Controlling the Floodgates

Auditors and managers of municipal agencies around Orange County said Friday that the alleged theft of more than $2.2 million at the Irvine Ranch Water District might have been prevented by elementary financial controls regularly required by public agencies and private businesses.

Such controls, including inspecting work before payment is made and having several managers divide responsibility for approving disbursements, were apparently not in place or broke down at the water district.

A former employee of the district, Wayne Melvin Smith, was accused this week of approving payments to three contractors for rebates on water conservation equipment that was never installed. In more than 35 instances over 2 1/2 years, Smith and the consultants allegedly pocketed the rebate money, Irvine Police Investigator Phil Cadenhead said. The alleged scheme ended early last year, when a district employee became suspicious, Cadenhead said.

“It’s a matter of pulling out the Auditing 101 textbook and saying, ‘These are the basic things you do, you separate and segregate tasks,’ and so on,” said Michael Fine, assistant superintendent at Newport-Mesa Unified School District, where a then-top official siphoned off $3.5 million in funds over seven years after internal controls at the district broke down.

Since district officials discovered the fund diversion in 1992, they have gone back to basics, reorganizing their operations from scratch to prevent a recurrence.

“They are some pretty obvious things. You can open up any auditing book in college and find those guidelines,” Fine said. “But they get undermined. People undermine them, and then you have a problem.”

Smith allegedly masterminded the thefts when he ran the district’s water conservation program. The program, Operation Outreach, was designed to encourage large users to save water during droughts. Under the program, customers who installed updated water-saving equipment were rebated as much as half the costs of the devices.

According to court records, Smith allegedly created bogus rebate orders for the consultants, J. Randall Ismay of Laguna Niguel, Robert William Casey of San Dimas and Robert Edward Baier of Seal Beach. The district paid their consulting companies rebates for water-saving equipment they claimed were installed for homeowners associations, cities and school districts and UC Irvine. But the work was never done.

Police say the consultants pocketed a portion of the money and gave kickbacks to Smith. Of the $2.2 million paid to the three men, Smith reaped about $1.1 million, Irvine Police Sgt. Phil Povey said.

“If Smith didn’t exist, these other three didn’t have somebody on the inside to make the process work,” Povey said.

“He created the billing to [the water district] that would cause the checks [to be written]. He’s the guy leading the band.”

No one in the water district’s billing department spotted problems with the rebate orders, Povey said. Investigators said it’s unclear whether anyone in the department even reviewed the bills Smith was requesting to be paid to the consultants.

Unlike many other government agencies, the water district permitted payment directly to consultants instead of to the customers--a policy that some experts say was vulnerable to abuse.

But last July, an employee in the department responsible for writing checks noticed payments that usually go only to customers going to the consultants instead.

“That’s what sent the red flag up to this other employee: Why are they getting these large amounts?” Povey said.

Darryl Miller, president of the Irvine Ranch Water District Board of Directors, would not detail how the agency’s system may have broken down, but he said procedures have been tightened since then. He would not provide details on the reforms.

Smith had a supervisor at the district who was supposed to oversee his work, Povey said, but there’s no suspicion that person did anything criminal.

Miller would not name Smith’s supervisor or say whether that person could have or should have noticed the irregularities sooner. But he stressed that employees eventually uncovered the irregularities.

“It just takes time to uncover this type of misappropriation. It was a very sophisticated, complex operation to evade the [water district’s] system of controls,” Miller said.

When Irvine police began their investigation in July 1997, detectives discovered no work had been done for the district customers that the consultants had named, including the Turtle Rock Crest Homeowners Assn., the Irvine and Saddleback Valley unified school districts and the cities of Tustin and Newport Beach.

The consultants were charged this week with criminal conspiracy and several counts of grand theft. Smith was charged with the same counts, as well as misappropriation of public funds. One of the defendants, Ismay, denied any wrongdoing in an interview Thursday. Baier and Casey could not be reached for comment Friday. Smith remained in custody Friday night.

Bill Robertson, general manager of the Yorba Linda Water District, said routing payments through a contractor is unusual in the water business. At the Yorba Linda agency and at others, he said, district staff work directly with customers to provide services and make sure they are paid for.

“One of the things that really struck me is that we try to work with our customers directly, and they apparently didn’t do that at Irvine,” Robertson said.

The policy of establishing strict internal controls at all levels of bureaucracy is relatively new in government, said David Sundstrom, Orange County director of internal audit. Public agencies that have for decades relied on internal and outside auditors to discover malfeasance after the fact have in recent years been instituting checks and balances in every department and for every transaction, he said.

At county government, only now recovering from the 1994 bankruptcy precipitated by rogue investments made by former county Treasurer-Tax Collector Robert L. Citron, a number of new controls are in place. Regular audits are conducted on a sampling of the 20,000 to 30,000 contracts the county has out at any time, and department heads are held accountable for any problems detected, Sundstrom said.

“No control system can be perfectly designed up front to find every irregularity. You just can’t build the perfect mousetrap,” Sundstrom said.

But “someone on the operational level has to be involved in the process. In the Irvine district’s case, I would think that someone should have gone out to look [at the conservation systems]. There should have been some community feedback mechanism ensuring that the things were done. There were problems in the feedback loop there. It just broke down, from what I understand.”

At the Anaheim Public Utilities Department, which provides electricity and water to about 164,000 customers, rebate requests are carefully monitored, said Greg Broeking, financial services manager for the utility. Three or four people are involved in issuing the rebate coupon, approving it and inspecting the work for which the rebate was granted. Checks are written directly to customers, never to consultants or other middlemen.

“It’s just a matter of setting up the system so it goes the same way every time,” Broeking said.

At Mesa Consolidated Water District, which serves 100,000 customers in and around Costa Mesa, the general manager must approve purchase orders larger than $5,000. All payments, big and small, are reviewed by the district’s board twice a month.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

The Alleged Scheme, According to Police

1) Scheme: Contracts drawn up

Reality: never sent to customer

2) Scheme: Contractors perform work

Reality: Work is never performed

3) Scheme: Consultants submits invoice

Reality: Administrator fakes invoice

4) Reality: Checks cut for phony invoices

5) Reality: Consultant cashes check, keep half the money

* District employee notices check going to consltants rather than customers

* Loss: $14.67 per IRWD customer

Source: Irvine Police Sgt. Phil Povey

Graphics reporting by BRADY MacDONALD/Los Angeles Times