DOCUhIENT RESUME

04809 - r B0245105 ] (gestricted)

Cash and Investment ganageaent of Department of DefenseNonappropriated Funds geed To Be Improved. FPCD-78-15; E-148581.

January 19, 1978. 19 pp. + 3 appendices (4 pp.).

Report to Rep. Jack Brooks, Chairman, House Committee on

Government Operations: Legislation and National Security

Subcommittee; by Elmer B. Staats, Comptroller General.

Issue Area: Personnel ianagement and Compensation (300).

Contact: Federal Personnel and Compensation Div.Budqet Function: Natioinal Defense: Defense-reLated Actiwitie3

(054); General G0o5vnment: Central Fiscal Operations (803) ;Interest: Ot1-r Interest (902).

Organization concerned. Department of Detiense; Department of theAir Force; Department of the Navy; Department cf the Army;Department of the Treasury.

Conqressional Relevance: House Committee on Govsrnmentoperations: Legisl!tion and National Security Subcommittee.Rep. J qck Brooks.

The Pepartmeat of Defense (LOD) supplements the cost ofmorale, welfare, and ,recreation (MWR) programs withnonappropriated funds.' These programs generate approximately $5bi'i.iion in receipts tach year uhich are managed by centraloffices in each military department. As of June 30, 1977,central tunds had inyvestments totaling approximately $813million. Findinqs/Conclusions: Several options were consideredfor involving the Trqausury in holding and inveeting the cash,the most loqical option being to transfer banking functions tothe Treasury and limit investments to Treasury obligations. Thispractice would be consistent with Federal fiscal and accountingpolicies and would have the most safeguards, but it would reduceinterest income and investment flexibility. Hanagement of NWRactiv.ties did not maximize the effectiveness of cash andinvestment functions, thus reducing interest earr.ings. whilemany central activities used some centralized banking, the Armyand Marine corps did, not. In central banking, receipts from manyactivities are pooled into one or a few banks, enabling centralmanaqement to inv:st ljAger amounts of funds. Deficiencies notedin investment management practices were: dtfe -^''toeralrequirements were no t.bging followed in all case -ae

Navy, and Navy Resale,.ysten Office had large percentages oftheir central invest~9qts concentrated in single banks orqaoqraphic areas; thgjAray borrowed approximately $14 million toinvest at a higqher rite of interest than allowed by DODinstructions; the Ary lacked specific investment objectives andpolicies; ard the Marine Corps lacked central control overrevenues. Recommendations: The Secretary of Defense should:direct the Army to a opt a centralized banking and accountingsystem to establish formalized objectives, goals, and proceduresfor cash flow management and to monitor its investment program;

direct the Army, Navy, and Marine Corps to comFly with DODrequirements for collateral; and direct the Marine Corps toadopt a centralized badninq and accounting system and considerincorporating these functions with the Navyts. (HTN)

.4- -,

A*moIt ·rl -. r Not to be relea.eode odlc o ,y , :'Wee except o. th e basis of h*ci GMMb the (te of Congressio Rebasisioa

REPORT OF THECOMPTR OLLER GENERALOF THE UNITED STATES

Cash And Investment ManagementOf Department Of DefenseNonappropriated FundsNeed To Be ImprovedDepartment of Defense morale, welfare, andrecreation activities generate about $5 billionin nonappropriated funds annually. At June30, 1977. they had invested $813 million,much of it in non-Government obligations.These funds were accounted for entirely out-side the jurisdiction of the Treasury Depart-ment, responsible for accounting and report-ing for most Federal Government fund3. Ifthese funds are deposited in the Treasuryand investments limited to Treasury obliga-tions, greater safeguards would be applied,risk of loss reduced, and the Treasury wouldhave information required for its manage-ment of cash resources and the public debt.

The Defense Department needs to improveimmediately its nonap2rcGpriated fund cashand investment management. The Armyshould adopt central banking, require propercollateral for its investments, refrain fromborrowing money to reinvest, and establishinvestment objectives. The Marine Corpsshould have central banking and investingand could share the Navy's systems. TheNavy also should require proper collateralfor its investments.

FPCD-78-15 JANUARY 19, 1978

COMPTROLLER GENERAL OF THE UNITED STATESWASIINGTON, D.C. UN

B-148581

The Honorable Jack Brooks, ChairmanSubcommittee on Lsegislation andNational Security

Committee on Government OperationsHouse of Representatives

Dear Mr. Chairman:

This report is in response to your April 26, 1977,request that we conduct an indepth review of the managementof military central. nonappropriated funds with particularattention to the investment practices and depository re-lationships of the funds. You also asked that we considerwhether the best interests of the Government would beserved if these funds were held by the Treasury and in-vested in Treasury securities.

As you requested we did not obtain written commentsfrom the Departments of Defense or the Treasury or diLcussour findings and recommendations with them.

This report contains a recommendation to the Secretaryof Defense. As you know section 236 of the Legislative Re-organization Act of 1970 requires the head of a Federalagency to submit a written statement on actions taken onour recommendations to the Senate Committee on GovernmentalAffairs and the House Committee on Government Operationsnot later than 60 days after the date of the report and tothe House and Senate Committees on Appropriations with theagency's first request for appropriations made more than60 days after the date of the report.

As arranged with your office, we plan no furtherdistribution of this report until it is released. At thattime we will send copies to the Department of Defense and

B-148581

other interested parties and make copies available toothers upon request. We will soon be in touch with youroffice to arrange for its rele,.se and to set in motion therequirements of section 236.

7 erely yo ,

Comptroller Generalof the United States

2

COMPTROLLER GENERAL'S CASH AND INVESTMENT MANAGEMENTREPORT TO THE SUBCOMMITTEE OF DEPARTMENT OF DEFENSEON LEGISLATION AND NONAPPROPRIATED FUNDSNATIONAL SECURITY NEED TO BE IMPROVEDCOMMITTEE ON GOVERNMENTOPERATIONSHOUSE OF REPRESENTATIVES

DIGEST

Department of Defense nonappropriated fundprograms generate approximately $5 billionin receipts each year by providing morale,welfare, and recreation services to militarypersonnel and their dependents. Central non-appropriated fund offices in each militarydepartment perform varying degrees of cashand investment management of funds. As ofJune 30, 1977, central funds had investmentstotaling approximately $813 million. Thesewere in certificates of account and deposit,insurance companies, savings accounts, andTreasury obligations.

At the request of the Chairman, House Govern-ment Operations Subcommittee on Legislationand National Security, GAO (1) consideredwhether the best interests of the Governmentwould be served if central nonappropriatedfunds were held by the Treasury and investedin Treasury securities and (2) evaluatedcentral cash and investment management bythe military services.

GAO identified four possible ways of involvingthe Treasury in holding and investing the cach:(1) transfer banking functions to the Treasurywith no nonappropriated fund investments, (2)transfer banking functions to the Treasuryand limit investments to Treasury obligations,(3) transfer banking functions to the Treasurywith investment authority retained by themorale, welfare, and recreation activities,and (4) no transfer of banking functions withinvestments limited to Treasury obligations.

Ur a', Up n nmovl. the rort i FPCD-78-15cover dshould be notd heon.

Implementing any of these options is possiblebecause the Treasury can establish the neCes-sary mechanism to handle the services' cash.(See p. 6.)

Transferring banking functions to the Treasuryand limiting investments to Treasury obliga-tions (option 2 above) appears to be the mostlogical option. It is consistent with Federalfiscal and accounting policies and proceduresand would provide greater cash management safe-guards and less risk on investment. However,it would also reduce interest income and in-vestment flexibility of the morale, welfare,and recreation activities. (See p. 8.)

Unless Defense can show that these disadvantageswould outweigh the advantages of option 2, theCongress should enact legislation directing thatthese funds be pu+ in the Treasury and specifyingwh.t the interest policy on such funds will be.Congressional actic . would be required in view ofDefense's longstanding position that morale,welfare, and recreat'on activities should managetheir own funds. (Se: p. 11.)

The morale, welfare, and recreation activitieswere not maximizing the effectiveness of theircentral cash and investment management func-tions, thereby reducing the interest earningssupporting their programs. While many centralactivities employed a form of centralizedbanking, the Army and Marine Corps did not.Central banking enhances both cash and invest-ment management. In central banking, receiptsfrom many activities are pooled into one or afew banks, enabling central management to in-vert larger amounts of funds. (See p. 12.)

For morale, welfare, and recreation activi-ties, improved performance and investmentearnings translate into a reduced need forfurther appropriated fund contribution andan increased ability to provide improvedquality and expansion of services. GAO noteda need for improved investment managementpractices by various central ronappropriatedfund activities.

ii

-- Defense collateral requirements were notbeing fcllowed in all cases, thus increas-ing the risk associated with these invest-ments.

--The Army, Navy, and Navy Resale SystemOffice had large percentages of their cen-tral investments concentrated in singlebanks or geographic areas.

-- The Army borrowed approximately $14 millionto invest at a higher rate of interestalthough Defense instructions prohibit thistype of activity.

-- The Army lacked specific investment objec-tives, policies, procedures, and documenta-tion of investment decisions.

-- The Marine Corps lacked a comprehensivecentral investment program, which resultedin a lack of central control over revenuesand reduced interest income. (See p. 18.)

Transfer of banking functions to the Treasurydepends on congressional action and wouldhave to be carried out over a long period oftime. However, the Department of Defenseneeds to improve immediately its cash andinvestment practices. Therefore, GAO isrecommending that the Secretary of Defensedirect:

--The Army to adopt a centralized bankingand accounting system similar to the AirForce's.

-- The Army to establish formalized objectives,goals, and procedures for cash flow manage-ment and to monitor its investment program.

-- The Army, Navy, and Marine Corps to complyimmediately with Defense requirements forcollateral.

-- The Marine Corps to adopt a centralizedbanking and accounting system and considerincorporating these functions with theNavy's. (See p. 19.)

IUllfShott iii

As requested by the Chairman, GAO did notobtain written comments from the Departmentsof Defense or the Treasury nor discuss itsfindings and recommendations with them.

iv

Contents

?PaeDIGEST i

CHAPTER

1 INTRODUCTION 1Background

1Central nonappropriated funds 2Scope of review 32 SHOULD THE TREASURY HOLD MILITARY CENTRALNONAPPROPRIATED FUNDS? 4Possile uses of the Treasury 4

Option 1--transfer banking func-tions with no investments 5Option 2--transfer banking func-

tions and limit investments toTreasury obligations 8Option 3--transfer banking func-

tions with investment authorityretained by MWR activities 9Option 4--no transfer of bankingfunctions with investmentslimited to Treasury obligations 9Conclusions 10

Recommendation 11

3 CASH AND INVESTMENT MANAGEMENT SHOULD BEIMPROVED

12The Army and Marine Corps shouldadopt the central bankirg concept 12Improved performance in investmentmanagement is needed 14

Requirements for collateral notmet

15Investments concentrated in fewbanks

115Army borrowed funds to increaseinvestment yield 16

Army investment guidelines arelimited

16Marine Corps needs a centralinvestment program 17Marine Corps could benefit bysharing Navy banking system 17Conclusions 18Recommendation

19

kPPENDIX Lage

I Letter of April 26, 1977, from theChairman, Subcommittee on Legislationand National S'curity, House Committeeon Government Oparations 20

II Department of Defense proposed cate-gories of MWR activities 21

TII Schedule of funds invested centrally bythe military services, June 30, 1977 23

ABBREVIATIONS

DOD Department of Defense

GAO General Accounting Office

MWR Morale, welfare, and recreation

CHAPTER 1

INTRODUCTIOi4

We reviewed the management of the military services'central nonappropriated funds in response to an April 26,1977, request from the Chairman of the Subcommittee onLegislation and National Security, House Committee onGovernment Operations. We were asked to note particularlythe investment practices and depository relationships ofthese funds. The Chairman also wanted our opinion onwhether the Government's interest would be better servedif these funds were required to be held by the TreasuryDepartment and invested in Treasury securities. The re-view centered on the receipt, disbursement, and invest-ment of cash and the feasibility and value of transferringcash functions to the Treasury.

BACKGROUND

Department of Defense (DOD) policy is to providemorale, welfare, and recreation (MWR) facilities from ap-propriated funds 1/ and to supplement t~le cost of estab-lishing and operating the programs with Itonappropriatedfunds. These programs are established to insure the mentaland physical well-being of military personnel and theirdependents. DOD estimates that about 12,700 activities(other than commissaries) carry out the programs, employingabout 206,000 people and realizing about $5 billion yearlyin sales.

Revenue producing activities such as exchanges, con-solidated package stores, and gas stations sell goods andservices and, except for in-kind support, 2/ operate withnonappropriated funds, Profits from these-activities are

1/Our previous report, Appropriated Fund Support forNonappropriated Fund and Related Activities in the De-partment of Defensew (FPCD-77-58), Aug. 31, 1977,indicates that the Government spends over $600 millioneach year to subsidize cLse activities (other thancommissaries).

2/In-kind support includes the free use of buildings,utilities, and services at installations. Costs arepaid by appropriated funds.

distributed under prescribed formulas to headquarters, com-mand, and installation support activities to provide other MWRprograms (such as bowling alleys, gymnasiums, tennis courts,golf courses, marinas, and horseback riding). Most of theseactivities charge fees and produce nonappropriated funds fortheir own support. Clubs, messes, and other membership as-sociations alno generate operating revenue from charges forgoods and services. Their goal is to break even or make asmall profit for capital improvements. A description ofcategories of MWR activities is included as appendix II.

Central nonappropriated funds

Nonappropriated funds are cash and other assets receivedby MWR activities from sources other than congressional appro-priations. They are Government funds not recorded in thebooks of the Treasurer of the United States and are used forthe benefit of military personnel, their dependents, andauthorized civilians who generate them.

Headquarters activities in the military services cen-trally manage most of the funds. Cash not needed immediatelyfor program use is invested by the headquarters activities.The amount invested at June 30, 1977, was $813 million. Alist of amounts invested by military service is included asappendix III.

Comman, and base activities retain or receive a percentof profits :rom revenue-producing activities or receiveloans, grants, and dividends from headquarters for operating,constructing, or renovating facilities for MWR. The commandand installation activities may invest their reserves andtemporarily excess cash locally or centrally through theheadquarters activities. Because cash and investments werecombined at installation level, we were unable to determinethe exact amount invested locally. A conservative estimatebased on activities' reports was $50 million at June 30,i977.

Resale and revenue-producing activities make dailydeposits in commercial banks, usually the commercial bank-ing facility on the installation. The money is then trans-ferred to the headquarters activities, which have agree-ments or contracts with several commercial banks to performbanking services for them.

2

SCOPE OF REVIEW

We reviewed policies, procedures, and practices followedby the military services to administer central nonappropriatedfund programs relating to MWR. As requested, we reviewed themanagement of these funds, paying particular attention to theinvestment practices and depository relationships. We per-formed our work at Army, Navy, Marine Corps, and Air Forceheadquarters, the Navy Resale System Office, and the Armyand Air Force Exchange Service.

As requested, we also performed work at the militaryservices' headquarters and the Treasury Department to seewhether the Government's interest would be better served ifthese funds were required to be held by the Treasury andinvested in Treasury securities. We also performed work atcommands and installations in Europe and Hawaii to determinetheir role in receiving money from and sending money to theheadquarters central funds.

We analyzed fund financial statements, accountingrecords, contracts and agreements with banks, and auditreports as they related to cash and investment activities.We also held discussions with responsible officials atmilitary headquarters, commands, and installations and atthe Treasury.

3

CHAPTER 2

SHOULD THE TREASURY HOLD

MILITARY CENTRAL NONAPPROPRIATED FUNDS?

Whether the Treasury should hold military central non-appropriated funds, whether it should have interest-free useof the funds, or whether the funds should be invested onlyin Treasury obligations are policy questions that should beanswered by the Congress. We have identified benefits anddisadvantages to the Government, the Treasury, and militaryMWR activities. We believe the Congress should specificallyprovide that the central nonappropriated funds be depositedin the Treasury as described in option 2 (p. 8).

POSSIBLE USES OF THE TREASURY

We identified four possible ways of involving theTreasury in holding and investing cash generated by DOD'sMWR activities: (1) transfer banking functions with no in-vestments (interest-free use of cash), (2) transfer bankingfunctions and limit investments to Treasury obligations,(3) transfer banking functions with investment authority re-tained by the MWR activities, and (4) no transfer of bankingfunctions with investments limited to Treasury obligations.

MWR activities (excluding commissaries) generate over$5 billion in revenue annually. This cash is used in normalbusiness operations or is accumulated for designated purposesand invested in certificates of deposit, certificates of ac-count, Treasury obligations, repurchase agreements, andother instruments. Central funds amounting to about $813million were invested as of June 30, 1977. A major portionof the $813 million was nonappropriated fund employee andemployer contributions for employee retirement benefit plans.These are usually forwarded to contractors managing 'hepolicies and plans.

Central fund activities contract for banking serviceswith a few major banks. The hundreds of MWR activitiesthroughout the world deposit cash receipts at approvedlocal banks, which transfer the cash to accounts in thecontracted banks. MWR activities write checks on the con-tracted banks for their cash disbursements. This processis referred to as central banking, and the accounts arecalled concentration accounts.

4

Cash in concentration accounts consists of minimumbalance requirements agreed to with the banks in additionto that required for current business transactions. Forexample, the Navy Resale System Office has agrements withthree concentration account banks to handle its receiptsand disbursements. On an average day these accounts havea gross balance of about $17 million. Slightly less thanhalf this amount represents funds that were credited to theaccount but uncollected by the bank. The remaining balanceis referred to as the collected or available balance. Eachbank requires the NLvy Resale System Office to maintain aminimum available balance in the account to offset bankcharges for servicing the account. The remaining availablebalance is invested in short-term certificates of depositby the Office's investment manager.

The central funds had about $31 million at June 3 e1977, in concentration accounts as minimum balances. _.eseconcentration accounts are collection points for depositsmade at several hundred local banks and transferred periodi-cally, usually daily. In addition to the minimum balancesat the central level, local activities have to maintainminimum balances at their banks to offset bank servicecharges.

Option 1--transfer banking functionswith no investments

Under this option all banking activity performed bycommercial banks would be transferred to the Treasury.The Treasury would serve as a concentration bank andwould assess service charges. No interest would be paidby the Treasury on these deposits, and MWR activitieswould not invest in either Treasury or commercial securi-ties.

The Treasury would benefit from having several hundredmillion dollars of nonappropriated funds presently in thecommercial sector. The precise amount would depend on howmany of these funds were included in this proposal. Itwould be a detriment to DOD's MWR activities, however,since they would lose interest income which partly fundsthe various MWR programs.

All funds would be transferred to the Treasury andheld until needed. Sources of such funds include salesrevenues, proceeds from maturing securities held at thetime of implementing this concept, compensating balances

S

now required by commercial concentration banks, and loanrepayments by MWR activities. For the retirement programs,a decision would have to be made whether to allow reinvest-ments or requice transfer of the money to the Treasury. Ifthese investments were maintained, the amount of money avail-able for Treasury use and the attendant benefit to the Gov-ernment would be substantially reduced.

Transfer is possible

Nonappropriated fund banking functions can be trans-ferred to the Treasury subject to some modifications toDOD and Treasury organization and operations.

The banking mechanism exists for local MWR activitiesto continue to deposit funds in local banks, which in turnwould transfer the funds through the Federal Reserve Systemto the Treasury. Treasury officials did not envision main-taining separate accounts fcr each of the thousands of MWRactivities, but rather one deposit fund with subaccountsfor each service. Each service would administer the de-tailed accounts by activity and centrally monitor individualtransactions. At the present time neither the Army norMarine Corps is set up to administer detailed accounts sincethey do not have central banking programs.

The Treasury also could obtain the capability to per-form the check payment and reconciliation services for MWRactivities. It has taken the position that it should bereimbursed for costs incurred for these services. TheTreasury also suggested that if it were to take over thesebanking functions, provision be made for legislation com-parable to that provided for the administration of SocialSecurity trust funds. Under the Social Security legisla-tion, the agency determines the administration cost thegeneral fund in the Treasury should pay and the part theagency should pay. The agency then certifies the amountsand authorizes and directs the Treasury to transfer theamounts.

Treasury benefits: interest-free use of funds

If the minimum balances for central fund bank ac-counts plus receipts from liquidation of all investmentswere transferred to the Treasury, it would have interest-free use of about $845 million. Otherwise it would haveto borrow from the public at a cost of about $51 milliona year assuming a 6-percent interest rate. In addition,

6

the Treasury would have interest-free use of additionalmillions of dollars--that part of the $5 billion in salesreceipts and other revenues in excess of current liabilitiesand on deposit in the Treasury.

MWR activities would reap some financial benefits inthat large minimum balances in concentration banks now main-tained by MWR activities would be free for other uses. Thiswould be partially offset, however, by Treasury servicecharges. This advantage would be far outweighed by the lossof interest income on investments accumulated by MWR activi-ties for employee retirement plans, self-insurance, severancepay, and other programs. This loss would have to be made upthrough other means such as improving operations, increasingfees to membership activities, increasing prices at exchangesand clubs, or receiving additional appropriated funds.

In several instances, DOD's MWR activities have con-tractual agreements with commercial banks for centralizedbanking services and insurance companies for employee re-tirement programs. Immediately transferring banking func-tions to the Treasury and canceling investments would re-quire breaking contractual agreements, which could resiltin penalties or losses. An alternative, whenever possible,would be to phase in transfers to the Treasury as the con-tracts terminate.

Effect on minority banks

Transfer of commercial banking functions and divestitureof commercial investments, including those in minority banks,could adversely affect minority banks. At June 30, 1977,Federal funds on deposit in minority banks totaled $99.8 mil-lion, of which $22.4 million (22 percent) was DOD nonappro-priated funds.

Transfer problems

If this option were to be implemented, we believe itshould be carried out over a relatively long term. Cur-rent investments should be allowed to mature before de-positing the proceeds in the Treasury, and contracts shouldbe allowed to end before transferring banking services.Also, Army and Marine Corps decentralized operations wouldhave to be centralized to deal with the Treasury, since theTreasury does not intend to deal directly with each MWRactivity.

7

Option 2--transfer banking functions andlimit investments to Treasury obligation:s

Under this option the Treasury would replace commercialbanks as the central depository for noncppropriated funds.MWR activities would be able to invest in Treasury obliga-tions and obtain interest income that could be applied to-ward funding MWR programs. However, the activities wouldnot receive the higher interest they are now receiving oncertificates of deposit and certificates of account.The primary benefit to the MWR activities may be the free-

ing up of the approximately $31 million in central fundcomnpensating balances now in commercial banks with no in-

terest. This money would be a one-time saving that couldbe applied to the MWR programs, but MWR activities wouldbear the cost of Treasury services.

Treasury benefits under this option would not be assignificant as under option 1. Although the Treasury wouldcontinue to use the nonappropriated funds deposited and in-

vested, the benefits would be offset by interest paymentsto the MWR activities. As under option 1, a determinationmust be made whether to transfer all funds to the Treasuryor to leave part, such as the retirement funds, invested incommercial sources.

Investment functions would remain with MWR activitieseven though investments would be restricted to Treasuryobligations. Invstment officers would continue to deter-

mine such factors as cash needs, amounts available for in-vestment, type of security, and desired maturity date.Treasury officials said they did not want to assume DODinvestment functions because they would not be in a posi-tion to know how much to invest.

Use of the Treasury as the central bank or depositorywould require all MWR activities to be centralized at the

service headquarters level. At that level the milit;aryservice could deal with the Treasury and maintain detailedsummary records of cash and investments for its subordi-nate activities.

We believe, however, that this option is preferablebecause it reduces the risk of loss and provides greatersafeguards if the funds are deposited with the Treasuryand invested in Treasury obligations. Moreover, an

overriding principle of Federal financial management isthat all funds, including trust funds, received and dis-

bursed by the Government as a result of its operations

8

shall be included in the Federal budget. We have con-sistently recommended to the Congress the inclusion of off-budget activities in the Federal budget. This concept wasemphasized by the President's Commission on Budget Conceptsin its October 10, 1967, report and has been accepted asan underlying concept of a sound financial plan for the Fed-eral Government. This gives the Treasury information re-quired for its management of cash resources and the publicdebt.

As a general rule only where the Congress has specifi-cally provided to the contrary are funds received by theGovernment as a result of its operations not included inthe Federal budget, not reported to the Treasury, and notdeposited and disbursed in accordance with Federal fiscaland accounting policies and procedures as prescribed bythe Office of Management and Budget, the Treasury, and GAO.In view of DOD's longstanding position that MWR activitiesshould manage their own funds, however, clarifying legisla-tion should be enacted, directing that these funds be putin the Treasury and specifying what the interest policy onsuch funds will be.

Option 3--transfer banking functionswith investment authorityretained by MWR activities

Under this option the Treasury would replace commercialconcentration banks. MWR activities, however, would retaininvestment management authority to invest in securities ap-proved by DOD. The primary benefit would be eliminatingseveral million dollars in compensating balanceL low re-quired by the commercial concentration banks. But, thecost of Treasury banking would be borne by the MWR activi-ties.

In any event the Treasury would get only limitedshort-term benefits on nonappropriated funds depositedwhile awaiting disbursement or investment. No apparentsignificant benefits would accrue to the Government byimplementing this option.

O2tion 4--no transfer of banking functionswith investments limitedto Treasury obligations

Under this option MWR activities would continue to usecommercial banks, but would be restricted to investing only

9

in Treasury obligations. Little advantage would accure tothe Government since the Treasury would obtain the use ofseveral hundred million dollars, but would have to pay in-terest on it as it would to any investor. MWR activities inthis instance simply replace private buyers of Treasurysecurities.

Restricting MWR activities investments to Treasurysecurities could adversely affect their rate of return oninvestment if Treasury yields should fall below commercialrates.

CCNCLUSIONS

Transferring banking functions to the Treasury andlimiting investments to Treasury obligations (option 2) ap-pears to be the most logical option and is consistent withFederal fiscal and accounting policies aid procedures.Transfer is possible since the Treasury can put the neces-sary mechanism in place to handle nonappropriated funds.In view of DOD's longstanding position that MWR activitiesshould control their own funds, however, clarifying legis-lation should be enacted, directing thit these funds be putin the Treasury and specifying what the interest policy onsuch funds will be. Also, the Army and Marine Corps wouldhave to centralize accoLnting. Any proposed transfer wouldhave to be carried out over a long period of time to avoiddisruptions, honor existing contracts, and give the Treasuryand DOD time to resolve the problems.

The Treasury under option 1 would benefit frominterest-free use of (1) the $813 million invested by MWRactivities (largely in certificates of deposit and account)and (2) operating funds between receipt and disbursement.Also, MWR activities would not need to maintain large com-pensating balances at commercial banks and could use thesefunds for MWR activities. They would incur Treasury servicecharges, however. The $813 million in investments consistslargely of trust funds for retirement programs and severancepay and reserves for self-insurance, construction, and ren-ovation purposes. This irteret-free use of funds, however,would deprive MWR trust fux.;s and activities of returns ontheir investments.

To maintain sound retirement programs and provide ade-quately for contingencies, the MWR activities would have toreplace the loss of interest income through some means or

10

reduce programs. If funds were invested in Treasury obliga-tions as in options 2 and 4, however, the Treasury would notbenefit from the use of most of the $813 million and MWRactivities would still lose income and investment flexibil-ity.

RECOMMENDATION

Unless Defense can show that these disadvantages wouldoutweigh the advantages of option 2, the Congress shouldenact legislation directing that these funds be put in theTreasury and specifying what the interest policy on suchfunds will be. Congressional action would be required inview of Defense's longstanding position that morale,welfare, and recreation activities should manage their ownfunds.

11

CHAPTER 3

CASH AND INVESTMENT MANAGEMENT

SHOULD BE IMPROVED

The military services have an immediate need to improvetheir cash and investment management. These improvementsshould not be delayed until congressional action on transferof banking functions and interest rates on nonappropriatedfund investments is taken. Cost reductions, better manage-merit, and greater efficiencies can be achieved through cen-tralized banking, investment, accounting, and other manage-ment improvements.

DOD nonappropriated fund policy, although providingguidance for cash and investment management, allows themilitary services latitude in implementing cash managementprocedures. As a result, each service manages cash dif-ferently. The Air Force and Navy manage cash centrallythrough headquarters, whereas the Army and Marine Corpsactivities manage cash at the installation and commandlevels. Unlike the other services, the Army has no speci-fic investment objectives, policies, or procedures. TheArmy and Navy concentrate large investments in a few banks andgeographic areas, and they did not require proper collateralon their investments. The Army, contrary to DOD instructions,commercially borrowed money and reinvested it at more de-sirable rates. The Marine Corps lacked a central invest-ment program and could benefit by sharing the Navy's cen-tral banking system.

THE ARMY AND MARINE CORPS SHOULDADOPT THE CENTRAL BANKING CONCEPT

The objective of a central or consolidated bankingprogram is to produce information that will allow programmanagers to control account balances and make timely in-vestments of cash resources. The headquarters activitiesmanaging the central nonappropriated funds generally enterinto agreements with a few large banks to obtain cash man-agement services. The MWR activities scattered throughoutthe world generally deposit cash daily at approved localbanks which transfer the money to the central account atthe contracted bank. Disbursements are made by writingchecks on the central bank.

12

Central banking permits writing checks on one account

with one minimum balance requirement. It also eliminatespassing cash through several activities and accounts before

"oming available for investment. The Army, as an example

decentralized banking, requires about 2J days each.month

collect money from local activities fo: employee contri-

butions for retirement and life and medical insurance. Ifcentral banking were used, these funds should be available

for investment a few days after being withheld from employeepays.

The Navy, Air Force, Army and Air Force Exchange Serv-

ice, and Navy Resale System Office use various forms of cen-

tral banking. Decentralized banking is used by the Army and

Marine Corps. The Air Force has an arrangement which pays

interest to each membership or revenue-producing activity

in the central banking program. Central banking, in conjunc-

tion with better contra.ts with commercial banks, could re-

sult in improvea control and increased income to the activi-

ties. For example, Army, Navy, and Marine Corps MWR activi-

_ies in Hawaii could increase their rates of return on

investments by approximately 2 percent if they operated underthe Air Force concept.

Air Force MWR activities do not have individual accountsin regular banks, but rather use the Air Force Central Wel-

fare Fund account in the local bank. Activities make deposits

through these accounts and electronically report them to the

Welfare Fund. Deposits not required to compensate localbanks for services rendered are subsequently transferred to

the concentration bank by electronic notification and deposi-tory transfer checks.

Anothec central system is used by the Navy ResaleSystem Office. It maintains three concentration bank ac-

counts through which all Navy exchange sales receipts are

deposited, disbursements made, and investments transacted.

Domestic retail activities deposit daily receipts in local

banks. Many activities prepare a transfer check in the

deposit amount and mail it to the concentration bank, a

process which results in delays of 2 to 15 days and which in

turn delays investments of the funds. Depository practices

of the other domestic exchanges provide for immediate credit

to the account of the Navy Resale System Office.

The Army and Marine Corps, in contrast, continue to

use the decentralized (or individual) bank account concept.

Funds idle under this concept could be available for use by

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a central fund manager. Under the Army concept for clubs,in the Central Investment Program, money is deposited in thelocal bank and an installation accounting unit does the ac-counting. If money is determined to be in excess of currentneeds, the accounting unit is notified by the fund custodianto draw a check on the local bank and mail it to Army head-quarters. Headquarters then deposits the check in its bankaccount. When sufficient funds have been accumulated, theinvestment officer in headquarters arranges to buy a security.Two to 3 weeks can pass from the date of initial deposit atthe local level to the date of investment.

Army officials said they wanted decentralized bankingto support the military banking facility program, and theydid not know whether central banking was any better. Theyrecently initiated plans to study central banking. MarineCorps officials believe local commanders know unit needsbest and should control local funds.

Central banking has its cost, most commonly paid bymaintaining compensating balances that earn no interest.Conversely, the cost of decentralized banking is the com-bined loss of interest at each installation from not in-vesting cash, delays in investing cash, or investing inlow-yield securities. Savings from central banking canmore than offset its costs. Timely investment of excessoperating funds at the best available rate is the mosteffective ways to keep the nonearning balance in theoperating accounts to a minimum.

IMPROVED PERFORMANCE ININVESTMENT MANAGEMENT IS NEEDED

DOD policy permits KWR activities to invest cash beingreserved for contingency purposes or used in normal businessoperations. Investments are limited to low-risk, short-termsecurities sold by the Treasury, commercial banks, creditunions, or savings and loan associations or insured by Fed-eral Government agencies. DOD's goal is to obtain maximumreturn on and protection of its investments.

An activity's invustment manager may operate throughone or more third parties (brokers or money managers) ormake investments directly. Because money markets are oftenvolatile, timing and knowledge of the market are importantin investing wisely. Procedures and controls are alsonecessary to assure sound investments and to avoid pref-erential investments.

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The services' central fund. activities differ to someextent in how they manage investments. In some cases wefound that collateral requirements were not met, large in-vestments were concentrated in a few banks or geographicareas, funds were inappropriately borrowed to invest at ahigher rate of interest, and limited investment guidanceexisted. Further, al. services except the Marine Cropshave a central investment program. We believe proceduralchanges are necessary to obtain maximum return and reducethe risk on the services' investments.

Requirements for collateral not met

DOD Instruction 7000.12 states that investments in banksavings accounts, time deposits, and certificates of depositare limited to the extent that they are insured by the Fed-eral Deposit Insurance Corporation or by pledge of collateralto the Treasury when they are not insured. 1/ In many casesthe investing activities made investments that were not in-su.'ed by the Federal Deposit Insurance Corporation or pro-tected by pledged collateral, thereby increasing the riskof loss.

In violation of DOD policy, the Navy follows a practiceof securing collateral after, rather than before, the invest-ment purchase. Further, a number of Navy investments (certif-icates of deposit) were not protected by the Federal DepositInsuLrance Corporation insurance or pledged collateral.

The Army required collateral for only one investmentin the past 2 years, but written notice of the collateralwas not received until after the security had matured. TheArmy relied on Fedveal Deposit Insurance Corporation insuranceto cover its investments. Many of its investments, however,were not covered by this insurance or by pledged collateral.Failure to require collateral could result in loss of fundsor lengthy delays in collection if a bank closes.

We could not readily determine whether the MarineCorps required appropriate collateral because its invest-ments are highly decentralized and little informationexists on them at Marine Corps headquarters.

1/DOD policy also provides that certificates of account atsavings and loan associations be insured by the FederalSavings and Loan Insurance Corporation.

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Investments concentratedin few banks

The Army and Navy had large percentages of their centralinvestments concentrated in single banks or geographic areas.At June 30, 1977, the Army had 48 percent of its investmentsin one bank, and the Navy had 42 percent of its certificatesof deposit (35 percent of its investments) in one bank. TheNavy Resale System Office had nearly all investments in NewYork City banks, indicating that banks outside the area maynot have been contacted for interest quotations. Concen-trating large amounts of investments in single banks couldhave an adverse effect on a bank in the event of quick lump-sum withdrawal by the military investor. Also, concentratinginvestments in one geographic area prohibits availability ofcompetitive rates outside the area.

Army borrowed funds toincrease investment yield

The Army commercially borrowed $10.8 million as ofJune 30, 1977, and increased the amount to $14.8 millionby August 1977 to finance purchases of certificates ofdeposit maturing over a longer period and earning morethan the cost of the borrowed funds. DOD instruction al-lows the investment of only excess funds and precludes thistype of activity. When we discussed this practice withArmy officials, they said they were taking steps to payback the borrowed funds and would not borrow again.

Army investment guidelinesa-e limited

The Army does not have specific investment objectives,policies, or procedures. Their absence permits poor in-vestment management and subjects Army officials to chargesof failure to exercise their trustee responsibility. AnArmy internal audit report noted similar deficiencies nearly4 years ago. Specific policies and objectives should beissued addressing such areas as investment composition,limitations or prohibitions regarding investment type ortechnique, conflicts of interest, expected return, port---lio review program, limitations on portfolio turnover,and limitations on the percentage of funds that may be in-vested in a particular security or group of securities.

In addition to not having specific objectives andpolicies, the Army has no record of what it does to assure

16

compliance with general regulations. We could thereforenot determine what the relationship of the investment of-ficer to patronized brokers and bankers was, how one invest-ment was selected over others, why funds were borrowed toreinvest, or why investment decisions were made.

Marine Corps needs a centralinvestment program

The Marine Corps is considerably more decentralizedthan the other services. MWR activities at each installa-tion are relatively independent of those at other installa-tions and Marine Corps headquarters. Recreation funds andconsolidated club systems invest revenue that is not con-sidered necessary for immediate needs in local accounts.No central investment program for these activities cur-rently exists; however, the Marine Corps exhange systemoffers its exchanges a voluntary central investment pro-gram.

To illustrate the need for a central investmentprogram, Marine Corps MWR activities in Hawaii had approxi-mately $2.6 million in local investments at an average re-turn of 5.6 percent at June 30, 1977. Other Pacific clubshad local investments drawing interests as low as 3.5 per-cent. If a central investment program were available, weestimate these activities could earn up to 7.5 percent(based on the Air Force current central investment programrate of return), or an additional $114,000 a year interestincome.

Marine Corps could benefit by sharingNavy banking system

The Marine Corps does not have a central banking sys-tem but could benefit by sharing the Navy system. MarineCorps headquarters, however, centrally invests assessmentsit collects from recreation and mess activities until theyare redistributed to MWR activities. Based on the bestavailable information, the Marine Corps could earn $3JU,000more each year under a central banking system.

The Navy can provide central banking, investment, andaccounting services to the Marine Corps recreation and messfunds. The Navy also noted that its central accountingunit already prepares some reports for the Marine Corps,and the Comptroller's office provides investment collateralservices. The Marine Corps is currently studying automatedaccounting, but using the Navy system would elimate dupli-cate systems.

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The Marine Corps officials stated that the Commandantbelieves all nonappropriated fund operations should be theresponsibility of the installation commanders and is op-posed to centralization. Since centralized banking in-volves money management and not program management, webelieve the Marine Corps could still function on a decen-tralized basis without reducing control. Centralizingwould relieve staff of administrative duties, however, suchas preparing financial statements, investing, and reconcil-ing bank statements. Each commander would still determinehow the funds are to be used. We believe the Marine Corpsalso should take advantage of the Navy banking system andshould not duplicate it.

CONCLUSIONS

The Army and Marine Corps can improve their cash andinvestment management by adopting a central banking con-cept similar to that used by the Air Force or Navy. Adopt-ing centralized banking should result in a greater returnon investment through more timely and efficient cash flow.The Marine Corps could realize a greater return on itsinvestments by establishing a central investment program.Also, the Marine Corps should seriously consider consolidat-ing its cash and investment functions with existing Navycentral operations.

By not requiring full collateral for their investmentsthe military services are not meeting their responsibilityto properly protect investments of nonappropriated fundsbelonging to the central funds and to MWR activities andtheir employees. This was perhaps the most serious short-coming in investment management and should be correctedimmediately. To improve its operations specifically re-lating to investing in one bank, borrowing funds, and fail-ing to require collateral for investments, the Army shouldestablish specific objectives, goals, and procedures forcash flow management and monitor its investment programmore closely to insure that prescribed procedures are fol-lowed.

These improvements should result in cost reductions,better management, and greater efficiencies. Therefore,action should be taken promptly, and the services shouldnot wait until action is taken to transfer banking func-tions to the Treasury and restrict investments to Treasuryobligations.

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RECOMMENDATION

We recommend that the Secretary of Defense direct

-- The Army to adopt a centralized banking andaccounting system similar to the Air Force's.

--The Army to establish formalized objectives, goals,and procedues for cash flow management and to moni-tor its investment program.

-- The Army, Navy, and Marine Corps to comply im-mediately with requirements for collateral setforth in DOD directives.

-- The Marine Corps to adopt a centralized banking,investment, and accounting system and considerincorporating these functions with the Navy's.

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APPENDIX I APPENDIX I

( PC-4152) -jo " .. ".r.=O n * -Ujm. _,4 As"LL.

nEa I. mv _lNAr. JoL rtcCuo. .WAI.

DL. LS. NINETY.FIFTH CONGRESSbLus" t. 9(1Erk. PA. _ , rI47

'-"-.-:. on". tyCm ess i the Wnittb otatesLEGISLATION AND NGNAL SECURITY SUCOI

LEGISLATION AND NATIONAL SECURITY SUICOMMITMEE

COMMITTEE ON GOVRNMENT OPERATIONS

RAVrSmN HOW OPICE BSWLDING. ROOM B.373wA.IlnTroN, D.C. 0s51s

April 26, 1977

Honorable Elmer B. StaatsComptroller General of the United StatesGeneral Accounting Office441 "G" Street, N.W.Washington, D. C. 2,548,

Dear M -

The revenues from nonappropriated fund activities ofthe military services are held in various central funds.These funds which now total several hundred nlill.on dollarsare managed by the individual services.

Please have the General Accounting Office conduct anindepth review of the management of these funds with par-ticular attention paid to the investment practices anddepository relationships of the funds. Included with thisreview should be a GAO opinion on whether or not theGovernment's interest would be better served if these fundswere required to be held by the Treasury Department andinvested in Treasury securities. Please provide this opin-ion as soon as GAO can give it rather than waiting for thereview to be completed. -

Please do not discuss your findings or recommendationswith any of the departments involved.

erely,

ack Brooks2Chairman

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APPENDIX II APPENDIX II

DEPARTMENT OF DEFENSE

PROPOSED CATEGORIES OF IWR ACTIVITIES

Category MWR activity

I Exchanges.

II Other resale and revenue-sharing activities--civilian employee restaurants and cafeterias,alcoholic packaged beverage stores, Stars andStripes newspapers, and resale audio clubs.

III Military general welfare and recreation,divided into the following subgroups.

IIIA--fund custodians at headquarters, majorcommands, and installation and unitlevels providing support to other MWRactivities.

IIIB--operating activities subdivided intothree groups according to their revenue-generating potential. Following areexamples.

IIIB-l--Lihraries, intramural sports,recreation centers/rooms, andfree admission movies at iso-lated posts and aboard ship.·These have little potentialfor generating revenue and areexpected to be primarilyappropriated-funded.

IIIB-2--Arts and crafts. entertainment.outdoor recreation, swimmingpools, youth activities, sportsabove intramural level, childcare centers, stables, marinas,and boating. These are consi-dered to have some potential toearn nonappropriated fund rev-enues.

IIIB-3--Bowling, golf, movies (paidadmission), tour, travel infor-mation, and ticket service,skating rinks, pro shops, amuse-ment machines, snack bars, skeetand trap ranges, Armed Forces

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APPENDIX II APPENDIX II

Category HWR activity (cont.)

recreation centers, cabins, andcottages. Operation of theseactivities is expected to beprimarily nonappropriated-funded.

IV Civilian employee general welfare and recrea-tion funds.

V Open messes.

VI Membership associations other than open messessuch as filing clubs, yachting clubs, motorcycleclubs. etc.

VII Common support services rendered to nonappro-priated fund instrumentalities. Pertains toconsolidated offices which give support suchas accounting, procurement, and personnel toseveral MWR activities. Does not includenormal staff management functions whose costsare chargeable to the benefiting category.

VIII Supplemental mission services. These are fundsthat are adjuncts to mission-oriented service.such as billeting, museums, and chaplains. Only-the costs of collecting, accounting for, anddisbursing nonappropriated funds are to be re-ported, not the cost of the entire function.

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APPENDIX III APPENDIX III

SCHEDULE OF FUNDS INVESTED CENTRALLY

BY THE MILITARY SERVICES

JUNE 30, 1977

Service (millions)

Army $101.8

Navy 109.4

Air Force 129.8

Marine Corps 16.5

Marine Corps Exchange 19.0

Army and Air Force Exchange Service 58.7

Navy Resale System Office 30.3

Total 465.5

Total retirement funds investedfor the services 347.7

Total all funds $813.2

(963067)

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