Devil in the Details: The State Auditor’s report confirms much of what the Red Plan’s critics have said all along

August 19, 2014

Jennifer Martin-Romme
Zenith City Weekly

Since the Minnesota State Auditor’s Office released its July 22 report on the Duluth School District’s long-range facilities “Red” plan, the report has become a kind of community Rorschach test.  

Red Plan supporters were quick to claim the Auditor proved the facilities plan had been carried out prudently and by the book—an assertion the Auditor’s representatives have specifically refused to endorse.

“That kind of conclusion is not the kind of conclusion we included in the report,” Mark Kerr, attorney for the State Auditor’s Office, said at the July 22 meeting when Board members pressed him for a favorable interpretation.

Red Plan critics were furious. “[T]he flimsiest financial review I’ve ever seen,” Loren Martell called the report in his July 31 Reader Weekly column. “Thankfully the whole thing was bound together with a stiff cardboard cover, otherwise it would have kept blowing off my desk.”

Martell was the driving force behind the State Auditor’s involvement. In 2012, he gathered enough signatures from the District’s eligible voters—at least 1,800 were required—to compel the Auditor’s Office to “examine the books, records, accounts and affairs” of Duluth’s Independent School District 709.

[Disclosure: I signed Martell’s petition requesting the Auditor’s response.]

Minnesota law requires the Auditor’s Office to respond to citizen petitions, but allows the agency “to confine the scope of the examination to less than requested by the petition,” which the Auditor’s Office opted to do in this case.

“Often petitioners ask questions that aren’t auditable,” Kerr says. “It’s understandable. Petitioners usually aren’t auditors themselves...[For example], they ask for a judgment that the Governing Board [the governmental body being reviewed—in this case, the School District] should make, or over which the Governing Board has discretion.”

Kerr declined to provide specific examples, but confirmed that these are the reasons the scope of Martell’s petition was pared down. “If it’s something like, ‘Was this a good idea?’ that’s generally one of the things that we would not be able to answer.”

So, the Auditor’s Office refuses to join either Team Red Plan or Team Not, but the auditor’s report—and the raw data used to compile that report, later released by the Auditor’s Office—provide ample evidence for much of what Red Plan critics have been saying for years.

Operational savings have been grossly overstated—and it has nothing to do with selling Central. Property sales have been lower than anticipated, but they were, by themselves, a very small portion (less than eight percent) of how we were slated to pay for the new facilities.

The original Comprehensive Plan estimated $5.3 million per year in operational savings—$60.5 million over the life of the Red Plan—just from running fewer schools.

In 2012, District administration told the Zenith that savings were right on-target, generating $4.4 million in annual operational savings; in 2013, they said that figure was up to $5.3 million. But according to the auditor’s report, operational savings only totaled $2.3 million in 2012 and $3.5 million in 2013.

Based on the original Red Plan, total savings from all sources should be about $45 million by now. According to the auditor’s report, total savings from all sources have been $12.9 million.

Similarly, the District claimed for years (as late as 2013 to the Zenith) that money from the general fund was not being used for the Red Plan. The Board even passed a resolution in 2008, promising not to use the general fund for the Red Plan, insisting there were “two pots of money.”

In a roundabout way, this is true. A designated account within the general fund—the Debt Service Fund—was set up for Red Plan payments and receipts. The account has consistently run in the negative, so money has been transferred from the general fund to the Debt Service Fund in order to make ends meet.

Thus, technically, no money from the general fund has been used to pay for the Red Plan because that money came out of the Debt Service Fund—which got its money from the general fund to the tune of $13.2 million.

The Debt Service Fund is currently -$8.8 million, according to the auditor’s report. The general fund is currently $-2.2 million, according to a 2013-14 Reserve Worksheet maintained by the District.

The Worksheet states that the District was in statutory operating debt during 2012-13 and expects to be again from 2017-19, with the general fund at -$13.7 million by 2019. Under Minnesota law, a school district enters statutory operating debt when it spends in excess of a -2.5 percent unreserved general fund balance.

In addition, the Red Plan’s “soft costs” have tripled from what they were in the initial job orders. “Soft costs” refer to all expenses not directly related to construction, ranging from architectural, engineering, and other professional services, to “reimbursables”—items in the contract that the client is going to pay, typically such things as insurance, permits, and inspection costs.

In the 2008 job orders, Red Plan soft costs were $26.7 million—nine percent of the total project cost. According to the auditor’s report, soft costs are now $84 million, or 27 percent. The lion’s share of that—$56.5 million—was paid to project manager Johnson Controls, Inc. (JCI).

This is what JCI was paid, but it does not represent JCI’s net profit from the Red Plan, which may be impossible to determine and is largely irrelevant. Few businesses could identify their net profit from any one sale or project.

But JCI has been compensated $56.5 million, some portion of which the company spent on internal and external expenses, just like any other business. In addition to overall project management, JCI managed construction on half the buildings—eight out of 16. Kraus-Anderson managed construction on four buildings and Bossardt the other four.

Soft costs are comprised of things that aren’t necessarily easy for a client to appraise. The price of soft cost items tends to be less fixed (e.g., the cost of steel versus that of design or environmental assessments). Thus, soft costs can be harder to contain than construction costs.  

As expected for a project of this size, the Red Plan has included hundreds of change orders related to construction, but only a small number related to soft costs. Among those were three change orders, totaling $11.2 million, for soft costs paid to JCI, according to the auditor’s report.

These three happen to be among five change orders, totaling $11,592,503, that School Board Members Art Johnston and Harry Welty say were never approved—or even seen—by the School Board. After combing through meeting minutes all the way back to 2009, they could find records of every other change order, except for these five.

Two of them were signed on November 30, 2009—a reuse plan for furniture and equipment, totaling $836,693, and $1.5 million for changes to the contracts for the eight buildings managed by JCI, including a reduction in the contract for the Transportation building.  

According to District Property Manager Kerry Leider, these were largely for additional space for early childhood programs, moving the Secondary Technical Center into the high schools (closing Central closed STC as well), and removing the Transportation building from the project.

Another change order was signed on January 13, 2012, for 8.7 million, for a combination of asbestos containment, extending the duration of Congdon Park’s construction, and $3.1 million in reimbursables to Kraus-Anderson, Bossardt, and JCI.

The two additional change orders that Johnston and Welty say were not approved by the Board are not specifically mentioned in the auditor’s report. One was signed on June 25, 2009, for real estate services from FI Salter. The other was signed September 27, 2013, for a reduction by removing Old Central from the facilities plan.

Did this violate District policy? The three from 2009 might, since they were all for soft costs. On August 19, 2008, the Board passed a resolution specific to the Red Plan, allowing the Superintendent or Director of Business Services to approve change orders that don’t “exceed 15 percent of the original contract amount.” But according to Leider, this resolution only applied to construction costs.  

On June 27, 2011, the Board passed another resolution, “authoriz[ing] the Board Chair to sign amendments to the Project Specific Agreements with Johnson Controls.” No percentage or amount was set at which the Board’s approval would be required—effectively giving the Board Chair carte blanche to approve soft cost changes.

June 27, 2011, was also the day the Board approved increasing the overall Red Plan price tag. The District requested permission from the Minnesota Department of Education (MDE) to borrow more money due to cost overruns at six of the schools, but MDE rejected the request because it was for work already completed.

After the District submitted its original $15.4 million increase, MDE replied on January 26, 2012: “Cost overruns at newly constructed buildings may pose a problem, since separate trusts were established for newly constructed buildings versus renovation of existing facilities, and work is largely completed at the new buildings...Cost overruns for asbestos abatement completed at sites other than Congdon and [Myers-Wilkins] can’t be funded through the revised review and comment.”

Upon resubmitting the request, the District simply changed the reason to projects that weren’t finished yet— Congdon and Myers–Wilkins. The “approved costs,” or funding increase, is listed in the raw data as $19.3 million. The “actual cost” is listed in the auditor’s report as $9.9 million—roughly the cost for Congdon and Myers-Wilkins in the District’s first, scuttled request.

There are some apparent problems with the auditor’s report. For example, soft cost numbers were transposed in the raw data for Laura MacArthur Elementary. The raw data by school indicates $2.1 million spent on property acquisition, and $8,475.80 spent on builder’s risk insurance. However, in the Cost by School Summary, those figures are reversed—property acquisition is listed as $8,475.80 and builder’s risk insurance as $2.1 million.

This does not affect the final soft costs total, but it affects the individual line items under soft costs in the auditor’s report. Builder’s risk insurance—a relatively small cost for every other school—winds up totaling $2.7 million in the final report, making it among the highest soft cost expenditures. Property acquisition, which actually totaled closer to $10 million, is reported as only $7 million.

“There are no errors in the report,” says Auditor’s attorney Mark Kerr. “We stand by the report.”

Such details may be of no real consequence, as most of the School Board is likely to display its usual alarming incuriosity about the finer points of facilities finance.

On July 24, Board Chair Mike Miernicki sent an email to the rest of the Board that stated, in part: “The Red Plan is over. The schools have been built. It is time we move on to important issues...We don’t need to go over 14,000 pages of contracts and change orders.”

Miernicki is half-right. The buildings have been built, but the Red Plan isn’t over until we’ve paid for them. Doubtless the District’s creditors see that as an important issue, from which we should not quite yet “move on.”


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