Accountable Strategies blog

A blog about accountability issues in the public, private, and nonprofit sectors

Archive for February, 2008

Performance, accountability, rules, and the Mount Hood-Big Dig dirt case

Posted by David Kassel on February 19, 2008

When I was with the Massachusetts Office of the Inspector General, we reviewed an interesting case in which hundreds of thousands of tons of fill from the ongoing “Big Dig” tunnel project underneath Boston were delivered to Melrose, a small city a few miles to the north.

It was done under an unusual arrangement in which a contractor actually offered to pay the city of Melrose to take the stuff.  The offer was made in April 2000.  City officials estimated they would garner more than $200,000 in revenues from the fill.  The then parks superintendent suggested to the then mayor that they could use the fill to make long-needed improvements to the 12th fairway of the city’s Mount Hood Memorial Park and Golf Course.

The problem was that those city officials failed to first do a project plan, design, or cost estimate.   As the truckloads kept coming, wetlands in the park became flooded and sediment from the fill got into resource areas.  Trees and other vegetation in a number of areas died or were stressed.  A partially installed drainpipe in the fairway failed, resulting in the need to install a new one, and the built-up fairway slopes had to be stabilized.  Rather than completing the project with $200,000 in revenues from the fill, as planned, the project was now projected to cost $1.8 million.  The parks superintendent was fired from his position and the mayor himself left office soon afterwards.

The IG’s office was called in to do an assessement.  We found, among other things, that in six instances, the city procured site preparation and other work without complying with the state’s public works bid law.  In 16 instances, the city failed to comply with a law requiring written contracts. 

I discuss this case and three other “design-build” contracting cases in which traditional bidding rules were bypassed, in an article in the March/April 2008 issue of Public Administration Review.  The purpose of the article is to offer a rebuttal to a view among some public administrators and academics since the 1980s that bidding, contracting and other rules are largely bureaucratic red tape and that they stifle innovation by public managers and hamper their performance.

On the contrary, these cases appear to me to show that there is a certain amount of wisdom inherent in public procurement laws and regulations, and that when managers evade those rules, their projects can implode.  Conversely, when they follow rules, they may well be rewarded with successful and accountable projects.

Public works bidding rules, in particular, require public managers to do a certain amount of up-front planning for their projects in developing their bid requirements.  Contracting laws help protect public entities by ensuring that legal agreements are drafted with private contractors.

In the Mount Hood case, the city of Melrose jumped at the offer to be paid for accepting the Big Dig fill.  Within weeks, the fill began arriving from Boston.  Between May of 2000 and July 2001, roughly 700,000 tons of Big Dig fill were dumped in the center of Mount Hood park.

In the case of the drainpipe installation in Mount Hood’s 12th fairway, the city had hired a contractor for the job without having sought bids as required by the state’s public works bid law.  The law would have required the city to prepare a full set of specifications for the drainpipe installation—in other words the city would have had to do some up-front planning for the job.  The city also failed to execute a contract for the drainpipe work—a violation of another state law requiring that contracts be used in municipal transactions with vendors with values over $5,000.

The drainpipe was partly installed by the contractor in an area of the fairway where peat was present.  According to the IG’s report on the project, portions of the pipe became dislodged when the peat moved, or “heaved,” underneath the drainpipe.  An excavating machine belonging to the contractor became buried in the fairway.  A decision was later made by the city to abandon the pipe and start all over again with a new one.  Not only did the drainage system have to be redesigned, but the city was forced to spend money to pump silt deposits out of nearby wetlands areas.  The silt deposits were found to have been caused by the drainpipe failure.

In the PAR paper, I conclude that in the drainpipe case alone, had the city complied with the bid law and hired an engineering firm to prepare plans and specifications, those plans would have been likely to have been based on existing conditions of the fairway and the presence of peat there, and presumably those conditions would have been disclosed to all of the bidders.  The expensive environmental problems could have been avoided.  Moreover, without a contract in the drainpipe case, the city had no legal means to protect its interests.

Interestingly, the city was not required to seek bids for the overall fill delivery contract because the city was not specifically paying for the fill.  Nevertheless, the city’s lack of plans and specifications for the overal project appears to have had a direct impact on the city’s ability to prevent the environmental problems that occurred.

The lesson here is that to the extent that rules encourage planning for major projects, it’s often a good thing to follow them.

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Getting a handle on highway public-private partnerships

Posted by David Kassel on February 11, 2008

Given the critical demands on the nation’s transporation system, including its highway infrastructure, state and local governments are increasingly turning to the private sector for help.

The U.S. Government Accountability Office has some concerns about the growing use by state and local governments of “public-private partnerships (P-PPs)” to plan, design, build, maintain, and even finance public highways.  In a new report, the GAO notes that  there are a number of advantages to the public in P-PPs, such as more efficient operation and management of facilities, but there are also tradeoffs.  “There is no free money” in P-PPs, the report states, and it is likely that tolls on a privately operated highway will increase to a greater extent than they would on a publicly operated toll road.

As has been noted here, many P-PPs are long-term arrangements, which can pose financial risks to the public.  In some of the highway P-PPs, the arrangements can be as long as 99 years.

 The GAO reported that highway P-PPs that it had reviewed, protected the public interest primarily through concession agreement terms that included performance and other standards.  But the GAO found that governments in other countries, such as Australia, have gone further than governments in the U.S. in requiring that the public interest be identified when considering private investments in public infrastructure.  In general, consideration of highway P-PPs “could benefit from more consistent, rigorous, systematic, up-front analysis,” the report recommends.

An example of the toll-rate risks that P-PPs can pose can be seen in the Chicago Skyway, a 7.8-mile elevated toll road in Chicago, which was originally built in 1958 and was operated and maintained by the City of Chicago until 2004.  That year it was leased to a private concessionaire under a 99-year lease for about $1.8 billion.

The GAO reports that during the time the Chicago Skyway was publicly managed, tolls changed infrequently and actually decreased by about 25 percent in 2007 dollars between 1989 and 2004.  Historically, the tolls had not been increased unless required by law, and the Skyway had been operating at a loss and had outstanding debt.

In contrast, the concession agreements for both the Chicago Skyway and the Indiana Toll Road, to which the Skyway connects, permit toll rates to rise each year, based on a minimum of 2 percent and a maximum of the annual change either of the CPI or the per capita U.S. nominal gross domestic product (GDP), whichever is higher.  The GAO calculated that based on projected increases in the GDP and the population, the tolls on the Chicago Skyway will be allowed to increase by nearly 97 percent in real terms between 2007 and 2047.  That translates into an increase from $2.50 to $4.91 in 2007 dollars.

According to the report, some governments have required that elements of the public interest be explicitly considered when entering into P-PPs.  The state of Victoria in Australia, for instance, requires that eight public interest factors be evaluated at the outset of the process.  Those factors include such questions as whether those affected by the projects have been able to effectively contribute during the planning stages, whether there are safeguards to ensure public access to the infrastructure, and whether there are assurances of community safety and security.

A number of countries also require analyses of life-cycle project costs—known as public-sector comparators or PSCs—which include initial construction costs, maintenance and operation costs, additional capital improvement costs over the course of the concession term, and levels of risk transfer to the private sector.

These types of analyses appear to be needed in one of the largest highway P-PPs under consideration in U.S. history—the Trans-Texas Corridor, which envisions a 4,000-mile network of new toll roads to bypass congested cities in Texas and speed freight to and from Mexico.  Accordng to The New York Times,  the project has been met by unprecedented public opposition.  As one opponent put it: “The only person who loses is the citizen.  We’re paying everyone’s profit.”

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How to Steal from a Nonprofit

Posted by David Kassel on February 5, 2008

Articles should try not to promise more than they actually deliver, and that may be a problem with a piece in the current issue of The Nonprofit Quarterly, titled “How to Steal from a Nonprofit: Who Does It and How to Prevent It.”

The article, written by Janet Greenlee, Mary Fischer, Teresa Gordon, and Elizabeth Keating, asks the following question in the first paragraph: “Is it easier to steal from a nonprofit organization than from a business?”   The article implies that the answer is yes because it states in the following sentence that:

…an atmosphere of trust, the difficulty in verifying certain revenue streams, weaker internal controls, a lack of business and financial expertise, and a reliance on volunteer boards all contribute to increased nonprofit vulnerability.

The problem is that the article never really makes the case that nonprofits are more vulnerable to theft than are for-profit companies, and it doesn’t examine whether nonprofits are particularly hampered by an atmosphere of trust, weaker internal controls etc.  In fact, the article is largely based on a 2005 survey done by the Association of Certified Fraud Examiners (ACFE), which reported that of a sample of 508 cases of occupational fraud, only 58, or 12 percent, occurred in nonprofit organizations.  That actually doesn’t seem to be too bad a record for nonprofits.  Seventy-two percent of the fraud cases occurred in publicly and privately held companies and 16 percent occurred in government agencies.

Greenlee et al. state that the survey found that median losses per incident among nonprofits were actually similar to the losses suffered by businesses (though they were significantly higher than those suffered by government).  Also, they note that both payroll and check tampering fraud were more common in the nonprofit sector than in the business sector, while false invoices and skimming from revenues were more common in for-profit entities.  Thus, the comparison of the levels of stealing in nonprofit versus the for-profit spheres  sounds like a bit of a wash.  The authors further note that the sample size is too small to draw firm conclusions about fraud in the nonprofit sector.

The article does provide some helpful information about the common types of fraud perpetrated on nonprofit organizations and ways to prevent it.  For instance, the authors note that the survey found that the typical nonprofit fraud case was committed by a female with no criminal record.  She earned less than $50,000 a year and had worked for the nonprofit for at least three years.  

According to the article, more than 25 percent of the reported nonprofit frauds were conducted by managers, while 9 percent of the perpetrators were executives.  What about the remaining 66 percent?  Were they administrative staff, direct-care workers?  The article doesn’t say.

The authors state that there are three types of occupational fraud: asset misappropriation, corruption, and financial statement fraud, with asset misappropriation accounting for the vast majority of all reported frauds.  The article doesn’t define corruption, which would be helpful here.  It defines asset misappropriation as involving cash skimming, larceny, and fraudulent disbursements.  Fraudulent disbursements include inflaton of invoices, overstating hours worked, and falsifying claims for expenses.

As the article notes, fraudulent financial statements were a major feature of the Enron and Worldcom scandals in the private sector.  Those scandals led to the passage in 2002 of the Sarbanes-Oxley Act, which was intended to curb those abuses.

Citing the ACFE survey, the authors state that contrary to what some might believe, it was relatively rare for fraud to be discovered by the audit process.  They state that 43 percent of the frauds were detected by tips, 25 percent through internal audits, 12 percent through external audits, and 22 percent “by accident.”  Actually, the internal and external audits together detected 37 percent of the frauds, which isn’t all that far behind the fraud detection record for tips.

The authors suggest that to prevent stealing from nonprofits, every organization needs property insurance and, depending on size, may also need to buy employee dishonesty coverage.  For this coverage, insurance companies may require that a nonprofit’s bank accounts are reconciled by someone not authorized to deposit or withdraw.  In addition, they state, officers and employees should be required to take annual vacations of at least five consecutive business days (financial personnel who don’t take vacations is a red flag for possible fraud) or the organization should be required to have an annual audit.

Fraud, however, is not the only employee-perpetrated financial problem that nonprofits, in particular, are subject to.  There is also waste and abuse—activities which don’t necessarily rise to the level of fraud, but which may cause even greater financial losses.  For instance, nonprofits are often involved in transactions with nondisclosed related parties—transactions that can secretly benefit relatives, friends and business associates of the executives of the nonprofits.  Executives of nonprofits are also sometimes known for using organization funds to buy expensive personal cars, take unnecesssary trips etc. 

A more comprehensive article on how to steal from a nonprofit might also examine whether there are different levels of fraud between nonprofits that primarily depend on government revenues and those that don’t.  It would also be helpful to have an article that considers the questions suggested in the first paragraph of this NPQ article:  do nonprofits really have weaker internal controls than for-profit businesses; do nonprofits have less financial expertise than their business counterparts; and do volunteer boards exercise less financial control and oversight than do paid boards?  Who knows, the answers to those questions might be surprising.

Posted in Governance, Nonprofit, Oversight, Private, Public | 2 Comments »

Always nice to be reprinted

Posted by David Kassel on February 4, 2008

The October 11, 2007 post on this site on the political nature of the Patrick administration’s cost numbers justifying the closing and privatization of the Fernald Developmental Center in Waltham, Massachusetts, has been reprinted in the Winter 2007 newsletter of the American Society for Public Administration’s (ASPA’s) Section on Professional and Organizational Development (SPOD).   Their interest is appreciated.

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Does global business have a responsibility to promote democracy?

Posted by David Kassel on February 1, 2008

Nien-hê Hsieh, associate professor of legal studies and business ethics at the Wharton School at the University of Pennsylvania, argues that there are conditions under which large, multi-national companies have a responsibility to promote democratic political institutions in host countries that lack them.

In a paper that he discussed this week at a seminar co-sponsored by the the Kennedy School of Government’s Corporate Social Responsibility Initiative, Hsieh acknowledges that his assertion is controversial and examines a number of objections to it. 

He maintains that if a corporation is operating in a country that doesn’t have a minimal level of electoral democracy, such as free and fair elections and freedom of speech, people in that country have no redress from economic harms.  It’s a long overdue subject of discussion and concern, given the long history of involvement of U.S.-based corporations, in particular, in countries around the world that have lacked basic democratic institutions.

Hsieh disagrees with the argument that while multi-national enterprises (MNEs) have a duty to avoid violating basic human rights in the countries in which they operate, they don’t have a duty to come to the aid of those whose human rights are violated.  He maintains that violations of human rights aren’t the only way a person can be harmed through economic activity.  He cites a case in which a subsidiary of Texaco in partnership with PetroEcuador, the state oil company of Ecuador, extracted oil from the Oriente region of the Ecuadorian Amazon basin and released oil-laced water and millions of gallons of crude oil into the Amazon forests between 1964 and 1990.

In addition, more than 4 million gallons of highly toxic “produced water” was dumped daily into open pits rather than re-injected into the ground.  The contamination dramatically increased cancer rates in the region and caused widespread sanitation problems and hundreds of cases of avoidable sickness and death.  Ultimately, a class action lawsuit was filed on behalf of 30,000 Indians and farmers in the Oriente region and 25,000 downstream residents of Peru.

Hsieh maintains that the Texaco case shows that while some people who were negatively affected by the pollution may have benefitted economically from the MNE partnership, there is no reason to assume they were made better off on the whole.  On the contrary, a significant number of people were harmed as a result of the oil drilling activities.

In cases such as that, a company has an obligation, Hsieh argues, to take action to provide people harmed by its economic activity with some form of redress by promoting the development of democratic institutions.  There are three ways a company can do that: 1) it can undertake business activities that fall under the heading of “corporate social responsibility”; 2) it can promote those institutions through normal business activities; and 3) it can promote those institutions through internal practices and policies.

Examples of the first method of promoting institutions through corporate social responsibility are the participation of the Norwegian oil company, Statoil, in the training of Venezuelan judges about human rights law and IKEA’s funding of bridge schools in India.  An example of the use of normal business activities for this purpose might be the provision by Internet service providers of access to information critical of the government of the host country in which they are operating.  An example of the third method might involve promoting democratic ideals, such as nondiscrimination or participatory decision-making in a company’s internal policies, as well as providing support to their workers who are engaged in the promotion of democratic political institutions in the host country.

Hsieh dismisses objections that his proposals would constitute unjustified interference with the sovereignty of the countries hosting the MNEs.  But in his presentation this week at the Kennedy School, he acknowledged that there are a number of questions about his approach that remain unanswered, such as how much it is reasonable to ask of MNEs in promoting democratic institutions.

Given the number of questions that Hsieh had to field at the seminar, it appears clear that the question of a MNE’s obligations to promote democracy in non-democratic regimes constitutes a field of study that is still in its infancy.  My own concern is that the vagueness of Hsieh’s proposals could allow companies that have caused economic or other harms in other countries to rationalize their continued presence there as long as they are working in some vague way to promote democratic institutions.  But it’s also clear that studies such as Hsieh’s are a start in the right direction.

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