Part 7: Unlawful expenditure by schools

Central government: Results of the 2005/06 audits.

In July 2004, we reported on the results of an audit exercise carried out to assess whether payments to school principals for additional duties were lawful and in accordance with any relevant Ministry of Education (the Ministry) requirements.1

We found examples of unlawful payments to principals made through the Ministry’s central payroll system and paid locally by schools. As a result of our findings, the Ministry agreed to take action to reduce the incidence of unlawful payments and to consider whether it was possible and appropriate for such payments to be recovered.

Since our July 2004 report, we have not examined the payments made to principals in detail. However, given the action taken by the Ministry to strengthen the arrangements, we consider that the current incidence of unlawful payments is likely to be substantially lower than when we reported in 2004.

In March 2005, we reported on the extent to which schools complied with the law on a number of financial matters.2 The report noted that most schools complied with the law, but that the Ministry needed to take further action to reduce the incidence of non-compliance, particularly by integrated schools.

In this Part, we assess the progress the Ministry has made on reducing the incidence of unlawful expenditure since our two earlier reports. It also describes the unlawful remuneration paid by a board to its principal in 2005. We address what further action might be appropriate to reduce the likelihood of unlawful payments, and recommend strengthening the arrangements for recovery of such payments.

While the Ministry has taken action on some of the matters raised in our two previous reports, it needs to consider further action to ensure public accountability on the part of school boards for unlawful payments.

In summary, we consider that the Ministry should:

  • review the approvals for additional remuneration that have been given to ensure that payments are not being made locally;
  • conclude its consideration of how best to address issues of enforcement and recovery in relation to unlawful payments made to principals;
  • request on a regular basis a statement from each proprietor of an integrated school of all money paid directly to all school staff, the amounts involved, and the reasons for the payments;
  • issue simple and accessible guidance, directed at inexperienced trustees, on the major financial constraints on the operation of schools – for integrated schools as well; and
  • attach a higher priority to regularising the $30 million of possibly unlawful expenditure incurred by integrated schools on buildings owned by proprietors.

Summary of our report on principals’ remuneration

Summary of the system for remunerating principals

A school board of trustees is a Crown entity in its own right and, as such, has legal obligations. A principal is responsible for the overall management and professional leadership of the school.

The terms and conditions of employment for school principals are contained in a collective or individual employment agreement. The Ministry approves all such agreements, which set the amount of remuneration to be paid for normal duties.

A principal might also have other responsibilities for which extra remuneration can be paid. Legislation requires that the Ministry approves all such additional remuneration before it is paid, and that it is paid through the Ministry’s central payroll system rather than locally by a board. Some of the reasons that the Ministry would usually consider an acceptable basis for granting approval include:

  • management of, and responsibility for, a residential/boarding hostel;
  • recruitment and management of large intakes of foreign fee-paying students;
  • management of, and responsibility for, a significant initiative that earns extra revenue for the school and is in addition to the principal’s normal role;
  • management of a school that is considered an exemplar of practice that results in other schools seeking information and advice; and
  • management of, and responsibility for, implementing a significant change process.

The main determinant the Ministry looks for when assessing an application for additional remuneration is that the principal has responsibilities over and above those that normally form part of a principal’s job. Payments recognising performance, or for recruitment and retention, are unlikely to be approved, as the Ministry considers these aspects to be covered by the standard agreements.

Summary of the audit findings on principals’ remuneration

In July 2004, we reported on the payments made to principals through the Ministry’s central payroll system and directly by boards.

We took a targeted sample of 70 payments made through the central payroll system and found that nine cases of additional remuneration totalling $63,217 had been made without the Ministry’s approval. The largest amount was $10,600 for renting a house.

Our school auditors reviewed payments made locally by secondary school boards and identified 119 separate instances of possible additional remuneration that had been made without Ministry approval. These payments involved 72 of the 402 secondary principals and were for amounts ranging from under $500 to more than $20,000. The two largest payments were $23,000 for implementing a video conferencing project and a $10,000 performance bonus.

In our opinion, 62 of the 119 payments were additional remuneration requiring Ministry approval. The total value of these payments was at least $210,000 and involved 46 school boards. In our view, many of the payments potentially had tax implications that not all of the boards appeared to have addressed.

The Ministry and we were concerned about the extent to which unapproved additional remuneration had been paid outside the central payroll system. That 11% of secondary schools made these payments was significant.

As a result of our findings, we considered the adequacy of the guidance the Ministry issues to boards on principals’ remuneration. We found that advice to boards was contained in seven documents. In our view, however, the guidance on the need for boards to obtain Ministry approval for additional remuneration could have been clearer.

Action taken on the principals’ remuneration report

Our 2004 report noted a number of actions for the Ministry to take and that it had given us firm assurances that it would appropriately address our concerns.

We are pleased to report that the Ministry has:

  • reminded payroll centres of the need to have the Ministry’s approval before paying additional remuneration through the central payroll system;
  • stopped all additional remuneration that was made through the central payroll system and informed school boards that new approvals are needed before any further additional remuneration is paid;
  • set up a routine where all approvals are ceased in January each year, requiring boards to review and seek renewal of approvals;
  • introduced in August 2006 new monitoring reports to check the correctness of additional remuneration paid through the central payroll system. The Ministry is confident that its controls have been sufficiently strengthened to substantially reduce the incidence of unlawful payments made centrally;
  • followed up with the relevant schools the examples of unlawful expenditure that we identified and confirmed our conclusions for the majority of cases. Schools have been recommended to seek the Ministry’s approval if they wish to continue to pay additional remuneration; and
  • reminded schools generally of the requirement for its approval of additional remuneration. This has been by issuing Circular 2004/19 in November 2004 and repeating that guidance in the Ministry’s Funding, Staffing and Allowances Handbook. The New Zealand School Trustees Association has also issued advice on the need to obtain the approval of the Ministry for additional remuneration.

As a result of our findings, the Education Review Office (the ERO) sought additional assurances from school boards during its regular reviews. The further assurances related to obtaining the approval of the Ministry for additional remuneration and making local payments.

These further assurances have been sought since July 2004 and, in more than 2000 reviews carried out since then, no board chairperson or principal has attested that they have not complied with the requirements. This gives considerable comfort that the majority of schools now understand the legal requirements on these matters.

We have not examined the Ministry’s systems and processes in the same detail as in the special audit exercise that formed the basis for our July 2004 report. However, we noted that 14 of the 90 applications for additional remuneration approved by the Ministry in 2006 did not appear to have been paid through the central payroll system. In most of these cases, there was no obvious reason why a board should seek and obtain approval for additional remuneration and then decide not to make the payments through the central payroll system. We recommend that the Ministry review approvals that have been given, as a matter of routine, to ensure that boards are not making payments locally.

We have not required our school auditors to examine local payments to principals in detail since our special audit exercise. However, except for the specific example mentioned in paragraphs 7.136-7.148, our school auditors have not brought any significant cases of unlawful remuneration to our attention.

Payment of remuneration by proprietors of integrated schools

Our July 2004 report noted that we had also become aware that the principals of some integrated schools receive remuneration from the proprietors of the schools (the owners of the school buildings) in addition to the normal salary payable from public funds. We considered that such arrangements might breach section 7(4) of the Private Schools Conditional Integration Act 1975, which prohibits the payment of additional remuneration by proprietors for normal duties. Therefore, we recommended that the Ministry consider the extent of the remuneration received by the principals of some integrated schools from the school proprietors, whether such payments are lawful, and, if so, how they may be stopped.

The Ministry considers that it has limited ability to identify payments made by proprietors directly to a principal. Any such payments would not be included in a school’s annual reporting on its principal’s remuneration (which is restricted to remuneration paid by the school) and would be outside the scope of the audit of a school (which does not include reviewing payments made by a proprietor or income received by a principal from third parties).

The Ministry also notes that payments made directly by a proprietor for activities outside the scope of a principal’s normal duties and responsibilities (for example, managing a boarding hostel) would not usually be subject to its approval and might also fall outside the requirements of the legislation mentioned above.

Consequently, we conclude that the current arrangements do not allow compliance with the above legislation to be monitored. If a principal is receiving additional remuneration from a proprietor in relation to the normal duties of a principal, this would not be detected.

Therefore, we recommend that the Ministry request on a regular basis a statement from each proprietor of all money paid directly to all school staff, the amounts involved, and the reasons for the payments. This would allow the Ministry to assess whether any unlawful payments have been made. The Ministry has confirmed that it will consider whether it may be appropriate to include a provision to this effect in integration agreements.

Recovery of unlawful payments to principals

In response to the recommendation in our July 2004 report that the Ministry consider whether recovery of the unlawful payments is possible or appropriate, the Ministry obtained a legal opinion in December 2005.

In summary, that legal opinion said:

  • The Ministry is the appropriate agency to consider how to prevent and recover unlawful payments. The State Service Commissioner has an interest in such matters, and therefore any action proposed might usefully be the subject of appropriate consultation with the State Services Commission.
  • A school board may take action to recover an unlawful payment. However, whether such action would be successful would depend on the facts of the particular case.
  • The Ministry has no power to require a board to apply for approval of a payment of additional remuneration or to cease making an unlawful payment. Also it is unable to direct a board to take action to recover an unlawful payment. The Minister is unlikely to be able to use his statutory powers of intervention in schools to require a board to take recovery action against an employee, or to replace a board with a Commissioner if a board was not prepared to seek recovery of an unlawful payment.
  • Board trustees might be personally liable for an unlawful payment they had made if it can be demonstrated that they did not act in good faith – for example, if they made the payment knowing it to be unlawful.

The Ministry has considered the legal opinion and remains concerned that the principle of equality of remuneration for all state schools is capable of being undermined by the lack of compliance by boards of current legislative arrangements. It recognises that there is a policy issue on the balance to be struck between the principle that unlawful payments should not be paid, but if they are paid then they should be recovered, and avoiding excessive intrusion into the affairs of school boards as separate entities in their own right.

We note that, before the Education Act 1989 (the Act) was changed in 2001, one of the provisions gave the Minister the power to dissolve a board and replace it with a Commissioner if satisfied that it had taken or intended to take an unlawful action, or had failed or refused or intended to fail or refuse to take an action required by law.

Since 2001, the grounds for appointing a Commissioner have been restricted to circumstances where there is a risk to the operation of the school, or to the welfare or educational performance of its students. Arguably, some types of mismanagement or other unlawful or improper acts that might have allowed the appointment of a Commissioner under the previous provisions of the Act are no longer permitted.

In our view, the current arrangements are unsatisfactory. A school board may make an unlawful payment to its principal, continue to make such an unlawful payment, and not be required either by legislation or the Ministry to consider recovery. The only recourse that appears to be available to the Ministry in these circumstances is to take action against trustees personally if it may be demonstrated that they did not act in good faith.

The Ministry is currently considering how best to address enforcement and recovery issues, and notes that this may require a change in legislation to strengthen its ability to promote compliance with the current legislation. In this context, we note that the legislation that existed before 2001 allowed a board to be replaced by a Commissioner in wider circumstances than currently.

Te Wharekura O Rakaumangamanga – unlawful remuneration

Te Wharekura o Rakaumangamanga is a decile 1 school established under section 155 of the Education Act 1989. It is located in Huntly with a roll of about 400 students. It has an annual income of $3 million. It has had stable governance, with the same chairperson, deputy chairperson, principal, and senior staff for the last 15 years. The school has a reputation for strong educational performance, and has been responsible for the development of a range of programmes in the primary and secondary area. It is in a very strong financial position.

Our audit report on the board’s financial statements for 2005 will contain a breach of law paragraph, drawing attention to unlawful remuneration provided by the board to its principal. As the scale of the remuneration is exceptional in comparison with the examples we identified in our July 2004 report, we considered that reporting the breach of law in the audit report would not be sufficient to give a full public account of the matter. Therefore we decided to give a summary of the unlawful remuneration in this article.

We consider that this case adds further weight to the need for the Ministry to strengthen the arrangements for reducing the incidence of unlawful payments, and to enable recovery action where they occur.

In May 1999, the board gave its principal an interest-free loan of $270,000 to assist with purchasing a house. This was because the board considered that the principal had transformed the performance of the school and been instrumental in obtaining substantial additional income for the school from contracts for services. It wished to retain the services of the principal for the following years, to lead the school through a further period of development, and saw the loan as a means of retaining the principal. The board has advised us that the principal was contracted to remain for a period of eight years in consideration of the loan facility.

The Ministry concluded that the loan was unlawful and that it should be repaid. This was achieved by the board purchasing the house from the principal in June 2000 for $238,000. The board believes that the housing market dropped between May 1999 and June 2000. The remaining $32,000 of the loan was written off by the board. The Ministry also gave approval for the board to rent the house to the principal at $5,000 a year less than the market rent, to compensate for the additional duties he carried out.

As part of the repayment of the loan, the board proposed that it enter into an agreement with the principal so that he had the first option to repurchase the house during the next 10 years. The Ministry’s agreement to the board’s purchase of the house was conditional on the option for the principal to repurchase the house being removed from the sale agreement.

The board’s annual report for 2004 shows that the principal received remuneration in the range of $110,000 to $120,000, which is in accordance with the collective agreement. It also noted that the principal was living in a school house, that the market rent and consequent subsidy was yet to be determined, and that tax would be required to be paid on the subsidy.

The board’s draft annual report for 2005 shows that a performance bonus of $120,000 gross was paid to the principal, being $20,000 a year for the previous six years. The principal paid PAYE tax on this sum when he received payment. The payment was made locally in February 2005. The board told us that it did not know that it was required to seek the Ministry’s approval for the performance bonus or that it was not permitted to make payments outside the central payroll system.

In April 2005 the board sold the house to the principal for $238,000, the same value as the house was purchased for five years previously. This was $89,000 below the market value of $327,000 at the date of sale. The board says that it believed that it was holding the house in trust for the principal for it to be returned to him at a future date. The board told us it was not aware that the benefit to the principal was deemed to be remuneration and accordingly it did not seek any advice on possible tax liability.

In the period between the purchase of the house by the board in June 2000 and the sale back to the principal in April 2005, the board allowed the principal to occupy the house without paying rent. This constituted additional remuneration of about $85,000 for the five-year period. The board had Ministry approval for about $25,000 of this remuneration ($5,000 a year), so the unlawful remuneration was about $60,000.

The total unlawful remuneration received by the principal amounted to $269,000. The total cost to the board, including tax and possibly penalties and interest on unpaid tax, could be nearly $400,000. The board says that it feels very strongly that it has moral and equitable obligations to the principal over and above the legal obligations it has under the employment agreement. The board has also told us that the penalties and interest on unpaid tax are a consequence of these other management failures, in particular the failure to require payment of rent by the principal and the failure to realise that the benefits for the principal attracted a tax liability. We note in this regard that taxpayers generally have a legal obligation to disclose fully all benefits received for tax purposes.

Since these matters were brought to the attention of the board, it has acknowledged that it has not complied with the relevant legislation and confirmed that it now fully understands its obligations. It has given the Ministry an assurance that there will be no further breaches.

The Ministry has recommended to the board that it take steps to recover the unlawful remuneration. The board has decided not to take any action, on the grounds that there is no reasonable prospect of recovery. Given the legal advice it has received, as referred to above, the Ministry will be considering what action to take on receipt of the 2005 audit report.

Summary of our report on legal compliance by schools

There are about 2450 state schools governed by boards of trustees, which are made up of members of the local community (usually parents of children attending the school), the principal of the school, a staff representative, and, in secondary schools, a student representative. The board of each school is a Crown entity in its own right and, as such, has legal obligations. Many schools are relatively small; some have a single employee, and expenditure of only $100,000 a year.

There are about 18,000 trustees, and about 45% (8000) will turn over at each triennial election. Many of the elected trustees may have little or no experience of governing a public entity when they first join a board. If they do not use the material made available to them, or the training opportunities that are on offer, they may not be aware of the requirements of public accountability and the many different pieces of legislation that constrain the operation of schools.

The Ministry performs an important role for schools. It seeks to support good governance and management, develop clear expectations of quality, and provide core infrastructure in the schools sector.

An important aspect of our annual audit work is assessing whether public entities, including school boards, have complied with the financial legislation that affects their operations. 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 school audits, we assess compliance with the financial provisions on:

  • Borrowing: Schools may borrow up to a prescribed limit, which gives them some flexibility in their financial affairs. Schools may also 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 financial difficulties at an early stage.
  • Investing money: Schools may invest their surplus funds with banks and other approved institutions. Any other investment needs the approval of the Ministers of Education and Finance. This protects public funds, by requiring schools to invest in sound institutions.
  • Purchasing land: Schools may acquire or occupy land or premises only with the Minister’s approval. This is to ensure that public funds are not spent on land and buildings without the Minister being satisfied of the need to do so.
  • Conflicts of interest: School trustees who have a financial interest in a matter, or any interest that may be regarded as likely to influence them, are required to exclude themselves from participating in board discussions or voting on the matter. Also trustees are disqualified from holding office if they have a financial interest in contracts with the school above $25,000 a year, without the approval of the Ministry.
  • Funding other organisations: Like any other public entity, a school 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. A transfer of money or other property from a board to another organisation may be unlawful.

We were pleased to report in March 2005, based on the results of the audits we carried out in 2004, that most schools complied with the financial provisions relating to the matters we examined. Some schools did not comply with all aspects of the legislation that we examined. Our report provided examples. Many of the breaches of legislation that we found were minor. However, some were significant. We made a number of recommendations for improvement, which we address in the following paragraphs.

Guidance to boards on legislative matters

Our March 2005 report noted that the Ministry recognised the need to provide simple guidance for schools, directed at inexperienced trustees, on important aspects of the financial legislation that governs their operations.

We also recommended that the Ministry 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.

The Ministry has issued a number of additional pieces of guidance on legislation during 2005 and 2006:

  • School Bank Accounts – Circular 2005/7 in June 2005;
  • Crown Entities Act – Circular 2005/16 in September 2005;
  • Governance – Circular 2005/17 in September 2005;
  • Integrated Schools’ Fundraising – letter of February 2006; and
  • Conflicts of Interest – Circular 2006/7 in May 2006.

We commend the Ministry for providing this relevant and timely advice to boards on some of the aspects of legislation that govern their operations.

We have also reviewed the guidance issued by the New Zealand School Trustees Association (NZSTA), which has a contract with the Ministry for training trustees. The guidance issued by the NZSTA is in four main forms:

  • A Trustee Handbook provides comprehensive guidance on relevant aspects of the role or trustees, including legislation.
  • Guidelines are issued on specific topics, to supplement the Handbook.
  • Electronic memoranda on topical issues are issued to boards of trustees and principals on a regular basis.
  • A helpdesk advisory service is available to respond to specific queries.

The guidance issued by the Ministry and the NZSTA on legislative matters is comprehensive and up to date. However, we remain concerned that it may not be sufficiently accessible for many of the 18,000 trustees who may have little or no experience in managing a public entity when they first join a board and who may be in office for only three years. The NZSTA notes that training cannot be imposed on boards of trustees, and accordingly there is no guarantee that all boards or individual trustees will achieve the same level of knowledge during their time in office.

In this context, we note that the Ministry’s recent report on its review of Schools’ Operational Funding identified that its communications might be difficult and time-consuming for schools to digest and follow, and that there was room for considerable improvement in terms of clarity and accessibility.

We therefore recommend that the Ministry consider whether it would be useful to issue simpler and more accessible guidance, directed at inexperienced trustees, on the major financial constraints on the operation of schools. The Ministry concurs with our view on simpler communication of legislation to schools.

Such simple accessible guidance would also be useful for integrated schools and their proprietors, as our audits continue to identify examples where the financial relationship between schools and proprietors is blurred.

Integrated schools

One specific issue mentioned in our March 2005 report related to some of the 325 integrated schools, where the distinction between the board of trustees (a public entity) and the proprietor (a private entity and generally the owner of the land on which the school is based) is not always fully understood and has become blurred. The consequence is that public funds have sometimes been used to provide financial support to private entities.

The boards of many integrated schools have used public funds to pay for constructing or improving buildings on land owned by the school’s proprietor. However, boards do not have the legal power to use their funds to pay for buildings that will be owned by the proprietor. A board may use its funds only 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 it obtains the approval of the Ministry and secures the proprietor’s written agreement recognising the board’s financial interest in the building.

Despite these requirements, the boards of about 200 integrated schools appear to have provided a total of about $30 million of public funds in previous years for the construction or improvement of buildings on proprietors’ land. Early in 2004, the Ministry agreed to carry out an exercise to make this expenditure lawful.

At that time, the Ministry also planned to issue guidance to boards of integrated schools. Some initial guidance was issued in February 2005. It reminded schools to seek the Ministry’s approval, and to have a written agreement protecting the Crown’s interest, where they wished to provide public funds to pay for constructing or improving buildings on land owned by the proprietor. The Ministry intended to issue more detailed guidance.

We have asked the Ministry whether the issue of its initial guidance in February 2005 has been effective. A register has not been kept of the individual applications from schools, but all of the Ministry’s local offices report an increase in the number of applications received since the initial guidance was issued.

The Ministry is preparing a Property Management Handbook for integrated schools. The objective of the Handbook is to provide comprehensive guidance, in one publication, on all property management policies and processes that apply to the sector, including board-funded capital works. The Ministry plans to publish the Handbook in July 2007.

Three years later, the Ministry is still considering the most appropriate method of regularising the $30 million of possibly unlawful expenditure. We recommend that the Ministry attach a higher priority to resolving this issue.

1: Central Government: Results of the 2002-03 Audits, parliamentary paper B.29[04a], pages 45-65.

2: Central Government: Results of the 2003-04 Audits, parliamentary paper B.29[05a], pages 83-92.

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