Orange County Department of Education - Orange County Workforce Innovation High School Report

Orange County Department of Education Extraordinary Audit of the Orange County Workforce Innovation High School September 19, 2019 Michael H. Fine Chief Executive Officer Fiscal crisis & ManageMent assistance teaM September 19, 2019 Al Mijares, Ph.D., Superintendent Orange County Department of Education 200 Kalmus Drive Costa Mesa, CA 92626 Dear Superintendent Mijares: In May 2018, the Orange County Department of Education (OCDE) and the Fiscal Crisis and Management Assistance Team (FCMAT) entered into an agreement for an Assemlby Bill (AB) 139 review. The OCDE has received information regarding possible fraud, misappropriation of funds or other illegal fiscal practices at the Orange County Workforce Innovation High School. Specifically, the agreement states that FCMAT will perform the following: • Determine whether the charter school engaged in related-party transactions and, if so, whether those transactions were conducted openly and in accordance with established national and state policies, standards and procedures. • To the extent reasonably possible, identify related parties. • Review the charter petition and articles of incorporation and bylaws. • Review contracts, purchase orders and memoranda of understanding for fiscal years 2015-16 through 2017-18 to date. • Review financial transactions of the charter school and any related party for fiscal years 2015-16 through 2017-18 to date. • Review any charter property or assets transferred to any related party for fiscal years 2015-16 through 2017-18 to date. • Review the annual independent audits for fiscal years ending June 30, 2014; June 30, 2015; June 30, 2016; and June 30, 2017. • Determine if expenditures made by the charter school are for legitimate educational purposes and in accordance with approved contracts, purchase orders and memoranda of understanding. • Determine whether any conflict of interest standards may have been violated by any of the charter school’s local public officials, designated employees, or any “consultant to the organization who makes, participates in making, or acts in a staff capacity for making governmental decisions,” as defined in the Political Reform Act (PRA) of 1974 (Government Code Sections 81000 - 91014). • Review applicable PRA Form 700 filings from 2013 through 2018 to date. • Review applicable board meeting minutes and other documents. • The main focus of this review is to determine, based on the sample testing performed and auditor’s judgment whether (1) the charter was involved in any related-party transactions that were in conflict with state and federal policies and standards or that violated conflict of interest laws, and whether the charter was involved in financial transactions that were not for legitimate educational purposes; and (2) based on that assessment, determine whether fraud, misappropriation of funds or other illegal fiscal practices may have occurred. • The team will review and test recorded transactions for fiscal years 2015-16 through 2017-18 to date to determine if fraud, misappropriation of funds or other illegal activities may have occurred. Testing for this review will be based on the auditor’s judgment and a sample of transactions and records for this period. Testing and review results are intended to provide reasonable but not absolute certainty about whether the charter’s financial transactions and activity were sufficiently accurate. This report contains the study team’s findings. We appreciate the opportunity to serve you, and we extend thanks to all the staff of the Orange County Department of Education for their cooperation and assistance during fieldwork. Sincerely, Michael H. Fine Chief Executive Officer Fiscal crisis & ManageMent assistance teaM i TABLE OF CONTENTS Table of Contents About FCMAT ...................................................................iii Introduction ........................................................................1 Background .....................................................................................................................1 Study and Report Guidelines (AB 139 Audit Authority) ......................................1 Conducting a Fraud Audit ............................................................................................2 Fraud Audit Fieldwork ..................................................................................................2 Scope and Procedures ..................................................................................................3 Study Team .....................................................................................................................3 Transaction Sampling ...................................................................................................2 Findings .................................................................................5 Educational Purpose of Expenditures ......................................................................5 Improper Check-Signing Authority ...........................................................................9 The Educational Advancement Corporation – Learn4Life Structure and Network of Organizations ..................................................................................11 Related Parties ...........................................................................................................17 Statements of Economic Interests – Form 700 ................................................19 Other Information .....................................................................................................21 County Office/Authorizer Information Requests .......................................21 Cash Flow and Sale of Receivables ...............................................................21 Paymaster Agreement .......................................................................................22 orange county department of education ii Conclusion ........................................................................ 23 Potential for Fraud ......................................................................................................23 Appendices ....................................................................... 25 Fiscal crisis & ManageMent assistance teaM iii ABOUT FCMAT About FCMAT FCMAT’s primary mission is to assist California’s local K-14 educational agencies to identify, prevent, and resolve financial, human resources and data management challenges. FCMAT provides fiscal and data management assistance, professional development training, product development and other related school business and data services. FCMAT’s fiscal and manage- ment assistance services are used not just to help avert fiscal crisis, but to promote sound financial practices, support the training and development of chief business officials and help to create efficient organizational operations. FCMAT’s data management services are used to help local educational agencies (LEAs) meet state reporting responsibilities, improve data quality, and inform instructional program decisions. FCMAT may be requested to provide fiscal crisis or management assistance by a school district, charter school, community college, county office of education, the state Superintendent of Public Instruction, or the Legislature. When a request or assignment is received, FCMAT assembles a study team that works closely with the LEA to define the scope of work, conduct on-site fieldwork and provide a written report with findings and recommendations to help resolve issues, overcome challenges and plan for the future. FCMAT has continued to make adjustments in the types of support provided based on the changing dynamics of K-14 LEAs and the implementation of major educational reforms. Studies by Fiscal Year 90 80 70 60 50 40 30 20 10 0 95/96 96/97 97/98 98/99 99/00 00/01 01/02 02/03 03/04 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 14/15 15/16 16/17 17/18 FCMAT also develops and provides numerous publications, software tools, workshops and professional development opportunities to help LEAs operate more effectively and fulfill their fiscal oversight and data management responsibilities. The California School Information Services (CSIS) division of FCMAT assists the California Department of Education with the implementation of the California Longitudinal Pupil Achievement Data System (CALPADS). CSIS also hosts and maintains the Ed-Data website (www.ed-data.org) and provides technical expertise to the Ed-Data partnership: the California Department of Education, EdSource and FCMAT. FCMAT was created by Assembly Bill (AB) 1200 in 1992 to assist LEAs to meet and sustain their financial obligations. AB 107 in 1997 charged FCMAT with responsibility for CSIS and its state- wide data management work. AB 1115 in 1999 codified CSIS’ mission. orange county department of education seidutS fo rebmuN iv ABOUT FCMAT AB 1200 is also a statewide plan for county offices of education and school districts to work together locally to improve fiscal procedures and accountability standards. AB 2756 (2004) provides specific responsibilities to FCMAT with regard to districts that have received emergency state loans. In January 2006, Senate Bill 430 (charter schools) and AB 1366 (community colleges) became law and expanded FCMAT’s services to those types of LEAs. On September 17, 2018 AB 1840 was signed into law. This legislation changed the how fiscally insolvent districts are administered once an emergency appropriation has been made, shifting the former state-centric system to be more consistent with the principles of local control, and providing new responsibilities to FCMAT associated with the process. Since 1992, FCMAT has been engaged to perform more than 1,000 reviews for LEAs, including school districts, county offices of education, charter schools and community colleges. The Kern County Superintendent of Schools is the administrative agent for FCMAT. The team is led by Michael H. Fine, Chief Executive Officer, with funding derived through appropriations in the state budget and a modest fee schedule for charges to requesting agencies. Fiscal crisis & ManageMent assistance teaM 1 INTRODUCTION Introduction Background Orange County Workforce Innovation High School is a charter school located in the city of Anaheim and authorized by the Orange County Board of Education. The charter school is operated by Western Educational Corporation (WEC), a nonprofit public benefit corporation exempt from federal income tax under Internal Revenue Code Section 501(c)(3). The charter school is one of 20 that are part of the Learn4Life trademark or brand; 19 of these are controlled by Educational Administrative Corporation, a nonprofit public benefit corporation. The charter school was originally part of Desert Sands Charter School as a resource center serving children in Orange County. Learn4Life management determined Orange County Workforce Innovation High School should be its own charter school (grades 9-12) and submitted a petition to the county office of education in March 2016. The charter school obtained approval of its initial petition in June 2016 and was granted a five-year term from July 1, 2016 through June 30, 2021. The county office is the authorizer of the charter school and is responsible for its oversight. In performing its oversight, the county office requested documents and explanations of inconsis- tencies or deficiencies in the information provided by the charter school. The county office was concerned because it did not receive complete answers to its questions, especially regarding the charter school’s authorized check signers and expenditures. When the county office exhausted all options for the charter school to address these concerns, it began to suspect that fraud may exist. In May 2018, under the provisions of Education Code Section 1241.5, FCMAT entered into an agreement with the county office for an Assembly Bill (AB) 139 extraordinary audit to determine if fraud, misappropriation of funds or other illegal fiscal practices may have occurred at the charter school. Study and Report Guidelines (AB 139 Audit Authority) Education Code Section 1241.5(b)(c) permits a county superintendent of schools to review or audit the expenditures and internal controls of any school district or charter school in the county if he or she has reason to believe that fraud, misappropriation of funds, or other illegal fiscal practices have occurred that merit examination. This review or audit is known as an AB 139 extraordinary audit. The Education Code provides for a review or audit conducted by the county superintendent focused on the alleged fraud, misappropriation of funds, or other illegal fiscal practices to be conducted in a timely and efficient manner. In addition, Education Code Section 47604.4(a) states the following: In addition to the authority granted by Sections 1241.5 and 47604.3, a county superintendent of schools may, based upon written complaints by parents or other information that justifies the investigation, monitor the operations of a charter school located within that county and conduct an investigation into the operations of that charter school. orange county department of education 2 INTRODUCTION Because the purpose of an AB 139 extraordinary audit is to determine if sufficient evidence exists that fraud, misappropriation of funds, or other illegal fiscal practices may have occurred, it is referred to as a fraud audit. Education Code Section 42638(b) states that on completion of the fraud audit, the following will occur: If the county superintendent determines that there is evidence that fraud or misappro- priation of funds has occurred, the county superintendent shall notify the governing board of the school district, the State Controller, the Superintendent of Public Instruction, and the local district attorney. FCMAT focused on the allegations that the charter school may have been involved in undis- closed related-party transactions that were in conflict with state and federal policies and stan- dards, or that violated conflict of interest laws, and whether the charter school was involved in financial transactions that were not for legitimate educational purposes. In writing its reports, FCMAT uses the Associated Press Stylebook, a comprehensive guide to usage and accepted style that emphasizes conciseness and clarity. In addition, this guide empha- sizes plain language, discourages the use of jargon, and capitalizes relatively few terms. Conducting a Fraud Audit The fraud audit is conducted based on the team’s experience and judgment. Fraud audits have many components including fieldwork; obtaining and examining available original source documents; corroborating documents and information through third-party sources when possible; interviewing potential witnesses; gaining an understanding of internal controls applicable to the scope of the work; and assessing factors such as intent, capability, opportunity, and possible pressures or motives. Although there are many different types of fraud, occupational fraud, including asset misappro- priation and corruption, is more likely to occur when employees are in positions of trust and have access to assets. Embezzlement occurs when someone who is lawfully entrusted with prop- erty takes it for his or her personal use. Common elements in all fraud include the following: • Intent, or knowingly committing a wrongful act. • Misrepresentation or intentional false and willful representation(s) of a material fact. • Reliance on weaknesses in the internal control structure, including when an individual relies on the fraudulent information. • Concealment to hide the act or facts. • Damages, loss or injury by the deceived party. Fraud Audit Fieldwork Fraud audit fieldwork consists of gathering information and documents pertaining to specific allegations, establishing an audit plan, interviewing potential witnesses and assembling evidence from internal and external sources, performing various audit procedures to determine whether fraud may have occurred, evaluating the loss associated with the alleged fraud, and determining who was involved and how it may have occurred. The FCMAT study team’s fieldwork took place from February 2019 through May 2019. The fieldwork focused on determining whether there is sufficient evidence to indicate that fraud, misappropriation of funds, or other illegal fiscal acts may have occurred. Fiscal crisis & ManageMent assistance teaM 3 INTRODUCTION Scope and Procedures Investigating allegations of fraud requires several steps such as conducting interviews with potential witnesses, management, staff and others, and gathering available evidence from internal and external sources. FCMAT conducted interviews with the county office and charter school management and staff. The interviews and fieldwork were designed to obtain information related to the charter school’s business practices, events, contracts, and expenditures. Since the charter school began operations as of July 1, 2016, examination of transactions and records was confined to the 2016-17 and 2017-18 fiscal years. The charter school’s annual independent audits were reviewed for fiscal years ending June 30, 2017 and 2018, and WEC Form 700 statements of economic interest were reviewed for 2016 through 2018. FCMAT also reviewed, analyzed and examined business records, general ledgers, purchasing activity, board policy and administrative regulations, board meeting minutes, contracts, loan documents, audit reports, and other internal documents secured from the charter school, county office, and LifeLong Learning Administration Corporation. Study Team The FCMAT study team was composed of the following members: Michael W. Ammermon, CPA, CFE, CRFAC, DABFA Leonel Martínez FCMAT Intervention Specialist FCMAT Technical Writer Paul S. Horvat, CPA, CFE, MBA FCMAT Consultant Each team member reviewed the draft report to confirm its accuracy and to achieve consensus on the final findings. Transaction Sampling To determine if expenditures of the charter school were for an educational purpose, FCMAT sampled various types of cash disbursements. Fraud audit scope, objectives, and substantive trans- action testing was based on the audit team’s experience and professional judgment and did not include the testing of all available transactions and records. The sample population or number of transactions examined are represented by documents and other information provided by the charter school, county office, and LifeLong Learning Administrative Corporation that were related to the scope and objectives of the study. The transaction sample was derived from the sample population, as shown in the findings section below, by selecting transactions randomly and/or specifically selecting transactions based on the team’s judgment, regardless of dollar amount. The transactions selected were analyzed and compared with charter petition documents, board policy, administrative regulations, operational procedures and industry standard or best practice procedures. The transactions sampled were compared to contract terms, documentation of receipts for expenditures, and evaluated for proper authorizations and reasonableness based orange county department of education 4 INTRODUCTION on the team’s judgment and technical expertise in charter school business operations, internal controls, and accounting practices. The total population of charter school transactions available for review was selected from July 1, 2016 through June 30, 2018. Sample testing and examination results are intended to provide reasonable but not absolute assurance of the accuracy of the transactions and financial activity and/or to identify whether fraud, misappropriation of funds or other illegal fiscal practices may have taken place during the period under review. Fiscal crisis & ManageMent assistance teaM 5 EDUCATIONAL PURPOSE OF EXPENDITURES Findings Educational Purpose of Expenditures FCMAT examined a total sample of 76 charter school disbursements from a sample population of 2,425 transactions. The sample represents 3.13% of the sample population of transactions and 40.73% of the dollar value of the sample population. The purpose of the sampling was to determine if the expenditures sampled were for an educational purpose. 07/01/2016 - 07/01/2016 - Operating Expenditures 06/30/2018 06/30/2018 Sample Transactions Number Dollar Sample Population 2,425 $ 6,193,141.27 Transaction Sample 76 $ 2,522,423.21 Percent Sampled to Total Population 3.13% 40.73% The transactions examined were compiled and grouped into 17 categories with the largest cate- gory being loan repayments and the smallest being employee recognition. 07/01/2016 - 07/01/2016 - 06/30/2018 06/30/2018 Sample Transactions Summarized by Number Dollar Category Loan Repayments 20 $ 1,761,243.30 Consulting Fees 16 339,101.00 Leases & Rents 2 221,353.38 Program Services 6 48,504.00 Legal Fees 4 37,841.92 Oversight Fees 2 26,705.42 Books 2 25,126.79 Vacation Accruals 2 24,442.29 Equipment 3 14,321.18 Expense Reimbursements 5 7,880.16 Membership Fees 1 5,000.00 Audit Fees 1 5,000.00 Stipends 6 2,700.00 Food Services 1 1,400.75 Background Checks 3 815.00 Security 1 800.00 Employee Recognition 1 188.02 Totals 76 $ 2,522,423.21 Total Deviations 39 $ 1,421,684.15 The analysis identified 39 deviations representing a dollar value of $1,421,684.15. A deviation is defined as a transaction with one or more of the following characteristics: orange county department of education 6 EDUCATIONAL PURPOSE OF EXPENDITURES The invoice amounts Proper best practices It is not properly fail to properly documentation is not approved. calculate available. mathematically. Based on auditor judgement, the The check signer is transaction is not for incorrect. an educational purpose. The 39 deviations are specific to an incorrect check signer. FCMAT transaction testing quantified the number and dollar amount of checks issued with the incorrect signatures and grouped them across the sample transaction categories. The 39 deviations represent 51.32% of the 76 transac- tions sampled and 56.36% of the dollar amounts sampled. Operating Expenditures 07/01/2016 - 07/01/2016 - Sample Transactions Deviations 06/30/2018 06/30/2018 Sample Population 2,425 $ 6,193,141.27 Transaction Sample 76 $ 2,522,423.21 Total Deviations of Transaction Sample 39 $ 1,421,684.15 Percent Total Deviations of Transaction Sample 51.32% 56.36% Of the 17 transaction sample categories, the 39 deviations intersected 13 of those categories. 07/01/2016 - 06/30/2018 07/01/2016 - Checks with 06/30/2018 Sample Transactions Deviations Unauthorized Unauthorized Summarized by Category Signature Dollars Loan Repayments 11 $ 918,001.10 Consulting Fees 6 215,572.67 Leases & Rents 2 221,353.38 Program Services 3 33,396.00 Legal Fees 3 12,224.57 Equipment 2 10,463.07 Expense Reimbursements 2 857.59 Audit Fees 1 5,000.00 Stipends 4 1,800.00 Food Services 1 1,400.75 Background Checks 2 627.00 Security 1 800.00 Employee Recognition 1 188.02 Total Deviations 39 $ 1,421,684.15 Fiscal crisis & ManageMent assistance teaM 7 EDUCATIONAL PURPOSE OF EXPENDITURES The 39 deviations identified represent an internal control deficiency. Internal controls are the principal mechanism for preventing and/or deterring fraud or illegal acts to protect the charter school from fraud or misappropriation of funds. Internal Controls An effective system of internal control provides a foundation for sound financial management and provides reasonable assurance that a charter school’s operations are effective and efficient, the financial information produced is reliable, and the charter school operates in compliance with all applicable laws and regulations. Board policies, procedures, checks and balances are specific internal control elements intended to ensure that financial information provided to senior management and the governing board for decision-making is reliable and complies with laws and regulations. Management and employees with administrative responsibility have a fiduciary duty to the charter school, a higher standard of conduct in the course of their employment, and are entrusted to safeguard assets and ensure that internal controls function as intended. Internal control elements provide the framework for an effective fraud prevention program. An effective internal control structure includes the policies and procedures used by staff, adequate accounting and information systems, the work environment, and the professionalism of employees. The five interrelated elements of an effective internal control structure and their definitions are included in the table below. Internal Control Element Definition Control Environment Commonly referred to as the moral tone of the organization, the control environment includes a code of ethical conduct; policies for ethics, hiring and promotion guidelines; proper assignment of authority and responsibility; oversight by management, the board or an audit committee; investigation of reported concerns; and effective disciplinary action for violations. Fraud Risk Assessment Identification and assessment of the organization’s objectives to develop a strategy to react in a timely manner. Control Activities The development of policies and procedures to enforce the governing board’s directives. These include actions by management to prevent and identify misuse of the charter school’s assets, including preventing employees from overriding controls in the system. Information and Communication Establish effective communication to help prevent and detect fraud. Ensure that employees receive information regarding policies and opportunities to discuss ethical dilemmas. Establish clear means of communication within an organization to report suspected violations. Monitoring Conduct ongoing monitoring that includes periodic performance assessments to help deter fraud by managers and employees. The following is a partial list of deficiencies and omissions that can cause internal control failures: orange county department of education 8 EDUCATIONAL PURPOSE OF EXPENDITURES Failure to adequately enforce Failure to limit access to Failure to record and/or segregate duties and assets or sensitive data (e.g. transactions, resulting in lack responsibilities related to cash, fixed assets, payroll of accountability and the authorization. and personnel records). possibility of theft. Lack of monitoring or implementation of internal Unauthorized transactions, Failure to reconcile assets controls by the governing resulting in skimming, with the correct records. board and management, or embezzlement or larceny. because personnel are not qualified. Collusion among employees where little or no supervision exists. A system of internal controls consists of policies and procedures designed to provide the governing board and management with reasonable assurance that the organization achieves its objectives and goals. Traditionally referred to as hard controls, these include segregation of duties, limiting access to cash, management review and approval, and reconciliations. Other types of internal controls, typically referred to as soft controls, include management tone, performance evaluations, training programs, and maintaining established policies, procedures and standards of conduct. A strong system of internal controls that includes all five elements above is necessary to provide reasonable, but not absolute assurance that the organization will achieve its goals and objectives. Internal Control Deficiency Based on the scope of this audit, two of the five internal control elements have a deficiency. The control environment is deficient because management provided insufficient oversight to prevent the use of improper electronic check signing authority. The monitoring environment is deficient because ongoing monitoring was also insufficient to detect and prevent the use of improper electronic check-signing authority. Fiscal crisis & ManageMent assistance teaM IMPROPER CHECK-SIGNING AUTHORITY 9 Improper Check-Signing Authority Further inquiry about the check-signer signature found that it was electronic and not updated. When FCMAT discussed this at the beginning of the audit, the charter school had identified the use of the electronic check signature and prepared an introductory letter discussing the issue. The letter included a section titled “Errors Made with Respect to Check Signing Authority.” The charter school described the check-signing authority as follows: (FCMAT removed names of individuals in the response, see Appendix A for copy of entire letter.) orange county department of education 10 IMPROPER CHECK-SIGNING AUTHORITY FCMAT’s review of the sampled deviation expenditures concludes that those expenditures served an educational purpose, and met the other criteria of being properly approved, documented, and mathematically correct for the following reasons: Except for the proper check The charter signing signature, school brought Both the 2016-17 FCMAT cannot the expenditures the check and 2017-18 conclude there met FCMAT’s signature issue to independent was intent by the criteria for an FCMAT’s audit reports do charter to educational attention early in not present any deceive, take purpose the audit, did not findings advantage or expenditure of conceal the regarding the otherwise divert possessing the check signing check signature the funds for a proper approval, error, and or disallowances noneducational documentation, corrected the of expenditures. purpose. and being error. mathematically correct. Because the expenditures have been determined to serve an educational purpose, the expenditures sample was not expanded, and no further expenditure transaction testing was considered neces- sary. Fiscal crisis & ManageMent assistance teaM 11 THE EDUCATIONAL ADVANCEMENT CORPORATION – LEARN4LIFE STRUCTURE & NETWORK OF ORGANIZATIONS The Educational Advancement Corporation – Learn4Life Structure & Network of Organizations The organization structure of Learn4Life and the entities under it is complex Learn4Life is a trademark or brand. The Learn4Life brand is the umbrella name under which Educational Advancement Corporation (EAC), LifeLong Learning Administration Corporation (LLAC), the nonprofits that operate the charter schools, and the charter schools themselves operate. They are all part of the brand known as Learn4Life. Control of the brand, the services provided to the charter schools, and the price of those services is an arrangement between the LLAC, EAC, and the board members of the nonprofits operating the charter schools and the charter school management. The Orange County Workforce Innovation High School is one of 20 charter schools served by a network of 12 nonprofit corporations overseen by EAC. Prior to May 2019, EAC was the sole statutory member of the 11 nonprofit corporations under its control. Each charter school is operated by one of ten nonprofit corporations and receives administrative and educational services from LLAC. LLAC is considered an administrative management organization, which is comparable to a charter management organization. The purpose of LLAC is to provide administrative and educational services to the charter schools in the Learn4Life network. The services LLAC provides are through two of its “Doing Business As’” entities, which can be considered departments or entities within LLAC. These entities are known as Sequoia Administrative Resources and Scholastic Education Resources. Sequoia provides administrative services, which may be considered a business back office service, including but not limited to accounting, human resources, payroll, and financial reporting, supported by a finance team. Within Sequoia, instead of a master set of books that all charter schools are combined under, each individual charter school has its own unique database of accounting books and records. In other words, LLAC accounts for each charter school as a physically separate database. Therefore, to perform the accounting duties and process transactions for the charter school, the accountant must log into a specific charter school’s individual and independent database. Scholastic’s educational services include but are not limited to curriculum and educational support services provided by an educational services team. Western Educational Corporation (WEC) is the operator of Orange County Workforce Innovation High School, Alta Vista Innovation High School, and San Diego Workforce Innovation High School. WEC has its own board of directors and is responsible for approving contracts, expenditures, and budgets, and for other reporting and ongoing activities of the charter school. The structure of the organizations continues to evolve in 2019. As of February 2019, EAC was the sole statutory member of all 11 nonprofit corporations and therefore, the sole statutory member of all the charter schools. The organization chart below shows all organizations reporting to EAC. orange county department of education 12 THE EDUCATIONAL ADVANCEMENT CORPORATION – LEARN4LIFE STRUCTURE & NETWORK OF ORGANIZATIONS In March 2019, LLAC was separated from direct control of EAC. LLAC bylaws were amended to no longer have EAC as the sole statutory member of LLAC. The organization chart below shows LLAC separate from all other organizations. In June 2019, the organization structure was amended again because Ventura County Office of Education requested that Vista Real Public Charter school, or Vista Real, no longer be under the control of EAC, the sole statutory member. The organization chart below shows Vista Real Public Charter, Inc. nonprofit, which operates Vista Real separate from the other organizations. Fiscal crisis & ManageMent assistance teaM 13 THE EDUCATIONAL ADVANCEMENT CORPORATION – LEARN4LIFE STRUCTURE & NETWORK OF ORGANIZATIONS Control of the Learn4Life brand and the charter schools is established through control of the nonprofits who operate the charter schools. Control and what that means is defined in the bylaws of the nonprofit organizations operating the charter schools. Bylaws are additional laws that the organization agrees to follow. WECs bylaws in Article V, Membership, Section 1, Sole Member, and Section 2, Rights of the Statutory Member, state that EAC is the sole statutory member of WEC and describe the sole statutory member as follows: The Sole Statutory Member shall have the sole right, as set forth in these bylaws and Section 5056 of the Code, to elect or appoint members of the board of directors, to remove members of the board of directors, to amend these bylaws… The charter school charter petition at Element D: Governance Structure states, “The Charter School shall be operated by Western Educational Corporation, as a non-profit public benefit corporation (501(c)(3)).” Within the same element at Section A. Board of Directors, the charter petition describes, “The Charter School will be governed by a Board of Directors….” However, as typical with many charter petitions that include bylaws describing a sole statutory member, it fails to describe the sole member relationship, powers of the sole member, and what a sole member means within the charter petition governance element. While sole member relationships are not illegal, the authorizer and readers of the charter petition should know what the governance structure is, that a sole member relationship exists, and what that means. Sole statutory member is specific to having the power to exercise significant control over an organization and the charter schools operated by it. The relationship should be fully disclosed so that authorizers and charter schools clearly know the powers of the sole statutory member. FCMAT found inconsistencies within the charter school audit reports that do not fully and transparently describe the organizations within the Learn4Life network. The charter school, not the charter school’s auditor, is responsible for the audit report notes and how significant accounting policies and disclosures are described. The charter school’s 2017-18 independent audit report notes are incomplete as follows: orange county department of education 14 THE EDUCATIONAL ADVANCEMENT CORPORATION – LEARN4LIFE STRUCTURE & NETWORK OF ORGANIZATIONS The Organization Structure page identifies two separate positions, Chief Executive Officer and Executive Vice President –Chief Note A, Organization, fails to Academic Officer. The first name of the describe WEC is the operator of the individual holding these two positions is charter school, is a nonprofit public different, one is William and the other is Bill, benefit corporation, is tax exempt both with the same last name. The charter under Internal Revenue Code Section school explained that it is the same person. 501 (c)(3), and EAC is the sole Failure to present accurate names means statutory member of WEC. the reader of the report may be misled that there are two different individuals performing these duties and may or may not be related by last name. Such inconsistencies can be confusing to authorizers and the public, and may be misleading or designed to be confusing. Consistent naming and full and transparent disclosure of organization relationships, management positions, and structures should be expected from an organization such as Learn4Life. As FCMAT performed the audit, the charter school’s management team, LLAC, WEC, and the many management professionals assisting FCMAT from Learn4Life began implementing corrective action as the issues were discussed. The management team of the Learn4Life brand is centralized in the Lancaster, California administrative offices, where FCMAT performed a portion of the fieldwork. The structure, management teams, staffing, administrative facility, charter school facility, and technology that Learn4Life controls is representative of an organization that possesses the capacity and ability to provide services for an educational purpose. To understand and quantify the organizational capacity and management capability of the Learn4Life network, FCMAT compiled the fiscal year 2016-17 management positions, officers, directors, and key employees’ salaries, and work hours of the nonprofits under EAC. The compiled positions shown below excludes the administrative, technical, and other support staff (referred to as the human capital team) additionally available to provide services to the charter schools because those positions are not part of the nonprofit tax return. Nevertheless, FCMAT did meet various members of the human capital team and observed teachers and management staff at the charter schools’ Orange County location. Fiscal crisis & ManageMent assistance teaM 15 THE EDUCATIONAL ADVANCEMENT CORPORATION – LEARN4LIFE STRUCTURE & NETWORK OF ORGANIZATIONS orange county department of education 16 THE EDUCATIONAL ADVANCEMENT CORPORATION – LEARN4LIFE STRUCTURE & NETWORK OF ORGANIZATIONS Fiscal crisis & ManageMent assistance teaM 17 RELATED PARTIES Related Parties Related parties do not necessarily create a fraudulent relationship. In fact, related parties may provide benefits including favorable terms or services to an organization. What is necessary is that related-party transactions be transparent, fully disclosed, and avoid even an appearance of a conflict of interest. The Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 850-10-50 contains the disclosure requirements for related-party relationships and transactions. The disclosure requirements are for the following: • Affiliates of the entity. • Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option subsection of Section 825-10-15, to be accounted for by the equity method by the investing entity. • Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management. • Principal owners of the entity and members of their immediate families. • Management of the entity and members of their immediate families. • Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. • Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests. The FASB ASC glossary also defines the terms: affiliate, control, immediate family, management, and principal owners. The executive management of the charter school, its contracted administrative agent (LLAC) and EAC, are responsible for documenting conflict of interest disclosure reporting requirements in detail and fully disclosing to the auditors, governing board and the authorizing agency all and potential related-party transactions. Disclosure is required for compliance with Generally Accepted Accounting Principles (GAAP). Failure to disclose related-party relationships and trans- actions may be a departure from GAAP, which may result in a qualified or adverse audit opinion and the potential for civil and criminal prosecution. FCMAT reviewed the charter school’s 2016-17 and 2017-18 vendor documents, contracts, financial transactions, purchases and general ledger transactions; interviewed management staff; and reviewed board minutes to identify potential undisclosed related parties. The charter school’s independent audit reports describe related parties in the notes to the audit report. The audit report notes describe related party relationships with LLAC and other charter schools. To determine the extent, if any, of any potential undisclosed related party financial transaction disclosures, FCMAT requested and received access to the EAC accounting records for the 2016-17 and 2017-18 fiscal years. No financial transactions between the charter school and EAC were identified that may have required disclosure. Comparison of the financial transactions and nonprofit 990 tax returns of EAC present an organization that does not have a material financial orange county department of education 18 RELATED PARTIES interest in the Learn4Life nonprofit organizations and by extension, the charter schools. The EAC financial transactions examined in the accounting records provided to FCMAT agreed with the amounts reported in EAC’s official 990 tax returns. Based on FCMAT’s transaction sampling and examination of contracts and other records, no undisclosed related parties were identified. Fiscal crisis & ManageMent assistance teaM 19 STATEMENTS OF ECONOMIC INTERESTS - FORM 700 Statements of Economic Interests - Form 700 The state of California requires every elected official and public employee who makes or influ- ences governmental decisions to submit a Statement of Economic Interest, also known as Form 700. The Fair Political Practices Commission (FPPC) is responsible for the administration of the California Political Reform Act, which regulates campaign financing, conflicts of interest, lobbying, and governmental ethics. Form 700 is part of the documentation process for disclosure of economic interests or lack thereof. The FPPC does not maintain a database of Form 700s for many local governmental agencies such as charter school board members. The FPPC website, http://www.fppc.ca.gov/transparency/ form-700-filed-by-public-officials/form700-search/form700-new.html, states the following: NOTE: This search only includes state-level elected officials, elected judges, city coun- cilmembers, and certain other officials. Local planning commissioners, special district board members, school board members, and many other local officials do not file Form 700s directly with the FPPC. You must contact the local filing officer to determine how to obtain Form 700s for these other officials. [emphasis added] The charter school’s conflict of interest policy defines an interested person for purposes of conflicts of interest as, “Any director, officer, or member of a committee with Board delegated powers, who has a direct or indirect financial interest, as defined below, is an interested person.” The charter school’s conflict of interest code states, “This regulation and the attached Exhibits designating positions and establishing disclosure categories shall constitute the conflict of interest code for OCWIHS.” and defines a designated position as members of the governing board and corporate officers. The governing board and officers of WEC and the charter school meet the definition of desig- nated positions requiring conflicts of interest disclosure. Review of the Form 700s provided by the charter school resulted in one exception. The charter school’s chief executive officer position Form 700s for 2016, 2017, and 2018 were not completed, signed, and dated until October 2, 2018. FCMAT’s review of designated position Form 700s demonstrates that the forms are completed, but the form for the chief executive officer position is not completed timely. orange county department of education 20 STATEMENTS OF ECONOMIC INTERESTS - FORM 700 Fiscal crisis & ManageMent assistance teaM 21 OTHER INFORMATION Other Information County Office/Authorizer Information Requests In performing its oversight responsibilities, the county office charter division issued numerous requests for information from the charter school. The charter school provided what it considered adequate responses; however, they were often incomplete and required follow up by the county office. FCMAT reviewed many of the unanswered information request items the county office was questioning. Among the questions were issues the county office identified as improper check signature authority, and incomplete documentation of transactions supporting an educational purpose. FCMAT sent the list of 103 open questions corresponding to 57 transaction types to the charter school. The charter school presented a 22-page detailed response. FCMAT reviewed the response but still needed further clarification of the answers provided. Together, FCMAT and Learn4Life management readdressed each question. As the issues of each open item were examined, the charter school could produce the documents, supporting information, and provide adequate explanations. The charter school staff explained that they now have a better understanding of how to answer the authorizer’s questions. Cash Flow and Sale of Receivables The 2016-17 charter school audit report described two receivables sales at footnote M. Subsequent Events. The two amounts were $185,000 on August 23, 2017 and $180,000 on October 16, 2017. The need for the receivables sales was not clear in the 2016-17 audit report, and the charter school provided more information that addressed the cash flow needs and purpose. The charter school response was supported by documentation and the following narra- tive: Response: OCWIHS started operations in September 2016, and as a new charter, the school needed short term financing to meet its short term cash needs. In 2016- 17, OCWIHS received its first apportionment payment in March 2017. Until then, OCWIHS relied primarily on short term loans from LLAC and other charter schools from the Learn4life network (please refer to attached file, “OCWIHS-Summary of Loans 16-17 and 17-18”). This short term borrowing was in line with the cash flow plan the school had developed to meet its cash needs (please refer to attached file, “OCWIHS-Cashflow Plan 16-17”). It is noted that the cash flow plan projected first apportionment payment in January 2017, and as the school received its first payment in March (two months after what was previously projected), it borrowed additional funds compared to the plan. After starting receiving apportionment payments, the school started paying back the loans through the rest of 2017-18. During the early months of 2017-18, and due to the smaller apportionment payment taking place in the first months of the year, the school pursued short term financing via sale of receivables with…to meet its cash needs and repay loans to other charters. The school also pursued financing via short term loans from LLAC due to timing of apportionment from OC (usually paid in 3rd week of month after apportionment month) and to keep healthy levels of cash. Through the end of 17-18, the school paid back its sale of receivables and all but the last short term loan from LLAC. orange county department of education 22 OTHER INFORMATION Paymaster Agreement FCMAT became aware of a paymaster agreement, a methodology of allocating the costs for services or employee payroll from one centralized location across the charter school network. Rather than each charter school issuing a paycheck to the individuals performing services, which would result in multiple paycheck W-2 filings by each school, the schools pay the central location for the services, and the individual is paid with one paycheck. Regardless of the term used, such as cost allocation agreement or paymaster agreement, FCMAT recommends that at a minimum, the allocation methodology should document and identify in detail the agreed-upon services. The charter school response about the paymaster agreement is as follows: Response: The organization recently hired a National Superintendent effective January 1, 2019 to represent all of the schools utilizing the Learn4Life model. To best allocate the salary/benefits of the National Superintendent, the organization determined a strong option would be through a Common Paymaster. As the National Superintendent, Ms. … will work on behalf of all the Learn4Life charter schools, the Common Paymaster allows for a designated entity to pay the wages to the employee on behalf of the related entities and thus charged for that employee’s share of payroll taxes once. The organization presented the Common Paymaster agreement to the various school boards during the February/March 2019 school board meetings for approval. The schools have not yet implemented the Common Paymaster pending a final review by the schools’ auditors. We are estimating implementation to occur on or before January 2020. During the February/March 2019 school board meetings, each school board took action to approve Dr. … as the National Superintendent. The schools did not take any action in closed or open session to approve the salary, fringe benefits and benefits of the National Superintendent. This was an oversight and each school board has on its June 2019 agendas an action item to review and consider approval the compensation for the National Superintendent of Schools. Attached is the June 11, 2019 OCWIHS board agenda and handout for agenda item 10.a. (FCMAT removed names of individuals in the Response) Fiscal crisis & ManageMent assistance teaM 23 CONCLUSION Conclusion In accordance with the authority granted in Education Code Sections 1241.5, 47604.3, and 47604.4(a), FCMAT focused on the allegations of fraud, misappropriation of funds, or other illegal fiscal practices to determine whether the charter school and/or its personnel were involved in or may have committed fraudulent activities. Based on the findings in this report, there is insufficient evidence to demonstrate that fraud, misappropriation of funds and/or assets, or other illegal fiscal practices may have occurred in the specific areas reviewed. Potential for Fraud Deficiencies and exceptions noted during FCMAT’s review of the charter school’s financial records and internal control environment increase the probability of fraud, mismanagement and/ or misappropriation of the charter school’s assets. Because deficiencies in the internal control environment can increase the probability of fraud, mismanagement and/or misappropriation of the charter school’s assets, these findings should be of great concern to the charter school and the county office and require immediate intervention to limit the risk of fraud, mismanagement and/ or misappropriation of assets, or other illegal fiscal practices in the future. orange county department of education 24 CONCLUSION Fiscal crisis & ManageMent assistance teaM 2255 APPENDICDERSAFT Appendices orange county department of education 2266 DRAAFPTPENDICES Fiscal crisis & ManageMent assistance teaM 2277 APPENDICDERSAFT Appendix A — Letter from OCWIHS orange county department of education 2288 DRAAFPTPENDICES Fiscal crisis & ManageMent assistance teaM 2299 APPENDICDERSAFT orange county department of education 3300 DRAAFPTPENDICES Fiscal crisis & ManageMent assistance teaM 3311 APPENDICDERSAFT orange county department of education 3322 DRAAFPTPENDICES Fiscal crisis & ManageMent assistance teaM 3333 APPENDICDERSAFT Appendix B — Study Agreement orange county department of education 3344 DRAAFPTPENDICES Fiscal crisis & ManageMent assistance teaM 3355 APPENDICDERSAFT orange county department of education 3366 DRAAFPTPENDICES Fiscal crisis & ManageMent assistance teaM 3377 APPENDICDERSAFT orange county department of education