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COLLECTION OF FILING FEES

Audit No. 348
August 14, 2002

EXECUTIVE SUMMARY

A prior report by our office (No. 225, dated February 1996) found material weaknesses in the management controls for the collection of filing fees. Since then, our semi-annual reports to the Congress have reported this issue as a significant problem.¹

Since 1996, our semiannual reports have noted that the Commission has made many improvements to the management controls over filing fee collection. Final resolution of the weaknesses was expected with the implementation of a new automated filing fee system (known as Momentum), which took place in September 2001. Accordingly, we conducted this follow-up review to determine whether the material weaknesses have been corrected.

Our review did not identify any material weaknesses in the management controls over the collection of filing fees. Commission management generally concurred with our recommendations.

SCOPE AND OBJECTIVES

Our audit objectives were to identify any material management control weaknesses and determine whether to continue reporting the filing fee collection process as a significant problem in our semiannual reports to Congress. Our audit was limited and provides only "negative assurance", which entails reporting whether any material weaknesses came to our attention during the audit.

We did not review the transfer of balances from the prior filing fee automated system (the Entity Filing Fee System (EFFS)) to Momentum, transaction fees collected by the securities exchanges (which are also recorded in Momentum), or general computer controls. Our office has, however, reviewed general computer controls in prior audits.

During the review, we interviewed Commission staff, reviewed supporting documentation (e.g., Momentum's user manual), and performed tests of transactions, among other procedures. We generally limited our testing of transactions to those in fiscal year 2002 (beginning October 1, 2001).

The audit was performed from October 2001 to April 2002 in accordance with generally accepted government auditing standards.

BACKGROUND

GENERAL INFORMATION ON FILING FEES

Commission filings that require a fee are classified into four categories:

• Offerings of securities (registration statements under section 6(b) of the 1933 Securities Act);
   
• Short form registration statements (T+3 filings);
• Proxy statements; and
   
• Williams Act filings.

All filing fee payments are due at the time of filing.

Fee rates have varied over time. When our audit began, the rate was $250 and $200 per million dollars for registration statements and transactional filings (i.e., Proxy statements and Williams Act filings) respectively. On November 28, 2001, the fee rate for registration statements was reduced to $239 per million dollars by the Commission's 2002 appropriation bill. The 2002 appropriation bill did not change the fee rate for transactional filings. Later, on January 16, 2002, the Investor and Capital Fee Relief Act (HR 1088) further reduced the rate to $92 per million dollars for registration statements and transactional filings retroactively to October 1, 2001.²

According to the Commission, it collected a total of approximately $1 billion in filing fees in fiscal year 2001, and $575 million as of June 30, 2002. The filing fees are deposited in accounts at the Treasury. A portion (which changes annually) of the filing fees are used to fund Commission operations. For fiscal year 2002, the Commission's current year appropriation account will be credited for the initial $109.5 million received.³ The excess fees are deposited in the Commission's "no-year" appropriation account.

PROCESSING OF FILING FEES

Electronic Filings

Commission rules require most filings (except those from foreign issuers⁴ and registrants claiming a hardship exemption) to be submitted electronically through the EDGAR (Electronic Data Gathering Analysis and Retrieval) system. Fee payments are generally made by wire transfers to Mellon Bank. Mellon Bank updates Momentum every five minutes for wire transfers and once a day (at 2pm) for fees (e.g., checks) received in its lockbox.

When a filing is submitted, EDGAR calculates the filing fee based on the information provided by the registrant in the header section of the filing. EDGAR then verifies with Momentum that the registrant's account has the necessary funds. If sufficient funds are available, EDGAR releases the filing for further processing. Otherwise, EDGAR checks (polls) Momentum every 15 minutes until sufficient funds are available in the registrant's account. If Momentum does not receive sufficient funds by the close of business, the filing is suspended.

An account is established in Momentum for each registrant who submits a filing that requires a fee. The account balance increases with each fee payment; each filing submitted reduces the balance.

After the filing is accepted, the Office of Filings and Information Services' (OFIS) Filer Support One Branch reviews the mathematical accuracy of the filing fee data and verifies that the information provided in the header is correct (based on the information in the text of the filing).

Paper Filings

OFIS's Filer Support Two Branch receives paper filings. Before accepting the filing, branch staff review the mathematical accuracy of the fee offering data and ensure that the registrant's account has sufficient funds, unless the filing is accompanied by a fee payment (certified or cashier's check, money order, or cash). Branch staff then record the filing information in EDGAR.

If the fee accompanies the filing, Filer Support Two Branch staff forward the fee to the Office of Financial Management (OFM). OFM records the fee payment in Momentum and deposits the fee to a Commission Treasury account.

AUDIT RESULTS

We did not identify any material management control weaknesses in the collection of filing fees. Accordingly, we do not consider the collection process to be a significant problem now. However, we are making several recommendations to improve the collection process, as described below.

FILING FEE CALCULATIONS

We selected a judgmental sample of 40 filings to determine whether the proper fee was assessed. We verified arithmetical calculations, and agreement between the header information and filing text. We found that four of the filings (10%) had one of the following errors:

• The registrant miscalculated the filing fee in the text of the filing, and provided EDGAR with incorrect information; or

• The registrant properly calculated the filing fee in the text of the filing, but provided EDGAR with incorrect information.

As a result of the errors the four registrant accounts were misstated an aggregate amount of $40,690; net $18,704, since OFIS did not detect them. Our prior audit found similar errors.

As a result of these errors, we conducted a statistical sample of 100 additional filings (see Appendix A). We found that nine of these filings had one of the errors described above.

However, OFIS had already identified the errors in seven of these filings (all seven filings were form types 24F-2NT), and had asked the EDGAR contractor to correct them.⁵ The errors in the seven filings have since been corrected. The aggregate amount of the errors for the other two filings was immaterial ($69). During the audit, OFIS corrected all of the errors we identified.

OFIS is discussing with the Office of Information Technology (OIT) whether the fee information can be obtained directly from the filing, as opposed to the header. This approach would eliminate some types of fee related errors.

Recommendation A

OFIS, in consultation with OFM, OIT, and the Office of the Executive Director (OED), should continue to explore the feasibility of obtaining the fee information directly from the filing and implement those steps that are feasible. Changes that should be considered include:

• • The header could be modified to resemble the exact table that the registrant completes in the text of the filing.

  • The header could require a "yes" or "no" response for 24F-2NT filings with respect to whether or not the registrant is paying the fee for more than one series or class of securities.

  • The header could require, where appropriate, that the fields "Amount Being Registered" and "Proposed Maximum Offering Price Per Unit" be completed. The "Proposed Maximum Aggregate Offering Price" could be calculated based on this information. Under the current method, the registrant can just provide information for the "Proposed Maximum Aggregate Offering Price."

  • The header could include a "drop down menu" to indicate which section of 17 CFR 230.457 or 240.0-11 the registrant used; and

  • EDGAR could monitor 424b(2) and 424b(3) filings to ensure that the registrant does not exceed the offering amount from the Form S-3 shelf registration statement.⁶

AVAILABLE BALANCES

We found that many registrant accounts had a large available (i.e., credit) balance. For instance, as of February 6, 2002, 1,581 registrants had an available balance greater than $5,000. The aggregate dollar total of available balances for these registrants was approximately $69 million.

Several possible explanations for these balances include:

• Some registrants send their fee payment before submitting their filing to ensure that the filing is accepted;

• Some registrants had a large available balance transferred from EFFS to Momentum. Our prior audit identified the misstatement of account balances in EFFS as a problem. However, according to OFM, these registrants had an opportunity to notify the Commission about any errors upon receiving their EFFS account statements;

• Some registrants were unaware of reductions in the fee rates, and accordingly overpaid the fees;

• OFIS staff were unable, until recently, to adjust offering information for 24F-2NT and transactional filings once the filing was accepted;

• Registrants are not able to obtain refunds in certain circumstances (see the section on Refunds below); and

• Some registrants made errors in calculating the filing fee and/or providing EDGAR with the proper information (see the section on Filing Fee Calculations above).

According to OFIS, prior to our audit, they reviewed accounts with large available balances. During our audit, they revised their methodology for identifying accounts with questionable balances. Therefore, we are not making a recommendation regarding this issue.

SEPARATION OF DUTIES

We identified two instances where additional separation of duties would improve management controls over fee collections:

• Filer Support Two Branch staff have access to fees (e.g., checks) accompanying paper filings. Some staff in the Branch also have the ability to record paper filings, adjust offering information, perform fee overrides, and initiate fee transfers from the Unassigned Fee Account.

• The Branch Chief of the Accounting Analysis Section within OFM can initiate and/or approve write-offs in Momentum. The Branch Chief also has access to the fees received by Filer Support Two Branch because OFM records the fees in Momentum.

The risks posed by the insufficient separation of duties are mitigated by several factors. The Commission directly receives only a relatively small amount of filing fees, compared to Mellon Bank, and the amount the Commission receives may decrease further.⁷ Write-offs in Momentum are rare; none occurred during the period we reviewed. Finally, OFIS and OFM managers are able to review management reports to identify potential errors or irregularities.

OFIS and OFM management have indicated that they are willing to accept these separation of duties risks. Therefore, we are not making a recommendation regarding this issue.

REFUNDS

We reviewed all the refunds issued during fiscal year 2002, as of the date of our audit testing. Part of our testing included determining whether the refund was allowable pursuant to Commission rules. We did not find any exceptions.

However, while conducting other audit testing unrelated to refunds, we identified an instance in which a registrant made a duplicate fee payment. OFIS staff stated that, although a clerical error might have been made, it is not OFIS's policy to initiate a refund or notify the registrant of a clerical error. However, registrants are notified when staff are unable to substantiate account balances, according to OFIS.

IM staff told us that IM should be notified when an investment company registrant requests a refund. Currently, OFIS staff do not notify IM or CF of refund requests, unless the request pertains to a rule interpretation that will affect the fee.

Recommendation B

OFIS, in consultation with Office of General Counsel, OED, OFM, CF, and IM, should consider if its current policies (e.g., whether to initiate refunds or inform the registrant when OFIS staff identifies an apparent error) and procedures (e.g., coordinate with IM and CF) should be revised.

FEES DUE AT THE TIME OF FILING

Legal Compliance

Our prior audit found that while the Commission required the fee to be paid at the time of filing for registration statements (6(b) filings), it did not require the fee to accompany the filing for other filing types. An account receivable would be established, if the fee did not accompany the filing, and the filing would be accepted.

We reported this practice as non-compliant with the applicable statutes. OGC concurred with our legal analysis. It recommended to the Commission that

"until appropriate legislation is adopted or rules changed, filing fees are required to be paid before or at the time a filing is made to the Commission."

In conjunction with EDGAR release 8.1 (January 2002), the Commission began requiring that the fee be paid at the time of filing for all filings. This action fully resolves this compliance issue.

Fees Reported As Owed

There are some filings whose fee is reported "as owed" (i.e., an account receivable) by Momentum. However, in most instances, a fee is not actually owed. We identified several reasons why fees were reported as being owed, but the statute was not violated.

• Some registrants submitted a 24F-2NT filing, but did not include interest. Interest was assessed because they did not submit the filing timely, based on the information provided in the header. According to IM staff, IM determined (based on its legal analysis) that the filings should be accepted and the interest subsequently collected.

• After a filing was accepted, the offering amount was adjusted. As a result, an account receivable was established if there were insufficient funds in the registrant's account.

• Some registrants did not provide its correct account number (the CIK number) on its payment to Mellon Bank. The filing fees were initially credited to the Unassigned Fee Account or another registrant's account. Later, staff performed an override in EDGAR before initiating a fee transfer, in Momentum, therefore an accounts receivable was established. During the audit, OFIS began requiring that the staff change the corrective actions taken and perform the fee transfer only and not override EDGAR. Once the fee transfer is performed and sufficient funds are in the registrant's account, on the next fee polling cycle EDGAR would release the filing for further processing and no accounts receivable would be established.

• Some registrants filed an amendment. Additional filing fees were not required, and the registrants never sent fee payments. However, the registrants incorrectly completed the fee information on the headers when filing the amendments. As a result, the filings were processed as if fees were due. However, upon reviewing the documents and realizing no fees were due, OFIS staff performed an override of EDGAR and released the filings for further processing. An accounts receivable was established when the staff overrode EDGAR because the fees due field was not modified.

• The amount of the filing fees calculated and paid differed by less than $1. EDGAR can waive amounts less than $1 only during pre-acceptance. If an override is performed, OFIS staff must manually waive the fee amount.

The accounts receivable in the sample we reviewed did not provide evidence that a filing was accepted without a fee in violation of applicable statues.

APPENDIX A

DESCRIPTION OF STATISTICAL SAMPLING

We decided to conduct a statistical sample of certain electronic filings (described below) because of the preliminary error rate (12.5%)⁸ that we found when we conducted our judgmental sample of 40 filings.

The Commission's Office of Economic Analysis (OEA) assisted us in determining the appropriate sample size and sampling methodology. We decided to use a confidence level of 95%. Our statistical sample consisted of electronic filings that were submitted from October 1, 2001 to January 31, 2002. We excluded paper filings because few were filed. Based on the number of electronic filings and our preliminary error rate, OEA suggested a sample size of 100 filings. Given our actual preliminary error rate of 10% confidence level, and sample size; the actual error rate is projected to be between five and sixteen percent.

From October 1, 2001 to January 31, 2002, 78% of the filing fees (according to Momentum)⁹ were from four form types. S-3, S-4, S-8, and 24F-2NT. According to EDGAR, 1,138 S-3's; 1,214 S-4's; 1,489 S-8's; and 3,203 24F-2NT's were filed electronically during this period. Based on the number of filings, we took a proportional number of S-3's, S-4's, etc. in order to obtain our sample of 100 filings.¹⁰ As a result, we selected sixteen S-3's; seventeen S-4's¹¹; twenty-one S-8's; and forty-six 24F-2NT's¹².

OEA provided us with random date and number lists to select our filings. We first selected S-3's, the S-4's, etc. When selecting the S-3's, we first used a random date list. We then used the random number list, to pick the specific filing on that date. For instance, if the random number was "7", we selected the "7^th" S-3 (as listed by EDGAR) filed on the date selected. If there were only six filings filed, we used the next number on the random number list until we obtained a number between one and six.

¹ For several years, the Commission also reported filing fee collection as a material weakness in its annual certification of management controls under the Federal Managers' Financial Integrity Act.

² The Commission has estimated that between $155 - $160 million in filing fees will either be refunded or credited to registrant accounts because of the changes in fee rates.

³ This funding formula was different prior to HR 1088; the Commission kept a percentage of each dollar from Offerings and T+3 filings until a ceiling was reached.

⁴ On May 8, 2002, the Commission adopted a rule that requires foreign registrants to also file electronically as of November 4, 2002.

⁵ In February 2002, OFIS was given the ability to correct this type of error directly.

⁶ Registrants may file an S-3 registration statement to register securities for a future offering. The 424 filings serve to notify the Commission and the public that some or all of those securities previously registered by the S-3 are now being offered. Currently, neither EDGAR, Momentum, nor Commission staff verify that the 424 filings do not exceed the shelf registration amount.

⁷ According to OFM, the Filer Support Two Branch received 116 fee payments totaling approximately $1.8 million from October 1, 2001 to January 31, 2002. This represents only about .6% of all fees received. In addition, the Commission has recently adopted a rule requiring foreign issuers to file electronically. Starting in November 2002, the fee payments related to foreign issuer filings will be made to the Mellon Bank, rather than to the Filer Support Two Branch.

⁸ After additional audit work, we determined that the error rate was actually 10%.

⁹ The dollar value of these filings will be reduced when the filings are calculated at the fee rate of $92 per million. HR 1088 established the fee rate retroactively to October 1, 2001.

¹⁰ We did not include S-3 amendments because there was no readily available method to determine how many of the amendments required an additional filing fee. They represented 11% of the filing fees.

¹¹ One S-4 was rejected (and replaced) because it was judgmentally selected in our sample of 40 filings.

¹² We rejected (and replaced) forty 24F-NT filings because the filing did not require a fee to be paid because the value of the redemption credits exceeded the aggregate sales price of securities sold.