XV. Penalties

Pursuant to the Commission's Rules of Practice and Procedure, Rules 1 and 1.5, and Pub. Util. Code § 2107, DRA, the City, and the District request monetary penalties be assessed against San Gabriel.

In D.98-12-075, Standards of Conduct Governing Relationships Between Energy Utilities and Their Affiliates, we compiled "the principles that the Commission has historically relied upon in assessing fines and restates them in a manner that will form the analytical foundation for future decisions in which fines are assessed." (84 CPUC 2d 155, 193.) The decision is concerned with energy utilities and their affiliates, but it explains the principles the Commission utilizes in determining fines against all utilities. Pub. Util. Code § 702 is particularly pertinent.

Every public utility shall obey and comply with every order, decision, direction, or rule made or prescribed by the Commission in the matters specified in this part, or any other matter in any way relating to or affecting its business as a public utility, and shall do everything necessary or proper to secure compliance therewith by all of its officers, agents, and employees.

Such compliance is absolutely necessary to the proper functioning of the regulatory process. Disregarding a statutory or Commission directive, regardless of the effects on the public, merits a high level of scrutiny. It violates the integrity of the regulatory process." (84 CPUC 2d at 193.)

DRA sums up its penalty request:

DRA proposes setting a fine that will deter future violations not only of San Gabriel, but of other companies in the water industry. San Gabriel cannot be rewarded for actions that thwarted and attempted to subvert the regulatory process. ALJ Barnett's proposed split of the proceeds of 75% to ratepayers and 25% to shareholders would encourage such bad behavior because San Gabriel would be allowed to retain one-quarter of its ill-gotten gains. Therefore, 100% of the audit proceeds should be assigned to ratepayers as CIAC. DRA proposes a fine within the range of $100,000-$500,000. An amount in this range would provide effective deterrence to the industry and to San Gabriel. (DRA O.B., p. 104.)

DRA accuses San Gabriel of "misapplication of Section 790 to its condemnation, service duplication, and contamination settlement proceeds." (DRA O.B., at 101.) This refers to the Audit Report's assertion that of the entire $13.9 million of gain in the Fontana Division, only $431,000 relating to surplus property sales to private parties clearly was subject to Section 790. San Gabriel responds that, absent contrary guidance from the Commission it believes all of the proceeds at issue are subject to Section 790. Further, to the extent that any proceeds are not subject to Section 790, then DRA's allegations about inadequate tracking of those proceeds are irrelevant.

DRA asserts that San Gabriel diverted $13.9 million to its shareholders "that should have been reinvested in Section 790 plant infrastructure," using that entire amount to fund dividends. San Gabriel responds that dividends were paid from unrestricted net earnings. We have discussed this above under Payment of Dividends and repetition is not needed. Suffice it to say San Gabriel invested adequate amounts in plant during the period in question. San Gabriel's dividend policy did not harm or impact ratepayers and does not merit a penalty.

DRA accuses San Gabriel of "improper accounting" for the proceeds at issue, and complains about San Gabriel's having disregarded Section 790. DRA alleges that San Gabriel acted in "defiance of Section 790" by its commingling of the proceeds at issue and in "defiance" of Cal Water, D.03-09-021, by not tracking Section 790 proceeds with a memorandum account.

We have discussed those issues above and will not repeat, except to reiterate that San Gabriel never has been ordered not to commingle Section 790 proceeds with other funds nor was it a party to the Cal Water case; San Gabriel's records were sufficient for us to track the proceeds.

DRA's concerns regarding Section 790 and the concerns of the City and the District baffle us. Apparently, DRA's position is that these are Section 790 funds which require a memorandum account, which San Gabriel failed to establish. If it were true that these are Section 790 funds the ratepayers would not be receiving a refund, would not benefit from a lower rate base, would not have lower rates, and would have every right to complain of continuing high rates. The mere failure to establish a memorandum account would not merit a $13.9 million disallowance.

The actions that do merit a penalty are the Company's failures to adequately inform the Commission of the relevant material facts regarding the inclusion into ratebase of land acquired for a new headquarters building. These material facts were not included in the Company's original submissions to the Commission, but only uncovered as a result of inquiries by DRA.

San Gabriel did not disclose that the land it was seeking to include in ratebase was purchased from an affiliate. Further San Gabriel did not disclose that the purchase price of the land it was seeking to place in ratebase and on which it sought to earn a return, was not based on a market price, but rather based on an appraisal performed by an appraiser hired and paid for by the company. Finally, San Gabriel did not disclose that the price paid by the utility was significantly above the price paid by the affiliate when it purchased this land only a year and a half earlier.

In each of these three instances San Gabriel, in its application, failed to disclose material facts to the Commission. Facts pertinent to determining one of the most fundamental aspects of traditional rate of return regulation, calculation of ratebase. It does not matter, that in later meetings with the Division of Ratepayer Advocates these facts came to light. Rather these material facts should have been included in its application and or testimony. The Commission places great weight on applications and testimony. It is imperative that these applications (and testimony) provide full and compete information upon which the Commission can rely. In fact, in uncontested matters such applications can be the sole basis for the Commission's actions.

Affiliate transactions have long been of special interests for the Commission. Through out or regulatory activities we have rules and guidelines governing how such transactions should be handled and how they should be reported.

San Gabriel, in particular, should be aware of this Commission's longstanding concern with full disclosure of relevant information with regards to transactions with affiliates. In D.48942, we dismissed San Gabriel's rate application because it failed to disclose material information with respect to transactions with an affiliate. (Re San Gabriel Valley Water Co., 52 CPUC 729.) We affirmed D.48942 in D.49074 (52 CPUC 741; writ of review denied, S.F. 18940.) The language of the Commission in D.49074 is particularly blistering.

The affiliated interests with which the law and factual substance are concerned are the domination and control which the president of applicant exercises over both applicant and [its affiliate]. It is a case of the president of applicant dealing on behalf of applicant with himself as the alter ego of [its affiliate]. The law does not permit an official of a corporation to profit by dealings he has with such corporation. It follows that the Commission is duty bound to prevent the ratepayers of applicant from being saddled with the burden resulting from profits made by applicant's president at the expense of applicant. That such unreasonable charges may be disallowed by the Commission for the purposes of rate-fixing is beyond question. (Pacific Telephone and Telegraph Co. v. Public Utilities Commission, 34 Cal (2d) 822, 826). (52 CPUC 741, 742.)

There is no rule against engaging in an affiliate transaction. The fact that the utility acquired the land from an affiliate is not the problem. What is the problem is that the utility failed to disclose material facts regarding its request to place the land, which was later revealed was purchased from an affiliate, into ratebase.

Affiliate transactions create an opportunity for abuse of our ratemaking process. Transfers of property or sale/purchase of goods and services between affiliates creates the opportunity for the utility and its affiliates to engage in inappropriate "transfer pricing" by overvaluing the asset, good or service being sold to the utility by the affiliate or undervaluing the asset, good or service being sold by the utility to the affiliate that results in the transfer of profit from the regulated utility to an unregulated affiliate. Such activity has long been a concern of this Commission and other state and federal regulatory agencies.

San Gabriel's omission of the fact that the land in question was acquired from an affiliate concealed from the Commission that the inclusion of this land into ratebase merited the special considerations generally applied to such non-arms length transactions. San Gabriel's application and testimony did not disclose that the transaction was based on an appraisal rather than a market valuation; hiding from the Commission information that would cause us to further examine the basis of the valuation of the land prior to allowing it into ratebase. Finally, San Gabriel did not disclose that that the land was acquired by the utility at a significant mark-up above that paid by the affiliate only a short time before. While there is nothing wrong with the affiliate profiting from an affiliate transaction so long as that profit were due to an increase in the true value of the land, failure to disclose these facts shielded this relevant information from the Commission's view.

We conclude that these acts of omission violate Rule 1 of the Commission's Rules of Practice and Procedure which states:

Any person who signs a pleading or brief, enters an appearance at a hearing, or transacts business with the Commission, by such act represents that he or she is authorized to do so and agrees to comply with the laws of this State; to maintain the respect due to the Commission, members of the Commission or its Administrative law Judges; and never to mislead the Commission or its staff by an artifice or false statement of fact or law.

We conclude that San Gabriel's failure to disclose these relevant facts was misleading.

San Gabriel knowingly provided misleading information to the Commission regarding issues that are material to this proceeding. The submittal of misleading information causes substantial harm to the regulatory process, which cannot function effectively unless participants act with integrity at all times

We find the company in violation of Rule 1 for three acts of omission: 1) San Gabriel did not disclose that the land they were seeking to include in ratebase was purchased from an affiliate, 2) San Gabriel did not disclose that the purchase price of the land they were seeking to place in ratebase was not based on a market price but rather based on an appraisal performed by an appraiser hired and paid for by the company, and 3) San Gabriel did not disclose the fact that the price paid by the utility was significantly above the price paid by the affiliate when it purchased this land only a year and a half earlier. For each of the three violations of Rule 1 of the Commission's Rules of Practice and Procedure we impose a fine of $20,000 for a total of $60,000.

In this instance we are limited by § 2107 to imposing a $20,000 fine for each violation. This is problematic, because the Commission is limited in its deterrence to a $60,000 fine, when, if the transaction had gone undiscovered, the holding company would have benefited by $475,000.

The Commission discussed the overall guidelines for determining fines in D.98-12-075, In re Standards of Conduct Governing Relationships Between Energy Utilities and Their Affiliates, 84 CPUC 2d 155, and reiterated them and applied them to water companies in D.99-11-044, Strawberry Property Owners Ass'n v. Conlin-Strawberry Water Co., and D.05-11-030, Casmalia Community Services v. Unocal Corp. The purpose of a fine is to deter future violations by the perpetrator or others. The severity of the offense and the perpetrator's conduct guide the Commission in setting a fine that is proportionate to the offense.

In determining the fine we are mindful of the standards adopted in D.98-12-075 (84 CPUC 2d 1575, 188-190).

Harm to the Regulatory Process: A high level of severity will be accorded to violations of statutory or Commission directives, including violations of reporting or compliance requirements.

The Utility's Actions to Detect a Violation: Utilities are expected to diligently monitor their activities. Deliberate, as opposed to inadvertent wrongdoing, will be considered an aggravating factor. The level and extent of management's involvement in, or tolerance of, the offense will be considered in determining the amount of any penalty.

Management's involvement in this breach of trust was 100%; at the very top level of the utility and the holding company. San Gabriel is no stranger to failing to provide complete information to the Commission. In D.48942, we dismissed its rate application because it failed to disclose material information. (Re San Gabriel Valley Water Co., 52 CPUC 729.) We affirmed D.48942 in D.49074 (52 CPUC 741; writ of review denied, S.F. 18940.) The language, cited above, of the Commission in D.49074 is particularly blistering.

Need for Deterrence: Fines should be set at a level that deters future violations. Effective deterrence requires that the size of a fine reflect the financial resources of the utility.

The Commission's Rules of Practice and Procedure (Rule 1) states:

Any person who signs a pleading or brief, enters an appearance at a hearing, or transacts business with the Commission, by such act represents that he or she is authorized to do so and agrees to comply with the laws of this State; to maintain the respect due to the Commission, members of the Commission or its Administrative law Judges; and never to mislead the Commission or its staff by an artifice or false statement of fact or law.

San Gabriel knowingly provided misleading information to the Commission regarding issues that are material to this proceeding. The submittal of false information causes substantial harm to the regulatory process, which cannot function effectively unless participants act with integrity at all times.

Within 30 days from the effective date of this order, San Gabriel shall remit to the Commission's Fiscal Office at 505 Van Ness Avenue, Room 3000, San Francisco, CA 94102, a check for $60,000 made payable to the State of California's General Fund. The number of this decision shall be shown on the face of the check.