California Department of Water Resources - Internal Control Review

CALIFORNIA DEPARTMENT OF WATER RESOURCES Review Report INTERNAL CONTROL REVIEW January 1, 2017, through December 31, 2017 BETTY T. YEE California State Controller June 2019 BETTY T. YEE California State Controller June 28, 2019 Karla Nemeth, Director California Department of Water Resources 1416 9th Street Sacramento, CA 95814 Dear Ms. Nemeth: The State Controller’s Office (SCO) reviewed the internal control of the California Department of Water Resources’ (DWR) Accounts Payable, Accounts Receivable, Procurement, Division of Engineering (DOE), and Operations and Maintenance Division to determine whether DWR has adequate internal control over financial operations and activities to safeguard the State from theft, abuse, or losses; and is complying with applicable laws, rules, regulations, policies, and procedures. The review period was January 1, 2017, through December 31, 2017. We noted that DWR:  Devotes excessive resources to providing consulting services for projects that are not fully developed and does not have a project scoping and planning component in place to ensure that projects are properly prepared and budgeted prior to being submitted to DOE for engineering services (see Finding 1);  Has difficulty recruiting and retaining staff, especially engineers, due to competition with other state agencies and the private sector (see Findings 1 and 2); and  Faces environmental regulations that prevent projects from starting or being completed in a timely manner (see Findings 1 and 2). We also identified a deficiency in reporting emergency repair costs that is not significant to the audit objectives but warrants the attention of management. This issue is discussed in the Observation section of this report. We issued a draft report with our conclusions, findings, and recommendations on February 28, 2019. Cindy Messer, Chief Deputy Director, responded on behalf of the DWR to our findings and recommendations in a letter dated March 21, 2019. Her response, as a whole, is included as an attachment to this report. We have commented on your responses to our recommendations and have included those comments throughout the Findings and Recommendations section of this report. DWR should develop a detailed corrective action plan within six months of this report to address the issues noted in Findings 1 and 2 and the Observation. The action plan should be submitted to SCO to determine if a follow-up review is necessary. Karla Nemeth, Director -2- June 28, 2019 If you have any questions, please contact Andrew Finlayson, Chief, State Agency Audits Bureau, by telephone at (916) 324-6310 or by email at afinlayson@sco.ca.gov. Sincerely, Original signed by JIM L. SPANO, CPA Chief, Division of Audits JLS/as Attachment cc: Cindy Messer, Chief Deputy Director (via email) California Department of Water Resources David Whitsell, Chief, Internal Auditor Office (via email) California Department of Water Resources Joel Ledesme, Deputy Director, State Water Project (via email) California Department of Water Resources Kathie Kishaba, Deputy Director, Business Operations (via email) California Department of Water Resources David Duval, Chief, Operations and Maintenance Division (via email) California Department of Water Resources Behzad Soltanzadeh, Assistant Division Chief, Operations and Maintenance Division (via email) California Department of Water Resources Vinay Behl, Chief, Division of Fiscal Services (via email) California Department of Water Resources Jeanne Kuttel, Chief, Division of Engineering (via email) California Department of Water Resources Dave Kearney, Chief, Business Services Office (via email) California Department of Water Resources California Department of Water Resources Internal Control Review Contents Review Report Summary ............................................................................................................................ 1 Background ........................................................................................................................ 1 Objective, Scope, and Methodology ................................................................................. 2 Conclusion .......................................................................................................................... 3 Follow-up on Prior Review Findings ............................................................................... 3 Views of Responsible Officials .......................................................................................... 3 Restricted Use .................................................................................................................... 3 Findings and Recommendations ........................................................................................... 4 Observation ............................................................................................................................. 8 Attachment—Auditee’s Response to Draft Review Report California Department of Water Resources Internal Control Review Review Report Summary The State Controller’s Office (SCO) reviewed the internal control of the California Department of Water Resources’ (DWR) Accounts Payable, Accounts Receivable, Procurement, Division of Engineering (DOE), and Operations and Maintenance (O&M) Division to determine whether DWR has adequate internal control over financial operations and activities to safeguard the State from theft, abuse, or losses; and is complying with applicable laws, rules, regulations, policies, and procedures. The review period was January 1, 2017, through December 31, 2017. We noted that DWR:  Devotes excessive resources to providing consulting services for projects that are not fully developed and does not have a project scoping and planning component in place to ensure that projects are properly prepared and budgeted prior to being submitted to DOE for engineering services (see Finding 1);  Has difficulty recruiting and retaining staff, especially engineers, due to competition with other state agencies and the private sector (see Findings 1 and 2); and  Faces environmental regulations that prevent projects from starting or being completed in a timely manner (see Findings 1 and 2). In addition, based on our review of Oroville Dam repair costs and discussions with DWR management, we observed that DWR is able to start and complete projects expeditiously during a crisis or emergency. In these situations, DWR resources are made readily available and accessible to address the emergency conditions. DWR is able to suspend or defer regulatory environmental requirements in an emergency. However, emergency projects are more costly (see the Observation). Background The responsibility of the DWR is to manage the water resources of California in cooperation with other agencies, in order to benefit the State’s people and to protect, restore, and enhance natural and human environments. In 1956, the California State Legislature passed a bill creating DWR to plan, design, construct, and oversee the building of the nation’s largest state-built water development and conveyance system. Today, DWR protects, conserves, develops, and manages much of California’s water supply, including the State Water Project (SWP), which provides water for 25 million residents, farms, and businesses. Working with other agencies and the public, DWR develops strategic goals and plans of action for conserving, managing, developing, and sustaining California’s watersheds, water resources, and water management systems. DWR also works to prevent and respond to floods, droughts, and catastrophic events that would threaten public safety, water resources, water management systems, the environment, and property. Balancing the State’s water needs with environmental protection remains a long-term challenge. -1- California Department of Water Resources Internal Control Review Objective, Scope, The objective of our review was to assess internal control processes and and Methodology procedures. These processes and procedures ensure that DWR has adequate internal control over financial operations and activities to safeguard the State from theft, abuse, or losses and is complying with applicable laws, rules, regulations, policies, and procedures. The review period was January 1, 2017, through December 31, 2017. To achieve our objective, we:  Gained an understanding of the DWR’s legal, regulatory, and compliance requirements affecting DWR and evaluate whether DWR is in compliance;  Determined whether DWR has formal accounting processes and procedures for its headquarters and field offices;  Determined DWR’s key internal controls for Accounts Receivable, Procurement, Accounts Payable, DOE, and O&M Division; and  Evaluated the effectiveness and efficiency of these internal controls. We accomplished our objective through various methods including, but not limited to:  Reviewing applicable sections of the State Administrative Manual, Government Code, Public Contract Code, and other relevant laws, rules, and regulations;  Obtaining and reviewing written policies and procedures related to each operating cycles, and internal controls;  Conducting onsite visits to inquire about, observe, and understand roles and responsibilities of employees responsible for internal controls and functions;  Requesting and reviewing financial records and documentation;  Testing internal controls;  Examining processes and procedures for claims schedules submitted for reimbursement to the SCO to determine whether internal controls provided adequate evidence of review and approval for reimbursement. Selected a non-statistical haphazard sample of 10 contracts from a population of 3,587 contracts and tested 60 related claim schedules to verify that internal controls were adequate. Errors found in the samples selected were not projected to the intended (total) population;  Performing analytical procedures on financial records; and  Reviewing prior audit results. We limited our review of the DWR’s internal controls to gaining an understanding of the transaction flow and claim preparation process as necessary to develop appropriate procedures. -2- California Department of Water Resources Internal Control Review Conclusion Our review noted that DWR:  Devotes excessive resources to providing consulting services for projects that are not fully developed and does not have a project scoping and planning component in place to ensure that projects are properly prepared and budgeted prior to being submitted to DOE for engineering services (see Finding 1);  Has difficulty recruiting and retaining staff, especially engineers, due to competition with other state agencies and the private sector (see Findings 1 and 2); and  Faces environmental regulations that prevent projects from beginning or being completed in a timely manner (see Findings 1 and 2). We also identified a deficiency in reporting emergency repair costs that is not significant to the audit objective but warrants the attention of management. This issue is discussed in the Observation section of this report. Follow-up on An audit report issued July 12, 2016, by the Department of General Services (DGS) on DWR’s Delegated Purchasing Program, noted one Prior Review procurement finding for the DWR’s not ensuring full compliance with Findings DGS Delegated Purchasing Authority and not following state requirements governing Non-IT and IT procurement. DWR took corrective action to address this finding. The DGS audit also noted an observation that contained issues relating to invoices not being date- stamped. We designed our review to confirm whether the DWR took corrective action on this observation. Based on our review, the issue still exists. Views of We issued a draft review report on February 28, 2019. Cindy Messer, Chief Deputy Director, responded by letter dated March 21, 2019 Responsible (Attachment), partially agreeing with the audit results. This final audit Officials report includes the DWR’s response. Restricted Use This review report is solely for the information and use of DWR and the SCO; it is not intended to be and should not be used by anyone other than these specified parties. This restriction is not intended to limit distribution of this report, which is a matter of public record, and is available on the SCO website at www.sco.ca.gov. Original signed by JIM L. SPANO, CPA Chief, Division of Audits June 28, 2019 -3- California Department of Water Resources Internal Control Review Findings and Recommendations FINDING 1— DWR does not have a consistent project-scoping process to ensure that project requests are properly prepared and budgeted prior to being Excessive labor submitted to DOE for execution. DWR’s DOE provides consulting hours and other services on projects for various DWR divisions. Projects that DWR barriers to divisions bring to DOE for consulting services are not fully developed, and completing often require unplanned time spent with project managers to gain a better projects in a timely understanding of the project’s budget, scope, and design requirements. manner DWR also indicated that it has difficulty recruiting and retaining staff, especially engineers, due to:  Competition with other state agencies for college-graduating engineers;  Employees leaving DWR for the private sector as a result of pay differentials; and  Recruitment and retention problems resulting in increased workloads for current staff. The additional time required for project execution, coupled with difficulties in recruiting and retaining staff, results in some projects not being completed on time. Additionally, lengthy environmental permitting processes often prevent projects from being completed in a timely manner. DWR faces a myriad of state- and federal-imposed environmental restrictions that add long delays and prevent projects from starting construction (see the Observation). Recommendation We recommend that DWR:  Continue to improve the project-scoping and planning phases prior to seeking engineering services from DOE to ensure that projects are properly prepared and budgeted;  Develop strategies to maintain high-priority workloads during and after emergency situations, as it is imperative that an emergency situation does not delay other high-priority projects; and  Work with regulators and control agencies to adjust policies and allow for additional project delivery methods, including those for emergency and high-priority projects, to address challenges related to the State’s aging infrastructure. -4- California Department of Water Resources Internal Control Review DWR’s Response We do not agree with the description of the finding regarding “DWR does not have a consistent scoping-process...”. DWR does have a well- established process but, due to the unique aspects of any given project, the standard process cannot always be applied. This results in inefficiencies. A) DWR agrees with the recommendation to continue to improve this process. To accomplish this, DWR’s Division of Engineering has created a dedicated Project Management unit to coordinate planning and scope development with all divisions. In addition, DWR is currently working to implement a Portfolio & Project Management software tool that is broad enough to be used department-wide along with updated policies and procedures to strengthen the project- scoping and planning phases. This software tool is expected to go live in the summer of 2019 and will include broad based end user training for project managers. B) DWR agrees with this recommendation. DWR is already working to address a broad range of strategies to be able to address emergency situations so as to not impact other high priority work. This includes, but is not limited to, increasing current staffing levels via added positions from approved budget change proposals, executing architectural and engineering contracts to provide additional technical resources to support a broad range of projects, and implementing risk-informed decision making as it relates to project prioritization and execution. All of these strategies are intended to improve DWR’s ability to address unforeseen emergencies and to reduce emergencies’ impact on other priority work. C) DWR agrees with this recommendation and has requested additional authority for a variety of alternate project delivery methods. Currently, DWR has authority for design-build specifically for Salton Sea projects and is seeking Construction Manager/General Contractor authority. SCO Comment The finding remains unchanged. DWR indicates that unique aspects of a given project prevent it from having a consistent project-scoping process. However, it agrees with the recommendation. FINDING 2— DWR O&M Division lacks the resources to properly execute its detailed five-year plan for operation and maintenance projects as part of its DWR lacks developing Asset Management Plan. DWR has a plan to operate and resources to maintain its assets, but lacks the necessary resources that would allow it to perform operation execute the plan in a timely and effective manner. Projects in this asset and maintenance management plan are constantly being re-prioritized based on public projects safety, lack of resources, environmental permitting, and emergency situations. -5- California Department of Water Resources Internal Control Review The Oroville Spillway incident in 2017 is an example of an emergency situation in which all required resources were diverted from other projects, causing delays to other planned projects. DWR’s five-year plan contains 361 projects estimated to cost $1.7 billion. All of these projects were postponed and the required resources were diverted to address the Oroville Spillway incident. Emergency procedures allow DWR to suspend or defer some standard procedures, such as environmental permitting and competitive bidding, to prevent or mitigate the loss or impairment of life, health, property, or essential public services. This shift of a projected $1.7 billion in resources, whether due to environmental regulations (such as environmental studies and permitting) or lack of resources (such as personnel), puts other important projects with public risk considerations further behind schedule. When maintenance on SWP assets is delayed, the condition of assets further deteriorates and can result in increased costs, risk of asset failure, and risk to public safety. This puts DWR in a reactive rather than proactive pattern of operating (see the Observation). Recommendation We recommend that DWR:  Establish environmental Habitat Conservation Plans for existing SWP assets;  Maintain its existing assets in a timely, proactive, and cost-effective manner; and  Continue to develop its Asset Management Plan and risk-informed decision process to not be merely reactionary in its resource management and project delivery methods in order to address aging infrastructure needs and maximize public safety. DWR’s Response DWR does not agree with the finding that “DWR O&M Division is not able to properly execute its detailed five-year plan for operation and maintenance projects as part of its developing Asset Management Plan.” DWR does execute the five-year plan; however, planning is a continuous process and projects are reprioritized appropriately. DWR does not agree with the following: “DWR’s five-year plan contains 361 projects estimated to cost $1.7 billion. All of these projects have been postponed and the required resources have been diverted to address the Oroville Spillway incident.” It is important to note that, at the time of the Oroville Spillway incident, DWR was dealing with several emergencies resulting from the Winter Storms of 2017. While these emergencies required an extraordinary amount of DWR resources, it is more accurate to state that other projects were impacted, rather than to say all projects were postponed. A) DWR agrees with this recommendation. DWR has reorganized and has dedicated staff whose primary focus is to manage activities -6- California Department of Water Resources Internal Control Review required to establish Habitat Conservation Plans for key State Water Project (SWP) assets. Additionally, DWR continues to proactively engage regulatory agencies to streamline and navigate through a variety of environmental processes. This will be a needed step for DWR to be able to perform maintenance required on some critical SWP assets to protect public and employee safety and preserve the integrity and extend the useful life of those assets. B) DWR agrees with this recommendation and continues to maintain its assets while making risk-informed decisions within our resourcing capacity and in compliance with regulatory requirements. DWR strives to continuously improve our asset management. This includes, but is not limited to, requesting additional positions to meet current and projected essential workload, executing architectural and engineering contracts to provide additional technical resources to support a broad range of projects, and implementing risk informed decision making as it relates to project prioritization and execution. C) DWR agrees and this remains a high priority initiative. SCO Comment We updated the first sentence of the finding based on DWR’s response. DWR agrees with our recommendation. -7- California Department of Water Resources Internal Control Review Observation OBSERVATION— DWR is able to complete projects more efficiently in emergency situations. We observed that DWR is able to start and complete projects in Procedures to a timely manner during a crisis or emergency. In these situations, DWR estimate and report resources are more readily made available and accessible to address the emergency costs emergency conditions. Additionally, DWR is able to suspend or defer need improvement regulatory environmental requirements in an emergency. However, DWR did not have processes and procedures in place to accurately report emergency repair costs. DWR initially reported that the Oroville Dam repair would cost $200 million. By May 2017, the Oroville Dam emergency repairs had cost $160 million. DWR spent an additional $310 million on pre-project design that was not part of the estimated total project costs. These costs covered only preparing the site for construction. Plans to repair the main spillway were finalized in July 2017, and plans to repair the emergency spillway were finalized in August 2018 at an estimated $630 million. Total costs may have been miscommunicated because DWR did not know or report the exact $630 million estimated costs to repair the spillway until the plans were finalized. Final estimated costs to complete the Oroville Dam repair project are $1.1 billion as follows: Initial emergency response $ 160,000,000 Related recovery work, including debris removal, power line replacement, permitting, and development of access road 3 10,000,000 Main and emergency spillway repair 6 30,000,000 Total estimate to repair Oroville Dam $ 1,100,000,000 Operating under emergency conditions has its trade-offs. Projects completed under emergency procedures are substantially more expensive than those completed under normal conditions. Emergency procedures may involve substantial amounts of overtime labor, use of rented equipment, and purchase of materials outside of the competitive bidding process. Environmental regulations can be bypassed during emergencies; however, DWR is still bound by those regulations. As a result, DWR must pay remediation costs for any regulations that it violates. Remediation can cost more than the normal process of obtaining proper permits for a project. As mentioned in Findings 1 and 2, DWR faces environmental restrictions (e.g., environmental studies and permitting) and a lack of resources that add delays and prevent projects from starting in a timely manner. When an asset fails, and thus becomes a threat to health and human services, or is unable to deliver water, that asset is repaired under urgent or emergency operating procedures. This often becomes the most efficient and effective manner in which to complete projects, as DWR can bypass restrictions and divert resources as needed. -8- California Department of Water Resources Internal Control Review Recommendation We recommend that DWR update its processes and procedures for reporting emergency repair costs. Estimates should include a range of both known and unknown expected costs. Offsetting funding such as Federal Emergency Management Agency reimbursements should also be included in that estimated range to ensure that the public is not misinformed. DWR’s Response Observation: DWR does not agree with the statement “However, DWR did not have processes and procedures in place to accurately report emergency repair costs.” DWR uses a very robust accounting system, SAP, and mature processes and procedures for reporting costs in any project. It is important to note that in an emergency of this magnitude, DWR is required to place a higher priority on obtaining the necessary procurements while utilizing the Emergency Declaration efficiencies to manage the emergency. As the emergency stabilized, we transitioned back to normal processes and procedures. DWR awarded an initial $275 million contract in April 2017 to Kiewit to immediately plan and mobilize crews and equipment to begin construction in May 2017. This budget allowed Kiewit to begin necessary work while the project design was completed and was not an estimate of the total project cost. Final plans for the main spillway were completed in July 2017 and final design plans for the emergency spillway were completed and approved in August 2018. Observation Recommendation: DWR disagrees with this recommendation to include “unknown expected” and “offset funding” in its estimates. SCO Comment We observed that original estimated project costs reported were far less than reported project costs to date. We understand that emergency projects of this magnitude will have many unforeseen costs. Our goal is for state agencies to consistently and accurately report project costs at any given time to ensure that the public is not misinformed. -9- California Department of Water Resources Internal Control Review Attachment— Auditee’s Response to Draft Review Report State Controller’s Office Division of Audits Post Office Box 942850 Sacramento, CA 94250 http://www.sco.ca.gov S18-DWR-9000