Part 9: Legal compliance by school boards

Central government: Results of the 2003-04 audits.

Introduction

9.1
There are about 2500 state schools. Many are relatively small; some have a single employee, and expenditure of only $100,000 a year. Schools are governed by Boards of Trustees, made up of members of the local community (usually parents of children attending the school). Trustees may have little or no experience of governing a public entity. They may not be aware of the many different pieces of legislation that apply to schools, and the requirements of public accountability.

9.2
While the Board of Trustees of each school is a Crown entity in its own right and, as such, has legal obligations, the Ministry of Education (the Ministry) also performs an important role in relation to schools. The Ministry seeks to support good governance and management, develop clear expectations of quality, and provide core infrastructure in the schools sector.1

9.3
The Auditor-General is the statutory auditor of all state schools, and appoints auditors to carry out the audits on his behalf. An important aspect of our audit work is assessing whether public entities, including schools, have complied with the legislation that affects their operations. The stakeholders of public entities are interested in whether the legislation has been complied with. The audit process provides a degree of assurance on this.

9.4
We assess compliance with legislation of a financial nature, which is contained mainly in the Education Act 1989 (the Act). The Act regulates the financial operations of schools in a number of ways, to ensure that they behave in a publicly accountable manner, and requires schools to seek the prior approval of the Ministry in certain circumstances. As part of our audit, we assess compliance with the financial provisions on:

  • borrowing money;
  • investing money;
  • purchasing land;
  • conflicts of interest; and
  • funding other organisations.

9.5
This article presents our findings from the school audits we carried out for the year ended 31 December 2003, and makes some observations on those findings.

9.6
After we completed those audits, the financial legislation relating to schools was changed by the Crown Entities Act 2004. Some of the legal requirements described here will be different in the future.

What did we find?

9.7
We are pleased to report that most schools complied with the financial provisions relating to the matters listed in paragraph 9.4 above.

9.8
Some schools did not comply with all aspects of the legislation that we examined. We provide some examples, without identifying individual schools, in paragraphs 9.18 onwards.

9.9
Many of the breaches of legislation that we found were minor. Some breaches were significant.

9.10
Two specific issues arose:

  • Current legislation does not prohibit schools from entering into commercial contracts with their employees.
  • In some integrated schools, the distinction between the Board of Trustees (a public entity) and the proprietor (a private entity) is not fully understood, and has become blurred. The consequence is that public funds have sometimes been used to provide financial support to private entities.

9.11
In most cases, it appears that the schools were not aware of the legal constraints on their financial operations. However, in a few cases, the schools may have sought to operate on the boundary of the law, and in so doing went too far.

How may compliance be improved?

9.12
The majority of schools comply with the legislation. However, we remain concerned about those schools that transgressed. Breaches of legislation are reported in the schools’ financial statements or, if necessary, in our audit reports on those statements. We also refer to breaches of legislation in the management letters to school boards that accompany our annual audit reports, and notify the Ministry of all significant breaches.

9.13
We are also interested in helping to reduce the future incidence of cases where schools do not comply with the legislation. This is a challenge, given the number of schools, the relative inexperience of some trustees, and the range of legislation to which schools are subject.

9.14
The Ministry helps schools meet their legal obligations by:

  • providing advice to schools on the legislation they need to comply with;
  • arranging for the training of Boards of Trustees;
  • reviewing the annual financial statements of schools, and providing feedback;
  • monitoring specific cases where breaches have occurred; and
  • in exceptional cases, intervening in the management of schools.

9.15
With the introduction of the Crown Entities Act 2004, the Ministry also recognises the need to provide simple guidance for schools, directed at inexperienced trustees, on important aspects of the new financial legislation that governs their operations.

9.16
We recommend that the Ministry also consider:

  • providing simple advice to integrated schools, and their proprietors, on specific aspects of the legislation relating to the financial relationship between schools and proprietors; and
  • whether schools should be allowed to enter into commercial contracts with their employees.

9.17
We will continue to assess legal compliance by schools, and assist the Ministry in its efforts to help schools comply.

Breaches of legislation found during our audits

Borrowing money

9.18
Schools receive grants from the Ministry to fund their everyday expenses. The Act (sections 67 and 67A) allows schools to borrow up to a prescribed limit, giving them some flexibility in their financial affairs. The current limit is that annual repayments of principal and interest of any borrowing may not exceed 10% of a school’s annual operational grant.

9.19
Schools may borrow above their limits, but only with the approval of the Ministers of Education and Finance. This helps the Ministry to control the amount borrowed, and address any serious financial difficulties at an early stage. The Ministry told us that limits are in place so it can check the robustness of any borrowing proposal and to make sure that the loan will not adversely affect the day-to-day financial operation of the school.

9.20
Borrowing may take many different forms. The simplest is a bank overdraft. Other forms of borrowing include loans, finance leases (for example, on computer equipment), and hire purchase arrangements.

9.21
We are pleased to report that only 32 schools (less than 1.5% of the total) had borrowed above the prescribed limit without the necessary approval.

9.22
Most of the unauthorised borrowing was for less than $10,000. However, some of the breaches were for more substantial amounts:

  • A school had used an overdraft of $385,000, without approval. The need for an overdraft of that size was not apparent. The school also had a long-term investment of $321,000.
  • An integrated school had unauthorised borrowing, from its proprietor, of $300,000 – incurred to help finance the development of a school hall on the proprietor’s land.
  • A school entered into a number of finance leases to acquire computers. The extent of the unauthorised borrowing was assessed at $260,000.
  • An integrated school had unauthorised borrowing, assessed at $200,000, at the same time as it was owed $163,000 by its proprietor. The audit management letter noted that the proprietor appeared to be funding its own operations at the expense of the school, and suggested that consideration be given to recompensing the school for this cost.
  • A school had an overdraft of $650,000, substantially over its borrowing limit, without Ministerial approval. The overdraft was converted to a “flexible finance facility”, reducing the amount borrowed by $50,000 a year. This change in the loan agreement removed the breach of the borrowing restriction.

9.23
The Crown Entities Act 2004 provides an opportunity to review the borrowing rules. This Act amends the borrowing provisions in the Education Act 1989 by providing that the regime in the Crown Entities Act applies. Borrowing by schools will not be permitted, except in accordance with any regulations made under the Crown Entities Act, or any approval given jointly by the Ministers of Education and Finance. We understand that the Ministry is carrying out a review of the current arrangements. We will be pleased to contribute to that review.

9.24
The Ministry could also provide the registered banks and other approved lenders with a copy of the new regulations. This would ensure that the lender is aware of the legal requirement for the Ministry’s approval, where necessary. The Ministry has agreed to consider this suggestion.

Investing money

9.25
The Act (section 73) allows schools to invest their funds with registered banks, or in public securities such as government stock. Any other investment currently needs the approval of the Minister of Education. This protects public funds, by requiring schools to invest in sound institutions.

9.26
We are pleased to report that, in 2003, only 22 schools (less than 1% of the total) had made an unapproved investment. (This figure excludes the integrated schools funding buildings – see paragraphs 9.41 to 9.46 on pages 91-92.)

9.27
Most of the breaches of legislation were for less than $10,000 (for matters such as loans to staff, and holding company shares), and the breaches appeared to be inadvertent. However, some of the breaches were for more substantial amounts:

  • An integrated school advanced $250,000 to its proprietor, who owns the land and buildings from which the school operates. The loan does not incur interest, is unsecured, and is to be repaid over 10 years. The “interest free” element of the loan represents a substantial benefit to the proprietor, at the expense of the school, in the region of $100,000.
  • An integrated school invested $100,000 with a private company, for a period of 6 months. The same school had also agreed to advance $125,000 for a project to upgrade some of the proprietor ’s buildings. The proprietor’s representative organisation intends to repay these funds in 2008, but repayment is conditional and is therefore not guaranteed.
  • Many years ago a school invested $100,000 with a trust, to assist with the provision of a hostel for the school’s students. The school applied, some years later, for the Minister’s retrospective approval. The Ministry has told us that such an investment would not be approved. It appears that the Ministry has not informed the school of this decision.
  • Another integrated school gave an interest-free loan of $69,000 to its proprietor some years ago for 2 classrooms. The loan will be repaid in a few years.
  • A school provided resources to help a private company arrange an activity programme for overseas students. There was no written contract, but the school spent $55,000 of public funds in anticipation of a return, without any certainty that its funds would be repaid or that any returns would be made.
  • A school made advances of $34,000 to a number of its employees during 2003. At the end of 2003, about $15,000 had not been repaid.

9.28
The serious cases of investment without approval are isolated. Nevertheless, some of these examples are not consistent with the legislative intent of protecting public funds from unnecessary risk. Funds that have been entrusted to public entities for the provision of services should be handled with great care.

Purchasing land

9.29
The Act (section 69) prohibits schools from acquiring or occupying land or premises without the Minister’s approval. This is to ensure that public funds are not spent on land or buildings without the Minister being satisfied of the need to do so.

9.30
Only 4 schools (less than 0.2% of the total) had breached this legislative requirement. The acquisitions were mainly of land or houses adjacent to the school premises. The schools and the Ministry are discussing whether the transactions will be approved retrospectively, in some cases by transferring the interest in the land to the Crown.

Conflicts of interest

9.31
In the public sector, a conflict of interest exists where a person’s duties or responsibilities to a public entity could be affected by some other separate (usually private) interest or duty that he or she may have. Impartiality and transparency in administration are essential to maintaining the integrity of the public sector. Where activities are paid for by public funds, or are undertaken in the public interest, taxpayers will have strong expectations of probity. Members of the public take a strong interest when they think taxes are being spent irresponsibly, or misused for private gain.

9.32
The Act (clause 8(8) of the Sixth Schedule) prohibits Trustees who have a financial interest in a matter, or any interest that may reasonably be regarded as likely to influence them in carrying out their duties and responsibilities, from participating in Board discussions or voting on the matter. The Act (section 103A) also disqualifies a Board member from holding office if they have a financial interest in contracts with the Board, under which the total payments made by or on behalf of the Board exceed $25,000 in any financial year, unless approval has been obtained from the Secretary for Education. This provision ensures that Board members are not able to award contracts to themselves, which may not be in the interests of the school.

9.33
However, managing conflict of interest issues in the public sector often involves more than consideration of only the legal requirements. The ethics of the situation must also be considered.2

9.34
We are pleased to report that only 5 schools (0.2% of the total) had awarded contracts of more than $25,000, where a Board member had an interest, without obtaining the prior approval of the Secretary. We recommended to the relevant schools that they seek the retrospective approval of the Secretary. We understand that such approval has been given in 4 of the cases, and further consideration is being given to the fifth.

Specific issues

9.35
In September 2004, we announced our inquiry into possible conflicts of interest in the relationship between a school and a private training establishment. We will report on that matter in due course.

9.36
Another issue relating to conflicts arose during the year. A principal and deputy principal established a private company. The private company carried out many of the school’s functions relating to its overseas students programme (for example, organising home-stay accommodation). There was no written contract for the arrangement, which involved the company charging a management fee for each overseas student for the services it provided. During 2003, the company charged management fees of $145,000. We are pleased to report that the arrangement was terminated early in 2004. However, these two employees had already obtained a significant financial gain.

9.37
This form of contracting arrangement does not appear to have been unlawful. However, in our view, the arrangement was inappropriate because of the conflict of interest involved. Public sector employees should not be able to use their position to enter into commercial contracts with their employers, thereby obtaining financial benefit from their employment over and above that provided by their employment agreement. In our view, the Ministry should consider whether schools should be allowed to enter into commercial contracts with their employees.

Funding other organisations

9.38
Sometimes we find that a school board has given money, or other property, to another organisation. Boards need to be careful here. Like any other public entity, a Board may use its resources only for the proper exercise of its statutory functions. It cannot commit its funds or assets to activities that are not reasonably connected to its role in managing the school, providing education for its students, or other activities allowed by its charter.3

9.39
Similarly, a Board should not try to use its assets in an attempt to avoid its legal obligations. This can arise where the Board tries to establish another organisation, often a trust, with broader legal powers than the Board. In this situation, a transfer of money or other property from the Board to the other organisation might be regarded as an unlawful attempt to avoid the requirements of the Act. This risk is particularly high where the gift is used for a purpose that the Board is not permitted to undertake itself (or that the Board could undertake only if it complied with specific statutory restrictions, such as those relating to investment, borrowing, or property acquisition).

9.40
One example involved a school that set up an educational trust with wider powers than the school. The school routinely donated a portion of its income from foreign students to the trust. We considered this an improper use of funds that rightfully belonged to the Board, and that should have been spent by the Board on the school. At our suggestion, the money was refunded to the Board.

Integrated schools

9.41
About 325 of the 2500 state schools are integrated. They have the same governance arrangements as other schools, with a Board of Trustees responsible for running the school. They differ in that their proprietors (which are private organisations), rather than the Crown, generally own the land and buildings on which the schools are sited. Many of these schools have a religious character.

9.42
The Boards of Trustees of many integrated schools have used public funds to pay for the construction or improvement of buildings on land owned by the school’s proprietor. However, Boards do not have the legal power to use funds to pay for buildings that will be owned by the proprietor. A Board’s funds can only be used for its own proper purposes, and cannot be used for matters that are the responsibility of the proprietor. The Board of an integrated school should fund a building only if the Board obtains all necessary Ministerial approvals, and also secures a written agreement with the proprietor to make it clear that the Board or the Crown – not the proprietor – will own the building.

9.43
Despite these requirements, the Boards of Trustees of about 200 integrated schools appear to have provided a total of up to $30 million of public funds to proprietors in previous years for this purpose.

9.44
We decided not to report this matter to the individual schools for 2003, but have reported it to the Ministry instead, to allow the Ministry to consider a co-ordinated and centralised response.

9.45
The Ministry agreed early in 2004 to carry out an exercise to regularise this expenditure or make it lawful. The Minister of Education will give retrospective approval, and the Boards of Trustees are to obtain the written agreement of the relevant proprietors to the Crown’s interest in the buildings that have received the public funds. However, we understand that there has been a delay in starting this process. We will continue to closely monitor progress until the appropriate action has been taken.

9.46
The Ministry also planned, early in 2004, to issue guidance to Boards of Trustees of integrated schools. Again, there was a delay, but the Ministry issued some initial guidance to integrated schools in February 2005. The guidance reminds schools to seek Ministerial approval, and to have a written agreement protecting the Crown’s interest, where they wish to provide public funds to pay for the construction or improvement of buildings on land owned by the proprietor. This should help to minimise future instances of such unlawful expenditure. The Ministry intends to issue more detailed guidance, which we hope will be published as soon as possible.

1: Ministry of Education Statement of Intent 2004-2009, parliamentary paper E.1 SOI (2004).

2: A full discussion on conflicts of interest is contained in a report we published in November 2004 – Christchurch Polytechnic Institute of Technology’s management of conflicts of interest regarding the Computing Offered On-line (COOL) programme, ISBN 0-478-18123-X. This report is available on our website www.oag.govt.nz under Reports/2004.

3: This principle is reinforced by clauses 1A and 1B of the Sixth Schedule to the Education Act.

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