Mid-Central Blames Schoenfish Accounting Firm for Missing GEAR UP Embezzlement

In October 2015, shortly after Scott Westerhuis killed his family and himself to avoid facing the punishment for stealing millions from taxpayers via the GEAR UP program, I reported that the Mid-Central Educational Cooperative‘s financial reports showed discrepancies totaling over $3 million. Over the past year, I’ve asked how Parkston accounting firm Schoenfish and Company could have missed such obvious and enormous errors in its audits of Mid-Central’s books.

Facing a multi-million-dollar class action lawsuit on behalf of Native American students allegedly cheated by the Westerhuises’ embezzlement of GEAR UP funds, the unwinding Mid-Central is now asking the same question by naming Schoenfish and Company as third-party defendants in the lawsuit:

Mid Central says if it is found to be at fault, its fault is “slight in comparison to the fault of Schoenfish & Company.”  Mid Central says the accounting firm should have caught any missing money [Angela Kennecke, “SD Legislator’s Accounting Firm Named in GEAR UP Lawsuit,” KELO-TV, 2017.02.28].

Dragging the accountants into the lawsuit matters in part because one of those accountants is Republican Representative Kyle Schoenfish of District 19.

Rep. Kyle Schoenfish (R-19/Scotland)
Rep. Kyle Schoenfish (R-19/Scotland) 

KELOLAND News tried to reach Kyle Schoenfish Tuesday for comment.  We’ll let you know when we hear back from him.

This isn’t the first time the accounting firm of Schoenfish & Company has been under scrutiny over not catching the misuse of GEAR UP funds.

An independent group of citizens has prepared a list of ten questions it would like lawmaker Kyle Schoenfish to answer and has submitted them to the South Dakota Auditor General.

They specifically ask about discrepancies in Mid Central’s balances and if Schoenfish ever reported them to anyone outside of Mid Central. We’ve posted those ten questions online on this story if you’d like to read them.

KELOLAND News spoke with Randy Schoenfish, Kyle’s father who told me he cannot answer those questions due to client confidentiality [Kennecke, 2017.02.28].

Hey: when your client sells you out and tries to make you foot the bill for a lawsuit, are you still bound by client confidentiality?


33 Responses to Mid-Central Blames Schoenfish Accounting Firm for Missing GEAR UP Embezzlement

  1. Since when did accounting for the public money become confidential in the first place?

  2. Remember, the corruption is never in the legislative branch.

  3. Please forgive me as I take some small satisfaction in this breaking story after being assaulted by self-righteous claims of innocence as the legislature repealed IM 22.

  4. Jimbo, good question! I maintained a similar position during GOAC’s non-investigation of EB-5: SDRC Inc may have been a private company, but it was acting under a public contract on behalf of the state. Those docs should be open.

    Curt, yes, remember… at the crackerbarrels!

    Mark, yes, you are forgiven. At the point where we tie a sitting legislator to GEAR UP, IM22 doubles in impact in the 2018 election. How many votes has Schoenfish cast in the last few years against anti-corruption measures?

  5. Before you sharpen your pitchforks, please understand that financial audits are not suitable tools for catching fraud, no matter what your common sense tells you.

    http://www.cnbc.com/2014/05/20/study-external-audits-a-poor-tool-for-fighting-fraud.html

    Here’s the thing. The run-of-the-mill audit is meant to find financial statement fraud, not asset theft fraud. As I understand it, GEAR-UP was the latter.

  6. Darin Larson

    Wayne B.– If an organization the size of Midcentral loses $2 to $5 million over a decade and the financial auditors don’t catch on to it, I would ask what good are the auditors?

    I would also ask how you know that there was not financial statement fraud in addition to the asset theft fraud that took place?

  7. I’m sure that whoever “borrowed” that money will return most of it as soon as Marty Jackley asks them to. What’s the big deal?

  8. Daniel Buresh

    Darin, When an auditor sees a line item paid to AIII for 100k one quarter, would you expect that to throw up red flags? Or if it is 1 of 10 line items for 100k that year, would it even be questioned?

    Wayne makes a good point from an auditor standpoint. When I bring my accountant a bill from a company and tell them to pay it, they aren’t going to question the legitimacy of that bill. It isn’t their job. As long as all dollars are accounted for, that is where their job usually ends. An auditor is just going verify that math and make sure nothing is missing.

    I’m not saying these guys aren’t negligent, but I don’t think you can write off what Wayne brought up. The bigger failure is not having the checks in place to make sure Mid-Central was actually accomplishing what it was supposed to and doing work with company’s that had documented results.

  9. Wayne B., should auditors be expected to notice discrepancies in monthly financial reports?

    File, file, file….

  10. Darin,

    I don’t know if there was financial statement fraud, but that’s pretty easy to avoid if you know GAAP. Even then, as the article I referenced notes, financial audits are NOT a reliable way to catch fraud.

    The challenge is when you’re creating invoices for dummy organizations – the paper trail exists for the financial statements which show the money was accounted for, so there are no “missing dollars” between revenue and expenses.

    The auditor for our sanitary district finds when an invoice is mis-categorized (as in, it should’ve been maintenance but it went under supplies). But they can’t and don’t determine if the invoice was justified – did our maintenance personnel actually work 5 hours on the job, or did they only work 3?

    Likewise, if GEAR-UP was using funds for personal expenses – like meals, the records would be there, but it’s hard for a financial audit to determine if those meals were business-related expenses or not.

    Just about every audit I’ve read of small organizations include the material weakness of too few staff to actually separate financial duties necessary for fraud prevention. From our sanitary district to your average Critical Access Hospital, there just aren’t enough heads to do proper segregation.

    A forensic audit would be more apt to catch those kinds of fraud, but they’re more expensive and not required by statute. It costs our small district about 4% of our gross bi-annual revenue to conduct a financial audit every 2 years. That’s a huge expense. A forensic audit could very well be double that.

  11. CH,

    To answer your concluding question, yes until told by a court to disclose.

    I could go through an awful lot of public policy rationales for why this is so but it is a standard which is enshrined in historical practice, law, and professional standards (and probably their E&O insurance policy).

  12. Cory, weren’t you treasurer for Lake Herman’s sanitary district? Didn’t you guys do audits? Or did you not have to because you didn’t have any debt?

    Our auditors don’t bother looking at monthly statements – they look at the annualized data. They look for miscategorized expenses, misstatements, etc.

    Look, there was definitely “fire” (aka fraud”) here. The problem was, the financial statements in the minutes weren’t actually the “smoke”.

    Your fixation on the discrepancies between monthly financial statements is misplaced.

    Case in point.

    I just looked at our sanitary district’s financial position:

    Jan 31, 2017
    Bank Account Balance – $170,549.28
    Total Liabilities & Equity – $1,025,363.20

    Feb 1, 2017
    Bank Account Balance – $170,899.28
    Total Liabilities & Equity – $1,032,543.20

    The accounts and total financial position don’t match. FRAUD!!! I bet it was the firefighter – he drives a Mercedes.

    Wait… no… it’s a 2005 Mercedes he got for $3,000.

    Bills go out on the first, so we gained about $7,000 in accounts receivable. We deposited $350 into the bank that day. Our accounts payable also went up about $1,100 (our accountant bills us the first of the month, too). A few other minor things (depreciation, etc.) all account for the increased position of $7,180 for the day.

    Quickbooks updates continuously (I know because I always pull the bank account balance right before the meetings, even after grabbing the figure in the morning). If I were to check March 1st’s financial position now, it’ll be different when I come back and check it tonight. Tomorrow, when March 1st’s activity is closed, I’ll have a final disposition, but it won’t match Feb 28th’s statement.

    So when I show a beginning position and an end position for February, it won’t match last month’s balance unless I specifically use Jan 31 as my starting position.

    That’s why in our minutes, we just include financial position for the month. We also include P&L to show where that cash is moving.

  13. Darin Larson

    Wayne B., I don’t think you answered my question which was what good are the audits if they have little hope of exposing malfeasance?

    If it comes down to just checking the balance in the bank accounts matches what is reported on the financial statements, they could hire any part-time book keeper to do that. Instead of doing a useless financial audit every year, maybe the law needs to require a forensic audit every two or three years.

  14. Daniel Buresh

    Darin, They help in cases when someone is embezzling money and cooking the books to make it appear that the money is still there. The auditors have no concern for the companies the payments are going to as long as they are legitimate businesses. I doubt the auditors had any idea there was such a conflict of interest going on and I doubt they knew the expenses and receipts they were dealing with were fraudulent employee expenses.

  15. Darin, apologies. Let me be direct.

    The audits really aren’t worth the cost. We wouldn’t conduct one if it weren’t legally required (we have a loan through DENR, thus the legal requirement).

    Remember, an audited financial statement just verifies the financial statements materially represent the status of the organization – assets & liabilities. They’re not designed to verify the expenditures were appropriate – just whether they were properly accounted for. As Daniel succinctly puts it – are they cooking the books.

    But the challenge is the layperson (and many board members) without accounting backgrounds think an audit will catch fraud. This includes our legislators. Therefore the legal requirement.

    Our accountant pretty much provides audit-like services built into our contract. We reconcile annually.

    Here’s the thing – the board members of MCEC should’ve been financially literate enough to catch what was going on – they should’ve been asking about invoices, contracts, etc. But many folks aren’t financially literate when it comes to accounting principles. And since the organization was a pass-through grantee, you’d have to be extra diligent to ensure funds were heading to the right place in the right amount.

    We could require forensic audits. But they’re prohibitively expensive. Like I said, it costs us $6,000 – $8,000 every two years for an audit, and we’re a small organization with only a few thousand transactions a year. The staffpower required to forensically audit every transaction even for our small organization would be immense. Prohibitively so on a regular basis.

  16. Wayne—audits? At the Lake Herman Sanitary District? Not that I recall. Larry Dirks ran the books and wrote the checks; when he died, they sat in limbo.

    Wayne, Mid-Central and the AG have since said that the discrepancies, which spanned three years and totaled over $3 million, were indeed monkey business, part of Westerhuis’s shell game. Monthly errors were sometimes six figures. Should an auditor have noticed and questioned discrepancies of that magnitude?

  17. Darin Larson

    Wayne B., I appreciate your perspective, but I don’t know how board members who are only shown what the CEO provides them are going to catch accounting discrepancies that a CPA most likely won’t catch in a financial audit.

    It seems to me that the only likely way of catching this issue is to have strong staff oversight with every transaction verified by at least two staff members. The problem at MidCentral may have been compounded because both Mr. and Mrs. Westerhuis worked at MidCentral. The fault of the board may lie in the lack of policies and procedures that allowed two related parties to control the books of the organization and the lack of verification that MidCentral money was being spent on the programs that they were designated for.

    Also, I would suggest that a modified version of a forensic audit could be crafted that would only focus on more questionable transactions, i.e. amounts that are of consequence that go to unknown or unfamiliar vendors, for instance. Or another method could be employed whereby a certain random period of time (at least a month) would be chosen for a modified forensic audit that would be less costly but still effective at finding ongoing embezzlement.

    If boards want to protect themselves from liability for rouge officers and employees, it would seem some specially targeted audit crafted to find malfeasance could be created by CPA’s. The financial audit that has virtually no hope of finding malfeasance is off target and the forensic audit is too costly and over-broad.

    Of course, if they could just hire some one like Ben Affleck’s character in “The Accountant”, they could have found the malfeasance in about an hour.

  18. Daniel Buresh

    “Should an auditor have noticed and questioned discrepancies of that magnitude?”

    Yes, and it should have been in the report. I think that is why there were indications early on but nothing was done. The board at the very least should have been made aware. They should have told the DOE something was up. Schopp should be gone at the very least. You can follow it up from there depending on what was reported upward.

  19. huh? there must be an ethical reason behind nepotism rues for Platte, eh Tony? Jared? Trump’s kids? “The buck stops” w/ daugaard and rounds, our reelected officials during this time of state administrative fraud (eb5 ect).

  20. As long as the republican party hides the ball, (tidemann/EB5), (Russian/trump election hack investigation in closed door House), ethics rules must be strengthened.

  21. happy camper

    What about the Board? Month after month they would have been presented with financial information to scrutinize and looked into the faces of one, if not two people deceiving them. Was his wife also colluding as Jackley first suggested? We’re talking about a man who went on to kill his own children and no one on the board had any alarm bells? That’s difficult to believe. If the audits were insufficient by their own instruction as Wayne describes, then that’s something they should have understood and be responsible. It’s difficult to believe multiple people didn’t have some idea this man was troubled, not simply embezzling, but unhinged and capable of killing his own family.

  22. Cory, from what I’ve read, it’s not the beginning / end balances which are the issue; it was the $3.8 million in illegal contracts entered into without board approval.

    Please link me to the AG testimony regarding the beginning / end balances being the locus of fraud.

    Let me reiterate: I don’t know of any audit that looks at monthly statements. What’s the point? Their job is to audit the year. They’ll go through monthly expenses and receipts, but why bother looking at financial reports made on a monthly basis (which, by the way, the ones posted on MCEC don’t conform to either the balance sheet or profit & loss sheet)?

    I know from the news the auditor found and flagged something(s). From what I’ve read in the news, it gives me every indication that the contracts and invoices existed, and subsequent payments were made and accounted for. The audit probably found and flagged that some contracts didn’t have board signatures, perhaps the missing time cards for Melmer et. al. – it was probably even in the management letter. But that’s speculation.

    But if there was an invoice / receipt to show expense, and a corresponding dollar amount going out the door, then the financial position of the organization is true (financial audit complete).

    All of the embezzlement the Westerhuises committed was through AIII – the debit & credit card, child college savings accounts, amazon purchases, etc. My understanding is they then submitted those expenses to MCEC for reimbursement. For MCEC’s financial audit purposes, all the documentation was there. They were bogus expenses, but accurately accounted for.

  23. Darin, I appreciate the desire to have something like a forensic audit that isn’t as costly. I do too. The challenge is, even a financial audit requires significant work on the part of small organizations. The audit process is what drove my predecessor to leave the board. It’s generally a three month long ordeal for us. Something I’m not looking forward to this summer.

    The challenge, Darin, is to do a proper forensic audit, you cannot just look at significant transactions or new vendors. If you make the cut off at $10,000 transactions, then the $7,000 transactions become the locus for fraud. And there’s still the ability to make a $50,000 payment where you get a $10,000 kickback from the vendor.

    I’m going to bet MCEC’s auditor didn’t have access to AIII’s financials. (But if they did, one would hope Shoenfish could put 2+2 together!!!)

    I suppose you could try to do a forensic audit where you sample 10% of all transactions and see if you find anything. The challenge is it’s going to be hard to find the fraud if it exists; there’s a 90% chance you missed the smoking gun.

    This is where having financially literate board members actively partaking in the organization’s operations is essential.

    You make it sound like board members should just sit around, chit chat, and drink coffee. They are stewards of the organization they oversee! They have a moral responsibility to ensure the health and operation of the organization. It’s their job to scrutinize. It’s them approving the bills be paid. No auditor is going to be as familiar with the operations as a board member.

    That’s why financial audits are horrible tools at finding all but the most flagrant fraud – people writing checks to themselves, etc.

    The financial audit will say “look, we found these invoices which weren’t initialed by the board members. The payments went out, but this is against your policy. You should better adhere to your policy.”

  24. happy camper

    That’s a lot of money to slip by. The dynamics of the board would be interesting to know. Sometimes they can’t find people to serve so friends are recruited, or meek people who are afraid to question and challenge top administrators cause they want a rubber stamp. I haven’t heard discussion of just who Scott Westerhuis was as a person, but parents are convicted of crimes all the time and don’t kill their family. There’s a back story here just as important to how this was able to take place.

  25. Darin Larson

    Wayne B., any embezzler of any intelligence, and they usually have to have some intelligence to handle business finances in the first place, is up to the task of hiding financial malfeasance from a board of directors. I can think of any number of ways that a board could be in the dark about financial malfeasance. A board of directors is not a micro-manager and they certainly are not auditors. If they had proper procedures in place for staff oversight, the board probably had met its responsibility. If a CPA doing an audit is not going to find the malfeasance, then it is crazy to argue that the board should have found it, especially if the malfeasance was at the AIII level.

    If the malfeasance was at the AIII level, the MidCentral board may have been off the hook to a certain extent. Although, the structure of AIII quite possibly should have been examined by MidCentral’s board given the conflict of interest and quite possibly they should have investigated the efficacy of the programs that AIII was supposed to be carrying out.

  26. My story for NPQ has been posted this morning: https://nonprofitquarterly.org/2017/03/02/cooperatives-defense-blame-auditors-not-board/

    Note my comment about the 2014 audit report.

  27. Darin Larson

    Wayne, you seem to be arguing that a board is in a better position than an auditor to find malfeasance. That has not been my experience. The board is shown information that the CEO/CFO/business manager prepares. The board could be shown one thing and another thing entirely could be taking place. Only the worst embezzler in the world is going to provide evidence of their crime to the board.

    Embezzlers are usually caught because they are greedy ($2-$5 million? Holy cow!) or other staff members start asking questions or stumble on to the embezzlement. I have personally never heard of a board of directors finding malfeasance themselves. Maybe it happens, but it has to be extremely rare. Bank tellers who notice suspicious deposits have probably exposed embezzlement more often than board members.

  28. happy camper

    A lot of people don’t even understand the role of the board, and oftentimes new board members are not given any direction. I’ve known people who thought the Director was over the Board. Sometimes there’s a bully, or the board shuts down new board members who ask questions, a little faction wants control, there’s an endless list of dynfunction on boards. I’m thinking of quite a few strange things I’ve seen first hand, probably many readers can as well, people wanting to get out of there in 15 minutes regardless, obvious secretiveness, split boards because some are loyal to the administrators rather than looking at the facts. A lot of weird stuff happens when people are involved, so certainly this board can’t be blamed without actually knowing, but a functional board knows how to sniff out trouble, they have a sense something is amiss. This guy killed his kids somebody knew something was off with him. If you’re working around a lunatic you know it.

  29. Darin, I am asserting that a board member is in a better position to find malfeasance.

    Any one of those board members could’ve and should’ve asked about AIII. They should’ve been at the very least gathering information about MCEC’s administrator’s potential conflicts of interest.

    I’ll agree that I’ve also never heard of a board finding fraud / malfeasance. But that doesn’t surprise me; if they do, they’re certainly not going to publicize that an administrator was embezzling. They’ll fire the administrator, keep everything locked away in executive session, and quietly sweep it under the rug because of the devastating impact such fraud would have on the organization’s reputation. (I have personally heard about a dozen of these instances within South Dakota… none of them make the news)

    Look, we’re generally rational people here. We’re folks who believe in science and studies (at least well-done studies).

    There is a preponderance of evidence readily available which undeniably demonstrates that a financial audit is a poor tool for finding fraud, and the alternative is prohibitively expensive unless you already suspect fraud exists.

    http://www.sequenceinc.com/fraudfiles/2013/06/escaping-detection-why-auditors-do-not-find-fraud/

    Michael, I appreciate your article. Is the MCEC’s audit available online anywhere to examine? I’d love to see their management letter to know what those material weaknesses were.

  30. happy camper

    So who kills their own children? Some stupid male who is so ashamed he has been caught his whole family has to go? The monstrous ego and pride of the human male. He has to have the biggest house, the biggest home gym and be admired for his success. Some dumb animals will do almost anything to maintain that concept of themselves is all I can gather. Most of the male posters here are very uninsightful which should surprise no one.

  31. Wayne: To my knowledge, the 2014 audit report isn’t online as a separate file. However, it *may* be buried among the board minutes still available on the coop’s web site.

  32. Daniel Buresh

    Camper, don’t get too caught up over the stupid male. The stupid female may have been just as involved in the entire thing, including the murders. In fact, I would argue she had to be a part of it all. Take your sexist comments elsewhere.

  33. For those who are asking, here is the link to the most recent audit report for MCEC.

    http://legislativeaudit.sd.gov/reports/School/Mid%20Central%20Coop%202014.pdf