13. Urgent Need for Ongoing Independent Audits
13.1. Summary
The record in this proceeding does not show that Great Oaks has had its financial records audited by an independent Certified Public Accountant (CPA) with utility client experience.27 We are very concerned that the financial records in this proceeding may not be reliable and may not state the true financial position of the company. We therefore cannot independently know with the usual certainty whether Great Oaks has been earning its authorized return,28 has unreported debt obligations, or has been correctly accounting for its operations in accordance with generally accepted accounting standards and compliance with prior Commission decisions. (It is not DRA's obligation to perform such an audit; any examination by DRA is more likely to focus on the reasonableness and prudence of management actions and is not intended to substitute for an independent CPA's examination of Great Oak's financial statements.)
We believe that audited financial statements are invaluable not just for the protection of shareholders in publicly traded companies but equally for the protection of customers of any monopoly public utility. Audited financial statements provide a highly reliable foundation for cost of service rate regulation.
We have the inherent authority to order a jurisdictional utility to undertake an independent audit in order to ensure that "(a)ll charges demanded or received by any public utility...for any product or commodity furnished or to be furnished or any service rendered or to be rendered shall be just and reasonable." (Pub. Util. Code § 451.) Second, we have the authority to order an audit to ensure that Great Oaks maintains its accounts in proper conformance with Pub. Util. Code § 792.29 Third, we have the authority under Pub. Util. Code § 701 to order an audit to ensure that we are able to effectively and efficiently exercise our jurisdiction.30 Fourth, Pub. Util. Code § 701.10 specifies that the Commission must ensure that it authorizes adequate rates31 and therefore it must have access to independent reliable financial statements. And finally, Pub. Util. Code
§ 727.5(c)32 allows the Commission to authorize rate recovery of any cost necessary to ensure stable rates. An independent audit will provide the necessary information to determine whether the utility is earning an adequate return and spending funds as authorized by the Commission.
We therefore order Great Oaks to engage an independent CPA, with utility client experience, to perform a full and complete audit of the company beginning with all transactions as of January 1, 2009. Great Oaks must continue to be audited annually, indefinitely, unless or until this order is rescinded. We authorize Great Oaks to establish a CPA Audit Cost Memorandum Account. Upon providing full and complete records as described herein, and satisfying this Commission that it acted prudently in engaging an independent CPA and cooperated fully at all times during the examination, it may amortize the reasonable costs in rates.
13.2. Selecting an Independent CPA
A CPA is a person who has met the requirements of California state law and has been issued a license to practice public accounting by the California Board of Accountancy.33 The selected CPA must be authorized by the California Board of Accountancy to perform a full range of accounting services including signing reports on attest engagements. Attest engagements include an audit, a review of financial statements, or an examination of prospective financial information. (See California Board of Accountancy.34) This CPA must further be authorized by Great Oaks to disclose any and all information to the Commission that was acquired, developed, or otherwise used in the course of the audit engagement subject to the Commission's rules on confidentiality. (See General Order (GO) 66-C.35) It is our intention that the CPA perform an audit examination of Great Oaks' accounting records to formulate an opinion on the financial statements. The CPA must follow generally accepted auditing standards.36 Great Oaks must solicit audit proposals and bids from multiple CPA firms that are currently licensed to practice, and already possess recent experience in auditing regulated utilities in California, and are independent (as defined by the auditing standards) and therefore able to formulate an opinion.
Any time that Great Oaks undertakes to change a CPA for an audit required by this decision, Great Oaks must submit its request for proposals and, subsequently, copies of all bids to the Commission's Division of Water and Audits within 10 days of issuance or receipt, respectively. Great Oaks must prepare and submit to the Division of Water and Audits a written summary of its evaluation of the proposals and all the criteria applied to the selection process within 21 days after selecting a CPA.
We require that Great Oaks file a Tier 2 advice letter for preapproval of its selection process to engage a CPA. Great Oaks may solicit and retain a CPA for multiple annual audits; the preapproval sought by advice letter may cover that multi-year period. The advice letter must include the information required above, as well as any other justifications for the selection, the scope of the audit engagement, the engagement letter, and the cost of the audit engagement. Following preapproval, Great Oaks must submit a copy of an executed engagement letter to the Division of Water and Audits within 10 days of its execution. These documents shall all be confidential pursuant to GO 66-C.
The 2009 and 2010 audited financial statements, the related disclosures,37 and attest opinion of the CPA must be completed and submitted to the Division of Water and Audits on or before October 31, 2011. Thereafter, the annual audited financial statements, related disclosures, and attest opinion of the CPA must be filed with the Division of Water and Audits (or successor organization) annually on or before March 31 of the subsequent year beginning on March 31, 2012 for calendar year 2011 concurrent with the Annual Report required by GO 104-A.
13.3. CPA Audit Cost Memorandum Account
Great Oaks may establish a CPA Audit Cost Memorandum Account to record for subsequent recovery the reasonable costs of the required annual independent audits of its financial records.
The CPA Audit Cost Memorandum Account shall accrue interest using 1/12 of the most recent month's interest rate on Commercial Paper (prime, three months), published in the Federal Reserve Statistical Release, G.13. The company may file a Tier 3 advice letter to amortize reasonable costs recorded in the memorandum account concurrent with other balancing accounts' or memorandum accounts' recovery on an annual basis.
27 No audited financial statements are on file with the Commission nor were any included in this application or A.09-09-001, the pending general rate case.
28 See the discussion, for example, at Transcript 150-154 where it is not clear and accurate in the record what the company is earning over time on an actual rate of return basis or the precise causes of fluctuations in expenses and earnings.
29 Section 792. "The commission may establish a system of accounts to be kept by the public utilities subject to its jurisdiction, or classify such public utilities and establish a system of accounts for each class, and may prescribe the manner in which such accounts shall be kept. It may also prescribe the forms of accounts, records, and memoranda to be kept by such public utilities, including the accounts, records, and memoranda of the movement of traffic as well as the receipts and expenditures of moneys, and any other forms, records, and memoranda which in the judgment of the commission may be necessary to carry out any of the provisions of this part.
30 Section 701. The commission may supervise and regulate every public utility in the State and may do all things, whether specifically designated in this part or in addition thereto, which are necessary and convenient in the exercise of such power and jurisdiction.
31 Section 701.10. The policy of the State of California is that rates and charges established by the Commission for water service provided by water corporations shall do all of the following:
(a) Provide revenues and earnings sufficient to afford the utility an opportunity to earn a reasonable return on its used and useful investment, to attract capital for investment on reasonable terms and to ensure the financial integrity of the utility.
(b) Minimize the long-term cost of reliable water service to water customers.
(c) Provide appropriate incentives to water utilities and customers for conservation of water resources.
(d) Provide for equity between present and future users of water service.
(e) Promote the long-term stabilization of rates in order to avoid steep increases in rates.
(f) Be based on the cost of providing the water service including, to the extent consistent with the above policies, appropriate coverage of fixed costs with fixed revenues.
32 Section 727.5(c). The commission shall consider, and may authorize, a water corporation to establish a balancing account, rate stabilization fund, or other contingency fund, the purpose of which shall be the long-term stabilization of water rates.
33 See, Business and Professions Code §§ 5070-5079. ( http://www.leginfo.ca.gov/cgi-bin/displaycode?section=bpc&group=05001-06000&file=5070-5079).
34 http://www.dca.ca.gov/cba/index.shtml
35 http://162.15.7.24/Published/Graphics/644.pdf
36 Generally Accepted Auditing Standards are sets of standards against which the quality of audits are performed and may be judged, which were developed by the American Institute of Certified Public Accountants, and which consist of general standards, standards of field work, and standards of reporting, along with interpretations. (See,
http://www.aicpa.org/Storage/Resources/Standards/DownloadableDocuments/
AU-00150.PDF).
37 Audited financial statements must disclose all significant information that would be of interest to a concerned investor, creditor, or buyer. Among the types of information that must be disclosed are accounting policies employed, litigation in progress, lease information, and details of pension plan funding. In addition, accounting practices applicable to a particular industry and any other unusual applications of accounting principles are disclosed.
