June 2, 1998
The Honorable James A. Leach
House Banking and Financial Services Committee
Room 2129, Rayburn House Office Building
Washington, DC 20515
The Honorable Marge Roukema
Financial Institutions Subcommittee
House Banking and Financial Services Committee
Room 2129, Rayburn House Office Building
Washington, DC 20515
Dear Chairman Leach and Chairwoman Roukema:
Attached please find a report prepared at my request by majority staff of the Subcommittee on General Oversight and Investigations ("the Subcommittee") concerning the Community Development Financial Institutions Fund ("CDFI Fund") administered by the Department of the Treasury. I am transmitting the report for your consideration during the reauthorization process.
As you know, the CDFI Fund was created by an act of Congress in August 1994 "to promote economic revitalization and community development through investment in and assistance to community development financial institutions, including enhancing the liquidity of community development financial institutions." The CDFI Fund administers two separate programs: the CDFI program, which makes financial awards to "community development financial institutions" based upon proposed development activities, and the Bank Enterprise Award ("BEA") program, which makes awards to any type of financial institution that has demonstrated a commitment to community development lending. In July 1996, the CDFI Fund awarded $37.2 million to 32 awardees under the CDFI program, and more than $13.1 million to 38 financial institutions participating in the BEA program. In September 1997, the CDFI Fund awarded $38.3 million to 48 institutions under the CDFI program, and $16.25 million to 54 institutions under the BEA program. The Fund announced a third round of funding on March 20, 1998, and expects to spend $20 million on training and technical assistance programs in 1998. The Clinton Administration has consistently stated that its goal is to make the program a billion dollar program over five years.
In March of last year, the Subcommittee commenced a preliminary review of the operations of the CDFI Fund. As part of this review, I requested that Subcommittee staff be permitted to review documentation at the CDFI Fund relating to the awards made in its first round of funding in 1996. We later learned as a result of a Report of Investigation prepared by the Treasury Department's Office of Inspector General that on the eve of the Subcommittee's review of the files, the Fund's Deputy Director had worked through the night preparing undated evaluation memoranda purporting to justify some $11 million in awards made some eight months earlier to Chicago-based Shorebank Corporation and three institutions it substantially controls. Given that these institutions had received almost one-third of the funds awarded in the CDFI Fund's first, I requested that the Subcommittee staff conduct a review of the first round selection process.* The parallel BEA program was not addressed because its first round was undersubscribed, resulting in all BEA applicants being given awards.
The following are some personal observations on the findings in the report.
- The first round was marked by inadequate procedures and documentation.
For the Fund to have long-term credibility it must establish sound procedures and implement meaningful safeguards against abuse. This was not done in the first round, which resulted in substantial unfairness. It was unfair to those applicants that did not receive awards. But it was also unfair to winning applicants -- the CDFI Fund granted the Shorebank "system" almost $11 million without contemporaneously documenting the bases for the awards, thereby calling into question their legitimacy and drawing inevitable attention to Shorebank's well-documented ties to the White House. The Fund's failure to adopt meaningful procedures can also be said to work an injustice to the ultimate beneficiaries of the program - residents in economically distressed communities -- because it jeopardizes future funding of community development by undermining Congressional confidence in the program. Finally, and most importantly, it is unfair to the American taxpayer - the casual approach to public monies that characterized the CDFI Fund's first round is never justified.
It is my understanding that most federal grant programs utilize an objective scoring system for evaluating funding requests. It appears that a decision was made early on to reject such a scoring system for the CDFI Fund in favor of a far less structured approach. A Treasury Department transition team, with the input of an interagency task force, had recommended that the CDFI Fund adopt a scoring system in its regulations. Senior Treasury officials rejected this recommendation in "order to maximize the Fund's flexibility and discretion . . .." Instead, the Fund utilized an unorthodox "venture capital" model that utilized hand-picked outside "experts" to make subjective judgments about applicants. Furthermore, the Fund promoted the use of personal knowledge and information obtained from third party industry sources in making award decisions.
In defending this approach, senior Treasury officials have argued that the CDFI Fund is engaged in a process too complex for a scoring system to be effective. This argument is simply not convincing - other agencies utilize scoring systems in matters requiring far more subjective judgments than those made by the CDFI Fund. The National Endowment of the Arts, for example, uses a scoring system in making its grants.
Scoring systems are no panacea, but they do permit an agency to develop institutional expertise that can be deepened and refined over time. A central benefit of the use of a scoring system is that it forces an agency to confront ambiguities that exist in the program. For example, the CDFI Fund has never resolved whether its resources should be dedicated primarily to funding "start-up" CDFI's or to buttressing the efforts of established players. The Fund has never resolved this confusion on a programmatic level because it purportedly considers applications from start-ups and established firms under the same standards. Fund personnel maintain that management track record and financial standing were critical factors in reviewing applications; start-ups by definition cannot be meaningfully evaluated on these criteria.
Similarly, use of a scoring system would force the Fund to determine the relative importance of various factors - track record, management team, community impact, etc. - without which the process is rendered hopelessly discretionary. I note that the Fund's half-hearted commitment to utilizing a scoring system in its 1997 funding round addressed neither the difficulty in comparing start-ups to established firms nor the issue of identifying the most significant factors used in selecting successful applicants.
As detailed in the Subcommittee staff report, critical factors that were used in selecting first round recipients quite often were neither disclosed nor adequately described. As a result, $37 million in taxpayer funds was handed out without contemporaneous documentation detailing the decision-making process. This could be considered a scandal in and of itself.
On a number of occasions, Fund officials apparently resolved concerns about applicants on the basis of positive feedback received from third-party industry insiders. Fund documentation does not appear to reflect this reliance upon third-party recommendations. On other occasions, third party information was instrumental in the Fund's decision to reject applicants. In one notable example, the Fund rejected an applicant based in part upon what it determined to be credible allegations of sexual harassment against a key officer of the applicant. Neither the sources nor the specifics of the claim were documented. Fund officials have also conceded that at least in selecting certain finalists during the first round, the ethnic makeup of the target populations of applicants was considered. This practice, not authorized by statute or regulation, is not disclosed in Fund documents.
Despite its failure to produce contemporaneous documentation sufficient to support funding for at least one-third of the funds handed out during the first round, the CDFI Fund maintains that it did conduct a thorough review of each of the 264 applications it received. That may well be the case. However, the lack of documentation makes it difficult to explain what appear to be significant inconsistencies in the selection process:
- Many organizations were rejected due to poor financial performance. Yet, the Fund made an award to Finca International, an international organization that proposed to create a separate CDFI in the U.S to engage in community development lending. Recognizing that Finca International had experienced financial difficulty and had poor internal controls, the Fund endeavored to devise a structure that would prevent its award from flowing back to the troubled non-U.S. operations. Pursuant to statute, an organization does not have to be a CDFI to be selected for an award as long it promises to become one within three years; nevertheless, it is hard to understand how an international organization received funding for a CDFI not yet in existence when over 200 U.S. organizations were passed over. It is my understanding that Finca did not receive its award until early this year, due to continued complications arising from the establishment of its U.S. entity.
- Many applicants were reportedly rejected on the basis of an unsuccessful track record. Yet, Southern Development Bancorporation of Arkadelphia, Arkansas, the recipient of a $2 million award, had a checkered track record that included the mismanagement and ultimate failure of a Small Business Investment Corporation chartered by the federal government. Furthermore, pursuant to its business plan, Southern Development is reportedly using its CDFI award to help it acquire a bank controlled by its new CEO, Arkansas banker William Brandon. It is not readily apparent how using federal funds to subsidize a bank acquisition and consolidation necessarily helps expand capital availability in distressed areas.
- Enterprise Corporation of the Delta was described internally by the Fund as a "risky" application due to its startup status. In reviewing Enterprise's application, the CDFI Fund identified certain obstacles to Enterprise's success that needed to be addressed by Fund officials before approving funding. In interviews, Fund officials stated that the key issue with a start-up such as Enterprise was whether the selection panel was "comfortable" with the applicant's management; formal documentation does not explain how the Fund reached this comfort level, nor how it was determined that the potential benefits of an award to Enterprise outweighed the "riskiness" of its application.
- Domination of the industry by Shorebank
As noted, a system of institutions affiliated with Shorebank received almost one-third of the first round funding. I have never suggested that Shorebank did anything illegal, and I certainly hope its reputation for excellence in community development lending is justified. However, if one assumes these awards are justified, it suggests that the industry as a whole does not yet possess the capacity to absorb the hundreds of millions in funding that the Administration is seeking.
The Fund's approach to technical assistance awards underscores this point. Fund officials acknowledge that having Shorebank personnel manage an applicant increased the likelihood of the applicant receiving funding. This may explain why the Fund approved $489,500 in technical assistance for firms for which a Shorebank affiliate was providing the relevant assistance. (It is troubling that these technical assistance awards were made after Shorebank personnel made a direct pitch that the funds be earmarked for Shorebank.) This approach to technical assistance contracts raises the specter that a sophisticated applicant could bolster its chances for funding by retaining Shorebank to prepare its application and by proposing to have Shorebank manage it; it could reasonably expect to receive both an award and a technical assistance grant to pay for Shorebank's services.
This reality is apparently not lost on the industry - Fund documents indicate that one unsuccessful first round applicant reportedly "expressed optimism that [it] would reapply and that Southshore would either be a formal part of a future application, or would help strengthen the application through a consulting arrangement."
- Conflicts of Interest
The approach to conflicts of interest in the first round was casual at best. Neither the Director nor the Deputy Director appeared to be aware of the duty imposed by the ethics regulations to consult with a designated ethics officer before considering grants to organizations with which they had been previously associated. The Treasury Department's after-the-fact contention that the Director and Deputy Director were under no duty to consult with the agency's ethics officer is, in my view, nonsensical. I note that the conflict of interest statement utilized in the second round screened out reviewers with similar conflicts.
- Politicization of the award process
If one set out in advance to create a government grant program that operated as a political slush fund, it certainly would look something like the CDFI Fund during the first round: rejection of an objective approach to evaluating applications; a whole level of decision-making not adequately documented; a large percentage of grants awarded to well-connected applicants; and the general ease with which a million here or a million there could be distributed with no meaningful review. Treasury Department officials deny, of course, that political factors were considered during the review process. However, the overall approach of the Administration to this program is not reassuring, and certain findings detailed in the report suggest that the program has been politicized.
Failure to provide meaningful support for the Fund. In the CDFI Fund's first three years of operation, the Department's stewardship of the program suggested that it was more interested in short term political gain than in laying the groundwork for the long-term viability of the program. The Department's own Inspector General has observed that the Department's failure to develop a consistent approach to implementation of the program resulted in confusion over the placement of the CDFI Fund within the Department, the failure to perform a comprehensive written needs assessment, and the failure to provide critical accounting and procurement services. The Fund's 1997 annual report released earlier this year indicates that almost four years after the program was established, it still lacked key personnel and has not established critical management functions. It is my understanding that the Department has yet to clarify the Fund's status within the Department, as demonstrated by the last minute decision last September that the Fund needed its own annual report. Despite their numerous mistakes in judgment, it would appear that in many ways the former Director and Deputy Director were placed in an untenable position by indecisiveness and indifference toward the program.
White House and Treasury pressure to announce the awards. The White House reportedly requested that the CDFI Fund's awards be announced as early as the State of the Union address in January 1996 - and was disappointed when this timetable could not be met. Similarly, it appears that Fund officials resisted efforts in mid-1996 to force them to complete the award process by an arbitrary (and in the officials' view, unreasonable) date. (In fact, the Deputy Director apparently threatened at the time to resign in response to the pressure.) Even though it could have announced the awards as late as the end of September (as it did in 1997), the Fund raced through the process and announced its awards in late July 1996. This pressure had deleterious effects on program administration: the Deputy Director ascribed shortcomings in first round documentation to the pressure to announce the awards as quickly as possible and to the fact that he was pulled into the extensive public relations effort surrounding the first round announcement.
Contrary to a Treasury Department response, the letter from President Clinton commending an applicant was shown to review panel. Last May, the Department stated that a letter from President Clinton commending one of the first round applicants, Enterprise Corporation of the Delta, was not shown to the review panel that approved an award to Enterprise despite its being described as "risky" by its initial reviewer. (At the time, the Department sought to distance itself from this response by the unusual disclaimer it was "based upon information provided by the CDFI Fund.") A sworn statement contained in the Inspector General's report indicates that the letter was in fact shown to the Director of the Fund, who was a full participant in the five person panel that selected Enterprise for an award. Is it plausible that a letter from the President of the United States could have been forgotten?
Politicization of the "announcement" of the awards. On July 1, 1996, after the Fund had tentatively chosen first round award recipients but before it finalized its selections on July 11, the Director and the Deputy Director met with a special assistant to the Treasury Secretary. The meeting was purportedly scheduled to discuss various venues in which to announce the awards. However, notes taken at this meeting reflect that various connections between the tentative winners and prominent political figures, including the First Lady and certain members of Congress, were also the subject of discussion.
While Subcommittee staff did not conduct a detailed substantive review of the second round, it appears that the Fund moved in the right direction. Its documentation is far more extensive and the Fund did utilize a scoring system of sorts. Moreover, the Fund adopted a much more rigorous approach to conflicts of interest.
However, significant questions exist concerning the adequacy of procedures used in the second round. To begin with, the Fund's 1997 annual report details a list of internal deficiencies that were present during the second round and that have yet to be resolved. Almost four years into the program, the list of deficiencies is staggering and would be unacceptable for a government program in its infancy, much less one that has expended over $9 million in administrative expenses in its history: absence of a formal Federal Managers' Financial Integrity Act (FMFIA) program to identify and design corrective actions for material weaknesses; lack of a structured system of documentation for award files; vacant positions for oversight of awards programs; lack of formal post-awards monitoring procedures; no formal review of monthly financial statements, accounting records, budgetary reports, and supporting reconciliations; vacant positions for Chief Financial Officer and Controller; inadequate delineation of organizational responsibilities within the Fund; and general lack of documented policies and procedures.
Second, a cursory review of the documentation indicates that the Fund did not make a true commitment to objective standards (the scoring system, used merely to express subjective judgments in a quantifiable fashion, was not actually used to select the eventual winners). Furthermore, the Fund failed to address many of the programmatic ambiguities that were present in the first round.
The cavalier approach the Fund took in awarding taxpayer money was surpassed only by the laxity of its approach to spending taxpayer money. In fact, it would seem that the Treasury Department's contracting practices represent a virtual "case study" in how to avoid the Federal Acquisition Regulations.
As a general matter, the Fund utilized outside consultants to review the applications for funding. It appears that the Fund's failure to adopt sound internal procedures required reliance upon more highly-paid consultants for much lengthier periods of time than would be required by other agencies. These reviewers were hand-picked essentially on a "word of mouth" basis. (I note that if the Fund had made a comprehensive commitment to developing clear guidelines and an objective scoring system, it could have relied upon individuals with general expertise in financial services (such as officials with the various federal regulatory agencies) to apply the guidelines, thereby reducing its general dependence upon highly-paid industry insiders.)
The more disturbing issue is the Fund's decision to use highly-paid "management consultants" over extensive periods of time to perform functions that more properly should have been handled by government employees. The Treasury Department is authorized under 5 U.S.C. sec. 3109 to use outside consultants, but this provision is apparently viewed as inconvenient by the Department because it limits both the duration of consultants' tenure and their compensation. To avoid these restrictions, the Department engaged in a subterfuge involving a creative use of 8(a) minority and disadvantaged business set-aside contracts administered by the Small Business Administration. (As a result, an attempt last year by Congressional appropriators to restrict the exorbitant fees being paid by the Fund to consultants was rendered futile due to the Department's use of the 8(a) mechanism.)
Under these contracts, 8(a) firms were to provide undefined management consulting services. Instead of employees of the 8(a) firms providing the service, the firms used subcontractors hand-picked by the Department, who performed the overwhelming majority of the services - more than 90% on most task orders. (SBA regulations seek to prevent 8(a) firms from being utilized as mere brokers by requiring that 8(a) firm employees provide at least 50% of the services; the Treasury Department relies upon a loophole in the law to avoid this general requirement.) For all intents and purposes, the 8(a) firms were pass-throughs to provide a contracting vehicle for the subcontractors that the Fund wished to retain. Although the 8(a) firms changed, many of the same subcontractors were passed from firm to firm.
The 8(a) program ostensibly shelters minority and other disadvantaged firms from competition for the purpose of helping such firms develop the expertise and infrastructure necessary to withstand full competition. When these 8(a) firms are exploited as mere pass-throughs for pre-selected subcontractors, the firms never develop the necessary infrastructure and expertise. One can hardly blame the 8(a) firms, however, for participating in this sham, when they were able to collect markups as high as 18% (on one invoice, a firm was paid a markup of more than $100,000) for doing little or no work. If the Treasury Department's experience with the program is truly indicative of the manner in which the Small Business Administration administers it, it should be abolished immediately. I intend to make follow-up inquiries in this regard in order to determine the extent to which this program is being abused by the Department and the SBA.
When competitive procedures are evaded, waste and abuse often follows. Such appears to be the case here. Misuse of the 8(a) program facilitated placement of friends and acquaintances of CDFI Fund senior management on the public payroll at exorbitant rates and for excessive periods of time. The CDFI Fund's former Director has revealed that she was personally acquainted with 18 of the subcontractors selected. One management consultant was paid over $228,000 (predominantly for part-time work over an 18 month period) at hourly rates from $125 to $133; another consultant was paid over $180,000 for part time work. During one 18 month period, one of these consultants received over $31,000 for travel expenses incurred for weekly trips to Washington from her residence in New York City. She was housed at taxpayer expense during her lengthy employment at the Mayflower hotel, prompting the Director to request that an apartment be provided to her free-of-charge by the Department. A further consequence of such contracting practices is that the Fund may not have utilized the most qualified persons. Many highly-qualified individuals with extensive experience in community development lending were never approached by the CDFI Fund, and indeed never knew of the Fund's practice of retaining outside consultants.
The Treasury Department's response to the Subcommittee's inquiries has not been encouraging. I was disturbed to note that in October of last year, after several expressions of Congressional concern, one of the last acts of the former Director before leaving her post was to attempt to renew these ridiculous contracts. After taking 11 weeks to provide the Subcommittee a simple calculation of the contracting percentage, Treasury has given little indication that it is troubled by evidence that federal procurement regulations have been systematically flouted. Given that more than half of the procurements for the Departmental Offices are made through 8(a) firms, it appears that the abuses identified in the Subcommittee's report represent "business-as-usual" at the Treasury Department.
Beyond the obvious waste and abuse of public funds, the heavy reliance upon outside contractors has serious programmatic consequences for the CDFI program. By relying upon an outside consultant to serve as a de facto Chief Financial Officer, the Fund avoided hiring a CFO until November of 1997. The result of not having a real CFO was demonstrated by the findings of the outside audit firm of Peat, Marwick, which found that almost four years after the program was created, the Fund still does not have basic management, accounting, and awards functions established. Similarly, the Fund's reliance upon the consulting firm of Ernst & Young rather than permanent government employees to help devise its award procedures for the second round necessitated a "ground up" review of the procedures by the awards administrator hired in January 1998.
Issues to be Considered During Reauthorization
- Is a permanent authorization justified?
I voted for this program in 1994 and certainly support community development, but it is hard to imagine how the Fund could have been managed more poorly in its almost four years of existence. Simply touting the "potential" of the program is no longer sufficient. Given that a primary responsibility of the Congress is the safeguarding of public funds, the Department's troubled administration of this program raises questions as to whether it is appropriate to continue spending taxpayer monies in this manner. By retaining qualified personnel, it appears that the Fund is now headed in the right direction. However, the Fund has yet to hand out a round of awards under adequate procedures and, as demonstrated by its own Annual Report, is essentially starting from scratch in instituting basic infrastructure.
Under such circumstances, I am not convinced that it is responsible to reauthorize this program. At the very least, reauthorization should be made contingent upon an outside auditor determining that internal deficiencies have been addressed. (Put another way, would the Fund approve an award of millions in taxpayer dollars to an applicant with such a troubling list of problems as those that have been attributed to the CDFI Fund? I would hope that the Fund's response would be to suggest that the applicant fix its internal problems and apply again the next year.) Likewise, a permanent reauthorization based upon the Fund's track record is clearly unwarranted.
- Should Congress mandate that the Fund adopt procedures?
While it is generally preferable for an agency to devise its own internal procedures, in light of the Department's resistance to incorporating adequate procedures that would limit its discretion over taxpayer funds, I believe that the Committee should consider imposing certain procedural safeguards on the Fund to avoid the debacle that occurred during the first round. The following are possibilities:
- Should the Advisory Board be required to provide real input?
To date, the Fund's outside Advisory Board has operated as little more than a cheerleader (admittedly, with several members of the panel receiving awards, they have reason to cheer). The Fund desperately needs community development expertise in developing objective standards. A requirement that the advisory panel provide its "real world" expertise in devising a scoring system would move the Fund away from exclusive reliance upon a few Fund officials.
- Should a conflict of interest policy be applied to government employees?
It is my understanding that the Fund's current conflicts of interest standard is more rigorous for outside contractors than for the Fund's employees. I do not understand why the Fund must have a lower standard for its own employees.
- Can Results Act standards be incorporated?
Our debate on this program needs to move beyond the standard warring anecdotes. However, it is difficult to determine the "real world" impact of the CDFI Fund. This is especially true given the slow disbursement of the funds (less than 10% of the second round awards have been disbursed, indicating that less than $40 million of the more than $70 million in CDFI awards have been disbursed to date). In a letter to me last May, the Department claimed that as a result of the first round, the $13 million awarded under the BEA program had leveraged $126 million while the $37 million awarded by the CDFI program had only leveraged $50 million. I understand that the General Accounting Office has questioned the accuracy of these estimates, but if these estimates are correct, it would appear that the BEA program is more efficient in attracting capital to distressed areas. Furthermore, there seems to be little understanding of how CDFI Fund awards are used to revitalize economically depressed areas. Does the funding of a bank acquisition - as in the case of Southern Development -- really help expand access to capital in depressed eastern Arkansas?
Imposition of concrete standards on the program modeled on the Government Performance and Results Act would be a move in the right direction. Furthermore, the program would be improved if objective methods could be utilized to evaluate the social and financial performance of institutions in order to determine the Fund's impact.
- Should appropriations amounts be limited initially to address the reported saturation of industry?
Fund officials reportedly viewed the applicant pool as not being deep in the first round, and identified an even sharper decline in the quality of applicants in the second round. (This was reportedly expressed even to OMB.) The Fund's award of almost $11 million in the first round to the Shorebank "system" is consistent with this observation. Furthermore, the Fund's plan to spend $20 million this year on training programs certainly fosters the impression that the Fund is spending taxpayer money to create an industry that does not exist in order to justify its continued funding. Given the fact that the Fund currently has approximately $115 million in unobligated funds and expects to spend $94.5 million in the current fiscal year, a limitation on appropriations would seem to be in order -- at least until the "industry" demonstrates the management capacity to absorb such funding. Saturating an immature industry with public funds is obviously not in the interest of the taxpayer, nor is it in the interests of those communities intended to benefit from the program, as inevitable waste and abuse will undermine the long-term viability of the program. Under such circumstance, limits on the initial amount of appropriations under any reauthorization should be considered. Other alternatives to address this problem could include:
- Are changes to the Capital Enhancement Program necessary?
The Department has requested a statutory change to authorize the Fund to begin immediately disbursing its funds to states utilizing Capital Enhancement Programs. The proposed change would permit the Fund to disburse the funds based on criteria it develops; in light of its track record, the notion of providing such an open-ended authority to the Fund is troubling. More significantly, it is my understanding that in the last few years a substantial number of states have initiated these programs, with almost half the states doing so without being prompted by federal funding. Accordingly, I am not aware of a justification for making the change requested by the Treasury (other than to help the Fund dispose of its excess funding).
The last four years have done little to demonstrate the viability of the CDFI Fund; furthermore, with little monitoring of how existing awards have been spent, there is simply no track record on which to assess the CDFI Fund's performance. It is my hope that the issues identified above can be addressed during reauthorization. Please do not hesitate to contact me if I can be of further assistance in that process.
Rep. Spencer Bachus
Chairman, General Oversight and
cc: Rep. John LaFalce
Rep. Bernard Sanders
* The Subcommittee review was streamlined and only involved interviews of key officials at the Fund. (I note that all persons interviewed were allowed to review statements in the report that were attributed to them.) Certain issues have not been thoroughly reviewed due to the fact that the Funds former Director, Kirsten Moy, declined to be interviewed in person. I do wish to commend former Deputy Director Steve Rohde for his cooperation in the Subcommittees review. Although Mr. Rohde has acknowledged he made a serious mistake of judgment in creating misleading documents and I consider that his approach to the first round to have been in its best light -- hopelessly na´ve, his willingness to be interviewed at length by Subcommittee staff has demonstrated a true commitment to community development.