Audit Report

NEW Academy of Canoga Park Elementary (Charter) School 10-432 August 18, 2010

Los Angeles Unified School District Office of the Inspector General Internal Audit

TABLE OF CONTENTS

Executive Summary ............................................................................................ 1

Findings and Recommendations Finding A – Internal Control System ......................................................................................... 6 Finding B – Financial Operations and Fiscal Accountability .................................................. 17 Finding C – Assessment of Fraud by External Auditors .......................................................... 43 Finding D – Enterprise Risk Management ............................................................................... 53 Finding E – Implications for Other Charter Schools ................................................................ 56 Audit Observation .................................................................................................................... 59 Appendices Appendix A – Auditor Responsibilities for Consideration of Fraud ....................................... 60 Appendix B – Summary of Questioned Costs ......................................................................... 64 Appendix C – NACP Verbatim Comments 1. NACP Final Response dated June 25, 2010 ................................................. 66 2. NACP Revised Response dated June 25, 2010 ............................................ 80 3. NACP Original Response dated May 14, 2010 ………………………….112 4. NACP Exhibits……………………………………………………………145 Appendix D – OIG Response to NACP Comments 1. OIG Response dated August 18, 2010 ....................................................... 242 2. OIG Response dated June 9, 2010 ............................................................. 248 Appendix E – Innovation and Charter Schools Division Verbatim Comments…………...…294 Appendix F – Distribution List ……………………………………………………………...299 Appendix G – Audit Team …………………………………………………………………..300

EXECUTIVE SUMMARY

This report contains the results of our audit of NEW Academy of Canoga Park Elementary (Charter) School (“NACP”). NEW Academy of Canoga Park Elementary School is a charter school located in Los Angeles, California that serves students from kindergarten through fifth grade. This audit was requested by the President of the NACP Board. Objective Our audit objectives were to:

Determine whether the NACP Board of Directors and NACP management implemented appropriate controls to adequately monitor NACP’s fiscal and financial operations.

Determine whether NACP’s financial information was accurately recorded and reported.

Determine whether NACP was in compliance with its charter agreement with the Los Angeles

Unified School District (“LAUSD” or “District”).

Assess the nature and extent of any improprieties or irregularities that may have occurred during the period under audit.

Scope & Methodology We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. The audit covered the period from July 1, 2007 through November 30, 2009. In order to address the audit objectives, we performed certain procedures, which included, but were not limited to the following:

Reviewed applicable State laws and regulations.

Reviewed relevant LAUSD policies and procedures.

Performed walkthroughs with key personnel to obtain an understanding of the internal control system and current processes of NACP.

Assessed the design and operational effectiveness of internal controls.

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Tested selected transactions in the areas of cash collections and disbursements, revenue, investments, and other significant processes. See Use of Sampling section below.

During the course of our audit, we also interviewed selected NACP personnel, the NACP

Board President, and District staff about their activities and specific transactions related to our audit objectives. We performed the audit from January 11, 2010 through March 19, 2010.

It is important to note that certain records were not available during the time of our audit. In addition, we did not have access to the personal records of the former Principal. However, the OIG believes that the documentation used to complete the audit was both sufficient and appropriate to support our findings and conclusions. In addition, the OIG believes the amounts reported to be accurate and reliable as of the date of the revised Draft Report (based on the documentation made available to us during the period of our fieldwork). Use of Sampling The OIG employed sampling only for audit testing purposes. Sampling was used for the following audit areas:

• Check Disbursements – Statistical and judgmental sampling was used to determine whether the selected check disbursements were (i) adequately supported with invoice or receipts, (ii) approved for payment, (iii) recorded in the appropriate expense classification, and (iv) signed by the authorized signatory(s).

• Bank Reconciliations – We randomly selected four months and obtained the corresponding bank reconciliations for all NACP bank accounts to determine if monthly bank reconciliation statements were prepared timely and accurately and reviewed.

• Insurance Payments – We judgmentally selected three insurance brokers/agents and performed 100 % testing of all check disbursements to determine if insurance related payments were appropriate and adequately supported.

For all other audit areas (except cash deposits and withdrawals for which bank account detail was not available), the OIG performed testing on 100% of the population for the audited period. The use of sampling (statistical and non-statistical) is acceptable under Government Auditing Standards issued by the Comptroller General of the United States, the Institute of Internal Audit’s International Standards for the Professional Practice of Internal Auditing, and the American Institute of Certified Public Accountants' (AICPA's) Professional Auditing Standards. The use of statistics helps auditors to develop sample plans more efficiently and assess sample results more objectively than non-statistical methods alone. Audit sampling is the application of an audit procedure to less than 100 percent of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance or class.

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Statistical sampling involves the use of techniques from which mathematically constructed conclusions regarding the population can be drawn. For the area that statistical sampling was used, we did not extrapolate (project) our testing results. Our results are based solely on the transactions tested. Summary of Key Audit Findings Our audit found that NACP’s internal control system needed to be strengthened. Specifically, we noted that the NACP Board did not effectively monitor and oversee NACP’s financial operations, the NACP Board did not have an adequate risk assessment process, and many of NACP’s fiscal policies and procedures were not implemented or enforced by the business services provider or the former Principal. Based on the results of our audit procedures, there were considerable deficiencies in internal controls over significant processes and an overall lack of oversight, which resulted in $1.6 million in missing/misappropriated funds and $1.1 million in questioned costs (which were due to financial transactions initiated by the former Principal). Approximately $1 million of the misappropriated funds and questioned costs were transacted during the 2007-2008 school year, which was the latest period audited by the external auditors. As such, it appears that NACP’s external auditors may have been lax in their consideration of fraud in conjunction with prior financial statement audits. Lastly, the Innovation and Charter Schools Division did not have a risk management process in place over Charter Schools. Conclusion: We believe that the overall lack of oversight of personnel responsible for and monitoring of financial operations by the NACP Board created an environment where there was no perception of detection, which allowed for the actual occurrence of fraudulent and abusive activities. Potential Impact The conditions described above along with their underlying causes created a higher risk of fraud, waste, and abuse of NACP funds. Consequently, NACP resources were used for purposes that did not directly benefit the students and instructional programs of NACP. In addition, there was limited assurance that NACP’s financial reports (prepared by the business services provider) and June 30, 2008 audited financial statements were accurate and reliable. As a result of the conditions described above, we noted missing/misappropriated funds and questioned costs totaling approximately $2.7 million (as shown in Appendix B). Summary of Key Recommendations We gave 20 specific recommendations to the NACP Board of Directors and 2 specific recommendations to the Executive Director of the Innovation and Charter Schools Division.

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The complete description of these recommendations is included in the body of this report. Some of the more significant recommendations we made included the following: NACP Board of Directors

• Establish an effective organizational structure that clearly defines key areas of authorities, appropriate lines of reporting, and clear assignment of responsibilities among NACP staff and other third party services providers to ensure:

• Proper segregation of duties. Segregate the functions of authorizing, recording,

processing, and reporting of transactions. • Job descriptions are set with defined limits of authority. • Fiscal policies and procedures are updated to cover all aspects of NACP’s financial

operations.

• Develop a formalized risk assessment process to identify, analyze, and manage significant risk(s) for each of the organization’s objectives.

• Require the business services provider and NACP staff to implement and enforce NACP’s

approved fiscal policies and procedures. Also require the business services provider to identify internal control deficiencies and to communicate deficiencies noted in a timely manner to those parties responsible for taking corrective action and to the NACP Board, as appropriate.

• Instruct the business services provider to bring to the attention of the NACP Board (in a timely

manner) any irregularities or unusual matters concerning NACP’s financial operations.

• Instruct the business services provider to ensure that all transactions are supported by complete and appropriate documentation prior to recording transactions in the general ledger.

• Provide adequate oversight over the fiscal operations of NACP by reviewing and approving on

a monthly basis, the financial reports prepared by the business services provider (i.e. Bank Reconciliations, Budget versus Actual Reports). Review should be evidenced by signature and date.

• Require the business services provider to ensure that all transactions are recorded in the general

ledger on a timely basis (i.e. cash receipts, cash disbursements). Innovation & Charter Schools Division

• Consider developing and adopting a risk management process for Charter Schools. This process may be based upon an established framework such as that issued by the Committee of Sponsoring Organizations (“COSO”). Given that risk management is an evolving yet critical responsibility of management, consider asking for the assistance of the Office of the Inspector General on information, tools and techniques on how to establish a risk management process

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related to Charter Schools. • Designate staff to identify all Charter Schools that employ a back office services provider and

assess whether those Charter Schools have in-house staff and Board members with accounting/finance expertise. Determine whether those Charter Schools Boards have proper oversight over the back office services providers and day-to-day financial transactions (based on the internal control framework and policies and procedures). Ensure that roles and responsibilities as well as accountability are clearly defined in the policies and procedures.

• Encourage all Charter School Boards to restrict use of all debit cards. • Encourage all Charter School Boards to strengthen policies and procedures over the issuance of

manual checks. NACP Comments: NACP provided 3 comprehensive responses to our recommendations as well as some comments about our findings and conclusions. It is important to note that for each of the recommendations, NACP included the following language: “The Board incorporates by reference the Board’s response as provided in pages 1 through 17 above. Moreover, this matter is the subject of continuing investigation which may reveal additional relevant information. On that basis, the Board reserves the right to supplement the information and comments provided herein. Without admitting to the accuracy of the analysis provided in the IG Report, the Board agrees that this recommendation is a prudent measure for the School and, with that understanding, will implement the recommendation. With regard to the corrective actions, please note the following…” NACP agreed with all of the recommendations and stated that it had taken or would take corrective actions on all of the recommendations. Refer to Finding A, Finding B, and the Audit Observation for a summary of NACP’s response on specific recommendations and Appendix C for NACP’s Verbatim Response. Our summary of the NACP response as well as quotes from the response are shown in blue type font. It should be noted that even though NACP agreed with all of the audit recommendations, NACP expressed concerns about some of our methods, findings, and conclusions and included certain statements and positions in their response that we have a responsibility to address since their comments directly or indirectly bear on the credibility of our audit report. Refer to our response to NACP’s comments in Appendix D. Innovation and Charter Schools Division’s Comments: The Innovation and Charter Schools Division agreed with all of our recommendations. The Innovation and Charter Schools Division stated that it had taken or would take corrective actions on all of the recommendations. Refer to Finding D and Finding E for a summary of the Innovation and Charter Schools Division’s responses and Appendix E for the Innovation and Charter Schools Division’s Verbatim Response.

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FINDING AND RECOMMENDATIONS

FINDING A: Internal Control System For the Board of Directors, NEW Academy of Canoga Park

Elementary (Charter) School SUMMARY The internal control system of the NEW Academy of Canoga Park Elementary (Charter) School (“NACP”) had significant deficiencies. The internal control system included the oversight functions intended to be provided by the NACP Board of Directors (“NACP Board”) and NACP’s business services provider. Conditions Our Audit Found

• NACP’s control environment needed to be strengthened. • The NACP Board did not have an adequate risk assessment process in place. • NACP’s current fiscal policies and procedures were not implemented and monitored for

efficiency and effectiveness. In addition, there were potential material weaknesses in the control activities of NACP, the NACP Board, and the business services provider.

• There was inadequate control over information and communication within NACP, and between NACP, the NACP Board, and the business services provider.

• The NACP Board’s monitoring and oversight of NACP’s financial operations was both insufficient and ineffective.

Reasons for the Above Conditions

• Some of NACP’s control activities were not in place or enforced. • The NACP Board’s governance and oversight was focused on academic related affairs while

fiscal oversight was unofficially delegated to the business services provider. Impact of Noted Conditions The weak internal control system within NACP, which included the oversight functions intended to be provided by the NACP Board and by the business services provider, created ample opportunities for fraud, waste, and abuse to occur. The former Principal was able to override controls, which resulted in the misappropriation of NACP funds and resources. Our recommendations to correct these conditions begin on page 14.

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BACKGROUND Internal Control Internal control is a major part of managing an organization. It comprises the plans, methods, and procedures used to meet missions, goals, and objectives. Internal control also serves as the first line of defense in safeguarding assets and preventing and detecting errors and frauds. Internal control should provide reasonable assurance that the objectives of the agency are being achieved in the following areas:

• Effectiveness and efficiency of operations including the use of the entity’s resources. • Reliability of financial reporting, including reports on budget execution, financial statements,

and other reports for internal and external use.

• Compliance with applicable laws and regulations. Everyone in an organization has responsibility for internal control.

• Management – The School administrator is ultimately responsible and should assume “ownership” of the system. More than any other individual, the School administrator sets the “tone at the top” that affects integrity, ethics, and other factors of a positive control environment.

• Board of Directors – Management is accountable to the board of directors, which provides

governance, guidance, and oversight. Effective board members are objective, capable and inquisitive. They also have knowledge of the entity’s activities and environment, and commit the time necessary to fulfill their board responsibilities. Management may be in a position to override controls and ignore or stifle communications from subordinates enabling a dishonest management which intentionally misrepresents results to cover its tracks. A strong, active board, particularly when coupled with effective communications channels and capable financial, legal and internal audit functions, is often best able to identify and correct such a problem.

• Other Personnel – Internal control is, to some degree, the responsibility of everyone in an

organization and therefore should be an explicit or implicit part of everyone’s job description. Also, all personnel should be responsible for communicating upward problems in operations, noncompliance with the code of conduct, or other policy violations or illegal actions.1

Standards for Internal Control in the Federal Government issued by the United States General Accounting Office, presents the definition, objectives, and fundamental concepts that provide the

1 Executive Summary, Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), July 1994.

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foundation for the internal control standards. 2 The five Standards for Internal Control include the following:

• Control Environment – Management and employees should establish and maintain an environment throughout the organization that sets a positive and supportive attitude toward internal control and conscientious management.

• Risk Assessment – Internal control should provide for an assessment of the risks the agency

faces from both external and internal sources. Risk assessment is the identification and analysis of relevant risks associated with achieving the organization’s objectives.

• Control Activities – The policies, procedures, techniques, and mechanisms that enforce

management’s directives. The control activities should be effective and efficient in accomplishing the organization’s control objectives.

• Information and Communications – Information should be recorded and communicated to

management and others within the entity who need it and in a form and within a time frame that enables them to carry out their internal control and other responsibilities.

• Monitoring – Internal control should generally be designed to assure that ongoing

monitoring occurs in the course of normal operations. It is performed continually and is ingrained in the agency’s operations. It includes regular management and supervisory activities, comparisons, reconciliations, and other actions people take in performing their duties.

There is a direct relationship between organizational objectives and the five internal control components. This relationship can be depicted by the three-dimensional matrix, shown below:

Internal Control System

• The three objectives categories – Operations, financial reporting, and compliance are

represented by the vertical columns. • The five control components are represented by rows. • The units or activities of an organization to which internal control relates, are depicted by

the third dimension of the matrix.

2 Standards for Internal Control in the Federal Government, issued by the United States General Accounting Office, November 1999.

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Each component row “cuts across” and applies to all three objectives categories. All five components are applicable and important to the achievement of the operational objectives. These standards define the minimum level of quality acceptable for internal control in government and provide the basis against which internal control is to be evaluated. These standards apply to all aspects of an agency’s operations: programmatic, financial, and compliance. In implementing these standards, management is responsible for developing the detailed polices, procedures, and practices to fit their agency’s operations and to ensure that they are built into and an integral part of operations. NACP Organization NACP is organized as an arm of NEW Academy, a nonprofit 501( c )( 3) organization. The Board of Directors of the NEW Academy is the governing board of NACP. It is composed of seven members including a District representative as a non-voting member. The Principal oversees the daily operation of NACP and reports directly to the NACP Board. The NACP Board contracts with a business services provider, which oversees annual, independent financial audits including financial statements, attendance, enrollment, accounting practices and review of the School’s internal controls.3 The NACP Organization Chart per the approved Charter Renewal Petition is shown below:

3 Excerpts from NACP’s approved Charter Petition, dated November 23, 2007: Element 4 – Governance Structure, page 117, and Element 9 – Annual Audit, page 135.

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DISCUSSION This section discusses the following five areas:

• Control Environment • Risk Assessment • Control Activities • Information and Communication • Monitoring

Control Environment

The NACP Board’s control environment needed to be strengthened. A good internal control environment requires that the organization structure clearly define key areas of authority and responsibility and establish appropriate lines of reporting. The delegation should cover authority and responsibility for operating activities, reporting relationships, and authorization protocols. In addition, management plays a key role in providing leadership especially in setting and maintaining the organization’s ethical tone, providing guidance for proper behavior, removing temptations for unethical behavior, and providing discipline when appropriate.4 We noted the following conditions that contributed to a weak control environment:

• NACP’s and the NACP Board’s philosophy and operating style towards accounting, personnel functions, monitoring and evaluations was very detached and did not encourage strong accountability.

• The organizational structure of NACP and the NACP Board lacked clearly defined areas of

responsibility and authority, and reporting lines. This was a problem because according to the President of the NACP Board, responsibility for the oversight and accountability of overall operations is a shared responsibility between the NACP Board, the Principal, and the business services provider.

Risk Assessment

The NACP Board did not have an adequate risk assessment process in place. Specifically, the NACP Board did not establish mechanisms to identify, analyze, and manage the related risks arising from internal and external sources.

4 Standards for Internal Control in the Federal Government, issued by the United States General Accounting Office, November 1999, page 8.

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Control Activities

NACP’s current fiscal policies and procedures were not implemented and monitored for efficiency and effectiveness. In addition, there were potential material weaknesses in the control activities of the School, the NACP Board, and the business services provider. For Example:

• There was a lack of top level reviews by the NACP Board at the functional or activity level of NACP. NACP’s approved policies and procedures require the NACP Board to review financial records and transactions on a monthly basis. The NACP Board or designee did not review and validate the monthly financial reports and significant transactions prepared by the business services provider, such as bank reconciliations and checks over $2,000.

• Some key controls over the processing of financial transactions were either not in place or not

enforced, which led to the business services provider recording expenditures submitted by NACP staff without documentation or incomplete documentation. This led to the inaccurate and untimely recording of transactions and inadequate management and control over the retention of supporting documentation.

• Physical control over assets (inventory) was not performed periodically.

• There was no segregation of duties. Key duties and responsibilities were not distributed

among NACP staff to reduce the risk of errors or fraud. The former Principal controlled the majority of all key aspects of transactions such as depositing cash receipts at the bank, authorizing and approving check disbursements, processing and signing checks, and having physical custody of unused checks.

• Certain transactions and contracts were improperly executed. Transactions should be

authorized and executed only by persons acting within the scope of their authority. The former Principal entered into contracts and disbursed funds beyond his authority. Also, the business services provider did not follow approved NACP fiscal policies and procedures when they continuously paid vendors and consultants without obtaining the required approval for payment, and processed checks without the two required signatures.

Information and Communications

There was inadequate control over information and communication within NACP and between the NACP, the NACP Board, and the business services provider.

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For Example:

• The NACP Board did not effectively communicate duties and internal control responsibilities to NACP staff. In addition, there were no clear channels for staff to communicate suspected improprieties.

• The business services provider did not communicate the former Principal’s continuous disregard of NACP’s fiscal policies and procedures to the NACP Board. In addition, the business services provider accepted and indirectly validated the impropriety by continuously processing and recording some of the inappropriate financial transactions of NACP.

Monitoring The NACP Board’s monitoring and oversight of NACP’s financial operations was both insufficient and ineffective. Factors that contributed to this condition included the following:

• The NACP Board did not monitor the effectiveness of the internal control system and did not review financial data other than financial reports prepared by the business services provider and audited financial statements. For example, a regular review of the bank statements would have alerted the NACP Board of red flags for fraud, waste, and abuse such as:

o Existence of a debit card linked to the main checking account. o Regular use of NACP’s debit card for unauthorized, unsupported, and potentially

abusive purchases. o Regular electronic and miscellaneous withdrawals (not related to payroll and taxes)

such as cashier’s checks.

• The NACP Board over relied on the business services provider to oversee NACP’s financial operations.

Key Reasons for the Conditions Noted in this Section

The above weaknesses related to the internal control system occurred due to the following:

• Some of NACP’s control activities were not in place or enforced. • The NACP Board’s governance and oversight was focused on academic related affairs, while

fiscal oversight was unofficially delegated to the business services provider.

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Impact of the Conditions Noted in this Section The weaknesses within NACP’s internal control system created ample opportunities for fraud, waste and abuse to occur. The former Principal was able to override internal controls, which resulted in the misappropriation of NACP funds and resources. We discuss the actions needed to correct the above conditions in Recommendations A-1 through A-6.

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RECOMMENDATIONS AND COMMENTS The NACP Board should coordinate with the NACP staff and the business services provider to develop the following: A-1 Recommendation: Establish monitoring procedures to strengthen fiscal oversight and governance including:

• Test of controls such as regular review of the bank statements and reconciliation statements. • Self-assessments by the NACP Board regarding the tone they set in the organization and the

effectiveness of their oversight functions. • Ongoing and/or separate evaluations to determine whether the other components of internal

control continue to function over time. NACP Comments: The NACP Board agreed with this recommendation and stated that:

• The Board has directed the business services provider to obtain all original bank statements to ensure timely and accurate completion of bank reconciliations; which are to be provided to the NACP Board (by the business services provider) for review and approval by the Board’s Fiscal Officer. In addition, the Board will verify the correct bank and book balances used in the reconciliation, as well identify and question any usual reconciling items that may warrant further investigation on an ongoing basis.

Target Date of Implementation: April 2010 (for Board review) and May 2010 bank statements (for receipt of original bank statements)

• The Board has retained a forensic accounting firm to review the current operational and internal

control structure of the financial mechanisms within NACP.

Target Date of Implementation: Within 150 days of the issuance of the final OIG audit report

• The Board will become an organizational member of the national 501(c)(3) organization Board Source. As part of this membership, the Board will complete two training sessions involving assessments and evaluations and roles and responsibilities.

Target Date of Implementation: Within 160 days of the issuance of the final OIG audit report

• The Board will contract with an independent audit firm, (other than the one which performs the year-end annual independent audit) to perform reviews of internal control policies.

Target Date of Implementation: During fiscal year 2010-2011 OIG Comment: The NACP Board did not clearly indicate how it plans to test internal controls other than its reference to review of bank statements and reconciliations. The intent

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of the recommendation was for the NACP Board to develop a plan to test both the design and operating effectiveness of the internal controls on an ongoing basis. It is also important to note that monitoring is a function of management and should not be fully outsourced. The NACP Board should continue to be engaged in the work of the forensic accountants and should carefully review and analyze the results of the forensic accountant’s findings, conclusions, and recommendations.

A-2 Recommendation: Provide a written Code of Conduct to all employees and have employees sign as evidence that they have received and understand the Code of Conduct. NACP Comments: The NACP Board agreed with this recommendation and stated that the Board has prepared a separate Employee and Board of Directors Code of Conduct. The Code of Conduct will be provided to employees and Board members. Employees will be required to sign and return within 10 days of delivery. Target Date of Implementation: By June 30, 2010 The Code of Conduct will be integrated into the employee personnel manual as part of the pre-employment process and provided to all potential Board members prior to consideration for nomination. Target Date of Implementation: By July 1, 2010 A-3 Recommendation: Develop mechanisms to encourage employee reporting of suspected violations and identify channels of communication for employees to report such activity. NACP Comments: The NACP Board agreed with this recommendation and stated that NACP will place a locked comment box on NACP’s premises for anonymous employee and public reporting of suspected violations. Access to the locked box will be limited to the Board President. In addition, the NACP Board has contracted with a forensic accountant firm to implement an anonymous and confidential 24/7 phone and internet hotline to manage the reporting of Fraud/Code of Conduct violations. All reports of suspected violations will be collected and discussed regularly during Board meetings. Target Date of Implementation: No later than 60 days from the issuance of the final OIG audit report A-4 Recommendation: Establish an effective organizational structure that clearly defines key areas of authorities, appropriate lines of reporting, and clear assignment of responsibilities among NACP staff and other third party services providers to ensure:

• Proper segregation of duties. • Job descriptions are set with defined limits of authority. • Fiscal policies and procedures are updated to cover all aspects of NACP’s financial

operations.

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NACP Comments: The NACP Board agreed with this recommendation and has retained an independent consultant to review the current operational and internal control structure of the financial mechanisms within the NACP. In addition, the NACP Board has instructed the business services provider to conduct a review of its own internal controls. Target Date of Implementation: Within 150 days from the issuance of the final OIG audit report OIG Comment: The NACP Board should continue to be engaged in the work of the forensic accountants and should carefully review and analyze the results of the forensic accountant’s findings, conclusions, and recommendations. A-5 Recommendation: Develop a formalized risk assessment process to identify, analyze, and manage significant risk(s) for each of the organization’s objectives. NACP Comments: The NACP Board agreed with this recommendation and will work with external consultants to implement a formalized risk assessment process. Target Date of Implementation: As soon as practicable and no later than within 150 days from the issuance of the final OIG audit report OIG Comment: The NACP Board should continue to be engaged in the work of the forensic accountants and should carefully review and analyze the results of the forensic accountant’s findings, conclusions, and recommendations. A-6 Recommendation: Require the business services provider and NACP staff to implement and enforce NACP’s approved fiscal policies and procedures. Also require the business services provider to identify internal control deficiencies and to communicate deficiencies noted in a timely manner to those parties responsible for taking corrective action and to the NACP Board, as appropriate. NACP Comments: The NACP Board agreed with this recommendation and has required the business services provider to report and monitor NACP’s internal control structure and to notify the Board of any internal control deficiencies. The Board has emphasized to the business services provider that there will be a zero tolerance for any failure by the business services provider and NACP staff to adhere to the fiscal policies and procedures. In addition, the Board and the business services provider have agreed that issues will be communicated to the Board in writing (via email). Target Date of Implementation: Currently implemented

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FINDING AND RECOMMENDATIONS

FINDING B: Financial Operations and Fiscal Accountability

For the Board President, NEW Academy of Canoga Park Elementary (Charter) School

SUMMARY We reviewed the financial operations of the NEW Academy of Canoga Park Elementary (Charter) School (“NACP”) for the period from July 1, 2007 through November 30, 2009. The objectives of our review were to determine whether controls over the financial operations of NACP were adequately managed and whether the NACP Board’s fiscal oversight was adequate. We found that controls over the financial transactions at NACP were inadequate, and that the NACP Board’s fiscal oversight needed to be strengthened. Conditions Our Audit Found

• The Investments balance (in the amount of $645,600) booked by the business services provider was based on falsified documentation submitted by the former Principal.

• NACP revenues were not properly managed or recorded, which resulted in estimated

unrecorded revenues in the amount of approximately $661,000 and missing revenues in the amount of approximately $162,000.

• There were weak internal controls and a lack of oversight in the expenditures process, which

resulted in fraudulent and abusive activities.

• There were significant deficiencies within the internal controls over Cash In Bank. Fiscal policies and procedures were not enforced or monitored, which led to lapping and improper use of cashier’s checks.

• There was a lack of monitoring over contracts for professional services and consultants. This

resulted in a related party transaction that was not properly disclosed in the financial statements of NACP.

• The majority of equipment lease agreements were not approved by the NACP Board.

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Reasons for the Above Conditions

• Lack of oversight by the NACP Board • Undefined authority of the former Principal • Overreliance on the business services provider to monitor financial operations of NACP • The business services provider’s lack of due diligence related to accounting for financial

transactions and noncompliance with fiscal policies and procedures • Lack of segregation of duties • No NACP staff was designated to monitor contracts and payments • Policies and procedures were not enforced • Weakened control environment • Missing key fiscal policies and procedures • No clear line of communication between the business services provider and the NACP Board

Impact of Noted Conditions

• There was limited assurance that NACP’s financial reports were accurate and reliable. • There were indications that fraud, waste, and abuse of authority had occurred. • There was an increased risk of misappropriation of NACP funds (publically funded), and

resources may have been used for personal gain. • There was limited assurance that expenditures were authorized, appropriate, and allowable. • There was limited assurance that all donations and fundraising collections received by NACP

were complete and properly accounted for. • There was an increased risk that NACP funds were expended that did not benefit the school and

the students. Our recommendations to correct these conditions begin on page 38. BACKGROUND NEW Academy of Canoga Park Elementary School is a charter school located in Los Angeles, California that serves students from kindergarten through fifth grade. NACP was created under the approval of the Los Angeles Unified School Board (“LAUSD”) and the California State Board of Education, and receives public per-pupil funding to help support their operation. The stated mission of NACP is to create an exciting, standards-driven learning environment where students use their talents to contribute positively to the community. NACP is a tax-exempt, public educational agency. NACP is solely responsible for all of its legal obligations and financial debts. NACP began operations as an independent charter school on September 26, 2005. In 2004, the LAUSD Board of Education approved a Charter submitted by the NEW Academy Board to provide an elementary school for students in grades K through 5. The approved Charter was initially for three years. In FY 2007-2008, LAUSD approved the NACP Charter for a period of 5 years, beginning July 1, 2008. NACP currently serves over 450 students.

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The NACP Principal reports to the NACP Board and is in-charge of the daily operations of NACP. The Office Manager and the Charter School’s business services provider assists the Principal in handling the fiscal operations of NACP. Services provided by the business services provider include, but are not limited to budgeting, fiscal planning, bookkeeping, and assistance with operational financial issues. DISCUSSION This section discusses the following six areas:

• Investments • Revenues • Expenditures • Cash In Bank • Use of Consultants and Professional Services • Equipment Lease Agreements

Investments [Evidence of Fraud Confirmed] The Investments balance (in the amount of $645,600) booked by the business services provider was based on falsified documentation submitted by the former Principal. NACP Fiscal and Operating Policies for This Area

• The Board of Trustee shall have the sole authority to approve and incorporate into its own minutes such matters as…(vi) investment policies, (vii) depository and investment banks.5

• All checks are restrictively endorsed immediately by the Executive Director and a copy of each check to be deposited is made and attached to a copy of the deposit slip and filed to provide support for all deposits.6

Finding – Falsified Investment Account Per review of the June 30, 2009 financial statements prepared by the business services provider, we noted an Investments balance in the amount of $645,600. We inquired of the business services provider about this account balance. According to the business services provider, when they asked the former Principal about some missing checks (for anticipated revenue from LACOE and LAUSD) the former Principal told the business services provider that some of the LACOE and LAUSD checks had been “diverted” to an investment account with PMC Capital. Per the business services provider, the entry to book the balance was based on a one-page investments statement from PMC Capital provided by the former Principal. The business services provider booked a one-time lump sum entry in the 5 Fiscal and Operating Policies, Section 202, Board of Trustees Authorities. 6 Fiscal and Operating Policies, Section 1100, Cash Management Procedure, Procedures 1-8.

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amount of $645,600 to record the missing funds not deposited in the NACP’s operational bank account. We noted that the former Principal withdrew funds in the form of cashier’s checks totaling $1,073,700 for the period from July 1, 2007 through September 30, 2009 to deposit in the investment account. It is important to note that cashier’s checks show as ‘customer withdrawals’ on the bank statements. The former Principal later admitted to depositing a significant amount of LACOE and LAUSD checks into the FRIENDS of NACP bank account (designated for charitable donations) instead of the main operational bank account. These NACP funds were used for his personal Ameritrade account, not the PMC Capital account he claimed was in the name of and for the benefit of NACP. The former Principal claimed that funds deposited into his personal Ameritrade account were not withdrawn, but were deposited and repeatedly lost. The former Principal indicated that he was able to deceive the business services provider by creating a fictitious promissory note between NACP and PMC Capital in the amount of $1.1 million. To support this transaction, the former Principal altered the copies of the cashier’s checks by changing the payee name to PMC Capital from the original payee name, which was Ameritrade. It is important to note that the PMC Capital promissory note was not approved by the NACP Board, only the former Principal. This fact in and of itself should have been a red flag for the business services provider to notify the NACP Board due to the significant dollar amount of the promissory note. Falsification of documentation by the former Principal was validated by the auditors via review of copies of cashier’s checks provided by the former Principal and the bank. Significant Fact Impacting Finding We did not have access to the former Principal’s 1099-B statements and Ameritrade annual statements for 2008 and 2009, which would show realized gains and losses for investments. The Ameritrade statements provided showed unrealized gains and losses, but did not provide a summary of realized gains and losses. The manual calculation of realized gains and losses on a trade by trade basis would be an arduous task based on the volume of transactions initiated by the former Principal. As such, we did not confirm the former Principal’s allegation that the funds deposited into his Ameritrade account were lost as he claimed. The above condition occurred due to the following:

• Lack of segregation of duties over fiscal responsibilities at NACP. For example, the former Principal handled cash collections, deposits, authorization, and actual issuance of cash disbursements.

• Lack of due diligence by the business services provider in their monitoring of financial transactions such as significant customer withdrawals.

• Lack of fiscal oversight by the NACP Board as to the approval of the fictitious PMC Capital promissory note.

• Undefined authority of the former Principal.

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• The excessive use of cashier’s checks occurred due to the fact that the bank allowed the former Principal to make unauthorized bank withdrawals.

• The business services provider did not have an effective method to track anticipated LACOE and LAUSD revenues. The undeposited funds may have been identified sooner by the business services provider if this process was in place.

Due to the above instances, NACP suffered a monetary loss in the amount of at least $1,073,700. We discuss the actions needed to correct the above conditions in Recommendations B-1 through B-7.

Revenues [Evidence of Fraud Identified]

NACP revenues were not properly managed or recorded, which resulted in estimated unrecorded revenues in the amount of approximately $661,000 and missing revenues in the amount of approximately $162,000. NACP Fiscal and Operating Policies for This Area

• NACP records revenues on the accrual basis of accounting, consistent with generally accepted

accounting principles applicable to special purpose government units. 7 • A schedule of aged accounts and grants receivable is prepared monthly and reviewed by the

Executive Director for collection.8 • Listed receipts and credits are compared to accounts receivable and bank deposits.9 • General Ledger control accounts are reconciled with the Accounts Receivable Subsidiary

Ledger.10 • NACP has internal control systems in place to monitor cash receipts, and ensure that deposits

are made in a timely manner (daily or no later than on a weekly basis).11 • A copy of each check to be deposited is made and attached to copy of the deposit slip and filed

to provide support for all deposits.12 Federal and State Revenues The majority of NACP’s revenues came from various Federal and State funding sources, such as appropriations for General Purpose Entitlements, Categorical Block Grants, Special Education, Low Star Scores Entitlement, and Child Nutrition Program. Revenue appropriation checks are released either through the Los Angeles County of Education (“LACOE”) or through LAUSD.

7 Fiscal and Operating Policies, Section 501, Revenue Recognition. 8 Fiscal and Operating Policies, Section 307, Cash Management, Item B. 9, 10 Fiscal & Operating Policies, Section 1100, Cash Management Procedures, Item C (ii) and (iii). 11 Fiscal & Operating Policies, Section 1100, Cash Management Procedures, Major Controls, Item B. 12 Fiscal & Operating Policies, Section 1100, Cash Management Procedures, General Procedures, Item 8.

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Other sources of NACP revenues included fundraising events, proceeds from the sale of gym clothes and yearbook, rental income from the use of NACP’s gym, and donations from individuals and private companies. Finding – Missing/Unverified & Misappropriated Revenue We obtained copies of all LACOE checks totaling $7,069,915 issued to NACP for the period July 1, 2007 through November 30, 2009 (from the LACOE Business Unit) and copies of all LAUSD checks totaling $1,955,279 for the same period (from NACP). We traced all LACOE and LAUSD checks to the monthly bank statements to determine if all revenue checks received by NACP were in fact deposited and recorded. We noted the following conditions:

• 1 of the 53 LACOE checks in the amount of $46,588 (check number 16453570) could not be verified against any of NACP’s bank accounts.

• Per review of the cancelled checks, 1 of the 53 LACOE checks in the amount of $59,392

(check number 15350237) was deposited into the California Credit Union Certificate of Deposit Account. We obtained account detail directly from the California Credit Union and confirmed that the check was used to open a California Credit Union Certificate of Deposit account. Funds were withdrawn (including interest earned in the amount of $371.73) by the former Principal and the account was closed by the former Principal. Withdrawn funds in the amount of $59,763.73 could not be traced to any of NACP’s bank accounts. See details below.

Date Check No. Check Amount

Category

8/20/2007 15350237 $ 59,392.00 Misappropriated LACOE Revenue

8/28/2008 16453570 $ 46,588.00 Missing/Unverified LACOE Revenue

• 1 of the 30 LAUSD checks could not be verified against any of NACP’s bank accounts. This check totaled $55,527.72. See details below.

Date Check No. Check Amount

Category

5/28/2008 16214358 $ 55,527.72 Missing/Unverified LAUSD Revenue

Finding – Untimely Recording of Revenue

• Revenues were not recorded by the business services provider on a timely basis.

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Finding – Unrecorded Revenue We also performed an analysis of revenues for the audited period by comparing all cash deposits to the revenues recorded in the general ledger. We determined that approximately $661,000 in revenues was not recorded in the general ledger. Donations & Fundraising Activities Donation and fundraising activities were not approved and related cash flow transactions were not properly accounted for. Best practices dictate that all fundraising activities should be executed in accordance with the following policies:

• All fundraising activities for, at, or on behalf of NACP must be authorized and approved by the approving authority.

• All fundraising activities should be in alignment with NACP’s mission and vision. • Profit and loss statement must be prepared at the end of each fundraising event and reported

timely to all stakeholders such as the NACP Board, the business services provider, student body, and parents.

Finding – Lack of Monitoring Over Donations and Fundraising Activities Based on our inquiries and observation of the processes over fundraising activities and donations, we noted that NACP did not properly track or monitor the fundraising activities and donations totaling $60,683.96. Specifically, we noted the following conditions:

• NACP staff was assigned at the front desk to accept payments and record sales in a log book, but no receipts were issued to students or parents. The log did not have running totals and deposit receipts could not be tied back to the log book.

• The Event Fundraising Coordinator did not prepare a profit and loss statement for any of the fundraising events.

In addition, the business services provider booked fundraising and donations based solely on what was deposited in the bank. This practice increased the risk of misappropriation of cash received that was not deposited. The above conditions related to revenues occurred due to the following:

• The business services provider did not follow the fiscal and operating policies of NACP with regards to the proper accrual of revenues and proper recording of accounts receivables and revenues. This is in part due to the fact that the business services provider did not track LACOE billings to book Accounts Receivable.

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• The business services provider did not closely monitor the timing and recording of check deposits. The business services provider merely recorded transactions based on information sent by the former Principal without analyzing and verifying the validity of the transactions.

• Lack of fiscal oversight by the NACP Board. • Over reliance by the NACP Board on the former Principal and the business services provider to

monitor financial operations. • Lack of written policies and procedures on the proper handling of fundraising activities and

donations. As a result of the above conditions:

• There was limited assurance that NACP’s financial reports were accurate and reliable. • There was limited assurance that all donations and fundraising collections received by NACP

were complete and properly accounted for. • The business services provider was unable to recognize when LACOE checks were missing,

which increased the risk of misappropriation of NACP funds. • NACP was not able to assess the financial outcome of fundraising events.

We discuss the actions needed to correct the above conditions in Recommendations B-1through B-8, and B-13.

Expenditures [Evidence of Abuse Identified] There were weak internal controls and a lack of oversight in the expenditures process, which resulted in fraudulent and abusive activities. NACP Fiscal and Operating Policies for This Area

• When the transaction is complete and payment is due, a pre-numbered check is prepared by the back office business services provider who attaches all supporting documentation and submits the package to the Executive Director for approval.13

• All invoices submitted for signature will include approvals for payment, expense account

charged, check number, and date of payment.14

• All supporting documents are canceled (i.e. stamped PAID) by the signatory and filed by the back office business services provider.15

13, 14, 15 Fiscal and Operating Policies, Section 1100 Cash Management Procedures, Cash Disbursements, Procedures 1, 2 & 4.

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• The Charter School will execute a Purchase Order for all purchases and it shall be approved by the Executive Director for purchases less than $5,000 and by the Board of Trustees if greater than $5,000.16

• Charter School credit cards should only be issued with the formal approval of the Board of

Trustee and with proper justification. The cost/benefit to the Charter School should be fully reviewed to ensure that no other method is appropriate. If credit cards are issued they should be assigned to certain Charter School employees and should be used only for school-related expenditures. All charges must be supported by invoices or travel reports to be eligible for payment by the Charter School.17

The NACP Board adopted a Resolution dated May 26, 2005 authorizing:

• The Principal to approve and sign checks for disbursements amounting to $2,000 or less. • The Principal and one NACP Board member to approve and sign checks for disbursements

over $2,000. Scope We tested transactions for the period of July 1, 2007 through November 30, 2009. Sampling Methodology

• Check Disbursements – We employed both statistical and judgmental sampling to select our sample size for testing of electronic and manual check disbursements. There were 615 ($853,853.73) electronic check disbursements and 798 ($377,969.68) manual check disbursements processed during the audit period. Our selection excluded electronic check payments for professional services/consultants (tested in the Use of Professional Services/Consultants section of this report), employee benefits, voluntary deductions, and employee advances. Specifically, we selected 80 ($285,373.81) electronic check disbursements and 98 ($247,534.44) manual check disbursements.

• Credit Card/Debit Card Charges – We reviewed 100% of all credit ($59,859.44) and debit

($83,877.00) card transactions that occurred during the audited period. Per review of credit card statements, we noted that total credit card transactions were comprised of American Express credit card transactions totaling $8,610.42 and California Credit Union credit card transactions totaling $51,249.02. We also reviewed 100% of all debit card transactions ($83,877.00) completed per the bank statements for the main checking account.

16 Fiscal and Operating Policies, Section 700, Procurement Policies, Item A. 17 Fiscal and Operating Policies, Section 208, Use of School Credit Cards.

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Testing Procedures

• Check Disbursements – We reviewed supporting documentation for selected check disbursements to determine whether the selected check disbursements were (i) adequately supported with invoice or receipts, (ii) approved for payment, (iii) recorded in the appropriate expense classification, and (iv) signed by the authorized signatory(s).

• Credit Card – We reviewed supporting documentation (i.e. receipts, invoices, etc) for each of

the credit card transactions to determine whether the credit card transactions were adequately supported and whether the use of the credit card accounts were properly controlled.

• Debit Card Charges – We reviewed supporting documentation (i.e. receipts, invoices, etc) for

each of the debit card transactions to determine whether the debit card transactions were adequately supported and whether the debit charges were for valid NACP related expenses.

Authorized Cardholders The following are the authorized users of NACP’s credit cards:

• American Express Card o Office Manager o Cafeteria Manager

• California Credit Union Card o Former NACP Principal

According to the NACP Board President, the NACP Board was not aware of the WAMU/Chase Debit Card that was linked to NACP’s Main Checking Account and it appeared that only the former NACP Principal had access to the account.

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Summary of Conditions Noted Refer to Table 1 below for a summary of conditions noted related to non-compliance with NACP’s fiscal policies and procedures.

Table 1 Expenditures

Summary of Conditions Noted

1 Number of exceptions based on sample of transactions tested 2 Percentage of exceptions based on sample of transactions tested 3 Dollar amount of exceptions based on sample of transactions tested 4 Percentage of selected Debit/Credit transactions (in dollars)

Conditions Noted

Transaction Type

Electronic Checks Manual Checks Credit Card

Charges Debit Card

Charges No. of

Exceptions 1 % 2

Dollar Amount 3

No. of Exceptions

1 % 2

Dollar Amount 3 % 4

Dollar Amount 3 % 4

Dollar Amount 3

Unsupported 18 out of 80 23% $ 78,981.28 48 out of 98 49% $ 183,699.17 87%

$52,257.26 80%

$66,921.30

No Approval 80 out of 80 100% 285,373.81 98 out of 98 100% 247,534.44 100%

59,859.44 100%

83,877.00 Improper Expense Classification 18 out of 80 23% 84,234.41 59 out of 98 60% 133,745.09 N/A N/A Supporting Documentation Not Stamped "PAID" 80 out of 80 100% 285,373.81 98 out of 98 100% 247,534.44 N/A N/A Disbursements > $2,000 Not Signed By 2 Signatories 35 out of 35 100% 255,499.50 41 out of 41 100% 290,457.47 N/A N/A Not Recorded to G/L In Timely Manner N/A 98 out of 98 100% 247,534.44 100%

59,859.44 100%

83,877.00

Personal / Potential Abusive Expenses 904.81 4,622.00 19%

11,444.41 9%

7,643.88

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Note: Certain transactions may have more than one condition. As such, dollar totals for conditions shown should be evaluated separately and not combined. Other Significant Conditions

• NACP resources were used to pay for the personal cell phone (Verizon wireless) charges of the former Principal from the period August 2007 through September 2008 in the amount of $904.81 (based on scan of all expenditures for the audited period).

• Personal and potentially abusive personal purchases were misclassified as either office supplies or professional development.

• Procurement of NACP, computer, and custodial supplies were not properly planned and were not procured directly by NACP as evidenced by the heavy volume of reimbursements to NACP staff such as:

o Plant Manager – reimbursed a total of $18,279 for various cleaning/custodial supplies o Information Technology Staff – reimbursed a total of $5,704 o Various Teachers – reimbursed a total of $41,298

• The former Principal’s wife had access to NACP’s debit card. There was one receipt for debit charges made on July 15, 2008 in the amount of $12.41 at the Newhall Postal Connection. The receipt indicated that the former Principal’s wife initiated the transaction and used NACP debit card account to pay for the shipping cost. The amount and date of purchase was traced and verified to NACP’s bank statement.

• Copies of voided checks were not available for review. • The NACP Board was not aware of the debit card or the transactions initiated by the former

NACP Principal. • Excessive purchases of gift cards (i.e. Starbucks) were evident.

The above conditions related to expenditures occurred due to the following:

The overall lack of oversight and monitoring of financial activities by the NACP Board. Over-reliance on the business services provider to monitor NACP financial transactions and operations by the NACP Board. Roles and responsibilities related to financial transactions and fiscal accountability (among NACP, the NACP Board, and the business services provider) were not defined.

Conditions Noted Dollar Totals of

Findings Unsupported $381,859.01 No Approval 676,644.69 Improper Expense Classification 217,979.50 Supporting Documentation Not Stamped "PAID" 532,908.25 Disbursements > $2,000 Not Signed By 2 Signatories 545,956.97 Not Recorded to G/L In Timely Manner 391,270.88 Personal /Abusive Expenses 24,615.11

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Lack of a designated NACP Board member knowledgeable in the area of finance and accounting who was actively involved in fiscal oversight. The business services provider did not adequately communicate non-compliance with approved policies and guidelines by NACP staff to the NACP Board. There was no written policy on the specific use and limits of the manual checks issued by NACP. Segregation of duties for the issuance of checks was not adequate. Excessive authority was given to the former Principal. The business services provider’s lack of due diligence related to accounting for financial transactions and noncompliance with fiscal policies and procedures. No clear line of communication and reporting authority was established between the NACP Board and the business services provider to report irregularities and unusual transactions. The business services provider never requested or obtained original documentation to support financial transactions.

As a result of the above conditions:

There was an increased opportunity for the occurrence of fraud, waste, and abuse. NACP funds and resources may have been used for personal gain. There was limited assurance that expenditures were authorized, appropriate, and allowable. There was limited assurance that the financial statements of NACP were correctly reported.

We discuss the actions needed to correct the above conditions in Recommendations B-1 through B-13.

Cash In Bank [Evidence of Fraud Identified] There were serious weaknesses within the internal controls over Cash In Bank. Fiscal policies and procedures over Cash In Bank were not enforced or monitored, which led to lapping and improper use of cashier’s checks. Bank Reconciliations Monthly bank reconciliation statements were not properly prepared and approved. NACP Fiscal and Operating Policies for This Area

• Reconciliation of cash receipts to deposit slips and bank statements are performed by the Executive Director and the back office business service provider on a monthly basis.18

• All entries are supported by adequate documentation that clearly shows the justification and authorization for the transaction.19

18 Fiscal and Operating Policies, Section 1100, Cash Management Procedures, Item A.8. 19 Fiscal and Operating Policies, Section 1000, General Accounting Procedures, Major Controls , Item B (Support Documentation).

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• Either the back office business services provider or the Executive Director makes deposits on a daily or no later than on a weekly basis.20

• Bank accounts for the intended purpose and limitations have been authorized by the Board of Trustees of NACP at the indicated Federal Deposit Insurance Corporation (“FDIC”) insured banks.21

• The administrator should be notified by the business services provider of all checks over 60 days outstanding and should take appropriate action if necessary.22

For the period under review, NACP had the following six bank accounts:

• NACP Main Checking Account with Debit Card access (General Operating Account) • NACP Business, Money Market Account (Investment/Interest Bearing Account) • Friends of NACP, Checking Account (Charitable Donations) • NACP Arts Checking Account (Fundraising for the NACP Youth Art Center) • NACP Business, Money Market Account (closed as of July 18, 2008) • NACP Cafeteria Checking Account (closed as of November 9, 2009)

We randomly selected the four months ending November 30, 2007, November 30, 2008, November 30, 2009, and December 31, 2009 and obtained the corresponding bank reconciliations for each of the above accounts to determine if monthly bank reconciliation statements were prepared timely and accurately and reviewed. Specifically, we noted the following conditions:

• Monthly bank reconciliation statements were not completed and prepared for the FRIENDS of

NACP Checking Account. • None of the bank reconciliation statements (for all 6 bank accounts) were reviewed and

approved by the NACP Board designee. • Long outstanding checks amounting to $11,067.90 (over 60 days outstanding) were not cleared

or voided. • The monthly bank balances for NACP Main Account (for the months of November 2008,

November 2009, and December 2009) were not within FDIC limit requirements.

20 Fiscal and Operating Policies, Section 1100, Cash Management Procedures, Item A.7. 21 Fiscal and Operating Policies, Section 402, Bank Accounts, Item A. 22 Fiscal Operational Control Policies (School Level), Section 6.0, Bank Reconciliation, Item 5.

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• Bank reconciliation statements for NACP Main Account were not accurately prepared, as shown in Table 2 below:

Table 2

Bank Reconciliation Testing Summary of Exceptions for NACP Main Checking Account

Bank Deposits Internal controls over bank deposits needed significant improvement. NACP Fiscal and Operating Policies for This Area

• NACP has internal control systems in place to monitor cash receipts, and ensure that deposits are made in a timely manner (daily or no later than on a weekly basis).23

• A copy of each check to be deposited is made and attached to copy of the deposit slip and filed to provide support for all deposits.24

We tested 100% of LACOE and LAUSD checks issued to NACP for the period July 1, 2007 through December 31, 2009. Tests were also performed for cash receipts received from local fundraising and donation activities based on available records provided by NACP for the period under audit. Our testing includes tracing of checks against deposit receipts and bank statements to determine whether

23 Fiscal and Operating Policies, Section 1100, Cash Management Procedures, Major Controls, Item B. 24 Fiscal and Operating Policies, Section 1100, Cash Management Procedures, Item A.8.

Month Reviewed

Reconciled Book Balance per Business

Services Provider

Reconciled Book Balance

per Audit

Difference

Over (Under)

Explanation

November 2007 $ 48,978.70 $ 48,169.72 $ 808.98

Manual checks cleared by the bank, but posted to the GL in December 2007

November 2008 464,750.23 462,761.38 1,988.85

Manual checks cleared by the bank, but posted to the GL in December 2008

November 2009 467,728.09 468,440.59 (712.50)

Reversed (voided) check #10002626 was not properly reflected as a reconciling item on the November 2009 bank reconciliation

December 2009 679,335.75 681,460.48 (2,124.73)

Reversed (voided) check #10002619 was not properly reflected as a reconciling item on the December 2009 bank reconciliation

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cash receipts were properly supported, deposited timely, and accurately recorded. We noted the following conditions:

• Bank deposit slips and receipts were not maintained. NACP did not have deposit slips on file for any of the LACOE and LAUSD checks. Only deposit receipts from the bank teller with handwritten notes by the former Principal (as to the detail of the deposits) were provided as supporting documentation for cash received.

• Checks were not deposited in a timely manner. Some checks were deposited anywhere from 15 to 53 days from the check date (totaling $2,311,588.74 for LACOE checks and $1,112,486.39 for LAUSD checks).

• There were instances of check deposit “lapping”. Lapping is defined as the crediting of one account through the abstraction of money from another account. Certain checks totaling $1,341,263.02 were presented to the business services provider (by the former Principal) as back-up for deposits. These checks had been previously deposited to a different account on a different date.

• None of the cash deposited in the FRIENDS of NACP Checking Account was recorded in the general ledger. Over $1.4 million was deposited in this account for the audited period.

Use of Cashier’s Checks The former Principal used cashier’s checks to initiate unauthorized financial transactions. We performed a detailed review and analysis of all bank statements for all bank accounts for the period of July 1, 2007 through December 31, 2009. We noted that the former Principal made numerous customer withdrawals in the form of cashier’s checks. The business services provider was unable to provide adequate supporting documentation for the cashier’s checks as shown in Table 3 below:

Table 3 Use of Cashier’s Checks Summary of Exceptions

** The invoice indicated that professional services will be provided to fourth and fifth grade students for science preparation over the course of 6 weeks. We performed an internet search to verify the validity of the vendor. We noted

Date

Amount

Payee

Purpose

Supporting Documentation Provided by the Business

Services Provider

07/19/2007 $ 29,437 Pearson Education Power School Bank withdrawal receipt and copy of cashier’s check

11/16/2007 49,391 Unknown Software, books, and consulting package Bank withdrawal receipt

12/28/2007 1,354 Unknown Unknown None Available

12/09/2008 62,247 Burgundy Bunny Professional development session

Bank withdrawal receipt and invoice**

Total $ 142,429

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that the address and phone number were invalid. The address shows as a vacant lot. In addition, the business entity name does not exist. The above conditions occurred due to the following:

• Lack of oversight by the NACP Board. No one reviewed and approved the reconciliation statements as required per the fiscal policies and procedures.

• Undefined authority of the former Principal. • Over reliance on the business services provider (by the NACP Board) in the monitoring of

NACP’s financial operations. • The business services provider’s lack of due diligence related to accounting and monitoring for

financial transactions as well as noncompliance with fiscal policies and procedures. • The business services provider did not follow the accrual basis of accounting as indicated in

NACP’s fiscal policies and procedures. For example, “manual” check disbursements and deposit transactions were posted to the general ledger based on when they appeared in the bank statement instead of recording expenses when incurred and revenue when earned.

• The business services provider did not know of the existence of the FRIENDS of NACP Checking Account. In September 2006, the account was opened for the purpose of accepting charitable donations. It is important to note that an actual NACP Board Resolution was passed to open the FRIENDS of NACP Checking Account (signed on September 8, 2006).

As a result of the above conditions:

• There was no assurance that Cash In Bank for NACP was accurately recorded. • There was an increased risk that the loss or misuse of NACP funds would not be detected in a

timely manner. • There was an increased risk of loss of NACP funds for accounts with bank balances in excess

of the maximum FDIC limit. We discuss the actions needed to correct the above conditions in Recommendations B-1 through B-7, B-9, and B-13 through B-14.

Use of Professional Services/Consultants [Evidence of Abuse Identified] There was a lack of monitoring over contracts for professional services and consultants. This resulted in a related party transaction that was not properly disclosed in the financial statements of NACP. NACP Fiscal and Operating Policies for This Area

• Consideration will be made of in-house capabilities to accomplish services before contracting for consultants.

• Written contracts clearly defining work to be performed will be maintained for all consultants and contract services.

• Consultant services will be paid for as work is performed.

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• The administrator will approve proposed contracts in writing. • The board of directors will approve, and audit other significant contracts over $25,000. • Invoices or billings submitted by consultants include sufficient detail as to the time expended

and nature of the actual services performed.25 • All invoices submitted for signature will include approval for payments, expense charged,

check and date of payment.26 • NACP requires proof of adequate insurance coverage from all prospective contractors, as

deemed applicable by the Board of Trustee27. • It shall be the responsibility of NA/NACP to monitor its vendors, contractors, partners or

sponsors for compliance with the required insurance requirements.28 Per review of the general ledger, we noted expenses in the amount of $878,282.31 (for the audited period) that were paid to 33 professional service providers and consultants. We obtained and reviewed supporting documentation (i.e. contracts and invoices) to determine if expenses were authorized and covered by a valid contract. We noted the following conditions: Our testing found that expenses for 13 out of the 33 (40%) vendors (totaling $35,029.09) were improperly classified as professional service providers/consultants. Related Party Transaction Expenses for 1 out of the 20 vendors properly classified as professional service providers/consultants was for the contracting of a related party consultant. This consultant was a former NACP teacher at NACP who was subsequently hired as a consultant to write grants. At the time of our audit, we believed this person to be the wife of the former Principal. However, the date of marriage could not be determined. For the audited period, the consultant was paid a total of $129,350 (at least $4,500 every month). According to the Office Manager, the consultant was rarely present at NACP site. We also noted that grant writing was one of the responsibilities delegated to the business services provider (as stated in their contract). 25 Fiscal and Operating Policies, Section 900 Consultants and Contractors, Item 901 B. 26 Fiscal and Operating Policies, Section 1100, Cash Management Procedures, Cash Disbursements, Item B 2. 27 Fiscal and Operating Policies, Section 311, Insurance and Bonding. 28 New Canoga Charter Petition Renewal dated December 3, 2007, Insurance Requirements, page 128.

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Based on our testing of the expenses for the 20 vendors properly classified as professional services/consultants, we noted several conditions. Refer to Table 4 below for details.

Table 4

Professional Services/Consultants Expense Testing Summary of Exceptions

Description No. of

Exceptions % of

Exceptions Total

Amount Paid

No valid contract

10

50%

$529,760 Reasonableness of payments could not be determined due to no valid contract or incomplete contract

12

60%

$537,760

The contract was not signed by all parties 13 65% $554,041 NACP staff were unable to provide a valid Certificate of Insurance for the contractor

18

90%

$794,393

Contract was over $25,000 and was not approved by the NACP Board

5

25%

$753,407

Included in the 20 vendors properly classified as professional service providers/consultants was the business services provider. The business services provider was contracted to perform bookkeeping and accounting functions for NACP. Based on the results of our testing, we noted that the business services provider was paid a total of $249,832 for extra work, $44,295 of which was for services included in the functions stated in the base contract price. As such, the business services provider billed for extra services not included in the functions stated in the base contract price. Examples of these extra services include LEA Plan Approval, Grant Development Package, ASES, Grant Balances, Grant Continuation, Grant Progress Payments, and Reconciliation of 08-09 Income. In addition, the business services provider’s contract included the completion of monthly Nutrition Services Claim reimbursement forms. This service was also the responsibility of another vendor, which billed $62,275 for services rendered. Due to the complexity and volume of transactions involved, we performed separate testing for insurance related payments. We performed testing of all invoices for 3 judgmentally selected insurance brokers and carriers for the three year period covered by this audit. We noted the following conditions:

• The insurance broker’s contract did not specify the payment amount. As such, commission

payments totaling $16,443 could not be assessed for reasonableness. • 1 out of the 3 (33.33%) insurance carriers was overpaid in 2007 in the amount of $2,930. The

overpayment was later refunded by the insurance carrier.

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The above conditions occurred due to the following:

• Lack of oversight by the NACP Board over the fiscal activities of the former Principal. • The business services provider did not provide due diligence in monitoring, processing, and

recording NACP’s financial transactions. • The business services provider did not provide detailed invoices explaining extra services billed

to NACP. • No NACP staff was designated to monitor contracts and payments. • Undefined authority of the former Principal.

As result of the above conditions, we noted the following:

• NACP funds may have been misappropriated and misused by the former Principal. • Financial statement presentation was not accurate. • There was a loss of interest earned on funds that were overpaid to vendors.

We discuss the actions needed to correct the above conditions in Recommendations B-1 through B-8.

Equipment Lease Agreements [Evidence of Abuse Identified] The majority of equipment lease agreements were not approved by the NACP Board. NACP Fiscal and Operating Policies for This Area Debt Loan agreements approved by the Board of Trustees should be in writing and should specify all applicable terms, including the purpose of the loan, the interest rate and the repayment schedule.29 Procurement Policies The Charter School will execute a Purchase Order for all purchases and it shall be approved by the Executive Director for purchases less than $5,000 and by the Board of Trustees if greater than $5,000.

29Fiscal and Operating Policies, 2008-2009, Section 409, Debt, Item B.

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We performed 100% testing of all the equipment lease agreements recorded in NACP’s books for the period July 1, 2007 through November 30, 2009 to verify if they were approved and maintained. We noted the following conditions described in Table 5.

Table 5 Equipment Lease Agreements Summary of Conditions Noted

Conditions Noted No. of

Contracts (out of 10)

% Dollar Amount

Copy of equipment lease agreement not on file

1 10%

$ 113,917.68

Equipment lease agreement not approved by the NACP Board

9 90%

$ 304,427.16

Copy of equipment lease agreement not signed by the former NACP Principal

2 20%

$ 12,990.00

Based on the above table, it appears that the former Principal entered into equipment lease agreements totaling approximately $300,000 that were not approved by the NACP Board. It is likely that the NACP Board was not aware of these equipment lease agreements. The above conditions occurred due to the following:

• Lack of oversight by the NACP Board over the former Principal’s fiscal authority and responsibilities.

• The internal controls over equipment lease agreements were properly designed, but were not functioning as intended. As such, the former Principal was able to override the controls.

• No NACP staff was assigned to monitor lease contract agreements and payments. As a result of the above conditions, there was an increased risk that NACP funds may have been expended that did not benefit the school and the students. We discuss the actions needed to correct the above conditions in Recommendations B-1 through B-8.

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RECOMMENDATIONS AND COMMENTS The NACP Board should: B-1 Recommendation: Identify and define levels of authority and responsibilities of NACP Administrator. NACP Comments: The NACP Board agreed with this recommendation and stated that the identification and defining of levels of authority and responsibilities will be performed in conjunction with the forensic accountant’s review of the operational and internal control structure. Target Date of Implementation: Within 150 days from the issuance of the final OIG audit report OIG Comment: The NACP Board should continue to be engaged in the work of the forensic accountants and should carefully review and analyze the results of the forensic accountant’s findings, conclusions, and recommendations. B-2 Recommendation: Establish a direct line of reporting communication between the NACP Board and the business services provider for reporting of issues. NACP Comments: The NACP Board agreed with this recommendation and stated that the business services provider will communicate issues to the Board in writing (via email). Target Date of Implementation: Within 150 days from the issuance of the final OIG audit report B-3 Recommendation: Establish proper segregation of duties among NACP staff. Segregate the functions of authorization, custody, and recordkeeping of transactions. NACP Comments: The NACP Board agreed with this recommendation and stated that the establishment of proper segregation of duties will be performed in conjunction with the forensic accountant’s review of the operational and internal control structure. Target Date of Implementation: Within 150 days from the issuance of the final OIG audit report OIG Comment: The NACP Board should continue to be engaged in the work of the forensic accountants and should carefully review and analyze the results of the forensic accountant’s findings, conclusions, and recommendations. B-4 Recommendation: Instruct the business services provider to strictly enforce all fiscal policies and procedures. NACP Comments: The NACP Board agreed with this recommendation and has instructed the business services provider to comply with all fiscal policies and procedures. Target Date of Implementation: Currently implemented

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B-5 Recommendation: Instruct the business services provider to bring to the attention of the NACP Board (in a timely manner) any irregularities or unusual matters concerning NACP’s financial operations. NACP Comments: The NACP Board agreed with this recommendation and stated that the Board will enforce the business services provider’s responsibility to monitor NACP’s financial condition. In addition, the Board has established an agreed upon process with the business services provider in which communication (financial transaction information) between NACP staff and the business services provider will be in written format via email. Furthermore, the Board has informed NACP staff of their responsibility to provide the business services provider with appropriate and valid information. Target Date of Implementation: Currently implemented B-6 Recommendation: Instruct the business services provider to ensure that all transactions are supported by complete and appropriate documentation prior to recording transactions in the general ledger. NACP Comments: The NACP Board agreed with this recommendation and has instructed the business services provider to ensure that all transactions are supported by complete and appropriate documentation prior to recording transactions in the general ledger. Target Date of Implementation: Within 60 days from the issuance of the final OIG audit report B-7 Recommendation: Provide adequate oversight over the fiscal operations of NACP by reviewing and approving on a monthly basis, the financial reports prepared by the business services provider (i.e. Bank Reconciliation, Budget versus Actual Reports). Review should be evidenced by signature and date. NACP Comments: The NACP Board agreed with this recommendation and stated that as of the date of their response (May 14, 2010), the Board reviews and approves on a monthly basis, the financial reports prepared by the business services provider. The Board’s review is evidenced by signature and date. Target Date of Implementation: Within 60 days from the issuance of the final OIG audit report B-8 Recommendation: Instruct the business services provider to incorporate in NACP’s fiscal policies and procedures, detailed guidelines for the handling of donations and fundraising events; use of manual checks; procurement of supplies; and contracts, such as:

o Use of pre-numbered cash receipts book to acknowledge cash receipts for all merchandise sales, fundraising collections, and donations.

o Development of a template of a Profit and Loss Statement and provide guidance to NACP staff on the proper use of the form.

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o Require NACP Principal to instruct Fundraising Coordinators to prepare a Profit and Loss Statement for each fundraising activity and submit for review and approval by the Principal or designee.

o Setting the dollar limits for manual checks. o Delegating the signing authority for manual checks. o Defining the types of services or products allowed for manual checks. o Centralize procurement of NACP, custodial, and computer supplies. o Review and approval of all contracts (i.e. professional services, lease) over $25,000 by

the NACP Board. Review and approval should be documented in the Board minutes of the meeting.

o Require NACP Principal to report all contracts [i.e. professional services, lease] (below $25,000) and provide copies of the approved contracts to the NACP Board.

o Require all consultants to provide a detailed invoice with sufficient details as to the nature and timing of actual services provided.

o Instruct NACP Office Manager to process and approve the payments of consultants only if: (a) they have approved contracts on file, (b) amount billed is within the approved contract amount, (c) actual services performed are verified and complete, and (d) valid certificates of insurance are on file.

NACP Comments: The NACP Board agreed with this recommendation and stated that the Board will instruct the business services provider to update the fiscal policies and procedures (by including the procedures within B-8 Recommendation). The business services provider will also be responsible for monitoring compliance with fiscal policies and procedures and identifying deficiencies. Target Date of Implementation: Within 60 days from the issuance of the final OIG audit report B-9 Recommendation: Require NACP staff to submit all original supporting documentation for financial transactions (i.e. copies of receipts, invoice/s) to the business services provider. NACP Comments: The NACP Board agreed with this recommendation and stated that the Board will instruct the business services provider and NACP staff accordingly. The Board suggested two options to implement this recommendation: (1) fax supporting documentation to the business services provider daily or as agreed upon (weekly, bi-weekly),or (2) mail the original copies to the business services provider and maintain photocopies onsite. Target Date of Implementation: One of the two options will be implemented within 60 days from the issuance of the final OIG audit report B-10 Recommendation: (i) Adopt a board resolution authorizing the cancellation of all debit cards associated with NACP’s checking accounts, (ii) provide a copy of the approved Board resolution to bank(s) and the business services provider, and (iii) instruct the business services provider to monitor and ensure that debit card transactions are discontinued and to report any future debit card transactions to the NACP Board. NACP Comments: The NACP Board agreed with this recommendation. At the May 4, 2010 NACP Board meeting, the NACP Board adopted a resolution authorizing the cancellation of all debit cards

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associated with NACP’s checking accounts. A copy of the resolution has been provided to the business services provider and to all banks holding accounts for NACP. In addition, the Board has instructed the business services provider to monitor and ensure that debit card transactions are discontinued and to report any future debit card transactions to the NACP Board. Target Date of Implementation: Currently implemented

B-11 Recommendation: Work with the Principal, Office Manager, and the business services provider to identify all credit cards issued to the NACP and determine if there is a need for continued use of credit card account(s) by NACP staff. NACP Comments: The NACP Board agreed with this recommendation and stated that the Board with the assistance of the business services provider is currently identifying all existing credit cards guaranteed by the NACP. The Board will deliberate the need for credit cards guaranteed by NACP at the June 2010 Board meeting and will present a resolution detailing the final decision of the Board. Target Date of Implementation: The identification of the credit cards will be completed within 30 days of their response (dated May 14, 2010) and the credit card determination will be deliberated at the June 2010 scheduled Board meeting

B-12 Recommendation: (i) Adopt a board resolution that will provide written guidelines as to the specific purpose and use of a particular credit card, (ii) establish detailed procedures on the use of credit cards including a formal Code of Conduct outlining the disciplinary actions to be taken by NACP management for staff that violates standards, and (iii) require all NACP staff with responsibility for NACP’s financial operations to sign and acknowledge that they understand the consequences for violating the code. NACP Comments: The NACP Board agreed with this recommendation and stated that depending on the final outcome of the Board’s decision on credit cards guaranteed by the NACP, the Board will implement all three items noted in B-12 Recommendation. Target Date of Implementation: Within 45 days from the issuance of the final OIG audit report B-13 Recommendation: Require the business services provider to ensure that all transactions are recorded in the general ledger on a timely basis (i.e. cash receipts, cash disbursements). NACP Comments: The NACP Board agreed with this recommendation and stated that the Board will require the business services provider to ensure that all transactions are recorded in the general ledger on a timely basis. Target Date of Implementation: During Fiscal Year 2010-2011 B-14 Recommendation: Require the business services provider to monitor and ensure that only authorized and pre-approved electronic bank transfers are charged such as payroll and employment tax payments. In addition, any unusual fund transfers should be reviewed by the business services provider for appropriateness and communicated to the NACP Board, if necessary.

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NACP Comments: The NACP Board agreed with this recommendation and stated that the Board will require the business services provider to monitor and ensure that only authorized and pre-approved electronic bank transfers are charged such as payroll and employment tax payments. In addition, any unusual fund transfers will be reviewed by the business services provider for appropriateness and communicated to the NACP Board, if necessary. Target Date of Implementation: Within 60 days from the issuance of the final OIG audit report

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FINDING AND RECOMMENDATIONS

FINDING C: Assessment of Fraud by External Auditors For the Board of Directors, New Academy of Canoga Park School SUMMARY Conditions Our Audit Found It appears that NACP’s external auditors may have been lax in their consideration of fraud in connection with prior financial statement audits. Impact of Noted Conditions Fraud risk factors and internal control weaknesses that made it possible for the former Principal to commit fraud were not communicated to the NACP Board. There is also the possibility that the June 30, 2008 audited financial statements may have contained material misstatements and not been detected by the external auditors. BACKGROUND The external auditors performed the external audit for the year ended June 30, 2008. The audit was conducted in accordance with auditing standards generally accepted in the United States of America; the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States, and the Education Audit Appeals Panel’s Standards and Procedures for Audit of California K-12 Local Educational Agencies. California Education Code Guidance on Audits of Charter Schools Notwithstanding any other provision of law, charter schools shall be subject, with regard to subdivisions (c) and (d) of Section 47612.5 and this section, to audits conducted pursuant to Section 41020.30 An audit conducted pursuant to this section shall comply fully with the Government Auditing Standards issued by the Comptroller General of the United States.31 Each audit conducted in accordance with this section shall include all funds of the local educational agency, including the student body and cafeteria funds and accounts and any other funds under the

30 California Education Code Section 47634.2(d). 31 California Education Code Section 41020(b)(4).

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control or jurisdiction of the local educational agency. Each audit shall also include an audit of pupil attendance procedures.32

The audits shall be made by a certified public accountant or a public accountant, licensed by the California Board of Accountancy, and selected by the local educational agency, as applicable, from a directory of certified public accountants and public accountants deemed by the Controller as qualified to conduct audits of local educational agencies, which shall be published by the Controller not later than December 31 of each year.33 AU Section 31634 – Consideration of Fraud in a Financial Statement Audit The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. This section establishes standards and provides guidance to auditors in fulfilling that responsibility, as it relates to fraud, in an audit of financial statements conducted in accordance with generally accepted auditing standards (GAAS).35 It is management's responsibility to design and implement programs and controls to prevent, deter, and detect fraud. Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, authorize, record, process, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements. Management, along with those charged with governance, should set the proper tone; create and maintain a culture of honesty and high ethical standards; and establish appropriate controls to prevent, deter, and detect fraud. When management and those charged with governance fulfill those responsibilities, the opportunities to commit fraud can be reduced significantly.36 Two types of misstatements are relevant to the auditor's consideration of fraud – misstatements arising from fraudulent financial reporting37 and misstatements arising from misappropriation of assets38.39 Three conditions generally are present when fraud occurs. First, management or other employees have an incentive or are under pressure, which provides a reason to commit fraud. Second, circumstances exist—for example, the absence of controls, ineffective controls, or the ability of management to override controls – that provide an opportunity for a fraud to be perpetrated. Third, 32 California Education Code Section 41020(c). 33 California Education Code Section 41020(f)(1). 34 Source: SAS No. 99; SAS No. 113; Effective for audits of financial statements beginning on or after December 15, 2002. 35 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .01. 36 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .04. 37 Misstatements arising from fraudulent financial reporting are intentional misstatements or omissions of amounts or disclosures in financial statements designed to deceive financial statement users where the effect causes the financial statements not to be presented, in all material respects, in conformity with generally accepted accounting principles (GAAP). 38 Misstatements arising from misappropriation of assets (sometimes referred to as theft or defalcation) involve the theft of an entity's assets where the effect of the theft causes the financial statements not to be presented, in all material respects, in conformity with GAAP. 39 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .06.

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those involved are able to rationalize committing a fraudulent act. Some individuals possess an attitude, character, or set of ethical values that allow them to knowingly and intentionally commit a dishonest act. However, even otherwise honest individuals can commit fraud in an environment that imposes sufficient pressure on them. The greater the incentive or pressure, the more likely an individual will be able to rationalize the acceptability of committing fraud.40 Management has a unique ability to perpetrate fraud because it frequently is in a position to directly or indirectly manipulate accounting records and present fraudulent financial information. Fraudulent financial reporting often involves management override of controls that otherwise may appear to be operating effectively.41 Fraud may be concealed by withholding evidence or misrepresenting information in response to inquiries or by falsifying documentation.42 Fraud also may be concealed through collusion among management, employees, or third parties.43 Although fraud usually is concealed and management's intent is difficult to determine, the presence of certain conditions may suggest to the auditor the possibility that fraud may exist.44 Refer to Appendix A for Auditor’s Responsibilities concerning the Consideration of Fraud. The areas in which the external auditors may not have exhibited their full due diligence include the following:

• Consideration of Fraud Risk Factors • Fraud Risk Inquiries • Assessing the Identified Risks After Taking Into Account An Evaluation of the Entity’s

Programs and Controls that Address the Risks Refer below for auditor responsibilities for each of the above areas. Consideration of Fraud Risk Factors Because fraud is usually concealed, material misstatements due to fraud are difficult to detect. Nevertheless, the auditor may identify events or conditions that indicate incentives/pressures to perpetrate fraud, opportunities to carry out the fraud, or attitudes/rationalizations to justify a fraudulent action. Such events or conditions are referred to as "fraud risk factors." Fraud risk factors do not necessarily indicate the existence of fraud; however, they often are present in circumstances where fraud exists.45

40 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .07. 41 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .08. 42 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .09. 43 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .10. 44 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .11. 45 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .31.

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When obtaining information about the entity and its environment, the auditor should consider whether the information indicates that one or more fraud risk factors are present. The auditor should use professional judgment in determining whether a risk factor is present and should be considered in identifying and assessing the risks of material misstatement due to fraud.46 Fraud Risk Inquiries As stated in AU 316, external auditors should make inquiries of management and others within the entity about the risks of fraud to obtain the information needed to identify the risks of material misstatement due to fraud. The auditor should inquire of management about47:

• Whether management has knowledge of any fraud or suspected fraud affecting the entity. • Whether management is aware of allegations of fraud or suspected fraud affecting the entity. • Management's understanding about the risks of fraud in the entity, including any specific fraud

risks the entity has identified or account balances or classes of transactions for which a risk of fraud may be likely to exist.

• Programs and controls the entity has established to mitigate specific fraud risks the entity has identified, or that otherwise help to prevent, deter, and detect fraud, and how management monitors those programs and controls.

• Whether and how management communicates to employees its views on business practices and ethical behavior.

The inquiries of management also should include whether management has reported to those charged with governance on how the entity's internal control serves to prevent, deter, or detect material misstatements due to fraud.48 The auditor also should inquire directly of those charged with governance regarding their views about the risks of fraud and whether those charged with governance have knowledge of any fraud or suspected fraud affecting the entity.49 The auditor should also inquire of others within the entity about the existence or suspicion of fraud. The auditor should use professional judgment to determine those others within the entity to whom inquiries should be directed and the extent of such inquiries. In making this determination, the auditor should consider whether others within the entity may be able to provide information that will be helpful to the auditor in identifying risks of material misstatement due to fraud – for example, others who may have additional knowledge about or be able to corroborate risks of fraud identified in the discussions with management or those charged with governance.50

46 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .32. 47 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .20. 48 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .21. 49 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .22. 50 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .24.

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The auditor's inquiries of management and others within the entity are important because fraud often is uncovered through information received in response to inquiries. One reason for this is that such inquiries may provide individuals with an opportunity to convey information to the auditor that otherwise might not be communicated. Making inquiries of others within the entity, in addition to management, may be useful in providing the auditor with a perspective that is different from that of individuals involved in the financial reporting process. The responses to these other inquiries might serve to corroborate responses received from management, or alternatively, might provide information regarding the possibility of management override of controls – for example, a response from an employee indicating an unusual change in the way transactions have been processed. In addition, the auditor may obtain information from these inquiries regarding how effectively management has communicated standards of ethical behavior to individuals throughout the organization.51 The auditor should be aware when evaluating management's responses to the inquiries that management is often in the best position to perpetrate fraud. The auditor should use professional judgment in deciding when it is necessary to corroborate responses to inquiries with other information. However, when responses are inconsistent among inquiries, the auditor should obtain additional audit evidence to resolve the inconsistencies.52 Assessing the Identified Risks After Taking Into Account An Evaluation of the Entity’s Programs and Controls that Address the Risks Section 314 requires the auditor to obtain an understanding of each of the five components of internal control sufficient to plan the audit. It also notes that such knowledge should be used to identify types of potential misstatements, consider factors that affect the risk of material misstatement, design tests of controls when applicable, and design substantive tests. Additionally, Section 314 notes that controls, whether manual or automated, can be circumvented by collusion of two or more people or inappropriate management override of internal control.53 As part of the understanding of internal control sufficient to plan the audit, the auditor should evaluate whether entity programs and controls that address identified risks of material misstatement due to fraud have been suitably designed and placed in operation. These programs and controls may involve (a) specific controls designed to mitigate specific risks of fraud—for example, controls to address specific assets susceptible to misappropriation, and (b) broader programs designed to prevent, deter, and detect fraud—for example, programs to promote a culture of honesty and ethical behavior. The auditor should consider whether such programs and controls mitigate the identified risks of material misstatement due to fraud or whether specific control deficiencies may exacerbate the risks.54

51 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .26. 52 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .27. 53 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .43. 54 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .44.

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DISCUSSION As previously disclosed in the Executive Summary of this report, we follow Generally Accepted Government Auditing Standards (“GAGAS”). In this section we describe in more detail the specific fraud audit procedures we performed (as required by GAGAS). Although the fraud procedures required by GAGAS are not identical to those fraud procedures required by Generally Accepted Auditing Standards, we believe that effective performance of fraud procedures would have identified an environment with high fraud potential. Based on fraud procedures performed for the audit of NACP, we noted several conditions. This section discusses those conditions in the following four areas:

• OIG’s Consideration of Fraud Risk Factors • OIG’s Fraud Risk Inquiries • OIG’s Assessment of Internal Control • OIG’s Overall Assessment of the External Auditors’ Consideration of Fraud

OIG’s Consideration of Fraud Risk Factors

Prior to the start of our audit, we had a team “brainstorming” meeting to discuss the potential for material misstatement due to fraud. Some of the more significant fraud risk factors identified include:

• Overall lack of oversight by the NACP Board • Lack of monitoring of internal controls • Lack of segregation of duties • Lack of proper implementation of policies and procedures • Over-reliance on the business services provider to monitor NACP operations • The business services provider never requested or received original documentation from NACP

staff • Personal debt/gambling addiction of the former Principal • The former Principal’s role as one of NACP founders - significant trust in former Principal by

the business services provider and the NACP Board Per review of the examples of fraud risk factors related to fraudulent financial reporting and misappropriation of assets (in Appendix B of AU 316) and our audit results, we noted the following additional fraud risk factors applicable to NACP:

• Domination of management by the former Principal without compensating controls • Large amounts of cash processed (i.e. LACOE and LAUSD checks) • Inadequate retention of documentation • Lack of oversight of employees responsible for assets (i.e. former Principal and the business

services provider) • Disregard for the need for monitoring or reducing risks related to misappropriation of assets by

the NACP Board

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• Disregard for internal control over misappropriation of assets by overriding existing controls or by failing to correct known internal control deficiencies (by the former Principal and the business services provider)

Impact of Noted Conditions The above conditions represent opportunities for the occurrence of fraud. As a result of the level of opportunity that was present, it appears that there was at a minimum significant deficiencies in the existing internal controls. We believe that one or more of these internal control weaknesses should have been identified by the external auditors in conjunction with their external audit of NACP. We noted that the external auditors did not express an opinion on the effectiveness of NACP’s internal control over financial reporting as such an opinion is not typically required by the standards. It is important to note that the external auditors issued an Unqualified opinion for the year ended June 30, 2008 and indicated that no deficiencies in internal control over financial reporting (considered to be material weaknesses55) were identified by the external auditors.

OIG’s Fraud Risk Inquiries

As part of our audit of NACP, we performed fraud risk and internal control inquiries with the NACP Board President, current Principal, and Office Manager. Based on our inquiries, we noted the following responses and conditions:

• The NACP Board President was not aware of any allegations of fraud or suspected fraud affecting NACP other than allegations pertaining to the misappropriation of assets by the former Principal.

• The current Principal and Office Manager were not aware of any allegations of fraud or

suspected fraud affecting NACP.

• The NACP Board President was not aware of any internal or external pressures that could lead to fraudulent activities. However, the NACP Board President stated the following vulnerable areas that could lead to fraudulent activities:

o Inefficiency of NACP’s business services provider, the business services provider

in terms of timeliness of financial reports provided to the Board and the fact that internal control weaknesses were not communicated to the NACP Board (such as the fact that all checks over $2,000 were signed only by the former Principal, not two signatures as required by the policies and procedures).

55 When one or more of a company's internal controls, put in place to prevent significant financial statement irregularities, is considered to be ineffective. If a deficiency in an internal control is thought to be of material weakness, this means that it could lead to a material misstatement in a company's financial statements; http://www.investopedia.com/terms/m/materialweakness.asp.

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o The bank processed transactions that were not in accordance with the existing Board Resolutions.

• The current Principal and Office Manager were not aware of any internal or external pressures,

or vulnerable areas that could lead to fraudulent activities. • Per the NACP Board President, the Board does not have a formalized risk assessment

process or specific controls in place to prevent, deter, and detect fraud. The NACP Board President stated that the NACP Board meets with the business services provider two times per year to see how things are going. The responsibility for the implementation of internal controls and day-to-day operations was placed with the former Principal and the business services provider. The Board also reviews financial reports prepared by the business services provider such as the cash flow statement and annual budget.

o Currently, there are two versions of NACP’s fiscal and operating policies and

procedures. Based on our inquiries and test work, many of the policies and procedures have not been implemented or are not being followed.

• The NACP Board did not implement a Code of Conduct until February 2009. It appears

that the Code of Conduct was applicable only for Board members, and not NACP employees. As such, it appears that management did not effectively communicate to employees its views on business practices and ethical behavior.

Impact of Noted Conditions The above responses are directly related to weaknesses within the organization’s control environment. These conditions allow for both the risk of material misstatement due to fraud and the override of controls. Due to the fact that we did not have access to the external auditor’s work papers, we cannot confirm whether these fraud risk factors were considered, but these control environment weaknesses should have been discussed with NACP’s management and Board in conjunction with the prior external audits.

OIG’s Assessment of Internal Control As part of audit procedures, we obtained an understanding of and evaluated each of the five components of internal control (Control Environment, Risk Assessment, Control Activities, Information & Communication, and Monitoring). We noted that the internal control structure between NACP, the NACP Board, and the business services provider had significant deficiencies. Refer to the Finding A: Internal Control System for our discussion of the internal control components.

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OIG’s Overall Assessment of the External Auditors Consideration of Fraud The full extent of fraud at NACP is uncertain due to the fact that we did not have access to certain documentation (i.e. personal bank and investment statements of the former Principal). However, we did note several questionable practices and transactions that transpired during our audit period July 1, 2007 through June 30, 2008 (the latest period audited by the external auditors). Some of the more significant questionable practices and transactions (that occurred during the period audited by the external auditors) include the following:

• Contracting of a related party consultant (former NACP teacher that was hired as a consultant to write grants) who subsequently became the wife of the former Principal. For the audited by the external auditors, the consultant was paid a total of $40,500. According to the Office Manager, the consultant was rarely present at NACP site. We noted that grant writing was one of the responsibilities delegated to the business services provider (as stated in their contract). Refer to the Use of Professional Services/Consultants section for discussion of findings in this area.

• For the period audited by the external auditors, debit card charges (all made by the former

Principal) amounted to $37,383.16. NACP was unable to provide supporting documentation for 85% (or $31,851.91) of the debit card charges. Due to the fact that the majority of supporting documentation was missing, we were unable to verify that all of the debit card charges were for school related expenditures. Refer to the Expenditures section for discussion of findings in this area.

• For the period audited by the external auditors, credit card charges (mostly made by the former

Principal) amounted to $27,805.63. NACP was unable to provide supporting documentation for 92% (or $25,632.47) of the credit card transactions. Due to the fact that the majority of supporting documentation was missing, we were unable to verify that all of the credit card charges were for school related expenditures. Refer to the Expenditures section for discussion of findings in this area.

• The business services provider never requested or received original documentation for any of

the transactions. All documentation was faxed or emailed (as an attachment) to the business services provider. This condition allowed the former Principal to falsify and alter documentation.

• The former Principal was the sole signer on all checks issued, regardless of dollar amount.

According to the Fiscal and Operating Policies, all checks over $2,000 require two signatures. For the period audited by the external auditors, issued checks over $2,000 (including electronic and manual checks) totaled $370,926.75. Refer to the Expenditures section for discussion of this finding.

• For the period audited by the external auditors, the former Principal issued approximately

$175,228 in manual checks. Until August 2009, manual checks were booked based on when they cleared in the bank statement. Sometime in August 2009, the business services provider

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starting booking manual checks based on documentation sent by the NACP’s Office Manager. Refer to the Expenditures section for discussion of findings in this area.

• For the period audited by the external auditors, the former Principal used cashier’s checks

(totaling $80,182) to initiate unauthorized financial transactions. Refer to the Cash In Bank section for discussion of findings in this area.

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FINDING AND RECOMMENDATION

FINDING D: Enterprise Risk Management For the Executive Director, Innovation and Charter Schools Division The Innovation and Charter Schools Division did not have a risk management process in place over Charter Schools. According to the professional standards, one of the things that Internal Auditors must do is to evaluate the effectiveness and contribute to the improvement of the risk management process. According to the Institute of Internal Auditors, “Risk management is a key responsibility of senior management and the board. To achieve its business objectives, management ensures that sound risk management processes are in place and functioning.” What is Enterprise Risk Management? According to the Committee of Sponsoring Organizations (“COSO”) Framework, Enterprise Risk Management (“ERM”) is a process that an organization’s Board, management, and other personnel put in place and then apply in strategy setting and across the enterprise. It is done with the intent to:

Identify potential events that may affect the entity Manage risk to be within its risk appetite Provide reasonable assurance regarding the achievement of entity objectives

So an organization sets objectives, identifies and understands the risk that could affect the achievement of those objectives, and then takes action to manage those risks appropriately. Ideally, ERM is not something that is “added on” to an organization’s activities but something that should be built into its existing activities and processes. According to professional guidance, risk management activities can vary significantly from organization to organization depending on its size and complexity, and the risk management process can be formal or informal, quantitative or subjective, and embedded in the business units or centralized at the corporate level. We believe that there is not an effective Enterprise Risk Management Process in place within the Innovation and Charter Schools Division that addresses the numerous risks related to the District’s Charter Schools. The Los Angeles Unified School District views charter schools as integral to the District's offerings and an opportunity to teach both students and educators. Currently, there are 161

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charter schools under the jurisdiction of the LAUSD, serving approximately 60,000 students (as of FY 2009-2010 Norm Day) in kindergarten through 12th grade, which accounts for approximately 10% of the District’s total enrollment. More students attend charter schools in the Los Angeles Unified School District than in any other district in the country. Oversight and monitoring of the District’s Charter Schools is an important function of management and would benefit greatly by an effective risk management being in place. As a result of not having an effective Enterprise Risk Management Process in place over Charter Schools, the District risks not achieving its goals for this critical area. Our recommendations to correct these conditions begin on page 55.

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RECOMMENDATION AND COMMENT D-1 Recommendation: Consider developing and adopting a risk management process for Charter Schools. This process may be based upon an established framework such as that issued by the COSO. Given that risk management is an evolving yet critical responsibility of management, consider asking for the assistance of the Office of the Inspector General on information, tools and techniques on how to establish a risk management process related to Charter Schools. Innovation and Charter School Division (“ICSD”) Comments: The ICSD partially agreed with this recommendation and stated that ICSD will work with and seek guidance from the OIG to develop the Risk Management Process. Target Date of Implementation: January 10, 2011

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FINDING AND RECOMMENDATION

FINDING E: Implications for Other Charter Schools For the Executive Director, Innovation and Charter Schools Division Based on testing performed, we noted the following areas that may have implications for other Charter Schools:

• Governance/Oversight • Use of Back Office Service Providers • Use of Debit/Credit Cards • Manual Checks

Governance/Oversight Strong governance is necessary. Charter School Boards should ensure that there is someone with financial expertise on the Board at all times. Charter School Boards should be more involved in the monitoring of day-to-day transactions through review of monthly account reconciliations and monthly financial statements. The authority of Principals and staff responsible for financial transactions should be clearly defined in the fiscal policies and procedures of the Charter Schools. Use of Back Office Service Providers Many Charter Schools do not have in-house staff with accounting/financial expertise and hire back office service providers to perform the accounting function (to process and record financial transactions). The development, implementation, and enforcement of internal controls are functions of management, not of the back office service provider. Charter School Boards should ensure that there is someone with accounting/financial expertise on the Board at all times. In addition, Charter School Boards should exhibit adequate oversight of school management and staff involved with financial transactions. Use of Debit/Credit Cards In recent years, debit cards have become a more accepted form of payment for most vendors/retailers. As such, Charter Schools should establish detailed policies and procedures for the use of debit cards (instances used) and require supporting documentation.. Monthly credit card bills should not be paid with Charter School funds unless supporting documentation is maintained for all transactions and all transactions are for school related expenses. In the event that credit card expenses are not school related, payment should be required of the employee(s) that charged the expense.

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Manual Checks All checks (whether generated electronically or manual) should require the appropriate level of supporting documentation and approval. For Charter Schools that process checks electronically, the use of manual checks should be limited. Our recommendations to correct these conditions begin on page 58.

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RECOMMENDATION E-1 Recommendation: In light of the information presented in this audit, and consistent with our Recommendation D-1, which encourages the implementation of Enterprise Risk Management, we recommend that the Executive Director of the Innovation and Charter Schools Division do the following:

• Identify all LAUSD Charter Schools that use a back office services provider.

• Advise the identified Charter Schools that it is critical that they properly oversee their back office services providers and that this level of oversight requires that the Charter Schools have in-house staff and Board members with adequate accounting and financial expertise.

• Advise all Charter Schools that it is critical that they properly oversee their School's financial operations which includes all significant transactions and that this requires that the Charter Schools have in-house staff and Board members with adequate accounting and financial expertise.

• Provide education and awareness to Charter Schools about the need for strong and effective internal controls, which include clear policies and procedures [i.e. fiscal and governance] that are consistently followed and which describe roles and responsibilities of School staff. Consider collaborating with the Office of the Inspector General on the dissemination of this information.

• Advise Charter School Boards that it is important that they thoroughly review and understand their school's annual financial audit report prepared by their retained CPA firm. Encourage the Charter School Boards to (i) not over rely on the external auditor’s opinion on the Charter School’s annual financial statements for assurance on the effectiveness of fiscal operations, and (ii) discuss the audit reports with the CPA firms that prepared them and to ask any needed questions to satisfy themselves that the audit report is reliable.

• Develop a process to reasonably verify that the Charter Schools are following the guidance above or similar guidance to ensure sound practice. Consider collaborating with the Office of the Inspector General on the achievement of this goal.

• Consider meeting with the service providers referenced in this audit and discussing with them how they intend to address the deficiencies in their services described in this report.

• Encourage all Charter School Boards to restrict use of all debit cards.

• Encourage all Charter School Boards to strengthen policies and procedures over the issuance of manual checks.

Innovation and Charter School Division (“ICSD”) Comments: The ICSD agreed with the intent of these recommendations and will strengthen the current practices in these areas. The ICSD further agreed on the need for improved fiscal monitoring by the Boards of Charter Schools. Target Date of Implementation: Each of the above recommendations has been implemented or will be implemented by October 31, 2010.

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AUDIT OBSERVATION

As part of our audit procedures, we inquired with the NACP Board President, the business services provider, and NACP staff to determine if there were any intercompany receivables. We noted an intercompany receivable from the NEW Academy of Science & Arts (“NASA”), sister school to NACP, in the amount of $200,000. We traced and agreed the $200,000 deposit to the NASA April 2009 bank statement. Per review of the NASA April 2009 bank statement, we noted the following transactions, which may have been personal in nature:

• 2 ATM withdrawals in the amount of $300 each (which appears to be the daily maximum ATM withdrawal allowed)

• 3 check card/point of service purchases totaling $211.38 (for USPS, See’s Candy, and

IHOP) We did not obtain supporting documentation for any of the above transactions, as NASA was not included in our audit scope. Recommendation: We recommend that the NACP Board contract an independent CPA firm to perform a limited scope internal audit of NASA (covering the internal controls within the expenditures process).

NACP Comments: The NACP Board agreed with this recommendation and stated that the Board will commission a CPA firm to perform a limited scope internal audit of New Academy of Science and Arts (NASA) [covering the internal controls of the expenditures process]. Target Date of Implementation: Within 60 days from the date of their response (dated May 14, 2010)

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APPENDIX A

Auditor Responsibilities for Consideration of Fraud Auditor Responsibilities Procedures/Guidance 156 The Importance of Exercising

Professional Skepticism Due professional care requires the auditor to exercise professional skepticism. Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence.

257 Discussion Among Engagement Personnel Regarding the Risks of Material Misstatement Due to Fraud

Prior to or in conjunction with the information-gathering procedures, members of the audit team should discuss the potential for material misstatement due to fraud. The discussion should include:

• An exchange of ideas or "brainstorming" among the audit team members, including the auditor with final responsibility for the audit, about how and where they believe the entity's financial statements might be susceptible to material misstatement due to fraud, how management could perpetrate and conceal fraudulent financial reporting, and how assets of the entity could be misappropriated.

• An emphasis on the importance of maintaining the proper state of mind throughout the audit regarding the potential for material misstatement due to fraud.

358 Obtaining the Information Needed to Identify the Risks of Material Misstatement Due to Fraud

The auditor should perform the following procedures to obtain information that is used to identify the risks of material misstatement due to fraud:

• Make inquiries of management and others within the entity to obtain their views about the risks of fraud and how they are addressed.

• Consider any unusual or unexpected relationships that have been identified in performing analytical procedures in planning the audit.

56 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .13. 57 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .14. 58 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .19.

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• Consider whether one or more fraud risk factors exist. • Consider other information that may be helpful in the identification of risks of

material misstatement due to fraud. 459 Identifying Risks That May Result in a

Material Misstatement Due to Fraud The identification of a risk of material misstatement due to fraud involves the application of professional judgment and includes the consideration of the attributes of the risk, including the type, significance, likelihood, and pervasiveness of the risk.

560 Presume that Improper Revenue Recognition is a Fraud Risk

Material misstatements due to fraudulent financial reporting often result from an overstatement of revenues (for example, through premature revenue recognition or recording fictitious revenues) or an understatement of revenues (for example, through improperly shifting revenues to a later period).

661 Consideration of the Risk of Management Override of Controls

Even if specific risks of material misstatement due to fraud are not identified by the auditor, there is a possibility that management override of controls could occur, and accordingly, the auditor should address that risk apart from any conclusions regarding the existence of more specifically identifiable risks.

762 Assessing the Identified Risks After Taking Into Account an Evaluation of the Entity’s Programs and Controls that Address The Risks

Section 314 requires the auditor to obtain an understanding of each of the five components of internal control sufficient to plan the audit. It also notes that such knowledge should be used to identify types of potential misstatements, consider factors that affect the risk of material misstatement, design tests of controls when applicable, and design substantive tests. As part of the understanding of internal control sufficient to plan the audit, the auditor should evaluate whether entity programs and controls that address identified risks of material misstatement due to fraud have been suitably designed and placed in operation. After the auditor has evaluated whether the entity's programs and controls that address identified risks of material misstatement due to fraud have been suitably designed and

59 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .40. 60 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .41. 61 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .42. 62 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraphs .43 - .45.

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placed in operation, the auditor should assess these risks taking into account that evaluation.

863 Responding to the Risks of Material Misstatement Due to Fraud

The auditor responds to risks of material misstatement due to fraud in the following three ways:

• A response that has an overall effect on how the audit is conducted – that is, a response involving more general considerations apart from the specific procedures otherwise planned.

• A response to identified risks involving the nature, timing, and extent of the auditing procedures to be performed.

• A response involving the performance of certain procedures to further address the risk of material misstatement due to fraud involving management override of controls, given the unpredictable ways in which such override could occur.

964 Evaluating Audit Evidence

The auditor should:

• Assess risks of material misstatement due to fraud throughout the audit. • Evaluate whether analytical procedures performed as substantive tests or in the

overall review stage of the audit indicate a previously unrecognized risk of material misstatement due to fraud.

• Evaluate the risks of material misstatement due to fraud at or near the date of the auditor’s report.

• Respond to misstatements that may be the result of fraud. 1065 Communicating About Possible Fraud

to Management, Those Charges With Governance, and Others

Whenever the auditor has determined that there is evidence that fraud may exist, that matter should be brought to the attention of an appropriate level of management. This is appropriate even if the matter might be considered inconsequential, such as a minor defalcation by an employee at a low level in the entity's organization. Fraud involving senior management and fraud (whether caused by senior management or other

63 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .48. 64 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraphs .68 - .78. 65 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .79.

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employees) that causes a material misstatement of the financial statements should be reported directly to those charged with governance. In addition, the auditor should reach an understanding with those charged with governance regarding the nature and extent of communications with them about misappropriations perpetrated by lower-level employees.

1166 Documenting the Auditor’s Consideration of Fraud

The auditor should document the following:

• The discussion among engagement personnel in planning the audit regarding the susceptibility of the entity's financial statements to material misstatement due to fraud, including how and when the discussion occurred, the audit team members who participated, and the subject matter discussed.

• The procedures performed to obtain information necessary to identify and assess the risks of material misstatement due to fraud.

• Specific risks of material misstatement due to fraud that were identified, and a description of the auditor's response to those risks.

• If the auditor has not identified in a particular circumstance, improper revenue recognition as a risk of material misstatement due to fraud, the reasons supporting the auditor's conclusion.

• The results of the procedures performed to further address the risk of management override of controls.

• Other conditions and analytical relationships that caused the auditor to believe that additional auditing procedures or other responses were required and any further responses the auditor concluded were appropriate, to address such risks or other conditions.

• The nature of the communications about fraud made to management, those charged with governance, and others.

66 AU Section 316 – Consideration of Fraud in a Financial Statement Audit, Paragraph .83.

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APPENDIX B

SUMMARY OF QUESTIONED COSTS IDENTIFIED IN THIS AUDIT*

TOTAL MISAPPROPRIATED AND MISSING FUNDS $ 1,624,353.95

DESCRIPTION AMOUNT CATEGORY 1. Unsupported Expenditures ** $ 381,859.01 Questioned Costs

** Includes $ 24,615.13 identified to be personal and abusive purchases by the former Principal 2. Use of Cashier’s Checks withdrawn from the General

Fund that were not adequately supported

142,429.00

Questioned Costs 3. Use of Professional Services/Consultants Related Party Transaction 129,350.00 Questioned Costs No Valid Contract 400,410.00 Questioned Costs TOTAL QUESTIONED COSTS $ 1,054,048.01 TOTAL FRAUD, WASTE, & ABUSE $ 2,678,401.96 * The amounts included in this appendix represent questioned costs identified in the course of the audit. The dollar amount is composed of missing or stolen funds, expenditures made with checks, debit cards and credit cards which were not supported with any documentation, payment of professional services to a related party (spouse of the former Principal), and contract payments which were not supported by a valid contract (not on file).

DESCRIPTION AMOUNT CATEGORY 1. Deposits to FRIENDS Account used by the former

Principal to fund personal AMERITRADE investments account .

$1,073,700.00

Misappropriated Funds 2. Remaining deposits to FRIENDS Account used by the

former Principal – purpose of use unknown due to missing bank documentation (i.e. detail for all deposits and withdrawals).

337,450.20

Misappropriated Funds

3. LACOE revenue check # 16453570 that could not be traced to any of the School’s bank accounts.

LACOE revenue check #15350237 that was used to open a California Credit Union Certificate of Deposit account. Funds were withdrawn (including interest earned in the amount of $371.73) and account was closed by the former Principal. Withdrawn funds in the amount of $59,763.73 could not be traced to any of the School’s bank accounts.

46,588.00

59,763.73

Missing/Unverified Funds

Misappropriated Funds

4. One LAUSD revenue check #16214358 that could not be traced to any of the School’s bank accounts.

55,527.72

Missing/Unverified Funds

5. Cashier's check deposited to General Account from the FRIENDS Account to cover the missing Certificate of Deposit balance from closed California Credit Union Account.

51,324.30

Misappropriated Funds

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This document states an opinion of the personnel of the Internal Audit Unit and does not represent the official position of the Los Angeles Unified School District. This document is exempt from disclosure under the Public Records Act. This document should not be released outside of the School District because opinions stated herein if quoted outside of the proper factual context could be prejudicial to a full understanding of the subject matters to which these opinions relate.

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Other Attachments NACP submitted numerous documents and exhibits to support their response. We have extracted and included in this audit report only those specific pages referenced by NACP that support their comments.

Pages 66 – 241 are NACP’s responses.

The OIG replies to these comments are found in Appendix D on pages 242 – 293.

APPENDIX C-1

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cc: Alfred Rodas (via email: alfred.rodas@lausd.net)

Corazon Cenon (via email: corazon.cenon@lausd.net)

Parker Hudnut (via email: parker.hudnut@lausd.net)

Administrative Office 303 S. Loma Drive, Los Angeles, CA 90017

S c h o o l L o c a t i o n s : NEW Academy of Science and Art — 379 S. Loma Drive, Los Angeles, CA 90017 NEW Academy Canoga Park — 21425 Cohasset Street, Canoga Park, CA 91303

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APPENDIX C-2

LARA & IBARRA LLP ATTORNEYS AT LAW

S U I T E 2700 445 SOUTH FIGUEROA STREET LOS ANGELES, CALIFORNIA 90071

(213) 623-2600 FAX (213) 623-2616

R o b e r t o L a r a E-MAIL: rlara@laraibarra.com

June 25, 2010

BY HAND DELIVERY

Amanda Roberson Office of the Inspector General Los Angeles Unified School District 333 South Beaudry Avenue Los Angeles, California 90017

RE: Our Client: New Academy Canoga Park Elementary Charter School Revised Response to Draft Audit Report of the Los Angeles City Board of Education — Office of the Inspector General

Dear Ms. Roberson:

As you know, New Academy Canoga Park Elementary Charter School ("NACP") contracted with the Charter School Management Corporation ("CSMC") throughout relevant time period in this matter.

CSMC has requested that NACP insert certain changes to NACP's Response to the Draft Audit Report of the Office of the Inspector General ("Response"). The Response was originally submitted to your office on May 14, 2010. Among the changes requested is that CSMC not be referred to by name but generically as the "business services provider" throughout the Response. My client has agreed to revise the Response out of the spirit of goodwill and cooperation. Enclosed please find the revised response, which is now dated as June 24, 2010. Thank you.

Very truly yours,

Roberto Lara of LARA & IBARRA LLP

R L: rg 360842.1

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APPENDIX C-3

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Other Attachments NACP submitted numerous documents and exhibits to support their response. We have extracted and included in this audit report only those specific pages referenced by NACP that support their comments.

Pages 66 – 241 are NACP’s responses.

The OIG replies to these comments are found in Appendix D on pages 242 – 293.

APPENDIX D-1

FINAL OIG RESPONSE

TO

NACP’S REVISED COMMENTS TO THE DRAFT AUDIT REPORT [DATED APRIL 22, 2010]

AND

NACP’S COMMENTS ON THE REVISED DRAFT REPORT

[DATED JUNE 9, 2010] The OIG received a response to the April 22, 2010 Draft Audit Report from NACP. The response was submitted by NACP’s General Counsel. This original response to our Draft Audit Report is shown as Exhibit 3 in Appendix D. The OIG also received a revised response to the June 9, 2010 Revised Draft Audit Report from NACP. The response was submitted by NACP’s General Counsel. This revised response to our Draft Audit Report is shown as Exhibit 2 in Appendix D. The original NACP response to our Draft Audit Report is shown as Exhibit 3 in Appendix D. The final NACP response to our Revised Draft Report is shown as Exhibit 1 in Appendix D. Preliminary Observation: Revised NACP Response NACP comments regarding the actions of the business services provider and how these contributed to the fraud that occurred are different in the revised response. In the original response, NACP seemed to agree with our assessment that a lack of diligence by the business services provider contributed to the fraud that occurred at the school. In the revised response, NACP no longer deems the actions of the business services provider to have contributed to the fraud that occurred at the school. Significant comments about the business services provider were removed, and NACP shifted much of the responsibility for the occurrence of the fraud away from the business services provider to the former Principal, to the external auditors, and to some degree to the LAUSD and to the LAUSD OIG. In addition, NACP’s revised response to our audit reasserts the school’s position that the NACP Board acted reasonably; that the independent entities responsible to report to the NACP Board allegedly failed

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to inform the NACP Board of the fraud; and that the NACP Board has essentially no responsibility with regard to the fraud that took place at the school. We disagree with numerous elements of the NACP revised response. We believe the revised response is based in part on several flawed premises and contains some inaccurate statements not supported by the facts or by best practices. We address these in our detailed response below.

ACCOUNTABILITY OF BOARD In its revised response, NACP states:

The School’s reliance on independent entities to report on its financial condition was not a delegation of its oversight responsibility.

We disagree. Our audit found that the NACP Board relied excessively on independent entities to monitor its financial condition on its behalf and was lax in its own direct oversight responsibilities. Yet, the NACP Board relied solely on the business services provider to monitor the day-to-day financial transactions and operations of NACP. Monitoring by independent entities, including audits, is never intended to replace direct oversight efforts by the Board itself. As we previously said, effective board members are objective, capable, and inquisitive. They should have a working knowledge of the entity’s activities and environment and should commit the time necessary to fulfill their board responsibilities. This was not what our audit found for the period reviewed. The NACP Board’s overreliance on its business services provider as well as the imprudent level of trust it placed in the former Principal created an environment that allowed the former Principal to perpetrate fraudulent and abusive activities.

CAUSE OF LOSS The NACP Board identified what are, in its estimation, the three reasons for the loss related to the fraud and abuse perpetrated by the former Principal. The reasons, as stated, are misleading in that they present an incomplete picture as to what occurred at NACP that made the fraud and abuse perpetrated by the former Principal possible. Moreover, the three reasons offered by NACP fail to acknowledge the NACP Board’s role in the occurrence of the loss as well as other contributing factors beyond those described by NACP.

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Our comments for each of the reasons presented by NACP to explain the loss are shown below in red:

NACP asserts that the Loss Was a Result of Alleged Fraud by the Former Principal of the School.

The loss was the result of numerous factors. These include the actions of the former

Principal, but also the NACP Board’s lack of sufficient oversight, which created ample opportunities for the former Principal to commit fraudulent and abusive activities.

•• The NACP Board relied solely on its business services provider to monitor the

day-to day financial transactions and operations of NACP.

The business services provider did not exhibit due diligence related to accounting for financial transactions.

The business services provider did not communicate noncompliance with NACP fiscal policies and procedures to the NACP Board.

Despite Having Several Systems in Place to Identify This Type of Fraud, Those Systems Failed to Inform the Board of the Fraud.

Prior OIG Audit of NACP

We disagree with the NACP Board.

The NACP Board was notified in a timely manner of the prior OIG audit of NACP

performed in FY 2008, which covered the FY 2007 period, July 1, 2006 through June 30, 2007.

•• NACP Board minutes dated June 9, 2008 show that the former Principal did

advise the NACP Board about the results of the prior OIG audit. It was fully within the NACP Board’s capability to ask for any additional information about the audit either of the Principal or of the OIG.

It was appropriate to address the audit to the Principal, as this is who most internal audits of charter schools are addressed to.

The report stated that management oversight and review of expenditures needed improvement. The report also stated that the lack of adequate management oversight of established controls over purchasing and disbursements could increase the risk of inappropriate or unauthorized expenditures going undetected.

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The report recommended that NACP management improve its oversight and enforcement of controls over expenditures.

•• The NACP Board had ample time to address the issues and

implement the recommendations noted in the prior OIG audit report, but did not appear to have done so completely.

•• The NACP Board’s increased fiscal oversight and enforcement

of all internal controls could have prevented the majority of the missing/misappropriated funds and questioned costs discovered in our current audit.

At the time of the prior OIG audit covering the period from July 1, 2006 through June 30,

2007, the former Principal had not yet admitted to or been discovered to have been involved in fraudulent activity at NACP.

•• Based on our analysis of documentation provided during the period of our

fieldwork, it appears that the fraud and waste perpetrated by the former Principal did not begin until January 2008, subsequent to the scope of the OIG audit covering the period from July 1, 2006 through June 30, 2007. It is misleading to suggest or imply that the OIG audit performed in FY 2008 was deficient in some manner. All issues identified were properly included in the audit report and communicated to NACP.

OIG Reporting Responsibility

We fulfilled our reporting responsibility by advising the Charter School of the results of our FY 2007 audit of NACP. The audit report was provided to the former Principal who in turn advised the NACP Board of the audit results. As mentioned above, this fact the audit results were communicated to the NACP Board was confirmed via review of the June 9, 2008 NACP Board minutes.

By way of clarification, the OIG conducted a performance audit (in accordance with Government Auditing Standards), not an external financial audit, as stated by the NACP Board. Reliance on Reporting Systems

We disagree with the NACP Board’s level of reliance on its reporting systems.

The NACP Board should have internal processes (i.e. risk assessment, internal

controls) in place to prevent and detect instances of fraud, waste, and abuse. The NACP Board should not solely rely on the results of independent external audits to identify weaknesses in internal controls as well as instances of fraud, waste, abuse. This is a reactive, rather than proactive approach. This type of approach does not prevent issues, but can only detect issues after the fact.

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Despite Obtaining Reports of Its Financial Condition at its Board Meetings By the Business Services Provider, the Business Service Provider Claims that Those Reports Were Based on False Information Provided by the Former Principal.

The OIG acknowledges that the former Principal did falsify documentation, which was

relied upon by the business services provider to generate reports. •• However, the business services provider never requested or received original

documentation from the former Principal and did not enforce or follow all of the NACP fiscal policies and procedures when processing and recording certain financial transactions.

The requirement for original documentation would have deterred the former Principal

from falsifying documentation.

Adherence to all of the fiscal policies and procedures would have improved the accuracy of the reports generated by the business services provider.

IMPLEMENTATION OF OIG RECOMMENDATIONS The NACP Board made the following statement related to the implementation of the OIG recommendations included in the Revised Draft Report: “Indeed, even with the implementation of the OIG’s recommendations, it is highly likely that the loss would have occurred due to the faulty reporting provided to the Board as explained in the Revised Response…” The OIG acknowledges that the June 30, 2008 audited financial statements may have contained material misstatements that were undetected by the external auditors. However, the accuracy of the audited financial reports has no bearing on fraud prevention efforts. Stronger oversight by the NACP Board and full compliance with fiscal policies and procedures by both NACP staff and by the business services provider could have potentially prevented the occurrence of the fraud perpetrated by the former Principal.

QUESTIONED COSTS The NACP Board expressed some disagreement and uncertainty regarding the quantification and final determination of the questioned costs included in the OIG Revised Draft Report. It was not the intent of the OIG to make a final determination of the alleged fraud and abuse committed by the former Principal. Rather, the OIG’s objective was to assess the nature and extent of any improprieties or irregularities that occurred during the period under audit based solely on the documentation made available to us during the period of our fieldwork. We reiterate that the documentation used to complete our audit was both sufficient and appropriate to support our findings and conclusions.

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We advise the NACP Board to use the forsenic accountants to make this final determination of questioned costs.

ADDITIONAL NACP OBSERVATIONS

p. 10 – Finding – Missing/Unverified & Misappropriated Revenue NACP Comments: The OIG Revised Draft Report on page 21 made a modification to the number of LAUSD checks that could not be verified from 2 to 1. However, the OIG did not revise the total amount of the checks as indicated from $114,524.30 to the revised amount of $55,527.72. OIG Comments: Duly noted. The final report will reflect this correction.

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APPENDIX D-2

OIG RESPONSE TO NACP COMMENTS ON AUDIT FINDINGS AND CONCLUSIONS

June 9, 2010

Los Angeles Unified School District Office of the Inspector General Internal Audit

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INTRODUCTION

The NEW Academy of Canoga Park Elementary Charter School (“NACP”) provided a 30-page response to our OIG Draft Report, along with 9 exhibits to support the positions they assert in their response. The NACP Board response is organized into seven sections. These seven sections in turn include subsections [The actual verbatim response from the NACP Board is attached to this OIG Draft Report for reference and is shown as Appendix D]. The seven main sections of the NACP Board Response are:

Preliminary Statement

The Very Safeguards Intended to Avoid This Type of Misappropriation Failed To Adequately Inform The School

The School Has Implemented Corrective Actions In Furtherance of the Inspector General’s

Recommendations

The Board Accepts The Inspector General’s Recommendations, But Identifies Several Material Issues And Errors

Out of An Abundance of Caution, The Board Has Taken The Additional Step Of Retaining A

Forensic Accountant to Identify Areas Of Improvement Beyond Those Offered In The IG Report.

In Further Response To The IG Report, The School Provides Detailed Comments And Description Of The Corrective Actions Taken

Conclusions

The 30 page response included general comments about the content of our OIG Draft Report, as well as specific replies to the 21 recommendations (addressed to the NACP Board of Directors) included in the OIG Draft Report.

GENERAL SUMMARY OF THE NACP BOARD RESPONSE

The NACP Board response disagreed with some of the findings and conclusions made in the OIG Draft Report related to the performance of the NACP Board. The NACP Board response did not appear to express either explicit agreement or disagreement with many of the other reported findings or conclusions. The NACP Board response also asserted that the OIG Draft Report contained “several material issues and errors”. In spite of the above, the NACP Board stated that out of an abundance of caution it would take or had already taken action to implement all of our recommendations included in the OIG Draft Report.

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The following qualifying language is included prior to a description of the corrective actions planned or taken in response to our recommendations included in the OIG Draft Report: “Without admitting to the accuracy of the analysis provided in the IG Report, the Board agrees that this recommendation is a prudent measure for the school and, with that understanding, will implement the recommendation.” This qualifying language was used 20 times in the NACP Board response to our OIG Draft Report. Finally, the NACP Board stated that the NACP Board has taken the additional step of retaining a forensic accountant to identify areas of improvement beyond those offered in the OIG Draft Report.

OVERALL OIG COMMENT ON THE NACP BOARD RESPONSE The NACP Board is to be commended for its decision to implement our recommendations included in the OIG Draft Report. Notwithstanding, there are certain statements and positions taken in the NACP Board response that we have a responsibility to respond to since they directly or indirectly bear on the credibility of our report. The alleged “material issues and errors” that the NACP Board asserts are contained in the OIG Draft Report are addressed individually in the body of our comments that follow. We have organized our comments on the NACP Board response in the sections below:

• Accountability of Board • Defense of Detailed Findings • Nature of Our Engagement and the Length of Fieldwork

ACCOUNTABILITY OF BOARD NACP Board Response: p.3 – 7 – “Preliminary Statement” and “The Very Safeguards Intended to Avoid This Type of Misappropriation Failed To Adequately Inform The School” NACP Board Statement: 1. PRELIMINARY STATEMENT. Since 2005, New Academy of Canoga Park (“School”) has operated an elementary charter school, near the corner of Saticoy Street and Canoga Avenue in Canoga Park. The School has thrived and is well known for its excellent education program offered to the neighborhood children and children residing in the affordable housing units uniquely connected to the School. The School has earned a valuable reputation - - both in the neighborhood and in the Latino community throughout Canoga Park.

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Despite these accomplishments, the OIG Draft Report for the Audit of the School (“IG Report”) conducted by the Office of the Inspector General for the Los Angeles City Board of Education (“Inspector General”) alleges that the former Principal of the School misappropriated funds.67 The IG Report claims that the School’s former principal misappropriated over one million dollars of the School’s funds - - without any authority or knowledge by the School’s Board of Directors (“Board”). Once the Board became aware of the loss, it proactively informed the Los Angeles Unified School District (“LAUSD”), scheduled a meeting with the Inspector General and the Charter Division for LAUSD, and reported the loss to the appropriate authorities. The Board also took immediate additional steps to safeguard the School. The School’s finances were secured and the Principal’s employment was terminated. Moreover, out of an abundance of caution, the School has already implemented or is in the process of implementing all of the recommendations offered by the Inspector General in the IG Report. 1 The IG Report states that it has confirmed that there was fraud perpetrated by the former Principal. (See, IG Report at p. 2.) The former Principal’s employment at the School has been terminated. 2 In light of the findings in the IG Report, the Board is reevaluating its continuing relationship with the business services provider. 3 The IG Report confirms that the School’s financial reports prepared by the business services provider and the June 30, 2008 audited financial statements were not accurate or reliable. According to the Report, this led to the conditions that allowed to the misappropriation of funds and questioned costs. (See IG Report at pp. 2-3.) The IG Report’s characterization of the Board is unfair and not consistent with the actual facts. The alleged misappropriation of funds noted by the IG Report was made possible, ironically, by the Board’s reliance on the very safeguards it is required to have as part of its charter. In compliance with its Fiscal and Operating Policies and Charter, the School relied upon several independent entities to safeguard against this very type of loss. (See Exhibit [“Exh.”] 1, Fiscal and Operating Policies 2008-2009, at §§ 314-315; Exh. 2, Charter Petition approved by LAUSD on June 25, 2008, at p. 135, Element 9.) These safeguards include: (i) Periodic reporting of the School’s financial condition by its business services provider.68; (ii) External audits by duly licensed and independent accounting firms; and (iii) External financial audits commissioned by LAUSD itself in furtherance of its ongoing oversight responsibilities. The Board recognizes that there was a fundamental failure in the reporting required of these safeguards.69

67 The IG Report states that it has confirmed that there was fraud perpetrated by the former Principal. (See, IG Report at p. 2) The former Principal’s employment at the NACP has been terminated. 68 In light of the findings in the IG Report, the Board is reevaluating its continuing relationship with the business services provider. 69 The IG Report confirms that NACP’s financial reports prepared by the business services provider and the June 30, 2008

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2. THE VERY SAFEGUARDS INTENDED TO AVOID THIS TYPE OF MISAPPROPRIATION FAILED TO ADEQUATLEY INFORM THE SCHOOL.

In compliance with its charter agreement with LAUSD, the School contracted two separate entities to monitor and report on its financial condition. The School agrees in part with the conclusion reached by the IG Report, in that the theft was made possible due to: (i) Unilateral actions by the former Principal of the School; (ii) Inaccurate reporting of the School’s financial condition by the business services provider; and (iii) A faulty audit report prepared by an external auditor in the June 30, 2008.4

A. The Board Acted Reasonably, but Was Not Adequately Informed.

The IG Report correctly identifies the responsibilities of internal controls for management and the board of directors. The IG Report in pertinent part provides as follows: “More than any other individual, the School administrator sets the ‘tone at the top’ that affects integrity, ethics, and other factors of a positive control environment. . . . ¶ Management is accountable to the board of directors, which provides governance, guidance, and oversight. Effective board members are objective, capable and inquisitive. They also have knowledge of the entity's activities and environment, and commit the time necessary to fulfill their board responsibilities. Management may be in a position to override controls and ignore or stifle communications from subordinates enabling a dishonest management which intentionally misrepresents results to cover its tracks. A strong, active board, particularly when coupled with effective communications channels and capable financial, legal and internal audit functions, is often best able to identify and correct such a problem. [emphasis added] (See, IG Report at p. 6.)

As explained in its Charter Petition, which was approved by LAUSD, the Board contracted with the business services provider to oversee annual, independent financial audits including financial statements, and review the School’s internal controls. (See Exh. 2, Charter Petition, Element 9, at p. 135.) The business services provider was further required to provide monthly financial reports, fiscal analysis, commentary and review the School’s internal controls. (See Exh. 1, Fiscal Policies; See also, IG Report at p. 8.) The Board obtained periodic financial reports by the business services provider, but as noted by the IG Report, those reports were not accurate and the business services provider did not perform a meaningful review of the School’s internal controls.

audited financial statements were not accurate or reliable. According to the Report, this led to the conditions that allowed to the misappropriation of funds and questioned costs. (See IG Report at pp. 2-3.)

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As a further safeguard, the Board was required to obtain an annual audit by a certified public accountant. (See Exh. 2, Charter Petition, Element 9, at p. 135.) The Board complied with these requirements and commissioned its annual audit. (See Exh. 3, New Academy of Canoga Park Elementary School Audited Financial Statements for the Year Ended June 30, 2008.) B. The business services provider’s Financial Reporting Failed to Inform the Board of the Principal’s Disregard of the Fiscal Policies. The IG Report claims that there was a lack of top level review by the Board, in that there was no review of the financial records on a monthly basis. (See, IG Report at p. 10.) Regardless of the frequency of the Board’s meetings, the problem remains that even if the Board reviewed the financial records prepared by the business services provider on a monthly basis, those records were incomplete and inaccurate as alleged by the IG Report. (See, IG Report at p. 10.) The Board met at least on a bi-monthly basis and obtained reports by the business services provider. At each Board meeting when financial records were presented, the Board complied with its oversight requirements. As identified by the IG Report, the business services provider did not report the former Principal’s continuous disregard of the School’s fiscal policies and, most alarmingly, validated the Principal’s impropriety by recording inappropriate financial transactions. (See, IG Report at p. 11.) The Board’s reliance on the business services provider is reasonable to the extent that this is precisely what is called for in the Fiscal Procedures and Policies and in the Charter Petition, which was approved by LAUSD itself. (Exh. 1, Fiscal and Operating Policies 2008-2009, at Part II, § 1000; Exh. 2, Approved Charter Petition, June 25, 2008, at p. 135.) The Board recognizes that there was a dearth of capable financial reporting that allowed the former Principal to commit the acts identified in the IG Report. Moreover, it is difficult to impossible for any board in its oversight function to determine independently that the records its accountant presents are based on incorrect information. This structural issue is inherent for all boards and is precisely the reason LAUSD requires annual audits by a separate external auditor, but the external audit in this instance also failed to adequately inform the Board. C. The Independent External Auditor Failed to Identify the Problems Responsible for the Loss. In compliance with its oversight responsibilities, the Board commissioned an external audit, dated June 30, 2008, and a supplemental report was provided in December 1, 2008. The findings were clear, the School was in compliance and there were no negative findings whatsoever. (See Exh. 3, New Academy of Canoga Park Elementary School Audited Financial Statements for the Year Ended June 30, 2008, at pp. 14-18.) The external auditors claimed that they “did not identify any deficiencies in internal control over financial reporting that we consider to be material weaknesses.” (Exh. 3 at

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p. 15.)

The IG Report, in retrospect, correctly identifies that the external audit was lax in its consideration of fraud in conjunction with prior financial statement audits. (IG Report, at p. 2.) The School acknowledges that the External Audit did not identify the problems identified in the IG Report, but the Board cannot be faulted for its reliance on an external independent audit report. If the Board cannot rely on independent external audits, then what can it rely upon? The School is required to retain such auditors and these auditors were duly licensed. (Exh. 2, Approved Charter Petition, Element 9 – Annual Audit, at p. 135.) Had the external audit report identified the control problems or found deficiencies in its financial documents, the Board would have acted accordingly.

D. LAUSD’s Own Audit Identified Problems in 2008, but Its Findings Were Not Disclosed to the Board - - LAUSD Instead Addressed the Audit Directly to the Former Principal of the School, the Very Person Responsible for the Alleged Misappropriation. The Inspector General itself commissioned an audit report of the School in 2008 (“Internal Audit”). (See Exh. 4, Internal Audit of New Academy of Canoga Park Elementary School, Dated May 30, 2008.) The Internal Audit’s scope included, among other things, analysis of the Schools internal controls and interview school personnel responsible for financial reporting. (See Exh. 4, Internal Audit, at p. 1.) The Internal Audit identified several areas for corrective action, including, that the expenditure process be improved and that the Board hold monthly meetings. (Exh. 4, Internal Audit, at pp. 4 and 7.) The Board was never provided with a copy of the Internal Audit. Despite an extensive list of well over 45 recipients, the Internal Audit was not sent to the Board, but instead was sent directly to the former Principal, the very person who is responsible for the alleged misappropriation of funds. (Exh. 4, Internal Audit, Cover Letter.) Had the Board been informed of these findings it would have acted appropriately, but that audit was instead sent to management instead of the Board. As a result, the Board could not exercise its oversight function with respect to the Internal Audit.

OIG Comment: Points of agreement: In our OIG Draft Report, we expressed concerns about the services provided to NACP by both the business services provider and by the external audit firm retained by the NACP Board. We opined that the services provided by both entities were deficient. The NACP Board is in agreement with this assessment. Points of disagreement: We disagree with the underlying premise that the NACP Board was not capable of being adequately informed due to defects in the “safeguards” called for in NACP charter agreement. It should be noted that the work of the business services provider and of the external

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auditors is referred to as “safeguards” by the NACP Board, although this term is not used in the actual charter petition. We acknowledge that deficiencies in the services provided by the business services provider and by the external auditor made it more difficult for the NACP Board to be adequately informed. However, our view is that oversight and accountability for the financial reporting process and the integrity of the financial statements cannot be completely delegated away to other entities. Effective governance requires that board members play a strong active role in ensuring the reliability of financial information. Effective governance of NACP requires more than just the external auditors and the business services provider doing their jobs capably; it also requires that the NACP Board members discharge their oversight responsibilities in a thorough and effective manner. The National Association of Corporate Directors has stated that “to be empowered guardians and builders of corporate value, board members must:

Learn and follow best practices Avoid conflicts of interests Pay strict attention to board matters Draw on appropriate expertise, including their own

[Emphasis added]70 In addition, the very framework that we used as criteria to evaluate the NACP Board’s effectiveness [the COSO Internal Control-Integrated Framework] is itself acknowledged as reliable by the NACP Board on page 4 of its response. The COSO Framework is considered the industry standard for internal control and “has been praised and embraced by many organizations throughout the world for its comprehensiveness, effectiveness, and universal principles of strong internal control.” 71 This framework was quoted in our audit, and applicable sections are cited [and highlighted] here again for emphasis:

Management is accountable to the board of directors, which provides governance, guidance, and oversight. Effective board members are objective, capable and inquisitive. They also have knowledge of the entity's activities and environment, and commit the time necessary to fulfill their board responsibilities. Management may be in a position to override controls and ignore or stifle communications from subordinates enabling a dishonest management which intentionally misrepresents results to cover its tracks. A strong, active board, particularly when coupled with effective communications channels and capable financial, legal and internal audit functions, is often best able to identify and correct such a problem. [Emphasis added]

According to the Institute of Internal Auditors, “today’s governance arena requires board of directors to

70 Director Liability: Myths, Realities and Prevention, National Association of Corporate Directors. 71 Tone at the Top, Putting COSO’s Theory into Practice, Institute of Internal Auditors, November 2005.

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be proactive, informed, investigative, and accountable.”72 [Emphasis added] The NACP Board makes reference in its response to sections in its charter agreement and to its own Fiscal and Operating Policies 2008-2009 sections 314-315 to demonstrate that the NACP Board complied with its charter agreement by arranging for an annual external audit. However, these same sections indicate that the “Board of Trustees” would appoint an audit/finance subcommittee. To our knowledge, this was not formally done; so it is therefore reasonable to conclude that in the absence of a formal audit committee, then the NACP Board would have been expected to perform the duties of the audit/finance committee for NACP. The oversight responsibilities of audit committee members are high. Indeed, the Institute of Internal Auditors has stated that the vital oversight role audit committees play in the process of producing financial information has never been more important.73 A key element in the audit committee’s oversight of the integrity of the financial statements and of the financial reporting process is reviewing and discussing the annual financial statements with management and the external auditors. Audit committee members are expected to discharge these responsibilities effectively by “demonstrating the appropriate level of skepticism, asking probing questions, having frank discussions with management and the auditors, and building their knowledge of the organization and its operations from a wide variety of sources.” 74 [Emphasis added] While it is our opinion that the external auditors and the business services provider did not appear to capably provide the services they were retained to do, this does not diminish the NACP Board’s role and responsibility with regard to oversight. The NACP Board asks on page 6 of its response, “If the Board cannot rely on independent external audits, then what can it rely upon?” It should be evident from the discussion above that such reliance is never intended to be total and that a board of directors and an audit committee still has a responsibility to be inquisitive and to fully satisfy themselves about the integrity of the financial statements and of the financial reporting process. Finally, the NACP Board makes the following statement on page 7 of its response: “LAUSD’s Own Audit Identified Problems in 2008, but Its Findings Were Not Disclosed to the Board - - LAUSD Instead Addressed the Audit Directly to the Former Principal of the School, the Very Person Responsible for the Alleged Misappropriation.” The statement is misleading in that it gives the impression that the audit report was delivered to an inappropriate party. In fact, at the time of the FY 2008 OIG Audit (covering the period from July 1, 2006 through June 30, 2007), the former Principal had not yet admitted to or been discovered to have been involved in fraudulent activity at NACP. It was appropriate to address the audit to the acting Principal, as this is who most internal audits of charter schools are addressed to. 72 Tone at the Top, A Global Perspective on Risk, Institute of Internal Auditors, May 2009. 73 Audit Committee Effectiveness, What Works Best, Institute of Internal Auditors Research Foundation, Executive Summary, 2005. 74 Tone at the Top, Meeting New Audit Committee Challenges, Institute of Internal Auditors, May 2009.

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Also, NACP Board minutes dated June 9, 2008 (SEE EXHIBIT 8) show that the former Principal did advise the NACP Board about the results of our audit. The Board was aware of the existence of the audit and it was within their capability to ask for any additional information about the audit either of the Principal or of the OIG. Accordingly, we stand by the original assessment of the NACP Board’s effectiveness for the period under audit as stated in the Executive Summary and Finding A sections of the OIG Draft Report.

DEFENSE OF DETAILED FINDINGS NACP Board Response: p.8, 4A – The IG Report Remains Unclear as to the Total Amount of the Loss NACP Board Statement: The IG Report admits that it relies on sampling and incomplete records and is unable to determine the actual amount of the alleged misappropriation. It appears that the most certain amount is $1,684,282.74. OIG Comment: The use of sampling (statistical and non-statistical) is acceptable under Government Auditing Standards issued by the Comptroller General of the United States, the Institute of Internal Audit’s International Standards for the Professional Practice of Internal Auditing, and the American Institute of Certified Public Accountants' (AICPA's) Professional Auditing Standards. The use of statistics helps auditors to develop sample plans more efficiently and assess sample results more objectively than non-statistical methods alone. Audit sampling is the application of an audit procedure to less than 100 percent of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance or class. Statistical sampling involves the use of techniques from which mathematically constructed conclusions regarding the population can be drawn. Non‐statistical sampling is not statistically based and results should not be extrapolated over the population, as the sample is unlikely to be representative of the population. The OIG employed sampling only for audit testing purposes. Sampling was used for the following audit areas:

• Check Disbursements – Statistical and judgmental sampling was used to determine whether the selected check disbursements were (i) adequately supported with invoice or receipts, (ii) approved for payment, (iii) recorded in the appropriate expense classification, and (iv) signed by the authorized signatory(s).

• Bank Reconciliations – We randomly selected four months and obtained the corresponding bank reconciliations for all NACP bank accounts to determine if monthly bank reconciliation statements were prepared timely and accurately and reviewed.

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• Insurance Payments – We judgmentally selected three insurance brokers/agents and performed 100 % testing of all check disbursements to determine if insurance related payments were appropriate and adequately supported.

For all other audit areas (except cash deposits and withdrawals for which bank account detail was not available), the OIG performed testing on 100% of the population for the audited period. The Summary of Questioned Costs is our representation of the misappropriated and missing funds and questioned costs. As stated in the OIG Draft Report, we cannot determine the full extent of the fraud, waste, and abuse as we did not have access to personal bank and investment statements of the former Principal, nor did we have access to bank documentation for all cash deposits and withdrawals (for all bank accounts held by the School). However, the OIG believes the amounts reported to be accurate and reliable as of the date of the OIG Draft Report (based solely on the documentation that was made available to us during the period of our fieldwork). Please note that some figures in the Summary of Questioned Costs will be updated in the revised OIG Draft Report and Final Report based on the additional documentation that was provided by the NACP Board and the California Credit Union. NACP Board Response: p.9, 4B – The IG Report Misquotes the President of the Board of Directors NACP Board Statement: The IG Report claims that the President of the Board of Directors believes that the Board is a co-equal with it contractor and principal. (IG Report at p. 9.) This is clearly incorrect - - the organizational structure for the School is well set forth in the Charter Petition, which was approved by LAUSD. The President of the Board indicated that there were checks and balances in place regarding finances, wherein oversight is clearly within the purview of the Board while the principal and accountant contractor report directly to the Board. OIG Comment: The OIG met the NACP Board President on January 21, 2010 to perform inquiries related to internal controls. According to the President of the NACP Board, responsibility for the oversight and accountability of overall operations is a shared responsibility between the NACP Board, the Principal and the business services provider. The NACP Board President illustrated the control structure as depicted below:

NACP Board Principal Business Services Provider This finding is not based on the language in the Charter Petition, but on the actual responses provided to us by the NACP Board President. As such, we stand by the statement included in our OIG Draft Report. This finding is substantiated based on the NACP Board’s overreliance on the business services provider

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and the former Principal’s ability to initiate significant transactions without NACP Board approval and to override internal controls. Please note that no changes will be made to the section entitled “Control Environment” in our report. NACP Board Response: p.9, 4C – The IG Report Incorrectly Identifies the School as an “Arm” of New Economics for Women—the Two Entities are Unrelated NACP Board Statement: The Board is an independent entity established in 2003. The Board is a duly formed and operating not for profit California Corporation in good standing. It is entirely a separate legal entity from New Economics for Women. There is no financial or legal relationship between these two entities. OIG Comment: The OIG understands the clarification above and will make the necessary change to the revised OIG Draft Report and Final Report. NACP Board Response: p. 9, 4D – The “Finding – Missing/Unverified Funds” in the IG Report Should be Amended to Reflect the Actual Deposits Made NACP Board Statement: The governmental revenue checks and School’s deposit function discussed on Page 19 of the IG Report provides the following:

• LACOE check number 15350237 (dated 08/27/07) in the amount of $59,392.00 was deposited into the California Credit Union Certificate of Deposit Account (for which the deposit was unable to be verified);

• LAUSD checks 16864335 (dated 01/28/08) in the amount of $58,996.58 and 16214358 (dated 05/28/08) in the amount of $55,527.72 could not be verified against any of the School's bank accounts.

This totals to $173,916.30 in purported "missing/unverified funds" in Appendix B of the IG Report. Attached as Exhibit 6, are backup documents that provide the following:

• LACOE check number 15350237 (dated 08/20/07) in the amount of $59,392.00 deposited into the General WaMu account (ending 2713) on 03/19/2008 (See Exh. 6, pp I-A to I-D);

• LAUSD check 16864335 (dated 01/28/09) in the amount of $58,996.58 deposited into the WaMu Money Market account (ending 5408) on 02/04/09 (See Exh. 6, at pp. IV-A to IV-H);

• LAUSD check 16214358 (dated 05/28/08) in the amount of $55,527.72 deposited into General WaMu account (ending 2713) on 06/30/08 (See Exh. 6, at pp. II-A to II-H).

Therefore we request that the this Finding be amended, including the Schedule of Misappropriated and Missing Funds to reflect the actual deposits of the checks in the

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amount of $173,916.30 and that this amount not be deemed as "missing/unverified." This is important; this change should revise the total misappropriated and missing funds reported on page 29 to $1,510,366. OIG Comment: General Background Information The business services provider and the School did not maintain copies of the bank deposit slips (with details as to the components of the bank deposits). Due to the fact that the former Principal falsified documentation related to Investments (detailed in the “Investments” section of the OIG Draft Report) and initiated a lapping scheme75 (detailed in the “Cash in Bank” section of the OIG Draft Report), the OIG obtained cancelled check copies (directly from the LACOE Business Unit) of all LACOE checks issued to the School (for the audited period). The OIG also obtained a listing of all LAUSD checks and the dates cleared from the LAUSD Accounts Payable Branch (for the audited period). LACOE Check No. 15350237 - $59,392 According to records provided by the business services provider via the former Principal, LACOE check number 15350237 dated August 20, 2007 in the amount of $59,392 was deposited into the General Washington Mutual Account (ending 2713) on March 19, 2008. Per review of the cancelled LACOE checks, LACOE check number 15350237 dated August 20, 2007 in the amount of $59,392 was deposited into the California Credit Union Certificate of Deposit Account on October 3, 2007. During the time of our fieldwork, the OIG was unable to verify the deposit of this check, as we did not have access to the California Credit Union Certificate of Deposit Bank Statements. Subsequent to the completion of our fieldwork, the OIG was able to independently obtain account detail for the California Credit Union Certificate of Deposit Account directly from California Credit Union. Per review of the account detail, we were able to verify that $59,392 was in fact deposited into the California Credit Union Certificate of Deposit Account on October 3, 2007 and not into the General Washington Mutual Account (ending 2713) on March 19, 2008 as indicated by the NACP Board. SEE EXHIBIT 1. In addition, based on our testing of bank deposits (as referenced in our OIG Draft Report), check number 15350237 was included in the lapping scheme initiated by the former Principal. SEE EXHIBIT 6. As such, the OIG disagrees with the NACP Board that this amount ($59,392) should be removed from the Total Misappropriated and Missing Funds presented in the Summary of Questioned Costs. LAUSD Check No. 16864335 - $58,996.58 According to records provided by the business services provider via the former Principal, LAUSD check number 16864335 dated January 28, 2009 in the amount of $58,996.58 was deposited into the 75 Lapping is defined an accounting method that involves altering the accounts receivable section of the balance sheet when cash that is intended for the payment of a receivable is stolen. The method involves taking the first receivable collected and using that to cover the theft, while the second receivable collected is accounted to the first, the third receivable to the second, and so on.

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Washington Mutual Money Market Account (ending 5408) on February 4, 2009. During the time of our fieldwork, the OIG did not have supporting documentation for the February 4, 2009 deposit that was made to the Washington Mutual Money Market Account (ending 5408). Per review of the documentation provided by the NACP Board and listing of cleared LAUSD checks provided by the LAUSD Accounts Payable Branch, check number 16864335 in the amount of $58,996.58 was in fact deposited into the Washington Mutual Money Market Account (ending 5408) on February 4, 2009. As such, the OIG agrees with the NACP Board that this amount ($58,996.58) should be removed from the Total Misappropriated and Missing Funds presented in the Summary of Questioned Costs. This change will be reflected in the revised OIG Draft Report, Final Report in the Summary of Questioned Costs. LAUSD Check No. 16214358 - $55,527.72 According to records provided by the business services provider via the former Principal, LAUSD check number 16214358 dated May 28, 2008 in the amount of $55,527.72 was deposited into the General Washington Mutual Account (ending 2713) on June 30, 2008. Per review of the listing provided the LAUSD Accounts Payable Branch, LAUSD check number 16214358 dated May 28, 2008 cleared on July 1, 2008. The OIG was unable to verify the deposit of this check based on NACP bank statements available to us during the time of our fieldwork. However, based on the listing provided by the LAUSD Accounts Payable Branch and the fact that check number 16214358 was included in the lapping scheme initiated by the former Principal, we can confirm that the LAUSD check number 16214358 was not deposited into the General Washington Mutual Account (ending 2713) on June 30, 2008 (as indicated by the NACP Board). SEE EXHIBIT 7. As such, the OIG disagrees with the NACP Board that this amount ($55,527.72) should be removed from the Total Misappropriated and Missing Funds presented in the Summary of Questioned Costs. NACP Board Response: p.10, 4E – The Bank Reconciliation Portion of the IG Report Requires Clarification NACP Board Statement: The IG Report on Page 28 states that the bank reconciliation statements for the School’s Main Account were not prepared accurately with two of the following exceptions noted:

• In the November 2009 bank reconciliation check #10002626 (in the amount of $712.50) "was reversed per the bank reconciliation, but the corresponding GL entry was not recorded";

• In the December 2009 bank reconciliation check #10002619 (in the amount of $2,124.73) "was reversed per the bank reconciliation, but the corresponding GL entry was not recorded".

The backup information from the accounting system provided by the business services provider is attached as Exhibit 7, in pages V-A through V-D, for the finding related to the November 2009 bank reconciliation and pages VI-A through VI-D for the finding related to the December 2009 bank reconciliation.

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In reviewing the GL Batch Listing documents and the GL Transactions Listing documents (see Exh. 7, pp V-C, V-D, VI-C, VI-D) you will note that the checks described above are indeed recorded in the GL, contrary to the statements made in the IG Report’s Finding. Based on the nature of reversed checks and the variability in the determination of when they become invalid, lost, unusable, and the need to preserve prior period accounting data and prevent retroactive adjustments, the accounting software utilized by the business services provider posts checks reversed in the system on the physical calendar day they are reversed through user input. If the system was to allow retroactive dating for these reversed checks then it would undermine the basic integrity of all prior period data, adjusting cash balances for accounting periods that have been closed and perhaps even opined on by an external auditor. This, according to the business services provider, is what occurred for the two checks noted above. The checks were physically input as reversed on 12/02/2009 (check 10002626) and 01/07/2010 (check 10002619), the day the business services provider was made aware that they were no longer valid, both dates subsequent to the bank reconciliation periods tested. In order to accurately state the cash balance per the General Ledger at 11/30/2009 and 12/31/2009, respectively, both period end dates prior to confirmed knowledge that the applicable checks indicated above were indeed no longer valid, the accounting system properly included them as "outstanding" per report BK3010 (See Exh. 7, at pp V-A and VI-A) which is the summary report that evidences bank statement to cash book balance per General Ledger reconciliation. According to the business services provider, although the accounting system internally tracks the distinction between periods for checks input as "reversed", which can be traced to backup documentation across its different subledgers and General Ledger (as shown above), the bank subledger reports that the accounting system creates are only generated based on real-time information. Therefore, as both of the checks noted above were entered as "reversed" subsequent to the calendar month-end, but prior to the completion of the bank reconciliation process for those months, when the bank subledger report (BK1470) was produced as part of the completion of the applicable bank reconciliation procedures it indicated the checks were "reversed", because as of the day of the report production (12/03/2009 and 01/14/2010, respectively for the November 2009 and December 2009 bank reconciliations) they had been "reversed". This is a feature of the accounting system that is understood and it is the business services provider’s policy to manually amend the report BK1470 to indicate such instances. Therefore, based on the evidence above the business services provider believes the November 2009 and December 2009 bank reconciliation statements are prepared accurately, however, the manual adjustment need for report BK1470 was not documented properly, which is what we would believe the Finding should present.

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OIG Comment: The OIG stands by its finding that the bank reconciliation statements for NACP Main Account were not prepared accurately. The OIG acknowledges the business services provider’s policy of not allowing retroactive dating of transactions once the accounting period has been closed (to preserve the integrity of prior period data). Our finding relates to the accuracy of the Adjusted Cash Balance reflected on the Bank Reconciliation Report and does not concentrate on the process of handling reversed (voided) checks in the accounting system. The timing delay of posting adjusting entries to the accounting system is an acceptable practice as long as the adjustments have been noted as reconciling items at the time of reconciliation report preparation. In the exceptions noted in our OIG Draft Report, the Adjusted Cash Balance reported in the bank reconciliation statements for the periods ending November 2009 and December 2009 was understated by the amount of the reversed (voided) checks. The checks that were reversed (voided) should have been added back to the book balance and should not have not been included in the total outstanding checks (which were added to the statement balance to determine the Adjusted Statement balance). The reversed (voided) checks should have been reflected as reconciling items in the Bank Reconciliation Report (BK3010) to show the true balance of cash as of the close of each period. Please refer to the table below, which shows a comparison of the Bank Reconciliation Report prepared by the business services provider and the OIG. Based on the above, we will revise the language in the “explanation” column to state that the reversed (voided) checks were not properly reflected as a reconciling item on the bank reconciliation statement for both November 2009 and December 2009 bank reconciliations. However, the finding that the bank reconciliation statements for NACP Main Account were not properly prepared will remain.

Bank Reconciliation per Business Services Provider

Bank Reconciliation per OIG

November 2009: November 2009: Statement Balance $ 482,757.47 Statement Balance $ 482,757.47 (-)Withdrawals Outstanding ( 15,029.38) (-)Withdrawals Outstanding ( 14,316.88) Adjusted Statement Balance $ 467,728.09 Adjusted Statement Balance $ 468,440.59 Book Balance $ 464,413.98 Book Balance $ 464,413.98 +/(-) Bank Entries 3,314.11 +/(-) Bank Entries 3,314.11 Adjusted Book Balance $ 467,728.09 Reconciling Item: +/(-) Reversed Ck#10002626 712.50 Adjusted Book Balance $ 468,440.59

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Bank Reconciliation per Business Services Provider

Bank Reconciliation per OIG

December 2009: December 2009: Statement Balance $ 687,998.04 Statement Balance $ 687,998.46 (-)Withdrawals Outstanding ( 8,662.29) (-)Withdrawals Outstanding 6,537.56) Adjusted Statement Balance$ 679,335.75 Adjusted Statement Balance $681,460.48 Book Balance $ 694,808.71 Book Balance $ 694,808.71 +/(-) Bank Entries ( 15,472.96) +/(-) Bank Entries ( 15,472.96) Adjusted Book Balance $ 679,335.75 Reconciling Item: +/(-) Reversed Ck#10002619 2,124.73 Adjusted Book Balance $ 681,460.48 In Exhibit 7 (V-C) provided by the NACP Board, we noted that the following entry was made to reverse check number 10002626: Debit – Cash 712.50 Credit – Accounts Payable (712.50) Based on the documentation provided and the NACP Board’s response, check #10002626 was no longer valid on the date that it was voided. If the above check amount was not to be re-issued/replaced with another check then the entry should have reflected a credit to the Expense account that the original check amount was charged to. It should be noted that the above entry only corrects the Cash Account and does not reflect the proper entry to correct the Balance Sheet (Accounts Payable) and Income Statement (Expense) account balances. We noted that a similar entry was made to reverse (void) check number 10002619 in the amount of $2,124.73. NACP Board Response: p.12, 4F – The IG Report is Unclear on Several Other Issues NACP Board Statement: The IG Report admits that it does not have several necessary records available to complete the audit. (See, IG Report at p. 2.) The result is a report that heavily relies on sampling, which inherently provides an incomplete picture that leads to approximations. Upon review of the IG Report we observed the issues and questions yet to be resolved which are summarized below:

1. With regard to the Total Fraud, Waste and Abuse arising from misappropriated and missing funds and other questioned costs as reported on page 59 of the IG Report, please note the following:

(a) There appears be a disparity in the amounts of unaccounted for/missing revenue and funds arrived at in the IG Report of ($1,684,282) from what was presented in their March 25, 2010 Tentative Findings and Recommendation Power Point Presentation (reported as $1,925,335.)

(b) The amount of Certificate of Deposit funds (approximately $50,000) was

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counted twice when arriving at the $1,684,282 amount of Misappropriated and Missing Funds.

(c) The business services provider has been able to explain, account for, and provide supporting documentation for $173,916.30 of misappropriated and missing funds, with which we are in agreement with.

(d) Page 18 of the IG Report, refers to $661,000 in revenue likely misappropriated because it was not recorded in the general ledger and $221,000 of missing revenue. However, this amount does not appear to have been included in the amount of total loss arrived at of $1,684,282.74. This discrepancy needs to be resolved.

(e) Some of the loss amounts reported in the IG Report appear to be based on in part on use of estimates because the Inspector General did not have access to all requisite records, the IG Report also notes that their quantitative figures are not final.

2. In discussions with staff at the business services provider, we have been advised that

there are nutrition checks that are still unaccounted for. However, the business services provider indicates that the Inspector General believes all of the nutrition checks were accounted for in the IG Report and included in total of $1,684,282. As of the date of this response, we have been unable to verify the accuracy of this statement.

3. Regarding the Total Questioned costs of $1,054,048 reported on page 59 of the IG

Report, these amounts were in some cases derived from statistical sampling. In addition, the same portion of amount of identified unsupported expenditures of $381,859, may in fact be for valid business purposes, which as yet needs to be determined. The business services provider was not able to provide adequate supporting documentation to the Inspector General for these transactions. A further attempt to locate this information should be undertaken in an effort corroborate and determine the purpose and validity of the expenditures in question for disbursements, use of the questioned cashier’s check and use of professional services/consultants. This effort should include contacting the service providers or other informed individuals to determine the nature, scope and benefits received by the School for these questioned services, as well as any individuals who was involved in the approval process.

4. Page 17 of the IG Report, includes the following reference to the Ameritrade

accounts which reads: “The Ameritrade statements provided only showed unrealized gains and losses.”

While we are not clear what statements the Inspector General refers to, the statements provided by the School did in fact report realized gains and losses as they provided information on each trade (amount purchased, purchase price, amount sold, and selling price). By analyzing the activity beginning balance, plus deposits, minus withdrawals, one could calculate the overall gain or loss for a given a period.

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OIG Comment: Available Documentation The OIG agrees with the NACP Board that we did not have access to certain documentation such as personal bank and investment statements of the former Principal or bank documentation for all cash deposits and withdrawals (for all bank accounts held by the School). It is important to note that the OIG did not have any access to the former Principal for inquiry or explanation of transactions. However, the OIG believes that the documentation used to complete the audit was both sufficient and appropriate to support the findings and conclusions presented in the OIG Draft Report. Per GAGAS76 Section 7.55, auditors must obtain sufficient, appropriate evidence to provide a reasonable basis for their findings and conclusions. Per GAGAS Section 7.68, auditors should determine the overall sufficiency and appropriateness of evidence to provide a reasonable basis for the findings and conclusions, within the context of the audit objectives. Professional judgments about the sufficiency and appropriateness of evidence are closely interrelated, as auditors interpret the results of audit testing and evaluate whether the nature and extent of the evidence obtained is sufficient and appropriate. Use of Sampling The NACP Board’s statement that “the use of sampling inherently provides an incomplete picture that leads to approximations” gives the wrong impression about the use of sampling. While the OIG acknowledges that the use of sampling results in approximations, we believe that the approximations presented in the OIG Draft Report to be reasonable based on the documentation made available to us as of the date of the OIG Draft Report. We also believe the findings and conclusions to be reasonable and reliable based on the documentation made available to us as of the date of the OIG Draft Report. The use of sampling (statistical and non-statistical) is acceptable under Government Auditing Standards issued by the Comptroller General of the United States, the Institute of Internal Audit’s International Standards for the Professional Practice of Internal Auditing, and the American Institute of Certified Public Accountants' (AICPA's) Professional Auditing Standards. The use of statistics helps auditors to develop sample plans more efficiently and assess sample results more objectively than non-statistical methods alone. Audit sampling is the application of an audit procedure to less than 100 percent of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance or class. Statistical sampling involves the use of techniques from which mathematically constructed conclusions regarding the population can be drawn. Non‐statistical sampling is not statistically based and results should not be extrapolated over the population, as the sample is unlikely to be representative of the population.

76 Generally Accepted Government Auditing Standard

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The OIG employed sampling only for audit testing purposes. Sampling was used for the following audit areas:

• Check Disbursements – Statistical and judgmental sampling was used to determine whether the selected check disbursements were (i) adequately supported with invoice or receipts, (ii) approved for payment, (iii) recorded in the appropriate expense classification, and (iv) signed by the authorized signatory(s).

• Bank Reconciliations – We randomly selected four months and obtained the corresponding bank reconciliations for all NACP bank accounts to determine if monthly bank reconciliation statements were prepared timely and accurately and reviewed.

• Insurance Payments – We judgmentally selected three insurance brokers/agents and performed 100 % testing of all check disbursements to determine if insurance related payments were appropriate and adequately supported.

For all other audit areas (except cash deposits and withdrawals for which bank account detail was not available), the OIG performed testing on 100% of the population for the audited period. The Summary of Questioned Costs is our representation of the misappropriated and missing funds and questioned costs. As stated in the OIG Draft Report, we cannot determine the full extent of the fraud, waste, and abuse as we did not have access to personal bank and investment statements of the former Principal, nor did we have access to bank documentation for all cash deposits and withdrawals (for all bank accounts held by the School). However, the OIG believes the amounts reported to be accurate and reliable as of the date of the OIG Draft Report (based solely on the documentation that was made available to us during the period of our fieldwork). Please note that some figures in the Summary of Questioned Costs will be updated in the revised OIG Draft Report and Final Report based on the additional documentation that was provided by the NACP Board and the California Credit Union. Summary of Questioned Costs Change in Misappropriated and Missing Funds Total The OIG disagrees with the disparity noted by the NACP Board. The Summary of Questioned Costs presented at the March 25, 2010 meeting was a preliminary approximation of the total dollar value of misappropriated and missing funds ($1,952,335) based on the documentation that was made available to the OIG as of that date. Subsequent to the March 25, 2010 meeting, the OIG was able to obtain cancelled check copies for all LACOE revenue checks issued to NACP for the audit period.77 In addition, we were able to obtain a listing of all LAUSD checks and the dates cleared from the LAUSD Accounts Payable Branch (for the audited period). Per review of the cancelled check copies and LAUSD check listing, we were able to further validate the lapping scheme

77 The request for LACOE cancelled check copies was communicated to the NACP Board President, the business services provider President, and NACP General Counsel during the March 25, 2010 meeting. The OIG also communicated that the figures presented were preliminary and subject to change based on the receipt of additional documentation.

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initiated by the former Principal and to substantiate some of the missing LACOE and LAUSD revenue checks. The Summary of Questioned Costs presented is our representation of the misappropriated and missing funds and questioned costs as of the date of the OIG Draft Report (based solely on the documentation that was made available to us during the period of our fieldwork). Certificate of Deposit Funds We disagree with the NACP Board’s statement that the amount of Certificate of Deposit funds (approximately $50,000) was counted twice in the total Misappropriated and Missing Funds ($1,684,282). The amount of Certificate of Deposit funds (approximately $50,000) was not counted twice in the Misappropriated and Missing Funds total ($1,684,282.74). Subsequent to the completion of our fieldwork, we were able to independently obtain account detail for the California Credit Union Certificate of Deposit Account directly from California Credit Union. The OIG compared the transactions recorded in the general ledger by the business services provider to the California Credit Union account detail.

• Per the business services provider’s General Ledger – The California Credit Union Certificate of Deposit Account in the amount of $50,000 was opened sometime in 2007 and was closed on July 15, 2009 with an ending balance of $52,628.24 (including principal and interest). The ending balance of $52,628.24 was deposited into the Washington General Account on the same date. the business services provider recorded these transactions based on deposit detail and a fabricated bank statement provided by the former Principal. SEE EXHIBIT 3 and EXHIBIT 4.

• Per Audit (What Actually Happened) – Per review of the bank statements for the FRIENDS

account, we noted that the former Principal withdrew $52,628.24 from the FRIENDS account on July 15, 2009 and deposited the same amount into the Washington Mutual Main account on the same date. SEE EXHIBIT 5.

Results of Review of California Credit Union Certificate of Deposit Account Detail

• The California Credit Union Certificate of Deposit Account in the amount of $50,000 was opened on July 27, 2007 and closed (by the former Principal) on January 28, 2008. The ending balance as of January 28, 2008 was $51,324.30. Per review of all bank statements made available to us for the audited period, we were unable to verify that the proceeds from the California Credit Union Certificate of Deposit Account ($51,324.30) were deposited into another NACP bank account.

• We noted that an additional certificate of deposit account was established at the California Credit

Union (Account # 200000041) by the former Principal on October 3, 2007 in the amount of $59,392.00. The initial deposit to open this account represents LACOE revenue check No.

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15350237 dated August 20, 2007. We verified this fact via review of the cancelled check copy obtained directly from the LACOE Business Unit. SEE EXHIBIT 1 and EXHIBIT 2.

o The former Principal made subsequent withdrawals on: (i) October 3, 2007 in the amount

of $29,392.00 and (ii) January 7, 2008 for the remaining balance of $30,371.73. The account was closed on January 7, 2008.The amounts withdrawn by the former Principal included interest earned in the amount of $371.73 SEE EXHIBIT 2.

In reality, there were two California Credit Union accounts, which were both closed in January 2008. It appears that the former Principal never made the NACP Board or the business services provider aware of the second California Credit Union Certificate of Deposit account. In addition, the former Principal reported to the business services provider that he closed the California Credit Union Certificate of Deposit and deposited the ending balance ($52,628.24) in the Washington Mutual Main account on July 1, 2009. The former Principal fabricated a statement for the California Credit Union account to support this phony claim. SEE EXHIBIT 3. The ending balances from the two California Credit Union Certificate of Deposit accounts (totaling $111,088.03) were never recovered by NACP. $173,916.30 of Misappropriated and Missing Funds General Background Information The business services provider and NACP did not maintain copies of the bank deposit slips (with details as to the components of the bank deposits). Due to the fact that the former Principal falsified documentation related to Investments (detailed in the “Investments” section of the OIG Draft Report) and initiated a lapping scheme78 (detailed in the “Cash in Bank” section of the OIG Draft Report), the OIG obtained cancelled check copies (directly from the LACOE Business Unit) of all LACOE checks issued to NACP (for the audited period). The OIG also obtained a listing of all LAUSD checks and the dates cleared from the LAUSD Accounts Payable Branch (for the audited period). LACOE Check No. 15350237 - $59,392 According to records provided by the business services provider via the former Principal, LACOE check number 15350237 dated August 20, 2007 in the amount of $59,392 was deposited into the General Washington Mutual Account (ending 2713) on March 19, 2008. Per review of the cancelled LACOE checks, LACOE check number 15350237 dated August 20, 2007 in the amount of $59,392 was deposited into the California Credit Union Certificate of Deposit Account on October 3, 2007. During the time of our fieldwork, the OIG was unable to verify the deposit of this check, as we did not have access to the California Credit Union Certificate of Deposit Bank Statements. Subsequent to the completion of our fieldwork, the OIG was able to independently obtain account detail 78 Lapping is defined an accounting method that involves altering the accounts receivable section of the balance sheet when cash that is intended for the payment of a receivable is stolen. The method involves taking the first receivable collected and using that to cover the theft, while the second receivable collected is accounted to the first, the third receivable to the second, and so on.

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for the California Credit Union Certificate of Deposit Account directly from California Credit Union. Per review of the account detail, we were able to verify that $59,392 was in fact deposited into the California Credit Union Certificate of Deposit Account on October 3, 2007 and not into the General Washington Mutual Account (ending 2713) on March 19, 2008 as indicated by the NACP Board. SEE EXHIBIT 1. In addition, based on our testing of bank deposits (as referenced in our OIG Draft Report), check number 15350237 was included in the lapping scheme initiated by the former Principal. SEE EXHIBIT 6. As such, the OIG disagrees with the NACP Board that this amount ($59,392) should be removed from the Total Misappropriated and Missing Funds presented in the Summary of Questioned Costs. LAUSD Check No. 16864335 - $58,996.58 According to records provided by the business services provider via the former Principal, LAUSD check number 16864335 dated January 28, 2009 in the amount of $58,996.58 was deposited into the Washington Mutual Money Market Account (ending 5408) on February 4, 2009. During the time of our fieldwork, the OIG did not have supporting documentation for the February 4, 2009 deposit that was made to the Washington Mutual Money Market Account (ending 5408). Per review of the documentation provided by the NACP Board and listing of cleared LAUSD checks provided by the LAUSD Accounts Payable Branch, check number 16864335 in the amount of $58,996.58 was in fact deposited into the Washington Mutual Money Market Account (ending 5408) on February 4, 2009. As such, the OIG agrees with the NACP Board that this amount ($58,996.58) should be removed from the Total Misappropriated and Missing Funds presented in the Summary of Questioned Costs. This change will be reflected in the revised OIG Draft Report and Final Report in the Summary of Questioned Costs. LAUSD Check No. 16214358 - $55,527.72 According to records provided by the business services provider via the former Principal, LAUSD check number 16214358 dated May 28, 2008 in the amount of $55,527.72 was deposited into the General Washington Mutual Account (ending 2713) on June 30, 2008. Per review of the listing provided the LAUSD Accounts Payable Branch, LAUSD check number 16214358 dated May 28, 2008 cleared on July 1, 2008. The OIG was unable to verify the deposit of this check based on NACP bank statements available to us during the time of our fieldwork. However, based on the listing provided by the LAUSD Accounts Payable Branch and the fact that check number 16214358 was included in the lapping scheme initiated by the former Principal, we can confirm that the LAUSD check number 16214358 was not deposited into the General Washington Mutual Account (ending 2713) on June 30, 2008 (as indicated by the NACP Board). SEE EXHIBIT 7. As such, the OIG disagrees with the NACP Board that this amount ($55,527.72) should be removed from the Total Misappropriated and Missing Funds presented in the Summary of Questioned Costs.

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Unrecorded Revenue - $661,000 As stated in the OIG Draft Report, we performed an analysis of revenues for the audited period by comparing all cash receipts to the revenues recorded in the general ledger. We noted that approximately $661,000 in revenues was not recorded in the general ledger. We believe that the unrecorded revenue in the amount of $661,000 is more of a “bookkeeping” issue, which is linked to the business services provider’s (unsupported) recording of the Investments balance in the amount of $645,000. Per the business services provider, the entry to book the balance was based on a one-time lump sum entry in the amount of $645,000 to record the missing funds not deposited into NACP’s operational bank account. The entry to book this transaction was a debit to Investments and a credit to Accounts Receivable. No entry was made to the Revenues account. The entry that was booked shows the business services provider’s lack of prudence by recording unsupported and unverified transactions. A revision will be made to the Revenues Section of the report. We will remove the wording “and were likely misappropriated” as we know that the FRIENDS account was used to fund the former Principal’s personal AMERITRADE account. The funds misappropriated through the FRIENDS account is already reflected in the Summary of Questioned Costs. $221,000 of Missing Revenue The $221,000 in missing revenue is in fact included in the Summary of Questioned Costs. It is the sum of the missing/unverified LACOE checks ($105,980) and missing/unverified LAUSD ($114,524.30). As noted above, the missing/unverified LAUSD balance will decrease by $58,996.58 (for check number 16864335). This amount was traced into the Washington Mutual Money Market Account (ending in 5408) bank statement based on deposit detail provided by the NACP Board. Loss Amounts Reported The Summary of Questioned Costs included in the OIG Draft Report is our representation of the misappropriated and missing funds and questioned costs as of the date of the OIG Draft Report (and is final based solely on the documentation that was made available to us during the period of our fieldwork). No estimates were used in the Summary of Questioned Costs. Nutrition Checks We did not assess the completeness of all nutrition checks for the audited period, but verified that majority of all nutrition checks received by NACP (that were available to us during the timing of our fieldwork) were in fact deposited and recorded in the general ledger. We did not state that all nutrition checks were accounted for in the OIG Draft Report, nor were any nutrition checks included in the Summary of Questioned Costs. We suggest that the NACP Board direct the business services provider to work with the contracted forensic accountant firm to look into this matter.

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Total Questioned Costs - $1,054,048 The NACP Board’s statement that “the use of sampling inherently provides an incomplete picture that leads to approximations” gives the wrong impression about the use of sampling. While the OIG acknowledges that the use of sampling results in approximations, we believe that the approximations presented in the OIG Draft Report to be reasonable based on the documentation made available to us as of the date of the OIG Draft Report. We also believe the findings and conclusions to be reasonable and reliable based on the documentation made available to us as of the date of the OIG Draft Report. The use of sampling (statistical and non-statistical) is acceptable under Government Auditing Standards issued by the Comptroller General of the United States, the Institute of Internal Audit’s International Standards for the Professional Practice of Internal Auditing, and the American Institute of Certified Public Accountants' (AICPA's) Professional Auditing Standards. The use of statistics helps auditors to develop sample plans more efficiently and assess sample results more objectively than non-statistical methods alone. Audit sampling is the application of an audit procedure to less than 100 percent of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance or class. Statistical sampling involves the use of techniques from which mathematically constructed conclusions regarding the population can be drawn. Non‐statistical sampling is not statistically based and results should not be extrapolated over the population, as the sample is unlikely to be representative of the population. The OIG employed sampling only for audit testing purposes. Sampling was used for the following audit areas:

• Check Disbursements – Statistical and judgmental sampling was used to determine whether the selected check disbursements were (i) adequately supported with invoice or receipts, (ii) approved for payment, (iii) recorded in the appropriate expense classification, and (iv) signed by the authorized signatory(s).

• Bank Reconciliations – We randomly selected four months and obtained the corresponding bank reconciliations for all NACP bank accounts to determine if monthly bank reconciliation statements were prepared timely and accurately and reviewed.

• Insurance Payments – We judgmentally selected three insurance brokers/agents and performed 100 % testing of all check disbursements to determine if insurance related payments were appropriate and adequately supported.

For all other audit areas (except cash deposits and withdrawals for which bank account detail was not available), the OIG performed testing on 100% of the population for the audited period. The Summary of Questioned Costs is our representation of the misappropriated and missing funds and questioned costs. As stated in the OIG Draft Report, we cannot determine the full extent of the fraud, waste, and abuse as we did not have access to personal bank and investment statements of the former Principal, nor did we have access bank documentation for all cash deposits and withdrawals (for all bank

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accounts held by NACP). However, the OIG believes the amounts reported to be accurate and final as of the date of the OIG Draft Report (based solely on the documentation that was made available to us during the period of our fieldwork). Please note that some figures in the Summary of Questioned Costs will be updated in the revised OIG Draft Report and Final Report based on the additional documentation that was provided by the NACP Board and the California Credit Union. We agree with the NACP Board that identified unsupported expenditures in the amount of $381,859 (reflected in the Summary of Questioned Costs), may in fact be for valid business purposes and that these expenditures should be further probed. As referenced in our OIG Draft Report, the purpose of these expenditures could not be determined based on the lack of supporting documentation. We believe this amount to be properly included in the questioned cost total due to the fact that a questioned cost is defined as a finding in which, at the time of the audit, a cost that is not supported by adequate documentation; or, a finding that the expenditure of funds for the intended purpose is unnecessary or unreasonable. We suggest that the NACP Board direct the business services provider to work with the contracted forensic accountant firm to look into this matter. Ameritrade Statements Clarification will made to the report to state that the Ameritrade statements did not provide a summary of realized gains and losses. The manual calculation of realized gains and losses on a trade by trade basis would be arduous task based on the volume of transactions initiated by the former Principal. As such, we suggest that the NACP Board use the contracted forensic accountant firm to determine the total realized gains and losses or to subpoena the former Principal’s 1099-B statements and Ameritrade annual statements for 2008 and 2009.

NATURE OF OUR ENGAGEMENT AND THE LENGTH OF FIELDWORK In response to the OIG Draft Report, the NACP Board states several times that “…this matter is the subject of continuing investigation which may reveal additional relevant information. On that basis, the Board reserves the right to supplement the information and comments provided herein.” Per GAGAS Section 7.55, auditors must obtain sufficient, appropriate evidence to provide a reasonable basis for their findings and conclusions. Per GAGAS Section 7.68, auditors should determine the overall sufficiency and appropriateness of evidence to provide a reasonable basis for the findings and conclusions, within the context of the audit objectives. Professional judgments about the sufficiency and appropriateness of evidence are closely interrelated, as auditors interpret the results of audit testing and evaluate whether the nature and extent of the evidence obtained is sufficient and appropriate. The OIG believes that the documentation used to complete the audit was both sufficient and appropriate to support the findings and conclusions presented in the OIG Draft Report.

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Government Auditing Standards over performance audits do not specifically state auditor responsibility for length of fieldwork and subsequent events. However, Government Auditing Standards over financial audits do make reference to AU Section 561, Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report. AU Section 561, Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report, establish standards and provide guidance for situations when auditors become aware of new information that could have affected their report on previously-issued financial statements.

Under AU Section 561, if

auditors become aware of new information that might have affected their opinion on previously-issued financial statement(s), then the auditors should advise entity management to determine the potential effect(s) of the new information on the previously-issued financial statement(s) as soon as reasonably possible. Such new information may lead management to conclude that previously issued financial statements were materially misstated and to restate and reissue the misstated financial statements. In such circumstances, auditors should advise management to make appropriate disclosure of the newly discovered facts and their impact on the financial statements to those who are likely to rely on the financial statements. AU Section 561 makes reference to AU Section 560 – Subsequent Events for instances in which the financial statements have not yet been issued. Per AU 560, “… events that provide additional evidence with respect to conditions that existed at the date of the balance sheet and affect the estimates inherent in the process of preparing financial statements. All information that becomes available prior to the issuance of the financial statements should be used by management in its evaluation of the conditions on which the estimates were based. The financial statements should be adjusted for any changes in estimates resulting from the use of such evidence”. Generally accepted auditing standards are applicable to all audits and are generally referred to as the base line of acceptable auditing practices within the field of internal audit.79 Based on AU 560, the OIG will obtain and review documentation made available to us within 7 business days of the date the revised OIG Draft Report is issued [June 18, 2010] (if the documentation is found to be pertinent to the findings presented in the OIG Revised Draft Report issued on June 9, 2010).

79 An independent auditor plans, conducts, and reports the results of an audit in accordance with generally accepted auditing standards (GAAS). Auditing standards provide a measure of audit quality and the objectives to be achieved in an audit. Auditing procedures differ from auditing standards. Auditing procedures are acts that the auditor performs during the course of an audit to comply with auditing standards.

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APPENDIX E

Verbatim Response from the Innovative and Charter Schools Division

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RECOMMENDATIONS D-1 Recommendation: Consider developing and adopting a risk management process for

Charter Schools. This process may be based upon an established framework such as that issue by the COSO. Given that risk management is an evolving yet critical responsibility of management, consider asking for the assistance of the Office of the Inspector General on information, tools and techniques on how to establish a risk management process related to Charter Schools.

LAUSD Comments: We agree that the Innovation and Charter Schools Division (ICSD) should mitigate the risk(s) that are identifiable and could pose a problem to achieving our goals. We would, however, limit the identification of those risks to the situations over which we exercise supervision, not oversight. We do not supervise the charter school staff directly nor do we have line authority but rather have oversight responsibilities. In the fiscal arena we exercise these oversight responsibilities by: • Conducting an annual site visit - review

o Most current balance sheet o Most current income statement o Most current cash flow (monthly) – to end of current fiscal year and next two

years, show the various receipt and expense categories o Review board minutes to note approval of budget, budget modifications,

audit, etc… o Procedures manual for staff, approved by board o Thorough review of audit and comparison with prior audits including items

such as cash balance, assets/liabilities, findings, any material weaknesses, letters of deficiency, accounting manual, etc…

o Discuss the budgeting process and how stakeholders, the board and the staff are involved in the process

o Discuss role of Board, who is the fiscal person on the board o Who handles the day to day fiscal duties at the site, per the procedures

manual • Preparing ratio analysis • Discussing/investigating with coordinators and/or advisors and/or others as deemed

appropriate what they have observed at the school if we or they believe there may be a problem

o Conflict of interest o Brown act o Ethical issues o Complaints from stakeholders o Fiscal o Events with obvious fiscal implications

The above is done to comply with charter law 47604.32(b, d) and does not necessarily list all of our related activities. We believe our oversight to be sound, however we do take this and all opportunities to continually improve.

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The day to day fiduciary responsibility remains at the independent charter school and is in the hands of the independent charter school’s board of directors/education. The charter school and its board are accountable for the actions of the charter school staff. We will work with and seek guidance from the Office of the Inspector General to develop the Risk Management Process. To be completed approximately on January 10, 2011.

E-1 Recommendation: In light of the information presented in this audit, and consistent with our Recommendation D-1, which encourages the implementation of Enterprise Risk Management, we recommend that the Executive Director of the Innovation and Charter Schools Division do the following:

• Identify all LAUSD Charter Schools that use a back office services provider.

• Advise the identified Charter Schools that it is critical that they properly oversee their

back office services providers and that this level of oversight requires that the Charter Schools have in-house staff and Board members with adequate accounting and financial expertise.

• Advise all Charter Schools that it is critical that they properly oversee their School's

financial operations which includes all significant transactions and that this requires that the Charter Schools have in-house staff and Board members with adequate accounting and financial expertise.

• Provide education and awareness to Charter Schools about the need for strong and

effective internal controls, which include clear policies and procedures [i.e. fiscal and governance] that are consistently followed and which describe roles and responsibilities of School staff. Consider collaborating with the Office of the Inspector General on the dissemination of this information.

• Advise Charter School Boards that it is important that they thoroughly review and

understand their school's annual financial audit report prepared by their retained CPA firm. Encourage the Charter School Boards to (i) not overrely on the external auditor’s opinion on the Charter School’s annual financial statements for assurance on the effectiveness of fiscal operations, and (ii) discuss the audit reports with the CPA firms that prepared them and to ask any needed questions to satisfy themselves that the audit report is reliable.

• Develop a process to reasonably verify that the Charter Schools are following the

guidance above or similar guidance to ensure sound practice. Consider collaborating with the Office of the Inspector General on the achievement of this goal.

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• Consider meeting with the service providers referenced in this audit and discussing with them how they intend to address the deficiencies in their services described in this report.

• Encourage all Charter Schools Boards to restrict use of all debit cards.

• Encourage all Charter Schools Boards to strengthen policies and procedures over

the issuance of manual checks.

LAUSD Comments: The ICSD supports the intent of the recommendations provided by the Office of the Inspector General and will strengthen current practice in these areas and create new measures as noted below. We further agree about a need for improved fiscal monitoring by the Boards of Charter Schools.

1 This is currently underway. The ICSD will update its records and create a

comprehensive listing that will be completed by October 31, 2010.

2 The ICSD has communicated fiscal guidance to charter schools, but can improve by doing so more consistently during the year. The ICSD will prepare a series of informational communications as part of a new electronic communiqué being developed to be distributed on a regular basis to all charter schools. Such updates will provide suggestions as to areas of financial activity that are typically controlled by a back office provider that should be carefully examined by the charter board. The ICSD plans for this to begin by September 2010.

3 Please refer to the response for Item 2.

4 The ICSD will provide charter schools information on the importance of internal

controls. We will advise all the charter schools that a fiscal procedures manual is a critical tool to have in place. The ICSD will make it clear that the manual should include a clear delineation of segregation of fiscal duties at each site of the charter school. The ICSD anticipates that this will be completed by October 31, 2010.

5 The ISCD is in the process of updating our contact information for all charter school

board members. The ISDC will provide suggested topics and questions that the board can discuss with the charter school’s auditor at the time the audit is presented to the Charter Board. Please note that the ICSD considers the audit to be an authoritative, certified evaluation of the charter school’s financial position. However, the fiscal procedures, including segregation of duties, should be detailed in the fiscal procedures manual for the school. The ICSD will provide guidance to help the Board of the charter school differentiate between a sound fiscal position and the effectiveness of fiscal policies and procedures. The ICSD anticipates that this will be completed by October 31, 2010.

6 The ICSD will discuss the items above with the charter schools during the annual

site visit. At that time the ICSD will make recommendations as to the level of

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implementation and understanding at the charter school. This will be completed at the annual site visit.

7 The ICSD will meet with the OIG to outline the proper nature of the meetings and

particular items to be discussed. For specific information on the issues the service providers will contact the OIG. The ICSD will meet with the two service providers individually and discuss the items outlined by the OIG. The ICSD will reiterate our expectations to the service providers. The results of the meetings will be documented and communicated to the OIG. In addition the ICSD will, in conjunction with the OIG, craft a letter to all the back office providers and auditors outlining our expectations. This will be completed as soon as possible.

8 This recommendation has already been completed.

9 This recommendation has already been completed.

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APPENDIX F REPORT DISTRIBUTION Members, Board of Education Superintendent of Schools Senior Deputy Superintendent Chief Operating Officer Chief of Staff General Counsel Executive Director, Innovation and Charter Schools Division Director, Innovation and Charter Schools Division Business Advisor, Innovation and Charter Schools Division

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APPENDIX G

AUDIT TEAM

Amanda Roberson, Audit Manager Corazon Cenon, Audit Supervisor Emma Liza Baquir, Internal Auditor

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