Back when the scandal became public, I checked Bell’s website for financial reports, but could not find any. That alone made me suspicious even before the steady stream of allegations about Rizzo and company started to flow.
Perhaps the audit firm did not see the handwriting on the wall, but I would have to know what the scope of the audit was, the reports issued and their contents before really weighing in on culpability.
I do have a problem, though, with connecting a financial audit report with the term “clean bill of health.”
Allow me to get hypothetical – absurdly so – to make a point.
It is possible that Al Capone could have produced complete and accurate financial statements for his criminal operation; maybe even filed his tax returns. They may have indicated that his organization was financially sound. However, I doubt anyone would have described them as a “clean bill of health.” Also pity the poor accountant whose job it would have been to prepare Al’s reports and returns. He would have had to swap his wingtips for a pair of cement shoes.
The primary purpose of a financial audit is to determine if the financial statements and disclosures by an entity are reasonable representations of its actual condition. An entity does not have to be “healthy” to receive an unqualified opinion; nor does a favorable audit mean there is an absence of fraud.
Part of any audit is an evaluation of the internal controls – the checks and balances designed to prevent material errors or misrepresentations. Good internal controls also make fraud more difficult to commit, although nothing completely eliminates its possibility. Collusion involving key people could defeat sound controls, at least for a time.
The Times article quotes from a report issued by State Controller John Chiang, “ We found the city of Bell’s administrative and internal accounting control system to be, in effect, nonexistent, as all financial activities and transactions revolved around one individual — the former chief administrative officer — who apparently had complete control.”
If this is true, Bell violated one of the most sacred of internal control rules: separation of duties. You always read stories about the bookkeeper who tracked the cash receipts, deposited the checks, paid the bills and prepared all of the accounting entries. The end is always the same – the bookkeeper takes the company for all it is worth.
When auditors encounter weak internal controls, they are supposed to modify their procedures, including (but not limited to), expanding transaction samples, performing more analysis, asking more questions of the client’s staff, etc.
If the increased scrutiny turns up evidence of anomalies or fraud, a forensic audit is probably advisable, assuming the client is cooperative. Because of its objective, a forensic audit is more detailed and focused on activities rather than financial statement presentation and disclosures.
The Times suggests that sloppy auditing might be prevalent throughout the state.
I do not suspect the City of Los Angeles has a problem with its external auditors, but one should not assume their objective is to discover fraud. If anything, their audit reports (see pages 1 and 2) clearly state the purpose, as they should, as “obtaining reasonable assurance about whether the financial statements are free of material misstatement.”
That leaves a lot of wiggle room in a multi-billion dollar organization. Los Angeles is large enough to have several Bell-style operations occurring within its departments. A scheme in the DWP was only recently uncovered despite operating for years.
It is worth noting that the auditor’s report to the City in 2010 stated there was a deficiency in internal control over financial reporting . The deficiency was considered significant, but not material (http://phinvv.files.wordpress.com/2010/11/simpson-and-simpson-internal-control-report.pdf).
The nature of the deficiency is not described in the report, but was said to be included in a schedule of findings. I could not locate that document.
Even if the deficiency was not material at the time of the report’s issuance, the fact that it is significant could make it material at a later date.
It is interesting that Controller Greuel did not distribute an e-mail blast as she routinely and immediately does when problems are uncovered in other areas of the city.
The external auditor’s finding concerned her department.