Stuart Hartley, of FocusROI, is incensed. Here's the note he's circulating to friends and colleagues:
A CPA firm under fire for its audit of a Long Island, N.Y. school district is reportedly shutting its doors. This came right after the scandal-plagued school district filed a $12 million lawsuit against the firm and the release of a scathing report by New York State Comptroller Alan Hevesi in which he blasted the accounting firm for failing to identify a multi-million-dollar fraud, not meeting professional standards, and violating auditor independence standards in its audit.
Specifically, a press release from his office indicated:
- The CPA firm did not meet nine mandatory professional standards for conducting audits.
- When a whistleblower first exposed the fraud in 2002, the CPA firm investigated and found only $223,136 in inappropriate payments. Using the same methodology, State auditors found $1.6 million in questionable payments.
- In its testing of school district spending, the CPA firm didn't look at cancelled checks and a cursory review would have revealed instances where the actual payee on the check was different from the payee listed in the firm's workpapers.
- The firm's workpapers, supposedly created in 2002 and 2003, allegedly contained payment information that was put in the district's records by district officials in 2004 to cover up fraud.
- The CPA partners sold financial and other software to the district creating a conflict of interest and violating professional standards requiring auditors to be independent.
Hevesi opined the work of the firm was "so appallingly inadequate that it would shock anyone associated with the auditing profession and certainly the taxpayers who depend on the firm to safeguard their money. Our auditors found fraud so pervasive that it would have taken significant effort not to uncover it. Even a rudimentary review of disbursements and cancelled checks would have revealed many instances of wrongdoing," He concluded that he was "extremely troubled by our findings, and I urge the State Board for Public Accountancy and the Nassau County District Attorney's Office to pursue this matter aggressively."
What strikes me as so interesting is the tone and references in the release. Here we are two and one-half years after Sarbanes-Oxley and the focus is back on the auditor. The terminology being used refers to conflict of interest and failure to maintain independence. We also see claims of other revenue than for auditing services. In this case, it concerns software.
The Actual Testimony of Hevesi:
In March the public became aware of the alleged theft of $223,000 of Roslyn School District funds that had been discovered, and then covered up, 18 months earlier. Over the next three months, spurred by an investigation by Nassau County District Attorney Denis Dillon, the public became aware that the fraud at Roslyn was much more extensive and involved more people than had previously been thought. So far, three officials have been indicted and charged with stealing or misusing more than $2.3 million.
Subsequently, allegations arose concerning theft by officials at the William Floyd School District, where two officials have been arrested and charged with nearly $1.5 million in theft of public funds. In the Three Villages School District, the former Superintendent is alleged to have charged more than $40,000 in personal expenses on a district credit card. In addition, there have been a continuing series of public disclosures alleging questionable behavior by board members and school officials at the Hempstead School District.
These allegations have created a crisis of confidence throughout Long Island. The clearest evidence has come in voting on school budgets on Long Island. In 2004, well over one-third of school budgets were rejected by voters, an all time high.
Given this public turmoil and erosion of confidence, it is imperative that State leaders and elected officials take immediate steps to restore the public’s confidence and ensure that the resources we have dedicated to our children’s education are used exactly for that purpose. I would like to describe just some of my Office has done in response.
The best defense against fraud is strong internal controls in every school district. My Office has worked with a coalition of various education organizations to develop policy solutions to improve the internal control structures in school districts and increase the effectiveness of some of the oversight mechanisms. The Schools Financial Accountability Coalition is comprised of representatives from my Office, the New York State School Boards Association, the New York State Society for Certified Public Accountants, the New York State Council of School Superintendents and the New York State Association of School Business Officials. We also worked with representatives from the State Education Department in developing our plan, and their assistance has been invaluable.
In addition, I have redirected resources within my Office and initiated audits of 21 school districts on Long Island, including in-depth audits of operations in five districts and audits of administrative expenses such as credit card usage, meals and travel in 16 other districts.
To-date we have issued three final audit reports from this effort. Two of those were reviews of the Baldwin and Plainedge school districts. I am happy to report that in both districts we found no wrongdoing, although we did recommend some administrative improvements in each.
On January 6, we completed our review of the external audit process at Roslyn during the period the alleged thefts were occurring. The fact that each school district is required by the State Education Department to undergo an annual audit is intended to give the public some assurance that taxpayer funds are spent appropriately. In fact, it was the presence of this annual audit requirement that led Comptroller Edward Regan more than 20 years ago to suspend the State Comptroller’s routine audit efforts in schools. Comptroller Regan made this point clear in a May 10, 1984 letter to then Assembly Speaker Stanley Fink, when he wrote that the State Comptroller was not doing regular school districts audits, because of “the fact that State Education Law requires school districts to be audited annually by certified public accountants.” This rollback of the OSC audit coverage was necessitated by budget cuts that resulted in substantial reductions in the number of Comptroller auditors. In fact, the number of the local government auditors was reduced by half during the 1980s and early 1990s.
Our report on the Roslyn outside auditor, Miller, Lilly and Pearce, was designed to determine why this outside check on the school district failed to operate effectively. The results of our review were remarkable. We found a complete failure of oversight.
The CPA firm knew, as early as 2002, that a fraud had occurred, but in its audits it never looked for more fraud. The CPA firm looked at what were clearly fraudulent transactions in the sample that it tested, but did not identify them as fraudulent. The CPA firm’s workpapers contain evidence of significant internal control weaknesses, but it never followed up to see what might have resulted from those weaknesses or pointed out that they could cause problems. District officials had to post millions of dollars of accounting adjustments at the end of each year to cover up massive theft, but the CPA firm failed to identify any unusual activity in its annual audit reports. In fact, in both the years we examined, the CPA firm gave the District a clean, unqualified opinion on its financial statements.
We found numerous deficiencies in this audit. Nine of 22 required professional standards for such an audit were violated. Violating any one of those standards can lead to professional sanctions. For example, an auditing firm is required to be independent of the school district it is auditing. We found obvious conflict of interests, clearly prohibited by professional standards. The CPA firm had designed and developed computerized accounting software and sold it to the District. The CPA firm also provided ongoing support and periodic upgrades and maintenance for this software. Thus, when the firm was auditing the accounting system, they were auditing their own work. In addition, the firm was involved in selling to the District student tracking software. They therefore had a financial relationship with the District outside the audit, a direct conflict of interest.
When testing transactions, the CPA firm did not review cancelled checks. Such a review is basic and elementary. In fact, the name on some checks was different than the vendor name for those checks shown in the District’s records. Because they didn’t review the checks, they missed this obvious fraud.
In another case, we found that the vendors listed on the CPA’s workpapers for certain payments were not the vendors listed in the District’s records at the time the audit was done. They were phony names put into the District records to cover up the fraud. And they were put into the records after the CPA’s audits were completed. In other words, the CPA had fraudulent information in its workpapers supposedly completed in 2002 and 2003 that was not put in the District’s records until 2004.
We asked the CPA firm to explain this discrepancy. The CPA told us that he was given the vendor names by the former Assistant Superintendent. This is an extraordinary admission for two reasons. First, the auditor is admitting that he simply accepted the verbal representation of a member of the organization he was auditing without verifying these assertions by checking them against the written records. That would be bad enough. But consider, the Assistant Superintendent is the person the auditor found to have stolen $223,000. She had resigned before the second audit reviewed by us was done. So she was not around to provide the fraudulent information during this second audit. The fact that the workpapers presented to us, and ostensibly produced in the summer of 2002 and 2003, contain phony vendor names that do not appear in the District computer records until February 2004, when someone changed the vendor names in an attempt to cover up the theft, is more than troubling.
In 2002, a whistleblower went to the CPA firm with evidence that a theft had occurred in the District. As a result, the District asked the firm to identify the amount taken. The CPA firm calculated that $223,000 had been stolen from the District by the Assistant Superintendent. The firm then helped District officials keep this fact secret from the public and other interested agencies, such as the State Education Department, the District Attorney, and my Office. Even though it was aware of this theft, the CPA firm made no effort in its audit for the 2002-03 fiscal year to actively look for fraud or other questionable activity, as required by national audit standards. It is of course now obvious that had the CPA firm done its job and looked for additional fraud, it would certainly have found plenty. In addition, when we replicated the work that the CPA claimed he did in calculating the $223,000 theft in the fall of 2002, we identified $1.6 million in questionable transactions, not $223,000. How this could have occurred, what actually happened, how more than $1.3 million in additional questionable transactions could have been ignored, is a job for the Nassau County District Attorney to determine.
Hartley sums it up: "In short, one of the fundamental safeguards we have all come to depend on, the outside independent audit, failed."
