Discussion Item 6a
STAFF REPORT
City Council Discussion Item
DATE: September 6, 2022
TO: Honorable Mayor and Council Members
FROM: Ryan Plotz, City Attorney
THROUGH: Merritt Perry, City Manager
SUBJECT: Fortuna Business Improvement District (FBID) Audit Update STAFF RECOMMENDATION:
Staff recommends that the Council receive an oral report from the City Attorney on the status of the audit of the records of the Fortuna Business Improvement Corporation, which was the nonprofit entity that administered Fortuna Business Improvement District pursuant to a contract with the City.
Following the report, it is recommended that the Council receive public comment, discuss the report and ask questions of staff, and provide any desired direction.
DISCUSSION:
Over the past nine (9) months, the City Council has held numerous discussions about the future of the Fortuna Business Improvement District, which was established as a business assessment district in 1990 to fund certain activities within the District, including: (i) promotion of public events; (ii) decoration of public places; (iii) furnishing of music in public places; (iv) promotion of business activities; and (iv) marketing to fill available space, recruiting and expansion of commercial enterprise. Among other decisions and structural changes to FBID, the Council elected to terminate the contract with the non-profit Fortuna Business Improvement Corporation, which had administered FBID since at least 2005.
Among other reasons, the Council elected to terminate the contract with the Corporation based upon the City’s review of the results of an audit of the Corporation’s finances for the six fiscal years ending June 30, 2016, 2017, 2018, 2019, 2020, and 2021. The audit, which was performed at the City’s insistence and funded through a City-funded loan, included six fiscal years because the Corporation failed to conduct annual audits for the subject years, despite a contractual obligation to do so.
The audit was conducted by Anderson, Lucas, Somerville & Borges, LLP, which was retained directly by the Corporation to perform the six-year audit. In February 2022, the City received Discussion Item 6a
from the Corporation a draft audit report containing the Corporation’s audited financial statements for the six years under audit (Attachment A), which report the Council previously reviewed.
As the Council will recall, the audit report that was initially provided to the City in February 2022 did not include any findings and recommendations that would customarily be found in such a report. Accordingly, the City Manager inquired with the Corporation on February 24, 2022, as to whether the auditor had, in fact, supplied the Corporation with written findings and recommendations. The Corporation’s then-president informed the City Manager that the auditor provided the Corporation with internal control letters, and that, on advice of the Corporation’s counsel, the Corporation would not release to the City a copy of the internal control letters on the ground they were confidential.
Despite this claim of confidentiality, the City continued to insist that the internal control letters be publicly released because Corporation administered public funds. Ultimately, on or about March 30, 2022, the Corporation’s board of directors elected to release all audit related documents, including draft copies of internal control letters, which letter were made publicly available and were the subject of prior Council discussions. A copy of the above-referenced internal control letter is attached as Attachment B.
As previously reviewed with the Council, by way of the internal control letter, the auditor found certain deficiencies in the Corporation’s internal controls, and classified the deficiencies as either a “material weakness” or “significant deficienc[y]”. Among other things noted in the internal control letter, the auditor made the following findings:
• That the Corporation had a “total lack of internal controls in place” to ensure an appropriate segregation of duties. The Auditor noted:
“Because of the limited number of employees, one person, the executive director and coordinator, was primarily responsible for data entry and maintaining the Corporation’s general ledger accounting records. [The Executive director] had use of a debit card for the banks, signed checks, and processed her own payroll checks. [The auditor] found this employee had access to over-the-counter withdrawals from the bank and transferred funds between the operating account and the gift certificate accounts for cash flow purposes. These represented loans to cover expenses while waiting for the next assessment check.
Generally, when there are limited personnel, the Board of Directors can mitigate this lack of segregation of duties by performing the bank reconciliations and approving and signing accounts payable checks. The Board of [the Corporation] did not fully understand what their position and duties were. The Board was responsible for setting policy and direction for the executive director’s performance. From the minutes, it was clear that the executive director, set the agendas, and prepared the minutes. Her payroll checks were signed by a Board member, but there was no questioning or review of the checks being signed.
Placing the management functions and accounting functions on one person increases the risk that omissions and errors will go undetected. The Board was Discussion Item 6a
not presented with the financials per the minutes, because the director said they needed to be cleaned up first. Many errors were found during the six-year audit which indicates a complete lack of controls in place to prevent and detect errors.
The executive director lacked certain bookkeeping and accounting skills, and, in our judgment, her time would have been better utilized in the overall management of the daily activities and pursuit of organizational goals.” • That the Corporation had multiple payroll issues, including the following list supplied by the auditor:
“During our audit we encountered multiple concerns with payroll policies and issues.
1. It is advisable that the executive director does not issue their own payroll checks; it is also advisable that the director provide a timecard or explanation of duties performed and time expended as payroll documentation.
2. We suggest either having a written agreement or employment contract which outlines the duties, responsibilities and obligations of each party.
3. Employee cash advances should be discontinued or limited with concrete terms for repayment of such, preferably through subsequent payroll deductions.
4. Benefits such as health stipends should be paid through periodic payroll not in lump sum payments.
5. The executive director often paid herself in advance of working. For example, in March 2020, six payroll checks cleared the bank, meaning she was prepaid for two months. Because of quarterly payroll taxes, the Corporation had to pay taxes three months in advance for the April and May prepaid payroll.
When interviewed, the former director said because of Covid she was not able to obtain a Board signature. However, this does not explain why the checks were not dated as of the period for which they were intended.
6. Lacking concrete policies and procedures has caused inconsistencies in benefits provided by the corporation to its employees. The former director, when asked how the interns were receiving vacation and holiday pay, when this was not part of their stated benefits, replied that she was authorized to do whatever steps necessary to retain her employees, even though this was not included in the budget.
7. Employment pay and benefits for each year should be clearly documented going forward so that the parties do not have to reconstruct past practices with respect to bonuses, sick leave, and vacation pay.
Discussion Item 6a
8. During the audit, several EDD envelops were found unopened. Several payroll tax notices were received. This alone is a major red flag as it represents late tax filing and penalties and interest. Some payroll tax reports were not found in the files.”
Concerned by the findings in the internal control letter, the City Manager and the Mayor met with the assigned auditor on or about May 2, 2022, to discuss the findings. During this meeting, the auditor represented that, during the audit process, she found that the former executive director may have received overpayments of compensation in the amount of $9,656.02 over the course of the audit period. It was further explained that, in December 2021, the auditor questioned the former executive director about these payments and encouraged the former executive director repay the funds to the Corporation. The City Manager and the Mayor requested from the auditor any documentation that would support the auditor’s finding that overpayments were made.
The auditor provided the documentation supporting her finding that overpayments were made to the Corporation’s then-president, who transmitted the documentation to the City Manager on May 2, 2022. In her transmittal email, the Corporation’s then-president explained, among other things, that the Corporation’s counsel concluded that the alleged overpayments “were justified under CA employment law” and that “if there was any overpayment, it was not nearly what the auditor claimed, and it was not worth exposing FBID to liability for an attempt to reclaim.” The Corporation’s then-president further noted that, on advice of the Corporation’s counsel, the Corporation sent a letter (Attachment C) to the former-executive director on February 27, 2022, stating, in pertinent part, as follows: “As you know, FBID had an audit conducted this year for the years 2016 through 2021. After consideration and review by the auditor and an attorney, we do not believe there was any deliberate misuse of FBID funds. We did find, however, that it was difficult to reconstruct years of past practices by former Boards and employees, which likely would have prevented many of the questions put to you by the auditor.” The documentation provided by the auditor in support of her finding showed the following:
• On June 30, 2015, the former executive director received an overpayment of $1,251.02
• On July 1, 2020, the former executive director received an over payment of $4,000 • On November 1, 2020, the former executive director received an over payment of $3,000
• On November 23, 2020, the former executive director received an over payment of $1,000
• On July 31, 2021, the former executive director received an over payment of $405 The documentation from the auditor further showed that, of the $8,000 in claimed overpayments during 2020, the Corporation’s payroll records show $6,000 was paid in “vacation” pay and $2,000 was paid in “sick” pay. The auditor found that these amounts were paid in addition to the formerexecutive director’s salary and that she was not able to locate any Board approvals or other authorizations for the above-listed payments, resulting in her conclusion that these payments constitute overpayments of compensation to the former executive director.
Discussion Item 6a
By way of her May 2, 2022, email providing the auditor’s documentation of the overpayments, the Corporation’s then-president represented that the Corporation’s board considered the issue of the overpayments resolved and that the Corporation would take no further action, stating, “After going through all of this and sending [the former executive director the February 27, 2022, letter], I believe our board is done. The audit is done.” The Corporation’s then-president further conveyed that this situation has been difficult on the volunteers that served on board.
In May 2022, the City received notice that the remaining member of the Corporation’s board of directors intended to resign their seats, leaving the Corporation without a governing board. The notice was received at a time when, based on several considerations, the Council was considering making a change in the manner in which FBID is administered, including bringing the administration in-house or issuing a request for proposals for a new entity to assume the Corporation’s role.
At the request of the City, the Corporation’s then-president and other members of the Corporation’s board of directors agreed to remain on the board to facilitate an orderly dissolution of the Corporation and winding up of the contract, which was completed in short order including the transfer of the Corporation’s assets to the City.
At the request and direction of the Council, on May 20, 2022, the City Attorney sent a letter (Attachment D) to the former-executive director. This letter, among other things, provided notification to the former-executive director of the auditor’s findings and provided her the opportunity to repay any amount she concurred represents an overpayment of compensation during her employment.
The former executive director responded by letter on May 27, 2022 (Attachment E), stating that she disagreed with the auditor’s findings in regard to her compensation and requesting evidence demonstrating any overpayments.
The City Attorney responded by letter on June 6, 2022 (Attachment F) to provide her a complete copy of the documentation provided to the City by the auditor as the underlying support for the auditor’s conclusion.
The former executive director responded by letter on June 16, 2022 (Attachment G), stating that upon review of the auditor’s documentation she “still [does] not believe the [Corporation] overpaid [her]” and pointing out that the audit reports did not include any express finding of overpayments.
The City Attorney responded by letter on July 5, 2022 (Attachment H), stating, in pertinent part, the following:
While I know you disagree with the Auditor’s conclusions, you have yet to provide an explanation as to why the above-listed payments, which were in addition to your annual salary, were proper. So that I have your position and can provide your explanation to the Council, would you please explain the basis for the abovepayments and why, during calendar year 2020, you received $2,000 in sick pay and $6,000 in vacation pay, which amounts appear to be in addition to your salary? Discussion Item 6a
As mentioned previously, the City is relying upon the findings of the Auditor and the documents provided. As you were the sole person in charge of handling payroll for the Corporation and given the lack of any FBID Board minutes approving the above-referenced payments, your explanation is critical for the Council’s consideration. At this point, all the Council has is the Auditor’s conclusions.
The former executive director responded by letter on July 14, 2022 (Attachment I), stating that she processed her checks with the guidance of and approval of the Board. She did not, however, provide any specific explanation for why the particular payments were made.
Following receipt of the above-described letter, the City Manager contacted the former executive director directly to discuss the matter. During the call, the former executive director continued to deny receiving any overpayment of compensation, accused the City of harassing her, and asked that the City not contact her further.
The City Attorney will provide an oral report on the above-content and discuss further handling.
FINANCIAL IMPACT:
No fiscal impact.
RECOMMENDED COUNCIL ACTION:
1. Receive staff presentation and review Council questions with staff
2. Open Public Comment
3. Close Public Comment
4. Provide direction to staff as appropriate
ATTACHMENTS:
• Attachment A – Draft Audit Report
• Attachment B – Draft Internal Control Letter
• Attachment C – Letter to D. Rios
• Attachment D – Letter to D. Rios from City Attorney dated May 20, 2022 • Attachment E – Letter from D. Rios dated May 27, 2022 • Attachment F – Letter to D. Rios from City Attorney dated June 6, 2022 • Attachment G – Letter from D. Rios dated June 16, 2022 • Attachment H – Letter to D. Rios from City Attorney dated July 5, 2022 • Attachment I – Letter from D. Rios dated July 14, 2022