OFFICE

OF THE

NEW YORK STATE COMPTROLLER D IVISION OF LOCAL GOVERNMENT & SCHOOL ACCOUNTABILITY

Monroe County
Sale of Iola Powerhouse
Report of Examination
Period Covered: January 1, 2002 April 11, 2011 2012M-23

Thomas P. DiNapoli

Table of Contents

Page AUTHORITY LETTER 2

INTRODUCTION Background Objective Scope and Methodology Comments of Local Ofcials and Corrective Action

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SALE OF IOLA POWERHOUSE Use of an LDC to Issue Debt for Operating Expenditures Lack of Analysis Recommendations

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APPENDIX APPENDIX APPENDIX APPENDIX APPENDIX

A B C D E

Response From Local Ofcials OSC Comments on the County Ofcials Response Audit Methodology and Standards How to Obtain Additional Copies of the Report Local Regional Ofce Listing

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State of New York Ofce of the State Comptroller

Division of Local Government and School Accountability June 2012 Dear County Ofcials: A top priority of the Ofce of the State Comptroller is to help local government ofcials manage government resources efciently and effectively and, by so doing, provide accountability for tax dollars spent to support government operations. The Comptroller oversees the scal affairs of local governments statewide, as well as compliance with relevant statutes and observance of good business practices. This scal oversight is accomplished through our audits, which identify opportunities for improving operations and Board governance. Audits also can identify strategies to reduce costs and to strengthen controls intended to safeguard local government assets. Following is a report of our audit of Monroe County, entitled Sale of Iola Powerhouse. This audit was conducted pursuant to the State Comptrollers authority as set forth in Article V, Section 1 of the State Constitution, and Article 3 of the General Municipal Law. This audits results and recommendations are resources for local government ofcials to use in effectively managing operations and in meeting the expectations of their constituents. If you have questions about this report, please feel free to contact the local regional ofce for your county, as listed at the end of this report. Respectfully submitted,

Ofce of the State Comptroller Division of Local Government and School Accountability

OFFICE OF THE NEW YORK STATE COMPTROLLER

Introduction
Background Monroe County (County) is located in Western New York on the south shore of Lake Ontario. The County is comprised of 19 towns, 10 villages, and the City of Rochester, and has a population of approximately 750,000 residents. The County Executive and 29-member County Legislature (Legislature) govern County operations. The Countys budgeted appropriations for the 2011 scal year were $932 million. The County owned and operated the Iola Powerhouse (Powerhouse) to produce and supply steam to six major governmental buildings and building complexes. The Powerhouse served as the source of central heating and remote cooling for the following County facilities: Monroe Community College, Monroe Community Hospital, Monroe Community Health and Social Services Building, Monroe County Correctional Facility, Iola Campus Buildings, and the Pure Waters Facility. Local development corporations (LDCs) are private, not-for-prot corporations often created by, or for the benet of, local governments for economic development or other public purposes. Although created by, or for the benet of, a local government, an LDC is a separate private corporation, distinct from the local government, having its own set of powers under the governing statutes. In exercising these powers, LDCs generally are not subject to the same requirements and procedures as local governments with respect to borrowing, procurements and certain other matters that relate to implementing a capital project. These requirements and procedures applicable to local governments are intended for the protection of taxpayers. As a result, LDCs can be used to avoid statutory provisions that would apply to projects undertaken directly by a local government. On November 6, 2002, Monroe Newpower Corporation (Newpower), an LDC, was incorporated. The stated objective of Newpower was to lessen the burdens of government, which it claimed it would do by, among other things, purchasing the Powerhouse and providing more affordable utilities. Newpower is governed by a three-member Board of Directors, all of whom are appointed by the Monroe County Executive. Also, the County Executive (or designee) is a non-voting "ex ofcio" member of the Board of Directors.1 As a result, the County and Newpower are considered related parties. Therefore, none of the transactions between Newpower and the County could be considered arms-length. Absent clear documentation, the terms and conditions
1

Monroe County Controller Anthony Feroce currently holds this position.

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of such agreements would not necessarily reect market value but would be deemed to be dictated by the County. Objective The objective of our audit was to examine the activities related to the sale of the Iola Powerhouse. Our audit addressed the following related question: Scope and Methodology Was the Countys use of an LDC in its best interest?

We examined the activities related to the sale of the Countys Powerhouse for the period January 1, 2002 to April 11, 2011. We conducted our audit in accordance with generally accepted government auditing standards (GAGAS). More information on such standards and the methodology used in performing this audit are included in Appendix C of this report.

Comments of Local Ofcials and Corrective Action

The results of our audit and recommendations have been discussed with County ofcials and their comments, which appear in Appendix A, have been considered in preparing this report. County ofcials disagreed with the audit ndings and recommendations. Appendix B includes our comments on issues County ofcials raised in their response. The County Legislature has the responsibility to initiate corrective action. Pursuant to Section 35 of the General Municipal Law, the County Legislature should prepare a plan of action that addresses the recommendations in this report and forward the plan to our ofce within 90 days. For guidance in preparing your plan of action, you may refer to applicable sections in the publication issued by the Ofce of the State Comptroller entitled Local Government Management Guide. We encourage the County Legislature to make this plan available for public review in the County Clerks ofce.

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Sale of Iola Powerhouse

County ofcials have a duty to manage County operations as economically as possible in compliance with statutory requirements. However, County ofcials did not meet this standard in the sale of the Powerhouse. The County used Newpower, a Local Development Corporation (LDC), to purchase the Powerhouse; this sales transaction was not in the Countys best interests. Newpower purchased the Powerhouse for $7 million and issued bond anticipation notes for this amount essentially on the Countys behalf to pay for operating expenditures in the 2002 scal year. The County is not authorized by law to issue bonds or bond anticipation notes for operating expenditures. Because the debt issued by Newpower totaling approximately $33 million to purchase the Powerhouse and then build two new cogeneration2 facilities was secured by the Countys energy supply agreement (ESA) with Newpower, the County will be repaying the one-time revenue over the 32-year life of the bond. Further, the County is responsible for all of the debt for the purchase and construction of the cogeneration facilities, regardless of whether it continues to receive energy services from Newpower. We also found that the County did not perform an analysis to determine the best method for selling the Powerhouse and securing its energy services. While the County initially issued a request for proposals (RFP) for the sale of the Powerhouse and provision of energy services, it disregarded the proposals it received, deemed the Powerhouse a surplus asset, and sold it to Newpower, a newly-created LDC. County ofcials could not provide any information on their decision to disregard the RFP process and contract with Newpower. Further, we were unable to perform our own analysis of this transaction because, while County ofcials had the proposals they received from vendors in response to this RFP available during our initial review, they could not subsequently produce all of the proposals during the audit. Without appropriate analysis and documentation of their actions, County ofcials cannot assure taxpayers that they acted in the publics best interests. Use of an LDC to Issue Debt for Operating Expenditures LDCs are private, not-for-prot corporations often created by, or for the benet of, local governments for economic development or other public purposes. In certain instances, these entities are used to avoid statutory provisions that would apply to projects undertaken directly by a local government. With limited exceptions, the governing body of a county may determine that any real property owned by the
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Cogeneration is the use of a heat engine or a power station to simultaneously generate electricity and useful heat.

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municipality is no longer required for municipal use and authorize the sale or lease of the property to an LDC. The sale or lease may be made without appraisal, public notice, or public bidding. However, before the sale or lease is authorized, the municipality is required to hold a public hearing. Prior to 2002, the County faced a decision whether to build a new facility to replace its existing Powerhouse a 75-year-old coal burning facility and continue to produce its own energy, or to purchase energy services from an outside vendor. The County also was facing an operating shortfall totaling $13.5 million in its 2002 budget that it would have to nance either through one-time revenue sources3 and/or by raising property taxes. Ultimately, instead of raising taxes, County ofcials would sell the Powerhouse to Newpower, an LDC, for an inated price of $7 million, Newpower would issue a bond anticipation note for this amount, and the County would use these debt proceeds to pay for 2002 operating expenditures. The County is not authorized by law to issue bonds or bond anticipation notes to pay for operating expenditures, and was able to circumvent the law by using an LDC to do so on its behalf. On November 6, 2002, Newpower was incorporated to lessen the burdens of government, which it claimed it would do by, among other things, purchasing the Powerhouse and providing more affordable utilities. On December 23, 2002, the Legislature adopted a resolution authorizing the County Executive to sell the Countys Powerhouse, equipment and land it was situated on to Newpower for $7 million. In addition, the County Executive was authorized to execute two 32-year leases with Newpower for land to be used for the location of two cogeneration power plants at a cost of $1 for the entire contract term. Finally, the County Executive was authorized to execute a 32-year ESA for steam and electricity. Initially, the energy supply was to come from the existing Powerhouse and then from the two new cogeneration power plants at a cost not to exceed the expenses and debt service that Newpower incurred to acquire the property interests, and to construct and operate the cogeneration power plants. The sale of the Powerhouse for $7 million was an arbitrary amount determined by Newpower and accepted by the County. Since the County had deemed the Powerhouse to be surplus property, the law allowed for the sale of the Powerhouse to Newpower without an appraisal. Therefore, the County did not perform a valuation or calculation to determine if this amount was an appropriate selling
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The Countys 2002 budget included three one-time revenue sources: $4 million for the sale of a landll, $4.5 million for the sale of the Powerhouse, and $5 million for the sale of the Iola Complex.

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price. Such an independent valuation would be especially important in this transaction because the County and Newpower were related parties. The price was questionable because the Powerhouse building and equipment were old and outdated. The result was that Newpower recorded the purchase as $1.25 million for the land and building and $5.75 million in goodwill.4 To obtain the funds for this purchase, Newpower issued a $7 million bond anticipation note.5 The sale of the Powerhouse for $7 million allowed the County to pay off the remaining debt for the Powerhouse and provided a $5.3 million gain that was transferred to the general fund to pay for operating expenditures.6 This gain was close to the $4.5 million one-time revenue that County ofcials had budgeted for the sale in the 2002 scal year, which may have been the major factor in the determination of the price. Further, the County has no authority to issue bonds for operating expenditures, and borrowing for operating costs is an unsound practice. In effect, the County had Newpower issue a bond on its behalf 7 to provide the County with resources to meet current expenditures that the County could not legally provide by borrowing and was unwilling to provide through the real property tax levy. This postpones the payment of current year operating costs onto future taxpayers. The County will be repaying this one-time revenue, plus interest, over the 32-year life of the bond. Further, the County also is responsible for approximately $33 million in debt for the purchase and construction of the two new cogeneration facilities even if the County no longer receives energy services from Newpower. Since the County and Newpower were related parties and the County will repay additional moneys paid in excess of the propertys value through the ESA, there were no barriers that would normally exist to ensure that only fair market value was paid for the property. In addition, if the Countys intent was to borrow funds solely for the rebuilding of a capital asset (the Powerhouse), it would appear that the County could have obtained a lower interest rate than Newpower obtained because the Countys bond rating was higher than Newpowers.8

Goodwill is the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. 5 Newpower ultimately rolled this bond anticipation note into a 32-year bond totaling $33 million for the construction of the two cogeneration facilities. 6 In order for Newpowers bonds to be tax exempt, the County had to use the proceeds from the sale of the Powerhouse to pay operating expenditures as a result of an operating decit. 7 The bond anticipation note memorandum states Newpower is acting on behalf of the County. 8 The Countys rating was lowered to A from AA- in December 2002. Newpower had a BBB+ rating on the bonds.

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Lack of Analysis

When making decisions on expending taxpayer moneys, it is imperative that County ofcials perform an analysis to ensure that these decisions are in the taxpayers best interests. Further, when issuing RFPs for services, County ofcials should allow sufcient time for vendors to respond to ensure the process is competitive, and retain all documentation received to support their decisions. On June 14, 2002, approximately ve months prior to the incorporation of Newpower, the County issued an RFP to sell the Powerhouse to an entity that would provide a lump-sum price and then contract with the County to supply steam and possibly electricity to its facilities. The RFP further stated that the County intended to enter into a 20-year ESA with the provider to ensure its future energy needs. Because the County needed to ensure the sale was completed and revenue was received by year-end, all proposals were due by July 19, 2002, or just over a month after the RFP was issued. The short timeframe for proposal submission may have limited the competitive process.Three companies submitted proposals;9 however, two of the companies required further time and evaluation of the current operations before they could propose an offer for the purchase of the Powerhouse. The current operator (Siemens) was the only company that submitted completed proposals. Siemens already had experience with the County, including operating the cogeneration facility at the County airport. This experience with the County could have enabled Siemens to perform its assessment and submit a completed proposal in the allotted timeframe. The County did not contract with any of the three respondents for the sale of the Powerhouse and energy supply services. Instead, the County chose to deem the Powerhouse as a surplus asset and sell it to, and contract with, the newly-created LDC, Newpower. Because the County determined the Powerhouse was a surplus asset, it could sell it to an LDC without rst being required to notify the public or use competition for the sale. On January 1, 2003, Newpower took over the operation of the Powerhouse through the use of Siemens as its third-party operator. County ofcials did not perform an analysis to determine if contracting with Newpower was in the taxpayers best interests. Further, we were unable to perform our own analysis of this transaction because, while
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The respondents included Siemens (the current operator) and two other companies. Siemens submitted its proposal containing two alternatives that included constructing either two cogeneration facilities or a biomass power plant. The second alternative included a recommendation to use a special purpose not-forprot corporation to directly issue tax-exempt bonds on the Countys behalf for the construction of capital improvements.

OFFICE OF THE NEW YORK STATE COMPTROLLER

County ofcials had the proposals they received from vendors in response to this RFP available during our initial review, they could not subsequently produce all of the proposals during the audit. In addition, County ofcials were unable to provide us with any of the evaluation sheets or notes prepared by the review committee.10 Without formal evaluation documentation, there is no clear record for why the County decided to disregard its RFP process and sell the Powerhouse to Newpower. Further, there is no documentation to show why this transaction was in the Countys best interest. We also found that, instead of a 20-year agreement for energy services as specied in the RFP, the County and Newpower entered into a 32-year agreement, which was a material change to the original RFP. County ofcials could not provide documentation justifying the reason for this material change. Through the creation of Newpower, the County was able to alleviate budget pressure and obtain a quick inux of cash. The County could have directly entered into the same agreement with Siemens for construction and operation of the new power facilities. However, without the use of Newpower, the County could not use debt for revenue towards operating expenses. In the absence of other documentation, it appears that the goal of this transaction was to provide operating resources in a manner not available to the County if it had contracted with Siemens directly. Recommendations 1. The County should not use LDCs or similar private entities to nance County operations or the acquisition/improvement of County assets to avoid restrictions that would apply if the County were to perform the functions itself. 2. When an RFP process is authorized, County ofcials should allow sufcient time for vendors to analyze and respond, then thoroughly review and analyze all proposals using formal evaluation/rating criteria, and document their recommendation prior to awarding contracts. County ofcials should retain this documentation. 3. If material changes are made to what County ofcials requested in the RFP, County ofcials should authorize a new RFP process.

The County established a review committee to assess the relevant experience and expertise of each respondent using specic criteria. The evaluation criteria detailed in the RFP consisted of the proposals overall responsiveness, the nancial and management qualications of the respondent, the respondents experience in operating powerhouses, and the best nancial return to the County - including the lump sum up-front payment and projected energy costs.

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APPENDIX A RESPONSE FROM LOCAL OFFICIALS

The local ofcials response to this audit can be found on the following pages. As part of their response, County ofcials included a 77-page FlexTech Study report prepared by the New York State Energy Research and Development Authority (NYSERDA). We included the executive summary from the report but did not include the entire document in the nal audit report because of its signicant length. Further, the report only compared the Countys savings to one alternative: procuring energy services from Rochester Gas and Electric. The report did not include other alternatives in its analysis. Information regarding NYSERDAs FlexTech program can be found on its website at: http://www.nyserda.ny.gov/Page-Sections/Commercial-and-Industrial/Programs/FlexTech-Program. aspx?sc_database=web

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See Note 1 Page 19 See Note 2 Page 19 See Note 3 Page 19

See Note 4 Page 19

See Note 5 Page 19

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See Note 6 Page 20 See Note 7 Page 20

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APPENDIX B OSC COMMENTS ON THE COUNTY OFFICIALS RESPONSE

Note 1 Although the Powerhouse transaction was initiated in 2002, it has an ongoing effect on the County through 2034. The continued use of LDCs by the County also allows recommendations, such as those made in our report, to be applied to similar future activities. Note 2 We engaged the County for this audit on January 11, 2011 and met with County ofcials on February 15, 2011 for our audit entrance conference, not in 2009. Note 3 The recommendations in our report have a continuing value in protecting the Countys nancial health from inappropriate borrowings and procurement processes that do not allow for full competition. If followed, these recommendations can ensure that, in the future, major transactions will be entered into only after a fair and transparent process has been completed. Note 4 There is nothing speculative about our report. The facts are clear. The County used Newpower, an LDC, to purchase the Powerhouse for $7 million and issue bond anticipation notes for this amount on the Countys behalf to pay for operating expenditures in the 2002 scal year. The County is not authorized by law to issue debt for operating expenditures. Because the debt issued by Newpower totaling approximately $33 million to purchase the Powerhouse and then build two new cogeneration facilities was secured by the Countys ESA with Newpower, the County will be repaying the one-time revenue over the 32-year life of the bond. The County did not perform an analysis to determine the best method for selling the Powerhouse and securing its energy services. These actions do not provide taxpayers with assurance that County ofcials acted in their best interest. Note 5 As stated in our research publication cited by County ofcials, our Ofces experience has been that the use of LDCs and similar organizations to nance local government operations and projects increases the risk of waste, fraud, or abuse of taxpayer dollars or assets. This audit and our previous Monroe County LDC-related audit entitled Monroe County: Use of a Local Development Corporation to Contract for a Countys Information Technology System, which was released in September 2011, were based upon the facts encountered during the audits. These audit reports only conrmed the research reports conclusion.

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Note 6 While we recognize that the Countys use of an LDC to acquire energy was within the allowed uses of an LDC, County ofcials ignore the fact that the County also used the LDC to obtain nancial resources that the County could not legally obtain itself. Note 7 When procuring its energy services, the County would have further beneted from a process that increased competition and transparency for the public and did not include borrowing an additional $5.3 million for operating expenditures that will need to be repaid, with interest, over the 32-year life of the energy agreement.

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OFFICE OF THE NEW YORK STATE COMPTROLLER

APPENDIX C AUDIT METHODOLOGY AND STANDARDS

We examined the Sale of the Iola Powerhouse for the period January 1, 2002 to April 11, 2011. To accomplish our audit objective and obtain valid audit evidence, our procedures included the following: We interviewed appropriate County personnel regarding the sale of the Iola Powerhouse. We reviewed the County Charter, Administrative Code, and Board resolutions. We reviewed legal agreements between the County and Monroe Newpower Corporation including the energy supply agreement, purchase and sale agreement, and lease agreements. We also reviewed the installation, operations, and maintenance agreement between Monroe Newpower Corporation and the third party-operator. We reviewed bond documents related to the purchase and sale of the Powerhouse. We reviewed the 2002 budget to determine if the sale of the Powerhouse was included in the budget. We also reviewed the 2002 scal plan publication. We reviewed the comprehensive annual nancial report to determine if the County experienced an operating decit. We also compared budget to actual results of operation. We reviewed the RFP for the sale of the Powerhouse and available submitted proposals.

We conducted this performance audit in accordance with generally accepted government auditing standards (GAGAS). Those standards require that we plan and perform the audit to obtain sufcient, appropriate evidence to provide a reasonable basis for our ndings and conclusions based on our audit objective. We believe that the evidence obtained provides a reasonable basis for our ndings and conclusions based on our audit objective.

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APPENDIX D HOW TO OBTAIN ADDITIONAL COPIES OF THE REPORT

To obtain copies of this report, write or visit our web page:

Ofce of the State Comptroller Public Information Ofce 110 State Street, 15th Floor Albany, New York 12236 (518) 474-4015 http://www.osc.state.ny.us/localgov/

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APPENDIX E OFFICE OF THE STATE COMPTROLLER DIVISION OF LOCAL GOVERNMENT AND SCHOOL ACCOUNTABILITY
Andrew A. SanFilippo, Executive Deputy Comptroller Steven J. Hancox, Deputy Comptroller Nathaalie N. Carey, Assistant Comptroller

LOCAL REGIONAL OFFICE LISTING

BINGHAMTON REGIONAL OFFICE H. Todd Eames, Chief Examiner Ofce of the State Comptroller State Ofce Building - Suite 1702 44 Hawley Street Binghamton, New York 13901-4417 (607) 721-8306 Fax (607) 721-8313 Email: Muni-Binghamton@osc.state.ny.us Serving: Broome, Chenango, Cortland, Delaware, Otsego, Schoharie, Sullivan, Tioga, Tompkins Counties

NEWBURGH REGIONAL OFFICE Christopher Ellis, Chief Examiner Ofce of the State Comptroller 33 Airport Center Drive, Suite 103 New Windsor, New York 12553-4725 (845) 567-0858 Fax (845) 567-0080 Email: Muni-Newburgh@osc.state.ny.us Serving: Columbia, Dutchess, Greene, Orange, Putnam, Rockland, Ulster, Westchester Counties

BUFFALO REGIONAL OFFICE Robert Meller, Chief Examiner Ofce of the State Comptroller 295 Main Street, Suite 1032 Buffalo, New York 14203-2510 (716) 847-3647 Fax (716) 847-3643 Email: Muni-Buffalo@osc.state.ny.us Serving: Allegany, Cattaraugus, Chautauqua, Erie, Genesee, Niagara, Orleans, Wyoming Counties

ROCHESTER REGIONAL OFFICE Edward V. Grant, Jr., Chief Examiner Ofce of the State Comptroller The Powers Building 16 West Main Street Suite 522 Rochester, New York 14614-1608 (585) 454-2460 Fax (585) 454-3545 Email: Muni-Rochester@osc.state.ny.us Serving: Cayuga, Chemung, Livingston, Monroe, Ontario, Schuyler, Seneca, Steuben, Wayne, Yates Counties

GLENS FALLS REGIONAL OFFICE Jeffrey P. Leonard, Chief Examiner Ofce of the State Comptroller One Broad Street Plaza Glens Falls, New York 12801-4396 (518) 793-0057 Fax (518) 793-5797 Email: Muni-GlensFalls@osc.state.ny.us Serving: Albany, Clinton, Essex, Franklin, Fulton, Hamilton, Montgomery, Rensselaer, Saratoga, Schenectady, Warren, Washington Counties

SYRACUSE REGIONAL OFFICE Rebecca Wilcox, Chief Examiner Ofce of the State Comptroller State Ofce Building, Room 409 333 E. Washington Street Syracuse, New York 13202-1428 (315) 428-4192 Fax (315) 426-2119 Email: Muni-Syracuse@osc.state.ny.us Serving: Herkimer, Jefferson, Lewis, Madison, Oneida, Onondaga, Oswego, St. Lawrence Counties

HAUPPAUGE REGIONAL OFFICE Ira McCracken, Chief Examiner Ofce of the State Comptroller NYS Ofce Building, Room 3A10 Veterans Memorial Highway Hauppauge, New York 11788-5533 (631) 952-6534 Fax (631) 952-6530 Email: Muni-Hauppauge@osc.state.ny.us Serving: Nassau and Suffolk Counties

STATEWIDE AND REGIONAL PROJECTS Ann C. Singer, Chief Examiner State Ofce Building - Suite 1702 44 Hawley Street Binghamton, New York 13901-4417 (607) 721-8306 Fax (607) 721-8313

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