Even as Orange County’s then-treasurer was making wrong-way investment bets with public money and illegally
skimming millions into county accounts, the county got a clean bill of financial health from its auditor.
Even as Bell was paying enormous salaries and giving dubious loans to insiders, the city got a clean bill of financial
health from its auditor.
And now, as Placentia’s No. 2 finance manager stands charged with embezzling $4.3 million from under official
noses, city leaders fault their auditor for failing to detect theft.
There have been numerous examples of financial scandals in California local governments, each accompanied by
expressions of shock from officials, fingers pointed at auditors and vows to more vigilantly guard taxpayers’
money.
A raft of financial and auditing reforms was proposed in Sacramento to help accomplish that after Bell officials
were accused of looting millions from the small city’s treasury in 2010. But of seven bills pushed by then-state
Controller John Chiang and others, just two became law.
The state auditor was empowered to start a high-risk local government audit program, and the state controller to
appoint certified public accountants to examine agencies that failed to provide audits themselves. But proposals to
greatly expand the controller’s power to investigate counties, cities, special districts and joint-powers authorities
were shot down when agencies protested that they’d get stuck paying for the extra oversight.
Experts say more can be done to protect the public purse, including simple, inexpensive steps that would enhance
safeguards and make what allegedly happened in Placentia far harder to pull off.
They include adding the elements of surprise and secrecy, such as keeping top managers in the dark about the
focus of financial probes to lessen the potential for interference or cover-ups. Some of the strategies were
pioneered locally in Laguna Niguel, later embraced by Mission Viejo, and adapted by Yorba Linda and Pasadena.
But they’ve failed to catch on statewide, or even countywide.
Public agencies in Orange County spend close to $2 million every year on mandated, outside financial audits.
Despite what many officials believe, such audits aren’t designed to ferret out fraud. They essentially check one set
of numbers provided by officials against other sets of numbers also provided by officials, and sample internal
controls.
Rich Kikuchi, managing partner with Placentia’s auditor, Lance, Soll & Lunghard, said his firm did exactly what it
was supposed to do. But he believes governments should do more.
“I’m hoping that, out of all this, the public and city officials will really come to understand the need to have an
internal-type audit, a watchdog-type audit,” said Kikuchi. “To keep people on their toes, it needs to have an
element of surprise. When I put myself in the shoes of a mayor or city council member, that’s what I’d want. That
would help me sleep at night. But that’s not what a financial audit is.”
NO SURPRISE
In fact, experts generally agree, the type of audit required from local agencies is of limited value.
Its primary goal is to determine if financial statements are “materially correct” – or correct within reason – and
comply with generally accepted accounting principles. That’s an important certification demanded by outside
financial parties and those who lend cities money.
At the heart of such annual reviews are the financial statements, numbers supplied by the agencies themselves.
The reports provide a snapshot of the city’s books at year’s end. To ensure the city’s numbers are correct, financial
auditors look at documentation, reconcile account balances, ask questions and examine internal controls. But
importantly, according to Kikuchi and other government auditors, there are no surprises involved.
Audits happen at the same time every year. Appointments are scheduled months in advance. Managers have
plenty of time to prepare and get their books in order.
“What many citizens and governing board members think is an audit is most certainly not what financial auditors
are engaged to perform,” Kikuchi said.
Bell was the ultimate example of that. As Mayer Hoffman McCann – then Bell’s Irvine-based financial auditor –
stressed at the time, it’s extremely hard to fully vet an agency that’s determined to hide questionable or illegal
transactions.
Mayer Hoffman McCann conducted at least 17 audit procedures designed to address fraud risk in Bell, said Bill
Hancock, the company’s president, in a statement after the corruption was finally exposed.
At every step of its probe, city officials “misrepresented and gave false audit evidence that concealed the abuses,”
Hancock said. Such collusion raised “broad, profession-wide issues concerning fraud risk in financial statement
audits … which we believe the current standards do not completely reconcile.”
Ultimately, Mayer Hoffman McCann paid $350,000 in fines and investigative costs to the state Board of
Accountancy for failing to detect the abuses. It no longer does municipal audits in California.
There was hope for major reform in Bell’s wake. The state controller began to collect and publish pay data for
thousands of public agencies. The finances of “high risk” agencies came under greater review. Audit firms provided
more training to staffers. And Controller Betty Yee published “internal control” guidelines to help agencies avoid
the problems that befell Bell.
But those guidelines – “to assist local agencies in establishing a system of internal control to safeguard assets and
prevent and detect financial errors and fraud” – are voluntary.
And, as Placentia’s experience suggests, embezzlement can still continue with relative ease over the course of
many months, and perhaps years, without being detected.
SURPRISE!
Laguna Niguel was a leader in adopting key reforms before the Bell scandal erupted.
The seeds of the tighter controls were planted after Orange County Treasurer Bob Citron’s risky investments led to
the county’s $1.64 billion bankruptcy in 1994. The push intensified five years later when the Yorba Linda City
Council accused its top manager of doling out $600,000 in unapproved bonuses.
Outside auditors didn’t detect that things were amiss in either case.
Laguna Niguel responded by developing extra layers of examination, allowing auditors to work directly with
elected council members rather than city management, and incorporating new elements of unpredictability.
Each year, auditors gather personnel files for the city manager, top city brass and other selected employees. They
compare payroll records – what the workers were actually paid – to City Council resolutions on what they should
have been paid. Auditors check car allowances, bonuses, vacation cashouts and salary adjustments to make sure
everything adds up and is authorized.
In addition, each year, the mayor and mayor pro tem pick two areas that will get a deeper review of internal
controls. Those might be scrutinizing transfers in and out of the city’s bank accounts to be sure they’re legitimate,
examining how cash is handled in the Recreation Department or examining investment transactions for
irregularities.
The mayor and mayor pro tem communicate with auditors directly, which makes it harder for staffers to cover
their tracks, or bury unpleasant findings.
That sort of “audit-within- the-audit is very unique,” said Rod Foster, Laguna Niguel’s city manager, who has
worked in Colton, Chino, Hesperia and Upland. “I don’t even know what those are until the report comes out.”
The city also changes audit firms every five years to keep the watchdogs and the staff from getting too cozy. This
year, Laguna Niguel is asking its new auditor, rather than city employees, to prepare reports required by the state
controller’s office.
Taken together, the reviews and changes in reporting responsibilities mean more outside eyeballs on the city’s
books, which enhances accountability, said finance director Stephen Erlandson.
Those type of extras cost more, but not much. The basic financial audit for a city of Laguna Niguel’s size – total
revenue of $46 million, population 65,000 – is $39,000. With the extra work, Laguna Niguel expects to pay
$45,000, Erlandson said.
The more rigorous system was developed under former finance director Cheryl Dyas, who took the blueprint with
her to Mission Viejo, where she’s now administrative services director. In the wake of the Placentia embezzlement
case, her City Council wants to examine more ways to avoid similar problems.
Ideas include a rotating operational and financial review of individual departments, and will be discussed at the
next City Council meeting, she said.
Big agencies, like the County of Orange with its $5.6 billion budget, have an internal auditor to do this kind of work.
Over the years, the job has been handled with varying levels of zeal. Current auditor-controller Eric Woolery has
ruffled feathers in county management with an aggressive style. He has no apologies.
“Detecting fraud is very difficult, almost like finding that needle in a haystack,” he said.
“There are so many different forms. You can have something like Placentia, where an employee seems to go
rogue; you can have more sophisticated scheme where employees set up a dummy vendor and make payments to
it, which through the system looks very legit. To anyone auditing from outside, it would look like a normal
payment.”
One defense is promoting a culture of shared responsibility, in which all staffers are encouraged to report what
doesn’t seem right. The county received 346 tips on its fraud hotline last year. Other agencies might consider
starting one, Woolery said.
“The best defense for fraud is the internal control system,” he said. “Practices and segregation of duties to make
fraud more difficult. Elements of surprise in high-risk areas like petty cash … so no one knows it’s coming.
“The biggest frauds are always committed by managers overriding the system.”
http://www.ocregister.com/taxdollars/city-714331- financial-audit.html
