The City of Sunnyvale must by law respond to a finding and related recommendations made by the Santa Clara County Grand Jury regarding the City’s audit function.

The Grand Jury has recommended that it receive copies of the City’s future audit reports and that the audit staff report to the City Council. By law, the City must respond to these recommendations by September 25, 2003.

This report discusses the Grand Jury’s finding and recommendations, and explores the issues associated with implementing the recommended structural change. A proposed letter of response to the Grand Jury is provided as Attachment A.

In July 2002, the City Council received the final report of the Examination of Audits and Financial Reports of the 2001-2002 Santa Clara County Civil Grand Jury. The report had two findings relevant to cities and prescribed specific actions under California Penal Code Section 933 to which the City had to respond. The first finding was that management audits are not a routine function performed by the City. The recommendation issued was that the City implement a program of continuing management audits. The second finding dealt with GASB statement #34 and the City agreed with this finding. The second finding will not be further discussed here.

With regard to the first finding and recommendation, the City issued a response (RTC# 02-367) disagreeing with the Grand Jury finding and indicating that management audits are a routine function of the City. The response stated that "the City of Sunnyvale routinely conducts performance and financial/operational audits as part of the Planning and Management System (PAMS)." In addition, the County Grand Jury staff confirmed that the types of internal audits the City conducts fit within the Grand Jury’s definition of "management audits." These audits are conducted by the Department of Finance and cover two key areas: Program/Service Delivery Plan performance and Financial/Operational Management.

We indicated that during the time specified by the Grand Jury (January 1, 2001 to October 25, 2002), we had performed a number of audits, including performance audits of five programs.

The Grand Jury subsequently requested copies of those audits. On November 27, 2002, a packet went to the Grand Jury that contained copies of the audits the City had conducted.

The City recently received another Grand Jury report (2002-2003 Santa Clara County Civil Grand Jury Review of Audits and Financial Reports). This report contained a finding and recommendations that the City must respond to by law. The relevant finding is:

"The internal auditor for the City of Sunnyvale reports to the
City Manager. Two management/performance audits were
terminated in the early stages because of the need for major
restructuring of the departments under audit. These were
the audits of the Transportation Operations Department
and the Roadside Median Right-of-Way Services Department.
Since the audits were terminated without the public receiving
the information that would have been available with a direct
report to the City Council by an independent internal auditor,
the public has limited ability to evaluate the operations of the
departments and the effectiveness of the restructuring. Not
reporting to the City Council in open forum provides an
opportunity for public perception of a cover up, which
negates the value of internal auditors as independent
evaluators."

Fiscal Sub-Element Policy 7.1D.2 contains the following action statements:

7.1D.2a: "Conduct periodic financial, operational, and management audits to assure that adequate internal controls exist and that management practices are in compliance with Federal, State and City rules and regulations."

First, the Grand Jury finding stated that the internal audit function for the City of Sunnyvale reports to the City Manager. This is incorrect; the audit staff report to the Director of Finance. Further, with the release of the first Grand Jury report back in July 2002, it became clear to staff that the Grand Jury did not understand the City’s unique system of budgeting and auditing for program results. Sunnyvale’s one-of-a-kind system allocates resources entirely on the basis of measurable results. To be effective, the measurement system must be appropriately designed to capture results and the results reported must accurately reflect the true performance of the City’s programs. Since at least the 1980’s, the City has employed staff to provide management with feedback regarding the performance of this specialized system. The reviews conducted by these personnel are not "audits" in the traditional sense but rather a method of ensuring quality control for this highly specialized system.

Additionally, the Grand Jury finding cited the "termination" of the Transportation performance audit as problematic: "Since the audits were terminated without the public receiving the information that would have been available with a direct report to the City Council by an independent internal auditor, the public has limited ability to evaluate the operations of the departments and the effectiveness of the restructuring."

The Grand Jury understanding of the situation was not correct. In fact, the Transportation audit was not "terminated;" it was postponed until a more logical time. When it became obvious that the program required restructuring, that meant that the review of the program’s performance reporting system should be postponed until data became available following implementation ofthe new system.

As stated earlier, the primary purpose of the performance audits is to ensure that the management system itself is functioning properly. These reviews evaluate the results reported by departments, as well as the structure of the programs and measures, and the functionality of the methods and systems in place to provide the reported results. The reports generated provide feedback for management to ensure optimal functioning of the performance measurement system. While the reports have not been provided to Council in the past as a matter of practice, any resulting improvements in the system as a result of the reviews have been seen by Council in the form of new program structures or measures or enhanced accuracy of reported results. Council reviews and approves all restructures and program outcome measures.

A decision to alter the City’s own outcome measures and program numbering system with Council approval can hardly be construed as a "cover up." Staff believes that the Grand Jury does not understand the function of the City’s performance system and the role of staff who ensure proper functioning of that system. Staff would welcome the opportunity to work directly with the Grand Jury to assist its members in understanding Sunnyvale’s unique processes.

In addition to performance reviews, Finance Department staff also conducts financial or operational audits. These audits may be performed by Finance staff or by outside consultants. Most of these audits are planned at the beginning of the fiscal year. Finance staff occasionally perform reviews that are not part of the audit plan as information and needs change.

As indicated above, the Grand Jury’s finding is based on a flawed understanding of the facts and staff therefore disagrees with the finding. Based on the flawed finding, the Grand Jury has recommended that audit staff report directly to the City Council. Staff does not believe this recommendation can or should be implemented for both practical and philosophical reasons.

First, as a practical matter of limited resources, most cities of Sunnyvale’s size do not have an audit function reporting to the Council.

The State Controller’s office lists 44 cities other than Sunnyvale with populations ranging from 100,000 to 200,000. Of those, only 7 other cities have audit functions that are listed in the 2003 National Association of Local Government Auditors (N.A.L.G.A) membership directory. Of those seven, two audit shops (Berkeley and Modesto) report to their City Councils by city charter.

In two others, Orange and Ontario, the audit staff report to the City executive. The remaining three (Torrance, Fullerton and Thousand Oaks), report to "other," most likely the Finance Department.

Second, the City’s philosophy has been that Council’s role is to provide policy direction and management’s role is to implement that direction. By having staff report directly to Council, the elected body would take on the role of managing staff. Staff believes this is an inefficient use of both management and Council resources.

Third, the U.S. General Accounting Office establishes standards for government auditors in its document "Government Auditing Standards," also known as the "yellowbook."

The document describes auditors’ responsibilities as requiring them to "observe the principles of serving the public interest and maintaining the highest degree of integrity, objectivity and independence."

Audit staff can best adhere to the requirements for integrity, objectivity and independence by reporting to an administrative department, which can provide required technical peer review.

Therefore, staff recommends against the Grand Jury’s recommendation to change the reporting structure. However, staff believes that the City can and should implement the essence of the recommendation – that is, that the Council should have more information regarding the City’s audit program. Therefore, staff recommends implementing two changes in response to this recommendation.

First, staff recommends that Council direct staff to provide copies of all final performance audit reports to Council. Second, staff recommends that Council annually review and approve the planned performance audits for the upcoming fiscal year. Staff recommends that if Council has questions regarding either the audit reports or the planned audits, that staff hold a study session with Council. Staff therefore recommends that Council direct staff to provide the attached letter (Attachment A) in response to the Grand Jury for signature by the Mayor.

The Grand Jury made a second recommendation related to Sunnyvale, as follows:

"The Grand Jury recommends that all cities or towns that do not currently include the Grand Jury on their routine distribution list for financial reports, CAFRs, budget and audit reports add the Grand Jury to their list."

1. Direct staff to provide for the Mayor’s signature the attached letter in response to the Grand Jury’s finding and recommendation. The letter indicates that staff will provide copies of all final audit reports to Council and the Grand Jury and enlist Council in the development of the City’s annual audit plan.
2. Direct staff to prepare an alternate letter to the Grand Jury indicating that audit reports will continue to go to management only.

Prepared by:
Cheryl Waldrip
Management Analyst

1. Letter of Response to the Grand Jury