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Fighting Fraud in Schools

Lax controls open doors to crimes.

It’s no surprise that school districts 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’s 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 better manage 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, state 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

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

Many districts have adopted policies and implemented procedures to detect and prevent it. “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.

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,” says 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

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

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

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 now 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, a purchase between $10,000 and $90,000 requires approval of one of the superintendent’s leadership team members, who include seven division chiefs, five assistant superintendents and six area superintendents. A chief and the superintendent must approve purchases above $90,000.

Employees who have to make purchases under $2,500 can use credit cards—the district calls them “purchasing cards”—or Direct Pay Requests that require detailed documentation of the purchase and the signature of the appropriate “budget manager,” who is generally a principal or central service administrator with budget expenditure authority, Neter says. Then the accounting department issues a vendor check for the purchase. Before being certified as budget managers, administrators must attend a one-and-a-half-day training session on policy and practice issues including purchasing, risk management and compensation services, and then pass a test, Neter says.

Credit card purchases are limited to $2,500 per transaction and a maximum of $15,000 per month. Neter explains that before cards can be used, funds must be encumbered to cover the purchases. Budget managers must review and sign the monthly statements for the cards and confirm there are receipts and shipping documents for goods ordered and that the goods have been received.

Neter’s own hiring came in the transportation fraud’s aftermath when Deputy Superintendent Adelphos (Del) Burns was appointed superintendent in 2006 and created the position of chief business officer. “A lot of the system’s management [in the past] had been through promotion from within,” Neter says.

Another step was expanding the internal audit department from one person to five. When there was just one person, “he was dealing with anything that was acute, and that was about it,” Neter says. Now the expanded staff audits the district’s departments and divisions and 156 schools and their cash management procedures on a regular basis.

Further, the district has hired “fiscal administrators,” who have accounting or auditing backgrounds, and embedded them in different departments as “watchdogs” to ensure that fiscal policies and procedures are followed, Neter says. The fiscal administrators provide “expertise and counsel,” he explains. To underscore their independence in the departments where they work, they report to the district’s finance officer, who works under Neter.

Beyond School Employees

Some types of fraud do not involve crimes by school employees. In Arizona, the state charged a parent last December with defrauding the Prescott Unified School District of $3,000-$25,000 that should have gone to a special-needs tutor for his autistic son in 2007. Legal proceedings against the parent are underway.

“Even when there are controls, there are ways to circumvent them,” says Mullinax. “If you can have AIG and Bernie Madoff and all that stuff going on in the private sector, there are people who are clever enough to find the spaces in school finance systems,” adds Hersher of the California Department of Education, “and if the local folks who are supposed to be poring over the books to make sure everything is going right don’t do it, you’re only going to have after-the-fact law enforcement.”

Kelly Todd, a member of Forensic/Strategic Solutions, who spoke about school fraud last year at a conference for school district auditors in Minnesota sponsored by the Minnesota Society of Certified Public Accountants, 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.

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

Alan Dessoff is a contributing writer for District Administration.