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1999 Annual Report
To the Board of Directors
We have audited the statements of financial position as of December 31, 1999 and 1998, for the three funds administered by the Federal Deposit Insurance Corporation (FDIC), the related statements of income and fund balance (accumulated deficit), and the statements of cash flows for the years then ended. In our audits of the Bank Insurance Fund (BIF), the Savings Association Insurance Fund (SAIF), and the FSLIC Resolution Fund (FRF), we found
The following sections discuss our conclusions in more detail. They also present information on (1) the scope of our audits, (2) a reportable condition1 related to information systems control noted during our 1999 audits, (3) the current status of the goodwill litigation cases, (4) the current status of FRFs liquidation activities, and (5) our evaluation of the Corporations comments on a draft of this report.
Opinion on Bank Insurance Funds Financial Statements
The financial statements and accompanying notes present fairly, in all material respects, in conformity with generally accepted accounting principles, the Bank Insurance Funds financial position as of December 31, 1999 and 1998, and the results of its operations and its cash flows for the years then ended.
Opinion on Savings Association Insurance Funds Financial Statements
The financial statements and accompanying notes present fairly, in all material respects, in conformity with generally accepted accounting principles, the Savings Association Insurance Funds financial position as of December 31, 1999 and 1998, and the results of its operations and its cash flows for the years then ended.
Opinion on FSLIC Resolution Funds Financial Statements
The financial statements and accompanying notes present fairly, in all material respects, in conformity with generally accepted accounting principles, the FSLIC Resolution Funds financial position as of December 31, 1999 and 1998, and the results of its operations and its cash flows for the years then ended.
As discussed in note 8 of FRFs financial statements, a contingency exists from approximately 100 lawsuits pending in the United States Court of Federal Claims concerning the counting of goodwill assets as part of regulatory capital. Based on information currently available, a reasonable estimate cannot be made regarding future losses and settlements related to these cases. Information on the current status of the goodwill cases is presented later in this report.
Opinion on Internal Control
Although certain internal controls should be improved, FDIC management maintained, in all material respects, effective internal control over financial reporting and compliance as of December 31, 1999, that provided reasonable assurance that misstatements, losses, or noncompliance, material in relation to the Corporations financial statements would be prevented or detected on a timely basis. FDIC management asserted that its internal control was effective based on criteria established under the Federal Managers Financial Integrity Act (FMFIA) of 1982. In making its assertion, FDIC management also fairly stated the need to improve certain internal controls.
Our work identified the need to improve information systems control, as described in a later section of this report. The weakness in information systems control, although not considered material, represents a significant deficiency in the design or operations of internal control that could adversely affect FDICs ability to meet its internal control objectives as described later in this report. Although the weakness did not materially affect the 1999 financial statements, misstatements may nevertheless occur in other FDIC-reported financial information as a result of the internal control weakness.
Compliance With Laws and Regulations
Our tests for compliance with selected provisions of laws and regulations disclosed no instances of noncompliance that would be reportable under generally accepted government auditing standards. However, the objective of our audits was not to provide an opinion on overall compliance with laws and regulations. Accordingly, we do not express such an opinion.
Objectives, Scope, and Methodology
FDICs management is responsible for
We are responsible for obtaining reasonable assurance about whether (1) the financial statements are presented fairly, in all material respects, in conformity with generally accepted accounting principles; and (2) management maintained effective internal control, the objectives of which are
We are also responsible for testing compliance with selected provisions of laws and regulations that have a direct and material effect on the financial statements and for performing limited procedures with respect to certain other information appearing in FDICs 1999 Annual Report and 1999 Chief Financial Officers Act Report.
In order to fulfill these responsibilities, we
We did not evaluate all internal controls relevant to operating objectives as broadly defined by FMFIA, such as those controls relevant to preparing statistical reports and ensuring efficient operations. We limited our internal control testing to controls over financial reporting and compliance. Because of inherent limitations in internal control, misstatements due to error or fraud, losses, or noncompliance may nevertheless occur and not be detected. We also caution that projecting our evaluation to future periods is subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with controls may deteriorate.
We did not test compliance with all laws and regulations applicable to FDIC. We limited our tests of compliance to those which we deemed applicable to the financial statements for the year ended December 31, 1999. We caution that noncompliance may occur and not be detected by these tests and that such testing may not be sufficient for other purposes.
We conducted our audits from July 1999 through May 2000. We did our work in accordance with generally accepted government auditing standards.
FDIC provided comments on a draft of this report. FDICs comments are discussed and evaluated in a later section of this report.
As part of the financial statement audits, we reviewed FDICs information systems (IS) general controls. The primary objectives of IS general controls are to safeguard data, protect computer application programs, prevent system software from unauthorized access, and ensure continued computer operations in case of unexpected interruption. IS general controls include corporatewide security program planning and management, access controls, system software, application software development and change controls, segregation of duties, and service continuity controls. The effectiveness of application controls2 is dependent on the effectiveness of general controls. Both IS general controls and application controls must be effective to help ensure the reliability, appropriate confidentiality, and availability of critical automated information.
In performing our tests, we found FDICs IS general controls to be ineffective. We identified weaknesses in FDICs corporatewide security program, access controls, segregation of duties, and service continuity. The weaknesses in IS general controls significantly impair the effectiveness of FDICs application controls, including financial systems. We considered the effect of the information system control weaknesses and determined that other management controls mitigated their effect on the financial statements. FDIC recognizes the significance of the IS general control issues and has begun planning and initiating corrective actions. Because of their sensitive nature, the details surrounding these weaknesses and vulnerabilities are being communicated to FDIC management, along with our recommendations for corrective action, through separate correspondence.
In addition to these weaknesses, we identified less significant matters involving FDICs system of internal accounting control that we will be reporting in a separate correspondence to FDIC management.
Current Status of the Goodwill Litigation Cases
As discussed in note 8 of FRFs financial statements, a contingency exists from the goodwill-related lawsuits against the United States government pending in the United States Court of Federal Claims. These lawsuits assert that certain agreements were breached when Congress enacted, and the Office of Thrift Supervision implemented, the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which affected the thrift industry. The legislation changed the computation for regulatory capital requirements, thereby eliminating the special accounting treatment previously allowed for goodwill assets acquired when institutions merged with or acquired failing thrifts. The changes in regulatory treatment of goodwill assets caused some institutions to fall out of capital compliance. In such cases, institutions had to take action to meet capital requirements or they were subject to regulatory action.
On July 1, 1996, the United States Supreme Court concluded that the government is liable for damages in three cases, consolidated for appeal to the Supreme Court, in which the changes in regulatory treatment required by FIRREA led the government to not honor its contractual obligations related to the accounting treatment of goodwill assets. The cases were then referred back to the Court of Federal Claims for trials to determine the amount of damages. On July 23, 1998, the Department of the Treasury determined, based on an opinion of the Department of Justice, that FRF is legally available to satisfy all judgments and settlements in the goodwill litigation involving supervisory action or assistance agreements, in which the former Federal Savings and Loan Insurance Corporation (FSLIC) was a party to those agreements. Treasury further determined that FRF is the appropriate source of funds for payment of any such judgments and settlements.
During 1999, damage awards in three significant goodwill-related cases were decided. On April 9, 1999, the Court of Federal Claims ruled that the federal government must pay Glendale Federal Bank $908.9 million for breaching the contract that allowed the thrift to count goodwill toward regulatory capital. The plaintiffs were seeking up to $2 billion in damages. On April 16, 1999, the Court of Federal Claims awarded $23 million in damages to California Federal Bank, which had been seeking more than $1 billion in damages. On September 30, 1999, the Court of Federal Claims awarded approximately $5 million to LaSalle Talman Bank, which had been seeking more than $1.2 billion in damages. All parties in these cases have appealed. Subsequent to December 31, 1999, the Court of Federal Claims awarded $21.5 million to Landmark Land Company, which had been seeking approximately $750 million in damages in its supervisory goodwill case against the government. All parties in the Landmark Land case have appealed.
Because of the appeals and differences in awarding damages in the cases thus far, the final outcome in the cases and the amount of any possible damages remain uncertain. With regard to the approximately 100 remaining cases at the trial court level, the outcome of each case and the amount of any possible damages remain uncertain. However, FDIC has concluded that it is probable that FRF will be required to pay additional, possibly substantial, amounts as a result of future judgments and settlements. Because of the uncertainties surrounding the cases, such losses are currently not estimable.
Current Status of FRFs Liquidation Activities
FDIC, as administrator of FRF, is responsible for liquidating the assets and liabilities of the former Resolution Trust Corporation (RTC),3 as well as the former FSLICs assets and liabilities. FDIC continues to make significant progress in liquidating FRFs assets. As of December 31, 1999, FRF held total assets valued at $7.0 billion. Of that total, $2.9 billion was held in cash and cash equivalents, with $4.1 billion in assets remaining to be liquidated. These asset levels represent a significant decrease from the prior year, as shown in table 1.
The RTC Completion Act required the FDIC to return to the U.S. Treasury any funds that were transferred to the RTC pursuant to the RTC Completion Act but not needed by RTC. The RTC Completion Act made available $18.3 billion of additional funding. Prior to RTCs termination on December 31, 1995, RTC drew down $4.6 billion of the $18.3 billion made available by the RTC Completion Act. During 1999, FDIC returned $4.2 billion to the U.S. Treasury. Subsequent to December 31, 1999, FDIC made approximately $400 million in payments to the U.S. Treasury, so that as of February 3, 2000, the full amount of the appropriation transferred to RTC pursuant to the RTC Completion Act had been repaid.
After providing for all outstanding RTC liabilities, FDIC must transfer the net proceeds from the sale of RTC-related assets to the Resolution Funding Corporation (REFCORP). Any funds transferred to REFCORP are used to pay the interest on REFCORP bonds issued to provide funding for the early RTC resolutions. On April 10, 2000, FDIC transferred $533 million to REFCORP. The payments to REFCORP benefit the U.S. Treasury, which is otherwise obligated to pay the interest on the bonds. The final amount of unused funds available for transfer to REFCORP will not be known with certainty until all of FRFs remaining assets and liabilities are liquidated.
Funds available in FRF-FSLIC will be used to pay future liabilities of the FRF-FSLIC, including the contingency related to the goodwill litigation cases. Because additional and possibly substantial amounts could be paid out of FRF-FSLIC for the goodwill cases, FRF has been provided with an indefinite permanent appropriation for the payment of judgments and settlements in the goodwill litigation.
Corporation Comments and Our Evaluation
In commenting on a draft of this report, FDIC acknowledged the IS control weaknesses, and stated a commitment to implementing a strong IS security program for the FDIC and fostering an environment that makes all employees aware of their security responsibilities. We plan to evaluate the effectiveness of FDICs corrective actions in IS security as part of our audits of FDICs 2000 financial statements.
FDIC also stated that it will continue to monitor the other matters discussed in our report, including the status of the goodwill litigation cases and FRFs liquidation activities. We also plan to monitor these issues as a part of our 2000 audits.
David M. Walker
May 5, 2000
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