School Officials See Lesson in O.C. Scandal

NEWPORT BEACH —  Like aftershocks from a major earthquake, alarm is spreading among California school officials who have learned of the alleged embezzlement of at least $3 million from the Newport-Mesa Unified School District, and they wonder: “Can it happen to us?”

At a recent California School Boards Assn. convention in Long Beach, more than three times the usual number of school superintendents, trustees and finance officers jammed a panel discussion on audits, said William Pieper, a school finance and audit specialist for the Sacramento-based consulting firm School Services of California.

Pieper and fellow organizers asked how many in the packed conference room had heard of the scandal, in which Newport-Mesa’s once-trusted top fiscal officer has been charged with looting an employee health fund, developer fees and even federal food dollars for poor children during at least a five-year period.

“Virtually every hand went up,” Pieper said. “It was quite clear . . . that’s why a lot of people were there: They wanted to know how vulnerable their school districts are.”

The answer, unfortunately, say school finance experts and auditors, is that every district--indeed every business or city, for that matter--can become prey to an insider who has knowledge, access and the intent to steal.

Newport-Mesa, Orange County and even state school officials say state law already requires adequate checks and balances on the handling of school funds, including annual audits that must be reviewed by county departments of education and the state controller’s office. Moreover, the state controller has specific guidelines that auditors must follow when conducting school district audits.

But critics of Newport-Mesa say those checks and balances clearly broke down, at least to some degree, in a case that is by far the largest alleged school district embezzlement in state history.

The Newport-Mesa investigation is not yet complete, but education experts predicted that what is learned about how the alleged fraud occurred will change the way school district finances are handled and audited statewide.

“It’s important that we take a very unfortunate situation and learn from it,” said John Nelson, the Orange County Department of Education’s assistant superintendent for business services. “It’s going to cause us all to revisit our procedures, and especially to work with auditors to make sure a district’s checks and balances are working.”

Stephen Aldrich Wagner, a 21-year employee who rose from bookkeeper to director of business support services, has been charged with five counts of misappropriation of public funds and state tax evasion in the alleged theft of at least $3 million in district funds from April, 1987, through April, 1992. Wagner, 40, has pleaded not guilty. But through his attorney, he has offered to cooperate with authorities and make full restitution.

State and local education experts say thefts are not unusual in school districts. But they mostly are petty crimes ranging from a few dollars missing from a school’s student body fund to hundreds of dollars in stolen supplies.

Occasionally, larger schemes are uncovered.

In the Orange Unified School District in 1986, police uncovered a scandal in which the district’s maintenance officer and two contractors eventually were convicted for rigging bids in exchange for kickbacks totaling nearly $700,000. Four of the school district’s trustees lost their jobs after they were unsuccessfully prosecuted for “willful misconduct” in failing to oversee district finances.

In the mammoth Los Angeles Unified School District, a “sting” operation in late 1986 uncovered a ring of 21 employees and outside accomplices who stole, then resold more than $1 million in district supplies ranging from pesticides to toilet paper.

Last year, a former California community colleges official and his wife pleaded guilty in Sacramento to setting up a fictitious business and diverting nearly $1 million in school funds from 1982 to 1988 by submitting fake bills for computer services and surveys.

But Newport-Mesa has outstripped all of those, say state education experts. And as the tally climbs to $3 million and more, school districts elsewhere in the state want to know how so large a sum of money could be allegedly stolen without detection for so long.

There are three basic ways that embezzlements are carried out in school districts and other institutions, according to Pieper of School Services of California.

* Through dummy employees or employees who have died or left, but remain on the payroll;

* Through dummy vendors, vendors who give kickbacks for contract services, or theft of school district property that is sold by outside vendors;

* Through unauthorized bank accounts or diversion of checks.

According to court documents, Wagner employed two of the methods: He diverted school funds to a secret account, which he then tapped by way of withdrawal slips and cashier’s checks made out to himself. In July, 1991, the court papers say, he began siphoning funds from another account by writing checks to a shoe repair company he co-owns and wiring money to the bank account of a Florida gem trading firm with which he did business.

Law enforcement and district officials say Wagner’s was a relatively simple, yet ingenious scheme that relied on his being a trusted, longtime employee uniquely positioned to intercept checks and cash, as well as deposit them, make disbursements and reconcile bank accounts. The district used his numbers to compile the annual budget.

“I think we will probably find that there was too much authority placed in one person,” said Orange County Department of Education’s Nelson.

“In past years, we’ve all been cutting back and cutting back on personnel,” he said. “When you do that, you run the risk of eliminating some of your checks and balances. A lot of (school district officials) will want to . . . see if we’ve cut back too far in some areas.”

In Newport-Mesa, the district’s business manager and top finance officer both retired in 1989. Their jobs were consolidated to save money, and Wagner was appointed director of business support services, leaving no one at the district’s Costa Mesa business office to oversee him on a daily basis. Still, court documents show that the alleged scheme began well before 1989.

Internal controls are among the chief methods used by banks, businesses and government entities to foil would-be embezzlers. Those usually include requiring two signatures on sensitive transactions or disbursements--preferably from people in different departments--and ensuring that different people purchase goods, pay bills and receive payments.

“In an ideal situation, you don’t have the same person who opens the mail make the cash deposits,” said Don Driftmier, a partner in the certified public accounting firm of Vavrinek, Trine, Day & Co. of Rancho Cucamonga.

“You don’t have the same person able to approve expenditures and make those expenditures,” said Driftmier, whose firm is conducting the in-depth audit of Newport-Mesa’s books. “But any time you have a smaller office with one person doing a lot of different things with no oversight, then you have room for problems.”

To some degree, Newport-Mesa had internal controls: two signatures were required on most accounts, and purchasing was handled by someone other than Wagner. But Wagner frequently opened the mail, and checks received were only entered on a spotty basis in daily logs. Those logs were rarely reconciled at the end of each month with deposits, but if they were, it was usually Wagner who did it, sources say.

Also, missing funds were never mentioned in Newport-Mesa’s annual audits, although two different auditing firms did highlight questionable procedures involving the district’s employee health insurance accounts in fiscal 1987 and fiscal 1990--questions that school officials say in retrospect may have been a red flag to Wagner’s alleged scheme.

In both cases, the district responded that the problems had been or would be corrected. Top district officials and trustees said Wagner gave them that assurance.

The alleged scheme came to light only after a school district employee went to the Orange County Grand Jury last March with a tip about possible embezzlement by Wagner. It wasn’t until Oct. 23 that Wagner was suspended over a $57,861.25 check he allegedly wrote to a shoe company he co-owns.

Why didn’t the required annual audits catch the missing money?

“In this case, you ask where the hell was their auditor,” said Assemblywoman Delaine Eastin (D-Fremont), whose landmark legislation, AB1200, gives county education departments the responsibility and authority to reject school district budgets that are not in balance. The controversial bill grew out of the recent insolvency of the Richmond school district in Northern California.

“Clearly in the case of this Board of Trustees, they were being lied to by their chief financial officer. But why didn’t the auditing firm . . . find this problem?” asked Eastin, who said she is considering introducing legislation to tighten state auditing practices.

“There are many auditing firms that do a very good job,” she said. “But some just take the money and produce a pretty perfunctory examination of the books. . . . There is a certain slackness in this country when it comes to audits, and I think the savings and loan scandal is a perfect example.”

Yet to blame the auditor is to misunderstand their job, say school finance and accounting experts.

“It’s a common misconception that auditors are there to find fraud and abuse,” said Patrick Keegan, the state Department of Education’s assistant superintendent for business services.

“What auditors are there to do is to see that the books, the financial statements, are in order. They can only do random samples of transactions,” Keegan said. “If someone were clever and didn’t take out large amounts at one time, and basically was in a position to fix the books . . . it would be difficult to detect unless you happened to find a particular transaction in the sampling.”

Wagner made sure that didn’t happen by insisting that any auditor’s request for documents clear his desk first, according to former employees and sources close to the investigation.

But auditors would be hard-pressed to discover a secret account, say school business experts. It is standard practice for auditors to ask banks to verify a school district’s accounts; it is also recommended that they ask banks about any other accounts that may exist.

Trouble is, bank officials typically do not respond to such inquiries unless the auditor has a specific account number, according to school accounting experts.

When the Newport-Mesa investigation is completed, Nelson said he would be sitting down with school leaders across Orange County to discuss specific ways to tighten up procedures.

Some school leaders aren’t willing to wait.

Peter A. Hartman, superintendent of the Saddleback Valley Unified School District in Mission Viejo, has sent a pile of news clippings about the Wagner affair with a letter to his district’s auditing firm.

“I’ve asked them to please review our funds and practices to the extent we know what went wrong (in Newport-Mesa), and determine if we have some of the same problems,” Hartman said.

“I don’t think any district is immune,” he added. “We have had people associated with parent organizations, and there have been Little Leagues in the community where people have run off with as much as $25,000. This magnitude is unusual, but in a society where there are people who steal with guns and people who steal through white-collar crime--well, that’s why we put in safeguards.”

Maureen DiMarco, the state’s secretary of child development and education, said she and advisers to Gov. Pete Wilson are watching the Newport-Mesa case closely.

“I can assure you there isn’t a school board member . . . or a superintendent in the state who isn’t going back over their audit reports and looking for signs of these kinds of problems,” she said.

DiMarco, a former school board member in the Garden Grove Unified School District for 11 years, lamented the impact on Newport-Mesa, one of the wealthiest districts in the state and one with a sterling reputation for quality.

“Newport-Mesa’s pain is going to at least have one benefit,” she said. “Every school district in California is going to check and check again to make sure this kind of situation can’t occur to them.”