UA deficit brewed for years, report says

A $3.37 million spending deficit last year by the University of Arkansas at Fayetteville’s fundraising branch had been brewing for years, according to documents.

Records also indicate the overspending was a bigger budget crisis than university officials have maintained and that the 2012 deficit may have been $4.34 million, $1 million more than officials have said.

And the documents released Friday night raise questions about how long officials knew a problem existed and why they didn’t step in until after the fiscal year ended June 30.

Legislative and University of Arkansas System auditors are making plans to look at how the UA Fayetteville’s Division of University Advancement overspent its roughly $10 million budget in 2012.

They likely will trace back to when the problem started and why it wasn’t caught earlier, finance experts say.

“They would look at the system of controls to make sure this couldn’t happen again,” said Andy Terry, a finance professor at the University of Arkansas at Little Rock and a former auditor.

Terry said auditors typically examine controls, which include an organization’s spending and accounting procedures, “to figure out where things went wrong, what controls were missing and what we need to do” to avoid the problem in the future.

These issues, contained in the university’s audit report prepared by UA Treasurer Jean Schook, are likely to be reviewed by auditors, experts say:

Whether advancement division overspending and improper bookkeeping of a roughly $10 million budget go back years before 2012.

A Sept. 26 e-mail from Chancellor G. David Gearhart, who formerly ran the advancement division, says, “I’m also being told there has been no budget formulated since I left the office in 2008. Could this possibly be true?”

A Sept. 29 memo from UA’s vice chancellor for finance and administration, Don Pederson, refers to “the deficit from the last two years.”

An Oct. 4 e-mail by Schook to Pederson, which she said Choate wrote and asked her to send, said: “This issue has been building for many years and is not a one-year problem...”

According to e-mail correspondence UA released in December, the university found that the units under the Advancement Division had been operating without budgets going back to 2006.

In an interview in early December, Pederson said that meant the division’s units weren’t given beginning-of the-year budgets with forecasted revenues. “There was no documentation,” he said.

“To the units’ credit, they were operating to some extent off of their own budgets,” Pederson said, referring to their spending histories. “But those budgets weren’t connected to revenues.”

Sometime in 2009, this led to “sizable deficits,” he said, defining sizable as $1 million or more.

Documents that conflict with Gearhart’s comments in a Feb. 8 interview.

Then, the chancellor described the advancement division’s 2012 deficit of $3.37 million as “not good ... . But it’s not of a colossal nature that we can’t handle.”

But an Aug. 8 e-mail from Gearhart to Choate said: “This would be one of the largest deficits of any unit in recent university history and will place a huge strain on available resources this current fiscal year.”

The Sept. 26 e-mail from Gearhart to Choate referred to the shortfall as a “catastrophe.” In another e-mail to Choate, Oct. 20, Gearhart said the overspending “has created a colossal fiscal crisis. $8 million is huge. Frankly, beyond belief.”

John Diamond, associate vice chancellor for university relations, on Monday did clarify what Gearhart meant when he wrote “$8 million.”

The chancellor was referring to the combination of the2012 advancement deficit and a then-projected $4-millionplus deficit for the unit in 2013 unless corrective action was taken, Diamond said in an email. The chancellor has taken action to cut this year’s deficit, Diamond said. UA officials say they expect that deficit to be smaller than in 2012.

Why the spending deficit wasn’t discovered and corrected earlier.

“It appears that red flags should have been apparent to Financial Affairs staff for years, yet I was not notified until July 2012,” Choate wrote in an Oct. 20 e-mail to Gearhart.

Pederson wrote to Choate on Oct. 22 about deficit spending going back to 2009 of advancement’s private funds from the University of Arkansas Foundation. The division’s funding was about equally split between public and foundation funds, officials have said.

“Attached are a series of mails from FY09 asking [the advancement division] to manage their UA Foundation funds better. Athletics, also included in the e-mails, resolved their part of the problem completely to my satisfaction during subsequent years. Advancement never did,” Pederson wrote. “... on April 28, 2009, the Development UA Foundation deficit was $1.57 million ... . This Foundation year end deficit continued to exist at the level of $2-$2.5 million for subsequent years in spite of the request that it be dealt with.”

Gearhart requested on Feb. 5 that auditors from the Arkansas Division of Legislative Audit and the UA System examine spending within the UA Fayetteville advancement division.

Roger Norman, Legislative Auditor, said Monday the two agencies haven’t settled on a specific audit plan. Auditors hope to meet within the next couple of weeks. Norman and UA System examiners also wouldn’t comment Monday on the advancement budget deficit or documents released Friday.

University officials have said no one discovered the2012 overspending by the UA advancement division until after fiscal year ended June 30.

The two staff members who were disciplined, Vice Chancellor for University Advancement Brad Choate and his former budget director, Joy Sharp, will lose their jobs in June, Gearhart said.

Sharp declined comment Monday. Choate could not be reached.

Gearhart and Pederson, the university’s top finance manager, did not respond to requests for an interview and refused to answer most questions Monday from the Arkansas Democrat-Gazette. Diamond wrote in response: “I’ve shared the questions but do not know when I might have responses.”

Gearhart had declined since early December to make public the university’s own financial review into the deficit, contained in a report by Schook. The newspaper had asked for the records under the Arkansas Freedom of Information Act since Dec. 5, two days after the deficit was announced.

Though government agencies’ spending records are usually public, UA Fayetteville officials said the report was a personnel document that evaluated employee performance and was exempt from public release.

The Democrat-Gazette sued on Feb. 11. Five days later, at about 6:30 p.m. Friday, the university released 88 pages of documents, including Schook’s report. Officials had obtained signatures from three employees that the university said allowed the school to make the documents public, according to a school spokesman.

OVERSIGHT QUESTIONED

The Schook report found Choate “provided inadequate and essentially no oversight of the financial activities of the division.”

Choate denied those claims and said he relied on his budget officer and other finance office “checks and balances” that failed.

The report said Sharp was delinquent in processing reimbursements. She also incorrectly deposited a check for $1.36 million for construction of a Jean Tyson Child Development Center into an unrestricted account “in what appeared to be an intentional effort to disguise a prior year account receivable balance that had not been cleared,” according to Schook’s report.

Sharp wrote in response to the UA that the transfer was “human error on my part” and not an intentional misappropriation.

A member of the Tyson family, John Tyson, chairman of the board of Tyson Foods Inc., resigned from the University of Arkansas board of trustees Feb. 8.

He cited a busy schedule and becoming “increasingly frustrated” with the board’s “inability to make meaningful change in the structure and delivery of higher education in Arkansas.” He could not be reached Monday to answer questions. It’s not clear whether his resignation is related to the advancement division’s overspending.

CONTROLS

Most financial audits look at an agency or business’ controls to avoid a nasty financial surprise, experts say.

Ricky Quattlebaum, a state audit administrator, said one purpose for an audit is to assure management “specifically about whether [an organization’s] internal controls are functioning as designed.” An internal audit administrator for the Arkansas Department of Finance and Administration, Quattlebaum is not connected with the future UA Advancement Division audit.

Financial controls involve such issues as who reviews and approves spending, whether a second or third person looks at each transaction and what paperwork is required for each expenditure.

Terry of UALR said auditors’ first steps ordinarily involve interviewing managers to learn what controls are supposed to be in place, then map out the system.

One control might be “that all checks over $5,000 have to have two signatures,” the finance professor said.

Then auditors test it, he said. “We’d pick a sample of checks and see if they had two signatures. If we find some with one signature, obviously that control isn’t functioning the way it’s supposed to.”

Ultimately, after auditors test controls and examine transactions, they offer their opinion on why a financial problem happened. If they find internal controls are weak, auditors report that to management and make recommendations for improvement, Terry said.

UA System President Donald Bobbitt said Monday there are several ways the audit could proceed.

It could be a partnership in which the UA System’s auditors work simultaneously with Legislative Audit, he said, or more likely would be a “sequential” job in which the system auditors perform the audit first and then submit a report for review by Legislative Audit.

“The audit’s purpose will be to reconfirm the campus’s findings,” he said.

When asked whether auditors would have the ability to actively rule out fraud within the scope of their audit, Bobbitt said: “When you start talking about looking into people’s private business, that’s beyond the domain of what Legislative Audit or our auditors can do.” That would fall in the domain of prosecutors, he added.

The fraud issue came up in the documents released in response to the newspaper’s lawsuit. University officials have said recently that it was $3.37 million. But Schook’s report, written almost four months after the end of the fiscal year on June 30, estimates the fiscal 2012 deficit at $4.34 million.

Just as university officials have said since December, the treasurer’s report found “no evidence of intentional acts to misappropriate resources for personal gain.”

However, Schook’s report cautions that “a review of accounting records specifically to identify misappropriated resources has not been performed and [it] will likely be some time before staff resources are available to conduct such a review.” The university expects another, smaller deficit in the Advancement Division this year, Gearhart said in a Feb. 8 interview.

The documents released Friday, which include the school treasurer’s audit, said the potential for fraud was high because Choate had given his security code to approve transactions - a violation of university policy - to Sharp.

Speaking generally, two prosecutors said such a financial investigation on their end would typically start with a referral from an investigating agency.

“You can initiate them, but it’s not very common,” said Pulaski County Prosecuting Attorney Larry Jegley.

“It wouldn’t be something we would initiate,” said Washington County Prosecuting Attorney John Threet.

If Legislative Audit or some other investigating agency came to him with findings that were unusual, “or even suspect,” that’s how such a case would get started in his agency, Threet said.

Arkansas State Police would not routinely begin investigating a financial case before Legislative Audit had completed its review, said state police spokesman Bill Sadler. But if auditors, a prosecutor or a judge asks state police to assist them with an investigation, the agency might become involved.

“It’s important to emphasize that it may never come across the desk of the state police,” he said.

The scope of the UA Advancement Division audit won’t be clear for some time. In part, it will depend on what officials try to learn.

The university could ask to find out more about the size of the fiscal 2012 deficit - “whether it’s $3 million or some other number,” Terry said.

A different question might be: “Find out how the deficit happened,” he said.

Gearhart’s only public statement about the audit’s goal came on Feb. 5, when he issued a statement saying he asked for “audits of spending within the university’s advancement division.”

State auditors and university officials have said they expect the audit report will be available to the public when it is complete.’