82 FR 20555 - Bonding Requirements for Recipients

LEGAL SERVICES CORPORATION

Federal Register Volume 82, Issue 84 (May 3, 2017)

This proposed rule would revise the Legal Services Corporation's (LSC or Corporation) regulation about bonding requirements for LSC recipients. It would require recipients to bond all their employees and to ensure that third parties who handle recipients' funds have bond coverage, allow recipients to use other forms of insurance similar to fidelity bonds, raise the minimum level of coverage, and allow recipients to use LSC funds to pay for bonding costs. This proposed rule will update part 1629 to reflect current insurance practices and simplify the language in the rule to reduce confusion.

[Federal Register Volume 82, Number 84 (Wednesday, May 3, 2017)]
[Proposed Rules]
[Pages 20555-20558]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2017-08857]


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LEGAL SERVICES CORPORATION

45 CFR Part 1629


Bonding Requirements for Recipients

AGENCY: Legal Services Corporation.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This proposed rule would revise the Legal Services 
Corporation's (LSC or Corporation) regulation about bonding 
requirements for LSC

[[Page 20556]]

recipients. It would require recipients to bond all their employees and 
to ensure that third parties who handle recipients' funds have bond 
coverage, allow recipients to use other forms of insurance similar to 
fidelity bonds, raise the minimum level of coverage, and allow 
recipients to use LSC funds to pay for bonding costs. This proposed 
rule will update part 1629 to reflect current insurance practices and 
simplify the language in the rule to reduce confusion.

DATES: Comments must be received by June 2, 2017.

ADDRESSES: You may submit comments by any of the following methods:
     Federal Rulemaking Portal: Follow the instructions for 
submitting comments.
     Email: [email protected]. Include ``Part 1629 
Rulemaking'' in the subject line of the message.
     Fax: (202) 337-6519.
     Mail: Stefanie K. Davis, Assistant General Counsel, Legal 
Services Corporation, 3333 K Street NW., Washington, DC 20007, ATTN: 
Part 1629 Rulemaking.
     Hand Delivery/Courier: Stefanie K. Davis, Assistant 
General Counsel, Legal Services Corporation, 3333 K Street NW., 
Washington, DC 20007, ATTN: Part 1629 Rulemaking.
     Instructions: LSC prefers electronic submissions via email 
with attachments in Acrobat PDF format. LSC will not consider written 
comments sent to any other address or received after the end of the 
comment period.

FOR FURTHER INFORMATION CONTACT: Stefanie K. Davis, Assistant General 
Counsel, Legal Services Corporation, 3333 K Street NW., Washington, DC 
20007; (202) 295-1563 (phone), (202) 337-6519 (fax), or [email protected].

SUPPLEMENTARY INFORMATION:

I. Regulatory Background

    LSC created part 1629 in 1984 after several instances in which 
recipients lost LSC funds through the dishonest behavior of persons 
associated with the recipient. 49 FR 28717, July 16, 1984. While the 
recipient recovered the funds in some cases, in others, the recipient 
had to absorb the loss. Id.
    Before enacting part 1629, LSC recommended that recipients have 
fidelity coverage as a basic internal control. See LSC Audit and 
Accounting Guide for Recipients and Auditors, revised June 1977, p. 3-
3. LSC intended part 1629 to ``make mandatory [this] important 
protection for the limited funds available to serve eligible clients.'' 
49 FR 23396, June 6, 1984. LSC originally proposed requiring programs 
to obtain fidelity bond coverage at a minimum level equal to 25% of the 
recipient's annualized LSC funding. Id. Based on comments received in 
response to the proposed rule, LSC decreased the required coverage 
level to 10%. 49 FR 28717, July 16, 1984. LSC also set a $50,000 
minimum coverage level ``in response to the recognition that a loss to 
a small program is proportionally greater in effect than a similar one 
to a large program.'' Id.
    LSC added rulemaking on part 1629 to its annual rulemaking agenda 
in April 2016. Regulatory action is justified for three reasons. First, 
the regulation is outdated. LSC has not revised part 1629 since it was 
adopted in 1984, and LSC should update it to reflect current insurance 
practices.
    Second, the regulation was derived from a source that does not 
provide the optimal model for a federally funded grant-making entity 
today. The original rule was based on fidelity bonding provisions found 
in the Employee Retirement Income Security Act of 1974 (ERISA). See 
Section 412 of Public Law 93-406, and related regulations at 29 CFR 
2550.412-1 and 29 CFR part 2580. ERISA concerns minimum standards for 
retirement plans in private industry. LSC no longer believes that this 
is an appropriate model for LSC to follow, and that instead LSC should 
look to current regulations governing similar grant-making entities and 
to reflect current insurance practices.
    Third, the current regulation is in some respects unclear or 
ambiguous. LSC has received requests for guidance on how to interpret 
certain provisions in part 1629, particularly those sections about the 
form and extent of coverage required by the rule. LSC does not believe 
that the language in part 1629 provides sufficiently clear guidance to 
LSC recipients or to LSC staff. LSC proposes crafting an approach that 
is tailored to LSC's needs and that simplifies the language in the rule 
to reduce confusion.
    On October 17, 2016, the Operations and Regulations Committee 
(Committee) of LSC's Board of Directors (Board) voted to recommend that 
the Board authorize rulemaking on part 1629. On October 19, 2016, the 
Board authorized LSC to begin rulemaking. On April 23, 2017, the 
Committee voted to recommend that the Board approve publication of this 
NPRM in the Federal Register for notice and public comment. On April 
24, 2017, the Board accepted the Committee's recommendation and voted 
to approve publication of this NPRM with a 30-day comment period.

II. Discussion of the Proposed Changes

Section 1629.1 Purpose

    LSC proposes to add a purpose section stating who must be covered 
under the bond and what losses the bond must protect against. Part 1629 
currently does not have a purpose section.

Section 1629.2 Definitions

    LSC proposes to define annualized funding level to include the 
amount of the Basic Field Grant and special purpose grant funds a 
recipient receives annually from LSC. LSC believes it is necessary to 
include ``special purpose grants'' of LSC funds, such as Technology 
Initiative Grants, Pro Bono Innovation Fund grants, and emergency 
relief grants, in the definition of ``annualized funding level'' to 
ensure that the maximum amount of LSC funds are protected.

Section 1629.3 Who must be bonded?

    LSC currently requires recipients to bond ``[e]very director, 
officer, employee and agent of a program who handles funds or property 
of the program . . . .'' 45 CFR 1629.2(a) (emphasis added). LSC 
considers the term ``handles'' to include access to funds or other 
recipient property or ``decision-making powers with respect to funds or 
property which can give rise to [] risk of loss.'' Id. Through a review 
of recipient insurance policies, LSC has found that most grantees have 
fidelity coverage for all their employees. This common practice exceeds 
the current minimum requirements of part 1629. When employees who were 
not required to be bonded under part 1629 have misappropriated LSC 
funds, grantees that exceeded the minimum part 1629 coverage have 
typically been protected from loss. LSC believes this common practice 
is desirable and proposes to require that recipients carry coverage for 
all employees, regardless of whether the employees ``handle'' program 
funds.
    LSC currently requires grantees to bond ``agents'' who handle funds 
or property of the program. 45 CFR 1629.2(a). But LSC has found that 
most recipients' policies do not cover the dishonest or fraudulent 
actions of agents and independent contractors. In fact, many policies 
explicitly exclude agents and independent contractors from the 
definition of ``covered employee.'' This exclusion is problematic, as 
LSC recipients often turn to third parties to handle payroll functions. 
See Legal Services Corporation Board of Directors, Operations and 
Regulations Committee, Transcript of Rulemaking Workshop, Wednesday, 
May 18, 2016, pp. 82-84

[[Page 20557]]

(comments of Diana White). This means that LSC funds are handled by 
persons outside of the recipient's control and insurance coverage. In 
areas where there are few insurers to choose from, it may be impossible 
for recipients to get insurance that covers ``agents'' or ``independent 
contractors.''
    To address these issues and adequately protect LSC funds from 
misappropriation by recipients and third parties, LSC proposes three 
changes to the existing rule. First, LSC proposes to require that 
recipients' bonds cover volunteers, in addition to directors, officers, 
employees, and agents of the recipient. Second, LSC proposes to require 
that recipients ensure that third parties who provide payroll, billing, 
and collection services to the recipient have fidelity bond coverage or 
similar insurance. The recipient may accomplish this either by 
extending its own insurance to the third party or by ensuring that the 
third party has its own fidelity bond coverage sufficient to protect 
LSC funds in the third party's hands. Finally, LSC proposes to include 
language allowing recipients to either cover subrecipients through 
their own fidelity policies or ensure that the subrecipients have 
policies adequate to protect subgranted funds.

Section 1629.4 What forms of bonds can recipients use?

    Current Sec.  1629.5 allows recipients to choose different forms of 
bonds, such as individual, blanket, or schedule. 45 CFR 1629.5. Section 
1629.5 currently does not address whether recipients may choose types 
of insurance other than a fidelity bond that achieve the same purpose 
as a fidelity bond. Most LSC recipients now protect against employee 
dishonesty through riders to their standard commercial crime policies. 
Few grantees obtain separate fidelity bonds.
    In 1999, LSC issued an external opinion permitting recipients to 
use employee dishonesty insurance to satisfy the bonding requirements 
of part 1629 if the recipient could show that the policy gives the same 
level of protection as a fidelity bond. See External Opinion 1999-10-
26, part 1629 Purchase of Employee Dishonesty Insurance in Lieu of a 
Fidelity Bond (October 26, 1999). To reflect this long-standing LSC 
policy, LSC proposes revising part 1629 to expressly allow recipients 
to substitute employee dishonesty policies or other methods of coverage 
for fidelity bonds. This revision gives recipients greater flexibility 
to choose the most readily available and cost-effective methods of 
insuring LSC funds. The revision also will make clear that the 
substance and amount of coverage is more important than the form.

Section 1629.5 What losses must the bond cover?

    Current Sec.  1629.4 requires recipients to have bonds that protect 
them against ``all those risks of loss that might arise through 
dishonest or fraudulent acts in the handling of funds [.]'' The strict 
language--``all those risks of loss''--implies that recipients must be 
completely covered in the event of a loss, and that policies with 
deductibles would not be acceptable under current part 1629. That is 
because if a recipient has LSC funds stolen, and the policy requires 
the recipient to absorb a portion of that loss by paying a deductible, 
then the recipient's policy did not cover against ``all those risks of 
loss.'' Such strict language makes sense under ERISA statutes and 
regulations, as they are designed to protect retirees' pension funds. 
But such language may prevent recipients from obtaining policies that 
will protect LSC funds adequately if policies without deductibles are 
prohibitively expensive.
    LSC proposes to simplify the language about the types of losses 
that the bond must cover and to revise the rule to allow recipients to 
purchase policies that require payment of deductibles. LSC proposes 
revising the definition to state simply that the ``bond must provide 
recovery for loss caused by such acts as: Fraud, dishonesty, larceny, 
theft, embezzlement, forgery, misappropriation, wrongful abstraction, 
wrongful conversion, willful misapplication, or any other fraudulent or 
dishonest act committed by an employee, officer, director, agent, or 
volunteer.''

Section 1629.6 What is the required minimum level of coverage?

    Under the existing rule, recipients must maintain bond coverage 
equal to at least 10% of the recipient's annualized LSC funding or of 
the initial grant if the program is a new grantee. 45 CFR 1629.1(a). 
The minimum level of coverage may never be less than $50,000. Id. LSC 
proposes to increase the minimum coverage level, which has remained 
unchanged since 1984. Based on a sampling of current recipients' 
policies, the majority of recipients already exceed the $50,000 minimum 
level of coverage. In fact, most policies provided coverage in excess 
of $100,000. Because the common practice among recipients already is to 
insure recipient funds above the minimum amount required by current 
Sec.  1629.1(a), LSC believes it is reasonable for LSC to raise the 
minimum coverage level to $100,000. LSC does not propose to change the 
minimum percentage for coverage.

Section 1629.7 May LSC funds be used to cover bonding costs?

    Part 1629 currently is silent as to which costs associated with 
fidelity bond coverage--deductibles, premiums, rates, and single loss 
retention--are allowable using LSC funds. To improve clarity on this 
point, LSC proposes to allow recipients to use LSC funds to pay for the 
costs of bonding under this part if they are (1) consistent with 45 CFR 
part 1630, (2) in accordance with sound business practice, and (3) 
reasonable. This proposed rule is based on the Uniform Guidance, which 
allows for such costs. See 2 CFR 200.427.
    LSC considered limiting the amount of deductibles that LSC would 
consider reasonable in the proposed rule. During the process of 
drafting this proposed rule, LSC examined a sample of recipients' 
current fidelity bonds and found that most of those recipients' 
policies have deductibles ranging from $1,000 to $5,000. LSC could not 
determine, based on research of external sources, whether there are 
current best practices in the nonprofit insurance world that would help 
LSC establish a reasonable limit on deductibles. LSC determined that it 
would need more data to set deductible limits and has therefore chosen 
to allow recipients the flexibility to consider the losses they are 
willing to absorb when deciding the appropriate deductibles.

List of Subjects in 45 CFR Part 1629

    Fidelity bond, Grant programs--law, Insurance, Legal services, 
Surety bonds.

0
For the reasons set forth in the preamble, the Legal Services 
Corporation proposes to revise 45 CFR part 1629 as follows:

PART 1629--BONDING REQUIREMENTS FOR RECIPIENTS

Sec.
1629.1 Purpose.
1629.2 Definitions.
1629.3 Who must be bonded?
1629.4 What forms of bonds can recipients use?
1629.5 What losses must the bond cover?
1629.6 What is the required minimum level of coverage?
1629.7 Can LSC funds be used to cover bonding costs?

    Authority: 42 U.S.C. 2996e(1)(A) and 2996f(3).


Sec.  1629.1  Purpose.

    This part is intended to protect LSC funds by requiring that 
recipients be

[[Page 20558]]

bonded or have similar insurance coverage to indemnify recipients 
against losses resulting from fraudulent or dishonest acts committed by 
one or more employees, officers, directors, agents, volunteers, and 
third-party contractors who handle LSC funds.


Sec.  1629.2  Definitions.

    Annualized funding level means the amount of:

(1) Basic Field Grant funds (including Agricultural Worker and Native 
American) and
(2) Special grants of LSC funds, including Technology Initiative 
Grants, Pro Bono Innovation Fund grants, and emergency relief grants, 
awarded by LSC to the recipient for the fiscal year included in the 
recipient's annual audited financial statements.


Sec.  1629.3  Who must be bonded?

    (a) A recipient must supply fidelity bond coverage for all 
employees, officers, directors, agents, and volunteers.
    (b) If a recipient uses a third party for payroll, billing, or 
collection services, the recipient must either supply coverage covering 
the third party or ensure that the third party has a fidelity bond or 
similar insurance coverage.
    (c) For recipients with subgrants:
    (1) The recipient must extend its fidelity bond coverage to supply 
identical coverage to the subrecipient and the subrecipient's 
directors, officers, employees, agents, and volunteers to the extent 
required to comply with this Part; or
    (2) The subrecipient must supply proof of its own fidelity bond 
coverage that meets the requirements of this Part for the 
subrecipient's directors, officers, employees, agents, and volunteers.


Sec.  1629.4  What forms of bonds can recipients use?

    (a) A recipient may use any form of bond, such as individual, name 
schedule, position schedule, blanket, or any combination of such forms 
of bonds, as long as the type or combination of bonds secured 
adequately protects LSC funds.
    (b) A recipient may use similar forms of insurance that essentially 
fulfill the same purpose as a fidelity bond.


Sec.  1629.5  What losses must the bond cover?

    The bond must provide recovery for loss caused by such acts as 
fraud, dishonesty, larceny, theft, embezzlement, forgery, 
misappropriation, wrongful abstraction, wrongful conversion, willful 
misapplication, or any other fraudulent or dishonest act committed by 
an employee, officer, director, agent, or volunteer.


Sec.  1629.6  What is the required minimum level of coverage?

    (a) A recipient must carry fidelity bond coverage or similar 
coverage at a minimum level of at least ten percent of its annualized 
funding level for the previous fiscal year.
    (b) If a recipient is a new recipient, the coverage must be at a 
minimum level of at least ten percent of the initial grant.
    (c) Notwithstanding paragraphs (a) and (b) of this section, 
recipients must not carry coverage under this part at a level less than 
$100,000.


Sec.  1629.7  Can LSC funds be used to cover bonding costs?

    Costs of bonding required by this part are allowable if expended 
consistent with 45 CFR part 1630. Costs of bonding such as rates, 
deductibles, single loss retention, and premiums, are allowable as an 
indirect cost if such bonding is in accordance with sound business 
practice and is reasonable.

    Dated: April 27, 2017.
Stefanie K. Davis,
Assistant General Counsel.
[FR Doc. 2017-08857 Filed 5-2-17; 8:45 am]
 BILLING CODE 7050-01-P