Recommendations

December 2015 Central Basin Municipal Water District Its Board of Directors Has Failed to Provide the Leadership Necessary for It to Effectively Fulfill Its Responsibilities Report 2015‑102 COMMITMENT INTEGRITY LEADERSHIP The first five copies of each California State Auditor report are free. Additional copies are $3 each, payable by check or money order. You can obtain reports by contacting the California State Auditor’s Office at the following address: California State Auditor 621 Capitol Mall, Suite 1200 Sacramento, California 95814 916.445.0255 or TTY 916.445.0033 OR This report is also available on our website at www.auditor.ca.gov. The California State Auditor is pleased to announce the availability of an online subscription service. For information on how to subscribe, visit our website at www.auditor.ca.gov. Alternate format reports available upon request. Permission is granted to reproduce reports. For questions regarding the contents of this report, please contact Margarita Fernández, Chief of Public Affairs, at 916.445.0255. For complaints of state employee misconduct, contact the California State Auditor’s Whistleblower Hotline: 1.800.952.5665. Elaine M. Howle State Auditor Doug Cordiner Chief Deputy December 3, 2015 2015‑102 The Governor of California President pro Tempore of the Senate Speaker of the Assembly State Capitol Sacramento, California 95814 Dear Governor and Legislative Leaders: As requested by the Joint Legislative Audit Committee, the California State Auditor presents this audit report concerning the Central Basin Municipal Water District’s (district) planning, operations and management, long‑term financial viability, and control environment. This report concludes that the district’s board of directors (board) has failed to provide the leadership necessary for the district to effectively fulfill its responsibilities. For example, we found that the board failed to ensure that the district maintained stability in key executive management positions throughout our review period. Further, we found that the board failed to take basic steps to ensure the district’s long‑term financial viability, including engaging in long‑term financial planning and performing the necessary study to ensure the district’s water rate structure is appropriate and that it will collect sufficient revenues to meet its costs. Finally, the board’s actions contributed to the district losing its insurance coverage, forcing the district to purchase insurance with higher premiums for considerably less coverage than in previous years. The board also violated state law in 2010 when it improperly approved the establishment of a legal trust fund without adequate public disclosure. Further, it lacked a means of ensuring expenditures made from the $2.75 million trust fund were appropriate. In addition, the district consistently engaged in questionable contracting practices. For example, we found that the district often inappropriately circumvented its competitive bidding process when it awarded contracts to vendors. The district also spent thousands of dollars of public funds on purposes unrelated to its mission, some of which very likely constitute gifts of public funds, which are prohibited by the California Constitution. Additionally, the district did not always follow its policies for hiring employees, which led it to hire certain individuals who did not possess the necessary qualifications for their positions and to incur unnecessary expenses. In one instance, the district paid more than $22,000 for an employee to obtain a bachelor’s degree, when possession of such a degree was already a minimum requirement to qualify for his high‑level position. Ultimately, this individual did not obtain his degree during his employment with the district. We also found that some of the benefits the district offers its board members may be overly generous, as it provides them with full health benefits and a generous automobile allowance, even though their work is essentially part‑time. Finally, we noted multiple instances in which the district paid for unreasonable travel and meal expenses for both its board members and staff. Although the district has recently taken some steps to address these issues, the magnitude of the problems we found suggests that the district could benefit from a different governance structure. The district’s board is currently publicly elected, yet the board’s customers, to which it should be held accountable, are those various entities the district wholesales water to which is, in turn, then sold throughout the district. If the Legislature chooses to change the governance structure, it could consider a structure in which the board would be composed of members appointed by the district’s direct customers. Such a change would not be a novel approach—as we note, it is already used by certain other water agencies in the region—and it would enable the district’s customers to hold the board accountable when it takes actions or makes decisions that are not in the best interests of the district. Respectfully submitted, ELAINE M. HOWLE, CPA State Auditor 621 Capitol Mall, Suite 1200 Sacramento, CA 95814 916.445.0255 916.327.0019 fax www.auditor.ca.gov Blank page inserted for reproduction purposes only. California State Auditor Report 2015-102 v December 2015 Contents Summary 1 Introduction 9 Chapter 1 The Central Basin Municipal Water District’s Board of Directors Has Consistently Failed to Provide Appropriate Leadership and Oversight 21 Recommendations 42 Chapter 2 The Central Basin Municipal Water District Has Established Inadequate Policies Related to Contracting and Expenditures and Has Circumvented Other Policies 45 Recommendations 62 Chapter 3 The Central Basin Municipal Water District Did Not Always Follow Established Hiring Policies and Needs to Ensure Certain Benefits and Expenditures are Appropriate 65 Recommendations 80 Response to the Audit Central Basin Municipal Water District 83 California State Auditor’s Comments on the Response From the Central Basin Municipal Water District 97 vi California State Auditor Report 2015-102 December 2015 Blank page inserted for reproduction purposes only. California State Auditor Report 2015-102 1 December 2015 Summary Results in Brief Audit Highlights . . . The Central Basin Municipal Water District (district) was Our audit of the Central Basin Municipal established by a vote of the people in 1952 to help mitigate the Water District (district) revealed overpumping of groundwater in southeast Los Angeles County. the following: The district wholesales imported water from the Metropolitan » The district’s board of directors’ (board) Water District of Southern California (Metropolitan) to cities, poor leadership has impeded the other water districts, mutual water companies, investor‑owned district’s ability to effectively meet utilities, and private companies in southeast Los Angeles County. its responsibilities: In addition, it operates a system for obtaining and distributing recycled water. A publicly elected board of five directors (board) • The board has not maintained governs the district. The board appoints a general manager who stability in the district’s key executive oversees the district’s day‑to‑day operations and its staff. management position. • It has not established essential policies In recent years, the district’s actions have called into question the to safeguard the district’s long‑term efficiency and effectiveness of its operations. News reports have financial viability. focused public attention on a number of issues at the district, some of which we explore in detail in this report. Because of these issues • The board’s actions caused the and others, the County of Los Angeles Department of Public Works district to lose its liability insurance (Public Works) published a report in October 2014 that outlined the coverage, resulting in higher costs concerns it identified with the district’s operations. As a result of for less coverage. these concerns, the report explored the steps necessary to dissolve the district and transfer its work elsewhere. However, the report » The board violated state law when it stopped short of making such a recommendation and instead improperly approved the establishment recommended this audit. of a legal trust fund without adequate public disclosure. Further, it lacked a Our audit found that the board’s poor leadership has impeded means of ensuring the expenditures the district’s ability to effectively meet its responsibilities. For made from the $2.75 million trust fund example, the board failed to ensure that it provided the district were appropriate. with stability in its key executive management position. The » The district consistently engaged in district’s administrative code establishes the general manager questionable contracting practices as the district’s chief executive and notes that hiring the general by avoiding competitive bidding and manager is a critical function of the board. Nonetheless, inappropriately using amendments to between 2010 and 2015, six different individuals filled this role. Lack extend and expand contracts. of agreement among the board members was a factor contributing to the instability in this position. The district’s current general » The district spent funds on purposes manager is on a two‑year contract and is contemplating retiring unrelated to its mission that likely at the end of the contract term in May 2017. However, the district constitute gifts of public funds. does not have a formal policy for recruiting and hiring a general manager in the future. If the board does not fill the general manager » The district did not always follow its position either prior to the current general manager’s retirement or policies for hiring employees—it within a reasonable amount of time thereafter, the board will likely hired unqualified staff and created an hinder the district’s ability to effectively meet its responsibilities. unnecessary position. In addition, the board has not established the essential policies continued on next page . . . necessary to safeguard the district’s long‑term financial viability. Contrary to a recommendation directed to all government agencies 2 California State Auditor Report 2015-102 December 2015 » Some of the benefits the district from a national organization that promotes the professional offers to its board members may management of governmental resources, the district has not be overly generous. For example, it engaged in long‑term financial planning to help it develop provides full health benefits and a strategies to overcome financial challenges and achieve long‑term generous automobile allowance, even sustainability. In addition, the district has not performed the study though board members essentially necessary to ensure that its water rate structure is appropriate and work part‑time. that it will collect sufficient revenues to meet its costs. In fact, in planning its annual budgets, the district overestimated its revenues » The district paid for unreasonable travel in four of the past five years, and consequently its expenditures and meal expenses for both its board exceeded its revenues in three of those years. members and staff. » Although the district has made changes Also, the district’s debt coverage ratio, which measures its ability to to improve its ability to operate efficiently produce enough cash to cover its debt payments, has fallen below and effectively, it could benefit from a the level required by its debt agreements twice in the past five fiscal different governance structure. years. This is partly because the board has not ensured that the district has a formal debt management policy, despite the district’s external auditors’ recommendations that it implement one. Various factors contributed to the decline in the district’s debt coverage ratio—including that the district faced sustained high legal costs and a decline in water revenues—and the credit rating on the district’s debt was downgraded in August 2013 and again in October 2015. According to a former general manager’s memo, because of the August 2013 downgrade, the district could face an increase in total interest costs when it issues new debt to restructure its outstanding debt. The current general manager stated that as a result of the October 2015 downgrade, the district will likely incur additional costs when it restructures its debt. Further, the board’s actions caused the district to lose its insurance coverage. Specifically, in 2014 the board did not respond to the conditions required by its then‑insurer in a timely manner, and consequently the insurer canceled the district’s insurance coverage, including its general liability and employment practices liability coverage. Subsequently, in September 2014, after the district had obtained new insurance coverage from private insurance companies, the district’s insurance broker warned the district that any changes to senior staff could adversely impact the district’s employment practices liability insurance coverage. Despite this warning, the board subsequently fired the district’s then‑general manager, and the insurance company did not renew the district’s insurance coverage in 2015. As a result, the district had to obtain new coverage yet again and currently pays thousands more for $1 million less general liability and employment practices liability insurance coverage than previously. The board also violated state law in 2010 when it approved the establishment of a legal trust fund (trust fund) without adequate public disclosure. State law requires the district to hold open and public meetings, although it makes some exceptions to this California State Auditor Report 2015-102 3 December 2015 requirement. For example, the board may meet in closed session to discuss ongoing litigation or pending litigation if public deliberation on the matter would prejudice its litigation position. The board relied on its outside legal counsel’s advice and cited this exception when it met in a closed session in June 2010, reporting that its discussion and actions were related to pending litigation. However, a later investigation by an external law firm found reason to believe that the board used the discussion and vote in that closed meeting to create a programmatic environmental impact report pertaining to groundwater storage, to finance many other nonlitigation expenses, and to avoid criticism. State law does not allow public entities to use the litigation exception as a subterfuge to reach nonlitigation‑oriented policy decisions. Further, the district did not disclose to the public the $2.75 million in transfers it made to the trust fund. In addition, because the board did not approve the expenditures the district’s outside legal counsel made from the fund, the board lacked assurance that all of the trust fund expenditures related to the purposes for which the fund was established. Moreover, the board’s actions caused the district to incur more than $500,000 in ongoing costs for the subsequent investigation into the trust fund and for a lawsuit that a current board member filed to recover, in part, the money the board transferred to the fund. Additionally, the district often inappropriately avoided its competitive bidding processes when it awarded contracts to vendors during the period we audited. According to its procurement policy, the district is committed to obtaining the best value for the services it purchases and to using a competitive bidding process to procure these services. However, for 13 of the 20 contracts we reviewed that the district executed between July 2010 and June 2015, we determined that the district did not use its competitive bidding process. We further determined that the district did not adequately justify why it failed to competitively bid for 11 of these contracts, although its policies suggest using such justifications. When the district does not clearly identify and justify its reasons for avoiding its competitive bidding process, it leaves itself vulnerable to allegations of favoritism or conflicts of interest. For instance, in early 2015 the Fair Political Practices Commission fined a former general manager and a former board member for accepting gifts in excess of applicable limits from a contractor doing business with the district. By circumventing its competitive bidding process, the district cannot demonstrate that it obtained the best value for the services it purchased with public funds. In addition to failing to follow its contracting practices, the district spent thousands of dollars of district money on purposes unrelated to its underlying authority, some of which very likely constitute 4 California State Auditor Report 2015-102 December 2015 gifts of public funds. Allowable district expenditures include those that serve a public purpose and are within the scope of the district’s jurisdiction and specific purposes. However, it did not appear that the district met this criteria when it gave $9,000 to outside organizations for holiday turkeys in fiscal year 2012–13. It also currently allocates $3,000 in community outreach funds to each board member annually, which various board members had the district donate on their behalf to golf tournaments, a legislative member’s breakfast panel, religious organizations, local high school sports programs, local pageants, and car shows. The district also spent unreasonable amounts of money on installation ceremonies for its board members and does not expressly limit the amounts that can be spent on these ceremonies. We found no clear correlation between any of these expenditures and the district’s mission. Finally, on several occasions during our period of review, the district failed to follow its policies for hiring employees. Its administrative code states that the district must use a competitive process for hiring employees based on their qualifications and ability. Further, it outlines the use of an interviewing panel for senior manager positions. The district also maintains job descriptions that detail the minimum qualifications applicants must possess before being hired. Nevertheless, we noted that the district did not follow its policies for hiring four individuals into senior manager positions. Despite the fact that the district’s general manager is responsible for hiring, the board hired one of these employees—an assistant to the general manager who earned about $98,000 annually—without first authorizing the position. The district also hired two individuals who did not possess the required minimum levels of education for their positions as specified in their job descriptions. Further, the district chose to prepay $22,000 in college tuition, registration, and fees so that one of these individuals could earn the degree required for the position. The district authorized this payment, even though its policies limit payment for educational expenses to 90 percent of the cost of college courses and allows such payments only after employees complete their coursework. The district ultimately terminated this employee before he completed his coursework. When the district fails to follow its hiring policies, it risks not hiring the most qualified individuals for the job and unnecessarily spending the district’s funds. As we previously mentioned, Public Works explored the possibility of dissolving the district in its 2014 report. We believe such an extreme action might be viewed as premature given that the district and the board have recently made some changes to the district’s policies and practices that, if followed, will improve the district’s ability to operate efficiently and effectively. Nonetheless, the magnitude of the problems we found suggests that the district California State Auditor Report 2015-102 5 December 2015 could benefit from a different governance structure. Specifically, because the board is publicly elected, it is not directly accountable to its customers, which are the various entities that sell water throughout the district. Other water agencies in the region, including Metropolitan and the San Diego County Water Authority, have boards composed of members appointed by their customers. If the Legislature chose to change the district’s governance structure, modifying the structure to increase the board members’ accountability to the entities they serve would help to ensure that the board makes decisions that reflect the district’s best interest. Recommendations To ensure the efficient and effective delivery of imported and recycled water in southeastern Los Angeles County, the Legislature should pass special legislation to preserve the district as an independent entity but modify the district’s governance structure. In doing so, the Legislature should consider a governance structure that ensures the district remains accountable to those it serves; for example, the district’s board could be changed from one elected by the public at large to one appointed by the district’s customers. To ensure the stability of the district’s operations, by June 2016 the district’s board should establish a formal policy for hiring for the general manager position. Because the current general manager is on a contract set to expire in May 2017, the board should initiate the hiring process for a new general manager or begin the process of renegotiating the contract with the current general manager in the fall of 2016. To ensure its long‑term financial sustainability, the board should complete a long‑term financial plan no later than December 2016. To ensure its water rate structure is appropriate to provide the revenue necessary to cover its legitimate costs, the district should complete its planned water rate study no later than the spring of 2017. To ensure that it continues to take steps to improve its financial condition and avoids additional costs due to downgrades of its debt credit ratings, the district should immediately create a formal debt management policy. This policy should clearly define its credit objectives and provide guidelines for suitable debt agreements. This policy should also require the district to periodically monitor the specific financial ratios, such as its debt coverage ratio, that are relevant to its credit rating. 6 California State Auditor Report 2015-102 December 2015 To help it maintain its current insurance coverage and better position it to negotiate for more cost‑effective and appropriate coverage in the future, the board should review the district’s insurance coverage annually and renegotiate costs and coverage amounts as necessary, particularly as the district resolves outstanding legal claims against it. To ensure it holds itself accountable to the public, the district should follow the law and operate in an open and transparent manner by, among other things, disclosing to the public the true nature and purpose of all of its expenditures. To make better use of the funds it spends on services, the district should amend its administrative code by June 2016 to limit its sole‑source contracts to emergency circumstances and circumstances in which only one vendor can meet the district’s needs. Further, before executing any sole‑source contracts, the district should require written justification demonstrating the reasons for not competitively bidding the services. To ensure its expenditures do not constitute gifts of public funds, the district should do the following: • Immediately eliminate its allocation of funds to individual board members for community outreach. • Develop policies that specify limitations on the types of activities it will provide funds for in the future to ensure that it benefits only those organizations whose activities have a direct link to its authorized purposes. • Revise its administrative code by June 2016 to include more specific guidance as to what constitutes a reasonable and necessary use of public funds. The guidance should establish restrictions on the amount spent for board member installation ceremonies. To ensure it considers the most qualified candidates for positions, the district should follow its established hiring policies. Specifically, it should use a competitive hiring process and ensure that its board first formally approves all positions for which the district recruits. Further, the district should consider for employment only individuals who meet the established minimum qualifications for the positions for which they have applied. California State Auditor Report 2015-102 7 December 2015 Agency Comments The district generally agreed with our recommendations and indicated that it plans to take various actions to implement them. However, the district disagreed with our recommendation to the Legislature that it should modify the district’s governance structure. 8 California State Auditor Report 2015-102 December 2015 Blank page inserted for reproduction purposes only. California State Auditor Report 2015-102 9 December 2015 Introduction Background To help mitigate the overpumping of groundwater in southeastern Los Angeles County, the public voted to establish the Central Basin Municipal Water District (district) in 1952 under the Municipal Water District Law of 1911. The district’s founders realized they would have to curtail the region’s use of relatively inexpensive yet diminishing local groundwater by providing it with imported water. The district’s stated mission is to exercise the powers given to the district under its establishing act, utilizing them to the benefit of parties within the district and beyond. The district’s mission includes acquiring, selling, and conserving imported water and other water that meets all required standards and furnishing it to customers in a planned, timely, and cost‑effective manner that anticipates future needs. In 1954, the district became a member agency of the Metropolitan Water District of Southern California (Metropolitan), an agency that provides the Southern California region with water that it imports from Northern California and from the Colorado River. The district purchases the imported water from Metropolitan and wholesales it to cities, mutual water companies, investor‑owned utilities, and private companies. Further, the district supplies water for groundwater replenishment and provides the region with recycled water for municipal, commercial, and industrial use. Figure 1 on the following page provides an overview of the system of water supply and delivery in Southern California. The district currently serves a population of more than two million people in 24 cities in southeast Los Angeles County and in some unincorporated areas of the county. Its mission statement indicates that it provides leadership, support, advice, and information on water issues to the people and agencies within and outside its boundaries, as appropriate. For example, the district supplies information on drought‑conservation measures to the public and provides water education courses and materials to students. According to its comprehensive annual financial report, the district’s 227‑square‑mile service area used approximately 241,000 acre‑feet of water in fiscal year 2013–14.1 Figure 2 on page 11 shows the district’s boundaries and the cities included within those boundaries. 1 An acre‑foot of water is approximately 326,000 gallons, which the district states is enough to meet the water needs of two average families in and around their homes for one year. 10 California State Auditor Report 2015-102 December 2015 Figure 1 Central Basin Municipal Water District’s Role in Water Delivery Northern California Colorado River California Aqueduct Colorado River Aqueduct Regional Wholesaler Metropolitan Water District of Southern California Recycled water Local Wholesalers* Central Basin Municipal Water District (among others) Replenishment District† Retailers† Water Replenishment District of Cities, other water districts, mutual Southern California water companies, investor-owned utilities, and private companies Water sources Consumers Water suppliers Replenishment district Sources: Documents obtained from the websites of the named entities. * Members of the Metropolitan Water District of Southern California (Metropolitan). † Nonmembers of Metropolitan. California State Auditor Report 2015-102 11 December 2015 Figure 2 Central Basin Municipal Water District’s Service Area East Los Angeles 710 10 5 Montebello 605 60 Vernon Commerce West 110 Maywood Pico Huntington Whitter- Rivera Park Los Nietos Bell Walnut Park Bell Cudahy Florence- Gardens La Habra Graham Whittier Heights South Gate Santa Fe 710 Downey Springs South Willowbrook Lynwood Whittier 105 5 Norwalk La Mirada Paramount Bellflower Cerritos 91 Artesia 605 Lakewood Hawaiian 405 110 Gardens Signal 710 Hill Source: Central Basin Municipal Water District’s website. The District’s Governance and Administration A five‑member board of directors (board) governs the district. Each board member represents one of five divisions within the district and is elected to a four‑year term by the voters within that division. No limits exist on the number of terms a board member may serve; according to the district’s website, the longest‑serving member of the board was in his fifth four‑year term as of September 2015. Board elections are nonpartisan and held during November general elections.2 According to state law, the board is ultimately 2 In 2012 the district received approval from Los Angeles County to change its election to June for that year only. 12 California State Auditor Report 2015-102 December 2015 responsible for the performance of the district’s powers, privileges, and duties. Toward this end, the district’s administrative code states that the board’s responsibilities include ensuring that the district is managed well, determining its objectives and policies, approving its annual budget, and appointing its general manager. As we discuss further in Chapter 3, board members receive compensation for their service in the form of a payment for each day they attend meetings and other events on district business. They also receive medical and other health benefits equivalent to those of full‑time employees of the district. The general manager is the chief executive of the district and is responsible to the board for the district’s administrative affairs. The general manager prepares and recommends the district’s annual budget, hires its employees, and manages its day‑to‑day operations, among other duties. As of July 2015 the district had a total of 23 authorized positions, including the general manager. Figure 3 presents the organization of the district. Figure 3 Central Basin Municipal Water District Organizational Chart FIVE-MEMBER BOARD OF DIRECTORS GENERAL MANAGER FINANCE DIRECTOR OF ENGINEERING SPECIAL WATER DIRECTOR OF DIRECTOR OF DIRECTOR OF DIRECTOR ADMINISTRATION AND OPERATIONS PROJECTS RESOURCES HUMAN TECHNOLOGY EXTERNAL AND BOARD SERVICES MANAGER MANAGER MANAGER RESOURCES AFFAIRS CONSERVATION EDUCATION MANAGER MANAGER ACCOUNTING MANAGER ADMINISTRATION STAFF STAFF STAFF STAFF AND STAFF STAFF Source: Central Basin Municipal Water District’s website. California State Auditor Report 2015-102 13 December 2015 For more than 15 years the district shared administration with a companion organization, the West Basin Municipal Water District (West Basin). West Basin performs similar functions to the district but for communities in southwest Los Angeles County. Between 1990 and 2006 the two districts shared staff and an office building. However, in 2006 West Basin took action to end the partnership. West Basin purchased the office building, and the district relocated its headquarters to the City of Commerce, California. District Revenue The district’s primary source of operating revenue is the sale of imported water and, to a lesser degree, recycled water. Figure 4 shows the distribution of district revenue by source during fiscal year 2014–15. Its revenue from the sale of imported water was about $45 million, or 81 percent of its total revenues, in fiscal year 2014–15, while its sales of recycled water accounted for about $4 million, or 7 percent of its total revenues, in the same period. Figure 4 Central Basin Municipal Water District’s Revenue Sources by Major Category For Fiscal Year 2014–15 Other—$0.81 million (1%)* Grants—$2.73 million (5%) Standby charges—$3.31 million (6%)† Recycled water sales—$4.18 million (7%) Imported water sales— $45.21 million (81%) Source: Central Basin Municipal Water District’s (district) fiscal year 2014–15 draft financial statements as of October 2015. * The district derives other revenues from deliveries of treated water, investment income, and other miscellaneous sources. † Standby charges are imposed by the district on landowners and used by the district to help pay its debt service costs on its water recycling facilities and the purchase of its headquarters building. 14 California State Auditor Report 2015-102 December 2015 The district’s other significant source of revenue is standby charges that the district imposes on landowners with the annual approval of its board. Los Angeles County includes the charge on each property owner’s property tax bill. The standby charge’s purpose is to minimize the effects of the drought on the area through the construction of recycled water distribution systems that could provide an alternative source of water. The district currently uses revenue from the standby charges to pay debt service on the debt it issued to finance the construction of its water recycling facilities, as well as to pay for the acquisition of its headquarters building. The district’s standby charges accounted for about $3 million, or 6 percent of its total revenues, in fiscal year 2014–15. Recent Scrutiny of the District The district and its board have come under scrutiny in recent years. News reports have alleged that the district misused public funds, including that it established a legal trust fund in a manner that violated state open meeting law, that it inappropriately reimbursed meal expenses, and that it engaged in inappropriate contracting practices and employment practices. We address these allegations in this report. In addition, the district has been involved in a number of lawsuits over the past several years. Although many of these lawsuits have been settled or dismissed, a small number related to the district’s employment practices are still pending. In October 2014 the County of Los Angeles Department of Public Works published a report on the district that sought to ensure it addressed its ongoing problems so that it could continue to provide water and service to its customers. The report recommended an independent management audit of the district’s operations and included a discussion of the process necessary to dissolve the district and transfer its functions to another entity. We discuss this report further in Chapter 1. Scope and Methodology The Joint Legislative Audit Committee (audit committee) directed the California State Auditor’s office to perform an audit of various aspects of the district’s operations, including its contracting, expenditures, strategic planning, financial viability, and human resources. Table 1 includes the audit objectives the audit committee approved and the methods we used to address them. California State Auditor Report 2015-102 15 December 2015 Table 1 Audit Objectives and the Methods Used to Address Them AUDIT OBJECTIVE METHOD 1 Review and evaluate the laws, rules, We reviewed relevant state laws and regulations. and regulations significant to the audit objectives. 2 Assess whether the Central Basin • For our audit period of July 1, 2010, through June 30, 2015: Municipal Water District (district) has • We interviewed relevant district staff and reviewed documentation related to the district’s appropriate policies, processes, and process for setting its annual budget and the board’s process for approving the budget. oversight for various aspects of its • We reviewed the district’s administrative code and accounting policies. operations. Specifically, perform the following covering the five‑year period • We reviewed minutes and agendas for meetings of the district’s board, which included the from 2010 to 2015: consent calendar items from its finance committee. a. Assess whether the district’s board of • We reviewed expenditure lists the district provided to the board and the public, which we directors (board) has sufficient policies discuss further in Table 2 on page 19. and practices to guide its spending decisions. In addition, determine whether the board exercises sufficient oversight regarding expenditures. b. Assess whether the district has • We interviewed relevant district staff and reviewed documentation related to the district’s sufficient processes and controls process for approving expenditures. to ensure expenditures and other • We determined whether the district had and followed a debt management policy. financial activities are appropriate. c. Review the district’s contracting • We judgmentally selected 20 contracts active primarily during our audit period and determined procedures and determine whether the extent to which the district followed legal requirements and its own policies and practices they are consistent with applicable for contracting. We ensured that we reviewed contracts for a variety of different services, contracting requirements and with including engineering and construction services, legal services, lobbying services, and public procedures used by other municipal affairs services, as well as contracts that had received significant media attention. water districts. From a selection of • We judgmentally selected and reviewed five contracts the district entered into before our audit contracts, determine whether the period that were still active during our audit period. We selected these contracts based on their district complied with the applicable amendment histories and on the media attention they received. laws, policies, and regulations. • We identified best practices for contract management using the Project Management Institute’s Project Management Body of Knowledge, the State Contracting Manual, and contracting policies from other water agencies, including the Western Municipal Water District and the Municipal Water District of Orange County, as well as the San Diego County Water Authority. d. Assess whether the district has • We determined that the district maintained codes of conduct for both its staff and its board adequate resources and policies to throughout the audit period. address personnel matters, including • We reviewed district policies and interviewed relevant staff regarding how the district the conduct of its board members. investigates violations of its policies and codes of conduct. • We reviewed district records and noted that board members and senior managers attended ethics and sexual harassment training as required. • We ensured board members and relevant staff filed required conflict‑of‑interest forms. We reviewed those forms to determine whether the individuals reported significant relationships that conflicted with board decisions. We had no findings in this area; however, we note the results of an investigation by the Fair Political Practices Commission in Chapter 2. continued on next page . . . 16 California State Auditor Report 2015-102 December 2015 AUDIT OBJECTIVE METHOD e. Assess whether the district operates • We interviewed relevant staff regarding the district’s compliance with state open meeting laws transparently, including complying and training on such laws for board members. with laws governing public meetings, • We reviewed the district’s tracking of its compliance with state requirements regarding public records, and fee‑setting, and advanced posting of meeting agendas. According to the director of administration and whether it publicly reports on all board services, the district did not have any process for tracking its compliance with posting its spending. requirements until March 2013; however, our review of its tracking process subsequent to that date found no reportable concerns. • We reviewed a selection of eight public records act requests. We identified instances in which the district did not clearly indicate it had fully addressed requests and another in which the district missed a deadline by several days. Although in our judgment these issues do not rise to the level of reportable findings because the district still responded to the requests, we discussed ways to improve the district’s process with its staff. • We reviewed minutes of board meetings and determined the board conducted public meetings before considering changes to its fees. • We noted that the district includes lists of expenditures in its monthly board agendas, which are publicly available on the district’s website. 3 Assess whether the district’s • We reviewed the district’s comprehensive annual financial reports for the fiscal years 2010–11 expenditures and revenues are through 2013–14 and its draft fiscal year 2014–15 financial statements as of October 2015 reasonable. Specifically, perform the to determine the reasons for increases or decreases in revenues generated through following covering the five‑year period customer rates. from 2010 to 2015: • We analyzed reasons for large changes in the district’s revenues generated through a. To the extent possible, assess the customer rates. reasons for any trends in revenues generated through customer rates during the past five years. b. For major categories of expenditures, • We analyzed reasons for large changes in district expenditures, including its legal assess the reasons for any services expenditures. major trends, including those • We interviewed relevant district staff and reviewed the district’s audited financial statements to expenditure trends related to legal determine the reasons for increases or decreases in major expenditure categories. matters and those not directly related to the district’s primary mission. c. For a sample of expenditures, • We reviewed the district’s administrative code, prior external audit findings, and other determine whether they were legally policy documents. allowable, reasonable, and consistent • We interviewed relevant staff regarding the district’s internal controls over expenditures. with the mission of the agency. • We judgmentally selected 50 expenditures from the audit period and tested them for compliance with applicable laws, policies, and best practices. • We selected 35 expenditures for testing from the district’s file room and 15 expenditures from the public expenditure lists created from its accounting system. We found that the public expenditure lists were incomplete because they did not include certain transfers the district made to a legal trust fund, which we describe further in Chapter 2. 4 To the extent the district has a strategic • We reviewed the district’s strategic plans the board considered in October 2010 and May 2015 plan, determine the following: and determined they contained key elements of strategic plans and reflected the district’s a. Whether the strategic plan contains mission. However, as we describe in Chapter 1, the board did not approve or ensure the goals and objectives that support the district appropriately implemented its October 2010 strategic plan. mission of the organization. • We interviewed relevant staff regarding the development and implementation of the district’s strategic plans, including the district’s plans for periodic review. b. How often the district evaluates its • We reviewed proposed metrics for both the 2010 and 2015 plans. Because the district did success in achieving its goals and not adequately implement its 2010 plan, we reviewed its planned approach to evaluating its objectives, and updates the strategic current strategic plan and determined it is reasonable. plan to reflect changes, including changes in regulatory requirements, goals, and milestones. California State Auditor Report 2015-102 17 December 2015 AUDIT OBJECTIVE METHOD 5 Assess whether the district has • We interviewed the district’s director of human resources and engineering staff. qualified staff to manage its operations. • We obtained and reviewed position descriptions for the district’s engineering staff and its Specifically, perform the following: general manager. a. To the extent possible, determine • We compared the position descriptions to the staff’s qualifications. whether technical staff has sufficient • We reviewed the district’s contract for operations and maintenance of its recycled qualifications and resources to water pipeline. adequately maintain its infrastructure over the long term. • We determined that the district recently hired additional technical staff and that its current staff are qualified. We have no reportable findings in this area. b. To the extent possible, assess the • We interviewed the district’s director of human resources. qualifications and sufficiency of • We reviewed the district’s organizational chart and human resources files to compare position the district’s management staff descriptions to stated qualifications for a selection of current district managers. responsible for essential operations. • We determined the selected current managers were qualified and that the district had sufficient staff for its essential operations. • We interviewed the district’s current general manager regarding his tenure and the board’s plans for hiring general managers in the future. c. Identify the total compensation • We interviewed the director of human resources. of each member of the board of • We reviewed district policies regarding compensation, expenditure reports, and payroll data to directors and top managers. determine board member compensation. • To identify the amounts board members received for per diem and allowances, such as the automobile or transportation allowance, we relied on monthly reports of expenditures the district generated from its accounting systems and presented to the board. • We noted that board members generally receive health and other benefits to the same extent that staff do, and we describe these benefits in Chapter 3. • We reviewed data the district reported to the California State Controller’s Office (State Controller) regarding the compensation of its top managers. • We compared the salaries of selected district managers to the State Controller’s data to ensure the district accurately reported its compensation to the State Controller. d. Determine whether the total • We selected four additional water agencies in Southern California. We reviewed data the compensation received by each of the district and the four additional water agencies reported to the State Controller regarding district’s top managers is comparable the compensation for selected management positions. to that received by top managers in • We reviewed the district’s surveys of certain water agencies’ compensation and benefits. similar public agencies or municipal water districts in the region. 6 Assess the district’s financial viability • We reviewed the district’s contracts with its auditors for fiscal years 2010–11 through 2014–15. and control environment. Specifically, for • We reviewed licensing records for the district’s auditors. The district contracted with the five‑year period from 2010 to 2015, three different audit firms between fiscal years 2010–11 and 2014–15. We noted the firms determine the following: were licensed and had no complaints on file. a. Whether the district retained a • We reviewed the district’s website and determined the district made its annual financial audits qualified, independent auditor publicly available. for its annual financial audits and whether completed audits were publicly available. b. What deficiencies were reported • We reviewed the district’s independent auditors’ reports for fiscal years 2010–11 by its independent auditor and through 2013–14. how the district has addressed • We noted that the district received an unqualified opinion on its financial statements every such deficiencies. year for fiscal years 2010–11 through 2013–14. The district’s external auditor had not issued an opinion on the district’s fiscal year 2014–15 financial statements as of October 2015. • We noted that the district adequately addressed all deficiencies its independent auditors reported except for the following: – The district does not have a debt management policy. We discuss this further in Chapter 1. – The district did not have meal expense limits in place until July 2015. We discuss this further in Chapter 3. continued on next page . . . 18 California State Auditor Report 2015-102 December 2015 AUDIT OBJECTIVE METHOD c. How often the district changed • We reviewed the district’s contracts with its auditors for fiscal years 2010–11 through 2014–15. auditors and the reasons for • The district contracted with three audit firms, changing auditors twice during our audit changing auditors. period. In the first instance, according to board memoranda, the district selected a different firm than the one that had been its auditor for the previous 10 years. In the second, a board memorandum stated that the firm told the district it could not complete its contract. We had no reportable findings in this area. d. The district’s debt ratio coverage for • We interviewed relevant staff and reviewed documentation related to the district’s debt bond commitments and the reasons coverage ratio. We also examined the reasons why the debt coverage ratio fell below the for any year in which the ratio fell accepted level. below the generally accepted level. • We interviewed relevant staff and reviewed documentation to determine how the district’s inability to meet its required debt coverage ratio affected its credit rating and debt costs. e. To the extent possible, assess whether • We analyzed the information we gathered for Objectives 3a, 3b, and 6d, as well as pertinent the five‑year trends in revenues and information contained in the district’s audited financial statements and other records, expenditures indicate long‑term to determine the extent to which this information indicates the district’s long‑term financial viability. financial viability. • We determined whether the district had and used a long‑term financial plan. We describe our findings in this area in Chapter 1. 7 Review and assess any other issues that • We interviewed relevant staff and reviewed documentation related to the district’s attempts to are significant to the district’s operations obtain and retain insurance coverage for its operations. and management. • We reviewed state law and interviewed staff at the Los Angeles County Local Area Formation Commission to determine the process through which the district’s governance may change or the district may dissolve. • We interviewed the five current members of the board to obtain their perspectives on the district’s operations and its challenges over the last five years. While we did not directly quote any of the board members’ interviews in our report, we used their comments to help inform our audit fieldwork. Sources: The California State Auditor’s analysis of Joint Legislative Audit Committee audit request 2015‑102 and information and documentation identified in the table column titled Method. Assessment of Data Reliability In performing this audit, we relied upon reports generated from the information systems listed in Table 2. The U.S. Government Accountability Office, whose standards we are statutorily required to follow, requires us to assess the sufficiency and appropriateness of computer‑processed information that is used to support our findings, conclusions, or recommendations. Table 2 shows the results of this analysis. California State Auditor Report 2015-102 19 December 2015 Table 2 Methods Used to Assess Data Reliability INFORMATION SYSTEM PURPOSE METHOD AND RESULT CONCLUSION Central Basin Municipal Water To make a • This purpose did not require a data reliability As part of our audit work, we District’s (district): judgmental assessment. Instead, we needed to gain identified certain transactions not – New Logos Database data, for the selection of assurance that the population of expenditures present on the district’s expenditure period July 2012 through June 2015 expenditures was complete for our review purposes. lists. Nevertheless, we noted that – Master Accounting Series 90 data, • We obtained reasonable assurance by these lists materially agreed with for the period July 2010 through comparing total disbursements presented monthly bank reconciliations or June 2012 on the expenditure lists to the district’s payment register reports, and were thus adequate to use for selecting monthly bank reconciliations or payment expenditures for review. register reports. To calculate per To determine accuracy, we judgmentally Sufficiently reliable for the purposes diem payments selected 50 board‑approved per diem payments of this audit. the district from the district’s records and compared them made to its to claim forms detailing the meetings board board members members attended. To determine completeness, we reviewed district records and noted directors generally received per diem payments in each pay period between July 2010 and June 2015. The district’s: To make a This purpose did not require a data reliability Complete for the purposes of – New Logos Database data, for the judgmental assessment. Instead, we needed to gain this audit. period July 2012 through June 2015 selection of assurance that the population of contracts was – Access Database data, for the period contracts complete for our review purposes. To determine July 2010 through June 2012 completeness, we haphazardly selected 39 contracts from the district’s files and ensured they were present in either the New Logos or Access database, as appropriate. Sources: California State Auditor’s analysis of various documents, interviews, and data obtained from the district. 20 California State Auditor Report 2015-102 December 2015 Blank page inserted for reproduction purposes only. California State Auditor Report 2015-102 21 December 2015 Chapter 1 THE CENTRAL BASIN MUNICIPAL WATER DISTRICT’S BOARD OF DIRECTORS HAS CONSISTENTLY FAILED TO PROVIDE APPROPRIATE LEADERSHIP AND OVERSIGHT Chapter Summary The board of directors (board) of the Central Basin Municipal Water District (district) has failed to lead the district in a manner that encourages its efficient operation, effective management, and adherence to laws and rules. For example, the board has not maintained stability in the district’s top executive position: Over the five years of our review, six different individuals filled this role, a level of turnover that significantly affected the district’s ability to perform its necessary functions. Further, the board did not establish an effective structure for reporting and investigating ethics violations by board members and staff. In fact, the Fair Political Practices Commission (FPPC) uncovered such violations. Also, the board did not ensure that it approved or that the district implemented its previous strategic plan; it did not require the district to create a long‑term financial plan; and through its lack of action, it contributed to the district suffering two credit rating downgrades. Finally, the board’s actions led to several changes in its liability insurance, resulting in higher costs for less coverage. Because the district has lacked effective leadership, the public’s confidence in it has eroded, and it has risked being unable to meet its obligations to its customers. The district has recently taken some positive steps to correct these issues, such as retaining an experienced general manager on a two‑year contract and creating a new strategic plan. However, given the magnitude of its past problems, we believe considering ways to improve the district’s governance is necessary. Although the public currently elects the district’s board, the district does not serve the public directly but instead sells water to various entities that in turn sell water to the public. Thus, those who select the board are not those whom it directly serves. If the Legislature chose to change the district’s governance structure, it could consider a structure through which board members would be directly accountable to the entities the district serves. Such a change would enable those entities to hold the board responsible when it takes actions or makes decisions that are not in the district’s best interest. 22 California State Auditor Report 2015-102 December 2015 The Board’s Dysfunctional Oversight Has Threatened the District’s Ability to Meet Its Responsibilities The board’s poor leadership and decision making significantly impeded the district’s ability to effectively and efficiently perform its necessary functions over the course of our audit period from July 2010 through June 2015. Specifically, during this time, the board failed to ensure that it provided the district with stability in either the general manager or finance director position. In addition, the board did not establish a structure for investigating or referring ethics complaints against board members and staff related to violations of the district’s code of conduct or conflict‑of‑interest code that minimizes political influence. Finally, the board failed to approve or implement a strategic plan dated October 2010, and it is too soon to tell whether the district will effectively implement a subsequent strategic plan it adopted in May 2015. When the board fails to exercise appropriate leadership, it impedes the district’s ability to operate in an efficient and effective manner. The Board Has Not Ensured That the District Has Consistent Leadership Between July 2010 and June 2015 the board and the general manager demonstrated a lack of leadership by not maintaining stability in the district’s key executive management and finance positions, hindering the district’s ability to effectively manage and meet its responsibilities. Figure 5 presents the length of time these two critical positions were either vacant or filled by one of numerous individuals over the five‑year period. As shown in Figure 5, the district has faced high turnover in its top executive position. State law requires municipal water district boards to appoint a general manager. The board has full authority over the employment of the general manager, who in turn has full charge and control of the operation of the district, including the authority to employ and discharge all personnel except for those Between July 2010 and June 2015, the board is required to appoint. However, between July 2010 the district had six individuals in and June 2015, the district had six individuals in this critical critical leadership roles, including leadership role, including four general managers or interim general four general managers or interim managers and two interim chief operating officers (interim chiefs). general managers and two interim According to the position description, the interim chiefs served at chief operating officers the pleasure of the board until the board finalized the recruitment for the general manager position. The interim chiefs were not to have the authority to hire or fire staff or to enter into new contracts without board approval. Further, they could not participate as candidates for the general manager position. California State Auditor Report 2015-102 23 December 2015 Figure 5 Timeline of Changes in Key Leadership Positions at the Central Basin Municipal Water District GENERAL MANAGERS* JULY FINANCE DEPARTMENT HEADS† 2010 Aileen Umali-Hermoso, Chief Financial Officer 2011 April 2005 to December 2010 Art Aguilar, General Manager Position Vacant 2012 July 2006 – October 2012 Willdan Financial Services, under contract to the Central Basin Municipal Water District (district), fulfilled the duties of the Two new district’s chief financial officer board January 2011 to December 2012 members elected Charles Fuentes, Interim Chief Operating Officer October 2012 – January 2013 2013 Robert Quaid, Interim Finance Manager David Hill, Interim Chief Operating Officer December 2012 to June 2013 January 2013 – June 2013 2014 Tony Perez, General Manager May 2013 – October 2014 Richard Aragon, Finance Director May 2013 to February 2015‡ Richard Aragon, Interim General Manager September 2014 – November 2014 2015 Daniel Miles, Interim Finance Director February 2015 to April 2015 Kevin Hunt, General Manager November 2014 – present§ Josh Betta, Finance Director April 2015 to present Position vacant Sources: District human resources records, interviews with district staff, and the County of Los Angeles’s final official election results for June 5, 2012. * In certain cases during our audit period, this position was referred to as the interim chief operating officer and some of the position’s duties were restricted. † In certain cases during our audit period, this position was referred to as the chief financial officer, interim finance manager, finance director, and interim finance director. ‡ As shown in the figure, Richard Aragon briefly served as interim general manager during this time. § Kevin Hunt was initially hired as the interim general manager, a position he held from November 10, 2014, through May 10, 2015, until the district hired him as the current general manager on May 11, 2015. 24 California State Auditor Report 2015-102 December 2015 Lack of agreement among the board members was a contributing factor to instability in the district’s top executive position. In October 2012, the district’s long‑standing general manager retired. According to the district’s director of human resources, the board appointed an interim chief in October 2012. However, the board terminated him less than four months later in January 2013, during a contentious board meeting shortly after two new board members took office. The board approved the termination by a three‑to‑two vote. The board subsequently appointed a series of individuals to the top executive role. In January 2013 the board appointed a second individual to the position of interim chief. He returned to his former position as the district’s water resources and planning manager after the board hired a new general manager effective May 2013. The board placed this general manager on paid administrative leave in September 2014 and terminated his employment in October 2014. As with the first interim chief in 2013, this termination occurred during a contentious board meeting and was the result of a three‑to‑two vote by the board. Also in September 2014, the board appointed the district’s then‑finance director to also serve as an interim general manager. In November 2014 the board appointed another interim general manager and approved a recruitment process for hiring the general manager in that same year. The board subsequently entered into a two‑year employment contract in May 2015 with the individual it had previously appointed as interim general manager. The district’s current general manager’s two‑year contract expires in May 2017, and he stated that he is contemplating retiring at that time. If he chooses to retire at the completion of his contract, the general manager anticipates the board would start the recruitment process between June 2016 and October 2016. The most recent hiring process the district conducted for a general manager included establishing an independent ad hoc hiring committee, selecting a recruitment firm, and having the board interview the top candidates. However, the district does not have a formal policy for recruiting and hiring a general manager in the future, and the current general manager acknowledged that the district would benefit from such a policy. In our judgment, establishing a formal If the board does not fill the general policy for the hiring process of the general manager position and manager position either prior to beginning the hiring process a year in advance of the end of the the current general manager’s current general manager’s contract provides the district ample time retirement or within a reasonable to identify and select a replacement, should the current general amount of time thereafter, manager retire. If the board does not fill the general manager the board will likely hinder the position either prior to the current general manager’s retirement or district’s ability to effectively meet within a reasonable amount of time thereafter, the board will likely its responsibilities. hinder the district’s ability to effectively meet its responsibilities. California State Auditor Report 2015-102 25 December 2015 In addition, the district had five different individuals and The district had five different one financial services firm perform the role of finance director or individuals and one financial a similar position between 2010 and 2015. In December 2010, the services firm perform the role district’s chief financial officer resigned after more than five years of finance director or a similar in the position, and the district hired a financial services firm position between 2010 and 2015. to perform the duties of the chief financial officer. Despite the financial services firm’s recommendation in March 2012 that the district recruit and hire a full‑time dedicated finance director, the district did not fill the role with an interim finance manager until December 2012. According to the district’s director of human resources, she raised the question of hiring a finance director on multiple occasions, and the general manager at that time told her that the financial services firm was performing the job adequately and had some remaining work to complete. Nevertheless, the fact that the same financial services firm recommended that the district hire a finance director suggests that the district should have prioritized filling this position. The district finally hired a finance director in May 2013. He remained in the position until February 2015, when the district hired an interim replacement until it recruited a new finance director in April 2015. The lack of stability in these two key management positions has threatened the day‑to‑day operations of the district. As we note later in this chapter, a lack of stable management was a factor in the district’s losing its insurance in 2014. Further, together these positions help establish an environment that promotes effective stewardship of both resources and staff. As we note in Chapter 2, the district’s management of its contracts and expenditures needs improvement, and in Chapter 3 we discuss that the lack of a general manager contributed to staff not receiving timely performance evaluations. If the board struggles to maintain consistency in these critical positions in the future, the district may continue to lack the leadership necessary to meet its responsibilities. The Board Lacks an Effective Structure to Investigate Its Own and District Staff’s Noncompliance With Laws and Rules The board has not adequately maintained a mechanism to respond to complaints regarding its members’ or district staff’s violations of laws and district codes related to ethics. From the beginning of our audit period in July 2010 until the end of July 2015, the district’s administrative code called for an ethics committee to investigate ethics complaints against board members and staff. According to the administrative code in force prior to July 2015, this committee was to include two board members. Further, the administrative code indicated that certain district staff and the district’s counsel were to be members of the committee but was silent as to whether they would be voting members. However, according to the human 26 California State Auditor Report 2015-102 December 2015 resources director, district staff only provided information to the ethics committee and, according to our review of the district’s board minutes, these staff were not voting members. Until July 2015 the district’s administrative code stated that the ethics committee would meet twice yearly. However, this committee did not meet regularly. Specifically, according to the district’s director of human resources, she informed the then‑general manager in July 2011 that the ethics committee was listed in the administrative code as a standing committee that met every six months. She explained that the ethics committee met the following month, although it conducted no business during that meeting, and that it met again in February 2012. It scheduled another meeting for October 2012, but this meeting did not occur because not enough committee members attended. The ethics committee did not schedule another meeting until August 2013, 18 months after its February 2012 meeting. The director of human resources did not know why the ethics committee did not meet regularly during this time but commented that the board had not established the practice of ensuring the committee met every six months. When the committee finally did meet to conduct business in In August 2013 the ethics committee August 2013, the meeting generated controversy. First, the chair violated the Brown Act when it of the ethics committee chose to conduct the meeting in open conducted a meeting in open session, even though the posted agenda indicated that this meeting session even though the posted was to be in closed session. By conducting an open meeting agenda indicated that this meeting without correctly noting that in the advance agenda, the committee was to be in closed session. violated the Ralph M. Brown Act (Brown Act). We discuss additional concerns with the board’s adherence to the Brown Act and make a related recommendation in Chapter 2. Further, at its meeting the ethics committee discussed a letter from the district attorney’s office regarding its investigation into the alleged release of confidential information by the then‑board president to a local newspaper. During this meeting, the committee authorized the general manager to seek an investigator to review the matter further. After the investigation was completed, the committee voted in September 2013 to refer the then‑board president’s alleged disclosure of confidential information to the Los Angeles County Grand Jury. As of September 2015, published reports of the Los Angeles County Grand Jury had not addressed this issue. Shortly after the September 2013 meeting, the then‑board president—who had the authority to appoint members of committees—stated in a memorandum to the general manager that he was very concerned about the ethics committee and the manner in which it was using its role to investigate board members. He stated that he was reconfiguring the ethics committee immediately by placing himself on the committee as the chair, adding another California State Auditor Report 2015-102 27 December 2015 board member, and replacing the two sitting board members. In October 2013, in another memorandum to the general manager, the then‑board president stated that there was dissension and turmoil caused by the ambiguity of the administrative code and the ethics committee, and this was having a pernicious and destructive impact on staff morale. At a subsequent October 2013 meeting, the board temporarily suspended the ethics committee until it could resolve the ambiguity in the district’s administrative code. Although the board temporarily suspended the ethics committee in October 2013, it did not approve revisions to the district’s administrative code regarding the committee until July 2015. According to the district’s director of human resources, a former general manager postponed finalizing a new policy because he was concerned that board members would use a reinstated ethics committee to act on political disagreements. The board finally approved amendments to the administrative code in July 2015, establishing a new ethics committee; however, the committee’s structure remained fundamentally the same. Like its predecessor, it consists of two board members, and the ambiguity regarding staff membership—whether they are voting members or only provide information to the committee—remains. The director of human resources stated that the district plans to address this ambiguity in the administrative code and make staff nonvoting members of the committee, although she did not give a timeline. Because the board did not make significant structural changes to the new ethics committee, it will be subject to the same issues the former ethics committee faced. The district recognizes the inherent conflicts of interest in its The district recognizes the inherent current ethics committee structure and is making changes. conflicts of interest in its current In August 2015 the general manager made a presentation to ethics committee structure and is the board on this topic, and the board’s agenda included an making changes. informational document regarding its new ethics committee. The informational document acknowledged that the most significant difficulty in crafting an ethics enforcement policy is the inherent conflict of interest in asking board members and the general manager to investigate their peers, coworkers, friends, or bosses. To address this, the general manager discussed in the meeting the possibility of contracting with an independent law firm to conduct preliminary investigations. Also, the informational document suggested that the new ethics committee consider its role and alternative ways for it to function effectively. Finally, the general manager noted in the meeting that district staff recently met with the ethics officer for the Metropolitan Water District of Southern California (Metropolitan) and learned that Metropolitan participates in an independent, anonymous ethics hotline. Metropolitan’s ethics officer made a presentation to the board in 28 California State Auditor Report 2015-102 December 2015 In October 2015 the board adopted September 2015. At a meeting in October 2015, the board adopted a a plan to implement a hotline for plan to implement a hotline for reporting potential ethics violations reporting potential ethics violations and to contract with a law firm to conduct an independent review and to contract with a law firm to of those alleged violations. conduct an independent review of those alleged violations. Further, board members and staff have attended ethics training; however, the training by itself may not prevent ethical violations. As we will discuss in Chapter 2, in 2015 a former general manager and a former board member received fines from the FPPC of about $30,000 each for violating the Political Reform Act by, for example, receiving gifts in excess of established limits from a district contractor. Although a functioning independent ethics committee may not have prevented or detected these specific violations, the lack of such a body would prevent the district and the board from receiving and acting on complaints of similar potential violations. The Board Failed to Demonstrate Any Commitment to the Strategic Planning Process in the Past Until recently, the board demonstrated a lack of leadership by not ensuring the district had an approved strategic plan or made progress in achieving the plan’s goals and objectives. According to the Government Finance Officers Association (GFOA), strategic planning is a comprehensive and systematic management tool to help an organization assess its current environment, anticipate and respond appropriately to changes in that environment, envision the future, increase effectiveness, develop commitment to its mission, and achieve consensus on strategies and objectives for achieving that mission.3 The GFOA recommends that all governmental entities use some form of strategic planning to provide a long‑term perspective for service delivery and budgeting, thus establishing logical links between their authorized spending and broad organizational goals. However, the board did not demonstrate a commitment to the strategic planning process and missed opportunities to identify whether the district was making progress in achieving its goals and objectives. Specifically, the board considered a five‑year strategic plan in October 2010 that included a mission statement, a vision of the district in 2015, goals, and a set of metrics to help assess and guide the district’s progress toward that vision. However, according to the director of human resources, the board never approved this strategic plan. Nevertheless, she explained that when she began working at the district in January 2011, the then‑general 3 The GFOA represents public finance officials throughout the United States and Canada. The GFOA’s mission is to enhance and promote the professional management of governmental financial resources. One of the ways in which it does this is by providing best practice guidance to its members. California State Auditor Report 2015-102 29 December 2015 manager directed her to use this plan and implement its objectives. The director of human resources stated that staff initiated implementation of the strategic plan in the summer of 2011, but that continued execution of the plan was put on hiatus once the then‑general manager left the district in 2012. Not only did the district lack this critical organizational planning tool for several years, but the board failed to demonstrate its commitment to the strategic planning process by not approving the strategic plan or ensuring its appropriate implementation. Despite these past shortcomings, the board recently adopted a new strategic plan that, if properly implemented, appears adequate. The current general manager stated that one of his first priorities after joining the district in November 2014 was to develop a new strategic plan for the district. The district engaged a consultant to coordinate and facilitate the development of a strategic plan in January 2015. The plan was developed with input from the district’s customers, board members, and a project team that included the current general manager as well as various district managers. The new plan covers three years and reflects the district’s overall mission and responsibilities. The board adopted this strategic plan The board adopted a new strategic in May 2015, and the district implemented it beginning in fiscal plan in May 2015 that covers year 2015–16. District staff developed a performance measurement three years and reflects the district’s scorecard that provides a basis for the district’s periodic review overall mission and responsibilities of its progress toward its strategic planning objectives. According and, if properly implemented, to the general manager, the district will review this scorecard appears adequate. on a quarterly basis. Additionally, he explained that the district will use the budgetary process to update the board and identify strategic plan goals for the upcoming year. In October 2015 district staff presented a status update to the board that indicated steady progress has been made under the major goals included in the strategic plan. To the extent the board ensures that the district follows through on its plans to monitor and publicly report on its progress in achieving the strategic plan’s goals and objectives, the board will help ensure the district is transparent in its actual achievement of the strategic plan. The Board Has Failed to Take Critical Steps Necessary to Ensure the District’s Continued Financial Sustainability The board has not established the essential policies necessary to safeguard the district’s long‑term financial viability. It has not ensured that the district engages in long‑term financial planning to protect its long‑term financial viability or that the district conducts a water rate study to ensure it collects sufficient revenue to cover its operating expenses. These deficiencies, at least in part, contributed to the district’s inability to meet the debt coverage ratio required by its debt agreements, and as a result the district’s credit 30 California State Auditor Report 2015-102 December 2015 rating was downgraded in 2013. These deficiencies may also have contributed to the downgrade in 2015. The downgrades may lead to an increase in the costs the district pays on its debt. In addition, the board’s inaction at a critical moment led to the avoidable loss of the district’s insurance coverage, resulting in a substantial increase in costs and reduction in coverage for the district’s subsequent liability insurance policies. The District Has Not Developed a Long‑Term Financial Plan Although the GFOA recommends that all government entities regularly engage in long‑term financial planning, the district failed to do so throughout our audit period. Long‑term financial planning could help the district develop strategies to overcome financial challenges and achieve long‑term sustainability. Instead, the district has forecast its revenue and expenditures on a year‑to‑year basis during its budget process. According to the current finance director, one of the reasons the district did not engage in long‑term financial planning was its lack of consistent leadership in the finance director and general manager positions, which we describe earlier in this chapter. In August 2015 Moody’s Investors Service (Moody’s) placed $48.4 million of the district’s debt credit rating on review for a possible downgrade, in part because of the district’s lack of future year financial projections.4 Moody’s subsequently downgraded the credit rating on this debt in October 2015 citing other reasons, as we discuss in the next section. According to an article the GFOA published on building a financially resilient government, credit rating agencies point to long‑term financial planning as evidence of management’s dedication to the practices that maintain long‑term financial health. The credit rating downgrade—the second the district has received in the past three years—may cause the district to incur additional costs. We describe the credit downgrades and their financial consequences in the next section. Not surprisingly, the district’s recently adopted strategic plan includes an objective related to conducting long‑term financial planning. In October 2015 the board authorized the general manager to engage a consultant to prepare a 10‑year financial forecast. The general The district’s lack of a long‑term manager stated that his goal is for the district to have a completed financial plan to guide its revenue long‑term financial plan by the end of 2016. estimation process contributed to the district overestimating its The district’s lack of a long‑term financial plan to guide its revenues during the last four years revenue estimation process contributed, at least in part, to the in our audit period. district overestimating its revenues during the last four fiscal 4 Moody’s is a provider of credit ratings, research, and risk analysis. The purpose of its credit ratings is to provide investors with a simple system of gradation by which they may gauge the future relative creditworthiness of securities. California State Auditor Report 2015-102 31 December 2015 years in our audit period. When the district does not develop reasonable revenue estimates during its budgeting process, it risks that its revenue will not cover its expenses. The current general manager, who has more than 20 years of experience in the water industry, explained that in his experience it is normal for actual revenues from water sales to vary somewhere between 10 percent and 15 percent of estimates. However, as shown in Table 3, the yearly variance in the district’s budgeted‑to‑actual revenues was greater than 20 percent in three of the five fiscal years within our audit period. The district did not have an individual in the finance director position when it prepared its budgets for fiscal years 2011–12 and 2012–13—two of the fiscal years in which its actual revenues were at least 20 percent less than its corresponding estimates—and instead engaged a consultant to perform its financial management duties. According to the current general manager, the district’s former management was too optimistic when developing revenue estimates. Additionally, he explained that the 21 percent variance in fiscal year 2014–15 was primarily the result of lower replenishment water sales than the district had estimated because an invasive shellfish contaminated the source of the district’s replenishment water. Table 3 Differences Between Budgeted and Actual Revenues at Central Basin Municipal Water District Fiscal Years 2010–11 Through 2014–15 (In Millions) 2010–11 2011–12 2012–13 2013–14 2014–15 Budgeted revenues $58.3 $64.1 $66.0 $52.0 $71.4 Actual revenues 60.9 50.8 45.1 46.3 56.2 Difference (Shortfall) 2.6 (13.3) (20.9) (5.7) (15.2) Difference as a percentage of 4% 21% 32% 11% 21% budgeted amount Sources: Central Basin Municipal Water District budget documents, comprehensive annual financial reports for fiscal years 2010–11 through 2013–14 and draft financial statements as of October 2015 for fiscal year 2014–15. Despite large variances in the district’s past budgeted‑to‑actual revenues, it appeared to follow a reasonable methodology when preparing its budget for fiscal year 2015–16. Specifically, in a memorandum to the board, district staff reported that the district surveyed its customers to determine a baseline projection for potable water sales and then reduced the projection to reflect allocations from the district’s regional wholesaler. Staff also reported that they adjusted the projection to reflect the State’s recent mandated water conservation order due to the drought. The current general manager believes that this methodology will 32 California State Auditor Report 2015-102 December 2015 provide a reasonable estimate for the district’s revenue in fiscal year 2015–16. We believe the district’s approach was logical, especially since the drought has made it problematic to use historic trends to predict future water sales. Although the district appears to now have a reasonable methodology for forecasting its revenue on a short‑term The district has not conducted basis, it has not conducted a water rate study to determine the a water rate study to determine appropriateness of its water rate structure to ensure it meets the appropriateness of its its operating costs on a long‑term basis. As a wholesaler, one of water rate structure to ensure the district’s main sources of revenue to cover its expenses it meets its operating costs on a is the surcharge it adds to the water it purchases from the regional long‑term basis. wholesaler and sells to its customers. The district risks running deficits when declining water sales lead to lower surcharge revenues than it estimated and it does not reduce its expenses accordingly. Nonetheless, the district’s board has not increased the district’s surcharge since fiscal year 2011–12. According to the current general manager, the district intends to contract with an outside consultant to provide technical analysis of its water rate schedule to determine the appropriateness of its rates. He further stated that the district should not adjust its surcharge until it develops a long‑term financial plan to forecast its revenues and expenses; the water rate study it plans to conduct can then help it set its water rates to meet these revenue forecasts. The general manager plans to have the water rate study completed by spring 2017. Largely because the district collected less revenue than it had budgeted, its expenses exceeded its revenues in three of the past five fiscal years. The district incurred deficits in each of the fiscal years 2011–12 through 2013–14, with the largest of nearly $5 million occurring in fiscal year 2012–13. These deficits were due to a combination of factors, including reduced water sales, increased expenses, and an early debt payment. For instance, the district made a $3.9 million payment in June 2013 to pay off part of its debt early in order to reduce its overall debt load. In addition, the district’s imported water revenue declined by more than $12 million between fiscal years 2010–11 and 2013–14. During the same time period, its general and administrative expenses increased by more than half a million dollars, in part because its legal costs were greater than $1.5 million every year from fiscal year 2010–11 through 2013–14. In particular, the district reported historically high general and administrative expenses in fiscal year 2012–13 due to litigation involving another water agency. Further, during fiscal year 2013–14, the district’s legal expenses accounted for almost $2.6 million, or 60 percent, of its general and administrative costs. The district has now settled most of its litigation issues, and its fiscal year 2014–15 legal expenses of $677,000 were $900,000 less than its legal expenses in any of the other years during our audit period. California State Auditor Report 2015-102 33 December 2015 Finally, until recently, the board did not ensure the district had an adequate reserve policy. An article the GFOA published about building a financially resilient government highlights that public entities must maintain a reserve policy as a component of long‑term financial planning. By not following a reserve policy in the past, the board did not demonstrate a commitment to financial prudence and careful stewardship of district assets, and the district risked potential adverse impacts from unanticipated expenditures. The current general manager stated he wrote the district’s current reserve policy soon after he began providing interim general manager services to the district in November 2014; the board approved the updated reserve policy in April 2015. According to the district’s current reserve policy, its reserves are funds it sets aside to achieve its objectives, respond to operational uncertainties, and address emergencies. The district’s updated policy establishes funding levels for several designated reserves, which are earmarked for purposes such as cash flow, legal expenses, and building replacement. The current general manager stated that in his experience, an adequate reserve policy is necessary for the financial health of the district and is an important tool to assist with the budgeting process. According to the finance director, the district will reassess its The district averaged a $2.9 million reserve levels, which totaled nearly $15 million at the end of fiscal deficit between fiscal years 2011–12 year 2014–15, on an ongoing basis during its budget process. and 2013–14. If these deficits Nevertheless, because the district averaged a $2.9 million deficit continue, the district may not between fiscal years 2011–12 and 2013–14, and if these deficits achieve its reserve goals. continue, the district may not achieve its reserve goals. The District Could Incur Additional Costs on Its Debt Due to Credit Rating Downgrades in 2013 and 2015 The district may incur an increase in its debt costs due to downgrades by Moody’s to its credit rating. In August 2013 and again in October 2015, Moody’s downgraded the credit rating on the district’s debt. As a result of these downgrades, Moody’s current rating indicates the district’s debt is upper‑medium grade and subject to low credit risk. Nevertheless, in 2014, a former general manager stated he estimated that the district had already incurred costs and would incur additional costs due to the August 2013 credit rating downgrade. In addition, the current general manager stated that due to the October 2015 downgrade, the district will likely incur additional costs when it restructures its outstanding debt. Moody’s stated that it downgraded the district’s credit rating on $53 million of its debt in August 2013 in part to reflect the precipitous decline in the district’s debt coverage ratio in fiscal year 2012. 34 California State Auditor Report 2015-102 December 2015 Essentially a calculation of the district’s net revenues divided by its net debt‑service costs, the debt coverage ratio serves as a benchmark to measure the district’s ability to produce enough cash to cover its debt payments. When the district issued debt in the past to fund its capital projects, such as its recycled water distribution system, it entered into debt agreements with financial institutions that required it to maintain a minimum debt coverage ratio of 1.15. As shown in Table 4, the district’s debt ratio coverage dropped below the 1.15 ratio required by its debt agreements twice within the past five fiscal years, falling as low as 0.20 in fiscal year 2012–13 but improving since then. According to the district’s comprehensive annual financial report for the fiscal year ending June 30, 2013, this decrease occurred in part because the district faced sustained high legal costs and in part because of a decline in water revenues in fiscal year 2012–13. Moody’s also stated that the other reason for its 2013 downgrade of the credit rating on the district’s debt was the litigation surrounding one of its primary customers. Moody’s indicated that it was concerned about the district’s ability to restore debt‑service coverage and cash reserves to their historic levels. Table 4 Central Basin Municipal Water District’s Debt Coverage Ratio Fiscal Years 2010–11 Through 2014–15 REQUIRED DEBT COVERAGE RATIO* 2010–11 2011–12 2012–13 2013–14 2014–15 1.15 1.91 0.64 0.20 1.33 1.75 Sources: Central Basin Municipal Water District’s (district) comprehensive annual financial reports for fiscal years 2010–11 through 2013–14 and the California State Auditor’s analysis of information in the district’s draft financial statements as of October 2015 for fiscal year 2014–15. * The required debt coverage ratio is set by the district’s debt agreements. After Moody’s downgraded its rating of the district’s debt in August 2013, the then‑general manager prepared a memorandum to the board in April 2014 in which he estimated that the downgrade would cause the district’s costs related to one of its credit agreements to increase by a two‑year total of $65,000 from fiscal year 2013–14 through fiscal year 2014–15. The memorandum also stated that because of the downgrade, the district could face an increase in total interest costs when it issues new debt to restructure its outstanding debt. Specifically, the former general manager estimated that the credit downgrade could result in additional interest costs of between $100,000 and $500,000 over the life of the district’s restructured debt. The district’s current finance director, who was not a district employee at the time, explained that he does not have information related either to the decrease in the debt ratio coverage in fiscal years 2011–12 and 2012–13 or to the costs resulting from the credit rating downgrade. The current general manager California State Auditor Report 2015-102 35 December 2015 explained that he would like to restructure the district’s debt. The district’s financial advisor has recommended the district wait until the conclusion of our audit before proceeding with its plans for debt restructuring. Additionally, Moody’s stated that it downgraded the district’s credit rating on its debt again in October 2015 because it believed that debt service coverage levels will likely be lower than previously anticipated, given declining operating revenues caused largely by the conservation efforts associated with prolonged drought conditions. The current general manager stated that, as a result of this downgrade, the district will likely incur additional borrowing costs when it issues new debt to restructure its outstanding debt, although it is too early to determine what the actual effect will be. The district’s finance director believes this downgrade will not affect the district’s current debt costs because the district’s debt service coverage remains above the target set by the district’s bond agreements. The district may have struggled with its debt coverage ratio because the board has not ensured the district has a formal debt management policy. In 2011, 2012, and 2013, two different external auditors recommended that the district implement a formal debt management policy. According to the GFOA, a government’s adherence to such a policy signals to rating agencies that it is well managed and therefore is likely to meet its debt obligations in a timely manner. The GFOA recommends the policy should include, among other things, debt structuring practices and the potential credit rating impacts of weak debt coverage ratios. Although two district managers wrote memoranda to the board during our audit period that indicate their awareness of the district’s debt coverage ratio requirements, the current general manager confirmed that the district has never implemented a formal debt management policy. The current finance director stated he is uncertain why the board did not address the external auditors’ past findings but that he is aware of the GFOA’s recommendation. He The district’s lack of a formal debt explained that his goal is for the district to maintain a debt coverage management policy may put it at ratio of over 1.50. However, the district’s lack of a formal debt risk of making financial decisions management policy may put it at risk of making financial decisions that could impair its ability to meet that could impair its ability to meet its required debt coverage ratio its required debt coverage ratio. of 1.15, let alone its higher goal for this ratio. The Board’s Inaction Resulted in the District’s Loss of Insurance Coverage and Subsequent Higher Insurance Costs The district’s costs for its liability insurance increased significantly in 2014 and 2015 when the board failed to take action to preserve its insurance policies. Because an agency such as the district can 36 California State Auditor Report 2015-102 December 2015 be exposed to significant liability, we believe it is a good business practice for it to maintain both general and employment practices liability insurance. Until May 2014 the district procured its insurance through the Association of California Water Agencies Joint Powers Insurance Authority (Insurance Authority), a public entity that is a partnership of water agencies that provides risk‑sharing pools to meet its members’ needs for property, liability, workers’ compensation, and employee benefits insurance coverage. However, in March 2014 the Insurance Authority notified the district of its plans to recommend to its executive committee that it cancel the district’s participation in the insurance program, citing its concerns with the magnitude and frequency of employment practices claims against the district. The Insurance Authority specifically stated that its greatest concern was that many of these claims stemmed from the board’s actions. In that same month, the Insurance Authority’s executive committee voted to recommend to its board of directors the cancellation of the district’s participation in insurance programs for liability, property, and workers’ compensation—a recommendation the Insurance Authority’s board of directors approved in May 2014. The board failed to act on an However, the board failed to act on an opportunity to negotiate opportunity to negotiate its its coverage with the Insurance Authority before the district’s coverage with the Insurance insurance was canceled. In April 2014 the Insurance Authority Authority before the district’s offered the district the opportunity to apply to continue the district’s insurance was canceled. participation in its liability and property insurance programs so long as the district agreed to certain conditions. Specifically, these conditions included the district accepting a six‑month suspension of its employment practices liability coverage, withdrawing from the workers’ compensation insurance program, assuming responsibility for certain costs resulting from a number of lawsuits, and securing a four‑fifths vote by the district’s board before it could terminate a general manager. Had the district agreed to these conditions, based on its assessment, it would have had to temporarily obtain workers’ compensation and employment practices liability insurance from another insurance provider. However, the district then would have had the opportunity to apply to have its insurance coverage reinstated by the Insurance Authority. During March and April 2014 district staff informed the board on several occasions of the causes and consequences of the potential loss of the district’s insurance coverage, as well as proposed solutions. At a board meeting in late April 2014, the board postponed its decision on its response to the Insurance Authority’s proposal. Instead, it stated that it would consider the district’s insurance coverage at a special meeting that was scheduled just days before the Insurance Authority’s May 5, 2014, meeting when it was to consider the district’s response to its proposal. However, the special meeting was canceled because not enough board members California State Auditor Report 2015-102 37 December 2015 attended. As a result of the board’s inaction, it failed to reach an agreement on the Insurance Authority’s proposed conditions or to submit a counterproposal before the meeting. Consequently, the Insurance Authority’s board of directors voted in May 2014 to cancel the district’s insurance coverage effective in June 2014. Before its cancellation became effective, however, the district withdrew from the Insurance Authority’s coverage in order to obtain coverage from alternate carriers in May 2014. The district subsequently obtained new insurance; nonetheless, the board’s poor management practices caused the district to lose a part of that coverage. As previously mentioned, the Insurance Authority proposed as one of its conditions that the board require a four‑fifths vote to terminate its general manager. However, the board did not agree to this condition before the Insurance Authority canceled its coverage. After the district had obtained new insurance coverage from private insurance companies, the district’s insurance broker warned the district in September 2014 that any change to senior staff would create a level of uncertainty in the insurance markets that would affect the pricing for the district’s employment practices liability insurance. Despite this warning, the board terminated the district’s then‑general manager the next month in October 2014. In response, he filed a legal claim in February 2015 for more than $8.2 million against the district and three board members for wrongful and illegal termination. At that time, the insurance company that provided the district with its employment practices liability coverage notified the district that it would not renew the district’s policy when it expired in May 2015, citing its annual reevaluation of risks in light of changing conditions in the insurance market. As a result of the board’s poor decision making, the district is currently paying substantially more for less general liability and employment practices liability insurance coverage than it had before, as noted in Table 5 on the following page. If the board fails to maintain the district’s current insurance If the board fails to maintain coverage, it will place the district at risk of becoming uninsurable. the district’s current insurance According to correspondence from the district’s insurance broker in coverage, it will place the district at May 2015, marketing of its employment practices liability insurance risk of becoming uninsurable. coverage has been quite challenging. In fact, the insurance broker notified the district that it had approached numerous companies to obtain quotes for the district’s coverage, but only two responded while all the others declined. In other words, the coverage the district obtained in June 2015 was the less expensive of the only two quotes it received, in part due to the district’s history of litigation. 38 California State Auditor Report 2015-102 December 2015 Table 5 Central Basin Municipal Water District’s General Liability and Employment Practices Liability Insurance Coverage and Costs October 2013 Through June 2016 OCTOBER 1, 2013, COVERAGE PERIOD THROUGH MAY 15, 2014* MAY 15, 2014, THROUGH MAY 15, 2015 MAY 15, 2015, THROUGH MAY 15, 2016 General liability coverage $1 million per Deductible: $1 million per Deductible: occurrence $1,000 occurrence $10,000 $2 million per occurrence Carrier: Allied World Carrier: Allied World Assurance Company Premium: Assurance Company Premium: Carrier: Association $49,950 $49,096 of California Water COVERAGE PERIOD Agencies Joint Powers MAY 15, 2014, THROUGH JUNE 15, 2015 JUNE 15, 2015, THROUGH JUNE 15, 2016 Insurance Authority Employment practices $2 million per claim Self‑Insured $1 million per claim Deductible: (Insurance Authority) liability coverage Retention:† $250,000 Carrier: ACE Municipal Carrier: Kinsale Deductible: $100,000 Advantage Insurance Company $10,000 Premium: Premium: $69,826‡ $150,000 Total annual premium $70,420§ $119,776‡ $199,096 Sources: Central Basin Municipal Water District (district) insurance policies and its comprehensive annual financial reports for fiscal years 2010–11 through 2013–14. * The district maintained insurance through the Insurance Authority from the beginning of our audit period in July 2010 through May 2014. † The district’s former employment practices liability insurance had a self‑insured retention rather than a deductible. The insurance carrier’s liability only applies to the part of damages and claim expenses that are in excess of the retention. ‡ The district made an additional $6,000 payment for a one‑month extension to this insurance policy, which is not included in the amount above. § The $70,420 was the cost to the district of the policy through September 2014. However, the Insurance Authority voted to cancel the policy effective in June 2014, but the district withdrew from coverage earlier in May 2014. Further, according to the current general manager, the district losing its insurance would expose it to substantial liability and severe operational impacts. For example, between 2013 and 2015, the district’s insurers paid out about $1 million in claims against the district, amounts the district would have had to pay on its own in the absence of any insurance coverage. As of September 2015 the district had three employment practices lawsuits pending against it, including the more than $8.2 million lawsuit from the former general manager, which demonstrates the magnitude of the financial risk the district could face in the absence of adequate insurance coverage. A New Method of Governance Would Improve the District’s Leadership As described in this chapter, the board has failed to lead the district in a manner that encourages its efficient operation and effective management. Further, as we will show in Chapters 2 and 3, the board has violated its own policies related to contracting and hiring, and it also violated state open meeting law when it inappropriately approved the establishment of a legal trust fund in 2010. The California State Auditor Report 2015-102 39 December 2015 board’s poor decisions over the past five years have eroded the public’s trust in the district and cost the district many thousands of dollars in misspent funds. As previously discussed, the district and board recently made certain changes that have improved—or have the potential to improve—the management of the district. Most significantly, in the past year, the board hired a general manager with significant experience managing another water district and a finance director with experience in local government. Also, in July 2015 the board approved various changes to the district’s administrative code that, if followed, will help the district to address some of the issues we describe in this and subsequent chapters. Finally, since October 2014 the district has generally held monthly meetings for its customers to update them on the district’s activities and other issues of interest. Such meetings provide an opportunity for the district to report to and receive feedback from its customers. Although these are positive steps, we remain skeptical of the board’s Although the district and board ability to consistently ensure the district’s stability and to provide have made positive steps to it with effective, ongoing leadership. For instance, days after an improve the management of the October 2014 report by the County of Los Angeles Department of district, we remain skeptical of Public Works (Public Works) noted the improved stability of the the board’s ability to consistently district’s operations and senior management team, the board voted ensure the district’s stability to terminate the employment of the individual serving as general and to provide it with effective, manager at that time. At this time, we have little assurance that the ongoing leadership. board will not make similar decisions in the future that could undo the positive effects of the recent changes. Overall, Public Works’ report was critical of the district, and it included an exploration of the steps necessary to dissolve it. However, the report stopped short of recommending such an extreme action. Public Works noted that the Local Agency Formation Commission for the County of Los Angeles (LAFCO) controls the process for dissolving the district. Under state law, a petition for dissolution of the district could be filed by a resolution of the legislative body of an affected agency such as a city, county, or the district itself. A petition may also be filed by 10 percent of the voters in the district, or LAFCO itself may initiate a proposal. State law then requires LAFCO to hold a public hearing on the proposal and inform the affected entities, including providing written notice of the hearing to landowners and registered voters. Further, LAFCO may terminate the proposed dissolution or place the matter up for a vote by the voters in the district, depending on whether protests are received to the proposal under various specified conditions. If the district were dissolved, another entity would need to take over its responsibilities. According to state law, the choice of a successor to the district would be based on the existing jurisdiction 40 California State Auditor Report 2015-102 December 2015 within the district—such as the county or an individual city—that has the greatest assessed value of taxable property, or the terms and conditions of the petition for dissolution could name the entities to take responsibility for the district’s duties. Public Works’ report also noted that a reorganization of the district—for example, breaking it into smaller pieces—is also under the jurisdiction of LAFCO and would be subject to steps similar to those required to dissolve it. The report did not indicate whether Los Angeles County would be willing or able to take on the district’s work itself, nor did it recommend another entity to assume those responsibilities. Instead, the report recommended this audit. Given the concerns we raise in this report, a dissolution or Should the board not succeed in restructuring may become necessary in the future. Should the maintaining a stable leadership board not succeed in maintaining a stable leadership team, should team, experience additional the district experience additional lawsuits, or should it lose its lawsuits, or lose its insurance insurance coverage again, it will risk not being able to operate coverage again, it will risk not being effectively as an independent entity. However, because of the able to operate effectively as an district’s recent progress, a complete dissolution may be premature independent entity. at this time. A less extreme option to address the lack of leadership of the district would be to change its governance structure. Currently, the five divisions within the district elect the board members by popular vote, but electing new board members has proven to be ineffective at improving the board’s leadership. For example, in 2012 two board members were defeated and replaced with two new individuals, yet some of the same problems we discuss in this report continued well beyond 2012. In fact, the financing of board members’ political campaigns may also have contributed to some of the missteps we describe in this report, as their campaigns receive donations from entities doing business with the district. To address the problems we found, we believe that board members need to be answerable to those who select them. Although the voters in the district elect the board members, the district’s direct customers are not members of the public; rather, they are the cities, other water districts, mutual water companies, investor‑owned utilities, and private companies to whom the district sells imported and recycled water. Because these entities do not select the board members, the board members are only indirectly accountable to those they actually serve. As a result, the board may face few or no repercussions if it chooses to ignore the input of the district’s customers. Further, the board’s responsibilities are narrow in scope. Specifically, the district’s role is to purchase water from a limited number of sources and resell it to entities who in turn sell it directly to the public. Such a role does not require broad policy making, but instead requires significant input from its customers California State Auditor Report 2015-102 41 December 2015 regarding water purchases and sales. The district and its residents would be better served if its direct customers were able to select its policymakers. Consequently, we believe an option for improving the district’s We believe an option for improving governance would involve a board appointed by its customers, a the district’s governance would structure for which precedent exists. For example, Metropolitan, involve a board appointed by its which delivers water to numerous member public agencies including customers, a structure for which the district, has a board composed of representatives from its precedent exists. member agencies. The San Diego County Water Authority also has a board appointed by its member agencies. If the Legislature chooses to act on our recommendation, it could preserve the district as an independent entity, allowing the district to continue to provide both imported and recycled water without confusion or disruption. However, the Legislature could modify the district’s governance structure to adopt an appointed board, thus improving the board’s accountability to the entities the district serves. Further, because the local entities the district serves would appoint the board members from within their communities, the board would continue to represent the interests of the residents of the district. The district’s current general manager expressed reservations about an appointed board. He acknowledged that an appointed structure is possible but stated that such a move may simply replace one set of problems with another. For example, he said that state law does not provide for private water companies or mutual water companies having a seat on the board. Instead, the underlying city is represented, which would create a disconnect between service and rate setting and affect 25 percent of the district’s service area. Further, the general manager stated that the district’s electors are not its direct customers; however, they are all rate payers through the district’s standby charge. Also, he stated that the district serves residents through 40 water retailers5 and one water wholesaler. All of the district’s customers benefit from district activities, including its Metropolitan representation and its efforts regarding water conservation, water recycling, water resources planning, and water education. Further he stated that rate setting by more than 40 agencies—which is the model Metropolitan follows—that benefit in different ways from their associations with the district would be difficult and divisive. The electorate provides a balance for the various water entities the district serves and helps to ensure that they do not unduly influence the board. He said that, depending on how the district’s customers were to select their appointed representatives, larger or wealthier water districts could attempt to establish policies that disadvantage smaller or less wealthy districts. Finally, he noted that the district has been in existence for more than 60 years and the structure has worked fine for most of that period. In the opinion of the current general manager, the 5 As indicated in the footnote on page 83, the district provided us with updated information in March 2016 that reflected it had 40 water retailers. 42 California State Auditor Report 2015-102 December 2015 problems in the last five years are a result of actions by individual board members and not a failure of the institutional structure. Nevertheless, as we previously discussed, the district’s board is not directly accountable to those the district serves, and the decisions it needs to make are narrowly defined according to the district’s mission. Given the significant problems we outline in this report and the lack of leadership displayed by the board, in our judgment it is time to consider an alternate governance structure to improve the accountability of the board to its customers and ensure the district continues to focus on its responsibilities. Recommendations Legislature To ensure the efficient and effective delivery of imported and recycled water in southeastern Los Angeles County, the Legislature should pass special legislation to preserve the district as an independent entity but modify the district’s governance structure. In doing so, the Legislature should consider a governance structure that ensures the district remains accountable to those it serves; for example, the district’s board could be changed from one elected by the public at large to one appointed by the district’s customers. District To ensure the stability of the district’s operations, by June 2016 the district’s board should establish a formal policy for hiring for the general manager position. Because the current general manager is on a contract set to expire in May 2017, the board should initiate the hiring process for a new general manager or begin the process of renegotiating the contract with the current general manager in the fall of 2016. To better address potential ethical violations, the district should implement by June 2016 a means for investigating board members’ and staff’s potential violations of the district’s code of conduct and conflict‑of‑interest code that would insulate those investigations from undue influence from either the board or the general manager. To evaluate its progress toward its goals and objectives, the district should use its recently adopted strategic plan and issue an annual report that describes the steps it has taken toward achieving the goals and objectives in the strategic plan. California State Auditor Report 2015-102 43 December 2015 To ensure its long‑term financial sustainability, the board should complete a long‑term financial plan no later than December 2016. To ensure its water rate structure is appropriate to provide the revenue necessary to cover its legitimate costs, the district should complete its planned water rate study no later than the spring of 2017. To strengthen its financial stability against present and future uncertainties, the district should follow its recently adopted reserve policy. To ensure that it continues to take steps to improve its financial condition and avoids additional costs due to downgrades of its debt credit ratings, the district should immediately create a formal debt management policy. This policy should clearly define its credit objectives and provide guidelines for suitable debt agreements. This policy should also require the district to periodically monitor its specific financial ratios, such as its debt coverage ratio, that are relevant to its credit rating. To help it maintain its current insurance coverage and better position it to negotiate for more cost‑effective and appropriate coverage in the future, the board should immediately adopt a policy requiring a four‑fifths majority to terminate the district’s general manager. Further, the board should review the district’s insurance coverage annually and renegotiate costs and coverage amounts as necessary, particularly as the district resolves outstanding legal claims against it. 44 California State Auditor Report 2015-102 December 2015 Blank page inserted for reproduction purposes only. California State Auditor Report 2015-102 45 December 2015 Chapter 2 THE CENTRAL BASIN MUNICIPAL WATER DISTRICT HAS ESTABLISHED INADEQUATE POLICIES RELATED TO CONTRACTING AND EXPENDITURES AND HAS CIRCUMVENTED OTHER POLICIES Chapter Summary The Central Basin Municipal Water District (district) has not always demonstrated good stewardship of the public funds entrusted to it. Its board of directors (board) violated state law when it set up a legal trust fund (trust fund) in 2010 that it did not disclose to the public. Further, the board’s inadequate oversight of the millions of dollars of expenditures its outside legal counsel subsequently made from the trust fund may have led to payments for services unrelated to the fund’s purposes. In addition, the district consistently engaged in questionable contracting practices during our audit period. Specifically, it improperly avoided competitive bidding when selecting vendors in more than half the contracts we reviewed, and it inappropriately used amendments to extend and expand other contracts. Its inadequate contract management may also have led it to pay for unnecessary or unperformed services. Finally, some of the district’s expenditures very likely could be viewed as gifts of public funds. The Board Established an Improper Legal Trust Fund and Did Not Disclose Its Actions to the Public In June 2010, the board improperly approved the establishment of a trust fund for which it authorized the use of an unspecified amount of money, ultimately totaling millions of dollars, without adequate disclosure to the public. Because the board took this action in a closed session, we believe it violated state open meeting law. Further, the board allowed its outside legal counsel to make expenditures from the trust fund with no board oversight; thus, it has no assurance that its outside legal counsel used the trust fund only for purposes that aligned with the fund’s original intent. According to a board member at the time, the board voted in a closed‑session meeting on June 28, 2010, to approve the establishment of the trust fund whose proceeds would be used to develop a programmatic environmental impact report (PEIR) to support a groundwater storage program. The money in this trust fund was to be held by outside legal counsel retained by the district at that time. According to the former board member, the board also authorized its then‑general manager and the outside legal counsel 46 California State Auditor Report 2015-102 December 2015 to use whatever financial resources they deemed necessary to develop the PEIR. However, the published agenda for this meeting indicated that the purpose of the closed session was to discuss an issue under the pending litigation exception. The California Constitution provides that the constituents of public agencies have the right of access to information concerning those entities’ conduct, and therefore the entities’ meetings and writings must be open to public scrutiny. To ensure that public entities, in this case the district’s board, meet this goal, the Ralph M. Brown Act (Brown Act) requires them to hold open and public meetings unless a specific closed‑session exception applies. The board’s meeting minutes from June 28, 2010, indicate that the board believed it did not have to meet in open session under the Brown Act to discuss the establishment of the trust fund because the Brown Act makes an exception for pending litigation. This exception authorizes legislative bodies to discuss pending litigation, including anticipated litigation, in closed session with legal counsel if public deliberation on the matter would prejudice the legislative body’s litigation position. However, the pending litigation exception permits public entities to receive legal advice and make litigation decisions only; the Brown Act does not allow them to use the exception as a subterfuge to reach nonlitigation‑oriented policy decisions. Although the board had previously been involved in a legal dispute regarding the storage of groundwater, we did not observe evidence that suggested such litigation could reasonably be anticipated when the board took this action. An investigation performed by a law firm subsequent to the establishment of the trust fund stated that, while the board’s decision to create a groundwater storage plan was within the district’s legal authority at the time, if this action were to be reviewed by a governmental authority, that authority would conclude that this action should have been taken in open session. We believe the board should have We also believe that the pending litigation exception did not held the vote to establish the trust apply in this case and that the board should have held the vote fund in open session. to establish the trust fund in open session. Although the board’s official minutes from the June 2010 meeting state that in closed session it authorized its then‑general manager to provide resources and enter into an agreement as necessary for ongoing litigation, the law firm’s investigation found reason to believe the board used the discussion and vote to finance many nonlitigation expenses, avoid criticism, and create a PEIR. Although the investigation concluded that the board relied on its outside legal counsel’s advice when it decided that it was permitted to discuss and cast its vote in closed session, we believe it was the board’s responsibility to be California State Auditor Report 2015-102 47 December 2015 intimately familiar with the laws governing its operations, including the Brown Act, and that it should have questioned its outside legal counsel’s advice on this matter. The district did not disclose Further, the district did not disclose to the public the $2.75 million in to the public the $2.75 million transfers it made to the trust fund. It omitted the first $2 million in transfers it made to the trust in transfers from its public expenditure reports, and it reported the fund—it omitted $2 million from final transfer of $750,000 as a generic “legal services” expense. These its public expenditure reports, and omissions deprived the district’s constituents of their constitutional it reported $750,000 as a generic right of access to information concerning the district’s conduct. “legal services” expense. Once the board approved the establishment of the trust fund, the district violated another state law that requires the general manager to select competent environmental professionals when it instead allowed the district’s outside legal counsel to make this selection and contract with vendors to provide various services, including creating the PEIR. In fact, as reported in the law firm’s investigation, the district’s outside legal counsel selected the vendors, drafted contracts, and processed payments from the fund. According to a board member who approved the establishment of the trust fund, he did not have specific knowledge of how the outside legal counsel spent the resources of the trust fund because those expenditures did not come before the board for its approval. This acknowledgment indicates that the board did not ensure district staff or outside legal counsel provided it with the information necessary for it to fulfill certain of its duties, such as safeguarding the assets of the district. In addition, because the board did not approve the expenditures the district’s outside legal counsel made from the fund, the board could not ensure the district’s outside legal counsel entered into only contracts related to the fund’s purpose. As indicated in the law firm’s investigation, the outside legal counsel tracked the expenditures outside of the district’s ordinary course of business. Because of this lack of oversight, the district’s outside legal counsel may not have spent all the money in the trust fund on the purpose for which it was established. As shown in Table 6 on the following page, the outside legal counsel paid a total of roughly $2.3 million from the trust fund to the engineering services firm that was primarily responsible for creating the PEIR. However, according to the contracts or other available documentation, it also paid more than $400,000 to seven other consultants for services, summarized in Table 6. The district appears to have received very little value from its trust fund expenditures. In August 2012, after the district’s outside legal counsel had spent most of the trust fund, the governor approved statewide legislation that effectively denied the district the authority to manage, control, or administer the importation of water for the storage of groundwater. Nevertheless, the engineering services firm had created a draft PEIR by this time. As noted by the law 48 California State Auditor Report 2015-102 December 2015 firm’s investigation, the district categorized this cost as a five‑year capital asset rather than as a litigation expense. The district’s decision to categorize the cost of the PEIR as an asset instead of as a litigation expense further demonstrates that the pending litigation exception described earlier did not apply and that the board violated the Brown Act when it established the fund. Table 6 Summary of Expenditures From the Central Basin Municipal Water District’s Legal Trust Fund CONTRACTOR TOTAL AMOUNT PAID TYPE OF FIRM CONTRACTED SERVICES HDR Engineering, Inc. $2,298,750 Engineering To create a programmatic environmental impact report (PEIR) and to provide water services resources consulting services. Mark Fabiani LLC and 270,000 Strategic To provide advice, counsel, and litigation support regarding the representation of CSL Strategies LLC communications the district in various litigation and other related matters, including both ongoing and potential or anticipated litigation. Matrix New World 38,725 Engineering To conduct a peer review of the PEIR. Engineering, Inc. services Horvitz & Levy LLP 33,185 Law To conduct all necessary legal research and prepare and file in the California Supreme Court a letter asking it to depublish the Court of Appeal’s opinion in a lawsuit to which the district was not a party. Irell & Manella LLP 25,000 Law To provide legal consulting services in connection with appellate proceedings in a lawsuit between the local replenishment district and local cities. The Calderon Group 20,000 Consultant To provide advice and consultation services related to ongoing litigation, as well as to provide advice and/or settlement negotiation consultation concerning the storage and extraction of groundwater resources. Fitzgerald 15,625 Financial To provide advice with regard to financial matters as needed related to ongoing Public Finance services litigation, as well as to evaluate financial implications and resources of the storage and extraction of groundwater for anticipated litigation. Iverson, Yoakum, 553 Law To provide advice with regard to legal matters related to ongoing litigation, as well Papiano & Hatch as to evaluate an opinion on other legal issues involving litigation. Total $2,701,838* Sources: Accounting records, contracts, and other available documentation provided by the Central Basin Municipal Water District (district). * The remaining balance of approximately $48,000 plus interest left in the trust fund after the final disbursement by the district’s outside legal counsel was transferred back to the district by the end of January 2013. Finally, as a result of the board establishing the trust fund in closed session and not disclosing its actions to the public, the district incurred significant investigative and legal costs. Specifically, according to the district’s records, it has spent more than $500,000 on a law firm’s investigation and on legal costs related to a whistleblower lawsuit filed by a current board member. In particular, in 2013 a current board member who was not involved in establishing the fund filed a lawsuit under the California False Claims Act (CFCA) against certain former district contractors and employees pertaining to the establishment and California State Auditor Report 2015-102 49 December 2015 use of the trust fund.5 The purpose of the lawsuit is to recover the money transferred to the fund and to recover certain damages and expenses related to the district officials’ actions. As of November 2015 the outcome of this lawsuit was still pending. The District Did Not Consistently Use Competitive Bidding and May Not Have Received the Best Value for Its Expenditures The district did not consistently adhere to robust contracting policies and practices between fiscal years 2010–11 and 2014–15. Specifically, we found that the district did not adequately adhere to its own policies when it did not competitively bid 11 of the 20 contracts we selected for review. Further, it used amendments to circumvent the competitive bidding process in four out of five additional contracts that we reviewed. When the district does not make full use of its competitive bidding process, it cannot ensure that it receives the best value for the public funds it awards and it increases the risk that its board members or staff will develop conflicts of interest with vendors. The District Inappropriately Avoided Competitively Bidding Its Contracts Competitive bidding is a vital component of the district’s contracting practices. The district states Central Basin Municipal Water District Procurement Authorization Requirements for in its procurement policy that it is committed to Contracts for Professional Services obtaining the most reasonable value for the goods and services it purchases. Further, the district states • Services up to $5,000 require a single price quote and that it will procure the services of consultants purchase order approved by the department manager and contractors through a competitive bidding and the general manager. process. The text box describes the district’s • Services over $5,000 and up to $25,000 require an informal competitive bidding requirements for services solicitation with at least three competitive proposals or at different purchasing levels. When the district quotes, a justification for the contract award, and a contract purchases services without using competitive executed by both the general manager and the Central bidding by entering into a contract with a singular Basin Municipal Water District’s (district) general counsel. or sole‑source service provider, it skips key steps • Services over $25,000 require a formal solicitation process in its vendor selection process. These steps, such and board approval prior to execution of the contract by as soliciting bids and evaluating vendors, help the general manager and district general counsel. the district to ensure it meets its commitment to obtain the most reasonable value for its purchases. Source: The district’s administrative code. Figure 6 on the following page illustrates the 5 The CFCA permits private residents to initiate and prosecute false claims actions on behalf of the state or local government entity whose funds are at issue. Private suits under the CFCA are permitted as qui tam actions, in which prevailing private litigants are entitled to a percentage of the proceeds recovered as payment for their efforts in successfully prosecuting fraudulent claims against the government. The district declined to join the board member as a plaintiff in the lawsuit, and the board member is pursuing the lawsuit as a private resident on behalf of the district. 50 California State Auditor Report 2015-102 December 2015 district’s contracting process for obtaining services valued at greater than $25,000 and the critical stages in this process that the district bypasses when it chooses to use sole‑source contracts. Figure 6 Summary of Key Stages in the Central Basin Municipal Water District’s Procurement Process for Professional Services Contracts Greater Than $25,000 STAGE STAGE IDENTIFY AND INFORMALLY JUSTIFY PREPARE AND ADVERTISE A REQUEST 1 2 CONTRACT NEED FOR PROPOSAL (RFP) A project manager identifies a need for professional The project manager prepares an services and informally discusses that need with the RFP for review and distribution for general manager.* The general manager will soliciting vendor proposals. informally approve or deny the procurement. STAGE CONDUCT PROPOSAL EVALUATIONS SOLE SOURCE: Skip to Stage 4 3 AND AWARD CONTRACT TO VENDOR The Central Basin Municipal Water District’s (district) policies allow some Staff evaluate vendor proposals based on the exceptions to competitive bidding, such evaluation criteria in the RFP and interview as when a vendor provides a unique the most qualified vendors. Subsequently, capability that meets the district’s needs. staff recommend the most qualified vendor This should be based on unique expertise, to the board of directors (board) for its demonstrated competence, and approval, before contract execution. qualifications. Further, the price for the services should be fair and reasonable. STAGE 4 EXECUTE CONTRACT These contracts require board approval in a public meeting. If approved by the board, the district's general manager and general counsel execute the contract with the vendor. STAGE 5 MANAGE AND CLOSE OUT CONTRACT A project manager authorizes invoices as work is completed. When the vendor's work is completed, district staff close out the contract. Sources: The district’s administrative code, procurement procedures, interviews with district staff, and the California State Auditor’s observations during its testing of the district’s contracts. * The general manager can also be a project manager. Despite a policy to competitively bid its contracts, the district frequently purchased services through sole‑source contracts, often without providing sufficient justification for circumventing the competitive bidding process. Specifically, 13 of the 20 district contracts we reviewed were sole‑source. The district’s procurement policy suggests that the district’s justification for using a sole‑source contract when purchasing services demonstrates either that a vendor has a unique capability that meets the district’s needs or that California State Auditor Report 2015-102 51 December 2015 it is an emergency. According to the district’s policy, the district should base the determination to award a sole‑source contract because of a unique need based on the vendor’s unique expertise, The district did not include demonstrated competence, and qualifications. However, the district adequate justifications for did not include adequate justifications for 11 of the 13 sole‑source awarding 11 of the 13 sole‑source contracts we reviewed. contracts we reviewed. The district’s justifications for these 11 contracts did not contain all of the information its policy suggests its justifications should include. For example, in July 2012 a former general manager approved a sole‑source contract with the overall objective of providing professional assistance to the district’s public relations efforts and to support the district and board by creating the public perception that district staff are committed to the betterment of the community. The general manager at the time entered into this contract under his authority for an amount not to exceed $24,960. In his justification for the contract, he stated that communication with local agencies became strained two to three months earlier and a sole‑source contract was necessary because staff could not take the normal amount of time to solicit firms for this service. Similarly, in February 2013 a former public affairs manager justified a sole‑source contract not to exceed $9,000 for specialized media and public relations services by stating that the district was in a transitional period, had come under increased legislative and media scrutiny, and needed a crisis media expert immediately to assist with correcting misperceptions and misinformation. Neither of these justifications provided any description of the vendors’ unique expertise or demonstrated competence and qualifications, nor did they indicate an emergency. When the district does not adequately justify the reasons it enters into sole‑source contracts, it cannot demonstrate it received the best value for the services it procures and it leaves itself vulnerable to allegations of favoritism. Other public entities have more restrictive requirements for sole‑source contracts than the district. For example, the San Diego County Water Authority’s policy allows for noncompetitively bid procurements only when a contract’s requirements are so critical or call for such specialized expertise that only one source is capable of providing the services. State law also limits the circumstances under which a state agency may procure goods and services without a competitive bidding process. For example, a state agency can use a sole‑source contract in an emergency, when immediate acquisition is necessary for the protection of the public health, welfare, or safety. Further, the State Contracting Manual requires a department that awards a sole‑source contract to submit detailed information explaining why it circumvented the competitive bidding process, including its reasons for restricting the purchase to one vendor, the events leading to the purchase, a description of the vendor’s uniqueness, the consequences of not purchasing from 52 California State Auditor Report 2015-102 December 2015 the vendor, market research to substantiate lack of competition, and an evaluation of other items it considered. By contrast, the policies the district had in effect since the beginning of our audit period suggested but did not require that it justify sole‑source contracts based on a vendor’s unique ability or based on emergency When the district cannot clearly circumstances. When the district cannot clearly identify and justify identify and justify its reasons for its reasons for avoiding a competitive bidding process, it leaves itself avoiding a competitive bidding vulnerable to allegations of favoritism. Moreover, it also cannot process, it leaves itself vulnerable to demonstrate that it is obtaining the best value for the services it allegations of favoritism. purchases with public funds. The District Inappropriately Used Amendments to Extend and Expand Contracts The district’s inappropriate use of amendments to extend and expand contracts left it unable to demonstrate that it did not pay more than it should have for services. Although the district’s administrative code requires board approval of contract amendments that exceed the contract amounts the board originally approved, it does not offer guidance on the circumstances under which the district should amend an existing contract rather than use competitive bidding. According to the State Contracting Manual, a contract amendment that changes a contract’s original scope of services constitutes a noncompetitively bid contract award. It defines changes to quantity, pricing, and products as scope changes. Although we could not identify a similar district policy or process related to amendments that change a contract’s scope of work, the district’s current general manager stated that the district should reopen a contract to competitive bidding when the scope of work is so different that it constitutes a new project altogether. However, we noted instances in which the district appeared to circumvent the competitive bidding process by amending existing contracts to add new services. We also found an instance in which a former general manager failed to adhere to board instructions when amending a contract. The district circumvented the competitive bidding process through contract amendments on several occasions during our audit period. In fact, we found that four out of five contracts with significant amendment histories that fell within our audit period contained amendments that the district could have opened for competitive bidding. For example, in October 2009 the district entered into a $920,000 contract with a nonprofit foundation to purchase and install 3,000 high‑efficiency toilets for residents of a city within the district’s service area. Four months later, however, the district amended the contract to include marketing and outreach services to the city’s residents to promote the program and educate the community about the city’s water conservation California State Auditor Report 2015-102 53 December 2015 efforts, and increased the contract amount by $27,400. Because these services are a separate product from purchasing and installing toilets, the district could have competitively bid these services. In another example, the board failed to competitively bid strategic planning duties for the 2010 strategic plan we discussed in Chapter 1. Specifically, the district engaged the services of a human resources consultant to provide various human resources work in October 2008. However, in November 2009 the board approved changing this vendor’s contract to include providing services related to strategic planning for the district’s management team and board—a separate work product from the original scope of work. Ultimately, the board never approved the strategic plan or ensured its proper implementation. When the district chooses not to use competitive bidding to purchase additional goods or services and instead adds them to existing contracts through amendments, it risks paying for services that are not the best value for the district and creates the appearance of favoritism when other potential bidders are not given the opportunity to compete. Because the district does not maintain and adhere to clear contract amendment policies, it risks spending millions of dollars on professional services of substandard value. Unaudited district records from the database it has used since 2012 indicate that the amendments it executed during the most recent three years of our audit period constituted a sizable portion of its contracts’ overall costs. Our review found that the district had 264 contracts that were active between July 2012 and July 2015. We calculate that during these three years, the district executed a total of 134 amendments to 65 of these contracts. These 134 amendments Between July 2012 and July 2015, increased the total cost of the associated contracts by roughly the district executed a total of $14 million, from more than $15 million to almost $30 million. 134 amendments to 65 of these When the district avoids seeking competitive bids on new work contracts, increasing the total and instead amends existing contracts, it increases the risk that it cost of the associated contracts is spending millions of dollars on services that may not provide the by roughly $14 million to almost best value. $30 million. We also identified an instance in our review of 20 contracts that were active between July 2010 and June 2015 in which the district mishandled an amendment. In April 2012 the board voted to amend a $36,000 contract with a consultant who provided public affairs and public policy outreach services, increasing the contract’s value by $6,000, and extending its term by two months. Although the contract’s total value after the amendment should have been $42,000, the general manager at the time did not adhere to the board‑approved changes and instead amended the contract by increasing its value by $42,000, for a total contract value of $78,000. He also increased the contract’s term by 14 months rather than two months. According to district records, the district ultimately paid the vendor $30,000 during the amended term of the contract, 54 California State Auditor Report 2015-102 December 2015 or $24,000 more than the amount of the amendment authorized by the board. According to district records, staff noticed this discrepancy in an audit of the district’s contracts and in February 2013 asked the board to retroactively approve the additional payments. Although the board later approved the payments, the initial mistake was a violation of the district’s administrative code that cost the district more than the original contract amount. The district can do more to ensure that it executes accurate amendments that its board has approved. For example, according to its administrative code, the San Diego County Water Authority requires its general manager to provide annual reports to the district’s board of directors on all the contracts and contract amendments greater than $10,000 made or awarded by the general manager. The San Diego County Water Authority’s administrative code states that the report must identify the original amount and term of each contract, its total number of amendments, its cumulative dollar value, and any extensions to its term. By requiring a similar report, the board could ensure that it has the opportunity to review the amendment history of contracts to identify errors in contract execution and to uncover instances in which the district could have used competitive bidding. The District Repeatedly Circumvented Competitive Bidding in Its Contract With One Firm The district spent several million dollars on a contract with one firm—Pacifica Services Incorporated (Pacifica)—that exemplifies the concerns related to competitive bidding that we have previously described. According to its marketing materials, Pacifica is a professional consulting firm that specializes in providing engineering, environmental, and related management services to various clients, including private‑sector entities and federal, state, and local public agencies. In October 2007 the district entered into a $600,000 contract with Pacifica to perform a variety of activities that included assisting the district with recycled water operations, providing technical assistance for the district’s southeast water reliability project, and managing the district’s move to a new headquarters. However, the district did not use its competitive bidding process when it awarded this contract to Pacifica. Further, it subsequently amended the contract numerous times, in some cases changing the original scope of work. The contract ended in 2013. When we reviewed the contract files and board approvals for the district’s original contract with Pacifica, we could not find any requests for proposals, Pacifica’s proposal, or other competitive bidding process documents that would accompany a competitively bid contract. When we asked the district’s interim engineering and California State Auditor Report 2015-102 55 December 2015 operations manager why the district did not get competitive bids for this contract, she stated that the district executed the contract before her employment. Other district staff we interviewed who were employed at the time of the contract’s execution also did not know why the contract was not competitively bid because they told us they were not directly involved with it. The district could not provide any evidence that the services procured from Pacifica were unique and that a sole‑source procurement was justified. Consequently, the district cannot demonstrate that it received the best value for the public funds it spent on the services in this contract. The district ultimately amended its contract with Pacifica eight times, two of which we identified as opportunities to competitively bid as separate contracts. In October 2009 the district amended Pacifica’s contract, adding nearly $1.9 million to its value and 18 months to its contract term so that Pacifica could provide project management services during construction of the district’s southeast water reliability project. The district had not specifically included this project in the contract’s original scope of work. Further, in July 2011 the district executed another amendment for $278,000 for engineering design, project management, and construction management services for new projects not included in the contract’s original scope of work. In fact, at the time it executed this amendment, the district recorded in the board’s action calendar that the contract’s original scope of work was nearing completion, which suggests that the district could have competitively bid for these services. When we asked the district’s interim engineering and operations manager about these amendments, she stated that she was not a part of the district’s management when Pacifica contracted with the district. Because the services the district covered in these two amendments could have been competitively bid as new contracts, the district cannot ensure that it received the best value for the more than $2.1 million it spent on them. Moreover, circumventing competitive bidding processes can lead to the district developing inappropriate relationships that influence how it recommends and approves its contract awards. Early in 2015 the Fair Political Practices Commission (FPPC) found that In 2015, the FPPC found that the during the majority of the period of the district’s contract with district’s former general manager Pacifica, the district’s former general manager accepted gifts from accepted gifts from Pacifica in this contractor in excess of annual gift limits and failed to report excess of annual gift limits and to the public in a timely manner 31 gifts totaling approximately failed to report to the public in a $3,500. These gifts included rounds of golf and a company holiday timely manner 31 gifts totaling party. The FPPC further determined that the former general approximately $3,500. manager made, participated in, or attempted to use his official position to influence eight district decisions to award Pacifica more than $6 million in contracts. The FPPC also found that one of the district’s board members during this same time period committed similar violations by voting to approve these contract awards, 56 California State Auditor Report 2015-102 December 2015 accepting gifts from Pacifica in excess of gift limits, and failing to report 28 gifts totaling approximately $4,400. The FPPC fined the former general manager and former board member $30,000 and $31,500, respectively, for the violations. By the time the district made The Pacifica contract and a subsequent legal settlement ultimately its final payment to Pacifica cost the district more than $5 million. By the time the district made in April 2013, district records its final payment to Pacifica in April 2013, district records indicate indicate it had paid the firm it had paid the firm nearly $4.2 million, or roughly $3.6 million nearly $4.2 million, or roughly more than the original contract amount. Further, in July 2013 the $3.6 million more than the district sued Pacifica for fraud and misrepresentation. The district original contract amount. settled its dispute with Pacifica in June 2014 and agreed to pay an additional $875,000 to the firm. Because the district did not use its competitive bidding process when it awarded and amended its contract to Pacifica, it cannot know whether it received the best value for the services it purchased. Finally, neither the district nor the public can know to what degree the district’s decisions to enter into the contract and to add subsequent amendments were motivated by conflicts of interest rather than what was best for the district. The District Has Poorly Managed Its Contracts and Did Not Always Follow Best Practices or Its Own Contracting Procedures In addition to failing to use competitive bidding, the district often used procurement processes that did not follow best practices we identified from the State Contracting Manual, a global project management organization, and other water agencies. Further, it sometimes circumvented its own policies for managing its contracts. We noted that the district’s legal counsel did not always sign contracts when required to do so. When the district does not adequately manage its contracts, it increases the risk that it will pay for inadequate services, unnecessary services, or even services not rendered. The District’s Management of Its Contracts Did Not Follow Best Practices Although the district’s contracting processes should closely align with procurement and project management standards and best practices, they often have not. A global organization recognized for its development of standards for project management, the Project Management Institute publishes the Project Management Body of Knowledge (PMBOK), which provides guidelines for managing individual projects, including project procurements. According to PMBOK, an organization’s management of project procurement includes four processes: planning, conducting, administering, and California State Auditor Report 2015-102 57 December 2015 closing procurements. However, we noted numerous instances where the district did not conduct its procurements according to the best practices that PMBOK describes for these processes. For example, the district failed to include in many contracts’ scopes of work information that would allow it to effectively administer the contracts. The district’s procurement process calls for its project managers to develop a scope of work that clearly defines all expected tasks and deliverables for a proposed procurement; the scope of work should then form the basis for vendor solicitations and the contract. Similarly, PMBOK defines scope as the sum of the products, services, and results to be provided by a project. Although the district is not bound by the State Contracting Manual, the manual’s requirements further illustrate best practices in this area. According to the State Contracting Manual, a scope of work includes measurable results, timelines or progress reports, and an For 20 contracts we reviewed, evaluation component. Nonetheless, we found that the scopes of 15 did not contain any of the work for 19 of the 20 contracts we reviewed did not include all recommended elements of a scope of these elements.6 In fact, 15 of the 20 contracts did not contain of work—measurable results, any of these elements. Altogether, the 19 contracts constituted timelines or progress reports, and nearly $3.7 million the district awarded to vendors. evaluation components. When the district does not provide clear and concise language in its scopes of work, it increases the risk that it will not procure services of sufficient or relevant value. For example, in May 2011 the district entered into a $36,000 contract with a consultant to provide public affairs and public policy outreach services. When the former general manager recommended to the board that it approve this contract, he stated that the district was looking to develop potential projects and agreements in the San Gabriel Valley area and that he believed this consultant provided the unique services for this endeavor. However, the scope of work in the contract the general manager executed did not contain any evaluation component; any timelines or required progress reports to inform the district of the consultant’s progress; or any specific results to measure the consultant’s performance, despite requiring a review after six months to determine whether to extend the contract term further. When we asked the district to provide us with any reviews or evaluations it performed that were related to this contract, it was unable to do so. After a subsequent amendment in June 2012, this contract ultimately cost the district $66,000. However, because the scope of work lacked any mechanisms that would enable the district to monitor and review the adequacy of the services the consultant provided, the district cannot demonstrate to its stakeholders that the costs it incurred for this contract provided any value. 6 The remaining contract was a lease agreement for overflow parking. In our judgment, such an agreement does not need measurable results, timelines, progress reports, or evaluation components because there are no professional services being provided. 58 California State Auditor Report 2015-102 December 2015 In addition to the inadequate scopes of work in its contracts, the district could not always produce documentation demonstrating that it had verified vendors’ work products before approving their invoices for payment. As PMBOK indicates, project managers should monitor payments to vendors to ensure that they have met their contracts’ payment terms and that their compensation is linked to their progress, as defined in the contract. PMBOK emphasizes that one of the principal concerns when making payments to vendors is ensuring a close relationship between the payments and the work accomplished. The State Contracting Manual also notes that keeping an auditable paper trail of contract administration is a best practice, stating that departments are responsible for maintaining records in sufficient detail to allow anyone who reviews the documentation to understand how each procurement was requested, conducted, awarded, and administered. However, when we reviewed 30 invoices from the contracts that we had selected, we found 13 instances in which the district paid its vendors without sufficient evidence that they had provided the contracted services. For example, we identified nine invoices totaling about $125,000 that the district paid in advance for work the consultants in question had not yet performed. These consultants’ contracts each indicated that the district would pay them after they rendered the services. When the district disregards legally agreed‑upon payment processes and approves invoices for services yet to be completed, it risks paying for substandard or incomplete services. When we asked the current general manager about the issues we identified with the district’s contract administration, he stated that when the district split with West Basin Municipal Water District (West Basin) in 2006, West Basin kept most of its previously shared technical staff and projects. He further explained that Central Basin has historically tended to focus on public relations projects and contracts because the former general manager was a journalist by trade. He stated that, as a result, many employees have not had the necessary training to manage contracts and therefore do not know how to properly do so. The current general manager explained that the district is planning a comprehensive training on contract management, based on the Project Management Institute’s curriculum. Nevertheless, when the district does not effectively administer its contracts, it increases the risk that it will pay for inadequate services or even services never rendered. The District Circumvented Other Established Procedures Related to Contracting The district did not always follow its procurement policies when executing contracts between fiscal years 2010–11 and 2014–15. According to its administrative code, the district requires that California State Auditor Report 2015-102 59 December 2015 both the general manager and the district’s general counsel execute all procurements of professional services over $5,000. Further, the district’s administrative code requires the general manager to report all sole‑source contracts and contracts entered into under the general manager’s authority to the board’s finance committee, composed of two board members, on a quarterly basis. Nevertheless, we identified instances where the district violated each of these provisions. Specifically, three of the 20 contracts we reviewed did not include the general counsel’s signature, even though it was required in each case. If the district’s general counsel does not review contract If the district’s general counsel does language, the district risks engaging in contracts or contract terms not review contract language, the that could lead to overpayments or lawsuits. For example, we district risks engaging in contracts found that one of the three contracts that lacked the general or contract terms that could lead to counsel’s signature resulted in the district settling with the vendor overpayments or lawsuits. who had filed a lawsuit. Specifically, according to an email from a former general manager, in one case a former interim chief operating officer and the then‑board president entered into a verbal agreement with a law firm for $20,000 for investigative and legal services. The subsequent written contract, executed in March 2013, did not include a contracted amount and was not executed by the general counsel. When the district refused to pay more than the verbally arranged amount, the firm took the district to court, and the district eventually settled with the firm for a payment of more than $23,000. In addition, former district general managers did not always report certain contracts to the district’s finance committee. Specifically, former general managers did not correctly report seven of the 20 contracts we reviewed to the finance committee. For example, in August 2012 the then‑general manager approved a contract with a consultant for services related to client relations and government affairs for an amount not to exceed $24,960. Although the general manager entered into a sole‑source contract for this procurement and executed it under his authority, he approved a report to the finance committee in October 2012 that stated the district had not entered any contracts under his authority or entered any sole‑source contracts from July through September 2012. When we asked the district’s contracts and procurement analyst (contracts analyst) why some contracts were not accurately reported to the finance committee during our review period, she stated that prior to July 2014 the former general managers were in charge of finalizing and submitting these reports. Based on our review of the reports, it appears the general managers did not always ensure that they were accurate. The contracts analyst explained that the district created a new report template and process, which it implemented in July 2014. Based on our review, we believe that if appropriately 60 California State Auditor Report 2015-102 December 2015 followed, this process, which now includes approval of the report by the finance director, should help ensure the accurate reporting of contracts to the finance committee in the future. Nevertheless, when district leaders enter into contracts without publicly reporting them, the district decreases transparency while increasing the opportunity for waste and fraud. The District Spent Funds on Purposes Unrelated Allowable District Expenditures to Its Mission That Likely Constitute Gifts of Public Funds • An expenditure must serve a public purpose that is within the scope of the district’s jurisdiction and specific purpose. The California Constitution prohibits • For an expenditure made to a private party, the district governmental agencies such as the district from must receive consideration. making gifts of public funds. Rather, the district must use its public funds to carry out those Sources: Golden Gate Bridge and Highway District v. Dale W. Luehring (1970) 4 Cal.App.3d 204, 84 and purposes the Municipal Water District Law of Robert E. Winkelman v. City of Tiburon (1973) 32 Cal. App. 1911 authorizes. The district may not spend public 3d 834, 108. funds for purposes that do not return benefits to the district that are reasonably related to the laws under which the district was established. Allowable district expenditures are defined in the text box. Expenditures that do not demonstrate a clear relationship to the district’s purpose, which is to provide an adequate supply of water within its service area, constitute a gift of public funds. Nevertheless, the district’s board members have spent thousands of dollars of district funds on purposes unrelated to the district’s underlying authority. The district’s current administrative code allows each board member to spend up to $3,000 annually for outreach‑related purposes in their respective divisions. For example, the district may sponsor programs, conferences, and events on behalf of a particular board member’s own choosing. However, our review of the district’s records found that the purposes for which the board members directed the use of the funds did not always clearly support the district’s authorized activities. For instance, on behalf of various board members, the district donated funds to golf tournaments, a legislative member’s breakfast panel, religious organizations, local high school sports programs, local pageants, organizations that feed those in need, car shows, and other purposes unrelated to providing an adequate supply of water in the district. In addition to these board member‑directed expenditures, the district also spent more than $9,000 on holiday turkeys in fiscal year 2012–13 to provide to organizations in the community, a purpose that is also unrelated to the district’s mission. As a result, these expenditures very likely constitute gifts of public funds. California State Auditor Report 2015-102 61 December 2015 After we began our audit, the district updated its administrative code to clarify that the board members should use the $3,000 allocated to each of them annually for purposes that promote discussion and educational activities for regional water conservation, water public policy, and water‑use efficiency issues. However, we fail to see the value of providing any district funds to board members to spend at their discretion, particularly because the board’s role is the governance of the district, not its administration. Further underscoring our point, the district already has a public affairs department whose responsibility is to inform community stakeholders about the district’s programs and the water issues that impact the region. The district’s current general manager agrees that the district should eliminate the board members’ outreach funds because they are difficult to administer and subject to potential abuse. For example, a neighboring water district, West Basin, also allocated outreach funds to its board members until early 2015, when its ethics committee recommended—based on an independent audit—that the district eliminate these funds. West Basin’s board approved the elimination of these funds after one of its board members accepted a plea bargain on charges of misuse of public funds in September 2014. Similar to West Basin, the district’s current general manager suggested to the board in April 2015 that it should eliminate the outreach funds; however, rather than eliminating the funds, the board members agreed to reduce them from $5,000—the amount each board member was authorized to receive during fiscal year 2014–15—to the current annual amount of $3,000. The district has also spent an unreasonable amount of money on board member installation ceremonies that provided little or no benefit to the district. The current general manager stated that, in his experience, the practice in most of the Southern California region is for water agencies to swear board members into office at regular board meetings. In contrast, we found that the district The district has spent unreasonable has spent significant, and we believe unreasonable, amounts amounts on its board member on its board member installation ceremonies. For instance, in installation ceremonies. In January 2013 the district spent more than $6,500 on catering January 2013 it spent more than expenses and the equipment rental for an installation event for $6,500 on catering expenses three board members. Further, the district’s records show that in and the equipment rental January 2011 it spent more than $6,400 on catering expenses for for an installation event for an installation event for two board members. According to the three board members. district’s director of administration and board services, the district has budgeted as much as $10,000 per board member in the past when it has held these ceremonies off‑site, requiring the rental of a hall. Further, she stated that the district does not expressly limit the amounts it can spend on these ceremonies. The current general manager believes that board member installation ceremony expenses should be minimal and that a budget of $10,000 per board 62 California State Auditor Report 2015-102 December 2015 member is unreasonable. The district’s most recent installation ceremony—in December 2014 for two board members—cost less than $1,300. However, until it places reasonable and specified limits on these costs, the district risks spending unreasonable amounts on these ceremonies, which can undermine public confidence in its stewardship of the public’s funds. Recommendations To ensure it holds itself accountable to the public, the district should follow the law and operate in an open and transparent manner by, among other things, disclosing to the public the true nature and purpose of all of its expenditures. To ensure its board makes informed decisions on when it is proper to hold discussions and take votes in closed‑session meetings, the district should require its board members to attend training—as soon as possible and biennially thereafter—specifically focused on the Brown Act and its closed‑meeting requirements. To make better use of the funds it spends on services, the district should amend its administrative code by June 2016 to limit its sole‑source contracts to emergency circumstances and circumstances in which only one vendor can meet the district’s needs. Further, before executing any sole‑source contracts, the district should require written justification demonstrating the reasons for not competitively bidding the services. The justification should include the background of the purchase, a description of the vendor’s uniqueness, an explanation of the consequences of not purchasing from the vendor, market research to substantiate a lack of competition, and an analysis of pricing and alternatives. To ensure that it does not unnecessarily use amendments that limit competitive bidding for its contracts, the district should amend its administrative code by June 2016 to require that it rebid contracts if it significantly changes those contracts’ scopes of work, specifically the nature of the services or work products. To ensure its contract amendments reflect the authorization of the board, the district should revise its administrative code to require the general manager to submit a quarterly report to the district’s board detailing all its contracts, contract amendments, and contract and amendment dollar amounts. California State Auditor Report 2015-102 63 December 2015 To ensure it receives the best value from its contracts, the district should do the following by June 2016: • Adopt and implement a policy requiring that it include in all its contracts’ scopes of work specific, well‑defined deliverables, measurable results, timelines or progress reports, and evaluations of the contractors once they complete the work. • Ensure project managers verify services were rendered before approving invoices for payment. • Create processes for project managers to organize and retain contract files that include important documents such as vendor performance and deliverable verification and acceptance. To ensure its employees are able to properly administer contracts, by September 2016 the district should follow through with its plan to require that staff responsible for project management attend training by a reputable trainer on contract management. To minimize its risk when contracting with vendors, the district should adhere to its administrative code and execute all contracts only after approval by its general counsel. Further, the district should amend its administrative code to prohibit engaging in a verbal contract. Finally, the district should continue to report to its finance committee all sole‑source contracts and contracts entered under the general manager’s authority. To ensure its expenditures do not constitute gifts of public funds, the district should do the following: • Immediately eliminate its allocation of funds to individual board members for community outreach. • Develop policies that specify limitations on the types of activities it will sponsor in the future to ensure that it funds only those organizations whose activities have a direct link to its authorized purposes. For example, it should eliminate its purchase of holiday turkeys. • Revise its administrative code by June 2016 to include more specific guidance as to what constitutes a reasonable and necessary use of public funds. The guidance should establish restrictions on the amount spent for board member installation ceremonies. It should also include a process for the district to ensure that expenses are reasonable and necessary before it pays them. 64 California State Auditor Report 2015-102 December 2015 Blank page inserted for reproduction purposes only. California State Auditor Report 2015-102 65 December 2015 Chapter 3 THE CENTRAL BASIN MUNICIPAL WATER DISTRICT DID NOT ALWAYS FOLLOW ESTABLISHED HIRING POLICIES AND NEEDS TO ENSURE CERTAIN BENEFITS AND EXPENDITURES ARE APPROPRIATE Chapter Summary The Central Basin Municipal Water District (district) did not always follow its policies for hiring employees. For example, it did not use a competitive process to hire certain former staff members, which led it to employ individuals who did not possess the necessary qualifications for their positions. In one instance, the district paid more than $22,000 for an employee to obtain a bachelor’s degree when the high‑level position for which he was hired required him to already have one. Further, the district’s board of directors (board) improperly hired another employee for a position that it never formally created and that appears to have been unnecessary for district operations. In addition, the district did not always conduct annual performance evaluations as its administrative code requires. Although the district’s compensation for its staff and board generally appears reasonable, we found that some of the benefits it offers may be overly generous. Specifically, it provides board members with full health benefits, even though their work is essentially part‑time. It also pays its board members a generous automobile allowance. Finally, we found multiple instances in which it paid for unreasonable travel and meal expenses for both its board members and staff. The District Has Hired Some Unqualified Staff and Failed to Perform Regular Performance Evaluations Although the district has established appropriate policies related to hiring employees, it did not always follow them. Specifically, it hired individuals who did not meet the minimum qualifications for their positions. It also created a new position without following its approved process, which includes board authorization. Further, in some instances, it incurred unnecessary expenses because of its failure to follow its hiring policies. For example, the district violated its policies when it prepaid more than $22,000 for a new employee to complete his bachelor’s degree when such a degree was a minimum qualification for the position; this individual subsequently was laid off by the district before completing his degree. Additionally, the district’s administrative code requires it to provide employees with 66 California State Auditor Report 2015-102 December 2015 performance evaluations every fiscal year and generally to base their raises on performance. However, we found the district did not always perform these required evaluations. The District’s Failure to Follow Its Policies Led It to Hire Some Unqualified Staff The district failed to follow its policies for hiring employees in several instances during our audit period from July 2010 through June 2015. State law gives the board the authority to hire the general manager and gives the general manager full power and authority to employ and discharge all other employees, with certain exceptions. The district’s administrative code states that the district must use a competitive process for hiring employees that is based on their qualifications and ability. It also outlines the use of an interviewing panel for senior manager positions. Further, the district maintains job descriptions that detail the minimum qualifications job applicants must possess before being hired. However, in our review of the hiring process for individuals in certain positions, we identified four instances in which the district did not follow its established policies when hiring staff, as shown in Table 7. The district’s failure to follow its hiring policies resulted in legal disputes and caused it to incur unnecessary expenses in salary and benefits. Table 7 The Central Basin Municipal Water District’s Failure to Adhere to Its Hiring Process for Four Selected Positions FINAL APPOINTMENT MUST BE MADE BY THE CENTRAL BASIN MUNICIPAL GENERAL MANAGER, WATER DISTRICT (DISTRICT) THE POSITION WAS NOT BUT THIS PROCESS WAS DID NOT FOLLOW A THE INDIVIDUAL WAS APPROVED BY THE BOARD POSITION DATES OF EMPLOYMENT NOT FOLLOWED COMPETITIVE HIRING PROCESS UNQUALIFIED AS REQUIRED Interim chief October 2012 through NA operating officer January 2013 Business development April 2011 through manager July 2013 Assistant to the December 2012 general manager through January 2013 Public affairs manager December 2012 through March 2013 Sources: California State Auditor’s analysis of minutes from the district’s board meetings, the district’s administrative code, its human resources records, and interviews with the district’s human resources director. NA = Not applicable. Although the district’s current senior managers meet the qualifications required for their positions, the district hired certain individuals in the past who did not possess bachelor’s degrees in the fields their positions required. For example, in 2010 the board created a business development manager position. Although the California State Auditor Report 2015-102 67 December 2015 position required a bachelor’s degree, the resume of the individual the district hired for the position in April 2011 shows that he did not possess one. The individual’s annual salary—nearly $113,000 The district hired an individual for a by the time of his layoff in July 2013—made him one of the highest senior management position who paid senior managers at the district, despite his not meeting his did not meet the position’s position’s minimum qualifications. minimum qualifications. The district further violated its policies when it paid in advance for this individual’s education. As a condition of the business development manager’s employment, the district required him to pursue and complete a bachelor’s degree. Nevertheless, the district hired and continued to employ him for more than a year without his having such a degree. He eventually requested that the district pay his registration, tuition, and fees to obtain the required degree. Although these costs totaled more than $22,000, the district violated its administrative code by paying the amount in advance of the individual successfully completing any of the required coursework. Specifically, the district’s administrative code allows it to reimburse individuals for only 90 percent of the cost of college courses and then only upon the individuals’ completion of the courses with a passing grade. However, according to course records he provided to the district, this employee did not begin his coursework until after the district made the payment for his entire degree program, and he did not complete the program while he was employed by the district. According to the director of human resources, the former general manager authorized this payment at his own discretion. In July 2013—a little more than two years after hiring the business development manager—the district eliminated the position and laid off the individual. The director of human resources explained that the district did not seek reimbursement from him because he did not leave the district voluntarily. Regardless, the district hired this individual in violation of its own policies and then inappropriately paid his tuition and fees. The district also hired another individual for a high‑level position who did not meet that position’s minimum qualifications. Specifically, in September 2012 the board approved the October hiring of an interim chief operating officer who, according to his resume, did not hold a bachelor’s degree in business management, business administration, engineering, or public administration as the position description required. Rather, his resume indicated that he attended college and studied Latin American studies and general education. Also, according to the director of human resources, the district did not follow a formal recruitment process for this individual and thus cannot demonstrate that it used a competitive process to hire him. 68 California State Auditor Report 2015-102 December 2015 Further, the board did not follow the appropriate hiring process when it approved the hiring of an assistant to the general manager in December 2012. This appointment violated the district’s policies in a number of different ways. First, the district’s administrative code provides the general manager with authority over appointing and terminating subordinate employees. Nonetheless, in December 2012 the board voted in closed session to approve the hiring of an individual for the position of assistant to the general manager, with an annual salary of about $98,000. In addition, the administrative code requires the district to follow a competitive process when hiring district employees and states that the general manager must make the final appointment for senior manager positions based in part on the recommendations of an interviewing panel. However, according to the director of human resources, the board did not use any competitive process or perform any interviews when hiring for this position. The board also violated district policy by hiring the assistant to the general manager without having previously approved the creation of the position. According to the district’s administrative code, the general manager must propose a labor budget to the board for its approval each year. The director of administration and board services acknowledged that the assistant to the general manager position was By not following the district’s not in the district’s labor budget at the time the board approved the administrative code, the board hiring of the individual for this position. By not following the district’s risked hiring and paying an administrative code, the board risks hiring and paying an individual to individual to fill a position for fill a position for which the district has not budgeted sufficient funds. which the district had not budgeted Further, the current general manager believes that such a position is sufficient funds. unnecessary for an office of the district’s size. The board’s approval of hiring the assistant to the general manager was only one of two instances in which it did not follow the administrative code as it relates to hiring employees that occurred in the same month. Specifically, in the same closed session in December 2012, the board appointed a public affairs manager without following a competitive hiring process. The district terminated both this individual and the assistant to the general manager less than three months after their appointments. Two of these hires resulted in legal disputes, while another caused it to incur unnecessary expenses in salary and benefits. Subsequent to their dismissal, the former interim chief operating officer and the former assistant to the general manager filed two lawsuits and one made a demand for additional claims against the district for wrongful termination and retaliation. The district signed settlement agreements with the former interim chief operating officer for $80,000—which the district’s insurance paid—leaving one remaining lawsuit still pending. Furthermore, the district paid the former assistant to the general manager more than $6,000 in salary and benefits for less than one month of employment in an California State Auditor Report 2015-102 69 December 2015 unapproved position that was likely unnecessary. Finally, if the district had hired a business development manager with the requisite degree, it would not have incurred the more than $22,000 in education expenses described previously. To avoid similar situations in the future, the board approved changes to the district’s administrative code in July 2015 that In July 2015, the board approved expressly prohibit board members from participating in any aspect changes to the district’s of its employment and personnel matters except those pertaining to administrative code that prohibit the general manager. The director of human resources confirmed that board members from participating these changes were made to address the issues created by these past in any aspect of its employment board decisions. At the same time, the board also approved changes and personnel matters except those to the administrative code to create a specific requirement for it to pertaining to the general manager. approve employee positions and classifications as part of its review of the general manager’s proposed labor budget. Nevertheless, the board and the district must follow these and all other established policies if they are to avoid the risks associated with hiring individuals in a manner that is inconsistent with the district’s administrative code. The District Did Not Consistently Evaluate the Performance of Its Senior Managers The district did not consistently review its senior managers’ performance, and it issued raises to some of these employees without having completed the required evaluations. The district’s administrative code specifies that district employees will receive performance evaluations each fiscal year in May. Further, the code notes that the evaluating manager will review each employee’s compensation and will base decisions regarding raises on performance. However, the district did not provide some of its managers with the required performance evaluations. We reviewed the performance evaluations of six senior managers employed continuously by the district from fiscal year 2010–11 through fiscal year 2013–14 and expected to find a total of 24 performance evaluations for the four fiscal years. Instead, we found the district had completed only 14 evaluations and did not perform the other 10. Nonetheless, during this same time period, the district provided raises to most of these managers without the corresponding required evaluations. Although district policy allows for merit increases between evaluations, the policy states that such increases are rare. According to the district’s director of human resources, the district’s former general managers were responsible for completing the necessary evaluations but failed to do so. She explained that the former general manager, who began his service in May 2013, believed he did not have a basis for evaluating senior managers in that year. She also stated that the former general manager in fiscal years 2010–11 and 2011–12 simply did not complete many of the 70 California State Auditor Report 2015-102 December 2015 evaluations he was required to perform. Nevertheless, if it fails to provide regular performance evaluations, the district risks not identifying and correcting concerns with performance in a timely manner. Further, the district may provide raises to individuals whose performance does not merit a pay increase. Although the District’s Compensation for Its Board Members and District Managers Is Generally Reasonable, Some of the Benefits It Provides Board Members May Be Overly Generous The district provides compensation and benefits to its board members and staff that are generally reasonable; however, benefits may be excessively generous in some cases. Board members receive payment for days on which they attend meetings or certain other events related to district business, such as conferences, a monthly automobile or transportation allowance for the use of their personal vehicles, and an allowance for their personal communication devices. Although board members are not Although they are not full‑time employees, they also receive many full‑time employees, they receive of the same benefits as full‑time staff at the district, including fully many of the same benefits as paid medical, dental, and vision insurance for themselves and their full‑time district staff, including dependents. We noted that although some water agencies provide fully paid medical, dental, and benefits to their board members, others do not; given that fact, the vision insurance for themselves district could reconsider the necessity and reasonableness of some of and their dependents. the benefits it provides to its board members. Although the District’s Per Diem Compensation for Its Board Members Is Slightly Above the Average Provided by Other Water Districts, Its Senior Managers’ Salaries Are Below Average The district’s payments to its board members are above average relative to those provided by comparable water agencies but do not appear unreasonable. State law allows water districts to compensate their board members by paying them for the days they attend board meetings and the days they render services by request of their respective boards of directors. The district’s administrative code refers to these payments as per diems. The district’s administrative code authorizes board members to claim a maximum of 10 per diems each calendar month, although any board member who also serves as a representative to the Metropolitan Water District of Southern California may claim an additional 10 per diems for meetings associated with that agency. According to a 2014 district compensation survey of 10 municipal water agencies, the district’s per diem of approximately $233 was the third highest of the 10 agencies. The district’s survey noted that per diems ranged from $150 at the San Diego County Water Authority to roughly $241 at the Western Municipal Water District, with a median per diem of about $206. Although the district’s per diem is about 13 percent above the median, it does not appear unreasonable. California State Auditor Report 2015-102 71 December 2015 In total, the district may spend up to about $200,000 annually on board members’ per diems. According to the director of administration and board services, the district uses this amount when creating its annual budget. Table 8 shows the total per diem payments the district made to all of its board members in each of the last five fiscal years. Table 8 Summary of the Central Basin Municipal Water District’s Per Diem Compensation to Its Board of Directors Fiscal Years 2010–11 Through 2014–15 DIVISION TOTAL FOR BOARD MEMBER REPRESENTED 2010–11 2011–12 2012–13 2013–14 2014–15 FIVE YEARS Edward Vasquez Division I $26,348 $27,048 $13,524 – – $66,920 James Roybal Division I – – 13,524 $27,048 $27,980 68,552 Robert Apodaca Division II 22,851 24,716 27,514 30,079 27,747 132,907 Arturo Chacon Division III 18,654 20,053 19,353 21,918 21,918 101,895 Rudy Montalvo Division IV 24,949 26,115 9,560 – – 60,624 Leticia Vasquez Division IV – – 20,752 55,494* 37,074 113,321 Phillip Hawkins Division V 31,759 31,245 23,783 21,918 24,716 133,421 Totals $124,561 $129,177 $128,010 $156,457 $139,435 $677,640 Source: The Central Basin Municipal Water District’s (district) financial records. * In fiscal year 2013–14 Leticia Vasquez’s per diem compensation was larger than that of any board member in any other fiscal year. During this fiscal year, she attended meetings as both a district board member and a member of the Metropolitan Water District of Southern California, and the total per diem compensation she received was within legally allowed limits. While the district’s per diems for board members appear reasonable, the salaries it pays its senior managers are lower than those certain other water agencies pay. State law allows the district to hire staff as needed to conduct the district’s business. As we previously discussed, the general manager must submit salary classifications and a labor budget to the board for its approval each fiscal year. The general manager then sets the individual salaries of staff. We conducted a review of salary data from the California State Controller’s Office (State Controller) and found that the district’s current pay for senior managers overall is lower than that at certain other water agencies, which may in part reflect the fact that it has the smallest number of staff. For example, as shown in Table 9 on the following page, the maximum salary for the water resources manager at the district was just under $125,000 based on data from 2013, which were the most recent available and complete data as of the end of September 2015. This amount is below the average maximum salary of roughly $157,500 for the five agencies we reviewed. The district’s director of human resources has also conducted past surveys indicating that the district’s salary ranges for its senior managers were generally below average. 72 California State Auditor Report 2015-102 December 2015 9 elbaT snoitisoP reganaM suoiraV rof noigeR eht ni seicnegA retaW rehtO ruoF dna tcirtsiD retaW lapicinuM nisaB lartneC eht ta seiralaS reganaM ylraeY fo nosirapmoC 3102 dna 2102 sraeY eht roF 2102 FO ROTCERID SECRUOSER RETAW LARENEG SRIAFFA LANRETXE REGANAM ROTCERID ECNANIF SECRUOSER NAMUH FO ROTCERID *REGANAM FO REBMUN FO REBMUN ‡FFATS ‡SREMOTSUC MUMIXAM MUMINIM MUMIXAM MUMINIM MUMIXAM MUMINIM MUMIXAM MUMINIM YRALAS 32 §14 017,811$ 041,97$ 479,421$ 613,38$ †AN †AN 017,811$ 041,97$ 938,732$ tcirtsiD retaW lapicinuM nisaB lartneC 34 11 759,661 728,421 759,661 728,421 759,661$ 728,421$ AN AN 781,932 tcirtsiD retaW lapicinuM nisaB tseW 521 31 AN AN 135,171 057,421 139,551 704,311 856,221 602,98 573,562 tcirtsiD retaW lapicinuM nretseW fo tcirtsiD retaW lapicinuM 03 82 798,531 466,001 798,531 466,001 640,751 033,611 AN AN 460,512 ytnuoC egnarO 352 42 690,661 030,321 678,881 909,931 678,881 909,931 690,661 030,321 426,652 ytirohtuA retaW ytnuoC ogeiD naS – – 519,641$ 519,601$ 746,751$ 396,411$ 302,761$ 816,321$ 486,021$ 371,48$ 818,242$ egarevA 3102 FO ROTCERID SECRUOSER RETAW FO ROTCERID LARENEG SRIAFFA LANRETXE REGANAM ROTCERID ECNANIF SECRUOSER NAMUH *REGANAM FO REBMUN FO REBMUN ‡FFATS ‡SREMOTSUC MUMIXAM MUMINIM MUMIXAM MUMINIM MUMIXAM MUMINIM MUMIXAM MUMINIM YRALAS 32 §14 017,811$ 041,97$ 479,421$ 613,38$ 832,131$ 294,78$ 017,811$ 041,97$ 000,581$ tcirtsiD retaW lapicinuM nisaB lartneC 34 11 936,171 828,421 564,751 025,411 145,581 939,431 518,541 740,601 396,442 tcirtsiD retaW lapicinuM nisaB tseW 521 31 169,471 542,721 169,471 542,721 169,471 542,721 111,521 099,09 188,962 tcirtsiD retaW lapicinuM nretseW fo tcirtsiD retaW lapicinuM 03 82 516,831 876,201 516,831 876,201 102,271 655,721 AN AN 000,522 ytnuoC egnarO 352 42 617,971 526,331 907,191 800,241 907,191 800,241 690,661 030,321 910,192 ytirohtuA retaW ytnuoC ogeiD naS – – 827,651$ 305,311$ 545,751$ 359,311$ 031,171$ 848,321$ 339,831$ 296,211$ 911,342$ egarevA .setisbew ’seicnega retaw eht morf deniatbo noitamrofni dna ,tcirtsiD retaW lapicinuM nisaB lartneC eht yb dedivorp noitatnemucod ,ecffiO s’rellortnoC etatS ainrofilaC eht morf ataD :secruoS .elbaliava era seicnega retaw evfi lla rof atad hcihw rof sraey tnecer tsom eht era 3102 dna 2102 :etoN .elbacilppa toN = AN .tcartnoc yb seiralas ’sreganam lareneg rieht tes seicnega retaw detsil ehT * .raey taht ni secivres tnemeganam laicnanfi sti rof detcartnoc dna 2102 ni rotcerid ecnanfi a evah ton did nisaB lartneC † degnahc ton evah srebmun eseht taht eveileb ew ,seicnega eht fo erutcurts eht ot eud ,revewoH .niatbo ot elba erew ew noitamrofni tnecer tsom eht morf era ffats dna sremotsuc fo rebmun eht rof ataD ‡ .3102 ecnis yltnacfiingis .sremotsuc 14 fo latot a rof ,relaselohw retaw eno dna sreliater retaw 04 dah ti detcefler taht 6102 hcraM ni noitamrofni detadpu htiw su dedivorp tcirtsid eht ,38 egap no etontoof eht ni detacidni sA § California State Auditor Report 2015-102 73 December 2015 Additionally, based on information as of September 2015 from the websites of the four other agencies we reviewed, the current salary of the district’s general manager—$220,000 annually—is less than the general managers’ salaries for the four other agencies we reviewed. The board hires the general manager and negotiates an employment contract with that individual. The fact that the current general manager’s salary is less than that of the other agencies we reviewed is not surprising given that the district has the least number of full‑time staff. For example, the Municipal Water District of Orange County reported on its website as of September 2015 that its general manager receives a salary of nearly $238,000 but manages 30 full‑time staff members as opposed to the district’s 23 staff. The survey the district conducted indicates that its general manager’s salary is 7 percent below that of the average of seven other water agencies. Some of the Benefits the District Pays to Board Members May Be Overly Generous, but Its Staff Benefits Are Reasonable The district spends tens of thousands of dollars annually providing benefits to board members that appear to be excessively generous, especially given that the board members’ work is essentially part‑time. State law allows district boards to approve benefits in addition to the per diem we previously described as long as the amounts of most benefits do not exceed those that their staff receive. The district’s administrative code states that board members and their eligible dependents may receive medical, dental, and vision health care coverage and that the district will contribute to their insurance premiums in an amount it determines yearly. However, for most benefit categories, the district contributes the maximum possible—it pays all of the costs for board members’ and their dependents’ medical, dental, and vision coverage, as well as for their $10,000 life insurance policies. As of 2015 the cost for a board member’s medical, dental, and vision premiums with family coverage could be as much as approximately $2,000 per month. In addition, the district contributes a maximum of between $4,000 and $12,000 each year to each board member’s health expense reimbursement account, with the maximum determined by the board member’s number of dependents. The board member can use this account to pay for any eligible out‑of‑pocket health care Board member benefits are expenses not fully covered by the insurance policies. Overall, these equivalent to those the district benefits are equivalent to those the district provides to its full‑time provides to its full‑time employees, employees. The only exceptions are that the employees receive with the exceptions of life insurance greater life insurance and disability insurance benefits. and disability insurance benefits. Although state law does not prohibit the district from providing full‑time benefits to board members for part‑time duties, we believe that it risks providing benefits that are overly generous. 74 California State Auditor Report 2015-102 December 2015 In reviewing the most recent compensation data from the State Controller for 2013, we noted that the majority of water agencies’ board members in California do not provide any health benefits to their board members. For example, according to the websites of the Santa Margarita Water District and South Coast Water District, they do not provide board members any health, life, or retirement benefits. Based on district accounting records, the district spent more than $70,000 on medical, dental, vision, and life insurance benefits for board members in fiscal year 2014–15. According to the district’s director of human resources, the board has reviewed its benefit compensation during its annual budget review but has not voted to make any significant changes. The district’s administrative code In addition to benefits, the district’s administrative code allows it to allows it to pay board members pay board members a $600 monthly automobile or transportation a $600 monthly automobile or allowance that is significantly more generous than what other transportation allowance that is water agencies offer. Currently all board members receive this significantly more generous than monthly benefit as reimbursement for any vehicle expenses they what other water agencies offer. incur while conducting district business.7 According to a survey another water district in Southern California conducted regarding the compensation and benefits selected water agencies provided to their board members in 2014, most water agencies reimburse board members for mileage only, and the two agencies that reported providing automobile allowances offered much lower amounts. Specifically, Upper San Gabriel Valley Municipal Water District reported an automobile allowance of $335, and West Basin Municipal Water District reported an allowance of $411. According to district records, it paid nearly $36,000 to board members for the automobile or transportation allowance in fiscal year 2014–15. The director of human resources stated that the district has not formally considered a proposal to change the automobile allowance to a mileage‑based system. Further, in the past the district provided its automobile allowance without requiring proof that board members possessed valid California driver’s licenses and carried automobile insurance. However, the district updated its administrative code in July 2015 to ensure board members demonstrate they have a valid driver’s license, automobile insurance, and an acceptable driving record. Finally, the district pays board members compensation for the use of their personal communication devices. Until July 2015 the administrative code allowed board members to receive this benefit in an amount the board determined. In July 2015 the district revised its administrative code by fixing the amount at $200 per month. In fiscal year 2014–15 district records indicate that it paid a total of $12,000 to its board members for the yearly communications 7 According to the district’s administrative code, board members who are unable to drive due to a qualifying disability may use the automobile or transportation allowance for alternative transportation expenses if they provide medical certification on an annual basis. California State Auditor Report 2015-102 75 December 2015 allowance, or an average of $2,400 per board member. However, the director of human resources confirmed that during the past five years the district has not conducted an assessment to determine whether this amount was necessary or reasonable. Without conducting an analysis of the need for a communications allowance, the district cannot be certain whether the amount it pays is appropriate. In contrast to the benefits the district provides to its board members, the benefits that its pays to its staff appear reasonable given their full‑time status and salary levels. For example, full‑time district employees receive the same medical, dental, vision, and health reimbursement account benefits as board members. However, staff also receive other benefits, including short‑ and long‑term disability insurance coverage and life insurance policies for up to $150,000, for which the district pays the premiums. Staff also participate in the State’s pension program, under which retirees can receive a percentage of their final compensation as retirement benefits. Although the general manager receives a communication allowance and an automobile allowance, other staff—unless approved by the board—do not receive such allowances. However, the district reimburses them for mileage when on district business, and senior managers receive cellular phones for business use. Additionally, in the most recent district survey of employee salaries and benefits conducted in 2012, district salary ranges for 11 of 12 of the positions compared, excluding the general manager, were at or below the median of the ranges reported by eight nonunion agencies with fewer than 300 employees. Although the district’s salaries for nearly all of its staff are reportedly lower than those at other water agencies, the director of human resources told us that the district’s benefits have generally been effective in retaining staff, but have not been as effective for recruiting new staff following the statewide pension reforms in 2013. She explained that she plans to conduct a salary and benefits survey with the help of a consultant by the end of 2016. The current general manager participates in district‑sponsored benefit plans, including medical, dental, and vision, at the same level as other staff. However, the district has entered into contracts The district has entered into with past general managers that have provided for additional contracts with past general benefits beyond those the district provides to its staff. Because the managers that have provided for board negotiates the general manager’s compensation separately additional benefits beyond those from the staff’s compensation, it has the ability to make such offers. the district provides to its staff. For example, in 2011 the board approved a new contract for the then‑general manager that included the district contributing about $158,000 over three years to his retirement account. According to district records, it paid $99,000 into this account, the maximum allowed during 2011 and 2012, before the general manger retired in October 2012. The district’s records indicate that it then paid him 76 California State Auditor Report 2015-102 December 2015 the remaining $59,000, plus roughly $34,000, which, according to the director of human resources, was to offset his taxes on the remainder, as allowed for by the provisions of his contract. Further, in 2013 the board approved a contract with its then‑general manager that included the offer of lifetime retiree health benefits to the general manager and his spouse if he remained with the district for five consecutive years. However, he remained with the district for only about 17 months and did not receive the lifetime retiree health benefits. We observed similar provisions in two other comparable districts’ contracts with their respective general managers. Nevertheless, according to the director of human resources, instead of contributing to the former general manager’s retirement, additional consideration could have been given to negotiating a higher salary. The District Has Made Questionable and Inappropriate Expenditures for Travel and Meal Costs We identified instances in which the In our limited review of the district’s expenditures, we identified district paid amounts for travel and instances in which the district paid amounts for travel and meal meal expenses in excess of what we expenses in excess of what we consider reasonable. For example, consider reasonable. we found instances in which the district paid travel expenses for board members and employees to attend conferences and seminars having no clear connection to its mission or purpose. In addition, when we reviewed six flight expenses, we found that three included higher‑class airfares than the district’s policies allow. Moreover, the district often paid for expenses that exceeded the meal reimbursement limits that the Internal Revenue Service (IRS) has established and, to the extent these meal expenses were incurred by board members, they violated state law. Further, the district paid for business meals that it could have avoided by holding meetings at its office. When the district pays for unreasonable travel and meal expenses, it wastes public funds. Although the district’s administrative code states that it will only allow payment for travel and other expenses that are reasonably necessary to represent its interests and objectives, we identified instances in which the district did not ensure its payments for travel were necessary or prudent. As shown in Table 10, we found that the district pays expenses for board members and staff to attend conferences and seminars unrelated to its responsibilities, let alone water policy. For instance, the district paid for board members to attend a legislative caucus related to another state’s immigration law. It also paid for one of its general managers to attend a scholastic press association seminar. We believe that these expenses had no direct connection to furthering the district’s mission and that the district’s payment of these costs demonstrates that it did not use public funds in a reasonable manner. California State Auditor Report 2015-102 77 December 2015 01 elbaT sesnepxE levarT etairporppanI s’tcirtsiD retaW lapicinuM nisaB lartneC eht fo selpmaxE 5102 hguorhT 0102 ETAIRPORPPANI ESNEPXE STSOC NOITPIRCSED YCILOP )TCIRTSID( S’TCIRTSID RETAW LAPICINUM NISAB LARTNEC RAEY ROF DERRUCNI 487$ sucuac evitalsigel a dnetta ot srebmem draob owt rof sesnepxe levart rof diap tcirtsid ehT dewolla eb llahs sesnepxe rehto dna levart rof tnemyaP 0102 evitalsigeL saw pirt siht eveileb ton od eW .wal noitargimmi desoporp s'etats taht ot detaler anozirA ni stseretni eht tneserper ot yrassecen ylbanosaer nehw sucuaC s'anozirA seveileb osla reganam lareneg tnerruc s'tcirtsid ehT .stseretni s’tcirtsid eht rof yrassecen .tcirtsid eht fo sevitcejbo dna .ssenisub tcirtsid htiw od ot gnihton evah swal noitargimmi 164,2 sserp citsalohcs a dnetta ot reganam lareneg‑neht eht rof sesnepxe levart rof diap tcirtsid ehT 2102 ,0102 msilanruoJ noitartsinimda fo rotcerid eht ,ranimes 2102 eht roF .opsibO siuL naS ni ranimes noitaicossa ranimes suoiverp esu dluow eh taht denialpxe reganam lareneg remrof eht taht detats secivres draob dna saw pirt siht eveileb ton od eW .stneduts loohcs hgih rof slairetam gnihcaet sih ni sadnega draob .ssenisub tcirtsid ot detaler 932 latner eht taht tcaf eht etipsed rebmem draob a ot sesnepxe rac latner desrubmier tcirtsid ehT edoc evitartsinimda s’tcirtsid eht ,5102 yluJ erofeB 1102 rac latneR dedivorp rebmem draob ehT .elcihev eht detner laudividni tnereffid a taht detacidni tnemeerga eman eht rednu detner eb ot selcihev eriuqer ton did tcirtsid eht eveileb eW .esnepxe eht derrucni yllautca eh taht ,eton dengis a rof tpecxe ,foorp on ew ,sselehtreveN .eeyolpme ro rebmem draob a fo ,taht detats secivres draob dna noitartsinimda fo rotcerid ehT .mialc siht diap evah ton dluohs saw siht taht edulcnoc ot elbanosaer si ti eveileb era selcihev eriuqer ot 5102 yluJ ni edoc evitartsinimda sti desiver tcirtsid eht ,tnedicni siht ot eud .noitatcepxe eht .eeyolpme na ro rebmem draob a fo eman eht rednu ylno detner 054 rof eraf ymonoce level‑esab ro hcaoc eht evoba erew deweiver ew serafria xis eht fo eerhT ni levart ria seriuqer edoc evitartsinimda s’tcirtsid ehT 4102 ,2102 erafriA )detamitse( tcirtsid eht sa enilria emas eht gnisU .otnemarcaS dna noiger selegnA soL eht neewteb sthgifl ,defiitsuj esiwrehto sselnu ssalc tnelaviuqe na ro hcaoc sthgifl ni ecnereffid tsoc eht detaluclac ew ,5102 tsuguA ni stropria emas eht neewteb levart rof rof ro ytilibasid lacisyhp a sah relevart a nehw sa hcus s’tcirtsid ehT .thgifl rep 051$ ylhguor evas dluoc sthgifl ymonoce level‑esab rof gnitpo nehw .sruoh ruof fo ssecxe ni levart degnolorp level‑esab a sthgifl retrohs rof taht degdelwonkca secivres draob dna noitartsinimda fo rotcerid lliw tcirtsid eht ,drawrof gnivom taht detats osla ehS .desu eb dluohs eraf ssalc ymonoce .lavorppa rof draob eht ot meht ekat dna gnitirw ni snoitpecxe tnemucod *nwonknU yna dekcal—41—ytirojam eht taht deton ew ,sesnepxe gnigdol 02 fo weiver detimil ruo nI gnilevart srebmem draob seriuqer wal etatS 5102–0102 gnigdoL s'tcirtsid eht ro wal etats yb debircserp setar eht fo eno desu dah relevart eht taht noitatnemucod ro puorg eht esu ot tcirtsid eht rof ssenisub no devorppaerp draob eht taht noitatnemucod dekcal smialc eht fo neveS .edoc evitartsinimda ,ton fi ,ro elbaliava nehw gnigdol rof etar tnemnrevog reganam lareneg eht taht noitatnemucod dekcal eerht dna srebmem draob rof snoitpecxe erofeb gniteem cilbup a ni lavorppa draob niatbo ot ,taht detats secivres draob dna noitartsinimda fo rotcerid ehT .ffats rof snoitpecxe devorppaerp evitartsinimda s’tcirtsid ehT .derrucni si esnepxe eht puorg ro tnemnrevog eht desu sah tcirtsid eht ,gnigdol ffats dna ’srebmem draob ot tcepser htiw puorg ro tnemnrevog eht esu ot ffats seriuqer edoc ecnerefnoc eht sa hcus ,siht fo ecnedive tnednepedni evreserp ton did tub ,tsap eht ni etar .elbissop nehw etar etar puorg ro tnemnrevog a taht etacidni syawla ton od hcihw ,stpiecer letoh naht rehto ,eruhcorb setar ecnerefnoc taht noitatnemucod edulcni dluow ffats detats ehs ,drawrof gnivoM .desu saw .desu erew .sdrocer laicnanfi tcirtsid dna ,edoc evitartsinimda s’tcirtsid eht ,2.23235 noitceS edoC tnemnrevoG :secruoS .derrucni tsoc etairporppani eht etaluclac ot elbissop ton saw ti ,sesnepxe gnigdol 41 eseht rof setar puorg ro tnemnrevog desu ti taht etartsnomed ton dluoc tcirtsid eht esuaceB * 78 California State Auditor Report 2015-102 December 2015 In addition, the district’s administrative code requires board members and staff to exercise sound judgment when traveling in order to incur reasonable costs to the district. However, as shown in Table 10 on the previous page, we identified occasions when district representatives did not take appropriate steps to ensure the reasonableness of the district’s costs. For example, the code requires travelers to fly coach or an equivalent class unless otherwise justified, such as when a traveler has a physical disability or for prolonged travel in excess of four hours. However, three of the six airfare expenses we reviewed included higher‑class airfares, which often include privileges such as priority boarding and premium beverages, for short flights between the Los Angeles region and Sacramento. Additionally, state law requires board members traveling on business for the district to use the group or government rate for lodging when available or, if not, to obtain board approval in a public meeting before the expense is incurred. The district’s administrative code also requires the district’s staff Our review of 20 lodging expenses to use the government or group rate when possible. However, our found that the majority—14— review of 20 lodging expenses found that the majority—14—lacked lacked any documentation that any documentation that the travelers had used one of the rates the travelers had used one of the prescribed by state law or the district’s administrative code. Finally, rates prescribed by state law or in 2011 the district reimbursed a board member for the cost of a the district’s administrative code. car he purportedly rented while attending a water conference in Las Vegas. However, according to the car rental agreement and receipt, another individual who was not a representative of the district rented the vehicle. Other than a signed note from the board member claiming that he rented the car, the expense claim lacked any documentation showing that the board member had actually paid for the rental car. As a result of these incidents, we are concerned that the district is paying travel expenses for its board members and staff without ensuring that those expenses are reasonable and necessary. In addition, we found that the district often paid for inappropriate and questionable meal costs for board members, employees, and others. As shown in Table 11, we found that the district often paid for meals in excess of IRS limits and, to the extent these meal expenses were incurred by board members, they violated state law. In addition, the district paid for meals in the local area for meetings that participants could have held at its office, thus avoiding such costs. Finally, the district paid for meals to third parties which, based on state law and California Attorney General opinions, we believe were not permissible. California State Auditor Report 2015-102 79 December 2015 11 elbaT sesnepxE laeM etairporppanI s’tcirtsiD retaW lapicinuM nisaB lartneC eht fo selpmaxE 51–4102 hguorhT 11–0102 sraeY lacsiF FO REBMUN LATOT SESNEPXE ETAIRPORPPANI EUSSI HTIW STSOC NOITPIRCSED *)59 FO TUO( EUSSI 164,1$ derrucni stsoc laem yrassecen dna lautca no stimil tes ot ,)tcirtsid( tcirtsiD retaW lapicinuM nisaB lartneC eht sa hcus ,stnemnrevog lacol swolla wal ainrofilaC 93 sesnepxe laeM wal etats ,stimil tnemesrubmier laem nwo sti tes ton seod tnemnrevog lacol a fI .srebmem draob ot desrubmier era taht seitud laicffio fo ecnamrofrep eht ni setar SRI evoba ta draob eht yb devorppaerp neeb evah sesnepxe laem eht sselnu )SRI( ecivreS euneveR lanretnI eht yb dehsilbatse stimil esu ot tnemnrevog lacol eht seriuqer fo rotcerid eht ot gnidroccA .draob eht yb devorppaerp erew denimaxe ew slaem eht fo yna taht noitatnemucod on dnuof weiver detimil ruO .gniteem cilbup a ton did tcirtsid eht ,noitidda nI .sesnepxe laem no stimil esopmi ot tnemeriuqer wal etats eht fo erawa ton saw tcirtsid eht ,secivres draob dna noitartsinimda .5102 yluJ litnu ,seitrap driht ot dedivorp slaem rof esoht ro ,ffats yb derrucni ro drac tiderc tcirtsid a ot degrahc esoht sa hcus ,sesnepxe laem rehto no stimil evah derrucni ydaerla dah eh yad emas eht no rennid dnoces a rof drac tiderc tcirtsid eht no 16$ degrahc rebmem draob a 1102 rebotcO nI :1# elpmaxE .ranimes a gnidnetta elihw sesnepxe detaler‑rennid ro erew stseug eht ohw gniyfitnedi tuohtiw stseug eerht dna flesmih rof tsafkaerb no 101$ tneps reganam lareneg remrof a 2102 yaM nI :2# elpmaxE .nosrep rep 01$ saw emit eht ta etar tsafkaerb SRI eht ;laem eht fo esoprup ssenisub eht rof noitacfiitsuj gnidivorp 311,1 eht detcirtser yltaerg evah stnemnrevog ynam ,sraey tnecer ni taht ,1102 ,03 enuJ gnidne raey lacsfi eht fo tidua sti ni deton rotidua lanretxe s’tcirtsid ehT 02 eht ni slaeM evitartsinimda sti desiver tcirtsid eht hguohtlA .slaem lacol no snoitatimil on decalp tcirtsid eht tub ,seicnega tnemnrevog ot slaem lacol gnigrahc fo ecitcarp †aera lacol yrassecennu timil ot sretrauqdaeh s’tcirtsid eht ta sgniteem dloh ot troffe yreve ekam dluohs seeyolpme dna srebmem draob taht etats ot 5102 yluJ ni edoc .sesnepxe yrassecennu rucni ot eunitnoc yam srebmem draob dna ffats tcirtsid ,tluser a sa ,dna evissimrep llits si edoc evitartsinimda eht ,sesnepxe tnempoleved ssenisub‑neht s’tcirtsid eht dna rebmem draob a neewteb selegnA soL ni gniteem rennid a rof diap tcirtsid eht 2102 lirpA nI :1# elpmaxE .ecffio s’tcirtsid eht ta gniteem a dleh ylisae evah dluoc slaudividni owt eseht hguoht neve ,091$ ylraen fo tsoc latot a ta reganam ecffio s’tcirtsid eht hguoht neve ,srebmem draob owt neewteb selegnA soL ni gniteem hcnul a rof 07$ tsomla diap tcirtsid eht 5102 yraunaJ nI :2# elpmaxE .desu neeb evah dluoc 689 desaB .seitud laicffio rieht fo ecnamrofrep eht ni ffats ro srebmem draob yb derrucni sesnepxe ”yrassecen dna lautca“ rof ylno tnemesrubmier stimrep wal etatS 42 dedivorp slaeM hcus ,seitrap driht rof desahcrup slaem edulcni ton od sesnepxe yrassecen dna lautca taht eveileb ew ,snoinipo lareneG yenrottA ainrofilaC dna wal etats nopu seitrap driht ot .elbissimrep ton era yeht ,eroferehT .esoprup ssenisub a rof era slaem esoht fi neve ,srenwo ssenisub ro ,slaicffio cilbup ,stneutitsnoc sa .ecnerefnoc a gnidnetta srebmem draob rof ,nosrep rep 18$ tuoba fo egareva na ro ,rennid a rof 565$ tuoba diap tcirtsid eht 0102 rebmeceD nI :1# elpmaxE dewolla emit taht ta edoc evitartsinimda s’tcirtsid eht detats secivres draob dna noitartsinimda fo rotcerid ehT .sesuops owt rof stsoc dedulcni rennid ehT ta detats reganam lareneg‑neht eht taht eton ew dna ,noitressa siht htiw eergasid eW .tcirtsid eht ot tfieneb a sa nees erew yeht esuaceb sesnepxe eseht rof dna noitartsinimda fo rotcerid ehT .sesnepxe ’sesuops fo tnemesrubmier rof wolla ton did edoc evitartsinimda eht taht 0102 rebmeceD ni gniteem draob a .egnahc siht tcefler ot dednema neeb sah edoc evitartsinimda eht dna rof diap regnol on era sesnepxe ’sesuops taht detarobale rehtruf secivres draob a ,rebmem draob a ,reganam lareneg‑neht eht rof ecnerefnoc a gnidnetta elihw rennid a rof 022$ ylraen diap tcirtsid eht 4102 yluJ nI :2# elpmaxE ssenisub eht fo noitpircsed yna skcal esnepxe rennid eht rof mialc eht ,noitidda nI .rebmem licnuoc areviR ociP a dna ,rebmem draob loohcs ollebetnoM .tcirtsid eht fo stseretni eht derehtruf ti woh dna laem eht fo esoprup .tcirtsid retaw gnirobhgien a morf rebmem draob a dna rebmem draob tcirtsid a rof 5102 yraurbeF ni rennid a rof 001$ revo diap tcirtsid ehT :3# elpmaxE .tcirtsid eht fo stseretni eht derehtruf ti woh dna laem eht fo esoprup ssenisub eht fo noitpircsed yna skcal mialc ehT .sdrocer laicnanfi dna ,edoc evitartsinimda s’tcirtsid eht ,snoinipo lareneG yenrottA ainrofilaC ,snoisiced truoC ainrofilaC ,2.23235 noitceS ,edoC tnemnrevoG ainrofilaC :secruoS lacol eht ni reganam tnempoleved ssenisub a dna rebmem draob a neewteb gniteem rennid a rof ,nosrep rep 49$ ro ,881$ diap tcirtsid eht ,ecnatsni roF .eussi eno naht erom rednu dedulcni era sesnepxe laem emoS * ecnis wor aera lacol eht ni slaem eht ni 881$ lluf eht dedulcni eW .elpoep owt rof etar rennid SRI eht evoba diap tcirtsid eht tnuoma eht stcefler hcihw ,wor setar SRI evoba sesnepxe laem eht ni 611$ dedulcni eW .aera .selegnA soL ni dleh saw gniteem siht .ytnuoC egnarO dna ytnuoC selegnA soL sa aera lacol eht senfied tcirtsid ehT † 80 California State Auditor Report 2015-102 December 2015 Further, until recently, the district did not address a recommendation that it establish meal expense limits. Specifically, in 2011 the district’s external auditor at the time recommended the district set limits on the costs of meals, whether incurred locally or while traveling. The district disagreed with this recommendation, stating that some district business required travel around the country, which made setting limits on meals difficult because of cost variances between cities, states, and regions. However, we disagree, particularly given that the federal government has established meal rate limits for its employees that vary by city and that California sets a fixed meal reimbursement limit for state employees regardless of where they travel within the United States. Moreover, we believe that by failing to implement the external auditor’s recommendation, the district missed an opportunity to demonstrate to the public that it was spending its funds in a prudent manner. After we began our audit work and raised these concerns with district staff, the district finally adopted meal cost limits in July 2015 that are comparable to the IRS’s established rates. The district’s new limits apply to both board members and staff. Finally, board members have consistently violated state law by failing to report back to the board on meetings or conferences they attend at the district’s expense. Both state law and the district’s administrative code require a board member who travels to a meeting or a conference at the district’s expense to make a brief oral or written report to the other board members at the board’s next regularly scheduled meeting. Our review of 12 conferences attended by board members between July 2010 and June 2015 at the district’s expense found no evidence in half of these instances that board members provided the required reports at the subsequent board meetings. When board members do not provide these required reports, they deprive other board members and district officials of the opportunity to learn from their experiences, and they also fail to justify to the public the value of the expenses they incurred. Recommendations To ensure it considers the most qualified candidates for positions, the district should follow its established hiring policies. Specifically, it should use a competitive hiring process and ensure that its board first formally approves all positions for which the district recruits. Further, the district should consider for employment only individuals who meet the established minimum qualifications for the positions for which they have applied. If the district believes certain qualifications are not necessary for a position, it should indicate in the position description that such qualifications are desirable but not required. California State Auditor Report 2015-102 81 December 2015 To ensure that it does not inappropriately grant undeserved raises to its staff, the district should follow its policy to provide annual performance evaluations to all employees. To ensure it is efficiently using its resources, the district should do the following: • Eliminate its board members’ automobile or transportation allowances and instead reimburse them based on their business mileage or transit use. • Periodically analyze and, beginning in June 2016, report to the board whether all elements of its board member compensation, including health and related benefits, are appropriate and reflect the common practices of special districts. • Adopt a policy that its general managers will participate in benefits at the same level as district staff and that the board will negotiate the general managers’ contracts on the basis of salary and not other benefits, such as retirement. To ensure that its travel expenses are reasonable and necessary, the district should take steps, such as issuing a clarifying memorandum or providing additional training, to ensure all board members and staff, especially those who process reimbursement claims, are aware of what the district considers to be proper expenses incurred while traveling, including only paying for the following: • Air travel that is coach or an equivalent class. • Meetings and conferences that have a direct connection to water policy or the district’s mission. It should update its list of such preapproved meetings accordingly. • Lodging expenses that reflect group or government rates, unless there is documentation that such rates are unavailable. To ensure it reimburses only reasonable and necessary meal expenses, the district should take steps, such as issuing a clarifying memorandum or providing additional training, to ensure that all board members and staff, especially those who process reimbursement claims, are familiar with its meal reimbursement limits. 82 California State Auditor Report 2015-102 December 2015 The district should revise its administrative code by June 2016 to prohibit paying for or reimbursing meals that occur within the local area that involve meetings either between only district representatives or between district representatives and the district’s contractors. The district should revise its administrative code by June 2016 to prohibit paying for the costs of meals provided to third parties. To ensure it complies with state law and its own administrative code, the district should require board members to report back to the board on meetings and conferences they attend at the district’s expense. The district should record these reports in meeting minutes or document them in expense files before it reimburses the board members for their travel expense claims. We conducted this audit under the authority vested in the California State Auditor by Section 8543 et seq. of the California Government Code and according to generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives specified in the Scope and Methodology section of the report. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Respectfully submitted, ELAINE M. HOWLE, CPA State Auditor Date: December 3, 2015 Staff: Laura G. Kearney, Audit Principal John Lewis, MPA Joseph R. Meyer, CPA, CIA Richard Marsh, MST Marshall Miller, MPAc Kurtis Nakamura, MPIA Ray Sophie, MPA Legal Counsel: Heather Kendrick, Sr. Staff Counsel Richard B. Weisberg, Sr. Staff Counsel For questions regarding the contents of this report, please contact Margarita Fernández, Chief of Public Affairs, at 916.445.0255. California State Auditor Report 2015-102 83 December 2015 * ‡ * California State Auditor’s comments begin on page 97. † The district provided us with updated information in March 2016 that reflected it had 40 water retailers and one water wholesaler. 84 California State Auditor Report 2015-102 December 2015 1 California State Auditor Report 2015-102 85 December 2015 2 3 86 California State Auditor Report 2015-102 December 2015 4 5 3 California State Auditor Report 2015-102 87 December 2015 3 2 6 1 88 California State Auditor Report 2015-102 December 2015 California State Auditor Report 2015-102 89 December 2015 90 California State Auditor Report 2015-102 December 2015 California State Auditor Report 2015-102 91 December 2015 92 California State Auditor Report 2015-102 December 2015 California State Auditor Report 2015-102 93 December 2015 7 94 California State Auditor Report 2015-102 December 2015 California State Auditor Report 2015-102 95 December 2015 96 California State Auditor Report 2015-102 December 2015 California State Auditor Report 2015-102 97 December 2015 Comments CALIFORNIA STATE AUDITOR’S COMMENTS ON THE RESPONSE FROM THE CENTRAL BASIN MUNICIPAL WATER DISTRICT To provide clarity and perspective, we are commenting on the response to our audit report from the Central Basin Municipal Water District (district). The numbers below correspond to the numbers we placed in the margin of the district’s response. During the district’s official review of our draft report in late 1 October 2015, the board of directors (board) adopted a plan to implement a hotline for reporting potential ethics violations and to contract with a law firm to conduct an independent review of those alleged violations, which we describe on page 28. As a result of the board’s action, we added text to our recommendation on page 42 to clarify that the district should implement changes to its ethics policy by June 2016. At the outset, it is helpful to point out that, unlike most municipal 2 water districts in this state that directly provide water to residents, this district is a limited‑purpose agency whose primary responsibility during most of the 63 years of its history is to wholesale water from the Metropolitan Water District of Southern California (Metropolitan) to be resold to water distributors who directly provide water to residents of their respective communities. Whatever governance structure is put in place, this function remains the primary responsibility of the district. Therefore, a change in governance would not deny “2 million citizens the right to direct representation on major water policy issues” because the district’s role does not require broad policy making. Further, our recommendation to the Legislature on page 42 would not result in the loss of representation, or disenfranchisement, of the residents within the district’s jurisdiction. The district’s eligible voters currently have the power to elect the public officials of the public agencies that constitute the district’s customer base. If the Legislature implemented our recommendation, these public agencies would then have the power to appoint the board. Thus, the district’s residents would retain ultimate authority over the district’s board through representative democracy. This would be analogous to the way in which the representatives of Metropolitan and the San Diego County Water Authority are appointed, as we describe on page 41. Moreover, any subsequent governing body would continue to operate in an open and transparent manner under the Ralph M. Brown Act and would allow for public participation in the decision‑making process. 98 California State Auditor Report 2015-102 December 2015 3 As stated in our report on pages 39 through 41, because of the recent positive changes made by the district, we believe the options available under the Cortese‑Knox‑Hertzberg Local Government Reorganization Act of 2000 (Reorganization Act) are premature at this time. However, as stated on page 39, we remain skeptical of the board’s ability to consistently ensure the district’s stability and provide it with effective, ongoing leadership. Thus, the intent of our recommendation is for the Legislature to consider options, such as the one we propose, that are less extreme than those permitted under the Reorganization Act, but that create greater accountability between the district and its direct customers so that the district remains encouraged to continue the positive changes it recently made. We also note that while the Reorganization Act is locally administered, the Legislature may revise the statutes it enacted to authorize the district if it deems such revisions are necessary to meet changing conditions. 4 The district’s statement that our report fails to reflect the district’s operational improvements over time ignores the numerous instances in our report where we point out the district’s improvement in certain areas. For instance, we note the district’s recent progress related to addressing potential ethical violations on pages 27 and 28 and adopting a new strategic plan on page 29. Further, we acknowledge actions it has recently taken to address the issues we found related to the district paying for inappropriate and questionable meal expenses on page 80. In addition, the district’s statement that many of the individuals who were involved in the questionable circumstances described in our report are no longer with the district overlooks the fact that the district’s policies and controls were weak or lacking in many areas throughout our audit period, regardless of the individuals involved. For instance, the district still has no formal debt management policy, as we describe on page 35; its management of its contracts did not follow best practices and sometimes circumvented its own policies regarding contracts throughout our audit period, as we point out beginning on page 49; and several of the travel and meal expense issues we identified in Tables 10 and 11 on pages 77 and 79, respectively, occurred within the past two fiscal years. 5 Our contract selection included four contracts the district entered into in each of the five fiscal years in our audit period. The district is correct that 11 of the 13 contracts we identified as sole‑source contracts on page 50 were executed prior to fiscal year 2013–14. However, we describe additional contracting issues that occurred throughout our audit period in Chapter 2 on pages 56 through 60. For example, on page 57 we describe that 19 of the 20 contracts we reviewed had scopes of work that did not include one or more of the following elements: measurable results, timelines or progress reports, or an evaluation component. Further, on pages 62 and 63 California State Auditor Report 2015-102 99 December 2015 we recommend changes to the district’s contracting policies and processes to ensure that it not only receives the best value from its contracts, but also strengthens its control environment and ensures it has adequate contracting practices. We do not recommend a specific structure for or size of the board. 6 In the recommendation to the Legislature on page 42, we offer the example of a board appointed by the district’s customers to better reflect the fact that the district’s customers are generally water retailers and not the residents of the district. We can envision multiple ways that can happen that may include, among other possibilities, a hybrid board of elected and appointed officials or a board of limited size elected by the retailers from a slate of individuals nominated by those retailers. Ultimately the decision of whether or how to change the governance structure resides with the Legislature. Consistent with the audit objectives, we reviewed the qualifications 7 of the district’s senior managers. In reviewing the qualifications of specific former managers, we identified additional concerns with the district’s hiring process, including its failure to consistently follow established policies requiring it to use a competitive hiring process, and discuss those concerns on pages 66 through 69. Although we note on page 24 that the process the district used to hire the current general manager included interviews of top candidates, we did not review the competitiveness of the process the district used for its other current hires and therefore cannot conclude that it did or did not follow a competitive process for all individuals hired since 2013. Nevertheless, we stand by our recommendation on page 80 that the district follow its hiring policies by using a competitive hiring process.