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Fighting Fraud in Schools

Lax controls open doors to crimes.

It’s no surprise that schoolS are as vulnerable to fraud as the private sector or any other segment of government. Crimes in districts include collusion with outside vendors who provide kickbacks to employees, misuse of district-issued credit cards, embezzlement of district funds, and theft of district property.

“Fraud happens everywhere,” says David Neter, chief business officer at Wake County (N.C.) Public School System. The district created the new position in 2006 after losing at least $3.8 million in a case wherein a local company sent the district phony invoices, which the district paid without receiving anything in return. Then the company kicked back some of the money to the director and other employees of the district’s transportation department and they used the money to buy luxury items. Neter is a CPA with an MBA from Duke University.

There is no national data on fraud in school districts. But, says Don Mullinax, a former inspector general in the Los Angeles Unified School District, “I think there is a lot more than administrators are aware of because they’re not looking for it, and if you’re not looking, you’re not going to find it until it hits you.” He now leads the government practice team of Forensic/Strategic Solutions, a forensic accounting firm that has worked with districts including Wake County and LAUSD. Most district leaders lack ways to uncover it, and when it is found, it is not always reported, he says. “What’s scary is that a lot of administrators and principals figure that’s not their job,” Mullinax says. “They are hired to be educators, and they don’t have a background in financial management or accounting or auditing, so they don’t focus on fraud. They wouldn’t see it if it walks up and hits them in the face.”

And sometimes what looks like fraud is not. The California state legislature created the Fiscal Crisis & Management Assistance Team to conduct audits if district leaders suspect possible fraud. FCMAT conducts up to 50 audits a year and often finds that while poor internal controls, processes and procedures give the appearance of fraud, those cases generally turn out to be “either a compliance issue or some procedural policy not being followed,” says Joel D. Montero, CEO of the fiscal management team. FCMAT recommends about 15 percent of the cases it audits for further investigation by law enforcement authorities.

School Challenges

In the Los Gatos (Calif.) Union School District in 2006-2007, a district technology staff member was found guilty of stealing about $200,000 of computer equipment from the district and selling it to a local reseller. When Richard Whitemore was appointed Los Gatos superintendent in May 2008, he assured the community that he would manage better the district’s financial and physical assets. “We have put the building blocks in place for a best-in-class inventory management system,” Whitmore stated. He declined to give details.

In Los Angeles, Mullinax, while he was inspector general, investigated a high school construction project, the Belmont Learning Complex, that began in 1997 with cost estimates that rose to $200 million, making it the most expensive project of its type in the United States before the district stopped construction in 2000, he says. He called in Forensic/Strategic Solutions, which uncovered fraudulent activities and lapses in financial controls—including fictitious vendors, duplicate payments, and widespread violations of competitive bidding policies—totaling more than $70 million.

Also in California, authorities are investigating two cases of alleged fraud by charter schools. In one, state auditors found in 2006 that a charter school chain, Options for Youth and Opportunities for Learning, had overcharged the state more than $57 million over three years, reimbursed its top executives for expensive SUVs, and paid thousands of dollars for employee parties at Disneyland. While the audit findings are under appeal, the charter school chain is still operating and “has not paid anything back at this point,” says Michael Hersher, deputy general counsel in the legal division of the California Department of Education.

Meanwhile, he reports the charter school movement still seems strong in California and the “basic structure of charter school regulations hasn’t changed.”

Credit Card Misuse

Many districts have adopted policies and implemented procedures to detect and prevent misuse of credit cards. “There is a heightened awareness now that you have to follow the proper procedures,” says Michael Jumper, assistant superintendent for business in the Katonah-Lewisboro (N.Y.) School District, where the state comptroller in 2005 found lax controls, questionable expense claims, and improper credit card purchases.

"There was no functioning system of controls, and it appears that some took advantage of this." -Alan G. Hevesi, former New York state comptroller

The big tip-off that something was awry at the district was the audit, which revealed that 57 percent ($48,129) of credit card purchases from 2001 to 2004 were paid without supporting documentation and $38,400 of the charges were paid without information regarding their business purpose. The audit found that several thousand dollars worth of equipment purchased with a credit card by the district’s director of administrative services at the time, including computers, a copier, printer, fax machine, books and software, was at the administrator’s home. Some of the items ultimately were returned to the district, but two computers that were unaccounted for cost the district more than $5,000, the audit report stated.

Now, says Jumper, all purchases the district makes are shipped only to district buildings, and Katonah-Lewisboro doesn’t use credit cards anymore. Employees can tap petty cash for purchases of $10 or less and are reimbursed only if they have permission from an immediate supervisor and then provide an original receipt. For all other buys, a purchase order is required, even for the superintendent.

Credit cards present potential problems because “they can be passed around and anybody can go on the Internet and use your card,” says Melanie K. Johnson, a cash-handling consultant in Raleigh, N.C., who has worked with school districts and discussed fraud at meetings of school business officers. Cash also is hard to track. “It’s usually small amounts taken over a long period of time by many people. Then it’s reflected in the bottom line at the end of the year and administrators wonder where it went,” Johnson says.

The problems at Katonah-Lewisboro occurred “because those responsible for watching were not doing their jobs. There was virtually no functioning system of controls, and it appears that some took advantage of this,” states Alan G. Hevesi, the state comptroller at the time, in his audit findings.

Katonah-Lewisboro, with 716 employees and an operating budget of nearly $108 million, hired an experienced claims auditor, who reports to the board of education, to review purchase orders, invoices and checks to be sure they match. If the auditor finds an error, “we will follow up with whoever created the purchase order and ask for an explanation,” Jumper explains.

Similarly, in the Wake County system, multiple new safeguards were put in place following a multimillion-dollar scandal involving district employees and fake invoices that shook public confidence in the system in 2004. A local vehicular parts company sent phony invoices to the district, which paid the bills without receiving anything for them. Then the vendor and the district’s transportation director, budget analyst and four other employees of the transportation department used the money to buy large-screen TVs, vehicles, Jet Skis and other luxury items. Most of those involved were convicted, and the company provided restitution, Neter says.

Detecting Fraud

Once the scandal became known, the Wake County district’s first move was turning to the Summerford Accountancy, a group of certified public accountants now known as Forensic/Strategic Solutions, to review the district’s system of accounting, purchasing procedures and fiscal management.

"People are going to trust one another right up to the time they are caught." -Melanie K. Johnson, cash-handling consultant, North Carolina

Based on Summerford’s findings and recommendations, as well as its own initiatives, the district beefed up its fiscal system, including its internal purchasing controls. One way the Wake County district seeks to control fraud now is to detect it with software—ACL— that looks for patterns in transactions. For example, the district requires a purchase order for any purchase over $2,500. The software goes through accounting systems and looks for “patterns of invoices being paid to a specific vendor just under that $2,500 threshold,” explains Neter. If it finds any, his office takes a closer look at them. Neter says that the district’s internal audit department uses ACL regularly and proactively to examine purchasing patterns within different departments and divisions of the school system, which has 19,000 employees and a $1.3 billion operating budget. Forensic/Strategic Solutions also used ACL in its LAUSD investigation, and the district bought the software for its own use.

New Checks and Balances

In Wake County, buying items between $10,000 and $90,000 requires approval of a member of the superintendent’s leadership team. For purchases above $90,000, a chief and the superintendent must approve. Items under $2,500 must be purchased using Direct Pay Requests, which require the signature of the appropriate “budget manager,” who is a principal or central service administrator with appropriate training, Neter says. The accounting department issues a vendor check.

Kelly Todd of Forensic/Strategic Solutions says a “use it or lose it” budget mentality in many districts is a red flag for fraud. “You hear these horror stories about purchases districts make that they don’t really need, because if they don’t use the money in their budgets, they’ll lose it next year,” she says. That was a factor in the Wake County transportation fraud, she adds. “The money was in the budget for the transportation department to use, so they ramped up fictitious purchases from a vendor who gave them kickbacks,” she explains.

“The school environment is a very trusting network of people,” Melanie Johnson concludes, “and people are going to trust one another right up to the time they are caught.”

Read more on checks and balances and other potential fraud threats.

Alan Dessoff is a contributing writer for District Administration.

Community Watchdogs

Some districts that have been defrauded, as well as others that have not, have tapped business experts in their local communities to keep a watchful eye on their fiscal operations.

In 2006, the Wake County (N.C.) Board of Education established an outside audit committee that still includes six members from the community, appointed by the board, who have business or legal expertise but no business dealings with the district. A written board policy spells out the committee’s duties, which include reviewing the results of an independent firm’s annual audit of the district as well as internal fiscal documents. Similarly, in the Katonah-Lewisboro (N.Y.) School District, four community members with auditing experience serve with three board of education members on an audit committee that oversees all internal fiscal processes.

No fraud has been discovered in the Jeffco (Co.) Public Schools, where a financial oversight committee has functioned since 1999. The committee includes seven business community members who meet monthly with the district’s finance staff and quarterly with the board of education. “They are great advisors. They push us on how to look at things and also give us credibility in the community because they provide an independent look at how we operate,” says Lorie Gillis, the district’s chief financial officer.

In the Los Angeles Unified School District, concerned district employees, vendors and community members can report allegations of fraud, waste and abuse to the Office of the Inspector General (OIG) on a telephone fraud hotline that Don Mullinax, a former inspector general in the district, initiated, or by e-mail or snail mail on a special form. The OIG investigates the tips itself or refers them to district administrators.

State authorities have acted as well. Following financial scandals at several Long Island school districts, New York legislators enacted a measure in 2005 requiring school board members statewide to undergo training to better understand their fiscal responsibilities. It also mandates that every district be able to do internal audits, form an audit committee, engage external auditors through formal bidding every five years, and create a corrective action plan less than 90 days after receiving an auditor’s recommendations.

Steps to Avoid Fraud

Follow these examples from districts that have put better controls in place after they were defrauded:

? Provide receipts for small items; otherwise use purchase orders. Michael Jumper, assistant superintendent for business in the Katonah-Lewisboro (N.Y.) School District, says employees can tap petty cash for purchases of $10 or less with permission and get reimbursed with a receipt. For other buys, a purchase order is required. In the Wake County (N.C.) Public School System, a purchase between $10,000 and $90,000 requires approval of one of the superintendent’s leadership team members. A chief and the superintendent must approve purchases above $90,000.

? Hire an experienced claims auditor. This person reports to the board of education and reviews purchase orders, invoices and checks to be sure they match. Alternatively, a certified public accountant can review the district’s accounting, purchasing procedures and fiscal management.

? Use software. The program can look for patterns in transactions.

? Expand the district’s internal audit department. When there was just one person in the audit department at Wake County, “he was dealing with anything that was acute, and that was about it,” says David Neter, chief business officer.