City of Los Angeles Audit of the Telecommunications Fund Special Revenue Fund #342 June 26, 2014 controller.lacity.org

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5 City of Los Angeles Audit of the Telecommunications Fund Special Revenuee Fund #342 June 26, 2014 controller.lacity.org

6 CONTENTS SUMMARY... I BACKGROUND... 1 AUDIT FINDINGS... 8 APPENDIX I: SUMMARY OF FINDINGS AND AUDIT ACTION PLAN APPENDIX II: REVENUE TREND APPENDIX III: EXPENDITURE TREND... 23

7 SUMMARY The Office of the City Controller has completed an audit of the Telecommunications Fund, Liquidated Damages and Lost Franchise Fees (Fund #342). We audited this Fund because we noted that the cash balance in the Fund increased significantly from 2009 through 2013, and we wanted to determine if there were valid reasons for the increase. This audit is one of several in a series of audits of the City s 555 Special Revenue Funds. The Fund was established in 1982 to account for monies collected from cable/video television franchise holders. The audit found that the Fund's cash balance had risen from $3 million as of June 30, 2009 to $28.7 million as of June 30, 2013, primarily due to a new fee that the City began collecting in Fiscal Year , which is restricted to capital expenditures to support Public, Educational, and Government (PEG) channel facilities. These collections average about $6 million a year. To date, only a small percentage of the approximately $30 million in collected PEG access fees have been spent. Although there is now a plan to spend $19 million to $23 million on a new facility for the Channel 35 Television Studio, considering continued collections, the Fund is still anticipated to have $21 million to $25 million in available PEG access fees by the end of FY , when the new studio is projected to be completed. Implementation of a long-range spending plan will help to ensure that PEG access fee collections do not accumulate unnecessarily in the Fund. Also, closer monitoring of private franchisee billings will help ensure the City receives all of its anticipated revenue of more than $300,000 per year. I. BACKGROUND A. Establishment and History of Fund #342 The Fund was established in 1982 to account for monies from franchise holders as liquated damages and franchise fees lost to the City due to unexcused delays in the construction and/or activation of cable/video television systems ; however, it is currently used solely to account for telecommunication franchise revenue. In 2007, upon implementation of California s Digital Infrastructure and Video Competition Act (DIVCA), the State began regulating cable video/television franchises; previously, these franchise agreements were granted by local jurisdictions, including the City of Los Angeles. Since the cable franchisee s system uses the public right-of-way through local easements, DIVCA permits local jurisdictions to charge cable operators a franchise fee, based on the gross revenue from their operating area within the locality. Private companies that use the City s right-of-way for their businesses telecommunication lines also pay a franchise fee to the City, which is credited to this Fund. Currently, no monies are derived from liquidated damages and lost franchise fees. Page i

8 Summary The Fund accounts for various categories of fees received, as described below: Cable franchise fees The cable/video television companies pay the City franchise fees of 5% of their applicable gross revenues according to the federal and State laws. The City receives these revenues from the five cable companies operating in the City. In accordance with City ordinance #160873, 40% of these collections are allocated to Fund #342, while the remaining 60% is remitted to the General Fund. For example, for FY , total franchise fees collected were $31 million. $12.4 million (40%) was deposited to Fund #342 and $18.6 million (60%) was deposited to the General Fund. Public, Educational, and Government (PEG) fees As allowed by DIVCA, in January 2007, the City instituted an additional fee of 1% of cable/video television companies applicable gross revenues for Public, Educational, and Government (PEG) access. Because this fee exceeded the federal cap of 5% on regular franchise fees, its use is restricted to support PEG channel facilities consistent with federal law. The total amount of PEG fees is remitted to Fund #342. Private franchise fees Companies who wish to use the City s public rights-of-way for their internal telecommunications cabling and facility needs must apply for a permit to be granted a franchise for this use. The private franchisee installs conduits/fiber telecommunication lines, which are sometimes accessed through vaults and manhole covers under City streets, to connect their buildings and meet their private telecommunication needs. The total amount of private franchise fees is remitted to Fund #342. B. Financial Breakdown of Fund #342 Revenues/Sources of Funds Fund #342 s primary source of funds is derived from cable franchise fee & PEG access fees. These fees accounted for about 98% of the Fund s FY revenues as follows: o Cable franchise fees $12.4 million (65%) o PEG access fees - $6.2 million (33%) o Misc revenues, including private franchise fees - $.4 million (2%) Expenditures/Uses of Funds From FY through FY , reimbursements and transfers to the General Fund accounted for approximately 86% of Fund #342 s expenses/uses of funds. Following is a breakdown of the total expenditures for FY : Page ii

9 Summary o Transfers to the General Fund $7 million (49%) o Reimbursements to the General Fund $5.3 million (37%) o Contractual Services - $1.4 million (10%) o Other - $.5 million (4%) Cash Balance As of June 30, 2013, the Fund had a cash balance of $28.7 million, which is $25.7 million more than the balance as of July 1, The primary reason for the large increase is because the City began assessing an additional 1% of the gross revenues from cable/video television companies, due to legislative changes governing cable companies, which allowed for this fee. However, the law restricts the use of these additional monies for capital costs for PEG access facilities. Through June 30, 2013, $30 million has been collected as 1% PEG fees, but only a small portion of these funds had been spent. Figure 1 Flow of Telecommunication Revenues Cable Franchise Fees FY = $31M 60% to the General Fund $18.6M General Fund 40% to Fund #342 Restricted PEG Access Fees $12.4M $6.2M Fund #342 Revenue Miscellaneous Revenues $400K Total FY = $19M Private franchise billings Reimbursements from other City departments Misc. one time receipts Fund #342 Cash Balance As of 6/30/13 *95% is Restricted PEG Fees $28.7M* Projected for 6/30/17 $25M** Page iii

10 Summary II. OVERALL ASSESSMENT The audit found that the City properly recorded franchise fees and PEG access fees to the Fund. City ordinance # dictates that 60% of regular franchise fees received (which is derived as 5% of the operator s gross revenue) should be allocated to the General Fund, while 40% should be allocated to Fund #342. Based on our testwork, ITA correctly distributed these revenues. In addition, our testwork found that the additional 1% PEG access fees were deposited in Fund #342, as required. However, our audit identified concerns related to PEG access funds that require management attention. As of June 30, 2013, the amount of available PEG access funds was approximately $22 million 1. Though City Council has approved plans for the construction of a new PEG access facility to be paid by this source, the amount of restricted PEG funds remaining available is anticipated to be between $21 million and $25 million by the end of FY when the facility is expected to be completed. ITA has not developed a long-range plan for the continued use of these monies. Further, ITA has not established written guidelines to specify the types of expenses that qualify as eligible uses of collected 1% PEG access fees. The audit also found that ITA has not implemented adequate controls to ensure that other private franchisees/permit holders are billed in a timely manner, and has not completed timely audits of cable/video television companies to ensure they have paid the correct amount of franchise fees and PEG access fees to the City. III. KEY FINDINGS 1. ITA has not established written guidelines to specify the types of expenses that qualify as eligible uses of collected 1% PEG access fees. 2. Revenue allocated from the 5% franchise fees and the entire amount of PEG access fees are maintained in the same Fund. Consequently, the amount of available 1% PEG funds cannot be readily determined. 3. ITA has not developed a long-range plan for the use of 1% PEG access fees. By the end of Fiscal Year , the amount of funds available could be between $21 million and $25 million. 4. ITA has not completed timely audits of cable/video television companies to ensure they have paid the correct amount to the City. 1 This amount does not include an additional $5.2 million, which is currently the subject of a dispute between Time Warner and the City. Each year, the City receives approximately $6 million in PEG access fee revenues (1% revenues). Page iv

11 Summary 5. ITA does not have adequate controls in place to ensure private franchisees are billed in a timely manner. In May and June 2013, ITA billed 14 franchisees for a total of $101,000. Some of these billings were for fees due as far back as In addition, due to the poor condition of the billing and collection records, ITA is unable to determine the total amount of outstanding accounts receivable. 6. The ITA has not established a process to review outstanding encumbrances on a regular basis to determine whether any should be canceled. Canceling encumbrances in a timely manner increases the Unreserved and Undesignated Fund Balance, so that decision makers know the amount of available funds. 7. The Fund's name and the Los Angeles Administrative Code do not reflect how the Fund is currently utilized. IV. RECOMMENDATIONS ITA management should: 1.1 In conjunction with the City Attorney, establish clear guidelines on the types of expenses that are eligible uses of 1% PEG fees. The guidelines should list the most common types of expenses and should indicate whether the expense would, or would not qualify, as an eligible use. 1.2 Ensure that sufficient documentation exists to clearly show the individual who received purchased items. 2.1 Request Council authority to establish a new Special Revenue Fund to separately account for the 1% PEG access fee revenues/expenses, and include a provision that interest earnings be retained in the Fund. 2.2 Upon establishment of the new Fund, reconcile all sources/uses of the restricted 1% PEG access fees to determine actual monies on hand to support an appropriate balance transfer to the new Fund. Council should: 3.1 Direct ITA management to develop a long-range plan that addresses resources separately dedicated to Public, Education, and Government access and that will ensure effective use of accumulated and future ongoing PEG access fees that comply with federal requirements. Page v

12 Summary ITA management should: 4.1 Issue a new Request For Proposal for audit services; and consider engaging additional audit resources to conduct revenue audits. 4.2 Commence audits of cable/video television companies in a more timely manner, and strengthen oversight to ensure each audit is completed soon after it has commenced. 5.1 Assign responsibility for billing private franchise fees/permits to the Accounting Section and establish controls to ensure billings are made in a timely manner. 5.2 Take action to ensure private franchisees are billed using the billing/accounts receivable module of FMS. 5.3 Develop formal procedures for following-up on delinquent amounts owed by private franchisees, to help ensure the City is paid in a timely manner. 5.4 Proactively work with private franchisees who have expired agreements to effect new ones. 6.1 Implement procedures to ensure the Agency regularly reviews outstanding encumbrance balances to determine whether any can be canceled. 7.1 Work with appropriate parties to re-title Fund #342 and to modify Section 5.97 of the Los Angeles Administrative Code, to reflect the Fund s current or future anticipated use (as noted in Recommendation #3, the audit suggests establishing a separate Fund to account for PEG access fees). Review of Report On November 26, 2013, a draft of this report was provided to ITA management. We met with ITA management and representatives at a formal exit conference held on December 9, 2013, and we considered their comments and additional information they provided as we finalized this report. ITA management generally agreed with the report s findings and recommendations. We would like to thank ITA management and staff for their cooperation and assistance during the audit. Subsequent Events In January 2014, subsequent to our fieldwork, the City revised its estimated completion date for the new Channel 35 Television Studio to July 3, In addition, in March 2014 the City filed a lawsuit against Time Warner Cable, seeking $9.7 million. This amount includes $5.2 million in 2008 underpaid PEG access fees, as detailed in this Page vi

13 Summary report, as well as interest charges, late payment penalties, auditing fees, and claims for underpayments of franchise and PEG fees owed for audit years Page vii

14 BACKGROUND Creation of Fund #342 The Telecommunications Fund, Liquidated Damages and Lost Franchise Fees (Fund #342) was established by ordinance # in According to the ordinance and Section 5.97 of the Los Angeles Administrative Code (LAAC), all monies collected from cable/video television franchise holders as liquidated damages, and franchise fees lost to the City due to unexcused delays in the construction and/or activation of cable/video television systems, are deposited into the Fund. An amendment to the LAAC, approved in February 1986, via ordinance #160873, established a Telecommunications Development Account within the Fund. Forty percent (40%) of monies collected from cable franchise holders by way of a franchise fee are deposited to this account. The remaining 60% is remitted to the General Fund. For example, for FY , total franchise fees collected were $31 million. While $12.4 million (40%) was deposited to Fund #342, $18.6 million (60%) was deposited to the General Fund. The cable/video television companies pay the City franchise fees of 5% of their applicable gross revenues according to the federal and State laws. The City receives these revenues from the five cable companies operating in the City. Therefore, Fund #342 receives 40% of 5% of cable/video television companies applicable gross revenue. Although Fund #342 receives only a portion of the 5% franchise fee revenue from cable companies, ITA refers to these as 5% revenues when referring to this revenue source within Fund #342. The Fund is administered by the Information Technology Agency (ITA or Agency). Per the Ordinance that created the Fund, expenditures may be made from the Telecommunications Development Account only for public access, educational access and government access programming and other telecommunication uses in the City. In addition, funds can be transferred from the Telecommunications Development Account to the General Fund upon a majority vote of the Council and approval by the Mayor. Other expenditures from the Fund must be for the betterment and improvement of cable television in the City. Public access channels are available for programming developed by the general public. Educational access channels are used by educational institutions for educational programming. Governmental access channels are used for programming by local governments, who directly control the programming content of these channels. Page 1

15 Introduction and Background Receipt of Cable TV Franchise Fees and PEG Access Fees The City collects franchise fee payments from five cable/video television companies based upon their self-reported gross revenues derived from their operating areas to provide cable/video television service within the City of Los Angeles. The payments must be paid to the City within 45 days after the end of each calendar quarter. The five companies currently are: Time Warner Cable, AT&T, Verizon, Cox Communications, and Charter. All payments to the City are made via wire-transfers, except those received from Charter, which remits less than $5,000 annually to the City. Up until 2007, the City held the franchise agreements with local cable/video television companies. In January 2007, the California Digital Infrastructure and Video Competition Act (DIVCA) took effect. Under DIVCA, the State began regulating and issuing the franchises to private companies for the provision of cable television services. However, since the franchisee s cable system uses the City s right-of-way through easements, federal law and DIVCA allow local jurisdictions to charge a franchise fee based upon the operator s gross revenues, and the local agencies have the right to audit these companies records to ensure they have paid proper amounts. As allowed by DIVCA, in January 2007, the City instituted an additional 1% Public, Educational, and Government (PEG) access fee via ordinance # All collections related to these fees are deposited into Fund #342. As discussed later in this report, there are restrictions on the use of these monies; however, Section 5.97 of the LAAC has not been updated to address the collection and use of these fees. Prior to DIVCA, the City could legally charge a PEG access fee; however, it was not imposed because the cable/video television companies were required, as part of their franchise agreement, to provide Public Access facilities at their own expense. Other Private Franchise Fees Private companies doing business in the City who wish to use public rights-of-way for their internal telecommunications cabling and facility needs must apply for a permit to be granted a franchise. The initial application requires a non-refundable fee, and the agreement usually has a 10-year term and requires an annual fee, based on a linear or cubic foot formula. All fees received from these private franchisees are deposited into Fund #342. Liquidated Damages Revenue Liquidated damages are penalties that the City imposed when operators violated provisions included in the (old) expired franchise agreements, such as: 1) Liquidated damages for failure to meet accepted construction schedules ($500 per day) and for each missed activation milestone (an additional $1,000 per day) Page 2

16 Introduction and Background 2) Restrictions against transfers (company change of ownership or control ($5,000 per day) 3) Failure to provide PEG Access Facilities and Equipment ($500 per day) ITA no longer receives any amounts related to liquidated damages because the City no longer has a contractual basis authorizing the collection of such damages. Under DIVCA, the California Public Utility Commission has the authority for oversight of the cable operators and to ensure compliance with their franchise agreements. While DIVCA provides that local jurisdictions may charge a franchise fee based on the operators gross revenues within an operating area, the law states that, in the event of a dispute concerning compensation, either party must bring action in a court of competent jurisdiction. Cash Balance of the Fund Per the City s Financial Management System (FMS), the Fund s cash balance as of the end of each fiscal year has significantly increased, as noted in the figure below: Figure 2 Fund #342 Yearly End Cash Balance Fiscal Year Cash Fund Balance-Year End $28.7M $23.9M $18.2M $7.8M $3.0M FY2009 FY2010 FY2011 FY2012 FY2013 The primary reason for the large increase in the balance was because revenues from the 1% PEG access fees far exceeded the related expenses from that source. Page 3

17 Introduction and Background Revenues (Sources of Funds) Appendix II shows Fund #342 revenues (sources of funds), by revenue source, beginning in Fiscal Year (FY) Revenues have ranged from $10.4 million to $20.6 million a year. Over 98% of all revenues are classified as either Franchise Income-Television (revenues from the allocated amount of the straight 5% fee) and Franchise Income-Public Education and Government (revenues from the additional 1% fee). Table 1 below shows franchise fee and PEG access fee revenues, by company, for the last three fiscal years. The City receives the vast majority of revenue (approximately 85% in FY ) from Time Warner. AT&T constitutes an additional 10% of revenues. The franchise fee figures in Table 1 differ from those in Appendix II because this table shows total franchise fees received by the City, while Appendix II reflects only the 40% deposited to Fund #342. It should be noted that the City currently has a dispute with Time Warner regarding potential underpaid PEG access fees. The City contends that Time Warner owes approximately $5.2 million in underpaid 2008 franchise fees. In May 2011, when submitting their quarterly remittances, Time Warner reduced the amount of their franchise fees due to the City by $5.2 million and indicated that it was paying the 2008 PEG access fees under protest. Time Warner contends that under State law, it was not required to make $5.2 million in PEG payments in 2008, as long as it was required to operate the PEG studios (Public access) in Los Angeles, which they did up until January At this point in time, the City has accepted Time Warner s payment as PEG fees and not as franchise fees. For trending purposes, if the $5.2 million was reclassified as franchise fees, the total FY revenues received would be $28.6 million ($23.4 million + $5.2 million) for franchise fees and $5.8 million ($11 million - $5.2 million) for PEG Fees, respectively. After these adjustments, the data shows that revenues increased about 5% from FY to FY and another 3% from FY to FY Page 4

18 Introduction and Background Table 1 Franchise Fee and PEG Access Fee Revenues by Cable/TV Company Cable/TV Company FY2011 Franchise Fees FY2012 Time Warnerr $20,696,253 $26,608,621 AT&T $1,731,387 $2,317,794 Verizon $567,031 $757,987 Cox $426,767 $475,423 Charter $2,847 $2,409 FY2013 FY2011 $26,573, 632 $10, 419,168 $3,037,118 $346,277 $989,172 $113,406 $408,212 $85,353 $2,509 $573 PEG Fees FY2012 $5,168,629 $463,559 $151,597 $83,908 $484 FY2013 $5,327,008 $607,4244 $197,834 $81,7677 $503 Total $23,424,285 $30,162,234 $31,010, 644 $10, 964,778 $5,868,177 $6,214,536 Based on our research, we found that there was not a consensus among industry experts, as to future trends in the number of cable subscriberss within the City of Los Angeles. However, we obtained historical data by researching Quarterly 10-Q reports filed with the United States Securities and Exchange Commission for the threee companies that remit the most fees to the City. The figure below shows that the total number of national/global subscribers, while varying among companies, has steadily increased each year for the past several years. Figure 3 Pag e 5

19 Introduction and Background Expenses (Uses of Funds) Appendix III shows Fund #342 expenses (uses of funds), by type of expense, beginning in FY Expenses have ranged from $10.2 million to $13.3 million a year. Total expenses from July 1, 2006 through June 30, 2013, were $84.5 million. Approximately 99% of this amount was related to the following: Transfers to the General Fund ($55.7 million or 65%) - supports the direct costs of departmental operations, as defined by the annual approved budget (ITA; GSD; City Clerk and City Attorney); and general operating transfers as approved by Council and the Mayor. Contractual Services ($10.7 million or 13%) - amounts paid to consultants including a non-profit operator of Channel 36; contracted writers/producers/others supporting channel 35 programming activities; and audit and legal services. Reimbursements to the General Fund ($14.2 million or 17%) - application of citywide overhead costs, as applied to the amounts transferred to the General Fund related to direct salary costs. Equipment ($2.8 million or 3%) direct purchases of telecommunications and video equipment. (Note: 50% of the amount paid as contractual services to the nonprofit Channel 36 operator is designated to be used exclusively for capital equipment). OBJECTIVES, SCOPE AND METHODOLOGY The objectives of this audit were to: a) evaluate the adequacy of internal controls over the financial management of the Fund (e.g., separation of duties, budgeting for funds, etc.) and b) determine whether transactions (deposits, expenses, and transfers) were made in accordance with the specific purposes allowed by applicable policies, laws, regulations, and/or ordinances. 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 sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. We conducted the audit primarily between May 2013 and July The audit covered transactions between July 2009 and March Page 6

20 Introduction and Background In conducting our audit, we: interviewed ITA management and staff to obtain an understanding of how Fund #342 is operated and managed; reviewed applicable policies, procedures, and legal codes; analyzed accounting data from the City's Financial Management System (FMS); 2 reviewed budget data; and tested a sample of expenses and other Fund transactions to determine whether they were made in accordance with the specific purposes allowed by applicable policies, laws, regulations, and/or ordinances. The remainder of this report details our findings, comments and recommendations. 2 The City s new FMS was implemented effective July 1, Prior to this date, the City used the Financial Management Information System (FMIS) to record accounting transactions. For simplicity purposes, throughout this report, we use the term FMS for all accounting transactions, including those before July 1, Page 7

21 AUDIT FINDINGS Finding No. 1: ITA has not established written guidelines to specify the types of expenses that qualify or do not qualify as eligible uses of collected 1% PEG access fees. State law allows local entities to establish an additional 1% PEG access fee, not to exceed 1% of the holder's gross revenues. Specifically, California Public Utility Code, Section 5870 (enacted in September 2006) states, in part, (n) A local entity may, by ordinance, establish a fee to support PEG channel facilities consistent with federal law that would become effective subsequent to the expiration of any fee imposed pursuant to subdivision (/). If no such fee exists, the local entity may establish the fee at any time. The fee shall not exceed 1 percent of the holder's gross revenues, as defined in Section As of September 2006, the City was not imposing a separate fee to support PEG channel facilities. Rather, the City imposed a regular franchise fee of 5% of the holder s gross revenues, the maximum allowed by federal law (Cable Act, Section 622). State and federal law do not regulate the use of the regular franchise fees, though the City has designated that 40% be allocated to a special fund, with expenditures dedicated to channel access and telecommunications 3. In November 2006, the City adopted ordinance # to impose the additional 1% PEG fees, effective January 1, 2007, on State video franchise holders operating within the boundaries of the City of Los Angeles. Because this fee exceeded the federal cap on regular franchise fees, its use is restricted to support PEG channel facilities consistent with federal law. Federal law defines the term PEG access facilities as channel capacity designated for PEG use, and facilities and equipment for the use of such channel capacity (Cable Act, Section 602). It also excludes from the term franchise fee subject to the 5% maximum, capital costs which are required by the franchise to be incurred by the cable operator for public, educational, or government access facilities. In 2008 the Sixth Circuit Court sought to provide some clarification when it stated: The next question that arises is whether the FCC intended to limit its definition of capital costs only to facilities and not to equipment and, if so, whether this is a permissible construction of section 622(g)(2)(C). In clarifying the precise scope of the term PEG access facilities, Congress explained that it refers to channel capacity (including any channel or portion of any channel) designated for public, educational, or governmental use, as well as facilities and equipment for the use of such channel capacity. H. R. Rep. No , at 45 (emphasis added). In further detail, Congress specified that [t]his may include vans, studios, cameras, or other equipment relating to the use of 3 City ordinance also allows for transfer of these monies to the General Fund upon a majority vote of the Council and approval by the Mayor. Page 8

22 Audit Findings public, educational, or governmental channel capacity. Id. Thus, the unambiguous expression of Congress confirms that PEG access capacity extends not only to facilities but to related equipment as well. Our audit found that ITA has not established written guidelines to specify the types of expenses that qualify or do not qualify as eligible uses of collected 1% PEG access fees. While the City has flexibility regarding the use of regular franchise fees that are accounted for in Fund #342 (i.e., general programming and other telecommunications, and transfers to the General Fund upon approval by Council and the Mayor), the additional PEG access fees are highly restricted; therefore, a higher level of control is required to ensure eligibility of expenditures charged to this source. We selected a sample of expenses made using the 1% PEG access fees, which included five large purchases (those more than $5,000). Our testwork found that all the large purchases were for capital costs. However, we noted that three of the purchases did not have sufficient documentation to show who had received the items, a necessary control to provide accountability and assure appropriate segregation between the procurement and receiving functions. The three expenses totaled $160,000 and included items such as high definition lenses; camcorders; viewfinders; and video encoder boards. We physically verified that all equipment related to the three purchases were on-site at the Channel 35 Studio. Recommendations ITA management should: 1.1 In conjunction with the City Attorney, establish clear guidelines on the types of expenses that are eligible uses of 1% PEG fees. The guidelines should list the most common types of expenses and should indicate whether the expense would, or would not qualify, as an eligible use. 1.2 Ensure that sufficient documentation exists to clearly show the individual who received purchased items. Page 9

23 Audit Findings Finding No. 2: Revenue allocated from the 5% franchise fees and the entire amount of PEG access fees are maintained in the same Fund. Consequently, the amount of available 1% PEG funds cannot be readily determined. Since the 1% PEG access fee revenues have restrictions placed on their use by State and federal laws, it is important for the City to maintain accurate accounting records that support the appropriate use of those funds, so that the amount of these available funds can be easily identified at any given time for planning purposes. ITA deposits revenues from both the franchise fees and the PEG access fees into the same Fund (#342), and each is classified with a different "revenue code", which enables interested parties to determine the amount of collections for each type of revenue added to the Fund. The franchise fees and PEG access fees comprise over 98% of Fund #342 s revenues. In order to track funds available from each of the two revenue sources, ITA's Accounting Section performs calculations in a spreadsheet, outside of FMS. However, these calculations are not done on a regular basis, and are typically made only once a year as part of the budget process. The fundamental purpose of a Special Revenue Fund is to account for and report on the proceeds of a specific revenue source that is restricted or committed to expenditures for a specified purpose. Given that the 1% PEG fee is a specific revenue source above the 5% federally capped franchise fee amount, under State and federal law, all uses of that source must be committed to capital expenditures for PEG access facilities; therefore, these monies should be accounted for in a separate Special Revenue Fund. In addition, any related interest earnings associated with these restricted funds should be credited for this same restricted use. Fund #342 receives no interest earnings, because the ordinance creating the Fund did not contain an interest earnings provision. Recommendations ITA management should: 2.1 Request Council authority to establish a new Special Revenue Fund to separately account for the 1% PEG access fee revenues/expenses, and include a provision that interest earnings be retained in the Fund. 2.2 Upon establishment of the new Fund, reconcile all sources/uses of the restricted 1% PEG access fees to determine actual monies on hand to support an appropriate balance transfer to the new Fund. Page 10

24 Audit Findings Finding No 3: ITA has not developed a long-range plan for the use of 1% PEG access fees. By the end of FY , the amount of funds available could be between $21 million and $25 million. On April 11, 2013, the City Council and Mayor approved spending of up to $1.3 million in design costs related to the construction of a new facility for the Channel 35 Television Studio. The project was initially expected to be completed in FY , and ITA, in conjunction with the Bureau of Engineering, had estimated that the total project costs would be between $19 million and $23 million. Subsequent to our fieldwork, the expected completion date was changed to July 3, 2017; however, the total project costs remained unchanged. Even after this considerable investment, we estimate (based on ITA s revenue projections) that the City could have remaining funds of between $21 million and $25 million in available PEG access fees by the end of FY While ITA anticipates additional investments in digital technology for the new facility and other capital expenditures, the Agency has not developed a comprehensive long-range plan for using the total accumulated funds and the continued restricted revenue stream, which averages $6 million annually. Any long-range plan should also address the resources that would be dedicated to Public and Education access, since the $19-$23 million estimated costs for the new Channel 35 facility is solely for Government access. By developing a robust capital improvement plan that appropriately identifies future needs for equipment enhancement and infrastructure betterment, the City can provide assurance that the additional PEG fees collected are invested towards the benefit of the public, as intended. Recommendation 3.1 Council should direct ITA management to develop a long-range plan that addresses resources separately dedicated to Public, Education, and Government access and that will ensure effective use of accumulated and future ongoing PEG access fees that comply with federal requirements. 4 The $16 million to $20 million does not include $5.2 million currently in Fund #342, which is currently classified in FMS as 1% revenues. Page 11

25 Audit Findings Finding No. 4: ITA has not completed timely audits of cable/video television companies to ensure they have paid the correct amount to the City. State law requires that cable operators remit the franchise fee to the local jurisdiction in which they operate on a quarterly basis, within 45 days after the end of the calendar quarter. State law also provides that local entities may audit operators records to ensure appropriate compensation is paid. Any claims regarding either underpayment or overpayment must be made within three years of the last quarterly payment; however, the City has sometimes entered into agreements to extend the statute of limitations. These agreements (known as tolling agreements) are generally accepted by the cable companies as a good faith effort to comply with the City s intention to audit. ITA effectuates biannual audits of four of the five cable companies through a contracted CPA, and has tolling agreements in place for each. Due to minimal revenues received, ITA has not audited the fifth company. The initial audit agreement with the Floridabased CPA firm was signed in 2004, but has been extended through June 30, 2015 via several amendments/supplemental agreements. Audits can identify underpayments by cable/video television companies, and those that are well-planned and risk-based are typically a good investment of resources. Timely audits are imperative to ensure that the City recovers any underpayments as soon as possible, so the revenue can be deposited and used for intended uses. Generally, audits can be completed more efficiently when they are conducted within a reasonable timeframe, when outstanding audit issues can be resolved sooner. This requires ITA to ensure audits are initiated timely, and requires their additional monitoring of the CPA firm s progress towards completion, as well as actively working to facilitate resolution of audit issues. As of our fieldwork date, the last completed audits covered calendar years 2008 and 2009 for three providers, and the fourth was not yet complete. Each completed audit noted underpayments, resulting in the City collecting approximately $57,000 for these two years, though a significant potential underpayment by Time Warner, was in negotiation. The audits for 2010 and 2011 were initiated in 2012, but are still in progress. Delays in completing the revenue audits can be attributed to three factors: 1) late initiation, for example, the Data Request Letters for the 2008 and 2009 audits were not sent to the companies until September 2010; 2) untimely production of the documents by cable companies that are necessary for the audit; and 3) untimely monitoring and proactive follow-up by ITA to resolve pending audit requests. Based on correspondence between ITA and the CPA firm, only Verizon submitted documents timely; Time Warner has extended the process for more than eighteen months, still providing only incomplete records. The correspondence appears to indicate a lack of sufficient monitoring or action by ITA. Evidence of status inquiries were made to the CPA firm only in November 2012 and June 2013, and there was no Page 12

26 Audit Findings record provided of ITA s direct communication with the cable companies regarding the delays or their lack of cooperation, although the auditor had requested ITA s assistance in this matter. ITA stated that these financial reviews require third party cooperation, and because the City does not hold the franchise agreement, cooperation or enforcement through litigation are the only means of resolving disputes during or after an audit. It was not evident from our review that ITA took sufficient actions to initiate audits timely or to proactively monitor their ongoing progress, including demonstrating direct communication with the cable companies and encouraging them to cooperate with the auditor s requests. We acknowledge that the only legal means accessible to the City to compel production of the records is litigation, and we recognize that policymakers have preferred to work amicably through cooperation; however, before exercising any legal remedies, ITA should put additional emphasis on the revenue audit function by strengthening their oversight to ensure appropriate audit resources and audit progress, including actively working to facilitate resolving audit-related issues. Good business practices dictate that the City issue a Request for Proposal (RFP) every three to five years when contracting for particular services. This helps ensure the City obtains quality services at a competitive price. However, with the recent extension through 2015, the City will have had a contract with the same audit consultant for 11 years without issuing a RFP. ITA should issue a new RFP as soon as possible, and consider engaging additional audit resources to help ensure timely completion of audits of selected operators reported revenues, based on a risk-based audit plan. Recommendations ITA management should: 4.1 Issue a new Request For Proposal for audit services; and consider engaging additional audit resources to conduct revenue audits. 4.2 Commence audits of cable/video television companies in a more timely manner, and strengthen oversight to ensure each audit is completed soon after it has commenced. Page 13

27 Audit Findings Finding No. 5: ITA does not have adequate controls in place to ensure private franchisees are billed in a timely manner. In May and June 2013, ITA billed 14 franchisees for a total of $101,000. Some of these billings were for fees due as far back as In addition, due to the poor condition of the billing and collection records, ITA is unable to determine the total amount of outstanding accounts receivable. Private businesses who wish to use the City s public rights-of-way for their internal telecommunications cabling and facility needs must apply for a permit to be granted a franchise. The private franchisee uses conduits/fiber telecommunication lines, which are sometimes accessed through vaults and manhole covers under City streets to connect their buildings and meet their private telecommunication needs. For example, Kaiser Permanente uses telecommunication infrastructure under the City s streets to connect telecommunication lines between its buildings in Hollywood. The initial application requires a non-refundable fee of $2,500. Franchise agreements usually have a 10-year term and require an annual fee. The annual fee is calculated based on a linear or cubic foot formula, or both, when applicable. The fees ranged from $100-$10,500. Some companies have elected to pay in advance for the entire 10-year agreement. There are 19 franchisees subject to fees. Based on the agreements in place reviewed for this audit, the City is entitled to receive approximately $50,000 annually from private franchise fees/permits. However, during our audit, the City was negotiating a new franchise with the University of Southern California (USC) and anticipated it would increase the fee from $10,500 to approximately $285,000 per year. Soon after the start of this audit, ITA billed 14 franchises for a total of $100,881. The billings to each franchisee covered multiple years, indicating that ITA does not have sufficient processes to ensure each franchisee is billed annually. For example, in June 2013, one franchisee was billed $30,000 for the period 2004 through ITA sent no billing notices to franchisees in 2012, which ITA attributed to a lack of staffing resources. The billing function for private franchisees is under the responsibility of non-accounting personnel within the ITA Video Services Regulatory Division. We found the billing and collection records to be disorganized and difficult to follow in terms of amounts billed, dates billed, periods covered by the billings, and collection dates. Typically, billing and collection functions are performed by an Accounting Section whose staff is trained in these areas, not by an operating unit, such as the Regulatory Division. ITA management indicated that private franchise billings have always been the responsibility of this Division, as their staff are most familiar with the franchise regulations. However, since the billings are predetermined amounts based on the City s agreements, it would appear that the Accounting Section could easily take over these functions. Page 14

28 Audit Findings FMS has a billing/accounts receivable module to help departments manage billing and collection functions. If ITA used the module, it would result in more organized billing and collection records, and help ensure that billings are sent in a timely manner. ITA management indicated it not may not be cost effective to use the module, since the revenue collected from the private franchise fees/permits is a relatively small amount. However, with the anticipated new agreement with USC, annual revenue from private franchise fees/permits will increase to over $300,000. ITA should implement an improved centralized billing process through FMS. Delinquent Collections In August 2011, ITA billed a franchisee for $9,600 for 2010 and 2011 franchise fees and the amount remained unpaid as of our fieldwork completion, more than two years later. We found that minimal efforts were made to obtain the amount owed to the City; for example, we noted an to the franchise holder requesting payment of fees, but ITA could not show that more aggressive efforts were made to collect the outstanding amount. ITA attributed this partly to the fact that the individual in charge of the billings was on extended leave. An improved, systematic billing process by ITA s Accounting Section using FMS would better ensure that the City receives all amounts it is owed. In the event of non-payment, the City is required to send a letter of non-compliance with the agreement; if payment is still not satisfied, the City may revoke the agreement or redeem the company s bond. Expired Franchise Agreements As of our audit fieldwork, we found that seven private franchise agreements were expired. All seven expired between January 2006 and June According to ITA management, the City has the right to continue billing the franchises because they are considered holdover tenants. However, because the City did not renew the franchise agreements, the City may have missed the opportunity to potentially increase revenues. Recommendations ITA management should: 5.1 Assign responsibility for billing private franchise fees/permits to the Accounting Section and establish controls to ensure billings are made in a timely manner. 5.2 Take action to ensure private franchisees are billed using the billing/accounts receivable module of FMS. 5.3 Develop formal procedures for following-up on delinquent amounts owed by private franchisees, to help ensure the City is paid in a timely manner. Page 15

29 Audit Findings 5.4 Proactively work with private franchisees who have expired agreements to effect new ones. Finding No. 6: The ITA has not established a process to review outstanding encumbrances on a regular basis to determine whether any should be canceled. Canceling encumbrances in a timely manner increases the Unreserved and Undesignated Fund Balance, so that decision makers know the amount of available funds. An encumbrance reserves funds from an available balance to cover contractual obligations that need to be paid in the future. They are established as an accounting control to record obligations before goods are received or services are rendered, and are based on an anticipated total future obligation. It is imperative for departments to monitor outstanding encumbrances on a regular basis and to release any unnecessary encumbrances when it is determined that the obligation no longer exists; a process referred to as disencumbering funds. If unnecessary funds are not disencumbered, they continue to be regarded as obligated balances, thereby incorrectly reducing the available balance. The timely disencumbrance of funds is important to reflect an accurate and updated status on the availability of funds within FMS. Outstanding encumbrances in Fund #342 totaled $576,162 as of March 31, Although ITA does not have established formal policies and procedures to regularly review outstanding encumbrances, management stated that it periodically performs such reviews. However, the Agency could not provide any documentation of these reviews. After our audit commenced, ITA canceled $164,141 of unneeded encumbrances. We sampled 10 of these, and found that nine could have been disencumbered prior to June 30, For example, on four encumbrances, the last payment was made prior to July 31, This indicates that the Agency may not be diligent in reviewing outstanding encumbrance balances. Recommendation 6.1 ITA management should implement procedures to ensure the Agency regularly reviews outstanding encumbrance balances to determine whether any can be canceled. Page 16

30 Audit Findings Finding No. 7: The Fund's name and the Los Angeles Administrative Code do not reflect how the Fund is currently utilized. The Telecommunications, Liquidated Damages and Lost Franchise Fees Fund (Special Revenue Fund #342) was initially established to account for monies received from cable/video television franchise holders as liquidated damages, and franchise fees lost to the City due to unexcused delays in the construction and/or activation of cable/video television systems. However, according to ITA management, the Los Angeles Administrative Code Section a) For any state video franchise holder operating within the boundaries of the City of Los Angeles, there shall be a fee paid to the City equal to five percent of the gross revenue of that state video franchise holder. b) For any state video franchise holder operating within the boundaries of the City of Los Angeles, there shall be an additional fee paid to the City equal to one percent of the gross revenue of that state video franchise holder, which fee shall be used by the City for PEG purposes consistent with state and federal law. City may no longer impose these penalties, since the State is now the franchising authority; therefore, the City does not receive monies from these sources. In 1986, Section 5.97 of the LAAC was amended to reflect a new source of revenues, the allocated portion of the cable franchise fee, but the name of the Fund was not revised. Further, in 2007, Council and the Mayor adopted ordinance #178108, codified in Administrative Code Section , mandating the additional 1% PEG access fee. Again, the title of the fund was not amended; nor was Section 5.97 of the LAAC modified to discuss the collection and allowable uses of the PEG access fees. Fund names should accurately reflect their purpose or use to help ensure they are viewed correctly by City staff, public officials and the general public. Recommendation 7.1 ITA management should work with appropriate parties to re-title Fund #342 and to modify Section 5.97 of the Los Angeles Administrative Code, to reflect the Fund s current or future anticipated use (as noted in Recommendation #3, the audit suggests establishing a separate Fund to account for PEG access fees). Page 17