Military Readiness: Analysis of Maintenance Delays Needed to Improve Availability of Patriot Equipment for Training

Patriot is a mobile Army surface-to-air missile system deployed worldwide to defend critical assets and forces. The Army plans to extend the life of Patriot equipment until at least 2048 through maintaining and modernizing the system. To achieve this, the Army performs two maintenance processes, restoring equipment returning from combat back to pre-deployment conditions (“reset”) and comprehensively overhauling ("recapitalizing") a portion of its equipment annually.

The conference report accompanying a bill for the National Defense Authorization Act for Fiscal Year 2017 included a provision that GAO assess the Army's Patriot maintenance and recapitalization plans to ensure that operational needs are met. This report (1) evaluates the extent to which the Army's reset process supports the timely delivery of Patriot equipment back to units; and (2) describes the Army's plans for supporting the long-term viability of the Patriot system through recapitalization and any challenges associated with its plans. GAO analyzed Army guidance and equipment and maintenance data; interviewed Army officials; and assessed the Army's recapitalization plans.

The Army uses reset and recapitalization to extend the life of its Patriot surface-to-air missile system. The reset process—which is intended to repair recently-deployed equipment—has often returned equipment to Patriot units late, which has affected unit training. GAO found that of the seven Patriot battalions that underwent reset from fiscal years 2014 through 2017, only one received its equipment within 180 days, in accordance with Army policy (see figure). Patriot unit officials told GAO that such delays reduced the time available for unit training, creating challenges in meeting training requirements as units prepare for their next mission. The Army has identified and analyzed several factors affecting reset timeliness, ranging from supply chain issues to transportation. However, the Army has not comprehensively analyzed the relative importance of these factors. Such an analysis would better position the Army to target its efforts effectively to ensure units receive equipment back in a timely manner.

Patriot Equipment Reset Timeliness for Units, Fiscal Years 2014-2017

With respect to recapitalization, the Army has decided to recapitalize each battalion set of Patriot equipment once every 15 years to support the system's long-term viability through 2048, while recognizing that this approach introduces some challenges. The Army would prefer to recapitalize Patriot equipment every 10 years, but Army officials stated this is not feasible for the following reasons:

Reducing the amount of equipment for ongoing operational commitments to increase the pace of recapitalization is not feasible given current commitments and the projected security environment.

Buying extra equipment to provide to additional units undergoing recapitalization is not feasible because the Army has prioritized replacing the Patriot radar to improve its capability to defend against advanced threats.

Army officials told GAO that the current pace of recapitalization is not optimal and could introduce challenges, such as the possibility of equipment failure and increased maintenance costs. However, the Army has concluded that the current pace is the best path forward.

GAO recommends that the Army conduct an analysis of the primary factors affecting the Patriot program's reset timeliness to identify their relative importance and develop and implement appropriate corrective actions. The Department of the Army concurred with GAO's recommendation.

The Army’s Patriot surface-to-air missile system was first fielded in the  early 1980s and has been in high demand, with more than half of the  Patriot force currently deployed, forward stationed, or prepared to deploy  on short notice. While there have been upgrades to the system, the age  of the equipment and high pace of operations create risks that the Army  attempts to mitigate through maintenance. This maintenance, designed to  extend the life of the system until at least 2048, includes restoring  equipment returning from combat back to pre-deployment condition  (“reset”) and comprehensively overhauling (“recapitalization”) a portion of  the equipment annually. However, the current global threat environment  has the potential to further increase demands for the Patriot system and  result in additional maintenance requirements. The Department of  Defense’s 2018 National Defense Strategy, for instance, notes the  Democratic People’s Republic of Korea’s growing ballistic missile  capability. As we have previously found, with a limited fleet of 15  battalions, the Army has struggled to keep up with demands, so  increased operations could be unsustainable.

We have also previously reported that the Army’s current maintenance  schedule for the Patriot system presents an elevated risk of equipment  failure due to the pace of recapitalization and the Army’s fielding plan for  system upgrades. Congress has expressed additional concerns that  potential delays in modernizing Patriot systems, components, and  software will amplify these risks as units continue to train, deploy, and  operate legacy Patriot equipment at a high pace over an extended period.  The conference report accompanying a bill for the National Defense  Authorization Act for Fiscal Year 2017 included a provision that we  assess the Army’s Patriot maintenance and recapitalization plans to  ensure that operational needs are met. This report (1) evaluates the  extent to which the Army’s reset process supports the timely delivery of  Patriot equipment back to units; and (2) describes the Army’s plans for  supporting the long-term viability of the Patriot system through  recapitalization and any challenges associated with its plans.

For our first objective, we analyzed Army reset and recapitalization  processes and collected and analyzed data on the timeliness and quality  of Army Patriot reset and recapitalization activities from fiscal years 2014  through 2017. We selected these years to identify any trends in the  timeliness and quality of the maintenance activities and because this was  the most recent data available. We assessed the reliability of these data  by reviewing available documentation and interviewing officials, among  other things. We found the data to be sufficiently reliable for our  purposes, to include reporting on battalion-specific reset timeliness and  the time spent by the depot on correcting quality defects identified during  internal inspections. We compared the data on reset timeliness against  Army policy. We also interviewed cognizant Army personnel involved in  the planning and conduct of Patriot reset and recapitalization, as well as  officials from two Patriot battalions and their higher headquarters that  recently underwent reset to identify challenges, if any, with respect to  reset timeliness, such as equipment transfer delays and any effects on  training. We also evaluated the Army’s processes to identify and correct  factors causing any reset delays against Army guidance on program  performance improvement.

For our second objective, we identified and analyzed—via a review of  recapitalization schedules, briefings, and other documentation—the  Army’s current processes and planning for future Patriot recapitalization  activities, including Army assessments of the feasibility of adjusting the  pace of recapitalization. We also interviewed, among others, cognizant  officials from operational units, the Patriot program office, and  Letterkenny Army Depot (Letterkenny), which conducts Patriot reset and  recapitalization, to obtain their views on considerations influencing the  Army’s recapitalization planning and the current and optimal paces of  recapitalizing Patriot equipment. For more information on our scope and  methodology, see appendix I.

The Patriot weapon system is a mobile Army surface-to-air missile  system designed to counter tactical ballistic missiles; cruise missiles; and  other threats such as airplanes, helicopters, and unmanned aerial  vehicles. The Patriot system was first deployed in the early 1980s; since  that time, it has received a number of substantial updates to keep pace  with growing threats. Patriot units are deployed worldwide—in Germany  and South Korea, for example—in defense of the United States’ and its  allies’ key national interests, ground forces, and critical assets.

The Army currently has 15 Patriot battalions, all in its active component.  Each battalion is organized into groups known as fire units, along with a  headquarters and headquarters battery. Each battalion is controlled by its  own command and control station and can manage up to six fire units,  although a battalion is typically deployed with four. A fire unit is made up  of four basic components: (1) a ground-based radar to detect and track  targets; (2) launchers; (3) interceptor missiles; and (4) a command,  control, and communication station. Overall, a fire unit’s equipment  includes eleven unique major end items, including the radar, the  launchers, and an electric power plant, among other items. Figure 1  provides a listing of the major end items in a Patriot fire unit (top) along  with the notional employment of some of these items (bottom).

Two of the primary processes the Army utilizes to maintain the Patriot  system are reset and recapitalization, summarized in Table 1.

The Army’s reset program seeks to bring Patriot equipment returning from  the U.S. Central Command area of responsibility back to Army standards.  The reset process seeks to return Patriot equipment to a pre-deployment  condition in order to prevent Patriot units from having to spend home  station training funds to keep their equipment functional after returning  from operations in austere environments for extended periods.

The Army also relies heavily on recapitalization to restore Patriot  equipment. A longer and more intensive process than reset,  recapitalization seeks to restore equipment to what the Army considers a  “like-new” condition, and according to Army guidance is a “near zero time  or zero mile” maintenance process. The recapitalization process seeks  to add life to the system, and it provides an opportunity for the Army to  make incremental modernization upgrades, such as the insertion of new  software, technology insertions, or replacing obsolete parts. For example,  the Army is upgrading the Patriot system to prepare for its integration into  the Integrated Air and Missile Defense Battle Command System.

As the Army fields this modernized command and control system, the  Patriot equipment undergoing recapitalization will also change, but the  Army plans to continue recapitalization to support the Patriot system’s  mission through 2048. Specifically, the Army expects that the transition to  the Integrated Air and Missile Defense Battle Command System will allow  it to replace current command and control elements. However, remaining  end items, such as launchers, would continue to require recapitalization  through the full life of the system to 2048. If the Integrated Air and Missile  Defense Battle Command System, which is currently planned for initial  fielding in 2022, is delayed, program and depot officials expect that they  can continue to recapitalize current Patriot equipment as long as needed  to support the Army’s long-term goal. However, Army officials noted that  delays could require mitigation actions, such as the need to continue  repairing parts that the Army would otherwise have replaced.

Aside from the degree of work performed, the recapitalization and reset  processes differ in several other key ways. For instance, the Army  generally provides units undergoing recapitalization with another set of  Patriot equipment in a one-for-one exchange. In contrast, units  undergoing reset receive the same set of equipment back after work is  completed and are not provided other equipment while the unit’s  equipment undergoes reset at the depot. Additionally, the target length for  each process differs; the Army aims to recapitalize one battalion’s worth  of equipment each year, while reset work is expected to be completed in  180 days to meet the timelines of the Army’s process to prepare units for  potential deployment. Letterkenny Army Depot primarily conducts the  maintenance work for both of these efforts under the management of  Army Materiel Command and via coordination with the Patriot program  office.

Patriot Demands and Equipment Mission Capable Rates

Patriot units are in high demand. As we found in October 2017, the Army  believes its Patriot force is operating at capacity given a consistently high  pace of operations, and Army studies have found that any additional  operational demands and potential wartime demands would exceed  current capacity. We also found that the Army was planning to increase  the capacity of its Patriot force in two ways: first, by fielding five small  detachments in fiscal year 2018 that would provide the ability to deploy a  Patriot battery without a full battalion-level command and control element,  and second, by increasing the size of an existing test detachment in order  to relieve the Patriot battalion currently assigned to conduct testing for  Patriot modernization efforts of that mission. The Army intends for the  test detachment to begin supporting Patriot modernization test events  starting in the second quarter of fiscal year 2019.

From fiscal years 2014 through 2017, Patriot equipment across the force  was reported to be fully mission capable at least 90 percent of the time on  average, in accordance with the Army’s goal, as established in Army  regulation. These fully mission capable rates continue an overall trend  since 2009, which a 2014 Army assessment of Patriot readiness  attributed to the recapitalization program. Specifically, this assessment  noted that the worldwide average for Patriot unit fully mission capable  levels was above 90 percent, and that units that underwent  recapitalization consistently experienced positive spikes in readiness.  Further, this assessment highlighted the importance of the Army’s reset  program, noting that it must be sustained because deployed Patriot units  are subjected to the highest pace of operations in the Patriot force.

Reset Equipment Is Often Returned Late to Units, and the Army Has Not Analyzed the Relative Importance of Factors Contributing to the Delays

During the period we reviewed, the Army often did not return reset  equipment to units in accordance with the timelines established in Army  regulation, which affected unit training. Although the Army has identified  several factors that caused delays in returning equipment to units and  monitors these factors, it has not assessed their relative importance.

The Army Often Returns Reset Equipment to Patriot Units Late, Which Affects Training

From fiscal years 2014 through 2017, the Army often did not return reset  equipment to units in accordance with the timelines established in the  Army’s keystone regulation governing its process to build ready forces.  This regulation establishes phases through which a unit passes as it  prepares for a potential deployment. The first of these, the reset phase,  begins when a majority of the unit’s personnel have returned from  deployment and must last a minimum of 180 days. At the conclusion of  the 180 days, the unit enters the train/ready phase, at which point it may  be deployed again, and needs to have its equipment back in order to do  so. Because of this standard, the Army must return a unit’s equipment  from reset within 180 days from the start of the unit’s reset phase. From  fiscal years 2014 through 2017, the Army reset seven battalions and for  six of these battalions the Army did not return all of the units’ equipment  within 180 days. Two of these battalions—the 2-43 Air Defense Artillery  and 4-3 Air Defense Artillery—experienced delays that were deliberately  planned. Specifically, Army officials told us that the installation of system  upgrades for these battalions extended the overall reset timeline by 60  days. One official stated that this was requested and approved, and  explained that if the upgrades had been installed separately after  equipment had been reset, it would have taken 4 months to conduct the  work. However, as shown in figure 2, of the remaining five Patriot units  that completed reset during the period we reviewed, only one received all  of its returned equipment within 180 days.

Patriot battalion officials we interviewed told us that delays in the receipt  of reset equipment forced them to modify their scheduling and execution  of required collective training. For example, one battalion commander we  spoke with said that without equipment his battalion could not effectively  train for some collective tasks, such as exercises that require moving the  system. Additionally, leadership from two battalions we spoke with told us  that the late return of reset equipment compressed the training time  available for them to conduct field exercises. This can create  unnecessary challenges in meeting Army training requirements as units  progress through the Army’s process for building ready units. Specifically,  according to the Army’s force generation guidance, a unit is expected to  be ready to redeploy on day 181 after returning from its last deployment  to its home station. As one battalion commander described, the  collective-level training that units conduct during these shortened  windows is “sufficient, but not optimal.”

Patriot units have utilized a series of actions to mitigate the impact of  delays in equipment receipt after maintenance, but such mitigation  actions are sometimes not feasible or optimal. For example, Patriot unit  officials told us that the Army shares equipment between battalions that  are collocated on the same installation, but at different points in the  readiness building timeline. Specifically, when one battalion turns in  equipment for reset, certain pieces of equipment from another battalion  on the same installation, if available, might be borrowed to conduct  training. Battalion officials noted, however, that this measure may not  always be feasible. Leadership from two Patriot battalions, for example,  cited instances where their units were unable to train during their reset  periods and could not borrow equipment from other battalions located on  the same installation because those battalions were deployed. In addition,  units use simulators to conduct individual-level training to give personnel  experience with new system upgrades, though Patriot brigade officials  noted this is a stopgap measure while units are without equipment and  does not allow for collective training. Lastly, Patriot units can—once  delayed equipment arrives or via borrowing equipment—conduct some  collective training for extended hours (i.e. during evenings) each day  while at their home station, but a battalion official noted that doing so is  also not optimal for unit morale.

Battalion commanders we spoke with told us that their units were  sufficiently trained and ready to deploy, despite the delays in the return of  the equipment to the units. However, a memorandum from a brigade  commander noted that given the high pace of operations, it is important  that units receive their equipment in a timely manner to enable them to  complete training for their next deployment, as delays can create a  notable impact on crew and collective training. The late return of reset  equipment could therefore have a detrimental impact on units’ ability to  conduct training to meet assigned missions.

The Army Has Identified Factors Affecting Maintenance Timeliness

The Army has identified several factors affecting the timeliness of Patriot  maintenance as shown in table 2.

Some of the factors affecting timeliness, as identified by Army officials,  are directly within the control of Letterkenny, where reset is conducted,  and some are not. Specifically, Army officials stated that U.S.  Transportation Command and the Defense Logistics Agency also have  responsibilities related to some of the factors that can affect timeliness,  such as the transport of equipment and availability of parts, respectively.  These factors are discussed in more detail below.

Preventive maintenance. According to Army officials and Army  documentation, the unit leadership of some deployed Patriot  battalions do not emphasize preventive maintenance. As a result,  equipment may not be properly maintained to Army standards and  can create additional work tasks for depot personnel when they  receive it, such as conducting additional or more detailed inspections.

Unexpected damage. Army officials cited some instances where  equipment sent to the depot arrives in worse than expected condition,  either due to damage incurred during transport or because unit  personnel did not accurately report the condition of the equipment  prior to turning it in. For example, in December 2017 Letterkenny  officials documented that a battalion’s missile launcher was returned  to the depot with unexpected severe corrosion on power cables, and  certain equipment items, such as generators, were completely  inoperable. Officials cited another instance where a radar was  pressure-washed prior to its return to the depot, causing extensive  damage. These kinds of unexpected conditions result in greater repair  work than anticipated for depot employees.

Supply chain challenges. Officials at Letterkenny told us that their  forecasts for parts orders have not been consistently met via Army  and Department of Defense supply chain processes, but that the  depot was taking steps to improve its own forecasting. An official  also noted that problems can arise if sole-source suppliers for critical  parts go out of business, or if they have to order parts that are no  longer regularly produced by vendors due to obsolescence. Patriot  program office officials provided an example of a radio that is part of  the Patriot system and is no longer in production, and noted that the  program office was working with Army headquarters officials to  identify a solution.

The Army uses a series of measures to mitigate parts availability issues,  such as having the depot utilize its own equipment to fabricate some  items on short notice (see fig. 3) and, according to Army officials, by  taking parts from incoming equipment and using them for equipment  nearing completion of maintenance. Additionally, in July 2017, the depot  received permission to purchase critical “long-lead” parts for specific  Patriot items in advance of anticipated need, although, according to  officials, as a general rule and practice, the depot is not allowed to  purchase items without funding in place. Letterkenny officials told us  that in cases where they are unable to acquire critical parts, or lack the  funds to do so, delays can occur.

Depot quality controls. Time spent remedying maintenance errors and  quality defects—such as incorrect assemblies, defective parts, or  improper painting during depot operations—may contribute to the  depot’s timeliness challenges. Army officials stressed that the  Patriot system is complex, and certain maintenance tasks can be  challenging because it can be difficult to isolate equipment faults. For  example, the Patriot radar system is composed of thousands of  elements (see fig. 4), which, according to officials, requires extensive  testing to ensure that each element is operational. Depot officials told  us that their processes are designed to ensure that finished products  meet operational standards, and that doing so sometimes takes  longer than expected. Letterkenny uses a series of metrics and  reporting methods, such as internal tracking of defects and surveys  and reports from customers, to monitor, document, and correct quality  defects during the Patriot maintenance process to ensure that any  maintenance errors or defects are identified before the equipment is  returned to units.

However, quality defects that may affect timeliness can still arise. Each  fiscal year Letterkenny establishes a target for hours spent at the depot  correcting quality defects that arise during maintenance, which are then  tracked and used as indicators of the overall quality of the maintenance  process. As tracked by the depot, the monthly time spent correcting  quality defects varied, when averaged across each year. Specifically, the  average in fiscal year 2015 was below the depot’s set target, but the  averages in fiscal years 2014, 2016, and 2017 exceeded the targets. For  example, the time spent correcting quality defects ranged from 846 hours  a month in fiscal year 2016 to 1,242 hours a month in fiscal year 2017,  above those years’ monthly target of 800 hours.

Equipment transportation. Transportation time is included in the 180- day policy for returning equipment from reset to Patriot units, and it  often takes a significant amount of time before equipment is  transported to the depot from theater. As such, according to Army  documentation, the depot can be left with only 120 days to complete  reset work before it has to return equipment back to units if it is to  meet the 180-day policy. According to Army documentation, to  mitigate this issue the Army airlifts a number of critical Patriot  equipment items, such as radars, from theater to the depot so that  reset work can begin earlier on these items. Additionally, unit officials  and a program official involved in planning for the Army’s reset  process noted that equipment items are sent back from the depot as  soon as reset work is completed; the depot does not wait until the  entire unit equipment set is complete. However, as shown previously  in figure 2, these kinds of mitigation actions with respect to  transportation have not been sufficient in ensuring that units receive  all of their equipment back within the 180 days allowed by policy.

Army Monitors Factors Affecting Maintenance Timeliness, but Has Not Conducted an Analysis of Their Relative Importance

Although the Army monitors the factors that have affected maintenance  timeliness, it has not conducted an analysis to identify their relative  importance. According to Army documents and officials we interviewed,  the Army monitors and uses a number of processes to identify, discuss,  and select mitigation actions for factors affecting maintenance timeliness,  such as:

Quarterly working group meetings of Patriot stakeholders. The Army  monitors maintenance timeliness via a quarterly working group, which  includes representatives from key Army Patriot stakeholder  organizations such as Training and Doctrine Command, Aviation and  Missile Command, Letterkenny, and Patriot unit higher command  headquarters. Any timeliness issues discussed at such meetings,  such as potential training impacts and transportation delays, are  conveyed to units afterwards.

Letterkenny weekly production meetings. Letterkenny command staff  hold weekly production meetings to discuss various issues affecting  maintenance production, identify potential factors that could delay  depot work, and select mitigation measures against such factors.

Army Materiel Command oversight of Letterkenny production. Army  Materiel Command monitors and tracks Letterkenny’s actual and  projected maintenance performance against the scheduled  completion dates for Patriot maintenance projects, and depot officials  internally review the depot’s performance for each Patriot equipment  item each week before submitting the results to Army commands  monthly.

Although Army officials are aware of challenges in returning reset  equipment to Patriot units within the 180-day policy and have taken some  steps to minimize these impacts, they could not quantify how much each  of the factors affecting timeliness contributes to delays in completing  maintenance and returning equipment to units. Moreover, based on our  discussions with different stakeholders associated with the sustainment of  the Patriot system, there are different perceptions as to the degree to  which the various factors contributed to delays in completing maintenance  and returning reset equipment to units. For example, during our meetings,  depot officials indicated that supply chain issues were the primary  timeliness challenge. In contrast, a senior program office official and unit  officials emphasized the importance of transportation of equipment and its  effects on timeliness. In addition, Letterkenny and Army stakeholders told  us that while they work to identify and correct issues as they arise through  the processes described above, their efforts to remedy these issues are  conducted in isolation from one another and not compiled and compared  to enable the Army to identify their relative importance in terms of each  factor’s effect on timeliness.

Although aware of the challenges of returning equipment to units in a  timely manner, the Army has not comprehensively analyzed the relative  importance of the various factors identified above that affect Patriot  maintenance timeliness. Army Regulation 702-11 states that fact-based  decision-making and the use of performance information to foster  continuous improvement are essential activities of quality management  and assurance. Specifically, activities supporting logistics missions  should engage in continued review, evaluation, and improvement. This  regulation further states that Army Material Command, as the manager of  the Army’s quality program, should conduct performance reviews and  assist other applicable organizations in developing corrective action  plans, such as establishing protocols to mitigate risks and prevent  recurrence of issues when nonconforming performance is identified.  Although not required by Army regulation, one means of doing this is  through conducting comprehensive analysis, such as comparing the  relative importance of factors affecting performance in order to target  improvement efforts.

A comprehensive analysis to identify the relative importance of factors  could better position the Army to fully understand current and historic  issues affecting its ability to complete Patriot equipment maintenance in a  timely manner. Such an understanding would better inform corrective  actions than isolated efforts and would position the Army to determine  where best to target its efforts in order to ensure units receive equipment  back in a timely manner to conduct training.

The Army Plans to Recapitalize Patriot Equipment Every 15 Years, but This Approach Introduces Some Challenges

The Army has decided to recapitalize each battalion set of Patriot  equipment once every 15 years, while recognizing that this approach  introduces some challenges to upgrading and supporting the system’s  readiness to meet its assigned missions through 2048. While the Army  would prefer to recapitalize Patriot equipment every 10 years, the Army  has reviewed two options for recapitalizing Patriot equipment more  frequently and determined that these options are not feasible. According  to Army documentation, the Army plans to continue sustaining and  upgrading Patriot equipment to meet its long-term goal—which is to keep  the system viable through 2048—by, for example, improving system  reliability and enhancing its warfighting capabilities. The Army considers  recapitalization a key program to achieve this goal. Specifically, in its  2014 readiness assessment of the Patriot force, the Army concluded that  recapitalization is the single most important program with respect to  keeping Patriot equipment viable and sustainable. Officials from multiple  Army organizations also told us that the age of the Patriot system makes  replacement of expendable and aged components and insertion of new  technology during recapitalization important to Patriot sustainment,  readiness, and its ability to meet emerging threats.

While the Army has emphasized the importance of recapitalization in  achieving its long-term goals for the Patriot system, the Army is not  planning to adjust its recapitalization pace in the near term, as of March  2018. According to Army documentation, recapitalizing equipment every  10 years would maintain the equipment at the Army’s desired condition.  However, the Army’s near-term schedule for recapitalization in fiscal  years 2018 through 2022 and its long-term notional schedule for  recapitalization of Patriot equipment through fiscal year 2031 both outline  cycling one battalion per year through recapitalization. With 15 Patriot  battalions, the pace of one battalion per year does not restore the  equipment to its desired condition every 10 years.

According to Army Patriot officials, there are two main options for the  Army to increase the pace of recapitalization, but each of these options  poses challenges. These two options are:

Reduce the amount of equipment available for ongoing commitments  and recapitalize it at the depot. Officials told us that one way the Army  could increase the pace of recapitalization would be to reduce the  amount of equipment available for ongoing commitments, but that this  is not feasible given the current high pace of operations. Further, the  Army does not anticipate that operational requirements will lessen  under the projected security environment. The near-term schedule  assumes that ongoing operational commitments will not change and is  designed to synchronize recapitalization with currently scheduled  operational deployments and training. Army officials responsible for  coordinating the near-term schedule told us that the near-term  schedule has little flexibility given the Army’s limited force structure of  15 battalions, and program and depot officials stated that if the Army  were to recapitalize more than one battalion per year, the pool of  battalions available to meet these current commitments would  decrease.

Procure additional equipment to provide to units turning in equipment  for recapitalization. Army officials said that the Army could buy extra  equipment to provide to additional units turning in their equipment for  recapitalization if the Army wanted to accelerate the recapitalization  pace. At the current pace of recapitalization, the Army has sufficient  quantities of major equipment items to ensure that as a Patriot  battalion turns in equipment for recapitalization it receives recently  recapitalized equipment back on a one-to-one basis and thus is  generally not without equipment. This process prevents removing  Patriot battalions from operational rotations during the recapitalization  period. However, officials stated that if the Army were to adjust the  pace to recapitalize more than the current one battalion per year, it  would require buying more equipment to ensure that any additional  units undergoing recapitalization would not be left without equipment.  Army documents indicate that the Army has assessed whether to  acquire additional equipment to enable an accelerated pace of  recapitalization. However, an official with responsibility for the Patriot  capability and senior Army headquarters officials with responsibility for  Patriot resourcing and planning told us that the Army instead has  prioritized developing a replacement for the Patriot radar. This  replacement radar is expected to address capability needs related to  radar reliability and range to better defend against advanced threats.  Army documentation indicates that this replacement radar is expected  to reach initial operational capability in fiscal year 2025.

If the Army decided to reduce the amount of equipment available for  ongoing commitments or buy more equipment, then the Army would also  need to make additional investments in depot resources to support  accelerating the pace of recapitalization. According to Army documents  and officials we interviewed, these include personnel, facilities, and  equipment. However, there are a number of challenges related to putting  these resources in place.

Personnel. Army documentation shows and depot officials stated that  they would likely hire contractors to meet workload demands and the  depot could add shifts if the Army decided to adjust the pace of  recapitalization to what it considers an optimal pace. Depot officials  also told us they would try to hire contractors with some Patriot  experience and place them alongside more experienced personnel in  order to preserve work quality, as they have done in response to  previous surges in reset work. However, the Army recognizes that  Letterkenny faces challenges in expanding its workforce due to a  limited pool of available workers in the area around the depot.

Developing skilled Patriot maintenance personnel is also difficult. An  Army study of the organic industrial base found that 11 of the 15 most  critical personnel positions at Letterkenny are directly associated with  Patriot maintenance and officials noted that, due to the complexity of  the system, it can take up to 5 years for Patriot maintenance  personnel to become proficient.

Facilities and equipment. Depot officials stated that if the Army  decided to adjust the pace of recapitalization to what it considers  optimal, they would likely need to review, among other things, the  tools, equipment, and facilities needed to support such an adjustment,  as well as supply availability. They also told us that Letterkenny  already has proposed expanding its facilities to meet projected future  work, and the depot has planned for the plant equipment it will need to  continue maintaining the Patriot system as upgrades are incorporated.  However, they noted that it takes a full year to recapitalize the Patriot  radar, including 3 months of testing, and that Letterkenny has one of  only two radar test sites. Given the time required and the single test  site, if the Army wanted to recapitalize more than one battalion a year,  program officials stated that current conditions probably would not  support doing so.

Continuing the current pace of recapitalization could introduce other  challenges in meeting the Army’s long-term goals for the Patriot system,  and Army officials stated they are aware of these challenges. Specifically,  Army documentation shows, and Army officials told us, that the current  pace is not optimal and that it could introduce the possibility of equipment  failure as specific items remain in use past the Army’s desired timeframe  for recapitalizing equipment every 10 years. Additionally, depot officials  told us that their biggest concern with continuing recapitalization at its  current pace is that there may be increased costs to conduct  recapitalization due to the system’s increasing age. As an example, they  stated that there may be increased corrosion issues, adding that they  have already seen a significant deterioration in the condition of some  trailers. Also, the Army’s decision to continue recapitalizing equipment  every 15 years instead of every 10 years provides fewer opportunities to  conduct modernization, which is often done in conjunction with  recapitalization. Program officials stated that modernizing the system is  important because upgrades reduce the number of items that can fail,  thereby making field maintenance easier. Moreover, officials from one  Patriot brigade stated that their main concern with respect to Patriot is  that additional operational commitments could potentially slow  modernization progress and affect the Army’s capability to meet threats,  particularly since the capabilities and sophistication of enemy threats  continue to increase.

The Army has reviewed its options and the associated challenges related  to increasing the pace of recapitalization and has decided the best path  forward based on its review is to continue recapitalizing Patriot battalion  equipment sets once every 15 years. However, this pace of  recapitalization includes some risk—as identified by Army officials—and  will likely create challenges in meeting the Army’s long-term goals for the  system.

Maintaining good equipment condition is particularly important given the  current high pace of operations for Patriot units, as well as the potential  for a further increase in operational requirements. However, the Army’s  reset process has often delivered equipment to units late, affecting units’  ability to schedule and execute training as they prepare for their next  mission. The Army is aware of the challenges in completing maintenance  and returning reset equipment to units, and has identified several factors  that contribute to delays, but has not analyzed how much each of the  factors contribute to delays. Unless the Army conducts a comprehensive  analysis of the relative importance of the factors affecting Patriot reset  timeliness and develops and implements appropriate corrective actions to  address the results of the analysis, it will not be positioned to target its  efforts most effectively to take corrective actions.

We recommend that the Secretary of the Army ensure that Army Materiel  Command, in coordination with its subordinate and other Army  organizations as appropriate, conducts a comprehensive analysis of the  primary factors affecting timeliness to identify their relative importance in  the Army’s Patriot reset program and develops and implements  appropriate corrective actions. (Recommendation 1)

In written comments on a draft of this report, the Department of the Army  concurred with our recommendation. The department stated that it is  taking steps to address the recommendation, noting that it will continue  analysis between Army Materiel Command, Headquarters Department of  the Army, and the Patriot program office to identify and address factors  that may affect reset timeliness. The Department of the Army’s comments  are reprinted in their entirety in appendix II. The department also provided  technical comments, which we incorporated into the report as  appropriate.

We are sending copies of this report to the appropriate congressional  committees, the Secretary of Defense, and the Secretary of the Army. In  addition, the report is available at no charge on the GAO website at  http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-3489 or pendletonj@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made major contributions to  this report are listed in appendix III.

To evaluate the extent to which the Army’s reset process supports the  timely delivery of Patriot equipment back to units, we analyzed Army  documents concerning recapitalization and reset activities. This included  analysis of, among other things, documents describing the processes for  Patriot battalion equipment transfers to and from Letterkenny Army Depot  (Letterkenny), depot activities to recapitalize and reset equipment, and  testing to ensure the equipment’s proper operation. We also reviewed,  among other documents, Army guidance on Patriot equipment status  reporting, reset, materiel maintenance, and on ensuring the quality of  Army programs; as well as planning schedules and documents on  backorders and critical items. We evaluated the Army’s processes to  identify and correct factors causing any reset delays against Army  guidance on program performance improvement.

Additionally, we analyzed data provided by the Army on Patriot equipment  fully mission capable rates and the timeliness of Army Patriot reset  activities from fiscal years 2014 through 2017—the most recent data  available—to identify any trends. Specifically, we analyzed Patriot unit  fully mission capable data as recorded by Army Aviation and Missile  Command G-3 (Readiness) based on data submitted by Patriot  operational units. We analyzed it to corroborate statements regarding  equipment readiness and the quality of maintenance work made by  program and operational unit officials and to compare against the Army’s  goal for fully mission capable rates. To determine depot timeliness, we  analyzed aggregate monthly data provided by the Army on Letterkenny’s  timeliness in completing Patriot maintenance activities against  performance schedules. We also analyzed Patriot battalion-specific Army  data on reset timeliness in order to determine the frequency with which  Letterkenny met the reset timeliness policy. Finally, we reviewed Army  data on the time spent re-working and re-inspecting equipment with  quality deficiencies found during internal inspections at Letterkenny in  order to inform our assessment of the potential effects of addressing  quality deficiencies on depot timeliness.

We assessed the reliability of these data by reviewing available system  documentation, such as user manuals and data dictionaries for each of the automated information systems from which the respective data were  drawn. We manually checked the data for obvious errors and missing or  outlier values. We administered data reliability questionnaires to officials  familiar with the data systems and assessed their responses and answers  to follow-up questions, and we interviewed cognizant officials about their  data management practices and use of the data. Based on these steps,  we found these data to be sufficiently reliable for our purposes, to include  providing fiscal years 2014 through 2017 Patriot equipment fully mission  capable rates, battalion-specific reset timeliness, and the time spent by  the depot on correcting quality defects identified during internal  inspections.

To describe the Army’s plans for supporting the long-term viability of the  Patriot system through recapitalization and any challenges associated  with its plans, we analyzed Army regulations, guidance, and planning  documents, as well as Army studies. These included, among others, the  Army’s recapitalization management policy; Army documents proposing  and approving a recapitalization program for Patriot; Army studies of its  depot workforce, worldwide Patriot equipment readiness, and Patriot  operational demands in relation to available assets; and Army guidance  on materiel maintenance and useful equipment life. We also analyzed,  among other documents, the Army’s near-term schedule synchronizing  Patriot recapitalization, reset, incremental modernization, training, and  deployment schedules for fiscal years 2018 through 2022 and a long-term  notional schedule for the recapitalization of Patriot equipment, by  battalion set, through 2031. We also reviewed depot equipment and  personnel planning documents and the Patriot life-cycle management  plan, among other planning documents.

For both objectives, we interviewed cognizant Army personnel involved in  the planning and conduct of Patriot recapitalization and reset. We visited  Letterkenny to speak with officials and observe the facilities and the  conduct of Patriot maintenance activities. In addition, we interviewed  officials with responsibility for Patriot funding; for monitoring Patriot unit  readiness; as well as officials from two Patriot battalions that recently underwent reset and their brigade headquarters; and one Patriot battalion  that recently underwent recapitalization and its brigade headquarters to  identify challenges, if any, with respect to these maintenance processes,  such as any training or equipment transfer delays or maintenance  deficiencies. The list of the organizations and offices we interviewed  during the course of our review is below.

Assistant Secretary of the Army for Acquisition, Logistics, and

Program Executive Office, Missiles and Space, Redstone  Arsenal, Huntsville, Alabama

Lower Tier Project Office, Redstone Arsenal, Huntsville,

G-4, Logistics Maintenance Directorate: G-44 (M) Maintenance

G-4, 3/5/7, Current Operations and Strategic Readiness Division

G-8, Programs and Priorities, Fires Division

Army Aviation and Missile Life Cycle Management Command,  Redstone Arsenal, Huntsville, Alabama

Army Aviation and Missile Command Logistics Center,  Redstone Arsenal, Huntsville, Alabama

Letterkenny Army Depot, Chambersburg, Pennsylvania

32nd Army Air and Missile Defense Command, Fort Bliss, Texas

11th Air Defense Artillery Brigade, Fort Bliss, Texas

3-43 Air Defense Artillery Battalion, 11th Air Defense Artillery  Brigade, Fort Bliss, Texas

31st Air Defense Artillery Brigade, Fort Sill, Oklahoma

3-2 Air Defense Artillery Battalion, 31st Air Defense Artillery  Brigade, Fort Sill, Oklahoma

4-3 Air Defense Artillery Battalion, 31st Air Defense Artillery  Brigade, Fort Sill, Oklahoma

Fires Center of Excellence, Fort Sill, Oklahoma

Training and Doctrine Command Capability Manager – Army Air  and Missile Defense Command, Fort Sill, Oklahoma  We conducted this performance audit from June 2017 to June 2018 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

Appendix II: Comments from the Department of the Army

Appendix III: GAO Contact and Staff Acknowledgments

Appendix III: GAO Contact and Staff  Acknowledgments Error! No text of specified style in document.

In addition to the contact named above, individuals who made key  contributions to this report include Kevin O’Neill, Assistant Director; Jason  Blake, Vincent Buquicchio, Clarice Ransom, Michael Silver, Erik Wilkins- McKee, and Matthew Young.


Securities Regulation: SEC Inspections of Financial Industry Regulatory Authority's Governance Were Consistent with Internal Guidance

The securities industry is generally regulated by a combination of federal and industry oversight. FINRA, a self-regulatory organization, is responsible for regulating securities firms doing business with the public in the United States. SEC oversees FINRA's operations and programs.

Section 964 of the Dodd-Frank Act includes a provision for GAO, following an initial report, to triennially review and report on aspects of SEC's oversight of FINRA. GAO issued its first report in May 2012 ( GAO-12-625 ) and its second report in April 2015 ( GAO-15-376 ).

This report (1) determines if SEC's oversight of FINRA included the 10 areas specified in Section 964 of the Dodd-Frank Act and (2) evaluates the extent to which selected SEC internal guidance for examinations of FINRA follows generally accepted government auditing standards and the extent to which SEC's examinations of FINRA's governance practices followed SEC internal guidance. GAO reviewed all SEC examinations relating to a Section 964 area completed since fiscal year 2015 (including five that were governance-related), reviewed certain SEC procedures used to examine self-regulatory organizations against Government Auditing Standards , and compared completed inspections against SEC guidance. GAO also interviewed SEC and FINRA staff.

Since fiscal year 2015, Securities and Exchange Commission (SEC) examinations of the Financial Industry Regulatory Authority, Inc. (FINRA) covered each of the 10 areas specified in Section 964 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), such as governance, funding, and transparency. The most commonly covered area was FINRA examinations of its members.

Selected SEC guidance used to examine FINRA, including requirements for planning, prefieldwork scoping, and communicating findings, was consistent with generally accepted government auditing standards, and SEC inspections of FINRA were consistent with SEC's guidance. The five governance-related inspections of FINRA that GAO reviewed were consistent with SEC guidance for planning examinations and communicating findings (see fig.). Not all the requirements were applicable (because in certain instances completion of one requirement eliminated the need to satisfy others).

GAO is not making any recommendations. SEC agreed with GAO's findings.

The securities industry is generally regulated by direct Securities and  Exchange Commission (SEC) regulation and industry self-regulation with  SEC oversight. Self-regulatory organizations (SRO), such as national  securities exchanges and associations, perform much of the day-to-day  oversight of the securities markets. SROs are primarily responsible for  establishing standards under which members conduct business;  monitoring the conduct of business; and bringing disciplinary actions  against members for violating applicable federal statutes, SEC rules, and  SRO rules. SEC oversees SROs to ensure that they carry out their  regulatory responsibilities.

The Financial Industry Regulatory Authority, Inc. (FINRA) is an SRO  registered with SEC as a national securities association. All securities  broker-dealers doing business with the public in the United States— approximately 3,700 firms with 630,000 brokers—must be registered with  FINRA. Among other activities, FINRA writes rules to govern these firms  and their representatives, examines for and enforces broker-dealer  compliance with FINRA rules and federal securities laws, and conducts  surveillance of the over-the-counter securities market. FINRA also  provides regulatory services to other SROs—specifically, U.S. equities  and options exchanges. Through its relationships with exchanges, FINRA  conducts market surveillance on more than 99 percent of U.S.-listed  equities and 50 percent of U.S.-listed options. Given the scope of  FINRA’s regulatory responsibilities, ensuring that it carries out these  responsibilities is critical to SEC’s mission to protect investors; maintain  fair, orderly, and efficient markets; and facilitate capital formation.

Section 964 of the Dodd-Frank Wall Street Reform and Consumer  Protection Act (Dodd-Frank Act) includes a provision for GAO to evaluate  SEC’s oversight of national securities associations registered under  Section 15A of the Securities Exchange Act of 1934 (Exchange Act), a  provision that currently applies to FINRA. Specifically, Section 964  identifies 10 aspects of SEC’s oversight of FINRA for our review:  1.  Governance of FINRA, including the identification and management of  conflicts of interest.  2.  Examinations performed by FINRA, including the expertise of  examiners.  3.  Executive compensation practices of FINRA.  4.  Arbitration services provided by FINRA.  5.  Reviews performed by FINRA of advertising by its members.  6.  Cooperation with and assistance to state securities regulators by  FINRA.  7.  Use of funding to support FINRA’s mission, including the methods and  sufficiency of funding, how FINRA invests funds pending use, and the  impact of these aspects on FINRA’s regulatory enforcement.  8.  Policies on the employment of former employees of FINRA by  regulated entities.  9.  Effectiveness of FINRA’s rules.  10. Transparency of FINRA’s governance and activities.

Section 964 also specified that GAO was to conduct an initial review no  later than 2 years after the enactment of the Dodd-Frank Act and every 3  years thereafter. We issued our first report in 2012 and the second in  2015. The first report examined how SEC conducted oversight of FINRA  and planned to enhance such oversight and the second report included  an examination of SEC’s implementation of a risk-based framework for  overseeing FINRA.

This report generally focuses on SEC oversight of FINRA’s governance.  Specifically, this report (1) determines if SEC oversight of FINRA  operations and programs since fiscal year 2015 included the 10 areas  specified in Section 964 of the Dodd-Frank Act, (2) evaluates the extent  to which selected SEC internal guidance on conducting examinations of  FINRA follows generally accepted government auditing standards, and  (3) evaluates the extent to which SEC examinations of FINRA’s  governance practices followed SEC’s internal guidelines.

To assess SEC oversight of FINRA since fiscal year 2015 as it relates to  Section 964 areas, we requested and reviewed materials for SEC  examinations (a term we use to include program inspections,  examinations, and oversight activities stemming from tips and referrals)  that addressed those areas. To determine the extent to which selected  SEC internal guidance for FINRA examinations followed generally  accepted government auditing standards, we compared the current  version of SEC’s internal guidance (examination manual) to an earlier  version that we previously determined had done so. Any differences or  additions were then assessed for compliance with government auditing  standards. To determine the extent to which SEC’s program inspections  of FINRA’s governance (in fiscal years 2015–2017) followed SEC’s  internal guidance, we compared SEC internal guidance (examination  manual) with examination documents that included scope memorandums,  letters to FINRA describing any deficiencies found, and closing letters to  the file explaining disposition of examinations. We only reviewed the  extent to which examinations followed specified guidelines and did not  evaluate the analysis, findings, or disposition of the examinations. We  also interviewed SEC staff about the examination process and  documentation requirements.

We conducted this performance audit from November 2017 to July 2018  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

The Office of Compliance Inspections and Examinations (OCIE)  administers SEC’s nationwide examination and inspection program for  registered SROs, broker-dealers, transfer agents, clearing agencies,  investment companies, and investment advisers. OCIE conducts  examinations and inspections to improve compliance, prevent fraud,  monitor risk, and inform policy. Individual groups in OCIE have oversight  responsibility for the various registered entities. The FINRA and  Securities Industry Oversight (FSIO) program within OCIE performs  examinations of FINRA and the Municipal Securities Rulemaking Board,  an SRO that regulates the municipal bond market.

As part of its FINRA oversight activities, FSIO conducts four types of  reviews that may involve Section 964 areas.

Program inspections are reviews of FINRA operations and program  areas (for example, FINRA’s review of applications by broker-dealers  seeking to become members).

Oversight examinations are single, stand-alone examinations of  specific examinations that FINRA conducts of its member firms. FSIO  initiates an oversight examination when its examinations of a broker- dealer find deficiencies FSIO believes should have been identified by  FINRA in its own examination of the broker-dealer.

Thematic oversight examinations are a series of oversight  examinations that evaluate FINRA’s review of a particular regulatory  area across a number of its member firms.

Tips, complaints, and referrals are allegations or statements of  concern about possible violations of securities laws or risky conduct  received by SEC. FSIO reviews FINRA-related tips, complaints, and  referrals by evaluating facts and circumstances and conducting  background research. The reviews may result in FINRA-related  inspections or examinations or may be used for inspection planning  purposes.

To help identify the FINRA programs and topics that it will review, FSIO  uses a risk-based approach that includes an annual assessment of high- risk areas and consideration of the areas specified in Section 964.  According to SEC staff, FSIO also conducts ongoing monitoring of  FINRA’s activities through reviews of information provided by FINRA and  meetings with FINRA officials.

Standards Useful for Assessing Examination Policies and Procedures

Generally accepted government auditing standards define performance  audits as those that provide findings or conclusions based on an  evaluation of sufficient, appropriate evidence against criteria.  Performance audit objectives can include assessments of program  effectiveness, economy, and efficiency; internal control; compliance; and  prospective analyses.

SEC’s examinations of SROs share many of the attributes of performance  audits, including their objectives. For example, examinations (including  inspections) of FINRA enable FSIO staff to evaluate compliance with  applicable laws and regulations; FINRA rules, regulations, or by-laws; or  both. Although SEC is not required to follow the auditing standards when  examining SROs, these standards and guidance provide a framework for  conducting high-quality reviews that can serve as useful criteria in  evaluating a regulatory agency’s examination or inspection programs.

Areas of generally accepted government auditing standards relevant to  SRO examinations include independence, competence, quality control  and assurance, planning, supervision, evidence, documentation, and  reporting:  Independence refers to the audit organization and individual auditor’s  need to be independent and include documentation proving  independence.

Competence refers to the extent to which audit staff collectively  should possess adequate professional competence and technical  knowledge, skills, and expertise.

Quality control and assurance refers to a system of quality control that  an organization should establish that is designed to provide the  organization with reasonable assurance that its personnel comply with  professional standards and legal requirements.

Planning includes creating a written audit plan for each audit.

Supervision requirements include sufficient guidance and direction to  the staff assigned to the audit to address the audit objectives and  follow applicable requirements, while staying informed about  significant problems encountered, reviewing the work performed, and  providing effective on-the-job training.

Evidence refers to sufficient, appropriate evidence to provide a  reasonable basis for the auditor’s findings and conclusions.

Audit documentation requirements state that auditors must prepare  documentation related to planning, conducting, and reporting for each  audit.

Finally, communication of the results entails auditors issuing audit  reports.

SEC’s FINRA Oversight Activities Covered Key Areas Identified in the Dodd- Frank Act

Since fiscal year 2015, SEC examinations related to FINRA included  reviews of all areas identified in Section 964. We determined that FSIO  completed at least one examination covering each of the Section 964  areas since fiscal year 2015 (see table 1). In total, FSIO began or  completed 61 examinations (program inspections, oversight  examinations, and thematic oversight examinations) related to FINRA  programs and operations in that period. Some examinations evaluated  other aspects of FINRA’s programs and operations (those not specifically  identified in Section 964), such as market surveillance and restitution for  harmed investors.

FSIO examinations either focused on a single Section 964 area or  considered multiple areas.

Some examinations focused specifically on a single Section 964 area.

For example, in 2017 FSIO reviewed FINRA’s arbitration program,  which provides retail investors a venue for resolving disputes with  their brokers.

Other examinations considered one or more of the areas as part of a  broader scope. For instance, a program inspection completed in 2016  touched on FINRA’s arbitration services, cooperation with state  securities regulators, transparency, and other topics. Another program  inspection involved governance, policies on former employees, and  other topics.

FSIO examinations most frequently covered FINRA examinations (41  of 61). Nearly all of the oversight examinations reviewed at least some  aspect of FINRA examinations. In two cases, the oversight  examinations also covered another area—review of advertising by  FINRA members.

Selected Guidance Used for FINRA Governance Inspections Generally Was Consistent with Relevant Auditing Standards

We found that OCIE policies and procedures used for examining FINRA  since fiscal year 2015 generally were consistent with the requirements of  generally accepted government auditing standards. SEC uses an  examination manual to conduct its SRO examinations. We previously  found that OCIE policies and procedures (including the prior version of  the manual) generally were consistent with the requirements of the  auditing standards that we determined were most relevant to assessing  examination policies and procedures: independence, competence, quality  control and assurance, planning, supervision, evidence, documentation,  and reporting.

We compared the current and prior versions of the examination manual.  More specifically, we selected requirements for planning, prefieldwork  scoping, and communicating findings from the current manual and  compared those with similar sections in the prior version of the manual.  We found that the new version includes the same material as the prior  version while also incorporating additional guidance in certain areas. The  planning section of the current version includes two additional  requirements on the inclusion of non-National Examination Program  staff. The communicating findings section of the current version  included two additional requirements related to extensions of time to  respond to disposition letters. Two of the four additional requirements  were generally consistent with government auditing standards, and the  remaining two additional requirements were minor adjustments that did  not materially change the requirements. Therefore, we deemed the  selected sections of the current version of the manual to also be  consistent with the auditing standards.

Inspections of FINRA Governance Were Consistent with SEC Internal Guidance

OCIE (and from 2016, FSIO) program inspections of FINRA governance  in fiscal years 2015–2017 were consistent with internal examination  guidance. OCIE identified five inspections in that period that related to  FINRA governance. Each of the inspections focused on one of the  following areas: (1) code of conduct, (2) executive and employee  compensation practices, (3) investment portfolio, (4) compliance resource  provider program, and (5) the funding mechanism for its regulatory  services agreement.

FINRA’s code of conduct imposes restrictions on employees’  investments and requires financial disclosures that are uniquely  related to its role as a securities regulator. The code also outlines  FINRA’s ethical commitments and expectations and provides  guidance on what employees must do to meet them.

FINRA’s executive and employee compensation practices consist of  salary and incentive compensation determined by FINRA’s  Management Compensation Committee using operational, strategic,  and financial factors, in addition to individual performance.

FINRA’s investment portfolio is governed by a policy based on the  degree of risk appropriate for FINRA assets, as applied by its board to  its investment objectives.

In the compliance resource provider program, FINRA worked with  organizations to offer firms compliance-related products and services  at a discounted price or with additional features. According to FINRA  staff, this program was discontinued in May 2017 and replaced with  FINRA’s Compliance Vendor Directory.

FINRA’s regulatory service agreements are designed to provide  market surveillance, financial surveillance, examinations,  investigations, and disciplinary services to other entities, including the  New York Stock Exchange LLC and the Chicago Board Options  Exchange.

For our review, we judgmentally selected the most relevant requirements  from the section of the examination manual related to planning  inspections and the most relevant requirements from the section of the manual related to communicating inspection findings to determine if OCIE  conducted the inspections in accordance with its guidance.

The planning section covers planning examinations and prefieldwork  scoping and requires the examination team to discuss the results of  background research and determine an appropriate scope for the  examination as early as possible.

The communicating findings section requires entities to be provided  with timely and concise communications on the results. It also  discusses how examination staff should take further actions for those  findings that could involve notifications to other regulators.

We reviewed relevant inspection-related documentation (including scope  memorandums, disposition letters, emails, and information extracted from  an examination database) and compared them against the selected  requirements to determine if the guidance was followed. We tallied our  results with a scorecard methodology (see fig. 1).

We found that all five inspections we reviewed met all requirements  applicable to that particular inspection. For example, across all the  inspections, OCIE examiners held prefieldwork meetings and  documented and received approval for the scope of the examinations.  Additionally, all five inspections met the required 180-day completion  deadline and closed the inspection with a disposition letter. In cases in  which requirements were not applicable, the reasons generally were that  a triggering event had not occurred and no further action was needed. For  instance, the scope was not modified in any of the inspections, so the  requirement for approval of such modifications did not apply.  Furthermore, none of the inspections included non-National Examination  Program staff (such as personnel from SEC’s Enforcement Division), and  so requirements surrounding participation by those groups did not apply.

We provided a draft of this report to SEC for their review and comment. In  its comment letter, which is reprinted in appendix II, SEC concurred with  our findings and appreciated our attention to the issues discussed in the  report. SEC also provided technical comments on the draft report, which  we incorporated as appropriate.

We are sending copies of this report to the appropriate congressional  committees, the Securities and Exchange Commission, the Financial  Industry Regulatory Authority, Inc., and other interested parties. In  addition, this report is available at no charge on the GAO website at  http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-8678 or clementsm@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix III.

Appendix I: Objectives, Scope, and Methodology

This report (1) determines if the Securities and Exchange Commission’s  (SEC) oversight of the Financial Industry Regulatory Authority, Inc.’s  (FINRA) operations and programs since fiscal year 2015 included the 10  areas specified in Section 964 of the Dodd–Frank Wall Street Reform and  Consumer Protection Act (Dodd-Frank Act), (2) evaluates the extent to  which selected SEC internal guidance on conducting examinations of  FINRA follows generally accepted government auditing standards, and  (3) evaluates the extent to which examinations of FINRA’s governance  practices followed SEC’s internal guidance.

To assess whether oversight of FINRA by SEC’s Office of Compliance  Inspections and Examinations (OCIE) included the Section 964 areas, we  requested and reviewed documentation for all examinations since fiscal  year 2015 (from October 2014 through April 2018) that OCIE staff  identified as relating to Section 964 areas. We use the term  “examination” to include program inspections, two types of oversight  examinations, and oversight activities stemming from tips and referrals.  The documentation included scope memorandums, deficiency letters, and  closing letters to the file for OCIE examinations. We evaluated whether  the documentation indicated that an examination’s scope and findings  covered one or more Section 964 areas or included other areas related to  FINRA oversight that were not specified in Section 964.

To determine the extent to which OCIE’s internal guidance on conducting  examinations of FINRA followed generally accepted government auditing  standards, we compared SEC’s examination manual against generally  accepted auditing standards. We reviewed selected sections of the  current version of the manual and the earlier version. We judgmentally  selected the two sections that most directly related to our focus on self- regulatory organization (SRO) inspections, which focused on preparing  for examinations and communicating examination findings. Other areas of  the examination manual that were not relevant focused on administration  and organizational issues. We relied on our work that found that the  earlier version of the manual followed the auditing standards and also  interviewed pertinent staff within OCIE to discuss the guidance and why it  did or did not include certain elements. We analyzed any differences  between the versions to determine whether changes or additions in the  current version of the manual also followed auditing standards. In  addition, we interviewed FINRA staff to gain a general understanding of  how OCIE staff work with them to conduct examinations.

To determine the extent to which OCIE’s program inspections of FINRA’s  governance in fiscal years 2015–2017 followed OCIE’s internal guidance,  we used a scorecard methodology to compare inspections of FINRA’s  governance with the examination manual and draft updates. We only  reviewed the extent to which examinations followed specified guidelines  and did not evaluate the analysis, findings, or disposition of the  examinations. We created a checklist of relevant elements from the  examination manual by judgmentally selecting 6 requirements from the  planning inspections section of the manual and 11 requirements from the  communicating findings section of the manual that were most applicable  to our focus on the actual SRO inspection process. Other requirements  that we deemed less relevant include examinations of exempt reporting  advisers and the process for approving examination documents.

The planning section of the manual covers planning examinations and  prefieldwork scoping and requires the examination team to discuss  the results of background research and determine an appropriate  scope for the examination as early as possible.

The communication of examination findings section requires entities  to be provided with timely and concise communications on the results.  It also discusses how examination staff should take further actions for  those findings that could involve notifications to other regulators.

We then reviewed different types of inspection-related documentation to  determine whether the guidance was followed. For instance, we assessed  certain inspection requirements, such as compliance with changing the  scope of the inspection, based on formal written documentation such as  scope memorandums and disposition letters. We assessed other  requirements (such as whether prefieldwork team meetings were held)  based on informal documentation, such as email appointments. We also  relied on other internal documentation, which included the examination  tracking database, which is used to certify compliance with a requirement  to complete an inspection within 180 days from the completion of audit  work.

Two analysts then independently compared the elements against  documentation for the five OCIE inspections to determine the extent to  which the inspections documented the requirements outlined in the  examination manual. Analysts assigned a rating of “yes” if the element  was found in the inspection materials we reviewed, “no” if there was no  mention of the element in the inspection materials we reviewed, “partially”  if the element was not fully addressed in the inspection materials we  reviewed, and “n/a” if the element was not applicable to the inspection.  We also interviewed pertinent staff within OCIE to discuss the guidance  and why it did or did not include certain elements.

We conducted this performance audit from November 2017 to July 2018  in accordance with generally accepted government auditing standards.  These standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

Appendix II: Comments from the Securities and Exchange Commission

In addition to the contact named above, Karen Tremba (Assistant  Director), Jon D. Menaster (Analyst in Charge), Kevin Averyt, Farrah  Graham, Marc Molino, Akiko Ohnuma, Barbara Roesmann, and Jessica  Sandler made key contributions to this report.