6. Division of Water and Audits' Verification Report

On June 21, 2010, the assigned Commissioner and ALJ issued a ruling in response to learning that Great Oaks had been withholding monthly payments to SCVWD of ratepayer-provided pump tax funds since April 2009. The June 21, 2010 ruling granted in part DRA's March 19, 2010 "Motion to Reopen the Record to Admit Great Oaks' Nondisclosure of Lack of Payment of Groundwater Charges and Request that the Commission Issue an Order to Show Cause for Violation of Rule 1.1. and Possible Violation of Section 2114" and directed our Division of Water and Audits to:

- verify Great Oaks' assertion that the ratepayer provided funds are being held in a separate bank account and that the provisions of the account require approval by the Santa Clara Superior Court for any of these funds to be dispensed to an entity other than the SCVWD,

- verify that Great Oaks' accounting entries reflect the utility's assertions that ratepayers are not liable for late payment interest and penalty charges relating to the withheld payments, and

- determine whether Great Oaks' failure to inform the DRA and the Commission of its actions in withholding the funds from SCVWD violates any GAAP or Commission accounting or reporting requirements.⁹⁰

Pursuant to the June 21, 2010 ruling, Division of Water and Audits served its Financial and Compliance Verification of Great Oaks Water Company for the Period March 1, 2009 through June 30, 2010 (Verification Report) on the service list to this proceeding on August 20, 2010. The verification assignment was performed by Division of Water and Audits' Utility Audit, Finance and Compliance Branch (UAFCB) and its Verification Report is attached to this decision as Appendix D. In the executive summary, UAFCB summarizes its findings as follows:

1. Great Oaks deposited its ratepayer-provided pump tax funds in an "escrow-type account" (a money market mutual fund account) with Waddell & Reed Services (W&R), rather than a banking entity. As of June 30, 2010, deposits in the escrow-type account total $5,363,124.01, including interest earned.⁹¹ (Refer to Section IV, Goal of this report for details.)

2. Great Oaks did not make any withdrawals from the aforementioned "escrow-type account" during the verification period. Great Oaks is setting aside its SCVWD pump tax payments in the escrow-type account pending the outcome of a lawsuit. (Refer to Section IV, Goal 2 of this report for details.)

3. Great Oaks did not hold ratepayers liable for the late payment interest and penalty charges imposed by SCVWD on the withheld pump tax payments. Great Oaks recorded the interest and penalty charges in its Income Statement as the expense of its shareholders. (Refer to Section IV, Goal 3 of this report for details.)

4. Great Oaks used the Financial Accounting Standard Statement #5 (FAS #5) to support its action of not disclosing to DRA and the Commission that it withheld pump tax payments to SCVWD and the establishment of an escrow-type account. With regard to the disclosure requirements, UAFCB is unaware of Great Oaks being out of compliance with Generally Accepted Accounting Principles (GAAP) requirements. However, UAFCB found that Great Oaks is not in compliance with Public Utilities Code §§ 451 and 794, the Uniform System of Accounts (USOA) for Class A Water Utilities, and D.04-06-018. (Refer to Section IV, Goal 4 of this report for details.)

Based on the above findings, Division of Water and Audits provides recommendations as to how Great Oaks should bring its procedures into compliance with the Commission's accounting and reporting requirements. The June 21, 2010 ruling did not direct Division of Water and Audits to reach any conclusions as to whether fines or other penalties should be assessed, and Division of Water and Audits does not do so. Division of Water and Audits' recommendations are:

· Separate Bank Account - Great Oaks should provide the Commission's DRA with the conditions, requirements, agreements, instructions, etc. for the separate escrow-type account opened with W&R which Great Oaks was not able to provide during UAFCB's verification fieldwork. Great Oaks should be required to transfer the entire balance in its W&R escrow-type account into a secured and separate "bank escrow" account or to a regular standard bank account.

Great Oaks should propose as part of its next GRC rate design filing a method to separate out the total pump tax component collected as revenue via surcharges, service charges, and quantity charges if pump tax is still an operating expense.

· Withdrawals from Separate Bank Account - To the extent that Great Oaks continues to maintain its escrow-type account with W&R, Great Oaks should be required to establish a specific withdrawal provision with W&R to ensure that any withdrawals made to entities other than SCVWD must require an approval of the Superior Court of Santa Clara County or the Commission.

· SCVWD Interest & Penalty Charges - No recommendation.

· Accounting Compliance - Great Oaks should be required to submit to the Division of Water and Audits a written proposal for its accounting of pump tax revenues, expenses, cash, receivables, and payables in compliance with the USOA. To avoid future confusion and problems, Great Oaks should be required to advise the Commission with information relating to any new accounting approaches, unusual accounting treatment or items, relevant procedures and records especially involving significant amounts.

Pursuant to the schedule set in the June 21, 2010 ruling, both Great Oaks and DRA filed comments on August 30, 2010 and reply comments on September 7, 2010.

In its opening comments, Great Oaks states that based, in part, on the Verification Report it has decided to remit to SCVWD all the payments it has withheld and to continue to make payments to SCVWD when due, under protest; further, Great Oaks commits that it will not withhold future payments unless it first notifies the Commission. Great Oaks requests that the Commission correct the Verification Report in the manner specified in its comments and declare the Verification Report moot as to the issues in this proceeding, due to Great Oaks' decision to pay groundwater charges under protest to SCVWD.

In the remainder of its comments, Great Oaks focuses on whether (1) Division of Water and Audits exceeded the scope of the June 21, 2010 ruling when it investigated the type of account holding ratepayer funds and the terms and conditions of the account, (2) Division of Water and Audits properly cites to the latest Rate Case Plan decision, and (3) Division of Water and Audits improperly presents legal conclusions rather than compliance findings. We do not find these issues to have substantive merit. In the instances where Great Oaks directly addresses whether its nondisclosure to the Commission and DRA of the approximately $5,000,000 in ratepayer-provided funds it was withholding violated any of the Commission's accounting and reporting requirements, we do not find Great Oaks' positions persuasive.

In its comments, DRA generally supports Division of Water and Audits' findings and recommends that the Commission admit the Verification Report into the record, adopt Division of Water and Audits' recommendations, hold an additional hearing if necessary, and issue a decision in this proceeding, not in a separate proceeding. DRA continues to recommend that Great Oaks be fined; it does not agree with Great Oaks' assertion that the issues raised in its motion and the June 21, 2010 ruling are "moot" due to Great Oaks having released the withheld funds.

DRA's comments reflect its comprehensive understanding of the Commission's accounting and reporting requirements and provide strong support for Division of Water and Audits' findings in its Verification Report. In addition to Division of Water and Audits' recommendations, DRA requests the Commission make a specific finding that Great Oaks' shareholders will be responsible for all interest, penalties, and legal expenses associated with the nonpayment of groundwater production charges. DRA makes this recommendation due to the current size of the interest and penalties, approximately $500,000, and because it asserts that Great Oaks could make adjustments to its operating and maintenance recorded expenses to include these interest and penalty charges in its next or future GRCs and there is no mechanism in place to prevent this.⁹²

Based on a review of Division of Water and Audits' Verification Report and parties' comments, we find that good cause exists to further investigate Great Oaks' actions and whether to impose fines. However, we are not clear on why DRA recommends that further investigation be done here rather than in an adjudicatory proceeding.

We find that Commission staff should prepare an Order Instituting Investigation (OII) to further review whether Great Oaks' actions in not informing the Commission and its staff that it was withholding payment to SCVWD of the pump tax revenues collected from its customers violated any of the following: the Commission's Rule 1.1., our Uniform System of Accounts (USOA) for Class A Water Companies, our Rate Case Plan, or Public Utilities Code Sections 451 and 794, and that as part of the OII Great Oaks should be ordered to show cause why penalties should not be imposed for any violations.

Based on Great Oaks' actions we also find that good cause exists to routinely require Great Oaks to timely report to the Commission any significant changes it makes in its accounting approaches or treatment. We will also ensure that the Commission carefully reviews Great Oaks' operations within the next three years under our Rate Case Plan application procedures. We should not grant a waiver of Great Oaks' triennial filing requirement, an extension of time for filing, or a request to file by advice letter rather than application.

In addition to finding that an OII should be prepared, we find that:

- Great Oaks must advise by a letter to the directors of the Division of Water and Audits and the Division of Ratepayer Advocates, with copies sent to the branch chief of the Utility Audit, Finance and Compliance Branch and the service list of this proceeding or its subsequent GRC, within 60 days when it adopts any new accounting approaches, unusual accounting treatment or items, and changes to relevant procedures and records, especially any event involving a change that represents a difference of 10% or more between the new accounting approach or treatment and the prior accounting approach or treatment.

- The shareholders of Great Oaks shall be solely responsible for all interest, penalties, and legal expenses associated with the nonpayment of groundwater production charges.

- Great Oaks shall timely file its next GRC request as an application, not as an Advice Letter, and shall do so under the schedule adopted in Decision 07-05-062 and in compliance with all filing requirements set forth in that decision's Rate Case Plan.

⁹⁰ Great Oaks takes exception with the ruling's statement that Great Oaks' asserted "ratepayer provided funds are being held in a separate bank account and that the provisions of the account require approval by the Court for any of these funds to be dispersed to an entity other than the SCVWD." We clarify here that the actual assertion by Great Oaks' Chief Financial Officer is that she precisely followed the instructions of Great Oaks' CEO to "establish a separate bank account (the `groundwater charge account') for the purpose of depositing and securely holding, groundwater charges imposed by the Santa Clara Valley Water District until a legal determination is made on the disposition of the funds" and the actual statement by Great Oaks' General Counsel is "Of course, if DRA had conducted an investigation it would also have learned that Great Oaks has deposited all of the disputed groundwater charges into a secure account under instructions that the funds remain in the account until a court of competent jurisdiction, along with the Commission, approve the final disposition of the funds." See Great Oaks' April 12, 2010 response at 9 and the attached Declaration of Vicki Morse at 1.

⁹¹ Per W&R's July 28, 2010 confirmation letter.

⁹² See Reply at 10.