Call to Order and Roll Call
The third meeting of the Interim Joint Committee on Local Government was held on Wednesday, September 28, 2011, at 10:00 AM, in Room 171 of the Capitol Annex. Senator Damon Thayer, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Damon Thayer, Co-Chair; Representative Steve Riggs, Co-Chair; Senators Walter Blevins Jr., R.J. Palmer II, John Schickel, Dan "Malano" Seum, and Johnny Ray Turner; Representatives Julie Raque Adams, Ron Crimm, Mike Denham, Ted Edmonds, Richard Henderson, Brent Housman, Adam Koenig, Stan Lee, Tom McKee, Michael Meredith, Jody Richards, Arnold Simpson, Kevin Sinnette, Rita Smart, and Jim Wayne.
Guests: Dawn Bellis, Don Newberry, and Roger Banks, Department of Housing, Buildings and Construction; Brian Lykins and Jill LeMaster, Auditor of Public Accounts Office; Kenton County Judge/Executive Steve Arlinghaus; Campbell County Judge/Executive Steve Pendrey; Chuck Heilman, Amanda Waters, and Mark Wurschmidt, Sanitation District No. 1; Shelley Hampton, Kentucky Association of Counties; J.D. Chaney and Tony Goetz, Kentucky League of Cities; Jim Dugan, Hebron, Kentucky; and Bob Weiss, Home Builders Association of Kentucky.
LRC Staff: Mark Mitchell, John Ryan, Joe Pinczewski-Lee, Jessica Causey, and Cheryl Walters.
Approval of Minutes
Upon the motion of Representative Crimm, seconded by Representative Henderson, the minutes of the August 24, 2011 meeting were approved.
Consideration of Referred Administrative Regulation
The committee considered referred Administrative Regulation 815 KAR 8:030, which guides the issuance of apprentice heating, ventilation, and air conditioning (HVAC) mechanic licenses. Senator Thayer stated that a written report of the review will be submitted to the LRC.
Sanitation District No. 1
Senator Thayer said that a recent audit of Sanitation District No.1 (SD1) of Northern Kentucky by the State Auditor of Public Accounts (APA) has revealed issues of concern. Representative Simpson said that the discussion would be worthwhile to those members who have special districts in their district.
Brian Lykins, Director of the Office of Technology and Special Audits with the APA, told the committee that SD1 is the second largest public sewer utility in Kentucky, and that it serves approximately 100,000 customers. The audit was requested by Kenton County Judge/Executive Steve Arlinghaus to address questions about the financial management of the sewer district and its rate setting process. The audit reviewed SD1 policies and procedures, records retention, rate increases, construction in progress projects, and the accounting of financial transactions.
Although the audit found that overall policies of SD1 generally provide an effective structure for the oversight of the organization, the report presents 14 findings related to administrative matters and makes 72 recommendations to strengthen accounting controls, procurement, and board governance.
During the course of the examination, auditors noted several instances of accounting errors and apparent lax accounting controls and oversight. The specific instances involved errors in a spreadsheet allocating labor costs to projects, significant accounting entries made without proper review or documentation, and errors in the rate setting model.
SD1 calculated the labor costs to be charged to a particular project using an excel spreadsheet containing a formula which multiplied the hours by the applicable rates. The formula was in error, resulting in 151 projects being charged excessive labor costs. SD1’s failure to recognize such a significant error in labor allocation calls into question the quality and frequency of accounting review and oversight.
An initial error in the 2008 “Pro Forma” model used to set rates produced erroneous sewer rate projects of 25 percent for fiscal years ending 2009 and 2010. The error was detected by staff prior to being presented to the board and the corrected 15 percent rate increase was approved. Though the model used by SD1 to produce and evaluate rate setting scenarios appears to be reasonable, the amount of manual input and extensive base of knowledge required to effectively maintain and use that model dictates the need for broader financial oversight and review.
In addition, the examination of specific charges recorded in the Construction in Progress (CIP) account balances raised several questions as to whether treatment of those costs was appropriate and accurate. Certain charges were included in CIP account balances and eventually capitalized as assets rather than expensed in the year they were incurred.
Auditors also found there were instances of entries made to the general ledger with no supporting documentation, approval, or prior period adjustments. The SD1 director of finance and the current SD1 controller were unable to produce a copy of fiscal year-end June 30, 2008 adjusting journal entries or provide the details that support the year-end adjusting entries.
In review of procurement practices, the audit found that SD1 purchased materials and supplied and procured services for the construction of a major project without following its own procurement requirements. One CIP had over $100,000 in engineering services approved by the board of directors with no documentation of formal requests for proposals for those engineering services or of a review by a selection committee as required by the SD1 guidelines.
SD1 purchased $385,239 of drainage pipe couplings and pipe directly from the contractor’s vendor without going through the competitive bidding requirements, which is required by SD1 guidelines for the purchase of materials exceeding $20,000.
The audit found that CIP change orders were not always preapproved by the staff, nor reviewed by the board. Internal controls and procedures related to CIP project change orders did not properly address oversight for increases to project totals.
Regarding board governance, auditors found that policies for the board of directors did not address several critical responsibilities necessary for proper and effective oversight. There was no internal audit function that reports directly to the board, or any independent process to receive information and resolve conflicts. Since the audit, the board has created an internal audit function.
Auditors recommended that the board strengthen its oversight policies, including a whistleblower policy, policies or procedures regarding the use of credit cards, reimbursements to employees, electronic backup of financial information, and fixed asset inventory.
Auditors found that ethical polices of board members and employees were comprehensive and recommended that the board establish a comprehensive code of ethics applicable to both board members and employees and require financial disclosure statements from board members and executive staff.
In response to a question from Representative Smart, Mr. Lykins stated that special districts have a chief financial officer that should know their responsibilities. There is specific training for special districts.
In response to a question from Representative Koenig, Mr. Lykins replied that because SD1 has personnel already in place it would not be a significant cost for them to implement the recommendations of the audit.
In response to a question from Representative Lee, Mr. Lykins said SD1 board members are compensated and officers are board members who are limited to two terms.
In response to another question from Representative Lee, Mr. Lykins stated that SD1’s annual revenue in 2010 was around $70 million, and the salary of the executive director is over $100,000.
Representative Riggs commented that the committee has seen entities with similar issues. His concern is that boards are not performing at the level they should. The statutes are not adequate to deal with the larger boards. The committee needs to think about how to change the statutes and come up with one solution for all boards. There is no accountability. The Auditor’s office has seen this over and over.
Mr. Lykins commented that there is much interest in the Auditor’s 32 recommendations for non-profit boards. The Auditor has seen in many instances, inadequate policies, non-existent policies, or ignored policies. Some organizations are highly driven by staff. The Auditor’s recommendations provide an opportunity for these organizations to improve accountability and transparency.
Senator Thayer stated that he would be happy to work on a collective solution with members of the committee.
In response to a question from Representative Wayne, Jill LeMaster, with the Auditor’s Office, said the code of ethics legislation that was passed (KRS 65.003) did not apply to special districts. Representative Wayne commented that the committee needed to study this issue for the next session and have a tighter statute.
In response to a question from Representative Housman relating to the procurement findings, Mr. Lykins stated that since his office cannot enforce the recommendations, it recommends policies and procedures for accountability.
In response to a question from Senator Thayer, Mr. Lykins replied that the audit did not warrant an investigation by the Attorney General.
Senator Thayer commented that he has been a long time opponent of SD1. In response to a question from Senator Thayer, Mr. Lykins said he is not prepared today to offer any specific recommendations for legislation but would be happy to work with the committee.
Kenton County Judge/Executive Steve Arlinghaus introduced himself and entertained questions from the members.
In response to a question from Senator Thayer, Judge Arlinghaus stated that there are eight board members who serve on SD1, and he appoints four of them. The judges of Boone and Campbell Counties appoint two members as well. His first appointments are not due until the summer of next year. In response to another question from Senator Thayer, Judge Arlinghaus said no one on the current board was appointed by him.
The directors of the board are the ones who actually review with staff and determine what rate increases, for example, should occur and they bring those suggestions to the three county judges for approval of those rate increases. That policy will change for any increases of five percent or greater with the new law that was passed this summer. Any rate increases of five percent or above will be voted on by the entire fiscal courts of all three counties.
In response to a question from Senator Thayer on whether it was true that a rate increase was recently pushed through before the new law went into effect allowing for greater accountability, Judge Arlinghaus said there was a rate increase passed in June of 15 percent for this year and 15 percent for next year. In response to another question from Senator Thayer, Judge Arlinghaus replied that he voted “no” on the increase because he wanted to have the audit in place first.
In response to a question from Senator Thayer, Judge Arlinghaus stated that he requested the audit of SD 1 because when he was campaigning for office, he was asked many questions regarding the number of rate increases by SD1 and a number of lawsuits have been filed.
In response to a question by Senator Thayer in regard to Judge Arlinghaus’ thoughts on the findings of the audit, Judge Arlinghaus stated under finding number four, where it refers to conflicts of interest of board members, he was concerned about board members making additional money.
In response to a question from Representative Simpson, Judge Arlinghaus said he has dialogue with the members that he appoints to boards. He appoints people to 35 boards. He asks for resumes from the individuals who are to be appointed and thoroughly goes through them to make sure they are qualified to serve on those boards.
In response to a question from Representative Simpson relating to the adoption of SD1’s budget, Judge Arlinghaus stated that he has had the pleasure of sitting through the budget process with SD1 one time and found everyone to be accommodating and very interested in working with the judges and the board members. Everything was presented factually and there was nothing to be concerned about.
Mr. Chuck Heilman, President of SD1, introduced himself to the committee and entertained questions from the members.
In response to a question from Senator Thayer relating to the new statutory requirement for transparency, Mr. Heilman stated that SD1 is the first public utility to be required to provide financial information on-line by the passage of HB 26 in 2011. Outside counsel advised SD1 to use the state’s open door website as a model for meeting these requirements. SD1’s vision is to have an easy to find link on its webpage. SD1 will have basically four different documents: one page will show all of SD1’s payroll information; a second page will show payee information relating to SD1’s operations and maintenance, part of its budget as well as its capital projects; a third page will contain a copy of SD1’s approved budget for the year; and the final page will contain copies of SD1’s annual audit. All of this information is required by the legislation.
In a commitment to open transparency and in addition to this financial information, SD1 will also have meeting agendas, approved meeting minutes, and a complete set of board packets, which is information the board is given prior to each meeting. The board packets contain all current financial reports, bid documents, engineering and planning documents, operations and capital budgets or projects, and information about current administratively on-goings of SD1. Everything that the board sees prior to the meetings that SD1 is involved in making decisions on will be part of the board packets and they will be available on line. SD1 is aiming on having these on-line prior to the meetings. SD1 is going to put as much information on-line as it possibly can. All of this information will be updated monthly and retained on the website for three years. SD1 is making very good progress and hope to have this up and running, at least internally, in early November so it can be tested and have it implemented and on-line officially in January 2012.
In response to a question from Senator Thayer relating to the findings of the APA and the steps SD1 is taking in following the recommendations, Mr. Heilman stated that SD1 is taking the APA’s recommendations very seriously. Thirteen recommendations have been implemented or addressed; 36 are in the process of being woven in; and 23 are under review and being considered by the board. SD1 is making headway on complying with the recommendations. It has been a very challenging endeavor. It will cost SD1 $100,000 to implement the recommendations from the audit.
Mr. Heilman commented that he had not heard the federal Environmental Protection Agency (EPA) mentioned, which is the 800 pound gorilla that sits in their room. In 2007, the EPA consent decree was entered into to meet water quality standards calling for a $1.2 billion investment. The responsibilities of SD1’s service area, along with EPA regulations, require board members with specific qualifications.
In response to a question from Senator Thayer, Campbell County Judge Steve Pendrey replied SD1 has fought and pushed back the EPA.
Mike Apgar, Director of Governmental Affairs, SD1, said that SD1 has been working with the U.S. Conference of Mayors relating to rates as a result of the consent decree. With 2010 HB 504 enacted by the Kentucky General Assembly, SD1 drafted some points of needed change which were adopted by the conference of mayors and presented to the federal government. The EPA regulations are not doing what they intended to do, and are are costing taxpayers money. In addition, SD1 is working with other entities to try and effect change.
Senator Thayer commented that the committee will continue to watch SD1 to make sure it continues to implement the audit recommendations.
Representative Wayne commented that SD1 should not find a scapegoat and pick on the EPA. SD1 should have dialogue with the EPA if there are differences and not consider it the enemy.
Mr. Apgar noted productive dialogues are occurring and wants to ensure that every dollar spent improves the environment.
Representative Sinnette commented that oversight is important. There recently was no dialogue with the EPA, but through the recently enacted legislation, there is now.
Senator Thayer commented that after HB 26 passed, SD1 went ahead and made back to back 15 percent rate increases. It just looks bad.
Mr. Heilman said SD1 passed the rate increases because it needed to in order to pay bonds and to set the new infrastructure in place.
Judge Pendrey said that the infrastructure improvements will help the local economy.
Mr. Jim Dugan, representing the Tea Party, told the committee that the EPA needs to be challenged. Mandates from the EPA’s clean water requirements will cost $2 billion. He cited an analysis of the 10th Amendment and the federal government’s role in contrast to states’ rights.
In response to a question from Representative Simpson, Mr. Dugan said overall, SD1 is doing the best it can under the circumstances but did not like the fact that a $100,000 bond was passed without bids and that a $100 million bond was passed without any questions at SD1’s board meeting.
There being no further business, the meeting was adjourned at 12:35 p.m.