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Govt. Files Offer Inside Look at Indirect Cost Controversy

Federal Agency Canceled Audits After 'Contentious and Protracted' Negotiations With Harvard, Documents Show

By Gady A. Epstein and Joshua A. Gerstein

For years, private universities charged the government millions of dollars for overhead on federal research grants and drew little attention from Congress or the public. But recent headlines and closer scrutiny have put these schools on the defensive.

Congressional critics blasted Stanford University earlier this year after reports that the top-ranked school had charged taxpayers for floral arrangements and upkeep on a yacht. Several months later, under pressure from a General Accounting Office (GAO) investigation, Harvard publicly announced that it was withdrawing $500,000 in questionable charges from this year's request for federal reimbursements.

In the wake of these disclosures, the Office of Management and Budget has said it will likely overhaul the regulations that determine proper overhead billings--known in contracting circles as "indirect costs."

But beyond the occasional accounting indiscretions, some say, is a more ordinary--and more worrisome--phenomenon. Budget watchers say the sheer size of over-head payouts made to universities, billions of dollars last year, is the most serious federal funding concern.

Harvard Medical School is now operating under an arrangement which allows it to claim an extra 88 cents for every $1 the government pays on federal projects, except for equipment purchases. Harvard recently asked the government to increase that rate, currently the highest in the nation, to more than 100 percent.

Examples of spending improprieties have received national attention, but the process that determines indirect cost rates has remained, in large part, a mystery. Traditionally, schools supply information about their expenses and then negotiate with the government to establish a specific indirect cost rate.

Within the negotiation process, Harvard and federal officials have been reluctant to offer any further illuminating information about how such decisions are made. Officials from the Department of Health and Human Services (HHS), which sets Harvard's indirect cost rate, did not respond to questions submitted last week.

However, documents obtained under the Freedom of Information Act begin to shed light on the process. The files show that the negotiations are often heated and contentious and reveal a number of potential flaws in the indirect cost reimbursement system.

The following points emerge as the highlights of a 72-page release from Health and Human Services and from subsequent discussions with federal and University officials:

* Throughout the 1970s and 1980s, the federal government paid Harvard millions of dollars more than the University actually spent on allowable overhead costs. A major bargaining point in a 1987 negotiation concerned how much Harvard actually owed the government. Vice President for Finance Robert H. Scott said recently that the resulting rate--77 percent--was artificially low because it was adjusted to account for this discrepancy.

* Federal negotiators canceled audits which could have revealed inappropriate charges, like the senior dean's retirement party which Harvard has admitted including in this year's cost proposal. In 1987, Health and Human Services notified the University that it planned to carry out such audits, but after completing indirect rate negotiations with Harvard, called off the inquiry.

The Medical School's indirect cost expenditures have not been formally audited by HHS in at least a decade. Federal auditors are the only external check on Harvard's specific expenditures, including millions of dollars in maintenance, library and administrative costs.

* The government's approach to establishing overhead rates appears to give Harvard little incentive to control costs. Under the predetermined rates, if Harvard overspends, it will have an advantage in future rate negotiations because University negotiators can point to the Medical School's high costs incurred by federal research.

In addition, HHS does not concentrate on whether particular expenditures are necessary. HHS negotiators do not examine whether Harvard obtains products from the least expensive vendor or whether services are procured in an economical fashion. Instead, they look at the way costs are distributed. Only official auditors occasionally attempt to make more specific determinations.

* The terms of a 1987 rate agreement specifically prohibit any adjustments to the indirect cost payment rates, which one government official says may prevent HHS from recovering any inappropriate billings.

If Health and Human Services were to ask Harvard to pay back the government for improper charges, Harvard officials "would have a strong legal position" to resist the request, one HHS official said Tuesday.

* Federal and University officials disagree on several regulations governing indirect cost negotiations--disagreements which have contributed to problems in those discussions in the past. According to Harvard's interpretation of the rules, it is almost impossible for HHS to set overhead rates unilaterally.

The University contends that so long as it negotiates "with due diligence," the agency cannot legally make a unilateral ruling. HHS officials flatly reject this position and other such legal positions the University has taken.

These and other flaws in the indirect cost reimbursement system have prompted federal officials and Harvard to agree that the way universities are paid for their overhead costs needs to be revamped.

HHS has steadfastly refused to release any records pertaining to Harvard's indirect costs since 1987, citing the current negotiations between the department and the University. And Harvard has declined to release the Coopers & Lybrand audit report it recently commissioned to examine indirect cost billings for this year.

However, earlier documents provide insight into how the decision to allocate millions of dollars in federal funds is made.

Officials Alarmed

As early as 1986, HHS officials in Washington were alarmed about the indirect cost rate at Harvard Medical School. At that time, the school was entitled to receive an additional 99 cents for each $1 awarded in federal research grants.

"Although a medical school rate cannot be compared to a composite rate for an overall university operation, [Harvard's] rate nonetheless appeared very high," the officials wrote.

According to an internal memorandum, HHS decided in the summer of 1986 to make a "major commitment [to] reducing the rate significantly below historical levels." It entered into negotiations with the University and assigned staff members from Boston, New York, Philadelphia and Washington to pursue them.

The agency's task was not an easy one. Harvard vigorously fought the attempt to lower the overhead rate, which was then bringing the University more than $10 million a year.

Health and Human Services characterized the negotiations as "highly contentious and protracted." Harvard's Scott, who himself was not involved in the 1987 negotiations, agreed with this description in a recent interview.

According to HHS, "The negotiations broke down three times, and until the last negotiation conference, it appeared that a negotiated settlement would not be reached."

After negotiations reached an impasse in June 1987, HHS notified Harvard that it was setting a temporary indirect cost rate of 65 percent--substantially lower than the 98 percent rate Harvard had sought.

Harvard officials said the move was illegal and threatened to sue HHS. Harvard insisted that there was a "clear requirement" that HHS determine its rate through negotiations.

Moreover, that month, HHS blasted "the Medical School's practice of repeatedly overestimating budgets in its indirect cost proposals." Harvard officials took offense and challenged the government to provide "any evidence whatsoever" substantiating the claim.

In July 1987, HHS believed the negotiations were at a stand-still and asked the Inspector General's office to audit the Medical School's indirect cost billings for fiscal years 1985 and 1986.

Finally, in October 1987, the two sides clinched a three-year deal, guaranteeing the University payments of 77 cents in overhead for every $1 awarded in grants to the Medical School. Under one clause of the agreement, HHS with drew the audits it had requested.

In the inquiry into indirect cost abuses at Stanford University, Congressional investigators slammed the Navy for failing to oversee adequately the school's spending practices, questioning the Navy's decision to waive two audits at Stanford for the years 1981 and 1982.

In avoiding federal audits, Harvard has escaped the most effective external check on over billings that HHS has available. Harvard's savvy in its dealings with HHS does not end there, though, as the released documents show.

Nearly four years ago, University officials foresaw the indirect cost controversy that has now drawn national attention.

In an October 1987 letter, John M. Deeley, then-associate dean for business and finance at the Medical School, expressed the University's fears that sometime in the near future Congress might take action to cut all indirect cost rates.

Deeley wanted an agreement with HHS that would protect reimbursements if an across-the-board cut was implemented, but HHS rejected this idea.

Now, in 1991, Deeley's prediction is on the verge of becoming a reality. Politicians on Capital Hill and in the White House are calling for stricter regulations, including a possible cap on overhead rates nationwide.

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