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State Audit Exposes VCE Mismanagement

Aweek after the Island of Dr. Moreau scandal broke, the Virginia Auditor of Public Accounts released an audit of Virginia Correctional Enterprises (VCE) covering the period between July 1, 1996 and May 11, 1998. The report said that VCE posted an operating loss of $412,000 in FY 1997 and has liabilities of $5.1 million but only $3.5 million in liquid assets it could call on to pay its bills, including less than $150,000 in cash.

The audit report criticized VCE for lacking "adequate processes to review and evaluate joint venture contracts... lacks the ability to manage its cash flow... because the joint venture contracts lack sufficient monitoring controls and procedures."

The audit team "found over twenty customers [in VCE's Customer Master File] who did not appear to be government entities or non-profit organizations.... VCE management was unable to provide justification, letters of understanding, or other support establishing the credibility and validity of these customers... VCE s failure to validate its customers and subsequently conduct business with unallowable customers exposes the Commonwealth to unnecessary potential legal liabilities and contradicts public policies."

VCE's cash flow problems, say the report, began in the fall of 1996 when it first entered into joint venture contracts. The chief factor in VCE's cash flow problems, according to the audit, "is its inability to collect receivables, specifically from one of the joint venture dealers, Morton Marks and Sons."

Morton Marks, one of five furniture dealers involved in a joint venture with the agency, owed VCE about $1.2 million. And, says the report, "although VCE could not collect Morton Marks' receivables, VCE continued to make sales to Morton Marks increasing the dealer's receivables and worsening VCE's cash problems."

Unseemly Connections

According to state election records, Morton Marks was the second largest contributor to the successful gubernatorial campaign of then-Attorney General Jim Gilmore in 1997. Morton "Tracy" Marks III says his firm donated $44,625 worth of furniture to the governor 'e campaign and that the furniture was returned after the election. Marks disputes that his ties to Gilmore led to anything improper.

One connection that raises eyebrows, though, is David Jones, who was VCE's director from March 1992 to November 1996. One month after leaving VCE he became a vice president for the furniture company whose joint venture partnership with VCE was approved in April 1996.

Jones, who is now also the chief financial officer of Morton Marks, says the company's job offer came later and had nothing to do with his approving the joint venture.

VCE terminated its contract with Morton Marks on August 10, 1998. The attorney general's office has filed a $1.7 million suit against Morton Marks to collect past due accounts. Marks filed suit against VCE to debate the amount owed. Marks said he was owed more by other state agencies than the amount he owes VCE.

Who's Minding the Store?

VCE's first two joint ventures were with Zig Zag Embroidery for textile products and Ariens, Inc. to manufacture camp stoves. Neither of these ventures proved successful.

VCE closed its Zig Zag operations due to Zig Zag's "inability to meet payment obligations." VCE is currently in litigation with Zig Zag to collect unpaid invoices of $215,000.

The Ariens "letter of understanding" (in lieu of a contract) required VCE to manufacture 20,000 camp stoves at $43.97 each. VCE completed manufacture of the stoves in May, 1998. But according to the audit, VCE incurred extra labor and overhead costs [i.e. operating losses] of $88,000. The audit report dryly notes that "VCE management should ensure the prices of products are adequate to recover costs before starting production."

The largest joint venture deals were between VCE and a consortium of furniture dealers. Five of the dealers were consolidated under one contract for an entity called the Boling Company. These five were: Morton Marks & Sons, B.T. Office Products, Anderson Business Furniture, Harris Office Furniture, Chasen's Business Interiors.

Two other contracts covered Norix/York Industries and Network Business Furniture. Sales under these last two contracts were minimal, less than $150,000 combined between July 1, 1996 and April 6, 1998.

Under the Boling Company contract, sales for the five dealers for the period July 1, 1996 through December 31, 1997, totaled more than $13.2 million, with Morton Marks and Sons comprising almost $5.8 million.

The furniture sales contracts were sweet deals for the private furniture dealers. Under the terms of the contract, the dealers would take orders from customers who wanted furniture. They would submit those orders to VCE, whose prison factories would churn out the finished goods. VCE would then ship the furniture to the dealer, and in many cases directly to the end customer. Under the contracts, VCE invoices it's contract dealers at negotiated amounts and the dealers in turn invoice the end customer at a substantial markup.

The dealers were thus able to milk the contracts for what appear to be easy profits, billing end customers for prisoner-made furniture that in many cases was both manufactured and shipped by VCE.

According to the audit report, the joint venture furniture racket was rife with what the state auditor characterized as "weaknesses" including (but not limited to) the following:

"[VCE's] lack of a structured contract with sufficient monitoring controls and procedures forces it to rely on the dealers to send payments.

"VCE does not have the ability to manage its customer base or develop a sufficient marketing strategy because the contracts do not require dealers to tell VCE who their customers are.

"VCE cannot ensure the dealers invoice end users at negotiated contract prices because the contract language specifying how the dealers meet this requirement and VCE lacks the policies and procedures to monitor it.

"VCE must rely on dealers to notify it of [certain products sold; therefore, VCE cannot ensure that it has received 811 freight commissions due to it. The Department of Corrections' Internal Auditors identified unreported sales... on which they estimated VCE had lost a minimum of $72,300 and a maximum of $117,400 in [unpaid freight] commissions.

"VCE did not follow contract specifications and shipped directly to the end customer instead of the dealer in many instances. We also found instances where VCE shipped finished goods to a third party subcontracted by the dealer. The contracts do not provide for these subcontracting practices.

"VCE did not verify the credit worthiness of its dealers, rather it authorized arbitrary $1 million blanket credit limits that can be overridden by Customer Service Representatives.

"VCE continues to allow sales to dealers exceeding their credit limits. As of April 2, 1998, Morton Marks and Sons had exceeded its credit by $128,000 and had another $847,000 sales on order. We also found VCE invoicing the end user for a sale when the dealer reached its credit limit."

Also cited in the audit as a problem is VCE's outdated and poorly designed computer system and a computer security system (or lack thereof) that invites "fraud, abuse, and unauthorized disclosure of data."

The auditor found "at 1east 189 products [in VCE's catalog] priced below the standard cost," and observes that "failure to price products at or above standard cost can result in significant losses for VCE."

The report also criticizes VCE's entire cost accounting system, a system in such disarray that "it is difficult to identify products that are losing money, establish fair and adequate prices, or develop plans to increase, reduce, or discontinue products. This also distorts inventory and cost reporting throughout the year, making it difficult to evaluate industry and product profitability."

Sources: Virginian-Pilot, Richmond Times-Dispatch , Commonwealth of Virginia Independent Auditor's Report

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