Report 2005-123 Summary - January 2007
Department of Corporations:
It Needs Stronger Oversight of Its Operations and More Efficient Processing of License Applications and Complaints
Our review of the Department of Corporations' (Corporations) operations revealed the following:
- Corporations' current fee structure results in certain licensees subsidizing the administrative costs for others. For example, revenues from securities fees have exceeded the related service costs by $22.2 million over the last seven years.
- Corporations has taken important steps in strategic planning for its operations, however, these efforts are undercut by inaccurate statistical information about its actual performance as reported in its monthly and quarterly performance reports.
- Corporations does not always process applications within the time limits set by state law. In fact, for applications submitted between January 2004 and May 2006, the average processing time exceeded the time allowed by law for many of the application types we reviewed.
- Although there is no legal requirement dictating the length of time Corporations has to resolve complaints, we found examples of unneccessary delays in a sample of complaints we reviewed.
- Corporations has three primary information systems for capturing complaint related data; however, none of them are reliable for determining the number, type, and status of its complaints because the systems contain too many blank fields, duplicate records, and errors.
- Corporations did not conduct required examinations of at least 170 licensed escrow offices and 899 licensed finance lenders within its four-year goal.
RESULTS IN BRIEF
The Department of Corporations (Corporations), within the Business, Transportation and Housing Agency, is responsible for licensing and regulating the securities and financial services industries, including businesses such as securities brokers and dealers, investment and financial planners, and certain fiduciaries and lenders. As part of these responsibilities, Corporations issues and renews licenses, examines and investigates licensees, and collects periodic assessments from certain licensees. Corporations is supported solely by the fees and assessments it collects. Although it also conducts investigations into alleged violations of the laws over which it has jurisdiction, Corporations has typically been required to transfer any fines and penalties it collects to the State's General Fund.
We found that since 2001, Corporations has not analyzed the licensing and examination fees it charges businesses to determine whether the fees matched its costs of providing the related services. As a result, it has consistently overcharged for some activities and undercharged for others. For example, revenues from securities fees have exceeded the related service costs for six of the last seven fiscal years, resulting in excess revenues of $22.2 million from these fees during that time. Corporations has also generated excess revenues from three of the other business activities it regulates. Overall, excess revenues from these three activities have totaled $2.8 million over the last seven fiscal years. In contrast, the revenues generated from fees for nine other business activities have not been enough to cover the service costs, falling short by a total of $21 million over the last seven fiscal years. For example, the fees charged to process applications for businesses providing investment advice have not been high enough to cover Corporations' costs of providing these services, falling short by $8.2 million during this time. In effect, the excess revenues generated from some types of fees allow Corporations to offset the funding shortfalls for the services it provides for other applicants. Some of the fees collected by Corporations, such as licensing fees, are generally set by statute and thus cannot be raised without a change in the law. However, state law has given Corporations the authority to set certain fees below the statutory amount.
Similarly, Corporations has not recently updated its billing rates for audits and examinations. Our audit found that Corporations' Financial Services Division would have generated more than $1 million in additional revenues from examinations during the period from January 1, 2004, through May 23, 2006, had it revised its billing rates to reflect its increased employee costs for examiners.
Any excess revenues not used by Corporations to fund its operations and not transferred or loaned to other funds accumulate in the State Corporations Fund. These accumulated excess revenues may result in a violation of a state law that takes effect on June 30, 2007, which requires Corporations to limit the reserve it maintains in the fund to 25 percent of annual expenditures, or approximately $8 million by that date. Corporations stated that its reserve was $13.1 million on June 30, 2006; however, this amount does not take into account a loan to the General Fund of $18.5 million, $6 million of which Corporations' financial management chief expects to be paid back in fiscal year 2006-07. If Corporations does receive the $6 million loan repayment in fiscal year 2006-07, it would have to spend $11.1 million more than it collects in that year in order to reduce the State Corporations Fund to the statutory maximum. Given that Corporations has not changed any of its fees and had excess revenues totaling $3.2 million in fiscal year 2005-06, that does not seem to be a reasonable expectation.
Corporations has taken important steps in strategic planning for its operations, seeking to identify its strengths and weaknesses, eliminate inefficiencies, and increase productivity. It is also in the process of implementing a program-level action plan. However, these efforts are undercut by inaccurate statistical information about its actual performance as reported in its monthly and quarterly performance reports. Such errors, if they are significant, may direct Corporations' attention away from important issues needing improvement or toward lesser issues at the expense of areas of greater concern. The inefficient methods used to compile the performance reports also consume time that could instead be used to complete the tasks the reports are measuring. The performance report for the quarter ending September 30, 2006, indicates that Corporations has fallen short of most of its goals.
In addition, because it does not gather sufficient data and does not always identify benchmark goals for its performance measures, the effectiveness of Corporations' Education and Outreach Unit (outreach unit) is uncertain. For example, the outreach unit does not collect data for four of the 12 performance measures it has identified for its Seniors Against Investment Fraud Program. Further, of the eight performance measures for which it does collect data, it has established benchmarks for only two. Without sufficient data and benchmarks, it is impossible for Corporations to effectively assess the value of its efforts. Similarly, Corporations did not have any goals for its Troops Against Predatory Scams Investor Education Project.
Corporations does not always process applications within the time limits set by state law. In fact, for applications submitted between January 2004 and May 2006, the average processing time exceeded the time intended by law for many of the application types we reviewed. Although Corporations is responsible for some of the delays in processing license applications, other factors outside of its control also contribute to lengthy processing times. For instance, applicants frequently submit incomplete applications that require Corporations to issue deficiency notices. In fact, we found several instances in which Corporations had to send applicants multiple deficiency notices before it obtained the information needed to rule the applications complete. Furthermore, applicants do not always respond promptly to the deficiency notices. Delays in processing are detrimental to the applicants because they prevent applicants from conducting business.
Corporations also did not always resolve complaints related to securities regulation and financial services as quickly as it could have. Although there is no legal requirement dictating the length of time Corporations has to resolve complaints, our review of 20 complaints related to securities regulation identified four complaints in which unnecessary delays increased the length of the process. In one instance, the Securities Regulation Division did not begin its investigation until 277 days after the complaint was received. We found similar unnecessary delays in Corporations' handling of our sample of 20 financial services complaints. When Corporations does not investigate complaints promptly, its ability to protect consumers from fraudulent activities is compromised.
Furthermore, the information systems used by Corporations to track complaints are unreliable because they contain a large number of blank fields, duplicate entries, and inaccuracies. Fields commonly left blank include the date a complaint was received, the date the case was opened, the type of law involved, and the name of the staff member assigned to the complaint. In addition, one system listed an incorrect status for many of the complaints we reviewed. Consequently, it is difficult, if not impossible, for management to use these systems as tools for assessing some of Corporations' activities.
Corporations' Enforcement and Education Division (enforcement division) also did not always identify a reason for rejecting complaints, and for the cases for which it did identify a reason, it did not always fully document its rationale. Because the enforcement division cannot fully investigate every complaint it receives, due to its workload and budget constraints, its policy is to occasionally reject some lower-priority complaints, such as complaints involving out-of-state complainants or those involving a limited number of investors. However, to ensure that the process of rejecting complaints is consistent and fair, the enforcement division should carefully document its rationale for doing so in each case.
Corporations has recently modified its procedure for handling complaints. In addition to developing formal policies for rejecting and referring complaints, it has centralized the intake of all complaints into a new complaint team. Corporations believes that this new process will allow it to respond immediately to complaints and prepare each complaint for referral to the appropriate division. Because Corporations initiated this process near the end of our field work, we were unable to test whether it will correct any of the weaknesses we identified. However, it appears that the process contains good business practices.
Finally, contrary to law, Corporations has not conducted at least 170 (37 percent) of its required examinations of escrow office licensees within the last four years. In addition, it has yet to conduct examinations for 899 (35 percent) of eligible finance lender licensees within its four-year goal. According to Corporations' action plan, its examinations have the potential to detect violations of the law and unsafe, unsound, or abusive practices and serve to deter potential wrongdoing. Thus, having a significant examination backlog could leave consumers less well protected.
To strengthen its operational oversight, Corporations should seek legislative authority allowing it to set fees by regulation. This legislative authority should require that Corporations annually assess its fee rates and establish fees that are reasonably related to its cost of providing the services supported by its fees. Corporations should also factor in the amount of any excess reserves when conducting its annual assessment.
To improve the efficiency and effectiveness of its system for collecting actual performance measure information, Corporations should do the following:
- Consider assessing the need for new automated data systems or determining whether its current systems are capable of collecting the necessary information.
- Ensure the accuracy and completeness of the information in its automated systems by requiring staff to enter the information and requiring supervisors to review it periodically. For data not currently available in automated format, Corporations should develop stronger procedures to ensure that staff accurately report and supervisors review the information. Corporations should consider calculating and reporting performance measures quarterly, rather than monthly, until it has a more efficient data collection system.
To ensure that it has identified all necessary performance measures and appropriately focused its current performance measures, Corporations should continue to assess the reasons for performance deficiencies and add or adjust performance measures as needed.
To ensure that the outreach unit can effectively measure its success, Corporations should ensure that it collects all of the necessary data and establishes reasonable benchmarks.
To ensure that all applications are reviewed promptly and sufficiently, Corporations should do the following:
- Continue to monitor the progress of applications through the review and approval process to identify any that have stalled, and investigate the reason for the delay.
- Follow up with applicants that do not promptly respond to deficiency notices.
- Assess whether it needs additional staff to process applications.
- Maintain all necessary data in its information management systems so that it can effectively calculate the number of days it takes to process applications.
To improve the efficiency of its complaint-handling process, Corporations should do the following:
- Develop procedures to track the progress of complaints to ensure that they continue to move through the process without unnecessary delay.
- Monitor its newly established complaint-referral process and develop procedures, if necessary, to decrease the length of time it takes to refer cases to the appropriate division.
- Review its existing complaint records and eliminate duplicates and correct any inaccurate fields. Further, Corporations should maintain accurate and complete data to ensure that the information systems can be used more effectively as management tools.
Corporations should develop a plan to conduct examinations of licensees in accordance with state law and its own internal policy.
Corporations did not have any substantial disagreements to our report and found the recommendations to be useful. The Business, Transportation and Housing Agency concurred with Corporations and stated that the report should prove to be a useful blueprint for Corporations' recently appointed commissioner.