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California State Auditor Report Number: 2015-102

Central Basin Municipal Water District
Its Board of Directors Has Failed to Provide the Leadership Necessary for It to Effectively Fulfill Its Responsibilities





Summary

HIGHLIGHTS

Our audit of the Central Basin Municipal Water District (district) revealed the following:


Results in Brief

The Central Basin Municipal Water District (district) was established by a vote of the people in 1952 to help mitigate the overpumping of groundwater in southeast Los Angeles County. The district wholesales imported water from the Metropolitan Water District of Southern California (Metropolitan) to cities, other water districts, mutual water companies, investor‑owned utilities, and private companies in southeast Los Angeles County. In addition, it operates a system for obtaining and distributing recycled water. A publicly elected board of five directors (board) governs the district. The board appoints a general manager who oversees the district’s day‑to‑day operations and its staff.

In recent years, the district’s actions have called into question the efficiency and effectiveness of its operations. News reports have 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 and others, the County of Los Angeles Department of Public Works (Public Works) published a report in October 2014 that outlined the concerns it identified with the district’s operations. As a result of these concerns, the report explored the steps necessary to dissolve the district and transfer its work elsewhere. However, the report stopped short of making such a recommendation and instead recommended this audit.

Our audit found that the board’s poor leadership has impeded the district’s ability to effectively meet its responsibilities. For example, the board failed to ensure that it provided the district with stability in its key executive management position. The district’s administrative code establishes the general manager as the district’s chief executive and notes that hiring the general manager is a critical function of the board. Nonetheless, between 2010 and 2015, six different individuals filled this role. Lack of agreement among the board members was a factor contributing to the instability in this position. The district’s current general manager is on a two‑year contract and is contemplating retiring at the end of the contract term in May 2017. However, the district 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 position either prior to the current general manager’s retirement or within a reasonable amount of time thereafter, the board will likely hinder the district’s ability to effectively meet its responsibilities.

In addition, the board has not established the essential policies necessary to safeguard the district’s long‑term financial viability. Contrary to a recommendation directed to all government agencies from a national organization that promotes the professional management of governmental resources, the district has not engaged in long‑term financial planning to help it develop strategies to overcome financial challenges and achieve long‑term sustainability. In addition, the district has not performed the study necessary to ensure that its water rate structure is appropriate and that it will collect sufficient revenues to meet its costs. In fact, in planning its annual budgets, the district overestimated its revenues in four of the past five years, and consequently its expenditures exceeded its revenues in three of those years.

Also, the district’s debt coverage ratio, which measures its ability to produce enough cash to cover its debt payments, has fallen below the level required by its debt agreements twice in the past five fiscal 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 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 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 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.

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:

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.

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.





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