Tag: audit committee

Metro Internal Audit – Collier and MNPS reports

The Metro Audit Committee meets next on February 12. We will consider the Metro Auditor’s reports about Collier Engineering and various allegations related to MNPS. Both are getting media attention and I think it is appropriate for me to comment transparently.

In connection with two investigation reports in 2018, I said in Audit Committee meetings that I think the internal audit department findings were inadequate. To put a finer point on it — I think the internal audit reports on investigations recently have pulled punches and sought to move on rather than fully address the allegations.

If you want to read more info about my thoughts about the internal audit function generally, read this.

In connection with Collier, I think the supplemental report we will consider this week is inadequate. Regarding the MNPS investigation report, I don’t have an opinion yet. (It’s voluminous, it came out just a few days ago, and I just haven’t gotten through it yet.)

On Collier…here is the basic internal audit timeline…

The Auditor’s initial report was issued on October 26, 2018. That version doesn’t seem to be online any longer. The Audit Committee discussed this report at our November 27, 2018 meeting. I thought the report was inadequate and I made six motions asking for the report to be supplemented and updated. You can see the motions on pages 9 and 10 of this package. The motions passed unanimously and that sent the Auditor back to work further. For context, in 3+ years on the Audit Committee, this was the first time we ever did anything like this.

The Auditor’s supplemental report is dated January 24, 2019 (although it wasn’t posted online until January 30, after I asked about getting it online).

I consider the supplemental report to still be inadequate. My email to the Auditor dated January 30, 2019, explains my reasoning. The summary is that I think the supplemental report is holding back and downplaying the seriousness of the evidence. I’ll continue to ask these questions at the Audit Committee meeting on Tuesday.

And MNPS…

The Auditor releases a 69 page report about various allegations related to MNPS a few days ago on February 6, 2019. As I mentioned above, I haven’t had the time to dig in on this the same way that I have done with the Collier reports.

I know two things at this point.

First, I currently do not have full faith in the willingness of Metro’s internal audit function to shine the right amount of light on alleged bad acts.

Second, I know there are people asking good faith questions about issues related to MNPS. As just one example, I saw that yesterday Phil Williams put out a 74 tweet opus about these allegations and the audit report. I’ve only skimmed his tweets, but it looks like he’s asking some of the same questions that I have about the willingness of the internal audit function to shine a bright line on controversial topics.

I have got a full schedule between now and the Audit Committee meeting at 4pm on Tuesday. I’ll try to get through this report by then. If I don’t, I’ll ask the Audit Committee to push off considering this report until our next meeting. I am not sure we can expect any of the committee members to meaningfully get through this important report in just 3 or 4 business days.

General thoughts about Metro’s internal audit function

I’ll warn you right now…this post will be hard to keep interesting. But as Metro’s Internal Audit function has been more in the forefront on issues like Collier Engineering, various MNPS allegations, and looking into the former mayor, I need to get some thoughts out. In this post, I’m going to cover some basic information about Metro’s internal audit function, what traits I think make for successful internal audit, and then some areas of possible improvement. If I have time today, I plan to work on a second post about the ongoing Collier and MNPS investigations being conducted by the Internal Auditor.

Here are some basics:

  • The Metro Auditor is set up under the Charter to be independent. The Auditor serves an 8 year term. I believe (but am not sure) that the current term runs through 2022. The Auditor reports to but is not controlled by the Metro Audit Committee.
  • The Metro Audit Committee has 6 members, who are the Director of Finance, the Vice Mayor, two Council members selected by the Council, a person chosen by the Nashville Area Chamber of Commerce, and a person chosen by the Nashville Chapter of the Tennessee Society of Certified Public Accountants. Council Member John Cooper and I are the two CM’s picked by the Council to be on the Audit Committee.
  • There are three key functions for internal audit — work with the external third-party auditors in preparing Metro’s annual financial audit, conduct periodic internal audits of Metro’s key functions, and conduct investigations as necessary of allegations of wrongdoing that impact Metro’s finances.
  • Two of these functions are predictable. Working with external auditors on the annual financial audit and conducting periodic internal audits of each department can be scheduled easily at least a year in advance.
  • The third main function — handling investigations of alleged wrongdoing — is not predictable. Sometimes, there’s not a lot of this. Sometimes, there is a lot to do.

What does it take to be a good internal auditor?

My basic description is that you want someone who has good accounting experience, a very practical operational understanding of the government, and a willingness to call out bad acts when necessary. It’s critical to be well-balanced with these traits to be successful. For example, without a solid, practical operational understanding, internal audit findings tend toward being over-careful and unworkable. And then departments will just ignore findings and recommendations. Also, without a willingness to call out bad acts, then internal audit tends toward just moving paper around and not ever improving government.

For an additional data point, here’s a brief article summarizing a report from the Institute of Internal Auditor’s Audit Executive Center. The article indicates that when internal auditors are hired business acumen and critical thinking are valued substantially more than traditional audit and accounting skills. This matches my impression that, yes of course, you need your internal auditor to be good at debits and credits. But more importantly, understanding operations and being able to think through what is an operational snafu that can be redesigned and what is a bad act is critical to a good internal audit function.

Areas of improvement

In my 3+ years on the Audit Committee, here are some of the areas of improvement that I have noticed. Some have improved. Some are a work in progress.

  • Enterprise Risk Management:
    • This is an industry term to describe having a formal process for an organization to identify all areas of risk, and then grade those risks. Once this is done, the result is used to decide where to allocate your internal audit resources.
    • To make up an exaggerated example…if Metro were to have a single, unbacked-up computer that stored all of its information about property assessments and property tax collections, the risk of losing that information would be graded as very high. In theory, that would mean that the processes around collecting and storing that data would be at the top of the list for an internal audit.
    • Many organizations build a ground up ERM assessment annually to inform the internal audit plan for the next year. Metro doesn’t do this. Metro relies on industry publications and studies, and experience/anecdotal evidence, to build a risk assessment. Metro would need to invest in an ERM software package to improve this.
  • Follow-up on findings:
    • There should be long-term follow-up on any findings from an internal report. When I joined the Audit Committee in 2015, that wasn’t happening.
    • So prior to 2015, an audit report could have a finding, the department could promise to fix the issue, and if the department then ignored the issue, there was never any follow-up or further reporting.
    • At the request of the Audit Committee, we now get reports twice a year (I think it is twice??) on audit items that are unresolved or where the department has pushed back an implementation date. This provides dramatically more oversight.
  • Rejected findings:
    • From previous experience, I expect that departments will accept the internal auditor’s recommendations and promise an implementation date for the fix. When I joined the Audit Committee in 2015, there were way too many recommendations that were being rejected by the department or where no implementation date was promised.
    • To me, that meant that departments probably didn’t have respect for that “business acumen” component of the internal audit function. Rejected findings likely meant that the department was basically saying that internal audit didn’t know what it was talking about.
    • At the request of the Audit Committee, all findings now have an implementation date for the fix. That’s good.
    • Also, departments are rejecting audit findings less often now. To accomplish this, in late 2015 or early 2016, the Audit Committee started asking the Auditor and the department heads to talk more and work out their differences, if possible. As word got around Metro that rejected findings were going to get more attention from the Audit Committee, more of these differences got ironed out.
  • Reports not timely online: Over the last several years, the Audit Committee has leaned on the Auditor to more promptly and more completely get all reports online. To be perfectly honest, my experience has been that mundane reports get posted quickly and controversial ones do not. As recently as last month, a series of reports were issued within days of each other. The most controversial one was the only one to not be posted when I checked. I had to ask about it before it was posted. This is better than it used to be, but not where I’d like it.

What does it all mean?

This Audit Committee work is drudgery. But it is critically important. My work to push for a better enterprise risk management assessment, to force more communication and problem-solving, to require follow-up reporting on unresolved findings, and to get all reports online quickly is the highest value, lowest attention work I’ve done during this term. You should know that David Briley (when he was on the committee as Vice Mayor) and John Cooper (who is the other CM on the committee) have been strong, reliable allies in this work.

This post is to provide background context for my next post about the current ongoing investigations. What I would like you to takeaway is that, in my opinion, there is some evidence that the Metro departments don’t always have a great opinion about the practical business acumen of the internal audit function. There is also some evidence that the audit function has typically shied away from controversy. I think these observations are important context for understanding the current investigations.

Some things I think…

For a brief moment, I think there is no complicated legislation pending before the Council. Soccer, transit, transit oriented development, freezing tax increment financing, and an anemic operating budget are all in the rear view mirror. Amazon, the Church Street Park land swap, and next year’s more anemic budget aren’t here yet.

I know this lull won’t last. I’ll take this chance to throw out some quick thoughts about several topics:

  • The “no economic incentives for Amazon until employees get their raise” resolution before the Council on December 4 is a sideshow. If you’re against the Amazon incentive, just vote against it when it comes before the Council. The current fiscal year is nearly half over. Employees didn’t get their cost of living increase. I worked hard for a different result…but it’s too late to do anything about it until the next budget season. Again, my advice is to handle budget issues in the budget. And, if you can’t vote for the Amazon incentive, just vote ‘no’ whenever it comes before us.
  • In an ironic twist, I hear through the grapevine that the administration might not resist this resolution because Amazon wouldn’t get any money for a few years (i.e., not until after the 2019 Metro elections), and by then employees would have gotten a cost of living increase. It’s ironic because it is hard to imagine the cost of living increases happening without an increase in the property tax rate. So, if they say “no big deal, the COLAs will happen before Amazon gets money,” it will essentially acknowledge an intent to raise the property tax rate after August 2019 but before they pay Amazon an incentive.
  • If my colleagues want something in exchange for approving the Amazon incentive, they ought to have their eyes on the enormous amount of sales tax revenue being collected out of the Council’s control at the Convention Center Authority. Last summer, the administration raided this stockpile to the tune of $10 million per year. There’s more to be had there…and that would be a more meaningful and long-lasting win.
  • Metro’s annual audited financials will be released in a few weeks. State law allows an ongoing audit to be discussed in an audit committee executive session. So, as a member of the Metro Audit Committee, I’ve seen a draft of the audit in an executive session. Due to a change in accounting rules, Metro’s unfunded retiree benefits obligation has to be restated this year. I’ve already been talking for a while about this completely unfunded obligation going over $3B this year. With the new accounting rules, the number in the audit is going to be around $3.9 billion. That means Metro is going to cruise straight through the $3 billion range and cross over $4 billion in 2019.  That’s a lot of unfunded retiree benefits.
  • About the ongoing Tax Increment Financing Study Group, I think we are on track to recommend some meaningful changes. We’ve got a robust web page up. Follow the link there to “TIF Committee Document Library” and you’ll find just about anything you could want to know about TIF generally and also about how it is used here in Nashville. Here’s a video of our November 20 meeting.
  • While we work on the TIF study group, I think deeper changes are needed at MDHA. The Tennessean’s Nov. 21 reporting about conflicts of interest was pretty brutal. I think they need re-invention and not incremental change.
  • I get lots of people asking me who will run for Mayor in 2019. I only know rumors, which means I don’t know anything. As reported in the Scene in September, here’s what I am looking for in a candidate for Mayor:

“We Nashvillians are an optimistic bunch, and for good reason,” says Mendes. “But we need a dose of honesty injected into our politics — honesty about inequalities that hold us back and honesty about deals that move Nashville forward. I’ll be looking for a candidate who believes in a better Nashville and who believes that citizens truly are partners in government. Partial truths and con jobs need to end.”

I hope everyone has a happy holiday season!

 

Bob

Recovery Court Audit

The General Sessions Recovery Court was audited in the aftermath of former Judge Casey Moreland’s indictment. As a member of the Metro Audit Committee, I received the audit report when it was issued last Friday. It usually takes several days for Metro to get it posted online. As of this afternoon, it wasn’t posted yet…so I am posting it here.

Among other things, the report found that the Recovery Court paid some travel expense for the staff of non-Metropolitan Nashville Government entities. The report says: “Specifically, airline fares for employees of the Davison County Drug Court Foundation were paid for by the General Sessions Recovery Court. The Davidson County Drug Court Foundation subsequently reimbursed $1,780 to the Metropolitan Nashville Government for these expenditures.” Another $8,868 was not reimbursed until recently.

I have asked Metro Audit if they have a schedule of the names of the people for whom travel was paid, the company/entity with which they were affiliated, the destination, and the dates of travel. Metro Audit is checking with Metro Legal to see if those work papers may be released. I think it is important for Metro to continue to take a lead role in shining a light on how these funds were used, and how the Davidson County Drug Court Foundation interacted financially with the General Sessions Recovery Court while under the watch of Judge Moreland.

Knowles Assisted Living Facility Audit

On July 18, 2017, Metro’s Internal Audit department published its report about the Bordeaux LongTerm Care and J. B. Knowles Assisted Living facilities. The audit covered the period after Metro privatized day-to-day operations of these facilities. In 2013, the management of the Knowles facility was taken over by a private operator, Autumn Assisted Living Partners, Inc.  In January 2017, Metro removed Autumn due to poor performance and its inability to pay the operating expenses or maintain the facility. Several Council members asked Metro Internal Audit to examine what happened.

You can see the full report here.

It is worth reading, but the important takeaways are:

  • Internal Audit forwarded the report to the DA and to the State Comptroller. I’ve been on the Metro Audit Committee for almost two years and this is the first referral like this that I recall.
  • The report summarizes: “Management of Autumn Assisted Living Partners, Inc. mismanaged the fiscal affairs of the former J. B. Knowles Assisted Living facility. Vendors were not paid timely, financial reports were not prepared, resident trust fund accounts were not maintained, and corporate and 1099 tax returns were not filed.”
  • The summary continues: “Contract performance oversight was lacking by the Metropolitan Nashville Hospital Authority and Metropolitan Nashville Government.”

I think it was a reasonable decision to privatize the day-to-day management of these facilities, but the execution went really, really badly for the Knowles facility. The private operator wasn’t up to the task, and Metro didn’t maintain enough oversight.

I have no idea whether the poor management by Autumn rises to the level of criminal activity. But it is noteworthy that the Metro Auditor Mark Swann felt required to provide a copy of the report to the DA and to the Comptroller. Regardless of how this shakes out, Metro must do better if it is going to outsource a job that impacts the health and lives of our citizens.

FY2016 Audited Financials Are Out

Metro’s Comprehensive Annual Financial Report For the Year Ended June 30, 2016, or CAFR, was accepted by the Metro Audit Committee yesterday and is posted online. It’s 320 pages of financial details about Metro. Since I’m still recovering from my rotator cuff surgery, and typing doesn’t feel great, I’ll just hit a few points of interest:

  1. The auditors provided an unqualified opinion — that’s good. See pages 19-21 of the PDF. That means that Metro’s financials fairly present its financial position in accordance with generally accepted accounting principles.
  2. The auditors did not find any material weaknesses in Metro’s financials. This is good.
  3. Metro added some information about tax abatements to the Notes this year. This was voluntary by the administration — it’s not required to be included. It is at pages 153-54 of the PDF, and describes nine current real property tax abatements.
  4. If you want to read up about Metro’s long term bond debt and commercial paper program, there’s lots of detail from pages 96-110 of the PDF.
  5. Metro’s pension plans are discussed at pages 111-131 of the PDF.
  6. Metro’s other post-employment benefits (OPEB) plans are discussed at pages 132-134 of the PDF. This shows the OPEB obligations are funded at 0%.  This will bite Metro at some point if left unaddressed.
  7. There is information about our investment in roads, streets and bridges at pages 155-56 of the PDF. There’s some interesting data about how the quality of our roads and streets took a hit with the flood in 2010, but are making a comeback over time.
  8. The fact that Metro does not have a good, accurate budget for Nashville General Hospital has an impact on the audit.  At page 20, the auditors include a “going concern” note about NGH.  At page 144 of the PDF, there is more detail.  Basically, because we continue to budget about $35 million even though the real cost is higher, the audit has to say, “The Government has budgeted and legally approved an appropriation of $35 million to the Hospital Authority for the year ended June 30, 2017. The Government has also not committed to provide additional funding to the Hospital Authority should such funding become necessary.” If Metro would budget a realistic budget and NGH met the budget, we would likely eliminate the “going concern” comment about the hospital.

Feel free to email me any questions or comments.

CAFR FYE 6/30/15 (a.k.a. “The 2015 Metro Audit Is Out”)

On December 8, 2015, the Department of Finance released the Consolidated Annual Financial Report for the year ended June 30, 2015. In accounting-ese, that’s the CAFR FYE 6/30/15. For the rest of us, that means Metro’s latest audited financial statements are out. You can find the full CAFR document here.

There was also a Metro Nashville Audit Committee meeting on December 8, 2015. The newly-released CAFR was on the agenda and Metro’s external auditors, Crosslin & Associates, were there to answer questions.

I am writing this post to help me remember some of what was discussed, and to share information with the public. The entire CAFR is more than 300 pages long. I am not trying to cover everything – just some of the things I found most important.

IF YOU DON’T WANT TO READ THE WHOLE THING…

Financial statements are boring.  Talking about financial statements is boring.  If you don’t want to read all of this, you should know that because of changes to accounting rules, all of Metro’s pension liability is included in the 2015 financial statements.  The result is that Metro’s liabilities for its core government operations are $323 million more than its assets.  In 2017 and 2018, further accounting rules changes will require Metro to include its enormous unfunded retirement insurance benefit obligations on its financial statements.  This will dramatically increase the amount of red ink on Metro’s balance sheet.

The amount of these pension and retirement benefit obligations hasn’t changed overnight, but the new accounting rules are forcing some very large liabilities onto Metro’s financial statements.  As we go forward over the next few years, we will need to pay attention to what real world consequences there will be from showing this much red ink.

SOME LINGO FIRST

The most interesting things in the CAFR are being driven by the Governmental Accounting Standards Board, or GASB, which is the independent organization that establishes standards of accounting and financial reporting for U.S. state and local governments. GASB issues statements about how governments like Metro must present financial information. GASB typically issues new statements several years in advance in order to give the accounting profession and governments time to adjust to the new standards.

Fiscal year 2015 is the first time financial statements are required to comply with GASB Statement No. 68, which is designed to improve the financial reporting for pension obligations. Basically, instead of discussing long-term pension liability in the written notes at the end of the financial statements, this year Metro was required to show its pension liability directly on its financial statements.

In fiscal years 2017 and 2018, GASB Statement Nos. 74 and 75 will require Metro’s Other Post-Employment Benefit, or OPEB, liability also to be added to the financial statements. The OBEP liability is the amount that Metro is obligated to pay for health, dental, and life insurance for retirees. Also, in 2017, GASB Statement No. 77 will require Metro to include additional information about tax abatements.

I will also mention a “Statement of Net Position.” This is the balance sheet for a government. Private sector companies have balance sheets that balance – this means that the company’s assets always equal its liabilities plus how much equity the owners have. It always balances, by definition. A government doesn’t have owners. Instead of a balance sheet, a government has a statement of net position – this means the assets minus the liabilities equals the “net position.” You hope your government has more assets than liabilities, and therefore a positive net position.

The last bit of lingo is to mention “going concern” disclosures. With private sector companies, if auditors make a “going concern” disclosure, it means that there is legitimate doubt about whether the company will continue to exist for the next year. I am admittedly not well-versed with the exact implication of a “going concern” disclosure in a government setting. But, for auditors, where there is severe financial distress, their guidelines require them to insist upon a specific “going concern” disclosure. More about that later.

PENSION

I mentioned that 2015 is the first year where GASB 68 is mandatory. To comply, Metro has added its long-term pension liability to its financial statements. Adding this large obligation to its financial statements means that Metro’s net position has decreased compared to previous years.

There are two parts of this to look at. First, in order to provide accurate year-over-year comparisons, last year’s CAFR numbers had to be restated to reflect what they would have looked like if the pension liability had been on the financials last year. If you look at the 2014 CAFR, it showed a net position for Metro due to governmental activities of $87,113,535. After last year’s liabilities were restated to include the pension liability, Metro’s net position went down to a negative $241,742,450. (You can see this restatement at Note 2, at page B-47 of the CAFR.)

Then, what happened this year? The net position for governmental activities slid another $80,929,233 to the negative. (CAFR, B-5) And so Metro’s net position (that’s assets minus liabilities) as of June 30, 2015, was in the red by $322,671,683.

I want to be clear. Nothing about Metro’s cash flow changed. Nothing about Metro’s pension obligation changed. Nothing here changes the fact that everyone seems to agree that Metro’s pension obligations are pretty well funded. The only thing that happened was that Metro’s long-term pension obligations were promoted, if you will, from the written-in-words fine print in the Notes up to the actual financial statements with the rest of the numbers. That said, a large negative net position is striking, and it is new for Metro.

If you want to see all of the detail on how the pension liability numbers add up, look at Note 7, at pages B-75 to 94 of the CAFR.

OPEB

For the 2015 CAFR, the OPEB obligations are still in the written-in-words fine print in the Notes. In 2017 and 2018, these obligations will get moved up to the financial statements with the rest of the numbers.

To find the fine print on the OPEB obligations, look for Note 8, which is at pages B-95 to 97 of the CAFR. You will see that the actuarial accrued liability for Metro retirees’ OPEB benefits is $2.16 billion, and there is an additional $473 million liability for MNPS retirees, for a total of $2.633 billion. This means that the expected cost to Metro to fully honor its post-retirement health, dental, and life insurance promises to retirees is $2.633 billion. This is funded at 0% — Metro has no money set aside for this obligation.

The current GASB rules do require Metro to include a portion of this liability on its financial statements. The 2015 statements include a liability equal to the payment that would be required this year in order to get the OPEB obligations fully funded in 30 years. (Think about it this way – if you had a baby in 2015 and you wanted to have tuition money in 18 years – how much would the first year of an 18 year savings plan cost you?) The amount Metro would need to pay this year to have the OPEB fully funded in 30 years is $1.192 billion. Since Metro is NOT making that payment, the $1.192 billion shows up as a liability on the financial statements. You can see that number on page B-8 of the CAFR. And this means that the financials already show a billion dollar chunk of the OBEP obligation.

I can’t figure out all the math, or predict where things will stand in a few years, but it is clear that Metro should expect its “net position” to get pushed much, much farther into the red once the unfunded OPEB liability is placed entirely on the financial statements in a few years.

Finally, because the plan is unfunded, Metro makes all payments due for retiree OPEB benefits as they become due. You can see on page B-95 that Metro paid about $72 million this fiscal year to honor obligations for Metro and MNPS employee insurance benefits. This number has been climbing steadily over the years. You get the logic – people live longer, insurance costs more, there are more retirees, and none of it is pre-funded – so of course, the annual cost increases over time.

TAX ABATEMENTS

The external auditors, Crosslin, shared with the audit committee that GASB 77 will require some additional disclosures about tax abatements no later than 2017. Crosslin said that Metro probably will not have to make many changes to implement this rule. The audit committee will need to learn more about this over the next few years.

GOING CONCERN?

In addition to describing the finances of the core Metro government, the CAFR also includes a compilation of the finances of Metro’s “component units.” The “component units” are eleven separate organizations in Metro like MTA, MDHA, and the Convention Center Authority. These units have separate audits that are not individually included in the CAFR. Typically, you would need to go to each of the units to obtain a copy of its full individual audit. You can see a list of these units at B-39 and 40.

One of the units, the Hospital Authority, has a “going concern” note in its audit. According to page 2 of Crosslin’s opinion in the CAFR, financial conditions related to General Hospital and Bordeaux Long Term Care “raise substantial doubt about the Hospital Authority’s ability to continue as a going concern.” I guess this probably isn’t a surprise?

But, going back to the 2017/18 requirements to add the full OPEB liability to Metro’s financial statements, the audit committee asked Crosslin if that will create a risk of Metro requiring a “going concern” disclosure. The basic answer was that Crosslin would have to assess the situation at the time. After further questioning, my sense was that there are several things that could make a difference. First, Metro might take steps to limit, or change, or fund, its OPEB obligations between now and 2018. Second, the accounting industry may change or update its thinking about what circumstances warrant a going concern note for a government. Third, investment market conditions can make a dramatic impact (positive or negative) on how long-term OPEB obligations are calculated. These factors could influence whether adding the full OPEB obligations to the financials will create the risk of a going concern disclosure

For me, the important takeaway was that they didn’t say “no – don’t worry about it.” Instead, they said that it depends. In my day job as a lawyer, where I sometimes help companies deal with financial distress, when auditors say that a going concern note is a possibility, it is a sign that something important and fundamental needs to be addressed.

WRAP UP

I would like to compliment Metro’s finance department and Metro’s departments, commissions, and agencies who help put the audited financials together. I know it is a significant group effort to get the financial statements together and compiled for the CAFR. Thanks to everyone involved.

If anyone has questions or comments about any of this, please feel free to email me at bob.mendes@nashville.gov