Corporation Welcomes Auditor-General's Report

Media Release

9 June 2006

MEDIA RELEASE

Housing New Zealand Corporation Welcomes Auditor-General’s Report

Housing New Zealand Corporation (HNZC) has welcomed a report by the Auditor-General which has cleared the organisation of serious allegations of financial wrongdoing including the deliberate suppression and manipulation of financial accounts.

Corporation Chairman Pat Snedden said although the report identifies a need for improvement in some areas of the Corporation’s financial and accounting practices, the more serious and substantive allegations levelled by a former contractor were not upheld.

The Auditor-General in a major finding of his inquiry, released publicly by the Corporation today, June 9, said: “Our inquiry did not give rise to any significant concerns about the Corporation’s financial accounting practices.”

Commenting on the overall findings of the report, Mr Snedden said: “The Auditor-General’s clearance of the Corporation of any serious financial wrongdoing, its approval of the actions of our Chief Executive Helen Fulcher in her handling of the contractor settlement agreement and its conclusion that Corporation staff did not attempt to buy the contractor’s silence are all critical and very important findings.

“As well, the contractor made numerous and very serious allegations of deliberate financial manipulation and suppression of accounts and general financial wrongdoing. The Auditor-General has found no basis to any of these allegations which is very welcome,” he said.

In his other major finding, the Auditor-General highlighted concerns “about management reporting practices” in the National Property Improvement team. “In our view, there is a lack of suitable accounting resources at the operational level, a lack of ownership or responsibility over programme accounting, a need for improved documentation, and a need for better alignment between management reporting and financial accounting records,” he said in the report.

Mr Snedden said these were “operational issues which we will be moving quickly to address.”

“The immediate remedy will be to employ an additional fully qualified accountant at the programme level and adopt the change to monthly reporting routines.”

Mr Snedden said at the time the contractor’s original allegations were made public in late March, which led to the Auditor-General’s inquiry, media reports suggested he was paid “hush money” to gag him and stop him talking publicly and that the chief executive knew and approved of this.

Although criticising aspects of the management process of the settlement agreement and the “unwise” insertion of the non-disclosure clause, the Auditor-general’s report found the payment of $3000 to the contractor was a legitimate ex gratia payment and was not intended as “hush money” to buy the contractor’s silence.

Commenting on the actions and knowledge of the chief executive, the Auditor-General found that while she approved the decision to negotiate a settlement with the contractor and approved the financial parameters, “she did not see or approve the terms of the agreement entered into, including the non disclosure clause. The Chief Executive was kept properly informed of progress with the matter and discharged her responsibilities appropriately.”

Mr Snedden said: “The Auditor-General has completely endorsed the actions of Helen Fulcher and I am pleased to reaffirm the Board’s total confidence in her as the Corporation’s Chief Executive.”

He said while there were lessons to be learned from the contractor affair for the Corporation and all public sector agencies, the finding that Corporation management and staff had at all times acted honestly and with the best of intentions was hugely important to the Board. It was also reassuring and heartening to learn that the Auditor-General had not found any evidence to support allegations of bullying by some staff.

“Our motives were at all times honourable and well intentioned and that ultimately is what the public is entitled to expect of a major public service agency. Where we let ourselves down was in our execution and our attention to detail and the unwise drafting of the settlement agreement with the contractor. Elsewhere the Auditor-General has also identified some problem areas and the need for improvements in our management reporting and accounting.

“We accept that we need to bring these matters up to best practice.

“However as the Auditor-General also acknowledges, an inquiry of such a detailed nature of any state agency is bound to come up with areas of improvement and especially in a major state agency like the Corporation that houses 180,000 people, has $11 billion in assets, $700 million turnover and employs nearly 1,000 staff.”

The background to the inquiry started in August 2005, when the former contractor, who has not been publicly named, alleged in e-mails to the Corporation that:

- certain accounting practices in respect of the Corporation’s Modernisation and Maintenance programmes were inappropriate and produced misleading financial results;

- certain inspection activities in respect of the Corporation’s Modernisation and Maintenance programmes were carried out inadequately, or not at all; and

- he was subjected to bullying by other staff in response to his allegations.

The contractor left the Corporation in August 2005, and subsequently reached a settlement agreement which included a $3000 payment. One of the terms of the agreement was that the contractor would not talk publicly about his concerns.

In April 2006, the Auditor-General was asked by the Corporation Board to inquire into the events leading up to the settlement agreement with the contractor, and the allegations made by the contractor.

The major findings of the report, as contained in the Summary, are attached.

Mr Snedden said the Board would be reporting to the Minister within the next two weeks on steps to implement all the recommendations.

Mr Snedden said it was important to note that in the Auditor-General’s view, “none of the specific accounting transactions discussed in its report was material in the context of the Corporation’s financial statements taken as a whole.”

He acknowledged the Auditor-General’s criticisms of the way in which the settlement agreement with the contractor had been negotiated.

“As I said last month the inclusion of this clause attempting to prevent disclosure to the Minister was not appropriate. The Board will make sure this is understood by all our staff.”

Corporation Chief Executive Helen Fulcher said both management and staff also welcomed the report which was fair and thorough.

“None of the more serious allegations have been found to have substance and that is pleasing to me, my management team and the hundreds of hardworking and loyal Corporation staff.

“There are lessons to be learnt here for us and the entire public sector in relation to induction for contractors and protected disclosures. They have also found room for improvement in some specific financial areas which will all be acted on.

“I know I speak for all staff in saying we look forward to getting on with the very important task of delivering state housing assistance to many thousands of New Zealanders in social need.”

Full copies of the report are available at www.OAG.govt.nz

ENDS

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Summary

In March 2006, we received information about certain allegations made by a former contractor of Housing New Zealand Corporation (the Corporation). On 10 April 2006, the Board of the Corporation asked the Auditor-General to consider conducting an inquiry into those allegations, and the Corporation’s response to them.

The situation arose in 2005. On 8 August 2005, the contractor notified the Chief Executive of the Corporation by e-mail that he had concerns that:

certain accounting practices in the Corporation’s Modernisation and maintenance programmes were inappropriate, and produced misleading financial results;

certain inspection activities in the Corporation’s Modernisation and maintenance programmes were carried out inadequately, or not at all; and

he was bullied by other staff in response to his concerns.

The contractor did no further work for the Corporation after 8 August 2005. A settlement agreement was reached between the General Manager Assurance Services (the GM Assurance Services) and the contractor on 14 December 2005, which included a payment to the contractor of $3,000. One of the terms of the agreement was that the contractor would not communicate publicly or privately any of his concerns about the Corporation or other parties, including through communications with any Minister, member of Parliament, journalist, or radio or television station.

The allegations made by the contractor were potentially serious, and we advised the Board on 11 April 2006 that we would conduct an inquiry.

Our inquiry looked at:

the Corporation’s handling of the allegations, including the events leading up to the settlement agreement with the contractor; and

the allegations made by the contractor.

Our findings about Housing New Zealand Corporation’s handling of the allegations

The initial investigation of the allegations

The Corporation made an immediate and genuine effort to investigate the contractor’s allegations. It sought an agreement with the contractor as to what the allegations actually were, and agreed for the matter to be looked at internally, with a level of review by the external auditor. This was a reasonable response in the circumstances.

The payment made to the contractor

The payment made to the contractor was an ex gratia (voluntary) payment that recognised his grievance about the abrupt nature of his departure from the Corporation. It was part of a pragmatic solution by which the GM Assurance Services sought the contractor’s co-operation in moving the matter forward and enabling an orderly investigation of his allegations. The payment was calculated appropriately, and was based on about 2 weeks’ income that the contractor might have expected to receive if his engagement with the Corporation had been terminated with notice.

The terms of the agreement (except for the non-disclosure clause, which we discuss below) were fair and reasonable. However, the way the agreement was drafted was unwise. Referring to the payment immediately before the non-disclosure clause created a perception that the payment was being made in return for the contractor’s silence. Had that been the intention of the parties, it would have been highly inappropriate. However, we did not find any indication that either the contractor or the Corporation intended or understood that to be the case. The non-disclosure clause was included in the settlement agreement at the initiative of the contractor, not the Corporation.

The process used to reach the settlement agreement

We have concerns about the process used to reach the settlement agreement. These include a lack of documentation of the rationale for entering the settlement and a failure to obtain written legal advice, although oral advice was obtained from external legal advisors. Despite this, the GM Assurance Services had a clearly formulated rationale for the decision to settle with the contractor and make a payment to him.

The Chief Executive’s role

The Chief Executive orally approved the decision to negotiate a settlement with the contractor, and the financial parameters for the settlement. However, she did not see or approve the terms of the agreement entered into, including the non-disclosure clause. The Chief Executive was kept properly informed of progress, and discharged her responsibilities appropriately.

The non-disclosure clause

In our view, including the non-disclosure clause in the agreement was unwise. The form in which it appeared was inappropriate because it purported to close off legitimate avenues for disclosure of information about serious wrongdoing under the Protected Disclosures Act 2000.

However, there was some justification for a non-disclosure clause in some form, given the contractor’s repeated indications that he would disclose his concerns publicly. The clause would have been acceptable if it had been drafted in terms that preserved the contractor’s right to make any disclosure permitted by law.

Our findings about the contractor’s allegations

The Corporation had difficulty investigating the contractor’s allegations because many of them lacked specific detail. The contractor provided us with a greater amount of information, but we also had difficulty investigating because of insufficient detail.

Some of the allegations raised by the contractor were, in our view, based on a misunderstanding by the contractor of the Corporation’s accounting practices or a lack of appreciation of the overall picture. Given the size of the Corporation, we would not expect all staff members (nor contractors) to be involved in, or understand, the full accounting and reporting structure within the Corporation. This is especially so for an individual who spent only a number of months working for one area of the organisation.

We investigated all the allegations and reached the following general conclusions:

Our inquiry did not give rise to any significant concerns about the Corporation’s financial accounting practices.

However, we do have some concerns about management reporting practices within the National Property Improvement team. In our view, there is a lack of suitable accounting resources at the operational level, a lack of ownership or responsibility over programme accounting, a need for improved documentation, and a need for better alignment between management reporting and financial accounting records.

Our recommendations are set out in the “lessons learned” section of this summary.

Allegations about accounting and reporting practices

The contractor alleged that capital spending on Community Group Housing properties was reported in an untimely manner. We do not share that concern in respect of financial accounting for the Corporation as a whole. However, we are concerned that not all spending is recorded within monthly management reports in the month in which the costs are incurred.

The contractor alleged that reversing journals were being used to manipulate results. The Corporation’s use of reversing journals is in keeping with generally accepted accounting practice. We have no concerns with the use of such journals.

The contractor alleged deliberate manipulation of results between financial years. He expressed specific concern about an accrual of $720,000 in advance of the work being completed and about costs of $2.1 million held in a suspense account. We found that while an over-accrual of at least $200,000 did occur at 30 June 2005, we do not consider that this was a deliberate attempt to manipulate the reported results. We also found that if the job has been incorrectly set up, costs are held in a suspense account when such costs are uploaded into the accounting system. In such circumstances, staff identify the appropriate codes manually, and clear items out of the suspense account. The contractor helped with clearing costs amounting to about $2.1 million from this account, relating to 2 financial years.

We have no concerns about this suspense account as such, because costs are appropriately included in the Corporation’s balance sheet for financial reporting purposes. However, to provide an accurate picture of various programmes throughout the year, the costs held in this suspense account also need to be included for management reporting purposes.

We consider that the accumulation of costs in a suspense account over a period of many months without being cleared was inappropriate. We note that the account now has a much lower balance and is reconciled each month.

The contractor alleged that there was manipulation of results between various programmes. We found no evidence to support this allegation.

The contractor alleged that management reports were manipulated so as to disguise the true cost of projects. We found that management reporting of the Greenstone Gardens project did not consistently identify the extent of budget overrun on the project, because of the practice of comparing actual costs to forecast costs rather than the approved budgeted costs and because an accrual of $722,000 relating to the project was not correctly allocated to the project.

However, we did not find any evidence to support the contractor’s allegation that management reports on the performance of the Auckland Modernisation programme were manipulated. We noted that the under-performance of the programme had been drawn to the attention of the Assurance Committee of the Corporation’s Board. Therefore, the non-performance was not suppressed but, rather, was highlighted for the attention of the Board, as was appropriate.

The contractor alleged that payments made by the Corporation under the Property Maintenance Assessment System (PMAS) contract exceeded the contracted amount. In our view, the structure of the contract makes this unlikely and we found no evidence to suggest that this occurred.

The contractor raised general concerns about the robustness of the accruals process for some housing programmes. While we detected some inaccuracies in the accruals for the Modernisation programme relating to the end of the 2004-05 financial year, some of these appear to have resulted, at least in part, from errors made by the contractor.

We consider that the supporting documentation relating to accruals could be improved. This ought to reduce the potential for errors in future.

The contractor alleged that there was an unauthorised transfer out of a project manager’s 2005-06 budget without discussion with the manager. We consider that the “unauthorised transfer” was the consequence of an under-accrual from the previous year, and affected the 2005-06 actual figure rather than the 2005-06 budget figure.

Alleged suppressing and “watering down” of internal audit findings

The contractor alleged that internal audit findings were “watered down” or suppressed. We did not find any evidence to support this allegation.

Contestability of the Property Maintenance Assessment System contract

The contractor raised concerns about the tender process used by the Corporation to outsource the PMAS contract during 2005. In our view, the decision made to award the contract to the existing provider was appropriate. However, we do have some concerns about insufficient documentation of the tender process, and the adequacy of some aspects of the Corporation’s procurement policies.

We did not find any evidence to substantiate the contractor’s concern that the existing provider won the tender because of a personal relationship between an individual in the existing provider’s company and a senior manager at the Corporation. The senior manager was not involved in evaluating the tenders, and the evaluation panel’s recommendation was adopted by the Corporation without amendment by the senior manager.

Alleged inappropriate programme reporting structure

The contractor alleged that there were inappropriate reporting lines within the National Property Improvement team. This is a management decision that we do not intend to express a view on, but we note that managers within the Corporation have previously considered this matter.

Organisational culture

The contractor also alleged, in connection with his allegations about accounting and reporting practices, that he was bullied by 2 staff members. Although such issues are more within the mandate of the State Services Commissioner, we did discuss issues of organisational culture with the staff members we spoke to.

The contractor’s concern arose out of differences of opinion with staff members that perhaps were not handled or managed in the most appropriate manner. There is a distinction between strong management and workplace bullying. We did not find any reason to refer the contractor’s allegations to the State Services Commissioner for further investigation.

Use of Crown funding and third party revenue

We did not find any lack of clarity or transparency around the Corporation’s use of Crown funding and third party revenue.

Lessons learned

Several features of the matters we inquired into were unusual, but there are lessons that can be learned by all public sector organisations.

Induction procedures

The Corporation appears to have not considered whether the contractor needed to participate in the Corporation’s formal induction process. Given that he was to work in many respects as if he were an employee, formal induction would have been desirable. He could have been told about the State Services Commission’s Code of Conduct, to the extent it is adopted by the Corporation, and the procedure for making protected disclosures under the Protected Disclosures Act 2000.

Protected Disclosures Act 2000 procedures

The manner in which the contractor’s disclosures were made and subsequently managed was largely consistent with the Corporation’s internal policy on the Protected Disclosures Act. However, this appears to have been largely coincidental. Our inquiry reinforces the need for staff and management of public sector organisations to be aware of their respective rights and duties under the Protected Disclosures Act.

Use of non-disclosure clauses in severance agreements

There is a need for guidance for public sector employers on what is acceptable practice when using non-disclosure clauses in severance agreements. We have tried to set out what we consider to be acceptable practice (see Part 4), after consulting with Crown Law and the State Services Commission. We commend Part 4 to all public sector employers.

Accounting and reporting practices

In respect of the Corporation’s accounting and reporting practices, we recommend that:

1. Housing New Zealand Corporation report all programme spending in the monthly management reports when such costs are incurred, regardless of whether the costs have been entered into Rentel or are held in a clearing account.

2. Housing New Zealand Corporation reconcile each month the financial information in the management reports and the expenditure recorded in its accounting records. This would, for example, ensure that the clearing accounts (which are in capital work in progress in the general ledger) are accurately reflected in management reporting in the month the costs are incurred.

3. Housing New Zealand Corporation track leasehold property improvements on a property-by-property basis.

4. Housing New Zealand Corporation consider whether project managers need additional training on relevant accounting matters.

5. Housing New Zealand Corporation complete as soon as possible the guidelines and procedures for the Modernisation programme, to provide clarity for staff about allocating costs.

6. the Wellington-based Finance team remind all business groups within Housing New Zealand Corporation what the requirements are for manual accrual journal entries, and that exceptions will not be made.

7. Housing New Zealand Corporation employ suitably qualified accounting resources within the National Property Improvement team.

8. Housing New Zealand Corporation clarify the ownership of, and management responsibility for, the programme accounting function within the National Property Improvement team.

The Corporation’s procurement processes

As a result of our review of the PMAS contract, we recommend that Housing New Zealand Corporation:

9. follow the documentation requirements of its tender policy, and adequately supervise staff given responsibility for day-to-day management of tenders.

10. review its procurement policy and processes to ensure that they are consistent with best practice and relevant public sector procurement guidelines, and to ensure that any guidelines in use form part of that policy.

Materiality and our 2004-05 audit

In an in-depth inquiry, it is always possible that concerns will be uncovered that have not been identified in the normal course of the annual audit.

Ernst & Young, acting as the Auditor-General’s appointed agent, audits the financial statements of the Corporation each year. An audit, by its very nature, does not involve considering each accounting transaction. Rather, systems are audited, and selected transactions and balances are tested. In carrying out an audit, the auditor considers whether an amount is “material”, which is largely determined by the size of an entity’s assets and budget.

The Corporation has assets worth about $11 billion, and spent about $635 million in the 2004-05 financial year. In our view, none of the accounting transactions that we examined were material in the context of the Corporation’s financial statements taken as a whole.

The scope of our findings

It is also important to note that we have only examined one small part of the Corporation. Our findings cannot, and should not, be applied to the Corporation as a whole. While we have identified some concerns about the management and administration of the National Property Improvement team, we always expect to find areas for improvement in an inquiry.

ENDS

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