Audit Faults California City's Handling of Bond Proceeds

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LOS ANGELES — A state audit of Beaumont, Calif. found the Southern California city failed to properly account for bond transactions on $626 million in bonds.

The city was unable to provide the State Controller's office with any accounting records for the bond transactions and the current city management and employees did not have any information or records of bond transactions, according to the audit.

"We were given access to the former Finance Director's computer files; however, we were able to find only incomplete spreadsheets and copies of the requisitions pertaining to the bond transactions," the controller's staff said in the audit.

City officials say they are already taking steps to address what the report called pervasive shortcomings resulting in non-existent accounting controls for the city of 40,000 80 miles east of Los Angeles. The report found that 95% of the city's internal control elements reviewed in an audit of fiscal years 2012-13 and 2012-14 were inadequate.

"These kinds of deficiencies are of great concern," Controller Betty Yee said in a statement. "However, I am encouraged that city leaders recognize the need to implement major improvements."

Yee launched her audit in May, a month after the Riverside County District Attorney's office and the FBI executed warrants at City Hall, former City Manager Alan Kapanicas' house, and the Beaumont offices of Urban Logic Consultants, a firm that provided many of the city's top managers on a contract basis.

No charges have been filed, but the investigation is ongoing, said John Hall, a spokesman in the DA's office.

The audit found improper accounting by three city agencies for bonds issued between 1993 and 2014.

The Beaumont Financing Authority issued $313.09 million in local agency revenue bonds "for use mainly in acquiring District bonds and for a sewer enterprise project," Beaumont's Community Facilities District No. 93-1 issued $303.12 million in special tax bonds for various improvement areas, and the Beaumont Utility Authority issued $9.79 million in revenue bonds for a wastewater enterprise project.

Although legally separate entities, all three are governed by the City Council and are managed by city staff, thus the city was responsible for managing the agencies' activities, including performing accounting functions, but failed to do so, the audit said.

The findings of the controller's office confirm what the City Council and the new city management team uncovered this summer, according to a statement released by Elizabeth Gibbs-Urtiaga, the city's acting city manager since June. The city has been examining the books, soliciting independent reviews of administrative controls and making $4 million in budget cuts, the statement said.

Kapanicas, the former city manager, signed a separation agreement valued at $213,702.75 to terminate his contract on Oct. 6, according to city documents.

"We have been very busy correcting the business practices going forward," Beaumont Mayor Brenda Knight said in a statement.

The controller's findings could increase the odds of the Internal Revenue Service auditing the city's bonds, but not keeping good records of bond proceeds isn't in itself a violation of the city's tax-exempt status, some public finance attorneys said.

Although the bond's tax certificate probably stipulated that the city track the bond proceeds to prevent a tax-exempt status violation, failure to have the records doesn't mean they did not comply with the IRS restrictions, said Chuck Katz, a shareholder with Polsinelli PC.

It does heighten the risk of a tax problem, because if they can't prove what the IRS needs them to prove, it could be problematic, Katz said.

"It also might be a situation where different bureaucracies are applying different standards," said Harriet Welch, a partner with Squire Patton Boggs. "It might not be as horrible as it sounds from the controller's report. More needs to be known about the circumstances to determine that."

Vast differences exist between what the state controller's office contemplates in an audit as opposed to what the IRS would consider regarding the bonds' tax-exempt status, said a tax attorney, who asked not to be identified.

"There is no direct link between what the state controller, or anybody besides the IRS, might think is good accounting for tax purposes, and what tax law thinks is good accounting," the tax attorney said.

The expenditure of public funds from a state policy perspective is about making sure government did not overpay for something, or acquire something without going through the right procurement process, or that there isn't some conflict of interest, he said. The IRS would be more concerned that the project the bonds targeted got built; and would not be concerned about whether bond proceeds, or other city funds, ended up paying for the project, or that it cost too much to build, he said.

"The biggest issue they have is a higher likelihood of getting audited," he said. "The IRS is cagey about revealing how they choose which tax-exempt bonds to audit, but anecdotally it does seem like transactions that have some cloud around the bonds are more likely to get audited."

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