7. General Office Positions Requested by GSWC Due to the Sarbanes-Oxley Act
Among the most contentious issues between DRA and GSWC on the latter's personnel needs has been the number and kind of new positions that should be authorized for general office purposes due to the Sarbanes-Oxley Act of 2002 (SOX). This statute, which was passed in the wake of the Enron and Worldcom corporate accounting scandals, affects public companies like GSWC in three major ways.46 First, SOX § 302 requires that the CEO and CFO make a certification (under criminal penalties) of the truth of the quarterly financial statements filed with the Securities and Exchange Commission (SEC). Second, SOX § 404 requires that management prepare an annual "internal control report" that describes the company's internal control structure, states whether management believes these internal controls have been effective, and also states whether the company's outside auditors agree with this assessment. Third, SOX § 906 requires the CEO and CFO to make a quarterly certification to the SEC that the company's financial reports comply with SEC requirements. (Ex. 11, pp. 23-25.)
GSWC is requesting four positions where 50% or more of the new job's time would be devoted to SOX issues and compliance. The four new positions are: (1) Vice President of Finance, Treasurer and Assistant Secretary, (2) Tax Manager, (3) Financial Reporting Supervisor, and (4) Accountant. In addition, GSWC is seeking to add an Internal Auditor, 25% of whose time would be devoted to SOX compliance. As explained below, DRA opposes funding for all of these new positions except the Financial Reporting Supervisor.
We have decided that although GSWC has clearly incurred significant costs to comply with SOX, the total amount of salaries that the company is seeking to meet its alleged SOX needs is inflated. As we explain in Section 7.2, other state public utility commissions and academic commentators agree that while the initial costs of SOX compliance can be high, these costs are likely to decline significantly over time. In addition, because SOX was enacted largely to benefit investors, at least two state commissions have concluded that the costs of SOX compliance should be shared equally between a utility's shareholders and its ratepayers. As we explain in section 7.3, we have decided to use the same approach here.
7.1. GSWC's General Stance on New Positions Required for SOX Compliance
Most of the new general office positions GSWC is seeking based on its SOX needs relate to tax issues, because when the company changed its outside auditing firm from Arthur Andersen & Co. to PricewaterhouseCoopers (PWHC) in 2002, GSWC was required to restate its financial results for 2000 and 2001 due to deferred income tax errors.
Although Ms. Darney-Lane offered a justification for the five new positions in her direct testimony (Ex. 5, Darney-Lane, pp. 29-36), an even more substantial justification for the new positions is set forth in the rebuttal testimony of Robert J. Sprowls, GSWC's CFO, Senior Vice President of Finance and Secretary. We discuss each of these new positions below.
7.1.1. Vice President of Finance, Treasurer and Assistant Secretary
Ms. Darney-Lane's testimony states that this job was created in November 2002, too late to be included in the company's last general office GRC, A.02-11-007. According to Darney-Lane, "it is the Vice President of Finance, Treasurer and Assistant Secretary's primary obligation to oversee the company's day-to-day compliance with the Sarbanes-Oxley Act of 2002." (Ex. 5, Darney-Lane, pp. 32-33.)47
In her testimony, Darney-Lane sets forth at considerable length what overseeing GSWC's day-to-day compliance with SOX entails. With respect to SOX § 302, which requires the company's CEO and CFO to certify the company's financial statements, she notes that the company must now spend much more time reviewing and ensuring the accuracy of financial statements, and "while it is the CEO and CFO that must sign off on the certification, the bulk of the additional detailed work is performed by the Vice President of Finance." (Id. at 34.)
With respect to SOX § 906, which requires quarterly certification to the SEC by the CEO and CFO that the company's financial reports comply with certain SEC requirements and fairly represent the financial condition and results of the issuer, Darney-Lane notes that the Vice President of Finance is responsible "to ensure the compliance before the CEO and CFO sign off on the certification." (Id. at 33.)
With respect to SOX § 404, which requires GSWC's management to prepare an annual internal control report and state how effective the internal control structure has been in ensuring the accuracy of the company's financial reports (and whether the outside auditors agree with this assessment), Darney-Lane states:
In order to accomplish this, the VP of Finance has the responsibility to continually assess 16 mega accounting processes and document and test about 250 key controls (more than 400 key controls in 2004) to ensure the compliance. This requires a continuous monitoring and updating of accounting policies and procedures. The requirements of doing this are ongoing year after year. GSWC obtained an unqualified opinion in March of 2005 attesting [to] the effectiveness of its internal controls for financial reporting in 2004. (Id. at 35.)
In addition to ensuring SOX compliance, Darney-Lane notes that the VP of Finance is charged with focusing on the company's financing needs, which have grown significantly in the past decade due to the need for infrastructure replacement. Other duties include overseeing tax compliance and the preparation of accounting records, and serving as a liaison between the areas of the company that handle accounting and regulatory affairs. (Id. at 35-36.)
In his report for DRA, Aslam opposes funding for the VP of Finance position (which pays $162,500 per year) on the ground that it is "an unnecessary layer within GSWC's organization structure." (Ex. 23, p. 2-22.) Aslam states:
DRA . . . believes that the financial reporting requirements imposed by the various sections of the Sarbanes-Oxley Act directly involve GSWC's CEO and CFO but not the Treasurer. The CFO is paid an annual Salary of $235,000 and CEO an annual salary of $410,000. DRA wonders what these two top executives themselves are contributing, when GSWC is often requesting new additional positions to perform their responsibilities.
As for GSWC's financial reporting responsibilities, they are directly related to the Controller and not the Vice President of Finance. The Controller should report directly to the CFO and not the Vice President of Finance. (Id.)
We agree with GSWC that the Vice President of Finance position should be authorized. As discussion throughout this decision makes clear, SOX has imposed significant new burdens on public companies, including utilities. Ms. Darney-Lane presented a full justification for the position in her direct testimony, a justification that Robert J. Sprowls - who held the job until the Spring of 2006 - repeated largely verbatim in his rebuttal testimony.48 As Darney Lane's description of the duties of the job makes clear, the Vice President of Finance cannot reasonably be considered "an unnecessary layer within GSWC's organization structure."
For example, there is no dispute within the academic literature that in order to comply with § 404 of SOX by December 31, 2004 - as public companies like GSWC were required to do - the companies were required to conduct a detailed scrutiny of their accounting procedures and other internal control mechanisms and make changes where necessary. Darney-Lane's statement that the VP of Finance had to review 400 key controls in 2004, and about 250 in 2005 and thereafter, is consistent with a leading study on SOX compliance costs by CRA International that was cited by the Illinois Commerce Commission in a recent decision that we discuss in Section 7.2 of this decision.49
We also have little doubt that GSWC's financing needs demand a good deal of attention from the Vice President of Finance. As Darney Lane points out, the company's capital projects budget has grown from $16 million in 1995 to more than $60 million today, due largely to GSWC's infrastructure replacement needs. This has increased the need for executive oversight of financing activities:
The four-fold increase in GSWC's capital spending has created the need for increased financing activities. The current level of capital expenditures is about 3 times depreciation, resulting in a need to issue long term financing, debt or equity, nearly every year. These upward pressures on capital spending are driving the need for more executive oversight in the financing area. (Ex. 5, Darney-Lane, p. 35.)
We also have little doubt that the need to oversee in-house accounting and tax compliance (to avoid further restatements) require the attention of a senior executive like the Vice President of Finance.
Finally, we agree with Sprowls that Aslam's suggestion that the duties of the Vice President of Finance overlap with those of GSWC's CFO - and therefore the VP of Finance position is unnecessary - is without merit. In his rebuttal testimony, Sprowls explained the differences between the two positions as follows:
The formal title for the position is Chief Financial Officer, Senior Vice President of Finance and Secretary (`CFO, SVP-Finance & Secretary'). In an effort to save money, GSWC chose to combine the CFO position with the corporate Secretary position. Approximately 40% of the responsibilities of the CFO, SVP-Finance & Secretary position relate to the Secretary function. In addition, GSWC does not have an internal general counsel. The CFO, SVP-Finance & Secretary is also responsible for coordinating much of the work of the external general counsel. (Ex. 17, p. 19.)50
GSWC first hired a Tax Manager (who receives an annual salary of $127,000) in 2003, but this is the first time in the rate case cycle the company has sought authorization for this job.
In her direct testimony, Darney-Lane states that the position was created on the recommendation of PWHC, which replaced Arthur Anderson & Co. as GSWC's outside auditors in 2002. As part of the change in auditing firms, GSWC conducted a review of its income tax accounting. The income tax accounting had previously been handled by lower-level staff, and because of errors in their accounting for deferred income taxes, a restatement of the company's financial results for 2000 and 2001 became necessary. Based on this situation, GSWC's management concluded independently and was also advised by PWHC that "qualified tax staff should be added, specifically at the Tax Manager level." (Ex. 5, Darney-Lane, p. 29.)
Ms. Darney-Lane notes that the duties originally envisioned for the Tax Manager have increased since 2002, owing to the complexity of new tax legislation and new requirements of the Financial Accounting Standards Board (FASB). Darney-Lane also notes that "although this position was not created because of the Sarbanes-Oxley Act, the job has evolved and now is profoundly involved in compliance with the act." (Id.)
Consistent with its skepticism about most of the new SOX-related positions GSWC is seeking, DRA opposes authorization for a Tax Manager. In his report for DRA, Aslam states:
First, GSWC did not provide details regarding the nature, source, cause, and the remedial action relating to the so called internal control weakness in tax. DRA understands that utilities sometimes have to revise their financial statements, but GSWC did not show the same or similar problem would likely reoccur in the future. The fact that the GSWC's external auditor verbally made its recommendations for hiring a Tax Manger only validates the concern that the problem may not have been severe.
Further, the increasing complexities of Federal and State tax law are nothing new. Both Federal and State governments constantly revise, amend, and add to tax laws depending upon the current needs and policies of the day.
GSWC currently has one Tax Supervisor and two Tax Specialists in addition to the position of Controller and other Accounting staff. The existing level of staff handling tax related assignment appears sufficient. There is no need for adding an additional Tax Manager position. (Ex. 23, p. 2-19.)
Aslam also questions the need for a Tax Manager in view of the new tax software GSWC is buying, a purchase DRA does not oppose. (Id.)
In his rebuttal testimony, Mr. Sprowls takes issue with Aslam's assertion that GSWC should be able to deal with its tax problems using a tax supervisor, assisted by two tax specialists.51 On this question, Sprowls states:
While the specific titles may vary somewhat between public accounting firms and in industry, the general concept of four levels of staff is routinely applied by placement firms to the tax profession: entry-level (inexperienced staff), senior-level staff (experienced staff), manager/director level, and executive level (e.g., Vice President of Tax or Chief Tax Officer). To assert that a public company operating in the complex environment of regulation can support a tax function without adequate leadership (the role assumed at the tax manager level and above), including from a technical perspective, ignores the current accounting environment in which enterprises operate. (Ex. 11, p. 2.)
Sprowls also points out that tax law and compliance are usually considered separate disciplines from the work of the controller and other accounting staff:
While a Controller should possess some knowledge of tax-related matters, it has been well recognized in the accounting profession that taxes are a distinct and specialized discipline. For example, separate tax departments are established in accounting firms of significant size and tax professionals have responsibility to audit the tax-related items reported in financial statements. In addition, while a Controller should possess knowledge regarding the GAAP [Generally-Accepted Accounting Principles] accounting of taxes, most Controllers would recognize their limitation with respect to interpreting and applying tax law and would not venture into practicing outside of their areas of expertise. With respect to [the] `other Accounting staff' [referred to by Aslam,] none of the staff under the oversight of the Controller function in positions where tax knowledge is a requirement for their position. (Ex. 11, p. 2.)
In addition to arguing that a controller is no substitute for a Tax Manager, Sprowls notes that "a professional functioning in the capacity of a Tax Manager, with the requisite experience and expertise, is a `given' for a public company such as [GSWC]." (Id. at 3.) During cross-examination by the ALJ, Sprowls noted that income taxes are always challenging for a utility, and that when he joined the company in 2004, he was surprised to learn that GSWC had only recently hired a tax manager:
[G]etting your taxes correct for a utility that's got a lot of hard assets - you have timing differences between book and tax depreciation on these hard assets. It's a huge task to get it right. And it's important that you've got very capable people to get it done.
* * *
To be honest, I was very surprised that the company . . . didn't have a tax manager prior to 2003. It's . . . just a very difficult area. And you've got to have somebody with excellent technical expertise. (Tr. 969-70.)
Sprowls also takes issue with Aslam's assertion that the company's new tax software is an adequate substitute for a tax manager. According to Sprowls, a good tax manager is needed to use the software effectively, because "it is at times of implementing software solutions that the amount of past experience and the extent of technical knowledge come into play the most . . . Software is a tool of professionals, not a reason to justify an absence of staff at levels of higher proficiency." (Ex. 17, pp. 6-7.)
Finally, Sprowls takes strong exception to what he regards as Aslam's "cavalier" attitude toward the possibility of financial restatements, and his suggestion that a tax manager is not justified unless GSWC can show there is some likelihood of further restatements in the future. On these issues, Sprowls states:
Restating financials is an incredibly serious matter. DRA's comment reflects a cavalier, nonchalant attitude towards restatement, and its assertion that `GSWC did not show the same or similar problem would likely reoccur in the future' indicates a lack of awareness of developments in a post-SOX accounting world. DRA would have one believe that it would be acceptable to leave a gap in the leadership of the tax function because `restatements happen' and that unless it can be proven that another restatement or internal control weakness would occur by continuing to have a tax leadership position vacant, it is not necessary to fill it . . . [However,] it is incumbent upon Management to assess risk and act accordingly to prevent a reoccurrence of the internal control weakness in tax, not to continue with the same level of tax competency and hope that a similar problem is not likely to reoccur. (Id. at 4-5.)
In view of the need to restate its 2000 and 2001 financial results and the advice it received from PWHC that the company needed to hire a tax manager, we believe GSWC has provided an adequate justification for this position. Moreover, given the requirements of SOX § 404, we also find plausible Darney-Lane's argument that the duties of the Tax Manager have grown significantly since the position was created in 2002.
As Sprowls testified during cross-examination by the ALJ, the deferred income tax errors that led to the restatement of GSWC's financial results for 2000 and 2001 were not trivial:
Those amounts were in the neighborhood of $5 million. And in order to make the restatement, it affected the income statement as well as the balance sheet. These are balance sheet items, but to accommodate the restatement, you've got to take them through the income statement. So both the income statements for 2000 and 2001 for both Southern California Water and American States Water and the balance sheets for those two years were restated. (Tr. 961.)
During cross-examination, Sprowls also emphasized that SOX has made the work of the Tax Manager more difficult, because there is less room for error now:
What's happening in the tax area is: it used to be that, you know, you could take a pass on a quarterly basis getting your taxes right, as long as you got it right on an annual basis, because you had [a] cushion - tax cushion to move in and out. And that isn't the case anymore. With Sarbanes-Oxley, it has to be right every quarter. And that's why you're seeing three-, four-, five-fold increase[s] in restatements. (Id. at 965.)52
Although Sprowls conceded that GSWC is especially sensitive about restatements because of having to restate its 2000 and 2001 results, (id. at 964), we also agree with him that DRA's attitude toward the possibility of further restatements can fairly be characterized as "cavalier." As Sprowls noted, even though GSWC is a wholly-owned subsidiary of ASWC, it is nonetheless subject to SOX because it issues public debt. Moreover, the company's need to issue public debt is increasing, due largely to GSWC's ambitious infrastructure replacement program, particularly in Region II. In light of this, we agree with Sprowls that GSWC needs to take all reasonable efforts to maintain investor confidence by avoiding financial restatements, and that having a competent Tax Manager is an important step in that direction.
In her direct testimony, Darney-Lane offered the following justification for the new position of Financial Reporting Supervisor:
The organization under the Controller at the beginning of 2005 included one accounting supervisor with three staff reporting to this person, and one senior financial reporting analyst reporting to the Controller with no direct reports. Because of the significant changes over the past couple of years . . . the day-to-day responsibilities have varied depending on the availability of people and skill sets within the department. As work and issues come up, the work was allocated accordingly based primarily on individual skill sets.
* * *
However, this structure was not conducive to an effective department because of the fact we are a regulated entity. The monitoring and analysis of the utility plant area is a full time job and should have GO accounting staff devoted only to this area. This is the Company's biggest area (approx. 80% of total assets) and receives the most amount of attention from the external auditors, tax dept, regulatory affairs, CPUC and others. It was therefore suggested that the accounting department be split into two groups. [The] Controller would have two accounting supervisors as follows:
· Utility Plant Supervisor - in charge of all aspects of Utility Plant. This person would have one full time accountant reporting to them.
· Financial Reporting Supervisor - in-charge of all financial reporting and all other areas (excluding Utility Plant). This person would have three full time accountants reporting to them." (Ex. 5, Darney-Lane, pp. 30-31.)
In his report for DRA, Aslam accepts this justification and does not oppose the new position, which would pay $79,000 per year.
In light of the justification offered by GSWC and the lack of opposition by DRA, we will authorize this new position.
In her direct testimony, Darney-Lane states notes that GSWC is requesting one new Accountant, a "junior level" position that pays $68,307 annually, to add to the Financial Reporting Group within the Accounting and Finance Department. She notes that the workload of the Financial Reporting Group has increased significantly in recent years due to the need to monitor the effectiveness of internal controls required by SOX, greater regulatory complexity caused by things such as memorandum accounts, and "increases in non-regulated activities." (Ex. 5, Darney-Lane, p. 31.) Ms. Darney-Lane sums up the duties of the proposed new position as follows:
Currently, the Financial Reporting Group at the general office has one supervisor with two junior accountants reporting to the supervisor. The new junior accountant position will join this group and will assist with our ongoing compliance with Sarbanes-Oxley's Section 404 requirements and help reduce[] the workload of the other accountants in a fair and equitable manner which, in turn, will improve [the] efficiency and accuracy of the Department. (Id.)
In his report for DRA, Aslam opposes this position on the ground that GSWC already has enough staff to deal with the new issues SOX has created. Noting that the Accounting and Finance Department will soon have 26 employees (including the newly-authorized Financial Reporting Supervisor), Aslam argues that this is enough:
As a result [of the recent reorganization,] GSWC's Controller now has two Financial Reporting Supervisors and three junior accountants who assist the two Financial Reporting Supervisors. This arrangement gives the GSWC Controller adequate Financial Reporting staff to handle the increased workload that might have been created by the Sarbanes-Oxley Act. On the other hand, GSWC does have a position of a highly paid Controller who at the most part should be dealing with accounting related issue[s] herself. With this level of increased supporting staff, the contributions of the GSWC[] Controller itself becomes questionable. (Ex. 23, pp. 2-20 to 2-21.)
Because we have decided to split the costs of the new positions GSWC claims to need for SOX compliance between the company's shareholders and its ratepayers, we have decided to authorize this new position. Although he spends a great deal of his rebuttal testimony disputing various assumptions made by Aslam about the work of GSWC's Controller and its Accounting Department, Mr. Sprowls also offers the following SOX-based justification for the new Accountant position:
One of the main responsibilities of the new Accountant position will be to take over the numerous monthly bank reconciliations to be performed on a timely basis. There are over 20 bank reconciliations that need to be completed every month. This task alone involves significant time and effort and is considered a key control by both the Company and its external auditors from a Sarbanes-Oxley standpoint. In fact, during their quarterly reviews, our external auditors ([PWHC]) have informed us that the lack of timely bank reconciliations may have to be reported to the Audit Committee of the GSWC Board of Directors. Because of the significant increase in workload over the last couple of years, the preparation of timely bank reconciliations have at times fallen behind. We have attempted to allocate the completion of bank reconciliations to the existing two junior accountants while still balancing all other increased responsibilities. This has resulted in significant overtime and the use of temporary help. (Ex. 17, pp. 10-11.)
Combined with the rationale offered by Ms. Darney-Lane, we find this justification sufficient for the additional junior-level Accountant position.
Although this is a junior-level position paying $71,000 per year, the parties have devoted considerable attention to it because of DRA's assumptions about auditing responsibilities within GSWC.
In her direct testimony, Ms. Darney-Lane notes that this position is being sought at the direction of GSWC's Audit Committee:
The increased importance and emphasis on risk management and the monitoring of the effectiveness of internal controls over financial reporting, brought about by Sarbanes-Oxley, warrants this additional headcount. Approximately 25% of this position's job functions are related to our ongoing compliance with Sarbanes-Oxley's Section 404 requirements. The duties performed by this employee will greatly reduce the fees we currently pay to outside consultants (e.g., Jefferson Wells International, Robert Half, etc.) and should result in a net reduction in cost to the company. (Ex. 5, Darney-Lane, p. 32.)
In his report for DRA, Aslam opposes this position because he believes the auditing is performed for the benefit of GSWC's corporate parent - which he and Sprowls both refer to as "AWR" - rather than the SEC:
GSWC does not report to the [SEC] at the end of the year; it is AWR that is responsible for this financial reporting. GSWC's own organization chart does not depict these positions as having any reporting relations within the Accounting & Finance Department. The Audit Manager directly reports to the Board of Directors instead.
Therefore, DRA recommends disallowing not only the position of Internal Auditor, but also removing all labor expenses related to the other Internal Auditing staff: namely, the Audit Manager and Senior Auditor as well. (Ex. 23, p. 2-21.)
In his rebuttal testimony, Mr. Sprowls states that all of the assumptions behind Aslam's position on auditing are incorrect. After quoting the Aslam statement above, Sprowls states:
I disagree with Mr. Aslam's recommendation because his first two observations are incorrect[,] and there is an excellent reason justifying the situation contained in his third observation.
GSWC's internal auditing is not performed for the benefit of AWR, but is performed for the benefit of GSWC and its customers. It has been a standard practice in U.S. business to have an internal audit department long before the U.S. government passed [SOX]. Internal Audit departments have been in place to confirm that the procedures followed by regulated and competitive businesses were both effective and efficient. The requirements of SOX have made the need for an Internal Audit department even more critical. GSWC's Internal Audit Department has played a key role in assisting management in preparing GSWC to be compliant with SOX for 2004, 2005 and in the future . . .
Mr. Aslam is [also] incorrect in his observation that GSWC is not required to file its financial statements and associated disclosures with the SEC. GSWC has issued public debt in the past and many issues are still outstanding. GSWC's customers enjoy the benefit of lower financing costs as a result of public debt issuances. Since GSWC issues publicly-traded debt, it is required to make quarterly filings of its financial statements with the SEC along with the associated disclosures. GSWC is responsible for its financial reporting with the SEC, not AWR.
Mr. Aslam stated that the fact the Internal Audit Manager reports to the GSWC Board of Directors rather than to the Accounting & Finance Department is a reason for disallowing the expenses of the Internal Audit department. Technically, the Internal Audit Manager reports to the Audit Committee of the GSWC Board of Directors. For an internal audit department to be effective and for its audit reports to have credibility, it is critical that the department maintain its independence. A best practice for competitive and regulated companies is to have the internal audit department report directly to the Audit Committee of the Board of Directors to ensure its independence, which is how it is structured at GSWC. (Ex. 17, pp. 13-14.)
We accept these explanations by Mr. Sprowls. In addition, we note Ms. Darney-Lane's point that by adding a junior-level Internal Auditor, GSWC expects to save money by reducing consultant fees. Mr. Sprowls noted during cross-examination that when consulting firms provide an employee to a client on a temporary basis, they typically charge the client three times the amount they are paying the temporary employee. (Tr. at 971-72.) Thus, bringing the Internal Auditor position in-house makes sense.
8. DRA's Challenge to General Office Positions At Issue in A.02-11-007
In addition to its challenge to the 25 new general office positions that GSWC is seeking in this rate case, DRA also argues that eight of the general office positions that were approved in the company's last general office GRC, A.02-11-007, should be disallowed.
DRA acknowledges that there is nothing in D.04-03-039, the decision that resolved A.02-11-007, to indicate disapproval of these positions. However, DRA argues that the burden was on GSWC to justify these new positions, and that it failed to meet that burden:
When requesting new positions in the prior GRC, A.02-11-007, GSWC presented no supporting written testimonies; DRA was not informed that GSWC was requesting any new positions. The salary expenses for the new hires were embedded in the GSWC's forecasted labor expense and the positions were inserted into the organizational charts. The absence of supporting testimony for those new hires was not only deceiving but indicated the lack of justifications for the new positions. DRA now finds out that some of the positions added in this fashion make no practical and economical sense at all. DRA strongly protests this sort of evasiveness. GWC must present and justify all of its requests for additional expenses in a clear and detailed fashion.
The Commission's approval of an overall labor expense does not amount to the Commission approval of new positions that are unjustified and unsupported by specific written testimony. GSWC's elusive presentation deprives DRA of notice and due process and results in an incomplete and less than full record for the Commission's deliberations. (Ex. 23, pp. 2-26 to 2-27.)
8.1. DRA's Position
DRA's report identifies 19 general office positions with annual salaries totaling $1,169,204 that were subject to the allegedly stealthy tactics described above. As noted previously, DRA is challenging eight of these positions as unjustified, and asks that their salaries be disallowed in this GRC. The challenged positions and their respective annual salaries are: (1) System Programmer ($69,956), Risk Manager ($115,289), (3) Senior Human Resources (HR) Specialist ($62,243), (4) CIS Billing Specialist ($51,906), (5) Assistant Applications Support ($53,861), (6) Senior Financial Analyst ($85,365), (7) Financial Analyst ($68,000), and (8) Senior Auditor ($89,666). (Id. at 2-27 to 2-30.) The combined annual salaries of the challenged positions total $596,286.
In summary, DRA's reasons for challenging these positions are as follows:
· System Programmer - DRA argues this position is unnecessary because GSWC already has two Senior System Programmers, who receive regular technical help from outside vendors as well as GSWC's functional areas such as Accounting and Finance.
· Risk Manager - DRA opposes this position because the Risk Manager "mostly performs liaison services between GSWC and its outside Brokers and Third Party Claim[s] Administrator," both of whom are also well-paid. However, DRA does not oppose the subordinate position of Risk Analyst.
· Senior HR Specialist - DRA opposes this position because it believes GSWC's Human Resources Department is already adequately staffed.
· CIS Billing Specialist - DRA opposes this position in the department that handles GSWC's customer billing because there has not been enough customer growth to justify it, and more likely, the increase in GSWC's Non-regulated Billing Service Contracts [is] the most salient cause for this new position.
· Assistant Applications Support - DRA opposes this position because GSWC already has an Applications Support Manager with an Assistant and other personnel, in addition to receiving support from various vendors for the software installed throughout the company.
· Senior Financial Analyst - DRA opposes this job because GSWC already has one Senior Financial Analyst, in addition to a manager, supervisor, financial analyst and associate financial analyst in its Accounting & Finance Department.
· Financial Analyst - DRA also opposes this position because GSWC already has one Financial Analyst in the Accounting & Finance Department, and in DRA's view does not need another.
· Senior Auditor - Consistent with its position that all of GSWC's auditors ought to be considered employees of GSWC's parent company, AWR, DRA opposes this position.
8.2. GSWC's Position
Although the company's rebuttal testimony does not devote as much attention to the eight positions described above as to the new general office positions being sought in this GRC, the company argues that DRA is wrong on every job covered by D.04-03-039 that DRA is now challenging.
Four of the eight jobs are addressed in the rebuttal testimony of Robert Sprowls, and the other four in the rebuttal testimony of Joel Dickson. In brief, the company's rationale for the challenged positions is as follows:
· Risk Manager - Sprowls points out that GSWC's Risk Manager has many duties other than performing "liaison services" with outside insurance brokers and the third party claims administrator. These duties include (1) using knowledge in the fields of insurance, operations, finance and safety, among others, to reduce risks within the company, (2) managing damage and injury claims brought against the company by persons in its service area, and (3) preparing information for potential insurance carriers, since the company carries large amounts of insurance to cover claims involving its operations and $920 million of gross utility plant (including vehicles), even though GSWC self-insured for workers compensation. (Ex. 17, pp. 21-22.)
· Senior Financial Analyst and Financial Analyst - With respect to these positions, Sprowls argues that the duties of the company's Finance section have grown so much since 2002 that it is unreasonable to expect that the staff in place when A.02-11-007 was filed can meet all of these needs. For example, there is more need for help in securing short- and long-term debt, since GSWC's gross utility plant has grown from $731 million in 2002 to over $920 million today. Another example is the increased time that must be devoted to preparing quarterly and annual reports for the SEC since the passage of SOX. (Id. at 23-24.)
· Senior Auditor -- Although Sprowls does not specifically address this position, his opposition to DRA's position is implicit from his comments that under sound principles of corporate governance, the internal auditors of GSWC should and do report to the Audit Committee of GSWC's board of directors, rather than to the board of GSWC's corporate parent, AWR. (Id. at 12-14.)
In his rebuttal testimony, Mr. Dickson offers the following justifications for the following positions:
· System Programmer - Dickson argues that this position is needed to monitor and allocate capacity on GSWC's mainframe computer, which is "continually being stretched to its limits by the increased workload." In addition to this traffic management function, the System Programmer monitors access to files that GSWC's auditors consider crucial "from a fraud and sabotage perspective" to ensure SOX compliance. (Ex. 11, p. 77.)
· Senior Human Resource Specialist - Many of this position's duties relate to SOX, which has led to a need for more extensive background checks for both new hires and promotions, as well as numerous requests from the auditors during the quarterly audits of the Human Resource Department. There are also annual audits of three benefit plans administered by the department, which also has responsibility for helping with increased certification requirements for operators, and well as compliance with the Health Insurance Portability and Accountability Act (HIPPA). (Id. at 78-79.)
· CIS Billing Specialist - In response to DRA's argument that only one such position should be necessary, Dickson notes that one of the CIS Billing Specialists is responsible for generating customer bills on active accounts (including past-due notices), while the other handles closed account and bad debt collections, including the maintenance of relevant legal documents. (Id. at 80.)
· Assistant Applications Support Analyst - Dickson argues that GSWC does not currently have an Applications Support Manager, and that DRA does not understand the duties performed by the company's other personnel who work in applications support. The Applications Support Supervisor supervises the staff that prepares customer bills using the current CIS system, and the Senior Applications Support Analyst helps design, develop and test new systems needed within the company along with outside applications vendors. The Assistant Support Analyst, on the other hand, performs tasks required to administer the CIS system, including transferring customer revenue information, helping with audits, and providing second-level support for CIS trouble-shooting and configuration changes. (Id. at 81.)
8.3. Discussion
While we appreciate the clarification provided by Dickson and Sprowls about just what duties the challenged positions do perform, we agree with GSWC that DRA's challenge to these positions amounts to a collateral attack on D.04-03-039, and is therefore improper. As Dickson points out in his rebuttal testimony, while DRA "closely examined" total labor costs in A.02-11-007, it apparently did not request information about any of the new positions included within this total. In light of this, we agree with Dickson that DRA is improperly attempting to impose the standards that now apply to Class A water GRCs onto a case that was filed more than four and one-half years ago:
[A.02-11-007] was filed in the same manner as many earlier General Office filings. That is how the expectations were set and both the Company and DRA had a somewhat common degree of understanding of those expectations. To impugn purposeful deception with respect to traditional expectations does little to advance the efficient and effective process of rate setting. With the advent of the new Rate Case Plan[,] many of the old expectations have been changing and GSWC is readily adapting to them . . . The mandatory filing requirements, the master data requests, and the process of examining filings for deficiencies has changed the traditional way rate filings were made. In criticizing GSWC's previous filing, DRA is imposing the filing requirements of the new Rate Case Plan onto previous cases that were submitted and litigated under different rules and filing protocols. It is improper for the DRA to engage in this type of four year retrospective analysis of previous GRC proceedings. (Id. at 76-77.)
Accordingly, DRA's challenge to the eight general office positions described above is rejected.
9. Most of the Miscellaneous Disputed Issues Between GSWC and DRA Should Be Resolved in Favor of the Company
As noted in our discussion of the August 4, 2006 settlement stipulation between GSWC and DRA, there are a number of miscellaneous issues these two parties have left for resolution by the Commission, including general office rent, the proper amounts for insurance, and the amount of water usage that should be assumed for commercial customers. In this section, we discuss and resolve these issues.
9.1. Miscellaneous General Office Expenses Including Dues to Trade Organizations
As noted above and in ¶ 5.08 of the settlement stipulation, DRA and GSWC remain about $600,000 apart on the amount of proper miscellaneous expenses for the general office. Although they used different forecasting methodologies, a significant part of the difference between GSWC's position and DRA's concerns the dues paid to trade associations such as the National Association of Water Companies (NAWC), the California Foundation on the Environment and Economy (CFEE), and the American Council on Education (ACE). In his report for DRA, Aslam estimates that GSWC pays annual dues to NAWC of $121,857, to CFEE of $15,000, and to ACE of $1385 per year. (Ex. 23, p. 2-47.)
With respect to NAWC, Aslam contends that the dues payment should be excluded because NAWC's "sole purpose is political lobbying in the nation's Capitol." Aslam contends that GSWC's membership in CFEE, which he also characterizes as a lobbying organization, is redundant in view of the fact that the company is a member of the California Water Association, "which provides forums for sharing best practices, and promotes sound, reasonable, and science-based policy making by regulatory agencies," in addition to lobbying. (Id.) Finally, Aslam notes that GSWC's membership in ACE will be unnecessary if the Commission accepts DRA's recommendation to dissolve the EDU. (Id. at 47-48.)
In its opening brief, GSWC argues that DRA is wrong to argue that NAWC and CFEE engage solely in lobbying, and adds that "these expenses have been included in prior rate cases, and are allowed for other water utilities." (GSWC Opening Brief, p. 43.)
We agree with GSWC that its methodology for estimating the miscellaneous expenses for the general office is superior to that of DRA, and that all three of the above-noted dues payments should be allowed.53 Thus, we will allow the $2,009,400 that the company has requested as miscellaneous expenses for the general office in Test Year 2007.
9.2. General Office Rent
On this issue, the parties remain far apart: GSWC seeks $246,300 for general office rent, while DRA would allow $21,700. In its opening brief, GSWC argues:
GWC currently has a serious shortage of space. In fact, overcrowding in the General Office has forced several employees to telecommute . . . With the addition of the above-described requested positions, new space will be needed even more. GSWC needs the additional space because the company has grown in ways that simply could not have been anticipated . . . Besides the ordinary expansion of the business, GSWC's technological needs, training requirements, customer service requirements, and benefits and human resources initiative have all changed the Company's need for space. (GSWC Opening Brief, pp. 39-40; citations omitted.)
In its reply brief, DRA argues that the company's pleas for more space are unsupported, and that GSWC has not rebutted DRA's claim that the need for more general office space is really driven by the growth in GSWC's non-regulated businesses, especially ASUS. (DRA Reply Brief, pp. 34-35.)
On this issue, it appears to us that GSWC does indeed need more general office space, but that part of this need is driven - as DRA asserts - by the growth in the company's non-regulated businesses. As noted in our discussion of the new Call Center Support Analyst position the company is seeking, Mr. Dickson testified that GSWC wants to include only 69% of the salary for this position in rates; the rest is to be allocated to ASUS "new business." (Ex. 11, p. 53.) In her direct testimony, Ms. Darney-Lane states that one of the reasons GSWC needs a new Accountant is an increase in workload in the Financial Accounting Group due to, inter alia, "increases in non-regulated activities." (Ex. 5, Darney-Lane, p. 31.) These statements lend some credence to DRA's assertion that the growth in non-regulated businesses is a significant factor driving the need for new space, especially since GSWC's own customer growth is essentially flat.
In view of our conclusion that the need for new office space is driven partly by the growth in GSWC's non-regulated businesses, we will allow the company to include $184,725, or 75% of its rental space request, in rates for general office operations.54
9.3. Business Meals
In its report and opening brief, DRA argues that GSWC should be allowed $66,100 for general office meals, while the company seeks $89,300. Part of the difference relates to different forecasting methodologies; GSWC escalated the last two years of data, whereas DRA looked at 2001-2005 but excluded 2001 and 2005 as unrepresentative. However, another difference between the parties centers on whether ratepayers should be asked to pay for business meals where no travel is involved. (Ex. 23, p. 2-43; GSWC Opening Brief, p. 40; DRA Reply Brief, p. 35.)
On the meal issue, we think the arguments of both sides have some merit. DRA is correct that under the Rate Case Plan set forth in D.04-06-018, the utility is supposed to present (although it is not bound by) five years of data. The average of the five years of general office meal data set forth in DRA's report is $63,445.80. On the other hand, we know from common experience that meal expenses, especially at restaurants, have increased significantly since 2004. We also think that GSWC should not be bound by state government reimbursement rules for meals, under which lunch expense is generally recoverable only in connection with out-of-town travel. Taking all these factors into account, we will authorize GSWC $82,500 for general office meal expense.
9.4. Injury, Damage and Property Insurance
In their briefs, GSWC and DRA state that they remain far apart on how much should be allowed for the company's insurance needs. Although they have agreed that 79% of insurance costs should be expensed and 21% should be capitalized, for Test Year 2007 the company is seeking $3,157,000 for injury and damage insurance, while DRA would allow $2,869,000. For property insurance, GSWC requests $456,000, while DRA would allow $382,300 (which includes zero for excess property insurance).
Basically, DRA is seeking a reduction of 11.69%55 in most insurance categories because of what DRA characterizes as an apples-and-oranges comparison. DRA claims that when it compared the company's actual insurance costs for 2005 with those that had been budgeted, the former amount was 11.69% less. Using an escalation factor, DRA based its recommendation for GSWC's insurance costs in Test Year 2007 on the actual data for 2005.
However, in his rebuttal testimony, GSWC's Keith Switzer asserts that DRA has erred, because it ended up comparing the actual insurance costs for GSWC's 2004-2005 fiscal year (which ran from October 1, 2004 to September 30, 2005) with the insurance budget for calendar year 2005. (Ex. 13, pp. 38-39.) Switzer acknowledges, however, that if DRA had properly compared the amount budgeted for calendar year 2005 with the amount actually spent on insurance in calendar year 2005, the latter would have been about 8% lower. (Id. at 39.)
Switzer continues, however, that no reduction in what GSWC has requested is appropriate, because the company's request for Test Year 2007 is based upon a reasonable escalation of its actual insurance expenses for 2005:
Even if you accept DRA's basic premise that the 2005 recorded costs were 12.52 percent less than the 2005 budgeted costs, the Commission should not reduce GSWC's request for future year costs by the same 12.52 percent. The reason is that GSWC's request for year[s] 2006, 2007, and 2008 are not based on the 2005 budget, but rather are tied to the 2005 recorded costs. Thus, GSWC's request already incorporates and reflects the lower 2005 recorded costs, not the 2005 budget costs.
As shown in Mr. Brewer's testimony [Exhibit 5], the 2005/2006 budget is based on the 2004/2005 actual data plus adjustments for known or projected changes and inflation. Thus, the fact that 2005 recorded costs were less than budgeted has been carried forward into the future test years. A couple of examples will illustrate my point.
General Liability Insurance: As shown in the DRA workpaper [Exhibit 44], the 2005 budget amount for this coverage was $303,000. The 2004/2005 actual cost shown in Mr. Brewer's Prepared Testimony was $242,500. GSWC's budget for the 2006 transition year is $247,000 and for the 2007 Test Year, GSWC requested [$]255,398.
Umbrella Liability: As shown in the DRA workpaper, the 2005 budget amount for this coverage was $733,000. The 2004/2005 actual costs shown in Mr. Brewer's Prepared Testimony was $561,000. GSWC's budget for the 2006 transition year is $562,000, and for the 2007 Test Year, GSWC requested $581,108.
Fiduciary Liability Insurance: As shown in the DRA workpaper, the 2005 budget amount for this coverage was $25,000. The 2004/2005 actual costs shown in Mr. Brewer's Prepared Testimony was $10,500. GSWC's budget for the 2006 transition year is $11,000, and for the 2007 Test Year, GSWC requested $11,374. (Id. at 40-41.)
We have compared Exhibit 44 with the amounts for 2004/2005 and 2006 shown in Mr. Brewer's testimony (Ex. 5, Brewer, p. 5), and find Mr. Switzer's assertions to be accurate. In view of the fact that the actual results for the 2004/2005 insurance year are the foundation for the injury and damage insurance requests GSWC has made here for Test Year 2007, we agree with Switzer that no reduction is appropriate. Thus, we will allow GSWC the full "stipulated" amounts shown as the company's position for 2007 in ¶ 5.02 of the August 4, 2006 stipulation between GSWC and DRA.56
With respect to property insurance, DRA has recommended not only the 11.69% reduction explained above, but also a group of individual adjustments that Mr. Switzer discusses separately in his rebuttal testimony. We agree with Mr. Switzer that none of these individual adjustments are justified, and thus we will allow GSWC the full amounts for Test Year 2007 shown as the company's position in the "proposed" column in the table that accompanies ¶ 5.03 of the August 4, 2006 stipulation.
9.5. Sales per Commercial Class Customer in Region II
Although the parties were able to reach a stipulation as to virtually all issues for Region II, they remain significantly apart on the forecasted usage for Region II commercial customers in Test Year 2007. As the prepared testimony and cross-examination show, the basis for this disagreement is the meaning of certain language in the "New Committee Method" and "Standard Practice No. U-25" and the supplement thereto, which the Rate Case Plan directs be used for such forecasting. GSWC's forecasted water use for commercial customers is 271.1 Ccf57 per year, while DRA's is 279.9 Ccf per year. According to GSWC, the difference amounts to $1.8 million in total operating revenues for each year. (GSWC Opening Brief, p. 1.)
In practical terms, the parties have reached these different positions because DRA concluded that under the applicable forecasting authorities, it was appropriate and proper to eliminate the data for two periods: (1) July 2001 to June 2002, which DRA considered to be an abnormally dry year, and (2) July 2004 to June 2005, which DRA considered to be an abnormally wet year.
In its rebuttal testimony (Exhibit 19) and briefs, GSWC argues that what DRA did was an unacceptable deviation from the New Committee Method and Standard Practice No. U-25 (as supplemented), as well as a statistically-improper way to conduct a regression analysis. As to the requirements of the Rate Case Plan, GSWC's opening brief states:
None of the changes DRA made are in keeping with the requirements of the Rate Case Plan. First, DRA removed the July 2001-June 2002 data on the ground that this period was the driest season in Los Angeles' history . . . However, under the new Rate Case Plan, DRA could only remove data if it occurred during a `recognized drought period.' Examples in the Rate Case Plan of recognized drought periods are when sales restrictions like rationing are imposed[,] or when the Commission provides the utility with sales adjustment compensation like a drought memorandum account. Importantly, DRA admits that neither sales restrictions nor sales adjustment compensation was implemented during the July 2001-June 2002 period . . .
Second, DRA removed the July 2004-June 2005 data on the ground that this period was the wettest season in Los Angeles' history . . . However, the Rate Case Plan does not provide for removing data for wet periods. Rather, the New Committee Method provides that rainfall in excess of four inches in a given month should be set at four inches in all the data used in the regression analysis [which GSWC states it did in its own analysis.] In that way, the data is adjusted to eliminate the impact of unusually wet months. Indeed, DRA followed the New Committee Method in all of its regressions and set rainfall at four inches in any month where actual rainfall exceeded that amount . . . (GSWC Opening Brief, pp. 2-3; citations omitted.)
GSWC also attacks the regression analysis that DRA conducted for replacing the two years of data that DRA removed with zeroes. On this question, GSWC states:
Moreover, the method DRA employed for removing data that it found to be objectionable and replaced that data with zeroes is inconsistent with basic regression analyses. Nowhere does the New Committee Method authorize replacing the data for usage, rainfall and temperature with zeroes in dry or wet years, as DRA has done. Merely replacing data with zeroes implies that the usage was zero, and there was no rain in that time period. Obviously, that makes no sense.
In addition, this technique of zeroing out real observations biased the results of DRA's model. Replacing the dependent and two of the independent variables with zeroes has the effect of artificially increasing the reliability measure of the regression . . . As shown in GSWC witness Adam Rue's rebuttal testimony, Exhibit 9, if GSWC added two years of zeroed data for usage, rain and temperature to its regressions, the resulting R-square value - which is a statistical measure that indicates the level of confidence in the results of the regression - exceeds the value DRA obtained . . . (Id. at 3-4; citations omitted.)
In its briefs, DRA does not take issue with GSWC's description of what it did in the regression analyses, but asserts that its adjustments are not forbidden under the Rate Case Plan, the New Committee Method, and Standard Practice No. U-25 as supplemented. (DRA Opening Brief, pp. 51-53; DRA Reply Brief, pp. 2-4.)
We agree with GSWC that DRA's approach of eliminating the 2001-2002 and 2004-2005 years, and then replacing the data for those years with zeroes, is not permissible under the approach adopted in the Rate Case Plan, nor is it consistent with correct statistical techniques. During the cross-examination of Victor Moon, DRA's witness, Mr. Moon could only point to his many years of experience as a justification for removing the years he considered abnormally dry and abnormally wet. However, even though experience is valuable, it is not a substitute for proper methodology when the authorities adopted for forecasting purposes in the Rate Case Plan - the New Committee Method and Standard Practice No. U-25 as supplemented - specify what constitutes a "recognized drought year," and also specify how the data for wet years is to be accounted for.
It is also clear that DRA's decision to replace the data for the omitted years with zeroes biased its regression analysis. Under recognized statistical techniques, DRA should have used only eight years of data to conduct its regression analysis, instead of the eight years of actual observations and two years of zeroes that it did employ.
In view of the errors in DRA's implementation of the forecasting methodology adopted in the Rate Case Plan, we will employ GSWC's forecast of 271.1 Ccf per year as the water usage of Region II commercial customers, rather than DRA's forecast of 279.9 Ccf per year.
9.6. Dividend Equivalent Rights
In ¶ 5.04 of the August 4, 2006 stipulation, GSWC and DRA reached a settlement on most of their differences concerning pension and benefit issues for the general office. However, there are two issues on which the parties require a Commission decision: the propriety of dividend equivalent rights (DERs), and on what GSWC refers to as its Annual Incentive Bonus program.
It is important to note that these compensation programs affect different management levels within the company. According to Joel Dickson, who presented the company's case on both issues, all those with the title of manager are eligible for the Annual Incentive Bonus program. DERs, on the other hand, are restricted to officers; i.e., those with the title of vice president or above. (Ex. 11, p. 86.) For DERs, the company requests that $406,100 be included in rates, while DRA advocates zero.
In his report for DRA, Aslam gives the following justification for his position:
Currently, the GSWC allows an additional compensation program in the form of Stock Option Compensation for its executives. However, in addition, GSWC also allows its executives to receive dividends while these stocks are not cashed in. GSWC failed to justify the reasonableness of imposing such an extra burden on ratepayers who are already paying for the high executive salaries and their stock options. Therefore, DRA recommends excluding these expenses from ratemaking calculations. The shareholders should bear the burden of these DER programs, which do not benefit the ratepayers. (Ex. 23, p. 2-42.)
In his testimony, Mr. Dickson disagrees with these assertions. He argues that that in order to attract and retain top executives, GSWC must offer competitive pay packages, and that DERs are part of an executive's total direct compensation. He also contends that according to a study he conducted comparing the total direct compensation of GSWC's five top executives with that of their peers at other, reasonably comparable water utilities, GSWC's compensation packages are just at the level they should be.
The results of Dickson's study are set forth in Exhibit 7 to his rebuttal testimony and are, he says, based upon "the compensation data used by GSWC's Board of Directors in their determination of executive pay." (Ex. 11, p. 83.) Dickson states that he assumed the larger the company, the larger the compensation it pays. He then describes the other assumptions behind his study:
The measurement of compensation I used to test this theory [of size versus compensation] was total direct compensation. Total direct compensation is defined as salary, bonus, and stock ownership through restricted stock or options including DERs. This is the most accurate measure of compensation for the peer group[,] as each Company may provide less compensation in the form of salary and more compensation in the form of options. Therefore any measure of compensation that does not include all direct compensation is a less accurate way of comparing relative compensation. GSWC's use of DERs as compensation is included in the definition of total direct compensation. (Id.; emphasis supplied.)
Dickson also looked at gross revenues, total assets and market capitalization for the utilities he considered comparable, and discovered that GSWC, which stood third with respect to each measure, was at the 71st percentile. He also ran a regression analysis which confirmed that for the five most highly-paid executives at each company, compensation was closely correlated with company size as measured by these three parameters. Dickson then plotted GSWC's compensation on charts to see where it ranked in relation to it size; i.e., at the 71st percentile. He continues:
If GSWC's total compensation on a position by position comparison were significantly above the 71st percentile, then it could be concluded that that GSWC executive compensation is [unacceptably] `high'. What I found is that [it] plotted near the 71st percentile. In fact, [Table 4 of Exhibit 7] shows that in total for the five most highly compensated positions[,] GSWC is exactly at the 71st percentile. The conclusion is that Mr. Aslam is wrong and GSWC executive salaries are not high. The salaries are right in line with its peer group and it can be concluded that GSWC compensation is at market. (Id. at 84.)
Since Dickson's analysis was set forth in rebuttal testimony, Aslam did not have an opportunity to submit a written response to it, nor was he cross-examined on his own position. However, DRA's reply brief, while not taking issue with the specifics of Dickson's analysis, argues that he has failed to show "a direct correlation between a drop in compensation below market levels at GSWC has caused the los[s] of `key individuals.' The notion that GSWC would have a hard time finding or retaining employees that are already handsomely compensated lacks credibility." (DRA Reply Brief, pp. 36-37.)
After examining Dickson's testimony and the tables set forth in Exhibit 7 to his testimony, we find GSWC's analysis of the DER issue to be persuasive. We agree with Dickson that GSWC needs to offer competitive pay packages to attract and retain talented executives. We also agree with him that total direct compensation is a good measure for comparing compensation among executives. As Dickson notes, his study includes DERs within this measure. It is also apparent from the tables in Exhibit 7 to Dickson's testimony that among the water utilities with which it is most comparable, GSWC relies more on stock options and DERs and less on base salaries and bonuses to determine total direct compensation. (Ex. 11, Appendix 7, Tables 5-9, 11.)58
Accordingly, we agree with Dickson's overall conclusion that the value of DERs included within GSWC's total direct compensation for executives is not unreasonable, does not constitute an "extra burden on ratepayers," and should be allowed in rates.
9.7. Annual Incentive Bonuses
As noted above, persons employed by GSWC who have attained the rank of manager are eligible for the Annual Incentive Bonus program. Under the terms of the August 4, 2006 stipulation between GSWC and DRA, the company would allow $990,000 for this program, while DRA would allow zero.
In his rebuttal testimony, Mr. Dickson notes that managers are eligible for a bonus equal to 12.5% of their salary "if certain measurable outcomes are met." The program specifies eight measurable outcomes, and for each one that is met on a company-wide basis, "the manager can receive 1/8th of 12.5%." (Ex. 11, p. 85.) Dickson describes the eight measurable outcomes as follows:
Establishing a downward trend in the complaint-to-customer ratio for complaints reported to the CPUC or DHS as compared to the previous year;
Achieving the CPUC-adopted return on shareholder investment;
Providing on average at least 20 hours of training per employee per year;
Improving communication and credibility of regional and district management by meeting with community leaders in the communities GSWC serves at least eight times per year for district managers and twice per year for all other regional management;
Maintaining operational and administrative costs no greater than the regulatory authorities' composite inflationary rate;
Maintaining a variance of not greater than 5% of CPUC-authorized operation and maintenance expenses and plant investment;
Pumping all water rights available and adhering to the annual energy resource plan in order to ensure the lowest supply costs possible;
Increasing leadership roles on industry boards, water district boards, AWWA committees and AWWARF research projects to cover basic areas of treatment, distribution, human resources and management, in order to keep abreast of best practices within the industry. (Id. at 85-86.)
Dickson argues that under the Annual Incentive Bonus program, "GSWC has provided incentives to its managers to perform in ways that keep costs down for customers. It is this group of managers that are tasked to live within the cost[s] adopted in the rate cases. Several of the measurable outcomes are tied directly to what comes out of the ratemaking process." (Id. at 86.)
In his report for DRA, Aslam opposes the Annual Incentive Bonus program, along with several others, on the ground that it needlessly burdens ratepayers:
GSWC's current salary levels are very competitive and for the most part are toward the higher end of the industry average. DRA already recommends the Discretionary Bonus program. However, any additional complementary compensation program will unfairly burden the ratepayers, and therefore, should be excluded from the ratemaking process. The shareholders [should] bear the burden for these complementary programs if the GSWC believes them useful. (Ex. 23, p. 2-42.)
We conclude that the Annual Incentive Bonus program should be funded only partly by ratepayers. As noted above, Dickson defends the program (which is apparently a new one) on the ground that "GSWC has provided incentives to its managers to perform in ways that keep costs down for customers." However, from an examination of the eight "measurable outcomes" Dickson sets forth, it seems clear that shareholders rather than ratepayers will be the principal beneficiaries of three of them (Outcome Nos. 2, 5 and 6). Under these circumstances, we believe ratepayers should be asked to fund only five-eighths (5/8) of the $990,000 GSWC has requested for the program, or $618,750.
9.8. DRA Computational Error
On page 16 of the stipulation between DRA and GSWC, in ¶ 5.04, there is a notation that a dispute arose between the parties after hearings concerning the amount that should be allowed for "Management Initiatives, Succession Planning, and Training," which is considered a general office pension and benefits issue. GSWC believes the correct amount for this item should be $353,000, while DRA asserts it should be $247,300.
In GSWC's Opening Brief, the company explains the dispute as follows:
Both parties' forecasts were the result of the separate methodologies they applied to derive each of the 28 line items that comprise Pension and Benefits costs. Upon reviewing DRA's report, GSWC accepted DRA's recommendation for this item and did not submit rebuttal testimony.
Most of these line items have been settled by accepting DRA's estimate. DRA now wants to lower its recommendation . . . to the amount requested by GSWC. But to do so would not make sense. DRA's recommended amount of $353,000 was the result of its methodology, and is not believed to be in error. It's that same DRA methodology that produced DRA's recommendation for all the other line items, and the parties have settled by accepting DRA's numbers. DRA's recommendation for this line item should stand. (GSWC Opening Brief, pp. 43-44.)
In its reply brief, DRA urges us to ignore GSWC's argument on the ground this was an issue the ALJ was supposed to resolve at the "true-up" hearing scheduled for September 11-12, 2006. DRA states, however, that its $353,000 recommendation was the result of "Mr. Aslam's proofreading error." (DRA Reply Brief, p. 39.)
For reasons explained in D.06-12-017, the true-up hearing was canceled, so we must now resolve the issue here. (D.06-12-017, mimeo. at 5.) For two reasons, we conclude that DRA should be bound by its original estimate of $353,000, even if that estimate was in error. First, GSWC alleges and DRA does not dispute that the company relied on DRA's original forecast in settling most of the Pension and Benefit issues. Second, although it is not entirely clear from their testimony that Messrs. Dickson and Aslam are talking about the same issue presented here, the annual figure that both of them use for Management Initiatives, Succession Planning and Training in their respective discussions of whether the EDU should be retained - $318,723 per year - is closer to DRA's original forecast here of $353,000 than to the $247,300 DRA is now advocating. (Ex. 23, p. 2-16; Ex. 11, pp. 74-75.) This suggests to us that the higher figure on which GSWC settled is not unreasonable.
In view of the many pension and benefit issues that GSWC settled using DRA's original forecast, we think it would be unreasonable to change now the number on which the parties settled the MIS&T issue.
9.9. When the General Office Case Should Be Filed
In their testimony and briefs, DRA and GSWC differed sharply over when the next general office GRC should be filed. GSWC contended that it would be more efficient to file the general office GRC along with its rate case for Region II, whereas DRA took the position that it made more sense to file the general office GRC along with the rate case for Region III, as specified in the Rate Case Plan. (See, e.g., GSWC Opening Brief, p. 43; DRA Reply Brief, pp. 38-39.)
In view of the issuance of D.07-05-062, this issue is now moot. Under the Revised Rate Case Plan adopted in that decision, GSWC has been instructed to file its next general office GRC along with its rate cases for Regions II and III on July 1, 2008, and the next general office GRC after that on July 1, 2011. (See Appendix A, pp. A-17 to A-18.)59
10. Categorization and Need for Hearing
In Resolution ALJ 176-3168, the Commission preliminarily determined the category of this proceeding to be ratemaking, and that a hearing was necessary. In our opinion today, we affirm that categorization. As noted earlier in the text of this decision, hearings in this matter were held on June 26-30 and July 6, 11 and 12, 2006.
11. Comments on Proposed Decision
The proposed decision of the assigned ALJ in this matter was mailed to the parties in accordance with Section 311 of the Public Utilities Code and Rule 14.3 of the Commission's Rules of Practice and Procedure. Opening comments were filed on August 13, 2007, and reply comments were filed on August 20, 2007.
In response to these comments, we have substantially revised section 4.3.5 (dealing with the interim cost allocation methodology) and section 6.3 (which increases the fine to $50,000). Other changes have also been made to the text where appropriate.
John A. Bohn is the assigned Commissioner and A. Kirk McKenzie is the assigned ALJ in this proceeding.
1. On August 4, 2006, DRA and GSWC filed a motion to adopt a joint stipulation that resolves most of the issues between them concerning GSWC's Region II, and some of the issues between them relating to GSWC's general office operations.
2. The cost of capital set forth in ¶ 10.04 of the August 4, 2006 stipulation, including the 10.1% return on equity, is reasonable and should be adopted.
3. The overhead rates and the methodology for refiguring them that are set forth in ¶¶ 2.01, 2.02 and 2.15 of the August 4, 2006 stipulation are reasonable and should be adopted.
4. The agreement between DRA and GSWC as to the general office pension and benefit expenses set forth in ¶ 5.02 of the August 4, 2006 stipulation are reasonable and should be adopted.
5. Apart from the stipulated office expenses described in ¶ 5.10 of the August 4, 2006 joint stipulation between GSWC and DRA (which should be rejected), the other agreements between GSWC and DRA set forth in said stipulation are reasonable and should be adopted.
6. The Commission should not accept DRA's recommendation that GSWC's general office revenue requirement be reduced by $2,957,438 for each of the three years covered by this GRC due to "missed allocations" required by D.98-06-068, because (a) the $101,300 revenue adjustment made by the Commission in D.04-03-039 was intended to serve as a proxy for the allocations that DRA contends should have occurred, and (b) in addition to this revenue adjustment, D.04-03-039 ordered GSWC to conduct a cost allocation study and present it in this general office GRC.
7. The Commission should not accept DRA's recommendation that 18.21% of GSWC's general office expenses that are not subject to being directly charged should be allocated to GSWC's non-regulated affiliates, because (a) such an approach would result in cost allocations well in excess of the revenues that these non-regulated affiliates generate, and (b) DRA did not consistently follow the four-factor cost allocation methodology the Commission has traditionally used, but instead added and subtracted allocation factors as DRA saw fit.
8. The Commission should not accept GSWC's recommendation to allocate nearly half of the company's costs that cannot be directly charged on the basis of single allocation factors, because, among other reasons, the Commission has rarely sanctioned the use of single allocation factors.
9. As a general rule, the Commission has departed from the traditional four-factor cost allocation methodology only where it is shown that use of the four-factor methodology would produce unreasonably skewed results in a particular case.
10. In D.03-05-078, the Commission approved the use of three allocation factors rather than four where it was demonstrated that using one of the traditional factors, the number of customers, would tend to shift an unreasonable share of the costs of the corporate parent of a water company onto the water company's ratepayers and away from its non-regulated affiliates.
11. The number of employees, which is the single factor GSWC proposes to use for allocating between itself and its affiliates, representing nearly 40% of the general office costs that cannot be charged directly, would produce skewed results in this case because, while GSWC's unregulated affiliates have few employees now, they are likely to experience significant growth in their operations and number of employees within the next few years.
12. Under the circumstances described in the preceding Finding of Fact (FOF), using the number of employees of GSWC and its affiliates as the sole determinant for allocating 40% of the company's general office costs would not present a fair picture of the demands that GSWC's unregulated affiliates are likely to place on the company's personnel.
13. In conducting its own cost allocation study, GSWC unreasonably assumed that its affiliate, ASUS, had only 11 customers, an assumption that is inconsistent with the approach the Commission approved in D.03-05-078.
14. In conducting its allocation study, DRA unreasonably assumed that ASUS had 74,270 customers, an assumption that is not justified in view of the wide variability of the services furnished by ASUS to the entities with which it has contracts.
15. The cost allocation factors that should be used to allocate general office costs between GSWC and its affiliates in this case are (a) total labor costs, (b) total expenses, and (c) a number of customers that is appropriately weighted to reflect the services that the entity being studied provides to its customers or clients.
16. It is reasonable to use total labor costs as a factor for allocating general office costs between GSWC and its affiliates because total labor costs reflect the nature and extent of the work actually performed for the entity under consideration, whoever the employer of the persons performing the work may be. Thus, using total labor costs gives a more accurate picture of the size of the enterprise being studied.
17. It is reasonable to use total expenses as a factor for allocating general office costs between GSWC and its affiliates because total expenses give a more accurate picture of the total work undertaken by the entity being studied, more illuminating than the entity's total revenue or gross plant.
18. A proper cost allocation study in this case must include a method for assigning to each of the entities with which GSWC's affiliate ASUS has a service contract, an assumed number of retail customers that is appropriately weighted to reflect the services ASUS provides under the contract.
19. For contracts where ASUS is providing services to a military base, it is appropriate to assume that each of the base's connections is equivalent to a full retail customer.
20. With respect to contracts where ASUS provides less-than-full utility services, an appropriate weighted number of retail customers can be developed using the ratios that O&M expenses minus supply costs, A&G expenses, amortization and depreciation, and taxes paid by GSWC have borne to GSWC's net operating revenues (minus supply costs and costs of capital) in recent rate cases.
21. Table 3 of Attachment B sets forth appropriate O&M, A&G, Amortization and Depreciation, and Tax percentages to use in determining the appropriate weighted number of retail customers to assume for each non-military ASUS contract.
22. Table 2 of Attachment B sets forth the derivation of the appropriate weighted number of retail customers to assume for each ASUS contract with a non-military customer.
23. Using the three-factor cost allocation methodology described in FOF 15 to 22 above, Table 1 of Attachment B sets forth the percentages of GSWC general office expenses that should be allocated to GSWC and its various affiliates, in cases where a particular general office expense cannot be charged directly.
24. The CIS system that GSWC currently uses has significant limitations in terms of the programming language it uses, the documentation available for the system, the cost of making modifications to the system, and the time necessary for vendors to make such changes.
25. The CIS system that GSWC currently uses cannot be modified to meet modern business needs in a cost- effective manner, such as the need for mobile computing, Internet access to account information, knowledge management and data exchanges with other utilities.
26. The new CIS/CRM system for which GSWC seeks approval here would not be subject to the above limitations, and would offer advantages such as reducing training time for customer service representatives, lower vendor costs, and better control of business rule changes, including those related to SOX.
27. The $9.1 million that GSWC is seeking here for the new CIS/CRM is only an estimate, based on what GSWC witness Andres describes as "standard high level pricing models of two independent vendor-consultants." More exact costs will not be available until GSWC issues an RFP in connection with the CIS/CRM system.
28. DRA opposes funding for the CIS/CRM system in this rate case because of the vagueness of GSWC's cost estimate, as well as concerns that the system will be used in large part to serve customers in GSWC's non-regulated businesses.
29. Because of the vagueness of GSWC's cost estimates for the proposed new CIS/CRM system, it is appropriate to approve only the $2.983 million (before overheads) that the company proposes to spend in connection with the CIS/CRM system in 2006.
30. In order to recover any additional costs for the CIS/CRM system, GSWC should be required to file a Tier 3 advice letter that sets forth the additional information concerning use of the CIS/CRM system required by this decision.
31. GSWC contends that 11 factors have changed the regulatory landscape and significantly increased the general office workload in a way not suggested by normal customer growth, including (a) a large increase in infrastructure replacement, (b) the need to apply for low-cost financing under Proposition 50, (c) increasingly stringent and complex water quality standards, (d) an increased number of water quality lawsuits, (e) increased certification requirements for water system operators, which has made it more difficult to retain qualified personnel, (f) increased water company security requirements in the post 9/11 world, (g) new legislation requiring comprehensive urban water management plans and proof of water supplies to serve new housing projects, (h) increased water basin adjudication and management needs, (i) electric power procurement associated with BVEC, (j) new requirements on management and business procedures imposed by SOX, and (k) regulatory changes including the requirements of the Commission's new Rate Case Plan.
32. The new general office position of Senior Vice President-Operations is necessary due to the need for (a) senior management coordination of GSWC's geographically far-flung operations, (b) senior management oversight of the company's ambitious capital construction program and water supply planning, (c) proper implementation of new water quality rules and timely construction of new treatment facilities, and (d) compliance with SOX requirements by providing a review point and control structure for regional financial and capital projects accounting.
33. The new general office position of Capital Projects Manager-Operations is needed due to the large growth in GSWC's capital projects budget since 1996, and with it the commensurate need for a senior construction manager who can provide increased coordination in soliciting bids, scheduling work on the increased number of projects, and ensuring compliance with more complex engineering and permitting requirements. Regional management of construction projects within GSWC is no longer an optimal model.
34. The new general office position of Administrative Support Analyst-Operations is necessary due to the need to provide support on documentation and statistical analysis to the Capital Projects Manager.
35. The new general office position of Assistant Application Support Analyst-Operations is necessary due to the need to make efficient use of GSWC's new Project Control System, which includes software that tracks and generates reports on the status of capital projects, including project milestones, resources, budgets, costs, etc. At the present time, GSWC outsources this function.
36. The new general office position of General Clerk-Information Technology is necessary due to the need to process manually payments that GSWC is receiving in more varied forms than in the past, including through payment agencies, banks and financial institutions such as CheckFree and EPrinceton.ecom. This position may not be needed once the proposed new CIS/CRM system is on-line.
37. The new general office position of Assistant Information Technology Manager-Information Technology is necessary due to the need for an in-house security officer who can ensure the security of GSWC's hardware, software and data bases. At present, GSWC relies on outside contractors to provide these services.
38. The new general office position of New System Administrator-Developer-Customer Service is necessary due to the need for an in-house capability to document change management and maintain the integrity of program code in the existing CIS system, and help with deployment of the proposed new CIS/CRM system.
39. Three new CSRs, a general office position, are needed due to the increase in the average amount of time that customer service calls require, the high turnover rate among temporary CSRs, the lower costs of hiring permanent CSRs rather than temporaries, and the need to maintain GSWC's current standard of call response time.
40. The new general office position of Call Center Support Analyst is needed to free up the time of the Customer Service Supervisor so that he or she can focus on the training and coaching of GSWC's 24 CSRs.
41. The new general office position of Applications Support Manager-Applications Support is necessary due to the need for overall direction of the choice of software among GSWC's various departments and segments. At present, the company only has a Senior Applications Support Analyst, who works with departments to provide the departments with the software they want.
42. The new general office position of Communications, Media and Technical Generalist is necessary due to the need for an experienced employee in media communications who can help inform customers, communities and employees of GSWC concerning water conservation, low-income programs, and particular capital improvement projects, especially during high-profile media situations.
43. The new general office position of Corporate Communications Manager is not needed because GSWC already has ample experience with and means of communicating with its employees, customers and shareholders.
44. The MIS&T costs that GSWC incurs to train its senior management are separate and distinct from the Management Development costs the company's EDU incurs to train qualified entry-level supervisors for the company.
45. Because of GSWC's company size and geographic diversity, it would incur substantial AWWA costs whether or not the EDU existed.
46. DRA's critique of the EDU's cost-effectiveness takes into account only the costs of developing and presenting classes, and leaves out the costs of making needs assessments, following up to be sure that training is properly applied, and evaluating whether particular training classes are effective.
47. Turning to outside vendors for training rather than having the EDU would not be cost-effective for GSWC, because no single vendor or group of vendors offers all of the courses that the company needs and EDU provides.
48. It is doubtful that any outside vendor would offer some of the courses that GSWC needs for some of its prospective employees, including courses in basic technical writing and basic mathematics.
49. DRA has failed to demonstrate that the EDU program is not a cost-effective way of providing the training and courses that EDU provides.
50. The new general office position of EDU Facilitator-Instructor is necessary due to the need to provide continuing education and training in the technical areas of water operations and management, which requires skills in engineering, management, teaching and curriculum design and development in addition to substantive technical knowledge on water, environmental, and health and safety issues.
51. The new general office position of EDU Support Analyst is necessary due to the expanded administrative responsibilities within EDU that this position will perform, including management of a comprehensive data base with employee information concerning safety, annual training, tuition reimbursement, operator certification records with the California DHS, and SOX compliance.
52. GSWC has not demonstrated that the general office position of EDU Senior Employee Development Specialist, which is currently a half-time position, needs to be authorized as a full-time position to comply with SOX requirements. If GSWC still wishes to make this a full-time position, it should present a full justification for doing so in the company's next general office GRC.
53. The new general office position of Associate Rate Analyst is needed due to the increased filing requirements and milestones for rate cases adopted by the Commission in D.04-06-018, as revised in D.07-05-062. This position will be in GSWC's Regulatory Affairs Department, which has not increased in headcount since 1996.
54. The new general office position of EPRP Coordinator is necessary due to the need under the PHBR Act to keep emergency response plans for water utilities updated and to provide table top training sessions concerning them. GSWC's existing Safety Specialist and Regional Managers do not have the time or training to meet these requirements.
55. The Commission specifically warned GSWC in D.04-03-039 that it was not permissible to wait until the submission of rebuttal testimony to present the main justification for significant new proposals.
56. The principal justification for many of the new general office positions discussed in FOF 32-54 was not set forth by GSWC until the company submitted its rebuttal testimony on June 9, 2006.
57. Even though DRA timely propounded 92 data requests to GSWC in connection with the company's rebuttal testimony, responses to many of these data requests were not received until June 24, 2006, two days before hearings were scheduled to begin.
58. No litigation team the size of DRA's in this case could reasonably be expected to digest and work into proposed cross-examination the volume of data responses that GSWC delivered to DRA on June 23-24, 2006.
59. Under the schedule the parties had agreed upon for this rate case, the filing of surrebuttal testimony was not a reasonable option for DRA.
60. DRA was prejudiced in its preparation for cross-examination of GSWC's witnesses by the company's actions in withholding until rebuttal testimony the detailed justification for many of the requested new positions, and by responding to DRA's data requests such a short time before hearings were scheduled to begin.
61. In view of the prejudice to DRA described above, it is reasonable to conclude that DRA's cross-examination of GSWC's witnesses was not as effective as it might otherwise have been.
62. In a Commission GRC, the burden is on the utility to prove that it is entitled to rate relief, and not upon the Commission, the Commission's staff or interested parties to prove that the utility is not entitled to such relief.
63. In various decisions over the years, the Commission has admonished utilities besides GSWC that it is improper to withhold the principal justification for new proposals until the submission of rebuttal testimony.
64. We are approving some of the positions described in FOF 32-42, 44-51 and 53-54 despite lingering doubts about the need for some of these positions.
65. In light of the factors set forth in FOF 55-64, it is appropriate to impose on GSWC an overall reduction of 10% in the amount of salary the company should be allowed to recover in rates due to the new general office positions described in FOF 32-54.
66. The new general office position of Vice President of Finance, Treasurer and Assistant Secretary is needed largely to enable GSWC to comply with the requirements of SOX, including (a) supervision of the detailed work needed to ensure that GSWC's CEO and CFO can certify the company's financial statements as required by SOX § 302, (b) assessing 16 mega accounting processes and 250 key controls so that GSWC's management can certify the effectiveness of its internal controls as required by SOX § 404, and (c) ensuring company compliance with SEC rules so that the CEO and CFO can provide the certification required by SOX § 906. In addition, the Vice President of Finance, Treasurer and Assistant Secretary oversees the company's financing needs and tax compliance and serves as a liaison between the departments that handle GSWC's accounting and regulatory affairs.
67. The new general office position of Tax Manager is needed to facilitate GSWC's compliance with SOX, including the need to avoid having to restate the company's financial results, as GSWC was required to do for the years 2000 and 2001. Public utilities like GSWC normally have Tax Managers, and the company's Controller does not have the necessary tax expertise. Even though the Tax Manager position was created at GSWC in 2002, before the passage of SOX, it is now needed largely to ensure compliance with SOX and avoid restatements, the vast majority of which are now due to tax errors.
68. The new general office position of Financial Reporting Supervisor is needed due to the reorganization of the Controller's Department, with one supervisor responsible only for utility plant and the other responsible for all other aspects of financial reporting.
69. The new general office position of Accountant, an entry-level position, is needed due to the general increase in workload of GSWC's Financial Reporting Group, and in particular with GSWC's need for more timely monthly bank reconciliations, which are a key internal control for SOX § 404 purposes.
70. The new general office position of Internal Auditor, a junior-level position, is needed due to GSWC's increased emphasis on risk management and the increased workload created by the requirements of SOX § 404. This position will report to the Internal Audit Manager, who in turns reports to the Audit Committee of GSWC's Board of Directors.
71. The state public utilities commissions of Illinois and Arizona have recently held that because SOX was enacted principally to protect shareholders, the costs of a utility's compliance with SOX should be split equally between the utility's shareholders and its ratepayers.
72. DRA has not shown that in A.02-11-007, it requested any information concerning any of the following positions that were included within GSWC's total general office labor costs in that proceeding: System Programmer, Risk Manager, Senior HR Specialist, CIS Billing Specialist, Assistant Applications Support Analyst, Senior Financial Analyst, Financial Analyst, and Senior Auditor.
73. GSWC's methodology for estimating its general office miscellaneous expenses is superior to that of DRA, and the dues GSWC proposes to pay to NAWC, CFEE, and ACE are reasonable.
74. Part of GSWC's need for more office space for general office purposes appears to be attributable to the growth in the company's non-regulated businesses.
75. The increase in restaurant prices in recent years means that using a five-year average of meal expenses to forecast meal expenses for 2007 will understate the reasonable amount of such expenses.
76. GSWC used its actual insurance expenses for the fiscal year running from October 1, 2004 to September 30, 2005, and then escalated these expenses, to arrive at its forecasts of injury, property and damage insurance for Test Year 2007.
77. GSWC's estimates of injury, property and damage insurance for Test Year 2007 are reasonable.
78. DRA's estimate of GSWC's injury, property and damage insurance expense for Test Year 2007 is unreasonable.
79. Under the New Committee Method and Standard Practice No. U-25 as supplemented, which were adopted in D.04-06-018 for water consumption forecasting purposes, it was not permissible for DRA to remove from the 10 years of data that it studied for estimating the consumption of GSWC's Region II commercial customers, the data for years running from July 2001 to June 2002 and July 2004 to June 2005.
80. Under generally-accepted standards for running regression analyses, it was not acceptable for DRA to replace the data for the two years described in the foregoing FOF with zeroes. Instead, it would have been proper for DRA to have run the regression analysis using only the eight years of data that DRA considered valid.
81. Total direct compensation, which consists of salary, bonus, and stock ownership through restricted stock or stock options that include DERs, are a good measure for comparing executive compensation from one water utility to another.
82. The study conducted by Joel Dickson demonstrates that in determining total direct compensation for its senior executives, GSWC places more reliance on stock options and DERS and less on salary and bonus than do other comparable water utilities.
83. When measured by market capitalization, gross revenues or total assets, GSWC ranks at the 71st percentile of the water utilities Dickson studied.
84. GSWC's total direct compensation for its senior executives as a group ranks at the 71st percentile of the group of water utilities that Dickson studied.
85. The expense for DERs that GSWC included in its estimate of general office pension and benefit expense for Test Year 2007 is reasonable.
86. Only five of the eight criteria that GSWC uses to award bonuses to managers under its proposed Annual Incentive Bonus program directly benefit GSWC's ratepayers; the other three criteria benefit mainly the company's shareholders.
87. GSWC settled most of its contested general office pension and benefit issues with DRA, and chose not to submit rebuttal testimony on these issues, in reliance upon DRA's forecast of the pension and benefit expenses.
88. In D.07-05-062, the Commission revised the Rate Case Plan to provide, among other things, that GSWC should file its next general office GRC along with its GRCs for Regions II and III on July 1, 2008.
1. Apart from the allocation of expenses set forth in ¶ 5.10 of the August 4, 2006 stipulation, the terms of that stipulation are reasonable, consistent with law and in the public interest, and should therefore be adopted.
2. The stipulation concerning certain office expenses set forth in ¶ 5.10 of the August 4, 2006 stipulation should be rejected.
3. The percentages set forth in Table 1 of Attachment B should be used to allocate, as between GSWC and its affiliates, general office expenses that cannot be charged directly to a particular entity.
4. In order to recover any additional costs for the CIS/CRM system beyond the $2.983 million authorized in this decision, GSWC should be required to file a Tier 3 advice letter in which it demonstrates that (a) the new system is designed principally to meet the needs of GSWC's customers, (b) any excess capacity in the system is designed to allow for growth in the number of such customers plus any additional applications GSWC's customers may need during the useful life of the new CIS/CRM system, and (c) GSWC has developed an adequate methodology for charging to GSWC's affiliates a share of the CIS/CRM system's total costs (including overheads) that is fully proportionate to the demands these affiliates place upon the CIS/CRM system while it still has excess capacity to serve these affiliates.
5. The following new general office positions requested by GSWC should be authorized for inclusion in rates, subject to the ten percent (10%) reduction described in FOF 65: (a) Senior Vice President-Operations, (b) Capital Projects Manager-Operations, (c) Administrative Support Analyst-Operations, (d) Assistant Application Support Analyst-Operations, (e) General Clerk-Information Technology, (f) Assistant Information Technology Manager-Information Technology, (g) New System Administrator-Developer-Customer Service, (h) three Customer Service Representatives, (i) Applications Support Manager-Applications Support, (j) Communications, Media and Technical Generalist, (k) EDU Facilitator-Instructor, (l) EDU Support Analyst, (m) Associate Rate Analyst, (n) EPRP Coordinator, and (o) Internal Auditor.
6. Sixty-nine percent (69%) of the salary and benefits for the new general office position of Call Center Support Analyst should be authorized for inclusion in rates, subject to the ten percent (10%) reduction described in FOF 65.
7. GSWC should not be authorized to include the salary and benefits of the proposed Corporate Communications Manager in rates.
8. DRA's recommendation to dissolve GSWC's EDU and transfer its Dean and Senior Employee Development Specialist to the company's Human Resources Department should be rejected.
9. GSWC should not be authorized to make the EDU Senior Employee Development Specialist, which is currently a half-time general office position for rate purposes, into a full-time general office position.
10. Because DRA did not request any information in A.02-11-007 concerning the following positions included within GSWC's total general office labor costs in that proceeding, DRA's recommendation to disallow these positions in this rate case should be rejected: System Programmer, Risk Manager, Senior HR Specialist, CIS Billing Specialist, Assistant Applications Support Analyst, Senior Financial Analyst, Financial Analyst, and Senior Auditor.
11. GSWC should be authorized to include $2,009,400 in general office rates for miscellaneous expenses in 2007, consistent with the estimate set forth in ¶ 5.08 of the August 4, 2006 stipulation between GSWC and DRA.
12. GSWC should be authorized to include $184,725 in general office rates for general office rental expenses in 2007, which is 75% of the amount shown as GSWC's request in ¶ 5.12 of the August 4, 2006 stipulation between GSWC and DRA.
13. In place of the figures set forth in ¶ 5.05 of the August 4, 2006 stipulation between GSWC and DRA, the company should be authorized to include $82,500 in rates as the reasonable cost of general office meal expenses for 2007.
14. DRA's proposed individual adjustments to GSWC's property damage estimate for 2007 are unreasonable and should be rejected.
15. GSWC should be authorized to include in rates its estimates for injury, property and damage insurance for Test Year 2007 shown in ¶ 5.02 of the August 4, 2006 stipulation between GSWC and DRA.
16. Because of DRA's unreasonable decision to eliminate two years of data and run its regression analysis with eight years of actual data and two years-worth of zeroes, GSWC's forecast of 271.1 Ccf per year of water usage for commercial customers in Region II should be adopted.
17. GSWC should be authorized to include in rates its estimate of general office DER expense for Test Year 2007.
18. GSWC should be authorized to include $618,750 in rates for its proposed Annual Incentive Bonus program, which is five-eighths (5/8) of the amount the company proposed and that is set forth in ¶ 5.04 of the August 4, 2006 stipulation between GSWC and DRA.
19. In view of GSWC's reliance upon it and decision to forego the submission of rebuttal testimony based upon it, DRA's original estimate of $353,000 as the pension and benefit expense attributable to GSWC's Management Initiatives, Succession Planning and Training program should be used, even if that estimate was the result of an arithmetic error.
20. In view of the schedule for the Revised Water Rate Case Plan adopted by the Commission in D.07-05-062, the issue between DRA and GSWC as to when the latter should be required to file its general office GRC is now moot.
21. Pursuant to Public Utilities Code Section 2108, GSWC's failure to disclose until rebuttal testimony its justification for at least 10 of the 20 new general office positions is considered a separate offense, for a total of 10 offenses.
22. Pursuant to Public Utilities Code Section 2107, the Commission may fine GSWC anywhere in the range of $5,000 to $200,000 for its failure to disclose until rebuttal testimony its justification for requesting at least half of the 20 new general office positions.
23. The ALJ Ruling denying DRA Motion to Strike, issued July 12, 2006, should be affirmed.
24. Pursuant to paragraph 9 of the July 26, 2005 stipulation between SCWC and DRA, which stipulation was approved in D.06-01-025 and attached thereto as Appendix B, GSWC should be authorized to include in its Region III rates for Escalation Years 2007 and 2008, the 39.49% share of general office costs attributable to Region III found reasonable in this decision. Such share should be determined after proper allocations of general office costs have first been made to ASUS, CCWC and BVEC in the manner directed by this decision.
25. Pursuant to paragraph 2.15 of the August 4, 2006 stipulation between GSWC and DRA, GSWC should be authorized to develop, in consultation with DRA, a methodology to allocate the balance of the Overhead Pool Account, whether negative or positive, to work orders at the end of each year. The objective of this methodology should be to achieve a zeroing out of the Overhead Pool Account. Such methodology should allocate the balance on the Overhead Pool Account to jobs in all three of GSWC's regions. The methodology thus developed should not be implemented without the prior approval of DRA, and shall remain in effect only for the three years covered by this rate case cycle.
IT IS ORDERED that:
1. The earnings and rates for Test Year 2007 calculated in conformance with this decision, as set forth in Attachment C to this decision, are authorized. Golden State Water Company (GSWC) is authorized to file, in accordance with General Order (GO) 96-B, and to make effective on no less than five days' advance notice, a tariff containing the Test Year 2007 increase as provided in this decision. Consistent with Decision (D.) 06-12-017, these revised rates shall be deemed effective as of January 1, 2007, and shall be adjusted upward or downward to conform with the provisions of D.06-12-017.
2. Subject to pro forma tests after the 2007 increases are effective, GSWC is authorized to file in accordance with GO 96-B, and to make effective on not less than five days' advance notice, a tariff setting rates for years 2008 and 2009, calculated in conformance with this decision. The revised rates shall apply to service rendered on and after the effective date.
3. Except for the amounts set forth in paragraph 5.10 thereof, the terms of the Joint Stipulation filed by GSWC and the Division of Ratepayer Advocates (DRA) on August 4, 2006, which stipulation is annexed to this decision as Attachment A, are adopted.
4. The terms of paragraph 5.10 of the Joint Stipulation filed by GSWC and DRA on August 4, 2006 are rejected.
5. Pursuant to paragraph 2.15 of the Joint Stipulation filed by GSWC and DRA on August 4, 2006, the following overhead rates for capital budget items should be used instead of the rates set forth in paragraph 2.01 of said Joint Stipulation: 24.68% in 2006, 26.06% in 2007, and 25.88% in 2008.
6. For the purpose of allocating general office costs that are not susceptible to being directly allocated, GSWC shall use the allocation factors set forth in Table 1 of Attachment B to this decision, as well as the cost allocation methodology set forth in this decision.
7. By this decision, GSWC is authorized to spend no more than $2,982,841.00 (before overheads) for the purpose of beginning the acquisition and implementation of the proposed new Customer Information /Customer Relationship Management (CIS/CRM) system. In order to recover any additional amounts for the CIS/CRM system, GSWC shall be required to submit a Tier 3 advice letter as set forth in GO 96-B that satisfied the criteria set forth in Conclusion of Law (COL) 3.
8. GSWC is authorized to include in rates, the salaries, benefits and related overheads of the new general office positions enumerated in COL 4 and 5 of this decision.
9. GSWC may continue to include in rates the following general office positions, which were part of the general office labor increase approved by the Commission in D.04-03-039: System Programmer, Risk Manager, Senior Human Resources Specialist, CIS Billing Specialist, Assistant Applications Support Analyst, Senior Financial Analyst, Financial Analyst, and Senior Auditor.
10. GSWC is authorized to include in rates, the amounts allowed in COL 12 through 20 of this decision with respect to the miscellaneous issues on which GSWC and DRA were not able to reach a stipulation.
11. We intend to fine GSWC $50,000, payable to the General Fund.
12. We direct Water Division to issue an Order to Show Cause for Commission consideration within 60 days of the effective date of this decision as to why GSWC should not be fined $50,000 for its conduct in this proceeding.
13. We direct Water Division to prosecute this Order to Show Cause.
14. Issues considered in the Order to Show Cause shall be considered adjudicatory and thus subject to a ban on ex parte communications.
15. The Administrative Law Judge's Ruling Denying Motion of Division of Ratepayer Advocates to Strike Rebuttal testimony, issued on July 12, 2006 in this proceeding, is affirmed.
16. Volumes 4 and 5 of the February 2006 General Office workpapers that GSWC submitted along with its application in this proceeding are admitted into the evidence as Exhibits 63 and 64, respectively.
17. Exhibits 63 and 64, which were submitted under seal along with the application as part of GSWC's General Office Workpapers in February 2006, shall remain under seal through December 31, 2009, and during that period shall not be made accessible or disclosed to anyone other than the Commission staff except on further order of the Commission, the assigned Commissioner, the assigned Administrative Law Judge (ALJ), or the ALJ designated as Law and Motion Judge. If GSWC believes that further protection of all or part of the information in Exhibits 63 and 64 is needed after December 31, 2009, then GSWC shall file a motion stating the justification for further withholding of such material from public inspection, or for such other relief as the Commission's rules may then provide. Such a motion shall explain with specificity why the designated materials still need protection in light of the passage of time involved, and shall attach a clearly-identified copy of the relevant ordering paragraphs of this decision to the motion. Such motion shall be filed no later than 30 days before the expiration of this protective order.
18. In compliance with COL 24 of this decision, GSWC shall include in its Region III rates for Escalation years 2007 and 2008, the 39.59% share of the general office costs for Region III approved in this decision.
19. GSWC shall develop, in a manner consistent with the requirements of COL 25, a methodology for allocating the balance in the Overhead Pool Account among the jobs in GSWC's three regions.
20. Application 06-02-023 is closed.
This order is effective today.
Dated October 18, 2007, at San Francisco, California.
MICHAEL R. PEEVEY
President
DIAN M. GRUENEICH
JOHN A. BOHN
RACHELLE B. CHONG
TIMOTHY ALAN SIMON
Commissioners
46 According to Robert J. Sprowls, the company's CFO, Senior Vice President of Finance and Secretary, GSWC is considered a public company because it issues debt in its own name, even though GSWC is also a wholly-owned subsidiary of ASWC. (Tr. 915.)
47 In the rest of her testimony, Darney-Lane often refers to this position simply as the "Vice President of Finance" or "VP of Finance." For the sake of brevity, we will use these terms as well.
48 The Vice President of Finance position is now held by Eva Tang. See Exhibit 16, p. 1.
49 The 2006 update to the CRA International study, which is referred to in the Illinois Commission's decision as the "Charles River Associates" study, is entitled Sarbanes-Oxley Section 404 Costs and Implementation Issues: Spring 2006 Survey Update. It can be found on the web at www.s-oxinternalcontrolsinfo.com/pdfs/CRA_III.pdf. The Fall 2005 update to this study had found that for "smaller companies" such as GSWC (which are defined as those with market capitalizations between $75 million and $700 million), the number of controls tested in 2005 declined significantly from the number tested in 2004, the first year in which such companies had to be in compliance with SOX § 404. On the question of how many controls are being tested, the Spring 2006 update states:
[T]he Fall 2005 Survey found that an expected decline in the number of key controls tested, reflecting the benefits of experience, and greater reliance on the work of others[,] would also tend to reduce costs. For Smaller Companies, the number of key controls tested by auditors decline more than 21 percent on average from 262 to 206 from year one [2004] to year two [2005] . . . Both Smaller and Larger Companies' management also reduced their own testing of key controls. (Spring 2006 Update, pp. 4-5.)
50 In his rebuttal, Sprowls also takes issue with Aslam's assertion that GSWC's controller should be reporting to the CFO rather than the Vice President of Finance. (Ex. 23, p. 2-22.) On this question, Sprowls states that having the controller report to the VP of Finance "gives management additional assurance that [accounting] errors will be caught," thus reducing the risk of further financial restatements. (Ex. 11, p. 20.)
51 On cross-examination, Sprowls stated that the Tax Supervisor who was with the company when the deferred income tax errors were discovered left sometime in 2002 or 2003. He was succeeded by the Tax Manager in August 2003. (Tr. at 903.)
52 At another point in the cross-examination, Sprowls noted that "the leading cause of restatements is in the tax area." (Id. at 964.)
53 This is consistent with our decision in section 6.2.13.4 of this decision not to dissolve the EDU.
54 DRA is also correct when it asserts that GSWC has erred in claiming that "DRA does not dispute, especially if GSWC's requested positions are granted, that additional space is badly needed." (DRA Reply Brief at 35, quoting GSWC Opening Brief at 40.) In fact, what Aslam stated in his DRA report was as follows:
[A]s discussed earlier in this Report, the need for [a] `fully staffed' Customers Service [Center] is growing due to GSWC's involvement in Non-regulated businesses and not due to increases of its regulated California operations . . . [I]f DRA's recommendations to close the EDU are adopted, more space will become available. Last, if DRA recommendations to reduce the staff level at the General Office are approved, this will also increase the availability of space at the General Office. (Ex. 23, pp. 2-49 to 2-50.)
55 This is the percentage used by DRA in both its opening and reply briefs, based on corrections Aslam made during the hearing. (See DRA Opening Brief at 42; DRA Reply Brief at 7-8.) However, the settlement stipulation filed on August 4, 2006 states that DRA reduced GSWC's forecasted amount by 12.52%. (¶ 5.02.) Although it does not matter in view of our resolution of the issue, we assume the 11.69% figure is the correct one.
56 As shown in the table that accompanies ¶ 5.02 of the stipulation, GSWC and DRA reached a settlement with respect to the DM&A Administrative Fee, the Brokers Administrative fee paid to Marsh, and the loss reserve for workers compensation. We approve the settlement amounts shown for these items.
57 "Ccf" stands for 100 cubic feet of water.
58 Among the eight companies Dickson surveyed - as measured by market capitalization, total revenues or total assets - GSWC's corporate parent, AWR, ranked third, behind Cal Water and ahead of San Jose Water Company (SJW). It is noteworthy that among the five most highly-paid executives at these three companies, GSWC relies significantly more on stock options (including DERs) and less on salary and bonus than do Cal Water and SJW. Moreover, GSWC's five top executives receive a total of $597,000 in stock options, DERs and restricted stock (which only the CEO receives), while the amount in controversy between GSWC and DRA in this case on the DER issue is $406,100.
59 At pages 17-24 of its opening comments on the PD, GSWC has raised various concerns relating to the PD's resolution of issues including the Annual Incentive Bonus Program, the recovery of the Low Income Program balance, and general office rent. To the extent they are not addressed in this decision, we find these concerns either to be without merit, or to be covered by provisions of the August 4, 2006 stipulation that are clear and essentially self-executing.
