Austin, April 25 – State Representative Mark Keough (R-The Woodlands) hailed the passage of House Bill 1930 as “major transparency legislation that will force counties to comply with national accounting standards.” The short and simple piece of legislation requires that county auditors, such as Montgomery County Phyllis Martin, in counties with a population that exceeds 190,000, must conform their auditing rules and regulations to “generally accepted accounting principles.” The legislation amends Section 112.002 of the Texas Local Government Code which permits county auditors to adopt regulations for audits in their respective counties.
HB 1930 passed the Texas Senate on April 19, 2017, by a unanimous vote of 31 to 0. The Senate bill’s language is identical to that of HB 1930, which passed on a second reading in the Texas House yesterday afternoon at 3:53 p.m. The House unanimously approved this major legislation and will finalize the passage with a third reading and final vote during the day today. After that vote, the bill will proceed to Governor Greg Abbott whom Keough expects to sign the law swiftly so that it will become effective immediately.
The bill is the brainchild of Lubbock Representative John Frullo, a certified public accountant who runs his own printing business. Frullo, a longtime Republican activist and Tea Party favorite, wrote the legislation after he observed the odd methods by which county auditors attempt to obfuscate financial statements so that citizens cannot get a realistic picture of the financial condition of most county governments. Frullo asked his legislative colleague, Charles Perry, a Republican State Senator also from Lubbock, to author the proposal in the Senate.
Keough noted that “county financial statements are especially hard to read when it comes to the way they report contingent liabilities and future liabilities relating to employee benefits. One of the main purposes of the bill is to that citizens and public employees, who deserve this information, can be aware of the financial health of the entities which represent them or for which they work.” Keough said, “this bill requires counties to provide a clean audit.”
The case of Montgomery County: external and internal audits lack independence, in contravention of Government Accounting Standards.
Local governments apply the United States Government Accountability Office’s Government Auditing Standards (the “Yellow Book”) in conducting audits, because the American Institute of Certified Public Accounts and the United States Office of Management and Budget’s Circular A-133 now establish the Yellow Book as the Generally Accepted Accounting Principles (“GAAP”). Since bond ratings and valuations often depend upon successful audits, a local government’s adherence to the Yellow Book is important. The citation for the Yellow Book is Comptroller General of the United States, Government Auditing Standards: 2011 Revision (Washington, D.C.: United States Government Accountability Office, 2011). Internet: http://www.gao.gov/assets/590/587281.pdf.
The audits of Montgomery County are not full audits but rather test audits. The outside auditor, currently Weaver and Tidwell, L.L.P., performs a test audit only by conducting tests of the accuracy of information which the county has reported rather than confirming that all information is accurate. See, e.g., Letter from Weaver and Tidwell, L.L.P., dated August 31, 2016, to the Honorable County Judge and County Commissioners and Management of Montgomery County.
In other words, the County Auditor, who also acts as the Chief Budget Officer of the County, prepares the financial statements for the County. She audits her own books and accounts. The outside auditor then only tests those books and accounts for their accuracy rather than conducting a full audit.
The outside auditor does not check conformance of actual expenditures to the budget that the Commissioners Court approved. Rather, the outside auditor only tests whether the reported financial statements accurately reflect actual expenditures and the actual balance sheet (assets and liabilities) of the County.
As the County Auditor, Martin, stated on November 17, 2016, in response to a Public Information Act Request:
“Barring the annual financial report, which is compiled by the Auditor’s Office and audited by an independent audit firm, such as Weaver, there is no other single document reporting an audit of the entirety of Montgomery County, Texas, for a specific point in time. Audits are performed regularly, on a much smaller scale, for individual functions, such as the cash counts referenced above.”
While the foregoing comments do not ascribe any sort of fault upon the County Auditor or upon the County, since 1987, Texas law has created a problem for counties such as Montgomery County with a population of 225,000 or more. The Local Government Code mandates that the County Auditor is also the chief budget officer of the Commissioners Court. Tex. Loc. Gov’t Code Ann. Section 111.032 (Vernon 2016).
The dual role of the County Auditor creates a serious problem in Montgomery County. She acts as the budget officer who establishes the budget and maintains the financial books and records of the County and then also audits those same books and records, which she prepared. In other words, the Auditor must audit herself. She reports her audit to herself.
Montgomery County’s outside audits are deficient
Under the Government Auditing Standards, which are the Generally Accepted Accounting Principles, the outside audits of Montgomery County contain the following deficiencies (in order of Yellow Book section numbers) all of which relate to the lack of independence of the County Auditor and constitutes failures of the independence of the outside auditing firm as well:
Section 3.31. Internal Auditor Independence – GAAP requires the internal auditor to be located organizationally outside the staff or line-management function of the unit under audit. Furthermore an audit must be sufficiently removed from political pressures to conduct audits and report findings, opinions, and conclusions objectively without fear of political reprisal. In this instance, however, the County Auditor works closely with the Commissioners Court on a regular basis for budgeting purposes. She sits with the Commissioners Court at their regular meetings. The Commissioners Court sets her salary, which is substantially higher than every county auditor in Texas with the exception of Harris County. The County Auditor regularly meets with individual Commissioners Court members (the County Judge and Commissioners) to work with them to establish their department budgets. These meetings occur on an ongoing basis. There clearly is a political relationship with the County Auditor because she not only audits but works on the budget side of the accounting ledger. There is not sufficient independence between the internal auditor and the Commissioners Court under GAAP scrutiny.
Section 3.35. Nonaudit Work by Auditor. – The Yellow Book makes a major point: “If an auditor were to assume management responsibilities for an audited entity, the management participation threats created would be so significant that no safeguards could reduce them to an acceptable level. Management responsibilities involve leading and directing an entity, including making decisions regarding the acquisition, deployment and control of human, financial, physical, and intangible resources.” The County Auditor has assumed significant management responsibilities for Montgomery County. She sits with the Commissioners Court, interrupts meetings regularly, injects her opinions and her department’s policies as policy guidance for the Court, and supervises the individual Court members in budgeting. As Chief Budget Officer of the County, the County Auditor has direct management responsibilities under the Texas Local Government Code. One cannot criticize her for fulfilling these duties but the dichotomy of her role as Chief Budget Officer and as County Auditor has created this major conflict of interest that suggests the necessity of an independent internal audit of the County’s finances.
Section 3.36 provides the following examples of practices, which constitute exercising management responsibilities for the audited entity, in which such practices the Montgomery County Auditor engages:
“…setting policies and strategic direction for the audited entity”;
“directing and accepting responsibility for the actions of the audited entity’s employees in the performance of their routine, recurring duties”;
“reporting to those charged with governance on behalf of management”;
“accepting responsibility for designing, implementing, or maintaining internal control”; and
“providing services that are intended to be used as management’s primary basis for making decisions that are significant to the subject matter of the audit”.
Section 3.49 states: “If performed on behalf of an audited entity by the entity’s auditor, management responsibilities such as those listed in paragraph 3.36 would create management participation threats so significant that no safeguards could reduce them to an acceptable level. Consequently the auditor’s independence would be impaired with respect to that entity.”
Section 3.38 makes the critical point: “In cases where the audited entity is unable or unwilling to assume these responsibilities…, the auditor’s provision of these services would impair independence.” Clearly, the Montgomery County Auditor’s assumption of the foregoing services, whether by statutory requirement or by practice of Montgomery County, impairs her independence as an auditor and suggests the need for an audit that is truly independent.
The Government Auditing Standards recognize there may be situations where an internal auditor, due to statutory requirements, cannot avoid engaging in certain management responsibilities. In those instances, however, the internal audit and the outside audit must disclose the nature of the threat, which could not be eliminated. None of the Fiscal Year 2013, 2014, and 2015 audits of Montgomery County disclose those threats. Therefore, they fail to comply with this important Standard under GAAP.
Section 3.50 of the Government Auditing Standards holds that some services involving preparation of accounting records always impair an auditor’s independence with respect to an audited entity. The services listed under Section 3.50, in which the Montgomery County Auditor engages, include:
“a. determining or changing journal entries, account codes or classifications for transactions, or other accounting records for the entity without obtaining management’s approval;
“b. authorizing or approving the entity’s transactions; and
“c. preparing or making changes to source documents without management approval. Source documents include those providing evidence that transactions have occurred (for example, purchase orders, payroll time records, customer orders, and contracts). Such records also include an audited entity’s general ledger and subsidiary records or equivalent.”
The fundamental violation by Montgomery County and the County Auditor of Government Auditing Standards appears in the contrast between the County’s practices and Section 3.51 of the Yellow Book: “3.51 Management is responsible for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework, even if the auditor assisted in drafting those financial statements. Consequently, an auditor’s acceptance of responsibility for the preparation and fair presentation of financial statements that the auditor will subsequently audit would impair the auditor’s independence.” In summary, the County Auditor violates GAAP by auditing her own financial books and records.
Section 3.88 of the Yellow Book requires outside auditors, such as Hereford Lynch or Weaver and Tidwell, to create internal policies in order to ensure independent practices and ethics, including written policies for audits. Hereford Lynch, the outside auditor, failed to disclose its internal policies for maintaining such independence. There is, however, a significant shortcoming in the 2013, 2014, and 2015 audits with respect to the outside auditor’s observations. Sections 4.07 and 4.08 require an outside auditor to detect financial abuse within the County government for personal or family gain and also to identify corrective measures. Section 4.07 explicitly notes that such abuse includes “misuse of authority or position for personal financial interests of those of an immediate or close family member or business associate.” Instances of such abuse include the following inside the Montgomery County government and none of which the supposedly outside and independent auditor has detected or identified within the 2013, 2014, or 2015 audits:
- Bobby Adams. Mr. Adams is a close business associate of County Judge Craig Doyal. They co-own at least two businesses together. Mr. Adams is the representative of Halff & Associates, a major county contractor the county contracts for which Doyal regularly votes.
- Lindsey Doyal. Ms. Doyal is an employee of Montgomery County who works in the County Treasurer’s Office as a Payroll Coordinator. Her father, County Judge Craig Doyal, regularly votes for the department budget, which includes her salary, $60,983.42. Furthermore, the County Commissioners regularly vote, by consent, for all county employee salaries. Doyal does not recuse himself.
- Craig Case and the Wright family. Craig Case is an employee of Montgomery County and the son of Paul Case, the director of Montgomery County’s Building Maintenance Department. Craig Case works as an unlicensed welder for the HVAC section of the Building Maintenance Department and receives a salary of $91,706.77, far higher than a person of comparable skills or seniority would receive as an employee of that department. His direct supervisor is his father. In order to skirt the obvious nepotism, Craig Case is officially assigned to the County Engineer. His business card, however, lists the address of the Building Maintenance Department on Airport Road. The Wright family has three immediate family members who work together in the Building Maintenance Department, including Mr. Wright who is the deputy director of the department with a salary of $93,980.93. His wife, Leslie Wright, is the Officer Manager with a salary of $54,979.07. Their son Adam is unlicensed in any field but works on a field crew with a salary of $50,135.37.
- Jule Puckett. Ms. Puckett is an administrative assistant who receives $54.93 per hour. Even though she should be classified as an exempt employee, Commissioner Mike Meador has classified her as nonexempt so that she may earn the maximum overtime per year of 248 hours, which she regularly receives from year to year. During FY 2016, Ms. Puckett received over $130,000 in compensation as an administrative assistant. Comparable salaries in other Commissioner’s offices are approximately one-third of that amount. Ms. Puckett was a close childhood friend of Janie Meador, Commissioner Meador’s wife. They have remained close friends into adulthood.
- Suzie Harvey, the Elections Administrator and head of the Elections Department, is the biological sister of County Auditor Phyllis Martin. Ms. Martin audits Ms. Harvey, her sister, and assists the Elections Department with its budgeting, accounting, and bookkeeping.
Under sections 4.07 and 4.08 of the Government Auditing Standards, the County’s internal auditor, Ms. Martin, should bring the foregoing examples of abuse (as defined in the Yellow Book) to the attention of the external auditors, Hereford Lynch. Ms. Martin has not carried out that practice. Under section 4.08, upon receiving information about these family and business associate abuses, it would be the duty of the external auditor to investigate nepotism abuses and similar circumstances. Clearly, such an investigation has not occurred.
Section 4.19 of the Government Auditing Standards mandates: “When providing an opinion or a disclaimer on financial statements, auditors should also report on internal control over financial reporting and on compliance with provisions of laws, regulations, contracts, or grant agreements that have a material effect on the financial statements. Auditors report on internal control and compliance, regardless of whether or not they identify internal control deficiencies or instances of noncompliance.” None of the 2013, 2014, or 2015 independent audits contain reports on (1) internal controls over financial reporting, (2) compliance with provisions of laws, regulations, contracts, or grant agreements that have a material effect on the financial statements, or (3) internal compliance or controls. This shortcoming reflects a major deficiency in the County’s compliance with the Yellow Book and GAAP. These problems constitute deficiencies under sections 4.23 and 4.24 of the Yellow Book as well.
Under 5.02 of the Yellow Book, the outside auditors of the County perform an attestation engagement at the review, rather than the examination, level. Even review level engagements, however, must comply with the requirements to test legal compliance and test for fraud. The outside auditors who prepared the FY 2013 through 2015 audits failed to address these issues entirely, in violation of sections 5.02, 5.07, and 5.08 of the Yellow Book.
With the enactment of HB 1930, regular citizens and public employees will have the opportunity to look at county financial statements with far greater assurance that those statements accurately and fairly portray the actual financial condition of each county. That’s an opportunity sorely lacking in Montgomery County where accounting gamesmanship and obfuscation prevail and where there simply is no outside independent audit of the County’s financial books and records.