TL;DR: The years overdue audit introduced last night is a signal of serious financial incompetence. A forensic audit is required.
“MATERIAL WEAKNESS” AND “AUDIT DEFICIENCY” ARE SERIOUS PROBLEMS
Failure to produce required annual audits for two consecutive years indicates severe financial mismanagement and carries heavy legal, operational, and financial consequences. Likewise, audits that include deficiency citations of duplicate payments, lack of internal controls, and an array of material weaknesses come with consequences for the leadership in charge at the time.
OMINOUS SIGNS – TEXAS CITY HAS ALL OF THEM
In yesterday’s commissioner’s court, the Mayor and his allies attempted to put a pretty spin on the situation. Here’s what the auditor found, explained in plain English:
1. Duplicate payments: Paying vendors twice for the exact same work is a classic indicator of a broken Accounts Payable (AP) system.
2. Lack of internal controls: This suggests there is no matching of purchase orders, receiving reports, and invoices (three-way matching).
3. Material Weaknesses: Internal control failures render financial data unreliable – auditors can’t be sure that the numbers are what the books say they are.
CONSEQUENCES CAN BE SEVERE
Consequences for fiscal mismanagement can be severe:
1. State intervention: Many states withhold state-shared revenues
2. Grant denials: Federal and state granting agencies typically require current audited financials. Missing audits can freeze existing grants or disqualify the city from future funding.
3. State Takeover: In severe cases state controllers have stepped in to take over local financial operations or freeze state aid until compliance was met.
4. Credit Rating withdrawal: Credit rating agencies (like Moody’s, S&P, or Fitch) will withdraw or severely downgrade a city’s bond rating
5. Skyrocketing interest: Lower credit ratings mean the city must pay significantly higher interest rates to borrow money for critical infrastructure.
6. Investor panic: The inability to produce audits violates standard bond covenants, potentially triggering technical defaults on existing debt.
WHAT HAPPENS IN THE PRIVATE SECTOR: WORLDCOM, An $180 BILLION DISASTER.
When a publicly traded company fails to produce audited financial statements and misses its mandatory regulatory filings, severe regulatory and capital market punishment is the result.
One of the largest accounting frauds in U.S. history, WorldCom was completely unable to produce valid, auditable financial statements. The Nasdaq delisted the company for failing to file required forms. The company’s stock plunged to zero; $180 billion in shareholder value was erased. Retirement funds like 401Ks and retirees were among the hardest hit.
HAPPENING NOW, ALL OVER TEXAS
The Texas Attorney General has discovered that of the 1,225 cities across the State, 1,000 of them (80%) have filed to publish fiscal audits timely. Research it yourself; the fiscal mismanagement is everywhere across Texas.
THE LAMARQUE EXAMPLE: WE’RE FINE…WAIT, NOBODY TOLD US…
La Marque discovered in September of last year that it was in a downward spiral. In the months and weeks leading up to September, there were few, if any, public statements acknowledging an imminent emergency.
New financial leadership came in, discovered that the city’s general fund had been drained, and had only enough cash on hand to cover the next two weeks of city operations. The city’s subsequent statements included things like “these circumstances were not caused by a single event, but rather a pattern that has now come to a head…there was massive oversight, poor revenue projection, and a severe lack of internal controls”
La Marque’s credit rating was downgraded to “Junk” status. The city is now in a fiscal crisis.
WHAT’S NEXT: FORENSIC AUDIT
In the private sector, companies with a budget the size of Texas City’s annual $76 million dollar budget don’t get to brush off such incompetence with “we’ll, we got behind, so-and-so left…but we made a checklist now”. People get fired. Certainly, issuance of $74 million in new debt does not happen (except that’s precisely what Texas City did, las year).
Forensic auditors come in and conduct a detailed, investigative examination of financial records, with a with a high level of professional skepticism. This house cleaning is necessary to restore order and trust.
Do you think the city requires a forensic audit? I do; it’s how we get back on track.
