Originally posted at CalFWD.

Sometimes the warning signs, in any dicey situation, are loud and clear and almost smacking you in the face. Other times, they’re subtle, so if you don’t pay attention to the warnings, you will end up with a big mess and in a lot of trouble.

So is the case in the city of Stockton. California State Controller John Chiang said, in a series of audits just released, city leaders ignored warning signs that would have saved them from falling into a deep financial hole, a hole which eventually led city councilmembers to file for municipal bankruptcy in June 2012.

In the audits, it’s quite clear the Controller was critical of Stockton city leaders’ accounting practices pointing out significant weaknesses in the City’s fiscal management practices and internal controls.

If those weaknesses are “left unaddressed, they will continue to invite wasteful spending and abuse of public resources,” said the Controller.

The audits also found that the City misused cash in its gas tax fund, and is unlawfully holding former redevelopment agency (RDA) assets.

“Stockton is not Bell. We found no evidence that corruption and self-dealing drove this city into insolvency. Instead, many of Stockton’s problems can be tracked to poor decision-making that was not only ill-informed by weak accounting and fiscal management systems, but failed to heed downward-trending data that should have curbed spending and borrowing decisions.”

Here are just a few of the findings:

  • Serious weaknesses exist in most aspects of the city’s administrative and internal accounting control system. Of the 79 accounting controls investigated, 48, or 60.8 percent, were ineffective or inadequate.
  • Most of the City auditor’s office planned audits were not carried out and few audit reports were issued.
  • The City is unlawfully holding more than $1.3 million in RDA assets. After RDA’s shut down, the money was supposed to be transferred to “successor” agencies to settle RDA debt, but the City inappropriately transferred money from the RDA to the city, not the “successor.”
  • Of the financial reports the City produced on time, many had several discrepancies that raise questions regarding their reliability.
  • The City’s co-mingling of taxpayer dollars resulted in the cash impairment of some funds.
  • The City has a decentralized fiscal management system that, without adequate oversight and internal controls, can result in abuse or misuse of public funds.
  • The poor management structure let to an estimated loss of $8.6 million in State and Federal grants.

“I recognize the all too clear challenges facing the city of Stockton. The purpose of these audits is to shine a light on serious, but solvable, problems that must be addressed by City leadership in order of Stockton to restore its financial integrity,” said Chiang.

The Controller initiated the audits in April 2012 after requests from the San Joaquin Taxpayers Association (SJTA) and other city leaders looking for an independent review of the city’s money management.

It’s clear, in a series of letters, from the City to the Controller, leaders are not happy with the audits.

In fact, after the audits were released to the public, city manager Bob Deis said, “this audit is a disappointment. It produces very little new information. Instead, it just inflames the situation and slows down Stockton’s recovery.”

He added, “the SCO audit covers primarily ‘old’ information going back to FY 2003-2004 up to June 2011. Much of their conclusions are two years old or more. It does not take into account that the City is and has been aggressively and comprehensively addressing the issues that contributed to its insolvency status.”

The City Council has hired a reputable CPA firm, Moss Adams, to help with evaluations of internal controls. The findings will be shared with the Audit Committee soon.

“The Audit Committee is now meeting monthly and taking a very active roll with respect to oversight of the City’s audit functions. We know there is more work to be done, and I look forward to receiving the internal control evaluation from Moss Adams so that we can continue our efforts,” said Paul Canepa, Vice Mayor and chair of the Audit Committee.

“The SCO report s simply restates findings already identified by the City and our external auditors and offers retrospective advice and counsel about what prior leadership and Council should have done differently in the decades before the City’s fiscal crises,” said Deis.

“Those that requested this audit did so over concern that the City was planning on filing for bankruptcy. Nothing they have reported has made any significant difference in the bankruptcy filing. Had the State Controller conducted a 15 month audit a decade or two ago, we may have avoided our current fate.”

“They are upset not with just the Controllers’ findings, but that there was an audit in the first place. They seemed to be very concerned with how the audit looked and our response to that is, we wish the focus to be on the audit substance. We think there are serious material issues here and we’re going to make recommendations on how to fix them,” said Jacob Ropper, Controller spokesman.

The Controller’s reports recommends the City to immediately separate its gas tax dollars and reverse the transfer of money in redevelopment assets.

“This doesn’t mean the City has to adopt them, but we do make some strong recommendations and we think there’s a lot of value to them,” said Roper.

Stockton was the largest city to declare municipal bankruptcy, however last month Detroit decided to do the same.