 220, Ms. Michalski indicated that a reviewer need only determine if there is "a method" for comparison of budgeted costs and actual costs, not whether the cost comparisons were accurate. Tr. at 3802. Ms. Michalski's interpretation of the requirements of Item 220 is incorrect.

The underlying regulation for this item provides that "the actual and budgeted amounts for each grant or subgrant shall be compared." 45 C.F.R. 74.61(d) (1993) (emphasis added). This regulation compels a reviewer to perform a specific cost comparison. Moreover, general ledgers are essential to the type of fiscal reconciliations in issue here. LCEOC did not have up-to-date general ledgers in time for either the 1993 or 1994 OSPRI. Thus, even had Ms. Michalski interpreted the regulation as requiring her to perform the cost comparisons, she would not have had an up-to-date general ledger to draw upon. Ms. Michalski clearly did not contemplate, nor conduct, such a review. Thus, her findings did not accurately reflect the regulatory requirement.

We therefore conclude that Ms. Pitts' conclusions as to both these items are accurate. The importance of the regulatory requirements measured by these items is underscored by CA-2's finding that LCEOC seriously overspent its budget in 1993 and 1994, a problem that these regulatory requirements were designed to prevent. LCEOC's failure to have a proper fiscal management system for several years constituted a material breach of its grant conditions and regulatory requirements.

OSPRI 223 Interfund loans have not been made.

Grant funds may be used only for the allowable costs for which the grant was awarded. 45 C.F.R. § 74.170; see also OMB Circular A-122, Att. A, §§ A.3.a. and A.4.a.(1). This item directs the reviewer to examine whether Head Start funds have been misapplied to other programs operated by the grantee. Ms. Michalski based her finding of compliance with this item on her review of LCEOC's accounting system design and cost allocation plan (CAP). Tr. at 3803; 3809. Ms. Michalski testified that it was her belief that a proper CAP would preclude interfund loans. Id. at 3811.

Ms. Pitts based her reversal of this finding upon the absence of a general ledger and LCEOC's history. As with previous items, she surmised that a reviewer could not reasonably examine the data necessary to reach the conclusion that no interfund loans had been made. Given LCEOC's ongoing problem organizing its fiscal affairs and the CA-1 finding on this same subject, she concluded that Ms. Michalski's review did not support her conclusion. Tr. at 1703-04.

The finding of noncompliance with the regulatory requirements measured by Item 223 was correct. While Ms. Pitts may have been mistaken in her belief that CA-1 cited a problem with interfund loans (the record shows that the problem was with intercompany receivables and payables), the fact remains that LCEOC's essential financial records were in disarray. Ms. Michalski's reliance on the existence of a cost allocation plan as the determinative factor on this question shows that she did not understand the nature of the potential problem. Ordinarily, interfund transfers involve a grantee willfully "borrowing" funds from one grant to pay expenses of another grant. See, e.g., Arizona Affiliated Tribes, Inc., DAB No. 1500 at 22 (1994). In order to obtain assurance that interfund loans had not taken place, one would have to examine the existence of a rather large funding pool (Head Start) and other programs with deficits. Given the finding in CA-2 that LCEOC accumulated a large operating deficit in 1993 and 1994, due in large part to its problems in maintaining a current general ledger, the likelihood of such fund shifting appears high. Consequently, we conclude that the record supports Ms. Pitts' conclusion that LCEOC was incapable of showing that interfund loans had not been made, i.e., that grant funds had been expended only in compliance with the terms and conditions of LCEOC's Head Start grants.

OSPRI 226 Previous audit deficiencies have been addressed and corrective actions have been implemented.

Ms. Michalski determined that LCEOC had complied with this Item. She indicated that she looked at problems cited in the previous audit and LCEOC's activity for 1992 and 1993. Tr. at 3812; 3815.

Ms. Pitts reversed this finding. She noted that the most recent audit available to Ms. Michalski was for 1988. Tr. at 1706. This was in fact the audit Ms. Michalski reviewed. Id. at 3812. ACF asserted that reliance on such a dated instrument is not trustworthy especially in view of the regulatory requirements for annual audits. Ms. Michalski's testimony in this area was vague. She gave no clear indication as to what "previous year's activity" she examined in reaching her conclusion. Moreover, given the delinquency of the various audits at the time of the 1994 OSPRI, it is implausible to have reasonably concluded that previous audit deficiencies had been corrected. Consequently, LCEOC was out of compliance with this grants administration requirement.

OSPRI 228 The grantee is complying with the 15% Administrative/Development cost requirement.

These Items are designed to determine compliance with the Head Start statute and regulations limiting administrative costs. Specifically, 45 C.F.R. 1301.32(a) provides --

Allowable costs for developing and administering a Head Start program may not exceed 15 percent of the total approved costs of the program, unless the responsible HHS official grants a waiver . . .
The limit of 15 percent for development and administrative costs is a maximum. In cases where the costs for development and administration are at or below 15 percent, but are judged by the responsible HHS official to be excessive, the grantee must eliminate excessive development and administrative costs.

This limitation is based on an express statutory provision. 42 U.S.C. 9839(b).

Ms. Michalski marked LCEOC in compliance with these Items. She based her determination on a comparison of LCEOC's grant application and its budget expenditure printouts. In doing so, she concluded that LCEOC was complying with the 15% administrative/development cost requirement. Tr. at 3819-22.

Ms. Pitts reversed these findings because LCEOC did not have a current general ledger or the data necessary to prepare SF-269s and was not preparing monthly statements for budget comparison purposes. Tr. at 1706. Again the absence of an accurate, current general ledger is critical. Even though LCEOC may have written a budget that kept administrative expenses within the stated limit, it did not know how closely its actual expenditures matched its budget. Moreover, as Ms. Pitts noted, administrative costs represent overhead which would accumulate in various general ledger accounts and must be allocated to various programs. Tr. at 1707. While Ms. Michalski also testified that she reviewed a grant application that apparently covered administrative costs (Tr. at 3819), she would have needed to review a current general ledger in order to assess whether that plan had been followed (assuming it limited administrative costs to 15 percent). Such a review was impossible given the state of LCEOC's accounting system. Accordingly, LCEOC was unable to demonstrate compliance with the statutory and regulatory limits on administrative costs.

4. Conclusion

For several years, LCEOC has consistently failed all of the tests established for monitoring whether a Head Start grantee is using federal funds for grant purposes. It admits that it has not filed timely fiscal monitoring reports and independent audits. It has not shown that it corrected serious internal control deficiencies identified by its independent auditor in a timely fashion. Its fiscal management was found to be severely deficient in an on-site review by an ACF official who had given LCEOC a year to get its fiscal house in order. We therefore conclude that the preponderance of the evidence on these issues establishes that LCEOC materially failed to comply with required fiscal and program requirements applicable to grantees in the Head Start program; materially failed to comply with the Head Start grants administration requirements set forth in 45 C.F.R. Part 1301; materially failed to comply with the requirements of the Head Start Act; and materially failed to abide by other terms and conditions of its award of financial assistance. Consequently, we find that the record supports denial of refunding based on 45 C.F.R. § 1303.14(b)(3), (6), (7), and (9).

B. LCEOC's Failure to Pay Salary Enhancements and Cost of Living Adjustments

Section 9835 of 42 United States Code governs the allotment of funds under the Head Start program and was applicable during the 1990-1993 period of time cited in ACF's denial of refunding. Specifically, section 9835(a) addresses the distribution of appropriations and priorities. In part, that section provides that quality improvement funds shall be used for a variety of goals including --

Ensuring that salary levels and benefits are adequate to attract and retain qualified staff. . . .

42 U.S.C. 9835(a)(3)(B)(iii).

The statute also provides that quality improvement funds shall be used for the following activities --

Not less than one-half the amount reserved under this subparagraph, to improve the compensation (including benefits) of staff of Head Start agencies and thereby enhance recruitment and retention of such staff. The expenditure of funds under this clause shall be subject to section 9848 of this title.¹²
If a Head Start agency certifies to the Secretary for such fiscal year that part of the funds set aside under subclause (I) to improve wages cannot be expended by such agency to improve wages because of the operation of section 9848 of this title, then such agency may expend such part for any of the uses specified in the subparagraph (other than wages).

42 U.S.C. § 9835(a)(3)(C)(i).

For fiscal years 1990-1993, ACF made a variety of supplemental grant funding available to grantees for cost of living adjustments (COLAs) and/or other salary enhancements to Head Start staff.¹³

LCEOC's disbursement of the following supplemental funding received over those years is in dispute --

1990 -- $40,368 for fringe benefits and $13,078 for differential salary increases;
1991 -- $116,438 for salary increases and $32,700 for fringe benefits;
1992 -- $98,354 for COLAs, $31,136 for salary increases and $6,287 for fringe benefits;
1993 -- $99,327 for COLAs, $67,104 for salary increases and $31,164 for fringe benefits.

Federal reviewers conducting the 1993 OSPRI heard complaints that LCEOC staff had not received salary increases in the previous three years. Following its investigation of those complaints, ACF determined that, from 1990 through 1993, LCEOC had not paid salary increases, COLAs and fringe benefits to its Head Start staff in accordance with applicable law and program instructions. Denial of Refunding at 2-4.

We discuss these findings below.

1. 1990 and 1991 Salary Enhancements

In a February 1990 program announcement, ACF informed Head Start grantees and delegate agencies of a programmatic funding increase of just more than 151 million dollars. Almost one-third of that increase ($49,335,000) was to be used to provide salary increases to Head Start staff. ACF Ex. 11 at 1. All grantees were eligible for this funding, which was intended to provide a minimum increase of 2.5% in salaries and benefits. Grantees and delegates were instructed that they should use --

their own personnel policies, wage scales and wage comparability studies to assess and determine the most equitable way of distributing wage increases among staff . . . .

ACF Ex. 11 at 2.

In late August 1990, LCEOC received a supplemental grant award which provided, in part, --

an increase in funds in the amount of $40,368 for the purpose of increasing salaries and/or fringe benefits. . . [The award also included] a Differential Salary Increase in the amount of $13,078 that . . . [could] only be expended during the period from September 1, 1990 through the end of this award's budget period [1/31/91].

ACF Ex. 6, Supplemental Financial Assistance Award No. 05CH4000/25, Att. 2.

In March 1991, ACF issued a similar announcement notifying grantees and delegate agencies of an increase in Head Start's funding level of just under $400 million. See ACF Ex. 12. Of that amount, $195,180,000 was earmarked as quality improvement funds. Grantees were instructed that "[a]t least one-half of all quality improvement funds . . . must be used for . . . increasing salaries and fringe benefits of staff." ACF Ex. 12, Att. at 1 (unnumbered). The instructions explicitly provided --

These funds must be used to increase the hourly rate of pay and/or improve fringe benefits for current staff positions. These funds may not be used for any other purposes.

Id. at 2.

As with the 1990 supplemental award, grantees were instructed to use their own personnel policies, wage scales and wage comparability studies to determine the most equitable distribution of funds. Grantees were also charged with determining what portion of the increase would be used for fringe benefits. Id.

On August 1, 1991, LCEOC received a supplemental award which, in part, provided $116,438 for salary increases and $32,700 for fringe benefit increases to current staff. See ACF Ex. 7, Supplemental Financial Assistance Award No. 05CH4000/26.

LCEOC's primary arguments concerning the 1990 and 1991 salary enhancements were contained in its Appeal. LCEOC argued that, contrary to ACF's assertions, from 1990 through 1993 it had provided salary and fringe benefit increases in amounts exceeding the corresponding COLA and salary increases provided for by ACF's supplemental funding. Appeal at 2. LCEOC did provide some charts and tables purporting to show that the 1990 and 1991 increases had been paid. See, e.g., Appeal at 3; and Appeal Atts. B and C. Additionally, LCEOC contended that "[a]ll salary and fringe information is further documented in LCEOC and delegate personnel files and payroll records . . . ." Appeal at 4. However, following this stage of the appeal, other than making general references to all manner of increases from 1990-1993 having been paid, LCEOC remained silent on the specific issue of payment of the 1990 and 1991 salary increases.

LCEOC's arguments and evidence have not demonstrated that these salary increases were paid. The most persuasive evidence in support of LCEOC's position would be records showing that a specific employee was paid "x" per hour as a salary in a given year and "x plus the appropriate increase" the next. LCEOC has not produced anything close to this quality of evidence. Rather, LCEOC offered its Appeal Attachments B and C as proof that the increases were paid. These Attachments are titled "Schedule of . . . Head Start Employee Salaries" for the years 1990 and 1991 respectively. It is impossible to determine anything of value from them. The Attachments purport to show comparative employee salaries for 1989-1990 and 1990-1991. However, it is not clear that they identify all employees entitled to salary increases, nor do they identify the employees' hourly rates of pay or the number of hours worked. At best, they evidence an unidentifiable change in the rate of pay for certain employees. To the extent that both Attachments identify the same positions from 1989 through 1991, they show salaries increasing by varying increments which bear no relationship to the across-the-board pay rate increases envisioned in the program announcements.

For example, a teacher (No. 200064) is shown to have made $2,480.40 in 1989, $9,245.56 in 1990 and $12,105.81 in 1991; a Head Start Director (No. 500005) $12,647.32 (1989), $18,745.62 (1990), and $20,368.86 (1991); a parent coordinator (No. 300007) $12,526.15 (1989), $12,530.70 (1990) and $12,652.12 (1991). Appeal Atts. B and C.

On May 10, 1994, ACF placed LCEOC on high risk status pending the resolution of a variety of issues. See ACF Ex. 2. As a condition for ending the high risk status, ACF sought evidence from LCEOC's independent audit that funds awarded for salary increases, as well as COLAs, had been used for their intended purposes. However, that audit (CA-1), submitted seven months later, contained no such evidence. See ACF PHBr. at 53; LCEOC Ex. 83.

On the whole, LCEOC has submitted no evidence that these funds were applied to increase the salary and fringe benefits of Head Start employees. The use of these funds was strictly limited to these purposes.

LCEOC's failure to show that it used these funds to increase salary and fringe benefits is critical for three reasons:

it is a violation of the terms and conditions of the supplemental funding awards for both years;
it is a violation of LCEOC's obligation under the regulations to document that it expended Federal funds only for allowable purposes; and
it provides further evidence of LCEOC's fiscal mismanagement.

2. 1992 and 1993 COLAs

In February 1992, ACF announced a FY 1992 Head Start funding increase of one-quarter of a billion dollars. Slightly more than $62.5 million of that increase was to be used to offset increases in the cost-of-living. Each grantee was given the opportunity to apply for a funding increase equivalent to 3.4 percent of its base FY 1992 funding.¹⁴ The increased funding was offered to "offset increased operating costs." ACF Ex. 13, Att. at 1. The instructions provided --

Grantees with delegate agencies are expected to allocate to each delegate agency the same 3.4 percent cost-of-living increase given the grantee, or justify why such an approach is not appropriate. We expect that all staff . . . will receive a cost-of-living increase of at least 3.4 percent, . . . Grantees proposing to award salary increases of less than 3.4 percent or proposing to award differential cost-of-living increases to staff must explain their rationale for this approach in their funding application.

Id.

The program announcement also notified grantees that just under $46 million was available for program quality (PQ) improvement funding. The instructions provided --

Each grantee must use at least one half of its quality improvement allocation to increase the hourly rate of pay and/or improve fringe benefits for current staff positions. (The salary increases awarded through the use of the COLA funds are separate and apart from this requirement.)

ACF Ex. 13, Att. at 2.

LCEOC applied for and received funding pursuant to this announcement in August 1992. See ACF Ex. 8 at 10-11 (unnumbered).

A similar program announcement was issued for 1993. See ACF Ex. 14. As pertinent here, the 1993 announcement was identical to the 1992 announcement. LCEOC applied for and received funding pursuant to that announcement in September 1993. The 1993 Supplemental Award came with a Special Condition, which provided, in part --

The FY 1993 supplemental application does not provide sufficient detail to allow release of all funds allocated for . . . [the COLA, PQ] and Expansion. By October 13, 1993, LCEOC . . . must submit: . . . a statement certifying that those positions not receiving a COLA increase are currently at wage comparability for the area. . . . a proposed salary increase breakout of COLA and program quality for Central Operations similar to the charts depicting the delegate increases in Attachment A. . . . COLA and program quality funds . . . cannot be drawed [sic] upon until the above conditions are met and you receive written notification from . . . [ACF]

ACF Ex. 9, Att. 1 at 1-2 (emphasis in original).

There is no documentation showing whether or how LCEOC responded to these special conditions in the record before us, but it is undisputed that LCEOC drew down the full amount awarded. Although the supplemental award was dated September 29, 1993 (ACF Exhibit 9), LCEOC did not distribute the 1993 COLA to its employees until May 6, 1994, effective as of March 1, 1994. Grantee's Motion for Reconsideration and Response to ACF's Motion for Summary Disposition at 3 (May 26, 1995) (LCEOC Motion).

As noted above, the 1993 OSPRI alerted ACF to the factthat supplemental funds received up to that point may not have been properly expended, and ACF gave LCEOC notice that this was a serious problem. LCEOC Ex. 155 at 35. Despite this notice and the May 1994 notice, reiterating this concern, by the time ACF issued its Denial of Refunding (January 1995), LCEOC had submitted no evidence to convince ACF that the funds were properly spent.

Generally, LCEOC maintained that it had paid the COLAs and that any instance where they might not have been paid was attributable to a lack of clarity in the instructions. LCEOC contended that the program instructions did not state explicitly that COLAs were required to be used exclusively for salary increases. LCEOC PHBr. at 61 (citing ACF Exhibits 11-14). LCEOC seized upon the word "expect" in the instructions, attacking it as vague and asserting that had ACF intended the funding be used entirely for salary increases, it should have simply stated that clearly. LCEOC noted that in its 1992 application for COLA funding, it proposed using almost 94% of COLA funds to offset increases in operating costs. The remaining 6% was allocated for budget categories titled "supplies" and "other." See LCEOC Ex. 122, Budget Information at 1. LCEOC reasoned that ACF's approval of this supplemental grant application underscored the validity of LCEOC's interpretation of the instructions, i.e., that operating costs covered by the instructions accompanying the COLAs were not confined to salaries. LCEOC PHBr. at 62-63.

ACF asserted that the instructions were clear about the use of these funds as being primarily for across-the-board salary increases. In addition, ACF contended that the underlying purpose of the COLA was to increase the salary for positions rather than individuals.¹⁵ Based on those instructions and LCEOC's application, ACF contended that it was disingenuous of LCEOC to argue that distribution of the COLA only to individuals working in the year for which the COLA was awarded and at the time it was actually distributed was proper.

In context, ACF's use of the word "expect" does not render the 1992 instructions vague. The language in question is found in a three-sentence paragraph in the instructions. The first sentence explains to grantees with delegates, such as LCEOC, that ACF expects that the delegates will receive the same 3.4 percent COLA given to the grantee. The second sentence explains that all Head Start staff are expected to receive the COLA. The final sentence explains that any grantee awarding increases of less than 3.4 percent was required to explain the rationale for that approach in its funding application. See ACF Ex. 13, Att. at 1. Thus, ACF recognized that there might have existed legitimate circumstances precluding a 3.4 percent award to staff. ACF asked that grantees explain such circumstances in the funding application. However, that language spoke to an award of less than 3.4 percent, not the failure to make an award altogether.¹⁶

In its application for the 1992 supplemental funding, LCEOC anticipated using the COLA funds for the following: $92,208 for personnel, $3,642 for supplies and $2,504 for "other" expenses. LCEOC Ex. 122, Budget Information, Lines 6(a), (e) and (h). Later in the application, LCEOC indicated that "[t]he 1992 cost-of-living increase will be distributed to all nine Head Start delegate agencies and to LCEOC central administration at the required rate of 3.4 percent . . . ." Id. at 7 (unnumbered). This statement was accompanied by a chart showing the anticipated dollar amount of COLA increases for LCEOC and its delegates. Id.

Based on the 1992 program instructions, LCEOC applied for slightly more than $98,000 in COLA funds. LCEOC earmarked approximately 94% of those funds for pay raises throughout its organization. In view of the language in the instructions and the specificity of LCEOC's grant application, we are hard-pressed to see how LCEOC can now credibly argue that the instructions were unclear or that it was not obligated to spend that money in accordance with the terms of its application. LCEOC's supplemental grant application was approved as requested. See ACF Ex. 8; see also Tr. at 2333.

The parties put forth a variety of arguments regarding the COLA issue. For example --

whether ACF sufficiently understood LCEOC's accrual accounting system to realize that the COLAs were paid;
whether LCEOC could have reasonably paid the COLAs in years following those in which they were awarded;
whether employees were due COLAs if they worked during 1992 or 1993, but were not employed when the adjustments were finally paid;
whether employer contributions to fringe benefits constitute COLAs;
whether there was sufficient supplemental funding to pay COLAs.

Under the best of circumstances, these issues would be difficult to resolve. In this instance, that task would be further complicated by LCEOC's fiscal disarray and its contradictory arguments throughout this process. However, we do not need to specifically resolve these questions. The key issue is whether the COLAs were paid to all eligible employees, as required by the terms and conditions of the supplemental grant award. While the parties are not in agreement as to the precise definition of an eligible employee, by either party's standard, the COLAs were not paid to all eligible employees. LCEOC took the position that an eligible employee was one employed as a Head Start staff person during the time period for which COLAs were applicable and employed as a Head Start staff person when the COLA was distributed. LCEOC PHBr. at 65. LCEOC argued that, with the 1992 award, it provided COLA increases to 43 of the 63 eligible employees.¹⁷ LCEOC PHBr. at 63; Tr. at 4011. It further argued that, with the 1993 award, it provided COLA increases to 82 of the 86 employees eligible for those increases. LCEOC PHBr. at 65; Tr. at 4011. LCEOC indicated that "pay increases effective March 1, 1994 and paid May 6, 1994 . . . were paid using 1993 COLA funds." LCEOC Motion at 3. Pointing to the unclear nature of the instructions and its good faith efforts to pay the COLAs, LCEOC asserted that its alleged failure to pay COLAs was not a sufficient basis for a denial of refunding. At worst, LCEOC reasoned, it should be subject to a disallowance for the unpaid funds. LCEOC PHBr. at 65-66.

ACF asserted that far more employees were eligible for COLAs in 1992 than appeared in LCEOC's calculations. LCEOC's Exhibits 10-19 consist of its paycheck records for 1992. Based on its examination of those exhibits, ACF determined that 153 employees were eligible for COLAs. ACF noted that LCEOC had offered a schedule purporting to show the individual 1992 (and 1993) COLA increases. See LCEOC Ex. 157. This document revealed that 39 people received COLAs in 1992.¹⁸ Thus, ACF asserted, rather than paying COLAs to 67% of eligible employees as it had alleged, LCEOC had in fact paid COLAs to something closer to 25% of its employees.

ACF made similar findings relative to the 1993 COLAs. Again relying on LCEOC's paycheck registers for this period (LCEOC Exhibits 10-19), ACF determined that LCEOC had 197 employees eligible for the 1993 COLAs. Consequently, only 42% of eligible LCEOC employees received 1993 COLAs. ACF PHBr. at 24.

Admittedly, the program announcements did not define an "eligible" employee. The absence of a definition aside, the announcements clearly required all grantees to provide written documentation of their rationale for paying COLAs to less than 100 percent of all employees. See ACF Exs. 13 and 14. ACF's definition of eligible employee as one who was employed during the budget period covered by the supplemental award provides a more sensible interpretation of that term. However, LCEOC readily admitted that it did not pay COLAs to all eligible employees even under its own, more restrictive, definition of that term.¹⁹ See LCEOC PHBr. at 65. LCEOC offered no credible explanation for its failure to pay these COLAs.

The intent of the program announcements was clear. Simply put, they were designed to provide funding in order to improve the compensation (including benefits) of staff of Head Start agencies and thereby enhance recruitment and retention of such staff. See 42 U.S.C. § 9835(a)(3)(C)(i). This was consistent with the statutory goal of ensuring that salary levels and benefits are adequate to attract and retain qualified staff. See 42 U.S.C. § 835(a)(3)(B)(iii).

LCEOC offered no substantive evidence to show that it satisfied either the statutory programmatic goals or the specific requirements set out in the announcements regarding the disposition of these funds. LCEOC applied for and accepted this supplemental funding specifically designated for COLAs without questioning who constituted eligible employees. LCEOC's applications for this supplemental funding did not alert ACF to the fact that LCEOC had another interpretation of the term eligible employees. See, e.g., LCEOC Ex. 122.

LCEOC's financial disarray permeates its arguments on the various salary enhancement issues. Over a four-year period, LCEOC received supplemental funding for specific purposes generally categorized as salary enhancements. LCEOC cannot say with certainty that it satisfied the requirements for any of the supplemental funding awards. This should not be an overly difficult task. LCEOC should be able to point to easily identifiable payroll records that show that supplemental funding for each year's salary enhancements was disbursed to 100% of all eligible employees, however defined, in a timely fashion. Instead, LCEOC has here admitted that it did not fulfill the terms and conditions of the supplemental funding awards. Thus, the evidence demonstrates that there exist sufficient grounds for denial of refunding as enumerated in 45 C.F.R. § 1303.14(b); specifically, LCEOC has materially failed to meet terms and conditions of its grant awards.

C. LCEOC's Repeated Failure to Meet Head Start Program Requirements

The 1994 OSPRI revealed a number of violations of performance standards and other regulatory requirements at LCEOC and its delegate agencies. Many of these were repeat findings from the 1993 OSPRI. In the denial of refunding letter, ACF stated that these failures to comply with program standards showed:

inadequate administrative oversight and coordination of delegate agencies;
inadequate parent participation in the planning and operation of Head Start programs;
inadequate delineation of roles and inadequate training for staff, members of the Board of Directors and parents;
inadequate financial management;²⁰ and
non-compliance with various program standards at the delegate level that were attributable largely to the lack of grantee oversight and coordination.

ACF Ex. 1 at 7.

Our prehearing Revised Notice of Issues identified the 1994 OSPRI Items that were apparently at issue and were therefore appropriate subjects for testimony. At the hearing, an ACF witness testified that the Report of Findings (ROF) following an on-site review, not the markings on the OSPRI document itself, is the official position of ACF on whether a grantee was in compliance with program requirements. Tr. at 51. Our subsequent examination of the ROF (LCEOC Ex. 129) revealed three items listed in the revised notice that were not listed as out of compliance in the ROF: Nos. 161, 185, 188. Consequently, we do not consider them here.

1. Uncontested OSPRI Findings

LCEOC did not contest 13 of the OSPRI findings that LCEOC failed to meet Head Start program requirements. We list by component the uncontested OSPRI items with the pertinent regulation, and the site or sites in bold print, below:

Education

001 There is a written education plan that is annually updated and/or revised. 45 C.F.R. § 1304.1-4 - Hammond School City.
015 Parents are involved in curriculum development and serve as resource persons. 45 C.F.R. § 1304.2-2(c)(3) - No location specified.
020 Parent participation in planning the education program and in classroom and home program activities. 45 C.F.R. § 1304.2-2(e)(1) - Hammond School City.
029 Safety and health report of Facilities Supplement. 45 C.F.R. § 1304.2-3 - Hammond School City.

Health

041 Each child enrolled in the Head Start program has a complete up-to-date medical, dental and developmental history. 45 C.F.R. § 1304.3-3(a) - Porter County.
042 Effective with the beginning of the 1993-1994 program year, all Head Start children receive health and developmental screening by 45 calendar days after the start of program services in the fall, or, for children who enroll after program services have begun, by 45 days after the child enters the program. This does not preclude starting screening in the spring before program services begin in the fall. 45 C.F.R. 1308.6(b)(1) - Porter County & Hammond School City.

Nutrition

092 Information about major community nutrition problems [is collected as part of community needs assessment]. 45 C.F.R. § 1304.3-10(a)(3) - Porter County.
096 The quantities of food served conform to recommended amounts indicated in the Head Start guidance materials. 45 C.F.R. 1304.3-10(b)(5) - Hammond School City.
098 The nutrition services contribute to the development and socialization of the children by providing that children and staff, including volunteers, eat together sharing the same menu and a socializing experience in a relaxed atmosphere. 45 C.F.R. § 1304.3-10(c)(6) - Hammond School City.

Disabilities

154 An annually updated disabilities service plan guides the program's efforts to meet the special needs of children with disabilities and to include them and their families in the full range of Head Start activities and services. 45 C.F.R. § 1308.4 - Hobart Township & Porter County.

Administration

195 There is evidence that personnel policies are implemented as written and approved. 45 C.F.R. § 1301.31 and § 1301.31, Appendix A - LCEOC, Metro Corps, East Chicago & Southlake County.

Staffing Requirements & Program Options

202 The Grantee has employed adequate staff for the program option(s) operated: 45 C.F.R. § 1306.20(b) - Metro Corps.
208 Grantees operating center-based and combination program options comply with class size requirements listed in the chart . . . [provided in the regulation]: 45 C.F.R. § 1306.32(12) - LCEOC & Metro Corps.

With respect to OSPRI items it admitted were "arguably out of compliance," including those in the financial component, LCEOC contended that, given that there were 256 items examined at ten locations, these were only a small percentage of a possible 2,560 noncompliances. LCEOC PHBr. at 52. This is disingenuous at best. The items LCEOC did not dispute concern substantial regulatory requirements and include items that support ACF's findings in the denial of refunding letter that LCEOC had problems in several aspects of its program. We have already discussed the serious consequences of LCEOC's admitted failure to comply with fiscal reporting requirements. Other significant requirements that LCEOC attempts to minimize with this argument are the requirement for timely health and developmental screening, which LCEOC failed to meet at two delegates, Porter and Hammond, serving 102 and 190 children respectively (Tr. at 3333 and 1027), and implementing personnel policies as written and approved for the 109 employees on LCEOC's staff.

Moreover, while LCEOC attempted to depict the OSPRI process as subjective, many of the items listed above measure objective standards, such as whether specified class size requirements have been met. Rather than trivializing the requirements it failed to meet, a better response would have been for LCEOC to acknowledge their importance and provide evidence showing that it had made timely efforts prior to the follow-up OSPRI to correct the deficiencies and had thereby significantly improved its performance.

2. Contested OSPRI Findings

LCEOC disputed 15 of the OSPRI findings of program non-compliance. We find sufficient evidence to conclude that LCEOC was not in compliance with the regulatory requirements measured by OSPRI Items 18, 90, 163, 190, 191, and 196.²¹ Below, we list each item and the regulation underlying that item, with the relevant location or locations in bold print.

We find that there was insufficient evidence to conclude that LCEOC was out of compliance with the regulatory requirements measured by OSPRI Items 25, 39, 89, 137, 148, 181, 182, 184, and 194.

Education

018 The educational aspects of other Head Start components are integrated into the daily education services program. 45 C.F.R. § 1304.2-2(d) - Southlake, East Chicago, Hammond School City.
025 Evidence that the center meets or exceeds state or local licensing requirements for facilities for fire, health and safety shall be accepted as compliance with fire, health and safety requirements. 45 C.F.R. § 1304.2-3(a) - Southlake County.

Health

039 There shall be a functional Health Services Advisory Committee advising in the planning, operation and evaluation of the health services program. 45 C.F.R. § 1304.3-2.

Nutrition

089 There is a written nutrition plan, annually revised and/or updated. 45 C.F.R. 1304.1-4 - Porter County.
090 The nutrition assessment data (height, weight, hemoglobin/hematocrit) is obtained for each child. 45 C.F.R. § 1304.3-10(a)(1) - Porter County.

Parental Involvement

137 The process of making decisions about the nature and operation of the Head Start program [as evidenced in the Policy Council minutes for the last 12 months, provides for involvement of parents from all program options to participate in -- training, budget input, approval/disapproval of hiring/firing decisions, annual review of component and other plans, annual self-assessment]. 45 C.F.R. § 1304.5-2(a) (Part 1304, App. B, I-30-2B) - LCEOC, Metro Corps, East Chicago, Hammond School City, Southlake County & Porter County.
148 There is a system for the regular provision of information to members of policy groups. The purpose of such communication is to enable the policy groups to make informed decisions in a timely and effective manner, to share professional expertise, and generally to be provided with staff support. At a minimum, information provided will include: [timetable for planning, development, and submission of proposals; communications from ACF; financial reports; work plans; grant applications; and personnel policies for Head Start]. 45 C.F.R. § 1304.5-4(b)(1-4) - LCEOC, Metro Corps, East Chicago, Hammond School City, Southlake County & Porter County.

Disabilities

163 Head Start IEP's are developed by a multi-disciplinary team. 45 C.F.R. § 1308.19(f)-(i) - LCEOC, Metro Corps, East Chicago & Southlake County.

Administration

181 The Grantee has conducted a community needs assessment (CNA) within its service area at least once every three years and updated it in each of the two intervening years by considering whether there have been significant changes in the information contained in the CNA. The CNA includes the following information about the Grantee's service area: demographic/social make-up of eligible children and families; other developmental and child care programs serving eligible children; estimated number of children with disabilities under four years old; data on the health, nutrition, education and social services needs of eligible children; those same needs as defined by the families of eligible children and community institutions serving young children; and available community resources for eligible children and their families. 45 C.F.R. 1305.3(b)(1)-(6) - LCEOC, Porter County & Jasper County.
182 Information from the community needs assessment has been used to: determine program objectives, determine necessary component services and program options, define recruitment areas, determine locations of centers and home-based programs, and set profiles of children and families given priority for recruitment. 45 C.F.R. § 1305.3(c)(1)-(6) - LCEOC, Porter County & Jasper County.
184 The program option chosen meets the needs of the children and families as indicated by the grantee's community needs assessment. 45 C.F.R. § 1306.31(b) - LCEOC & Jasper County.²⁵
190 Where programs are delegated, there shall be a written agreement that specifies: the delegate agency will adhere to all Head Start regulations; services to be provided (including specific performance standards delegated); number of children served and program design information by program option; terms and conditions; dollar amount of the award; and termination process for the agreement. 45 C.F.R. § 1301.33 - LCEOC, Metro Corps, East Chicago, Hammond School City & Southlake County.
191 Grantee has an internal monitoring procedure for delegate program operations which: A. Assures compliance with all contract and program requirements; B. Provides requirements for correction of deficiencies found; and C. Includes provision of technical assistance for areas requested by delegate agencies. 45 C.F.R. § 1301.33; HDS/GAM - LCEOC & Hammond School City.
194 Head Start agencies shall establish personnel policies and procedures. 45 C.F.R. § 1301.31 - LCEOC, Hammond School City, Hobart Township, Southlake County, Jasper County & Pulaski County.²⁷
196 A file and records system shall be maintained to include official documents for each staff member, related to: qualifications for appointment or promotion; periodic pay increases; records of continued training or education; official recognition; performance evaluation and adverse action. The system must protect the confidentiality of personnel records. 45 C.F.R. § 1301.311 and 1301.31, Appendix A - LCEOC & Hammond School City.

3. Conclusion

Our analysis of the OSPRI items pertaining to fiscal management aside, the record supports ACF's findings with respect to the 19 contested and uncontested OSPRI Items discussed above. These Items measure compliance with requirements in nearly all areas of the Head Start program -- Education, Health, Nutrition, Disabilities, Administration, Staffing Requirements and Program Options. Many of these program deficiencies were previously identified to LCEOC, and it was given at least six months to correct them. Compliance with ACF regulations is made an express term of each award of financial assistance. See, e.g., ACF Ex. 8, Att. 1 (1992 Notice of Grant Award). LCEOC's failure to demonstrate full compliance with Head Start requirements means that the 1,200 children served by LCEOC were not receiving the full value of the funding provided for their benefit. These OSPRI findings, along with the OSPRI findings concerning fiscal management, establish that denial of refunding is appropriate pursuant to 45 C.F.R. § 1303.14(b)(3), (4), (6), and (9).

D. LCEOC's Lack of Delegate Agreements

For the 1994-95 program year, LCEOC's application for refunding provided for operation of its Head Start program by contracting out the required services to children and families to nine delegate agencies. The applicable regulations provide that "Federal financial assistance is not available for program operations where such operations have been delegated to a delegate agency . . . unless the delegation . . . is made by a written agreement and has been approved by the responsible HHS official before the delegation is made." 45 C.F.R. § 1301.33.²⁹ The purpose of delegate agreements is to establish the terms and conditions for the relationship between the grantee and its delegate, including: the number of children to be served; the program design; the amount and method for payment of program funds; the applicability of Head Start performance standards and the method by which the grantee will monitor delegate performance; the applicable personnel policies; the manner in which disputes between grantee and delegate may be resolved; etc. HDS/GAM, Ch. 1, § K.1; Tr. at 2041. LCEOC was cited in the April 1993 OSPRI (Item 166) for failure to have any delegate agreements whatsoever, and again in May 1994, for the same deficiency (Item 190). LCEOC submitted a delegate agreement with its December 1994 application for refunding. Appeal Att. AA.³⁰

ACF's Denial of Refunding identified four specific substantial defects with the delegate agreement submitted with LCEOC's application for refunding.³¹ ACF contended that, while this issue standing alone would not warrant defunding, LCEOC's failure to address its delegate agreement problems for several years was indicative of its continued failure to operate a program within the required terms and conditions of the grant.

In this proceeding, LCEOC did not address the alleged defects by showing that the delegate agreement submitted with its application for refunding did indeed fulfill the requirements specified in the Denial of Refunding. Instead, it addressed the required components identified in OSPRI Item 190, and it attempted to portray ACF as hypercritical and inconsistent in its correspondence explaining other requirements. LCEOC claimed that it had never before had trouble with its delegate agreements and that the delegate agreement found insufficient by ACF was one authored by a former ACF official.

We agree with ACF that LCEOC's failure to correct this situation is indicative of its continued failure to operate a program within the required terms and conditions of the grant. It is absolutely untrue that LCEOC had never had any trouble with its delegate agreements prior to this dispute. LCEOC was first notified of the problem in a special condition attached to its 1990-91 grant. ACF Ex. 6, Att. 5. The problem was again brought to LCEOC's management's attention in the April 1993 OSPRI. ACF Ex. 34. At the 1994 OSPRI, the reviewers found that LCEOC still did not have a single signed delegate agreement with any of its nine delegates. ACF Ex. 16 (Head Start Program Review Report accompanying the 1994 Report of Findings) at 2 § 1.B (Program Weaknesses).

Despite these constant reminders of the requirement for delegate agreements, the evidence shows that LCEOC failed to execute any signed delegate agreements for both the 1991-92 and 1992-93 program years and did not execute the delegate agreements for 1993-94 until the final quarter of that program year. Instead, LCEOC issued its delegate agencies "continuation letters" which stated (for 1993-94):

Pending upcoming budget conferences and contract negotiations, this letter is your official authorization to continue to incur expenses related to the provision of Head Start services to your currently enrolled children and their families for Head Start Funding Year #28 (2/1/93-1/31/94) under the terms and conditions of your Budget Allocation for FY #27 (2/1/92-1/31/93). Upon receipt of the approved Head Start grant award for FY 1993-94 from LCEOC, Inc., we will finalize your delegate contract for issuance and signature based upon the availability of funds for this fiscal year.

LCEOC Ex. 30 (identical language in all eight letters to delegates). See also ACF Ex. 59 at 1 (similar letter to Lake Ridge delegate for 1992-93 program year). Although it promised future communications, LCEOC gave no further notice to its delegates until they were presented with a delegate agreement for signature in December 1994 (two months before the end of program year 1994-95).

This lack of delegate agreements was not a mere technical failing, but had the following significant and serious impacts on several aspects of LCEOC's Head Start program:

Several witnesses who operated delegated programs testified that the lack of a signed delegate agreement containing a definite annual funding figure caused serious problems in program planning and execution. For example, the Assistant Director for Component Coordinators for the Hammond delegate testified that, due to the uncertainty as to what funds would be available in 1993-94, she was unable to budget for transportation or the purchase of a vehicle to transport children and could not contract to pay for training. Tr. at 1038-39. Similarly, the Head Start Director for the Lake Ridge delegate testified that she was required to budget for liability insurance even though the school system could have covered the Head Start passengers if the bus were leased (Tr. at 1234), and that she was unable to contract for attention deficit disorder training that she felt was needed. Tr. at 1236-37.
The continuation letters did not recognize the expansion of Head Start services over previous years. Tr. at 86. For example, Porter County had significantly expanded program participation from 34 children in 1990-91 to 102 in 1992-93, but the continuation letters did not provide for any increase in funding levels. ACF Ex. 40. See also ACF Ex. 7, Att. 5 (increasing number of children to be served during 1991-92 at Gary, Hammond, Pulaski, and Newton by 140).
By stating that the budget continued at previous levels, LCEOC did not provide funds for the permanent increase in salaries that was supposed to be in place after COLAs were awarded each year. Tr. at 78-80; 1232.
When LCEOC finally submitted delegate agreements, it included delegate agreements it had signed with new delegate agencies that had never been approved by ACF. In fact, ACF had previously notified LCEOC that two delegates, LAFEP and ELKA, which were identified as reporting to delegate Metro Corps, could not properly be delegate agencies under that arrangement. ACF Ex. 16 at 4. LCEOC did not dispute ACF's assertions that both LAFEP and ELKA have separate boards of directors from Gary Metro Corps and that they are independent organizations that should contract directly with LCEOC. See ACF Ex. 20 at 4. Moreover, the Head Start regulations do not provide for subdelegation.
Since there was no deadline for reimbursement of program costs, one of the delegates which continually suffered from LCEOC's late payments had no contractual recourse, and ultimately turned to ACF for assistance in obtaining payment. ACF Ex. 58 (Lake Ridge).

ACF cited LCEOC's long-term failure to address the delegate agreement requirement as "indicative of the continued failure of LCEOC to operate a program within the required terms and conditions under which Federal funds were awarded to LCEOC." ACF Ex. 1 at 11. We concur with ACF that the history of this issue as established by the record here indeed provides additional support for the denial of refunding to this grantee pursuant to 45 C.F.R. § 1304.13(b)(6) and (9).

III. Conclusion

For the reasons discussed above, we conclude that LCEOC has materially failed to --

comply with the required fiscal or program reporting requirements;
meet the performance standards for operation of its Head Start program;
comply with Head Start grants administration requirements;
comply with the requirements of the Head Start Act; and
abide by other terms and conditions of its grant and applicable laws or regulations.

Accordingly, we find that denial of refunding is warranted pursuant to 45 C.F.R. §§ 1303.14(b)(3), (4), (6), (7) and (9).

______________________
Donald F. Garrett

______________________
Norval D. (John) Settle

______________________
M. Terry Johnson
Presiding Board Member

[1] Our analysis of the grounds for denial of refunding is set out in a manner convenient to the general development of the issues, rather than the order presented by ACF in its denial of refunding.

[2] These are the five regulatory grounds underlying the four grounds listed in ACF's determination. The disparity in number is due to standard grant language requiring compliance with the Head Start Act and applicable regulations. Thus, violation of a specific regulatory requirement is also a violation of the terms and conditions of the grant. In reaching our conclusion, we have considered the entire record consisting of approximately 15,000 pages including the hearing transcript, exhibits, briefing, and oral argument. In this decision, we have addressed the major grounds for denial of refunding cited by ACF. Since we found that there was convincing evidence substantiating these grounds, it was unnecessary to resolve every disputed issue presented by the parties. (For example, we chose not to discuss the parties' differing views concerning a March 14-15, 1994 technical assistance visit by an ACF contractor.)

[3] The concept of materiality applicable to these proceedings is found in 45 C.F.R. § 74.113. That regulation has been amended and redesignated as 45 C.F.R. § 74.62, but continues to require materiality. See 59 Fed. Reg. 43,760 (August 25, 1994).

[4] The delegates are: Gary Metro Corps (Metro Corps), East Chicago, Hammond School City, Southlake County, Jasper County, Pulaski County, Newton County, Porter County and Hobart Township/Lake Ridge (Lake Ridge).

[5] CA-2 was submitted into the record (as LCEOC Exhibit 159) after the evidentiary hearing was completed, and ACF was given the opportunity to comment, in writing, on its significance and weight. See Ruling (February 20, 1996). Subsequently, the Board permitted ACF to supplement the record with the Office of Inspector General's desk review of CA-2. See ACF Ex. 72. CA-2 consists of four parts, which we will cite as "LCEOC Ex. 159, Part #." Part 1 is the auditor's report of findings and recommendations, consisting of a 12/8/95 letter to LCEOC's audit committee with a 21-page exhibit. Part 2 is the combined financial statements for years ending December 31, 1992, 1993, and 1994. Part 3 is the auditor's OMB Circular A-133 audit reports for those same years. Part 4 is an undated letter from the auditors to the LCEOC Board of Directors concerning LCEOC's cost of living adjustment payments.

[6] We understand this to be the same as the Office of Human Development Services Grants Administration Manual (HDS/GAM) cited in the OSPRI. Therefore, we have cited HDS/GAM in this decision.

[7] ACF asserted that LCEOC's fiscal years ended on January 31. ACF PHBr. at 191. LCEOC indicated that its fiscal years ended on December 31. Even using the more favorable dates suggested by ACF, LCEOC's audits were extremely late.

[8] The audit findings discussed in this section are based on information provided by ACF, at the Board's request. See Hard Copy of E-Mail from ACF to Board titled "Audit Numbered Items Re: ACYF" (June 7, 1995). In its Post-Hearing Brief, ACF asserted that 18 audit findings were in issue, even though the Board had identified only 17 prior to the hearing. See Revised Regulatory Notice of Hearing on Lake County Economic Opportunity Council, Inc. (June 7, 1995). Given that our Revised Notice was based, in part, on specific information provided by ACF and that ACF had ample time to further question its accuracy, we will not here consider the audit finding not set out in the Revised Notice.

[9] ACF Exhibit 70 consisted of -- notes by OSPRI reviewers on a 1994 OSPRI document for Items 216-256 (pagination for this document appears in its upper right hand corner); the cover sheet to that section along with two pages identified as the Data Sheet (these three pages are unnumbered) and eleven pages of handwritten reviewers notes on plain paper (paginated as 70-1 to 70-11).

[10] ACF's OSPRI reviewer actually noted the lack of a fixed asset inventory in OSPRI Item 256 in May 1994, and marked it out of compliance. Ironically, ACF's financial specialist gave LCEOC the benefit of the doubt, and changed the final determination on that item, which contained several subparts that were both in and out of compliance, to a compliance. Tr. at 1761.

[11] At this time the Head Start regulations required an opportunity to correct program standard deficiencies. 45 C.F.R. § 1304.1-5(b). However, there was no such requirement for fiscal and management deficiencies. Moreover, Ms. Pitts met with LCEOC management at the end of the OSPRI visit and notified LCEOC that its fiscal system was so substandard that it was in danger of being designated "High Risk." Tr. at 1648.

[12] 42 U.S.C. § 9848 titled "Comparability of Wages," enables the Secretary to take "such action as . . . necessary" to assure that Head Start employees are not paid wages in excess of the average rate of compensation for the area in which the program is operating.

[13] The program announcements for this supplemental funding were ACYF-IM-90-06 (FY 1990), ACYF-PI-91-03 (FY 1991), ACYF-PI-92-02 (FY 1992), ACYF-PI-92-14 (FY 1993). See ACF Exs. 11-14.

[14] This percentage was equivalent to the FY 1991 increase in the Consumer Price Index. ACF Ex. 13, Attachment at 1.

[15] For example, if the COLA raised the base salary for a certain position to $5/hour and the individual in that position quit, a new employee in that position would be entitled to $5/hour.

[16] Since the 1993 instructions were identical in language except that the applicable rate was 3 percent, the same analysis applies. See ACF Ex. 14, Att. at 1.

[17] Elsewhere in its post-hearing brief, LCEOC asserts that it paid COLAs to 38 of an eligible 63 employees. LCEOC PHBr. at 65 and Appendix 18. See also Tr. at 4011. LCEOC never revealed when it paid the 1992 COLA.

[18] LCEOC's Vice-President of Finance testified that there were minor differences in the figures presented in this schedule and those contained in a Table submitted with his May 26, 1995 affidavit on the subject of COLAs. Tr. at 4157-58. ACF's examination of the schedule (LCEOC Exhibit 157) revealed 39 COLAs paid as opposed to the initial figure of 43. ACF PHBr. at 16, n.8.

[19] LCEOC asserted that it paid 100% of all COLAs in 1994. To the extent that this assertion was offered as a sign of good faith, there is no evidence that these COLAs were actually paid or of the criteria by which LCEOC defined eligible employees in 1994. Further, our concern here is with COLAs due in 1992 and 1993, as it was those years that were cited in ACF's Denial of Refunding.

[20] In our analysis of LCEOC's financial management, we examined the eight OSPRI Items (Nos. 218, 220, 223, 225-228 and 245) found by ACF to be out of compliance in the "Administration/Financial/Property Management" category. Consequently, we will not address those OSPRI Items here.

[21] While both parties referred to whether LCEOC or its delegates were in compliance with certain OSPRI Items, the OSPRI itself is not a regulation. The purpose of the OSPRI is to measure a grantee's compliance with Head Start and general grant regulations; it lists by item or section the pertinent regulation or regulations measured by that item or section. The language of each item most often parallels or paraphrases the applicable regulation, and sometimes elaborates on the regulation by listing possible documents that would evidence compliance. For brevity's sake, unless a party argued that an OSPRI Item was different from the corresponding regulation (see, e.g., Item 90), we do not repeat the regulation verbatim.

[22] The proposed Rules of Order (ACF Exhibit 65) definitely contained provisions that were inconsistent with basic tenets of 70.2.

[23] There are several policy groups involved in the Head Start program. These include: (1) advisory committees at both the delegate and grantee levels, such as the Health Services Advisory Committee, made up of parents and health professionals from the community; (2) a policy committee at each delegate, comprised of parents and community representatives from that delegate; (3) the Policy Council at the grantee level, made up of parent representatives from the delegate agencies and area-wide community representatives.

[24] The Metro Corps Head Start Director testified that IEPs were done for the '92 -'93 school year, but did not indicate they were done for the following year. Tr. at 3615-18. The Head Start Director for Hobart Township Lake Ridge (Lake Ridge) also testified that IEPs were done at that delegate. Tr. at 3496-99. However, Lake Ridge was not cited as out of compliance. See LCEOC Ex. 129 at Delegate 000 (DIS-1); Revised Issues Statement at 11.

[25] The 1994 Report of Findings also found Porter County to be out of compliance with this Item. However, since Porter was not listed in the prehearing Revised Notice of Issues, we do not include it here.

[26] This reviewer also examined this component in the 1993 OSPRI. Tr. at 202-203.

[27] The ROF included noncompliance for Porter County as well, but since that delegate was not included in the Revised Notice of Issues, we do not include it here.

[28] Specifically, these allegations involved Metro Corps subdelegates, ELKA and LAFEP. See also LCEOC Ex. 155, Delegate 000 at 38.

[29] Inexplicably, LCEOC argued that this regulation did not require that delegate agreements have prior approval. LCEOC PHBr. at 41.

[30] Appeal Attachment AA is titled -- Revised LCEOC Delegate Contract and Addenda Submitted on December 1, 1994. It purports to be effective February 1, 1994 and is signed by grantee and delegate officials between December 7-15, 1994. Although the signed version obviously could not have been submitted on December 1, 1994, this delegate agreement was apparently the one to which the Denial of Refunding referred.

[31] The defects were: (1) the pay scales included in the application for refunding did not reflect cost of living increases that had been approved for 1994; (2) contract language concerning personnel policy requirements uniformly referred to community service corporations despite the fact that at least two delegate agencies were school districts, not community service corporations; (3) inconsistencies between program design and staffing patterns, so that some staff with more responsibility (e.g., Head Start Director) was earning considerably less than staff with lesser responsibilities (e.g., teaching staff); (4) execution of agreements with totally new delegate agencies without prior ACF approval.

DAB Decision No. 1580: Lake County Economic Opportunity Council, Inc. HHS/DAB/HSB. 1996. English.

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