Trust, but Verify: Case Study Examines Financial Fraud in Government

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This is a guest post written by Adam Levenson of UNC-Chapel Hill’s MPA@UNC program.

Trust-Verify

“Trust, but verify.” According to certified public finance officers Stan Helgerson and David Richardson, Ronald Reagan’s famous stance on international arms control is just as applicable to financial controls in municipal government.

As experts in government accounting and financial management, Helgerson and Richardson have been involved in cleaning up after the largest municipal fraud case in US history in which a trusted city comptroller embezzled more than $50 million in a decades-long fraud.

In the recent “Trust, but Verify” webinar co-sponsored by MPA@UNC and NLC University, they joined University of North Carolina associate professor Kimberly Nelson to describe what went wrong in one small, mid-western city and how other cities can avoid similar thefts.

Weak Internal Controls: Inviting Abuse

As Richardson describes it, the scam began in 1989 when the city comptroller began exploiting internal control weaknesses to embezzle as much as $5 million per year from city accounts. The comptroller took the following covert actions:

  • Set up a secret, city bank account without the knowledge of city commissioners or her colleagues.
  • Directed statements from that account to a PO Box that only she controlled.
  • Improperly raised spending limits by manipulating application of state budget and appropriations procedures.
  • Inflated annual pension fund and liability insurance property tax levies.

She also commingled funds to hide deficits in individual funds by setting up 35 checking accounts in multiple banks.

The city outsourced its accounting, auditing, and bookkeeping functions, and the comptroller was able to intercept and re-direct funds to her personal accounts.

From a financial management perspective, Helgerson and Richardson say multiple factors set the stage for fraud:

  • One person was given too much power.
  • The city council did not conduct a constructive review of financial activity; nor was it receiving the type of reports that enable such review.
  • The comptroller assembled budgets without staff input and with little feedback from the city council.
  • Employees and constituents were encouraged to take advantage of personal favors such as loans or advances, institutionalizing dubious behavior.
  • A significant capital projects program provided more opportunities for siphoning off funds.

With a city commissioner form of government, the city’s elected officials—rather than paid professional staff—functioned as heads of various departments such as finance and public works. An expert in form of government and performance, Nelson notes that research does not conclusively prove that certain forms of government are at higher risk of corruption.

However, she says three evident risk factors can contribute to local government corruption: inadequate level of professionalism in government, insufficient internal controls, and in locations with population demographics characterized by low income, high unemployment and poverty rates, and lower education rates.

The Scam Unravels

The comptroller’s scam finally unraveled in fall 2011. While the comptroller was on vacation, the city clerk covering her duties discovered a secret checking account and notified the mayor. The mayor promptly notified the FBI who launched an investigation that ultimately led to the comptroller’s arrest and conviction for wire fraud.

To date, through insurance and the sale of the comptroller’s assets, the city has recovered about $40 million of the $54 million stolen.

Moving Forward: Lessons Learned

With the fraud exposed, the city moved proactively to address the crisis—bringing in Helgerson and Richardson to restructure and reorganize its financial operations. While their work was specific to the city’s situation, they say every city can learn these lessons from the case:

  • The governing body should require and discuss annual management letters from auditors to identify possible internal control weaknesses. With staff sometimes inclined to discourage management letter comments, a strong audit committee may be needed.
  • The governing body must play a meaningful role in the development and review of annual budgets and the review of regular financial reports.
  • Internal controls for all major accounting and financial reporting functions should be formalized and documented—from purchasing procedures to debt issuance.
  • Checking accounts and funds should be consolidated wherever possible.
  • Duties should be segregated and staff cross-trained wherever feasible.
  • Statistical and financial comparisons should be made with similarly sized governments to detect anomalies.
  • A reporting process should be established to review and evaluate how internal control initiatives are performing.
  • Outsourcing financial functions can only work securely with the proper in-house procedures in place.

Learn more about MPA@UNC’s partnership with the National League of Cities and fellowships available to NLC members.

Editor’s note: The names of the city and comptroller have been omitted at the request of the National League of Cities.

Adam HeadshotAbout the Author: Adam Levenson is the community manager at UNC-Chapel Hill’s MPA@UNC: online Master of Public Administration – a top ranked MPA program. To learn more about MPA@UNC, you can follow @MPAatUNC.