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Audits of city finances often cover up serious problems

The scandal in the city of Bell has resulted in seven separate investigations and one round of criminal charges against former City Administrator Robert Rizzo and other current and former officials. But year after year, during a period marked by record salaries, illegal taxes, loans to insiders and arbitrary fees on businesses, the city’s outside auditors, Mayer Hoffman McCann, gave Bell’s financial record a clean bill of health.

And Bell is far from being alone, according to a Times review of state and local records, which found that the independent audits that public agencies in California are legally required to obtain frequently fail to flag cases of fraud and mismanagement.

• Many cities that have been troubled by public corruption or mismanagement during the last decade — including San Diego, Compton and South Gate — got clean audits, even in cases in which public officials were later sent to prison.

• There has been a widespread failure by auditors to make sure that cities are properly spending hundreds of millions of dollars in redevelopment money. Each year, approximately 100 of the state’s 391 municipal redevelopment agencies fail to file annual reports as required by law. Auditors are supposed to flag that failure as a major audit violation subject to review by the attorney general’s office, but auditors catch the problem in fewer than 20% of cases, according to a recent report from the state Senate Office of Oversight and Outcomes.

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• Firms that deliver negative audits risk being replaced. Cities pay the auditors, and some officials have responded to negative findings by hiring new auditors. In at least one case, the new auditors gave Victorville a clean rating after the previous auditor found a raft of problems.

“The audits of municipal governments in California … are more creative than reality” based, said former San Diego City Atty. Michael Aguirre. “They come in and help cover up what has been going on in a city so they can issue a clean financial statement, for which they are charging lots and lots of money.”

Concerns about the quality of municipal auditing have been raised over the years by legislators and others. But the scandal in Bell has brought new attention to the issue. Even as Mayer Hoffman McCann issued audits that did not flag problems in Bell, the city won numerous awards for the financial reports signed off by the auditor.

State Controller John Chiang’s office is investigating the quality of the Bell audits. But officials said they have already seen enough to conclude there were major problems. Hallye Jordan, spokeswoman for Chiang, said state auditors were baffled by “how a CPA firm could miss the abuses the controller’s office found, and found rather quickly.”

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Mayer Hoffman McCann declined to comment on the Bell audits. The firm released a statement saying it was cooperating with the controller’s office in its review of Bell’s finances.

“Our hearts go out to the city of Bell’s hardworking taxpayers,” the statement said. “Our goal is to … work with the state controller and other regulatory authorities to pinpoint any issues that contributed to the situation in Bell, so that this can be prevented” in the future.

Among the most glaring problems in Bell, Chiang wrote in a September report, was the lack of internal controls, something auditors are usually supposed to check. “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,” Chiang’s report said, referring to Rizzo.

The Times, using documents obtained from the city, found excessive salaries for top officials, with Rizzo on track to earn more than $1.5 million in 2010. The Times also uncovered $1.9 million in illegal loans the city doled out to employees, a car dealer and a foundation without City Council approval, and special fees Bell demanded that some merchants pay to stay in business. None of these issues was noted by auditors.

After The Times’ reports, the controller’s office in a matter of weeks determined that the city had overcharged residents and businesses more than $6 million in taxes and fees. Chiang’s investigators also found that officials had placed $23.5 million in bond funds in a non-interest-bearing checking account, costing the city about $1.7 million in potential interest.

Those problems and others could have been found by auditors, according to experts in the field.

“I audit 70 cities in the state. I know what these guys make,” said Gary Caporicci, a certified public accountant who gives seminars on government accounting. “If I saw somebody makes $800,000, you have to say, ‘Time out. What’s going on here?’ ... It’s so out of line to what other clients have. ... Where are they getting all the money?”

Auditors also missed simple things, Caporicci noted, including the fact that Bell’s redevelopment agency did not produce an annual report or adopt an annual budget.

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“Should there have been enough red flags that some reasonable tests and procedures would have detected them?” asked Eric Sussman, a lecturer in accounting at UCLA’s Anderson School of Management. “There’s no question about that.”

Records and interviews show that the problems extend beyond Bell, with some of the biggest audit breakdowns occurring in redevelopment agencies — obscure arms of municipal government that allow cities and counties to use property taxes that otherwise would go to local schools and counties for economic development.

The Times’ review found that auditors around the state do a poor job of verifying that agencies are following the most basic tenets of redevelopment law.

Each year, according to a review by the Senate Office of Oversight and Outcomes, approximately 100 of the state’s 391 municipal redevelopment agencies fail to file their annual report on time.

That is supposed to be a “major audit violation,” and auditors are required to report it the controller’s office the following year. But only about 15 or 20 auditors each year do so, according to the report.

In addition to noting whether agencies have filed their required annual reports, auditors are supposed to make sure cities are following proper procedures before spending affordable housing money on things like city officials’ salaries.

But in nine of 12 municipalities the Senate Office of Oversight and Outcomes selected for review this year, officials had failed to do so. Not one of those agencies — Culver City, Hercules, Kerman, Marina, Monterey Park, Pismo Beach, San Bruno, Torrance or Tulare County — had been flagged by their auditor for the problem, according to the report.

“Nobody is watching anybody,” said state Sen. Alan Lowenthal (D- Long Beach), who has been a critic of redevelopment auditing and sponsored a bill in 2008 to strengthen it; the bill was vetoed. “I don’t think people understand the enormity of the problem.”

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San Diego provides another example. Four years ago, when some said the city was teetering on the brink of bankruptcy, a number of officials, including former Mayor Dick Murphy, resigned after it was revealed that the city had a $1.5-billion deficit in its pension program. An independent investigation led by Arthur Levitt Jr., a former chairman of the Securities and Exchange Commission, found mismanagement and illegal financial manipulations.

And yet, during that period, auditors had given the city a clean bill of health. In 2007, the auditor agreed to pay a $15,000 fine to the SEC for signing off on misleading financial statements.

Financial auditors are not supposed to be prosecutors or detectives. They are supposed to investigate and comment on the accuracy of the city’s financial statements. If they fail to do so, they could be sued for negligence. Los Banos filed a suit against its auditor last month for failing to detect that an employee had stolen more than $1.5 million. The state Board of Accountancy can fine an auditing firm or even strip it of its license.

But not all city officials want their auditors to uncover problems, and firms that do so are sometimes replaced.

In Victorville, Caporicci’s firm issued an audit that found more than a dozen major problems and concluded that the city “had not maintained adequate internal control and accounting records.”

City officials fired his firm and hired Mayer Hoffman McCann, Bell’s auditors.

Victorville spokeswoman Yvonne Hester said officials had fired Caporicci not because they did not like his findings but because he had turned his audit in late.

Mayer Hoffman McCann gave Victorville a clean audit the next year, although it also found that the city was under so much financial strain it was “unclear if the city could continue as a going concern.”

jessica.garrison@latimes.com

jeff.gottlieb@latimes.com


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