Questionable practice alarms forensic auditor

By Brooke Edwards
Staff Writer

VICTORVILLE • The city has two versions of its Water District audit done by two different firms for the 2007-08 fiscal year — and the reports show the same $51 million used two different ways, the Daily Press has learned.

On the Water District audit completed by Charles Z. Fedak & Company, the district was shown to have $58 million in cash and cash equivalents as of June 30, 2008.

That audit was used to help try and secure bond financing for the city’s wastewater treatment plant, according to Deputy City Manager Doug Robertson. But on the citywide audit for the same time period, completed by Mayer Hoffman McCann P.C., the Water District was listed as having just $7 million in cash.

That’s largely because the city’s audit includes $39 million in interfund loans not mentioned on the Water District audit. The city audit states these loans were needed to plug revenue holes for Southern California Logistics Airport Authority, the city’s utility and its golf courses.

However, no interfund loans were approved by the City Council and no promissory notes were executed for a loan from the Water District during that fiscal year.

Robertson said that’s because no formal loans were ever made, and the money used to cover the $39 million gap may or may not have literally come from the Water District.

“We looked at what unrestricted funds were available to be borrowed at that moment in time,” Robertson said. “The Water District had quite a bit of cash on-hand, and so, as a matter of convenience, we used it to show we weren’t borrowing from restricted funds.”

He said it’s called a “30-second loan” and that it’s a common way to balance the books in the municipal accounting world.

“I’ve never heard of a 30-second loan unless you’re trying to make the numbers look good,” said Greg Raffaele, owner of the forensic auditing firm Crosscor Valuations in Newport Beach, who reviewed portions of the two audits for the Daily Press.

Raffaele equated this type of “window dressing” to someone having two warehouses, and when an auditor comes to assess the value of what’s in one site you move all of your goods into that warehouse. Then, before they visit the other site, you move all of the same goods into the second warehouse so the assets are counted twice and the owner’s position looks better than it is.

“I don’t know if it’s fraud, but if it looks like a duck … If there’s smoke. You know the expression,” he said. “There is some manipulation here.”

The other problem is, according to the Water District’s audit, only $36 million of the cash total was unrestricted funds — $3 million less than what was pledged on paper.

Regardless, t h e Quarterly Investment Report ending June 30, 2008, and approved by council on Aug. 19, 2008, shows the Water District still had roughly $60 million total in the bank, which would indicate that no portion of the district’s cash was actually loaned out.

This begs the question: If the Water District funds weren’t used to cover the shortfalls in the other accounts, what funds were used?

That’s a question Robertson could not specifically answer.

He said that because the Water District funds are co -mingled in a pooled account with other unrestricted city funds, they are all used to balance each other out and not necessarily tracked separately. He said the city does not have a policy for documenting informal loans between these pooled funds, no matter the amount.

“If the Water District monies weren’t used,” he said, “there just would’ve been a longer list of unrestricted funds” pulled from that pooled account.

However, the Quarterly Investment Report shows that the water district funds were (and still are) held in separate bank accounts than the city’s pooled funds, with some even in different banks.

“The bank accounts themselves are completely separate issues and not part of the accounting,” Robertson said in response. He said “the accounts are still essentially pooled,” with frequent “movement of funds” between them.

This massive “30-second loan” aside, there are a series of other discrepancies between the two audits.

The other $12 million cash difference comes from the Water District audit listing money “due to the city” for operating expenses as a positive cash flow. This payment is not listed on the city’s water audit.

The city’s version also lists the Water District as starting that fiscal year with $60 million cash, while the Water District audit books it at $54 million. There’s a $663,268 d i f fe re n ce b e twe e n how much the district paid vendors that year, a $553,896 difference between what was paid out to employees and a $68,539 gap in how much the city took in from customers, to name a few.

Raffaele said the simple fact that the city has two accounts of the same fund by different auditors “always raises some sort of suspicion.” He said reputable firms can typically rely on each other’s work rather than duplicating it — and somehow coming up with such different numbers.

“The whole point of an audit is to give a third party user the comfort in knowing that they are relying on financial statements that are not materially misrepresentative,” Raffaele said. “How can I have confidence as the user of this audit when there’s a $50 million cash discrepancy? It begs the question: Which number is right or can I trust either?”

Robertson said the reason staff suggested auditing the Water District separately was because they knew the audit would be delayed and have some complications. He said they needed a clean audit quickly in order to seek bond financing to build the wastewater treatment plant and so they decided to use the Water District to leverage for that financing.

After those financing efforts failed, the city has instead continued to fall back on the Water District’s cash to fund the plant’s construction.

The Water District did loan the city’s utility $20 million in September — this time formalizing that exchange with a promissory note, per the recommendation of the city’s last two auditors.

Brooke Edwards may be reached at (760) 955-5358 or at