Discussion

With this factual background we turn to a discussion of the specific issues raised in the OII, in the sequence established by the ALJ's Ruling of September 10, 2002.

The extension of distribution mains from Hillview's basic production and transmission system to serve new customers described in this investigation is governed by the terms of the company's Tariff Rule 15, a standardized water utility tariff approved by the Commission. The material provisions of Tariff Rule 15 in this dispute were included in an approved version of the tariff in effect from 1982 throughout the period subject to investigation. The parties agree on the substance of those provisions, but differ as to their interpretation.

Tariff Rule 15 requires a main extension contract to be executed by the utility and the applicant(s) in advance of the construction work. The Commission has alternative approved versions of this main extension contract to be used for individual customers and for real estate developers and builders. (Tariff Rule 15 defines the latter to include individuals and others who divide a parcel of land into two or more portions, or who engage in the construction and resale of individual structures on a continuing basis. (Paragraph A.3.b.)) The sum paid by an applicant for a main extension is an advance, and is recoverable through refunds paid under a schedule specified in the tariff. An exception is made if, in the opinion of the utility, it appears that a proposed main extension will not, within a reasonable period, develop sufficient revenue to make the extension self-supporting, or if for some other reason it appears to the utility that a main extension contract would place an excessive burden on customers. In this event the utility may require non-refundable contributions of plant facilities from the developer in lieu of a main extension contract. (Paragraph. C.1.d.)

Staff contends that because of the cited language in Paragraph C.1.d above, these tariff requirements must be read in the alternative: Either a special facilities (or supply and storage) fee is refundable under the terms of a main extension contract, or it is a discretionary non-refundable contribution from the developer. Because Forrester testified that Hillview collected the fees pursuant to Paragraph C.1.b, which required them to be refunded as advances, the company's admitted failure to do so violated the refund schedule provided in Paragraph C.2.c.11

The respondents argue that refundable advances under main extension contracts and nonrefundable contributions under Paragraph C.1.d are not mutually exclusive. They cite D.02-01-014 (January 9, 2002) in Application of Del Oro Water Co., Inc., etc., in support of their contention that Hillview had the prerogative to receive the sums involved either as refundable advances or as nonrefundable contributions. This may be true, but the evidence is quite clear that if Hillview made this election, it did not do so in the proper manner: If Hillview intended these fees to be nonrefundable contributions, it should not have received them under the terms of a main extension contract, as that is the written instrument under which the refund arrangement is memorialized.

Consequently, we agree with Staff that there is substantial evidence of Hillview's violation of Commission-approved tariff procedure in collecting "supply and storage fees" from individuals. Hillview admits violating the tariff, and concedes that it was not proper to alter the approved form of its main extension contract to collect an unauthorized "supply and storage" fee. To complicate matters, Hillview admits that it mistakenly used the wrong form of agreement on a number of occasions, confusing a contract form used for developers with that used for individuals.

The respondents argue, as to any payments regarded as advances, that Paragraph C.1.d does not specify the time or manner of payment, and that per-lot installment payments of special facilities fees was not prohibited by the tariff. They also contend that Tariff Rule 15 did not prohibit the third-party beneficiary arrangement. We do not find these arguments persuasive. Our inability to reconstruct the record of fee payments to determine reliably all of the persons who might have been entitled to a refund is compelling enough evidence that this arrangement did not carry out the purposes of Tariff Rule 15.

Despite these errors, it does not appear that these actions harmed Hillview's customers. All of the sums collected for main extensions and special facilities were properly recorded in its CIAC account, as our auditors found in 1993. The funds in that account were devoted to the construction of facilities in districts with which they were associated, and were not included in its rates. Thus, while Hillview's customers paid for the facilities up front, they did not amortize them over time through higher water rates. Moreover, because the fees were treated as contributions, Hillview has never been able to earn a return on them. Even lot owners who subsequently sold their lots were not harmed under the pay-as-you-go arrangement into which Hilview entered with developers, because the added value of the fees was reflected in the market value of their properties. Consequently, we will not require Hillview to attempt once again to reconstruct the history of these fees, and we will not impose a fine or penalty, as we would in an instance where the public was harmed.

The allegation that the respondents furnished falsified documents to the Commission in response to a request relates to an incident that occurred in the course of our auditor's 1996 investigation. In a data request the auditor asked for lists of Hillview's new customers from 1993 and 1995. The response for this request was due in seven days.

Instead of responding with a list of these customers, Hillview responded by submitting photocopies of these customers' application forms. The lower portions of the forms were covered with a form of different appearance that had blanks for recording fee payments. Although these documents collectively comprised the customer lists requested by the auditor, Staff alleges that Hillview covered the lower portion of the forms when copying them in an effort to hide information and mislead the Commission.

Jacqueline, who by the time of these events was Hillview's office manager, credibly explained this incident in her testimony at the EH of May 20, 2000, in this proceeding.12 Essentially, she explained that the forms were copied and produced in lieu of creating a computer-generated list, because Hillview's computer system at the time did not have the capability to do so, and because of the short deadline given by the auditor. The bottoms of the forms were covered to prevent confusion, as the company had adopted a second, different form, and the information recorded thereon was not required in order to respond to the data request. Staff accepted Jacqueline's explanation at the earlier EH, and it is credible. There is no new information in the record that would cause us to doubt Staff's earlier determination. We find that, although the lower portions of application forms were admittedly covered for photocopying, this fact did not represent a deliberate effort to mislead the Commission, nor did it hinder Staff's investigation.

Staff alleges that in 1991 the respondents entered into an arrangement whereby Hillview would assist 41/49, the developer of the Old Mill Village commercial development, by getting Hillview customers to reimburse 41/49 for its special facilities fees. The customers to which this allegation relates were Longs Drugs and Vons Market, each of which built retail facilities on lots in the development. As set out in Staff's audit report, which constitutes its only evidence in support of this contention,

When 41/49 completed construction of a building in a shopping center and the building was ready for occupancy, 41/49 advised the store, market, or other retailer that was going to occupy the building that supply and storage fees would have to be paid to [Hillview] in order for it to have water service. When the store, market, or other occupant paid the money...[Hillview] immediately turned the money over to 41/49. (Exh. 68, p. 27.)

There is no controversy that in concept this is a correct rendition of the procedure that was followed. Staff admits that this produced no direct benefit to Hillview, but claims that it benefited 41/49 by making its properties appear less expensive and thus more attractive, and also benefited Forrester and Judith, by constituting part of the consideration for the $350,000 loan they received from 41/49.

The respondents explain that 41/49 had already paid plant and special facilities fees up front for Old Mill Village, and that the amounts returned to 41/49 were simply refunds of advances under the main extension agreement. The respondents also admit that they should have entered into main extension contracts with Longs and Vons under Paragraph C.2.d, and that this was not properly accomplished.

The $350,000 loan transaction between 41/49 and the Forresters is explained in detail above. There is no evidence in the record that this was a quid pro quo arrangement, and Forrester denies that it was, because 41/49 had already fulfilled its obligation to pay these fees. Although we are concerned about the closeness of the relationship and informality of the business dealings between 41/49 and the respondents, which aroused suspicion when they came to light during Staff's investigation, Staff concedes that Hillview's customers suffered no harm as the result of Hillview making these refunds.

Hillview admits that it did not carry out the refund transaction in accordance with Tariff Rule 15, but our inquiry must end there. Any contention by Staff that the payments were "illegal" or part of an "unlawful scheme" are either unsupported by the record or beyond the enforcement jurisdiction of the Commission.13 We will not impose any penalty in relation to this allegation.

Staff notes that Res. No. F-632 authorized the respondents to enter into the CoBank loan contracts for $540,000 and $960,000 for the specific purpose of refinancing existing unauthorized commercial debts, namely the SDWBA loan and $266,650 in improvements. Staff alleges that some loan proceeds instead were used to pay Forrester's past due property taxes and electric bills, and for some construction activities that had already been reimbursed through surcharges collected from customers.

The underlying facts are explained earlier in this decision. Regarding Hillview's construction activities, Res. No. F-638 (April 26, 1995) authorized Hillview to increase its loan agreement by $100,000 over the amount approved in Res. No. F-632, to reimburse Hillview for funds already spent for facility construction and improvements, and those improvements were made. As to the allegations regarding improper payment of taxes and electric bills, the respondents point out that Forrester personally owns the building in question and leases it to Hillview under the terms of a triple net lease that obligates Hillview, not Forrester, to pay these expenses. (Exh. 74; Tr.881: 9-23.) Hillview's payment of these expenses was therefore entirely proper.

All of the evidence indicates that we examined and approved these transactions before we issued the OII. The respondents have effectively rebutted any showing made by Staff to support its theory, and that showing is weak.14

As explained above, Hillview filed AL 53, asking the Commission to modify Res. No. F-632 by permitting diversion of $112,463.42 of surplus funds from paying down the CoBank loan to paying for new facilities. We granted this request, with the net effect that Hillview's indebtedness increased by that amount.

Staff contends that the net surplus in the loan account was $281,734 on October 23, 1995, when the respondents filed AL 53, and that the special fund was accordingly understated by $169,271. Staff argues that the present value of this figure at the time of the hearing was $200,467. (Exh. 22A.) The derivation of the claimed understatement remains a mystery. The utilities engineer who prepared Exh. 22A did so on the basis of figures in the auditor's workpapers, and calculated account balances by plugging those figures into a formula that in turn relied upon an unsupported assumption. The workpapers were marked for identification at the hearing, but Staff declined to offer them in evidence. Staff has not carried its burden of proof on this issue. However, we will require appropriate relief if an inconsistency in this account is revealed in the reconciliation to be prepared pursuant to our Order.

Hillview's history of long-term debt and plant account is largely recounted above. Staff relies solely upon Chapters 7 through 12 of its audit report (Exh. 68) in support of the allegations that there is no documentation for expenditures ostensibly used for utility plant, that the respondents misused corporate assets, and that these circumstances explain why the respondents did not seek Commission approval for the "initial" [SDWBA?] loan.15

The Staff auditor prepared Chapters 7 through 12 of the audit report (Exh. 68). He adopted all of this material as his testimony at the EH in lieu of providing prepared testimony (Tr. 447 - 478). He was extensively questioned about this report by respondents' counsel on cross-examination (Tr. 478 - 686; 689 - 790) and recross (Tr. 878 - 890), and much of the report was seriously discredited. Little of his testimony was effectively rehabilitated on redirect. His answers to many questions were incomplete, unresponsive or evasive. At times he also displayed personal animosity toward Forrester, and inappropriately expressed anger toward Hillview's management, attorneys, and accountant. All of these factors call into question the reliability of the portions of Exh. 68 that he sponsored, and we accord them little weight.

The portions of Exh. 68 sponsored by this witness are the heart of the investigative report the OII directed Staff to prepare. Staff issued the original report on November 20, 1997, and Exh. 68, an amplification of that report, in August 2002, offering it in substitution of the original as Staff's principal testimony. Yet despite the passage of more than five years since we had issued the OII and Staff had issued the audit report, Chapters 7 through 12 remained untouched in the revised version. By contrast, the respondents made a credible showing on the propriety of its loans and expenditures.

Notwithstanding the absence of substantial evidence to support Staff's broad accusations, several discrete issues relating to this aspect of the OII were raised by the parties and should be addressed. Fortunately, there is sufficient reliable evidence to make findings on these issues. We do so to enable the parties to prepare a final reconciliation of Hillview's accounts, so that its financial condition may be accurately established.

First, with regard to the transaction in which Hillview made a $350,000 loan to Forrester and Judith in 1992, a question arose as to whether the Forresters' assumption of a $47,900 loan to the company from Linton was valid consideration. The original debt derives from Linton's payment of Hillview's utility bills, satisfaction of a judgment against the company, and the deposit of $16,000 in cash to the company's general account. Altogether, Linton advanced a total of $50,000 on the company's behalf, but by December 1982 Hillview had repaid only a small portion of this obligation, and the remaining $47,900 was on Hillview's books until the 1992 transaction. We had occasion to review this obligation as early as January 21, 1982. (D.82-01-105 in Application (A.) 61148; see also D.82-12-062 in A.82-06-073 (December 15, 1982).) Forrester provided a credible explanation of its origin, and Staff has not persuaded us that any part of the obligation was invalid.

Second, with respect to the 1992 loan from the Forresters to Hillview, the respondents admit that Forrester should have immediately loaned $141,546.97 in cash to Hillview instead of executing a note. Forrester attributes his failure to do so to unspecified "personal problems." (Respondents' Brief, p. 28.)16

Third, Forrester admits that a book entry made in December 1992 that included the $350,000 obligation of the Forresters was improperly recorded, resulting in confusion of the company's accounting. He attributes this to the lack of sophistication of Hillview's bookkeeping staff (including Forrester himself) at the time the transaction was recorded. Peasley discovered the error after he was retained and learned that the accounts related to surcharge-funded utility plant, CoBank loans, income taxes, deferred taxes, and CIAC all needed adjustment before the 1995 financial statements could be prepared.

Peasley testified that Hillview had made an error in recording contributed property conveyed by 41/49, as well as the loan payable by Forrester. The company did not correctly record amounts to CIAC equal to the conveyed property, and actually recorded a slight decrease in CIAC. Hillview's records needed an adjustment of $141,546.97 to increase (credit) CIAC. In the loan transaction, Hillview failed to record a loan due from Forrester of $141,546.97(debit). (Exh. 81.) In sum, the entry related to the $350,000 obligation should have reflected:

· Cancellation of the prior loans of $160,553.03 from the Forresters;

· Assumption of Hillview's debt of $47,900 to Linton;

· A receivable from the Forresters of $141,546.97; and

· A debt payable to Forrester of $350,000.

A separate entry should have been made for plant, reflecting:

· $131,158.36 of utility plant, and

· $131,158.36 CIAC.

(Exh. 81, pp. 2-3, 123, and 124; Respondents' Brief, pp. 22-23.)

The consequence of this mistake was that for the 1994 test year, on the basis of which Hillview's rates prior to 2001 were adopted, CIAC was understated by $141,546.97, and rate base was overstated by the same amount. This circumstance in itself would have resulted in rates that were too high. However, Forrester testified that rate base was actually understated, because the recorded average plant in 1994 was $212,581 higher than the test year average plant. (Exh. 82A, p. 26.) This is corroborated by Jacqueline's testimony at the May 20, 2000, EH. (Exh. 83.)

In the 1993 general rate case, we adopted a reduced rate of return for Hillview because of its unauthorized borrowing activities. As a consequence of the current investigation, which was largely the result of the confusion in Hillview's accounting records, Hillview did not have a general rate case between 1993 and 2000. Hillview's average plant increased significantly over that period, and contributions generally decreased. (Exh. 126.) Hillview argues that it has lost part of the return on its actual rate base because of this, and that its loss has more than offset the consequences of its accounting error, producing unrealistically low rates.

This argument is predicated on the assumption that the corresponding plant, which was contributed by 41/49, was actually installed. Forrester testified that it was, and corroborated his testimony with Exh. 147, a confirming letter from 41/49. Staff has offered no evidence other than the unsupported testimony of its auditor that the plant was not installed.

Despite Staff's failure to prove much of what is alleged in Chapters 7 through 12 of Exh. 68, the evidence concerning these discrete issues is sufficient to support findings, and to indicate a need for further reconciliation of accounts, as provided in our order.

The loan transactions at issue are explained earlier in this decision. Staff's argument is based upon Chapter 8 of its audit report (Exh. 68), which characterizes this succession of loans as a "scheme of layers upon layers of loans...apparently designed to hide the true origin of the [CoBank] loan" for which Hillview sought our approval. (Id., p. 40.) In light of the facts of record set forth above, we find that Staff has misinterpreted the evidence. Staff's rendition of the loan history is as follows:

1. In 1991 Forrester obtained a personal loan of $350,000 from 41/49 in exchange for a letter declaring that 41/49 had provided all the required utility plant.

2. In 1992 Hillview "falsely" recorded the $350,000 as a company loan on its books.

3. In 1993 Hillview obtained the $424,000 SBA loan to pay off the $350,000 personal loan, which was now inaccurately recorded on its books, "apparently in order to mislead the Golden Oak Bank and the Commission."

4. In 1994 Hillview came to the Commission for approval of the loan for $540,000 to use to pay off the SBA loan.

Staff characterizes this "compounding" of loans as an attempt to disguise the origin of the loan. (Id., p. 41.)

Staff's rendition is based upon speculation, and the weight of the evidence indicates that its logic is flawed. First, irrespective of the reason why 41/49 requested, and the respondents furnished, the letter to Madera County as part of the personal loan transaction (which is nowhere explained in the record), the statement in the letter was correct: 41/49 had satisfied its obligation to contribute all of the utility plant under its main extension agreement with Hillview. Second, the personal loan was not recorded as a company loan at all; see the explanation in the preceding section. Third, Staff has offered no evidence to support its allegation that there was an effort to mislead us or the Golden Oak Bank, and our 1993 general rate case indicates just the opposite.

There is no substantial evidence in the record to convince us that the respondents "schemed" to conceal the personal loan to the Forresters, the proceeds of which were used principally to pay off Hillview's indebtedness. That debt reflected loans extended to the company by the Forresters, and by Linton apparently before he conveyed ownership to Forrester and Forrester's sister. Only the disposition of the remaining $141,546.97 is of any concern to us, and both Forrester and Peasley testified that Forrester reimbursed that sum to Hillview in 1998 in satisfaction of the loan he and Judith had received from Hillview. We infer from this succession of events and the absence of a cash transaction of this amount that Forrester and his ex-wife Judith simply retained the $141,546.97 loaned to them by 41/49, and gave the company a note in that amount to document that portion of the loan to the company; the company recorded the entire transaction as a $350,000 loan from the Forresters, and canceled the outstanding indebtedness to them in partial satisfaction thereof.

This leaves unaccounted for only the four withdrawals from the SDWBA surcharge account made by Judith, totaling $15,541.16. Forrester became defensive when questioned at the EH about these withdrawals, and we infer that his marital difficulties with Judith were very likely involved. These funds (which are not included in the succession of loans recounted above), were withdrawn as payments to the Forresters in satisfaction of their loan to Hillview. It appears that this was improper, and there is no record that they were ever repaid to the SDWBA account.17 If this is true, these funds must be reimbursed to the account with interest at the rate applicable to the SDWBA account at the time the withdrawals were made.

11 Under Hillview's Tariff Rule 16, the company was generally forbidden from charging individual customers a fee for making new service connections until June 9, 1992, but following that date, as a Class C utility Hillview could lawfully accept from such customers amounts in contribution as connection fees, and amounts in contribution as facilities fees, calculated in accordance with Commission-approved schedules. 12 Jacqueline Forrester died after giving this testimony, and the transcript of her explanation was received as Exh. 83 in addition to being part of the official transcript herein. 13 As explained in our Introduction above, all of these contentions were investigated by the California Attorney General with Staff's cooperation. That investigation was terminated, and no indictment was sought in Madera County Superior Court. We understand that the investigative documents were then turned over to the United States Internal Revenue Service. 14 We note that Staff has devoted only eight lines of argument to this theory in its Opening Brief. This fact suggests to us that the issue is not as significant as it may have appeared to Staff at the time the audit report was written. 15 Staff's Opening Brief devotes a short paragraph of argument to these charges, accusing Hillview's management of a "wholesale breach of trust," and representing a "flagrant flouting of state law and Commission authority," but contains no discussion of any evidence demonstrating that such serious allegations are justified. 16 We infer from Forrester's other testimony that this is a reference to the breakdown of his marriage to Judith, and that community property problems may have flowed from this event, impairing Forrester's ability to raise cash at the time. The occurrence of such personal problems does not excuse any failure of regulatory compliance, and we do not condone Forrester's actions in so finding. 17 If the Forresters (or either of them) retained the initial $141,546.97 and the $15,541.16 as well, it appears that the latter sum should have been recorded as a loan to Forrester and Judith, and repaid with interest to the SDWBA surcharge account. If this reimbursement has not been made, the company's customers will apparently have funded these cash payments to the Forresters through withdrawals from the company's SDWBA surcharge account.

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