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California State Auditor Report Number: 2015-047

The State Bar of California
Its Lack of Transparency Has Undermined Its Communications With Decision Makers and Stakeholders


Response to the Audit

THE STATE BAR OF CALIFORNIA

April 26, 2016
Via Encrypted Secured Email

Elaine M. Howle, State Auditor
Bureau of State Audits
621 Capitol Mall, Suite 1200
Sacramento, CA 95814

Re: State Bar of California Response to State Audit Report 2015-047

Dear Ms. Howle:

Please find below the response of the State Bar of California to the Audit 2015-047. Before turning to our specific observations, we wish to thank your audit team for its courtesy and professionalism.  We found them co-operative, thorough and easy to work with throughout a lengthy process. We know that they spent a considerable effort to gather information that would be comprehensive and allow careful issue exploration.  We believe that their final report offers a meaningful and balanced analysis of the myriad of issues facing the State Bar from which we can benefit, going forward.

1

That said, we were disappointed that the final report did not make a clearer demarcation between past management issues faced by the State Bar and the efforts of new leadership to transform legacy practices and approaches over the last seven months.  It is important to understand the challenges faced by a completely new management team: a new Executive Director, Chief Operating Officer, and General Counsel.  We believe that external readers need to understand this change in leadership and the efforts it is making to address a host of longstanding organizational, operational, and fiscal challenges. This reform-minded State Bar leadership team welcomed the audit and, we believe, exhibited significant openness to the audit process. Accordingly, we proactively identified potential areas for audit exploration.  Our cooperation in consistently providing timely and comprehensive responses to the large number of inquiries and requests for documentation presented throughout the audit period is further evidence of this change in approach, and is deserving of mention.

2

Unfortunately, the report, while relatively modest in content, is dominated by headlines that set a highly critical tone which we believe is inconsistent with both the audit findings themselves, and the State Bar’s overall co-operation and demonstrated commitment to transparency and accuracy.

3

Perhaps the best example of our concern is the report’s title: “Its Lack of Transparency Has Undermined Its Communications with Decision Makers and Stakeholders.” Use of the phrase “lack of transparency” suggests an intentional and deceptive approach.

Yet no evidence is presented to support either proposition. A more accurate description might have been “New Leadership Has Worked Conscientiously to Address Past Lack of Transparency Which Has Undermined…”

We hope you will accept these suggestions as an effort to better describe what we believe your team actually experienced. While we remain conscious of the State Bar’s past failings, we also believe that if a more collaborative relationship with all stakeholders, based on trust, is to be developed in the future, it will be important to highlight the efforts of new leadership.

Response to Specific Audit Findings

The State Bar has not ensured that its financial reports clearly communicate its financial situation.

As evidence of this assertion, the report points to the following:

4

While the State Bar agrees that additional efforts can be made to educate the public and other stakeholders about the condition of the CSF, the Bar rejects the assertion that the condition of the fund has not been communicated. The status of the CSF has been reported to the Board of Trustees via public board reports on multiple occasions, and has been communicated to legislative staff spanning back to the prior executive leadership of the Bar, and continuing to discussions regarding the current fee bill.

5

While the State Bar agrees that more explanation of changes can and should be provided in the State Bar’s financial statements, it is important to note that the audit did not find a single instance of impropriety with respect to any of these areas. With respect to unpaid CSF claims, these do not in fact represent a financial liability to the Bar. Inclusion in the organization’s financial statements as such overstated the Bar’s liabilities, thus artificially reducing the Bar’s available fund balances. So, while the Bar could have explained this change in financial statements more effectively, there is no doubt that removal of these unpaid claims as a negative liability reflects a more accurate depiction of the Bar’s fiscal position. We believe this point is important to a clear understanding of the report.

The State Bar has not clearly informed stakeholders that it lacks the funding necessary to pay victims of attorney misconduct.

4

As noted above, the Bar does not believe that this assertion by the State Auditor is accurate.

The State Bar has not accurately reported its use of certain restricted funds because it lacks a reasonable process for allocating costs of information technology projects.

6

We believe that this assertion is overly broad and that it is incorrect to assert that there is not a reasonable methodology in place for allocating information technology project costs, or that the Bar has inaccurately reported the use of restricted funds. The Bar accepts the audit finding as related to the inaccurate characterization of the IT Fund as unrestricted when it fact it is comprised of some restricted funding sources. However, there was no finding of improper use; all expenditures from the IT Fund were appropriately spent for IT related purposes, and there is a process in place to allocate costs appropriately to various technology projects. 

The State Bar has frequently changed how it presents certain costs in its financial statements, causing the statements to lose comparability.

While the State Bar agrees that additional explanation of changes can and should be provided in its financial statements, the Bar notes that the audit did not find any of the changes identified to be improper or inappropriate and in fact took no exception to the changes themselves. The Bar’s new leadership is committed to adopting ‘best practices’ wherever possible; this is part of our continuing commitment to improve the organization which may very well result in additional methodological changes. We agree, however, with your recommendation to provide more information about such changes, and will commit to explaining any future changes thoroughly.

The State Bar Misclassified the Legal Services Trust Fund as unrestricted and did not accurately report its administrative expenses.

While the Bar acknowledges this one-time error that occurred under the prior leadership, it also notes that there was no finding of any inappropriate use of funds. This should be made clear, lest such an administrative error suggest the presence of more serious problems to the non-technical reader.

The State Bar’s compliance with a new accounting standard has caused significant changes to its financial statements.

While the Bar acknowledges the accuracy of this statement, it is important to note that the implementation of GASB 68 caused significant changes to the financial statements of the vast majority of governmental organizations. The Bar is not unique, and has in fact accurately and timely implemented this new accounting standard. We would urge that this be made clear in the heading.

7

Although the State Bar’s Reserves are generally reasonable it has not adequately communicated the assumptions underlying its budget.

While this header leads to the conclusion that the issue of the Bar’s reserves is tied to budget assumptions, a careful reading of this section of the audit reflects the fact that these two statements are unrelated. In fact, the audit notes that, with the exception of the Sections fund, the Bar has developed and implemented a reasonable reserve policy pursuant to recommendations of the State Auditor’s 2015 report which suggested the need for same. This is an accomplishment for which the State Bar’s new leadership should be recognized, rather than being hidden in a header from which it might be inferred that there is something inadequate in its budget design. 

The State Bar did not adequately document or disclose its budget process.

Significant improvements have been made in this area beginning with the 2016 budget, and the State Bar looks forward to implementing additional enhancements in budget documentation and disclosure in the future.

8

The State Bar’s recent actions to improve its San Francisco building may limit the legislature’s ability to lower membership fees.

While the State Bar acknowledges that the statute relied on to substitute a revenue pledge for a debt service reserve for both the Los Angeles and San Francisco buildings contained a provision that limited the ability of the legislature to reduce membership fees absent amendment, and that this provision was inadvertently overlooked by executive management, the Bar also asserts that the substitution reflected sound fiscal management of the organization. However, the Bar has demonstrated its commitment to acknowledging concerns and moved expeditiously to revert to a debt service reserve fund structure.  As of the date of audit publication, it has executed modifications for both loan agreements and established a combined debt service reserve fund in excess of $7 million. 

The State Bar created an unnecessary nonprofit organization then used State Bar funds to cover the nonprofit’s financial losses.

The Bar agrees that the creation and operation of this nonprofit organization, which took place under the leadership of the former Executive Director, occurred in a highly unusual manner.

The State Bar’s management violated its board policies for interfund loans and expenses.

The Bar agrees that, under the leadership of the former Executive Director, this policy was violated.

The State Bar’s Salaries for its executives are significantly higher than salaries for comparable positions in state government.

While this proposition may be true, the State Bar believes that other State Bar associations are appropriate comparison entities for executive positions; we are advised that salaries for the new executive team were based on such comparisons. Moreover, a 2016 State Bar Executive Director salary survey sponsored by the District of Columbia Bar reflects the fact that the State Bar of California’s Executive Director salary is well within the range of other comparable positions nationwide.

Response to Audit Recommendations

1.      To ensure it maximizes its cost recovery efforts related to the Client Security Fund, the State Bar should do the following:

a.         Adopt a policy to file for money judgments against disciplined attorneys for all eligible amounts as soon as possible after courts settle the discipline cases.

Under the direction of the Bar’s new General Counsel, dedicated staff are addressing a backlog of judgment filings covering a several year period during which the Bar had put such work on a hiatus; while the State Auditor’s recommendation may in fact be appropriate, a cost benefit analysis of the current effort should be conducted prior to adoption of a policy regarding universal judgment filing.

b.         Annually evaluate the effectiveness of the various collection methods it uses to attempt to recover funds from disciplined attorneys.

The State Bar agrees with this recommendation.

2.      To reduce the risk of errors in financial reporting, the State Bar should update its procedures to include guidance on the following:

a.         Detailed steps staff should take to prepare financial statements and to ensure the statements are accurate and complete.

The State Bar agrees with this recommendation, and it has already been implemented.

To ensure the accuracy, consistency and completeness of the Bar’s financial reporting, in March 2016, staff created a financial statement template in Excel. This report template allows staff to automatically roll up general ledger balances exported from the Oracle financial system to appropriate expenditure and revenue categories for each program fund.  General ledger account consolidation converted from a manual to an automated process in 2016.  This new process not only increases the accuracy and completeness of the Bar’s financial statements, but also maintains the consistency for comparability.  In addition, a financial statement preparation check list which includes all necessary steps to compile quarterly and annual financial statements has been developed.

b.         Management’s review and approval of financial statements.

The State Bar agrees with this recommendation.

Bar financial statements were historically reviewed by the Chief Financial Officer and the Executive Director, prior to submission to the Board of Trustees. Currently, the Chief Operating Officer and Executive Director review the statements, which have been prepared by the Director of Finance, a CPA. Staff will continue this practice and will properly document the approval process for future audit purposes. 

3.      To increase transparency and comparability of its financial information, the State Bar should do the following:

a.         Limit significant changes in its indirect cost reporting.

The State Bar agrees with this recommendation in principle.

In 2015, the State Bar conducted a thorough study and review of the indirect cost allocation methodology. While this review confirmed the appropriateness of the Bar’s existing allocation methodology, several modifications were recommended. In January 2016, the Board of Trustees adopted a modified cost allocation plan pursuant to these recommendations. While it is the Bar’s intention to maintain this revised methodology going forward, additional modifications may be needed as related to one-time capital expenses, for example, or ongoing business improvement efforts. Thus, while in principle the Bar might agree to limit changes in indirect cost reporting, where that principle contradicts with the need to modify the methodology to make it more accurate, the latter concern will prevail.

b.         Clearly disclose any changes in its accounting practices.

The State Bar agrees with this recommendation.

c.         Disclose the reasons for any significant changes to program costs.

The State Bar agrees with this recommendation. 

4.      To ensure it accounts appropriately for information technology project costs and their related funding sources, the State Bar should do the following:

a.         Develop a reasonable method for allocating information technology project costs

b.         Apply this new cost allocation method to the costs of its Technology Improvement Fund

6

The State Bar agrees with this recommendation but believes that a reasonable allocation methodology is in place; this methodology will be codified as a procedure pursuant to State Audit findings.

5.      To ensure its budget documents conform to the requirements in State law and are comparable to prior budgets, the State Bar should do the following:

a.         Establish a process for ensuring budget documents conform to the requirements in State law.
b.         Update its budget policies to require supplementary schedules and narratives for any in the year in which it implements changes to the presentation of its budget.

The State Bar agrees with this recommendation.

6.      To ensure it informs stakeholders of conditions that may impact its policy and programmatic decisions, the State Bar should document the assumptions and methodology underlying its budget estimates. It should concisely present such assumptions and methodology in the final budget document it provides to its board and the legislature.

The State Bar agrees with this recommendation.

7.      To ensure that the State Bar’s Board of Trustees can make informed decisions regarding the recommendations its consultant made regarding budgeting and financial reporting, the State Bar should prepare a cost/benefit analysis of implementing its consultant’s recommendations regarding budgets and present this analysis to the board for consideration.

The State Bar agrees with this recommendation.

9

It should be noted that the Bar’s existing budget and financial reporting practices satisfy relevant legislative provisions and are in compliance with generally accepted accounting principles, in terms of its content, presentation and design. The consultant referenced by the auditor recommended that, in addition, the Bar implement budget and financial statement models recommended by the CSMFO and GFOA; implementation of these models would require extensive staff resources and additional qualified accountants to deliver.

8.      To ensure that the board retains appropriate supervision and control over the State Bar’s financial affairs, it should establish a policy that includes the following:

a.         A description of the parameters for the creation of nonprofit organizations limiting such organizations to the purposes consistent with the law and the State Bar’s mission.

b.         A description of its oversight role in relation to its nonprofit organization.

c.         Requirements that ensure the board reviews and approves all documents the State Bar uses in the creation and use of a nonprofit organization including, but not limited to, original and amended bylaws, as well as agreements between the State Bar and the organization.

d.         Requirements that ensure the board reviews, approves, and monitors on an ongoing basis the budgets and other financial reports of any nonprofit organizations.

e.         Requirements that it develop policies and procedures to prevent the mingling of the State Bar’s funds and any nonprofit organization’s funds.

The State Bar agrees with this recommendation.

9.      To ensure that the compensation it provides is reasonable, the State Bar should do the following:

a.         Include state government executive branch salaries and benefits for comparable positions in the comprehensive salary and benefits study it plans to complete by October 2016.

The State Bar agrees with this recommendation and its contract with CPS HR Consulting, Inc., the classification and compensation vendor, has already been modified to reflect the inclusion of executive branch salaries.

b.         Revise its policy for housing allowances and relocation expenses to align with the requirements in state law that are applicable to excluded employees.

The State Bar agrees with this recommendation.

Respectfully,


Elizabeth Parker
Executive Director





Comments

California State Auditor’s Comments on the Response From the State Bar of California

To provide clarity and perspective, we are commenting on the response to our audit report from the State Bar of California (State Bar). The numbers below correspond with the numbers we have placed in the margin of the State Bar’s response.

1

We believe our report provides appropriate context regarding the management issues faced by the State Bar. Our report focuses on the period between January 2013 and December 2015. We acknowledge that the State Bar experienced significant executive management turnover beginning in November 2014 and note that the current executive team started in September and October 2015. Finally, in multiple places in the report, we acknowledge the State Bar’s recent efforts to change management practices to address certain problem areas.

2

We disagree with the State Bar’s contention that the headings in the report are inconsistent with the audit finding themselves. The headings in our report are intended to summarize report content and they do so accurately. They are not intended to contain every detail of the report.

3

We disagree with the State Bar’s contention that a lack of transparency necessarily suggests an intentional and deceptive approach. We believe the lack of transparency we note made it difficult for stakeholders to understand the State Bar’s financial condition, irrespective of intent. We identified multiple instances in our report in which the State Bar reported information either inaccurately or in a manner that decreased comparability or understandability.

4

The State Bar mischaracterizes our conclusion regarding communications about the Client Security Fund. We conclude that the State Bar could have done more to communicate the fund’s difficulties and offer solutions sooner. We noted that the State Bar’s lobbyist stated that the State Bar has discussed the shortage of money in the Client Security Fund with the Legislature for a number of years and has explored solutions with legislators, including a fee increase. However, recent budgets the State Bar has provided to its board and to the Legislature have not discussed the fund’s problems or proposed any solutions.

5

While the State Bar’s decision not to report unpaid Client Security Fund claims as liabilities on the face of its financial statements is defensible, we believe that it should have disclosed in the notes to the financial statements that it had a commitment related to a large, continuing estimated payout. Specifically, the State Bar did not include information in its financial statements of its inability to pay estimated claims between 2012 and 2014. After we raised this issue with the State Bar, it added a disclosure to the notes of its 2015 financial statements that included an estimated payout of $18.9 million as of December 31, 2015.

6

We disagree with the State Bar’s assertion that it has a reasonable methodology for allocating information technology project costs. For example, we reported that the State Bar transferred $1 million from the Admissions Fund to the Technology Improvement Fund in 2012 but that it had only incurred about $173,000 in admissions project costs by the end of 2015. A reasonable cost allocation process would not have yielded such a result.

7

We disagree with the State Bar’s contention that the “header” is misleading. Further, we discuss the State Bar’s reserves and its budget assumptions under separate subheadings.

8

Despite the fact that we maintained communication with the State Bar during the agency response period and provided it with revisions based on the actions it took after we had completed our fieldwork, the State Bar chose not to include the revised heading located in its response.

9

We disagree with the State Bar’s assertion that its existing budget practices satisfy relevant legislative provisions. As we discuss, the State Bar’s decision to eliminate its fund condition statements from its 2016 budget documents removed detailed information about each fund’s revenues and significantly decreased the transparency of the State Bar’s budgeting process. State law requires the State Bar to provide supplementary schedules detailing, among many other things, all revenue sources, any reimbursements or interfund transfers, and fund balances. However, the State Bar eliminated much of this information from its budget when it switched from providing fund condition statements to providing a schedule of reserves.




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