More Transparency Needed in Higher Education Audits

Washington -- In the last post, I discussed the need for more transparency in colleges' enrollment management offices. In this post, I look at insufficient openness in higher education auditing.

One cause of this problem is confusion in the accounting profession about auditing standards. Some institutions are covered by one set of standards, others by another. Also at issue is what institutional elements are to be included, and to what extent. Public institutions, which have by far the largest enrollments and get the most tax support, are required to include their proprietary funds and foundations in their audits, but customarily this is done superficially. Institutions typically resist showing too much in audits.*

The upshot is that too many decisions in university management are guided by what the public is allowed to see in audits, and what not. An extraordinary illustration of this came to light a few years ago at Kansas State University. The KSU example also shows how inadequate audits can be when the auditors themselves do not have to worry about the public looking over their shoulders.

In Kansas, as in many states, the state auditor conducts audits of public higher education institutions that receive and spend tax dollars. These audits are public. Alumni, proprietary, and foundation entities associated with the institutions are typically summarized to comply minimally with professional auditing requirements, but not in the same detail. These entities are often audited by their own auditors; the audits are not made public, so there is no opportunity for the public to see the details of the transactions between the tax-supported and non-tax-supported entities.

Upon the retirement of the KSU president in 2009, the Kansas Board of Regents engaged the accounting firm of Grant Thornton to do a confidential audit of all the KSU accounts, not just the tax supported ones.

They found problems.

KSU, with the participation of its foundation, had entered into an agreement with a national lender to provide federally guaranteed loans to its students, then sell the loans to the lender under what was known as the "school as lender" program. The lender, in exchange for the business, paid the KSU foundation a large sum. But to the U.S. Department of Education, this arrangement (with Sallie Mae) looked like a kickback, a violation of the federal law against illegal inducements (a provision to protect the right of students to choose their own lenders). Congress quickly clarified the law to prohibit such agreements.

KSU had been counting on this source of money from the foundation and awarded scholarships from it. When the money was cut off, KSU found itself with a $2.4 million hole to fill. Rather than filling it directly with tax money, which would have shown up in a public audit, or transferring tax money to the foundation (illegal in Kansas), KSU officials moved a combination of proprietary revenue and tax money through other accounts where it would be less visible. Among the movements was a requirement that the athletic department make a contribution from its proprietary account; the athletic department was subsequently made whole by relieving it of paying a like amount to the tax supported part of KSU for services to the proprietary fund.

This circuitous procedure was approved by the KSU president, but the confidential Grant Thornton audit noted

The Foundation, the Alumni Association,.. and the Athletics Department view themselves, and are viewed by others, as part of or associated with the institution of KSU. However, they are all separate legal entities apart from the University. They all have as a common goal the advancement of KSU and have at times entered into transactions with one another in support of that goal. However, as separate legal entities, any transactions among them should be appropriately disclosed, approved and documented allowing for transparency of intent and substance. The failure to do so raises the question of the legitimacy of the transaction. Our report details numerous instances where transactions between the various entities did not meet this standard.

Kansas newspapers knew of the Grant Thornton audit from earlier documents in which the Regents contracted for it. When reporters asked for the final product, the Regents said it was off-limits. But the Kansas Press Association sued and the Regents eventually released it.

One KSU official was caught off-guard: "I was not aware they were going to release that," he told the Kansas City Star. The admission provides a rare glimpse into how decisions are influenced in higher education by lax standards in auditing transparency.

Release of the audit also provides a window into the knowledge -- or lack of it -- of the auditors. A statement in the audit that "monies to fund scholarships historically came from the Kansas State University Student Assistance Foundation from the resale of ... loans" is incorrect. The "school as lender" payments were historically nothing, zero; they were a newly created device that was under investigation by federal officials for fraud, waste, and abuse. Which is another reason audits should be public, so as to provide a check on the work of the auditors themselves.

The need for greater transparency in higher education auditing has never been greater, inasmuch as state cutbacks in tax support for many institutions has left them more dependent on proprietary entities and foundations, to include large corporate donors eager to move in on, and to control subtly or otherwise, university research and outreach. Agreements of dubious legality, conflicts of interest, attached strings, and ethically challenged behavior that strike at the heart of universities' integrity are correspondingly on the rise.

An antidote would be more tax support and its implicit corrective, but in the current opaque auditing environment it is hard to tell if more tax support would make much of a difference. States considering boosts in tax support for their public universities should simultaneously be demanding higher audit standards from their state auditors, who ultimately have the responsibility for how higher education auditing is conducted.

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* A component unit of a public university that raises and holds funds for the direct benefit of the university must be included in the university's financial statements, according to GASB Statement 39 and Statement 61. This is to prevent government audits that would render the financial statements of the reporting entity misleading or incomplete. Disputes have occurred recently between state auditors and universities in Ohio, North Dakota, and Kentucky. See links. In my opinion, universities are better off complying with the spirit as well as the letter of the GASB requirements (and OMB-133); the KSU example above shows why it is necessary to see all sides of financial transactions to understand them fully; to insist that foundation transactions are private is counterproductive to the purpose of the public institution.