State Auditor Crit Luallen's office found no evidence of fraud in insurance procurement by the Lexington-Fayette Urban County Government, but it identified a host of procedural problems that need to be corrected, from revamping the Internal Audit Board to changing many of the city's purchasing policies.
"If the measures we recommend had been in place, this issue would not have become such a public controversy, and it could have been handled calmly and professionally," Luallen said Monday.
The politically charged atmosphere of the mayor's race between Mayor Jim Newberry and Vice Mayor Jim Gray made the controversy worse, highlighting the need for better policies, Luallen said.
In addition to a now 6-month-old controversy, the city also could have avoided more than $50,000 in legal bills over a conflict that now has the Internal Audit Board suing a council member. The city also will have to pay at least $50,000 to cover the cost of the state audit.
Luallen's office investigated at the invitation of Newberry after council members started asking questions about fraud allegations made by Patrick Johnston, the director of risk management. Johnston questioned the way some of the city's insurance had been switched to the Kentucky League of Cities in 2007.
Some council members wanted to know why they had never been informed about the allegations, why it was so difficult to get information from the administration and whether Johnston's allegations had anything to do with his job being marked for elimination earlier this year. City council members voted not to eliminate his job because of the controversy over the allegations.
The council initiated its own investigation with a committee of the council, which also found no fraud, but it recommended that alleged reprisal against Johnston and other employees be referred to the LFUCG Ethics Commission.
Luallen's audit does not specifically address the issues of whistle-blowing and whether the elimination of Johnston's job was in retaliation for his report. She said her auditors found no evidence of retaliation, although that does not mean there was none.
"The issue of retaliation is not resolved by our audit," Luallen said. "There are legal avenues for the employee to pursue, but our real focus was on fraud allegations."
Luallen's audit looked closely into the city's purchasing, finding a piecemeal system that does not use scoring methods for competitively bid proposals.
And, like the council committee, it recommends a revamping of the Internal Audit Board to add more members from the community to make it more independent of the administration. It also should create a clear set of bylaws with a strong conflict-of-interest policy and a written procedure for how the internal auditor should take confidential information from employees and how he should inform the Internal Audit Board.
"All of those clarifications of communication would help to eliminate the perception that there's any effort to cover up or whitewash anything," Luallen said.
Newberry: I was right
In an official response to the audit, Newberry wrote, "Your report has done much to clarify the facts giving rise to unfounded allegations of fraud, to enhance the highly desirable independence of the Internal Audit Board and to improve our procurement processes."
In a statement Monday, Newberry said: "Several weeks ago, I said during a radio interview that this issue involved a lot of smoke and no fire, and that is exactly what the state auditor has found — no fire, as in no fraud."
In a statement Monday, Vice Mayor Jim Gray said: "It's apparent that had this administration been transparent about potential improper conduct, the taxpayers could have been spared a long and expensive process. It makes you wonder what this cat and his aides were really up to in their litter box."
The audit also found that Law Commissioner Logan Askew did not manipulate documents to favor the League. But auditors could not determine whether the League was a better choice for the city's insurance than the previous pick, AIG.
George Myers, chairman of the council's investigative committee, agreed with Luallen that the controversy could have been avoided. As an Internal Audit Board member, he first learned of the allegations when council member K.C. Crosbie asked him about them, and he had never heard of them. Internal auditor Bruce Sahli had told the chairman of the audit board, but not the board itself, about the allegations.
Later, the investigation found that Askew had a copy of the 2009 allegations. In interviews, Crosbie has said Askew did not tell her he had a copy of the allegations when she asked about them.
"If people in the administration had been more forthcoming, there never would have been a committee," Myers said.
The audit says that at least one council member had a copy of the allegations on May 6. The council member, whom the audit said was a member of the special investigative committee, is not named in the audit.
Among the auditor's findings and conclusions:
■ Joe Kelly, senior advisor to Newberry, was not required to tell Askew, the law commissioner, that he was part of an internal audit investigation based on Johnston's allegations. Askew then made an open records request for the documents, and he received the fraud allegations with Johnston's name shown. Johnston worked for Askew at the time.
The audit recommends that LFUCG develop procedures governing how and when employees can provide confidential information to internal and external auditors.
"Confidential allegations found not to be credible should not be reported to the individual against whom the allegations were made, so that the issue of retaliation never arises," the report states.
The audit recommends that LFUCG develop procedures to inform council members of confidential issues and a procedure for possible fraud allegation to be communicated to the Internal Audit Board.
■ Neither LFUCG nor the audit board has an established method for employees and citizens to anonymously report issues of concern and should develop one, either through a tip line, e-mail or a mailing address.
■ Procurement policies have no clear hierarchy of authority, they conflict with one another, and they have not been approved by the council. "Much of the potential confusion in policy and oversight authority could have likely been avoided had the council adopted purchasing procedures as part of the LFUCG Code of Ordinances," the report said.
In addition, the city never used consistent methods to hire insurance brokers, and it doesn't use a scoring method for competitively bid vendor proposals.
■ The audit board was advised that it could not close meetings to discuss confidential issues, but the audit report found that there is an exemption in the state's open meetings act dealing with an employee's potential discipline or dismissal.