A former president of the Kentucky Association of Counties was concerned when he found that the organization had spent thousands of dollars on staff Christmas gifts, he told state auditors recently.

That expense item wasn't in KACo's budget.

And the two-page budget summaries board members received had few specifics, the unidentified official said in a report released last week by State Auditor Crit Luallen.

The 34 board members of KACo, all elected county officials, essentially allowed former Executive Director Bob Arnold to create, interpret and carry out the rules of the organization, according to the audit, even though its bylaws state "the association shall be governed by the Board of Directors."

The vast disconnect between the board's knowledge of the group's operations and what the staff members were doing meant the very people charged with overseeing the spending didn't know what was going on — in the budget, in spending, in salaries and in benefits.

"It seems like ... the last three years it just got completely out of hand," said Webster County Judge-Executive Jim Townsend, KACo's president in 2004 and a board member for eight years. "I don't know whose fault that was. But I guess I have to take some responsibility because I was on the board. I just had no clue this was going on."

Townsend wasn't alone. While the whole board failed to oversee KACo, the organization spent $3 million on overly generous benefits and salaries, lavish meals, expensive parties and improper expenses over the last three years, the audit said.

"I think, over time, they became very lax and neglected their fiduciary responsibility as board members," Luallen told reporters Thursday.

The rampant spending led to a public black eye for the organization after the Herald-Leader reported in June that KACo's top executives spent more than $600,000 on travel, meals and entertainment, and allowed $890 in charges to strip clubs and an escort service over two years.

Luallen's audit of KACo — a non-profit group set up to provide services such as lobbying, legal help, insurance and financing for Kentucky's 120 counties — went further, identifying benefits, bonuses and contracting policies as well as expenses.

"This has been quite embarrassing, especially because a lot of this I didn't know until I read it," said Jessamine County Circuit Clerk Doug Fain, a two-year member of KACo's board. "I expect I will be hearing more detail about things and know to ask more questions now."

Luallen found that, in addition to being uninformed about what was going on with KACo's spending, board members were also often beneficiaries of that spending.

Those same officials often scrutinize budgets in their home counties, but they collectively failed to devote the same attention to KACo, Luallen said.

"I think over time this culture developed where those same rules didn't apply," Luallen said. "If we were doing an audit of a local county, we would have serious findings if they were providing birthday lunches, if they were having extravagant, or any kind of, Christmas parties."

Auditors said KACo's board was in the dark in a number of areas.

Expenses

When it hired Arnold in 2000, the board gave him "the discretion to determine the expenses considered to be in the course of normal business."

That allowed him to authorize much of the $3 million auditors cited as questionable, such as at least $43,000 in alcohol, $247,944 in radio and television advertising that aired during University of Kentucky basketball and football games, more than $219,000 for 77 meals and $28,700 in sports and entertainment tickets.

Townsend, who doesn't drink, said he was aware alcohol was served at KACo events but didn't know the extent of it.

Arnold, who was forced to resign in September, turned down auditors' request to be interviewed and, through his attorney, declined to comment to the Herald-Leader last week.

Townsend said he didn't think Arnold should have had to resign — until he read Luallen's audit.

"From this report, I didn't think there was any choice," he said. "What really changed my mind was the expenditures that had no explanations."

Auditors found more than $800,000 in expenses that lacked documentation over three years.

Henderson County Judge-Executive Sandy Lee Watkins, who has served on several KACo program boards, said executive directors have long had broad powers.

"I think it was kind of an inherited thing," he said.

Arnold was also chief executive officer and treasurer of KACo, which Watkins said "gave a little wiggle room" for him to have more autonomy. (Luallen says the treasurer should be a separate, elected officer.)

Watkins, a longtime friend of Arnold's, said the public perception has been Arnold allowed it to go too far. How much of that is the board's fault is debatable, he said.

"Is the board responsible for individual actions? At some point they are," Watkins said. "But at the same time, I don't think they're on equal footing."

Salaries

KACo spent $2.5 million on salaries for its more than 40 employees in 2008. Yet "many of KACo board members had no knowledge of what staff was paid," according to the audit.

Arnold had "exclusive authority over setting salaries," the audit found.

LaRue County Judge-Executive Tommy Turner, who is aggressive in his questioning of KACo activities, said he and others had to request details about compensation.

"These are things that board members shouldn't have to ask for," he said. "From this point forward, I think they will be clearly outlined."

Bonuses

Over the past three years, two key managers — Joe Greathouse, director of insurance, and Grant Satterly, director of financial services — received a combined $140,000 in bonuses from KACo's Commonwealth Insurance Co.

Those bonuses weren't disclosed in the CIC board minutes, and the KACo board of directors was unaware of them. "If someone is given a bonus, board members should be aware of it at the very least," Fain said.

Condos and contracts

KACo has no formal bidding process for vendors and failed to require invoices for services, such as its contract lobbyists, as the Herald-Leader previously reported.

Luallen's report slapped the board for not installing such procedures as suggested by a 1993 state audit of KACo.

"This exemplifies the historical hesitance of the boards to properly control and monitor expenses," the audit said.

In addition, the audit found KACo spent $11,000 over 10 months to rent a Frankfort condominium for Brian Roy, KACo's product development manager, who lived in Western Kentucky.

"There is no record of the KACo board having approved the condo rental," the audit said.

New policies

KACo President J. Michael Foster, who took office a year ago, has implemented several rounds of policy changes aimed at preventing more spending problems and has pledged to go farther now that the audit report is complete.

Luallen, who praised Foster's early responses, said she hopes the public flak over KACo's expenses will permanently change its culture.

"It was an accepted set of practices," Luallen said of the spending habits. "I don't think they thought they were doing anything wrong until all this scrutiny began."