Connecting state and local government leaders
COMMENTARY | Local governments should recognize the potential threat of corrupt uses of federal stimulus money by public officials. There are some steps auditors and honest public leaders can take to prevent fraudulent activity.
The American Rescue Plan’s $130 billion of direct aid to local governments presents a major opportunity for governments to make investments in their communities. But it's also a major opportunity for those who seek to line their own pockets.
The fact is a lot more money brings with it a lot more risk—not only that the money will not be spent wisely but that it will tempt the corrupt who find their way into public service.
While it's a critical time for every jurisdiction to be on high alert for fraud, it's important to know that not all fraud is created equal. And governments that want to limit their risk would be wise to target their efforts carefully.
Types of Fraud
“Retail fraud” is your run-of-the-mill, small-scale malfeasance. It's the maintenance worker swiping city-owned tools, the cop taking overtime without permission or the manager who's getting the occasional lunch picked up by a contractor. It's unethical, and in some cases, it's illegal. But it's typically committed by people with no power, and has a miniscule budget impact. The damage it does to a jurisdiction is a PR hit more than a financial one.
On the other end of the spectrum is "wholesale fraud." It's embezzlement, bribery, bid-rigging and other serious corruption, often perpetrated again and again. It tends to involve high-ranking, well-connected leaders and serious dollars. In addition to the PR hit, it carries the risk of significant financial harm and, at its most extreme, jeopardizes a jurisdiction's ability to perform its responsibilities fully.
To put it plainly: If your community is broke due to fraud, it will be less capable of providing residents with impactful goods and services like building roads, hiring teachers and maintaining parks.
As a longtime auditor and a good-government advocate, I recognize that it's essential to prevent both types of fraud. But in the face of finite resources, we should focus on wholesale fraud. Those who cast their attention to workers swiping pens or occasionally fudging timecards can create the illusion of running a tight financial ship while missing the massive iceberg that could sink their community.
If you’re an auditor or watchdog seeking to ferret out wholesale fraud, or a public leader who wants to head off efforts to dip into the public purse, you’ll have a strong head start if you take three critical steps.
Watch for Official Overstepping
Be on alert for administrators who override or bypass normal purchasing controls. When a high-ranking official takes a particular interest in managing or executing a particular contract, they're likely overstepping, and that should raise questions. In San Francisco last year, then public works director Mohammed Nuru was arrested as part of an alleged scheme in which contractors were accused of giving him $300,000 in gifts, meals and construction work on his home in exchange for helping secure city contracts. But Nuru probably shouldn't have been so involved in those contracts in the first place.
This is precisely the type of scandal I wanted my town to avoid when I was part of a commission in the 1990s that sought to reduce public corruption in Kansas City, Missouri. Our very first recommendation was to be leery of council members who go beyond the parameters of their job description. They can share their opinions with staff, but they should never direct city staff actions.
Another solution we recommended is template contracts to ensure that departments don't have unique contracting procedures. After all, we need vendors to understand that they work for the city—not a particular department, or even worse, a department director.
Beef Up Internal Controls
Leaders should look at their community’s annual financial report for the auditor’s report on internal controls to know what it says about controls designed to prevent fraud and ensure accountability. These include segregating government employees' responsibilities so no single employee can authorize a transaction and execute payment for that transaction; regular reconciliation of accounts; and adequate documentation, which will enable the detection of rules and procedures being bypassed. One thing I learned in reviewing instances of fraud in my own and other jurisdictions is that no significant deficiency in internal controls goes unexploited.
Bottom line: If the auditor’s report identifies “material weaknesses” or “significant deficiencies” in internal controls, it's time to fix them. Though the external auditor writes the report, every leader within the government— from the finance department to the city manager to the city council to the mayor—is responsible for fixing these shortcomings. You may not be an auditor, but if you’re reading this, you care about good government, and you owe it to yourself and your community to at least become familiar with best practices like these.
At Kentucky State University, a financial scandal has become so expansive it might result in the school's closure. But it could have been avoided. From 2015 to 2019, the university's auditors warned that the school lacked adequate controls over financial reporting. Perhaps the university wouldn't be on shaky ground today if those reports had been acted upon.
Check Your Auditors’ Work
If an auditors’ report doesn't mention weaknesses in internal controls, ask the auditors about it. A jurisdiction or agency may be indeed running a stellar operation. But it's also possible the auditors didn't thoroughly check. Get them on the record and find out.
A cautionary tale is the story of a small-town Illinois comptroller who embezzled more than $50 million in city funds over 20 years. For years, the auditors never raised red flags and said there were no issues with internal controls. It turns out the funds were embezzled through an unauthorized account. Fraudulent invoices for capital assets could have been identified if the auditors had simply checked whether those assets existed (they didn't).
Of course, anyone looking to detect fraud will come across gray areas–situations that don't feel quite right but for which somebody in city hall has a plausible explanation. And those are the cases when it's time to really start digging.
Technology can play a significant role in identifying fraud. Robust data analytics tools can detect, in real time, whether out-of-the-norm transactions are occurring or whether approvals are following unusual patterns. By flagging potential problems automatically, technology can give auditors a hint of where their time and effort will most likely produce results. And here’s some great news: Data analytics and technology infrastructure are eligible expenses under the American Rescue Plan Act. Using stimulus dollars to help prevent stimulus theft is a virtuous cycle.
The 2009 stimulus funds taught us that it's possible to have a major influx of government spending without rampant fraud. One journalist observed that the nearly $800 billion program was "astonishingly clean" and scandal free due largely to strong management and a commitment to transparency.
This year’s stimulus provides even more opportunities to local governments to serve their citizens and invest in the future. Let’s make sure we get it right and use all available tools to make sure this incredible opportunity isn’t compromised.
Mark Funkhouser, president of Funkhouser & Associates, is a municipal finance expert who has spent decades in government service and is a former mayor of Kansas City. That experience, his long tenure as an auditor and his most recent post as the publisher of Governing magazine have made him a trusted and credible advisor to government officials across the country.