Federal auditors say Indiana intentionally misused federal funds when one of its contractors, operating with little state oversight, funneled nearly a half million dollars to a start-up business run by the nonprofit's chairman.
Elevate Ventures, which was the subject of anIndianapolis Star investigation last year, was hired by the state to manage millions of dollars in state and federal investment funds. The federal audit concluded that the nonprofit should not have awarded $499,986 in federal cash to a start-up business called Smarter Remarketer managed by the firm's chairman, Howard Bates.
The audit was performed by the Department of Treasury's Office of Inspector General. The treasury department said it would recoup the misused funds from the state by withholding future small-business development payments. State officials, however, say they've already repaid federal funds, with interest, and taken action to ensure better oversight.
INVESTIGATION: IEDC contractor steers Indiana investment funds to firms run by its chairman and his son
EXCLUSIVE: FSSA chief clashes over timing of Pence health insurance plan
It's the first time since the federally-funded State Small Business Credit Initiative was founded in 2010 that an audit has found money was misused intentionally, said Debra Ritt, the special deputy inspector general who oversaw the audit.
The federal probe was triggered by last year's Star investigation, which revealed Elevate Ventures steered $800,000 in taxpayer money to businesses run by its founder and his son.
The audit found that $300,000 Elevate Ventures invested in a company called MaxTradeIn in which Bates is an investor did not violate federal rules. But it "created the appearance of potential nepotism," since Bates' son, Justin, was the company's chief executive officer.
Mike Davidson, an Elevate Ventures board member, said in a statement to The Star that the nonprofit has worked with the Indiana Economic Development Corporation to improve its policies and procedures and "will continue to move forward to support Hoosier entrepreneurs and strengthen Indiana's economy."
Ritt said "it would behoove the state" to provide greater oversight of its contractors to avoid such problems in the future. Since 2011, the IEDC has dispersed $21 million in federal funds from the U.S. Treasury's State Small Business Credit Initiative.
"This is a situation where the state had relied on Elevate Ventures to manage the money to oversee how it was spent and comply with program rules, but it didn't do much oversight itself of the contractor," Ritt said in an interview Thursday. "There's lots of opportunities for conflicts of interest when you're dealing with venture capital funds."
But she added that Indiana officials appear to have taken steps to address these problems.
Gov. Mike Pence agreed.
"This matter is closed," Pence said in a statement. "The investment has been fully recovered with a 15-percent return, and following the independent review I ordered last year, Elevate and the (IEDC) both have put in place new policies and practices that will ensure funds are used appropriately in the future."
Bates, who resigned from Elevate Ventures in December, referred questions to Elevate Ventures and the IEDC.
"The IEDC will continue to work collaboratively with the U.S. Treasury in order to maintain compliance," said IEDC spokeswoman Katelyn Hancock. "Months ago, proactively and voluntarily, the IEDC and Elevate Ventures implemented standards that go above and beyond the recommendations included in the OIG report."
Indiana House Minority Leader Scott Pelath, D-Michigan City, said that state Democrats believe Republicans are using the IEDC to funnel taxpayer funds into private businesses with little accountability for how the money is spent and how many jobs are actually created.
"The IEDC in recent years has been about buddies passing around money to each other," Pelath said. "It's been about coming up with ridiculous job projections that amount to propaganda, and it's been about making sure that political powerhouses can get in at company ribbon cuttings."
The inspector general further recommended that the IEDC review every investment decision by Elevate Ventures going forward. In a response to the auditors' findings, state officials and federal treasury officials agreed to the recommendation.
But Indiana officials, as well as treasury officials who oversee the small-business initiative, disagreed with the audit's assertion that the funding was intentionally misused.
Instead, Eric Doden, the president of the IEDC, wrote in a response to the audit that the agency "did not intentionally misuse" the funds, but had merely made a "reasonable interpretation of an ambiguous regulatory requirement." Doden wrote the IEDC also had taken "extraordinary, voluntary steps to address compliance" following this "singular event that has not occurred in any prior or subsequent" use of the federal funds.
Treasury officials in their response to the audit said they didn't think the state knowingly broke program rules.
Davidson, the Elevate Ventures board member, said he agreed with state officials and the Treasury that the inspector general's "characterization of this investment is inaccurate." The inspector general is an independent government auditor within the larger Treasury Department.
In November, KPMG, the auditing firm Pence's office hired to perform an independent audit, determined the state should have had stronger oversight over Elevate Ventures but was "substantially compliant" with its own policies, federal guidance and state law.
Doden warned that the federal audit's claims of "intentional misconduct" will have a "substantial chilling effect" on the use of the job-creation money in the future.
But Ritt in her report said that "by his own statements" Bates knew "his ownership interest was an issue." She wrote that he also used the $500,000 that had not yet been awarded to make it appear his ownership interest in Smarter Remarketer was small enough to meet federal requirements.
Ritt wrote: "We believe the facts speak for themselves."