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Joint | May 5, 2014 | Committee Room | Joint Legislative Program Evaluation Oversight Committee

Full MP3 Audio File

Morning, everyone. I'd like to go ahead and call this meeting to order. This is the third meeting of the LRC Committee regarding public enterprise systems and use of funds. As I had indicated during our first meeting, we do not anticipate any short session legislation regarding our work. So this will be the last committee prior to short session and we will reconvene sometime in the fall to take up a package of recommendations that we will push into next year at the beginning of a long session. I'd like to introduce our sergeant of arms, and I always appreciate the hard work that they put forward in regards to getting our committee room together. We have Larry Elliot, BH Powell, ?? Morris. I'd also like to thank the committee staff: Miss Erica Churchill, Gale Moses, Mark Bondo, and Brad Kraheli. We always appreciate the hard work that they put forward, and keep them in your thoughts as we begin short session next week. I'd also like Theresa Lopez, our committee clerk, as well as Lisa Kennedy. Members, you have in your package the minutes from last committee meeting. Do we have a motion to accept the minutes? ?? Martin ?? moves that we accept the minutes, all in favor say I. All opposed. Minutes are adopted. We've got a fairly condensed meeting today, should last about an hour, hour and a half. I'd like to recognize Miss Norma Houston, with the School of Government. She's going to kind of pick up where we left off last time in regards to local government conflicts of interest. Miss Houston, welcome to our committee. You have the floor, you may want to turn your microphone on. [SPEAKER CHANGES] Mic is on. [SPEAKER CHANGES] ?? [SPEAKER CHANGES] Well, you know that's okay Mr. Chairman. Members have copies of the presentation. I am happy to just go. How's that? [SPEAKER CHANGES] That'll work for us. Carry on. [SPEAKER CHANGES] I took your hint, Mr. Chairman, when you said you were going to have a brief meeting. So, you have in your packets - sorry, for the record, I'm Norma Houston with the UNC School of Government. Thank you for having me here this morning to talk about ethics and conflicts of interest in local governments. You have in your packets a copy of the presentation slides, and I'm going to start by giving a brief overview of ethics versus the law. And when I teach this topic to local elected officials, delivering the mandatory ethics training that they are required to take, similar in the vein to the mandatory ethics training that you all have to take, we emphasize to them the difference between legal requirements and ethical considerations. What is legal is not necessarily ethical, or vice versa. The approach we take is a two-part decision analysis. If the law prohibits a certain type of conduct, we highly recommend they stop there. However, if the law does not prohibit a certain type of conduct, then they have a second decision to make. Is the particular action they're going to take appropriate or not? I'm going to be focusing primarily on the law, and what is and is not legal. In looking at what a conflict of interest is, we basically define it as when personal interests conflict with the public interest. And the conflicts of interest laws that are applicable to local governments, as well as many of these that I am going to review are applicable as well to members of the general assembly, state officials, and state employees, focus on three key points. First, they focus on prohibiting personal benefit. Benefitting personally from the use of your public office. Second, they are designed to ensure decision making that is free from inappropriate personal favoritism or influence. And third, focusing on the conduct of individuals, as opposed to a body. For you all here in the general assembly, you know that the ethics laws that you're subject to under Chapter 138A, focus on your individual conduct, not the conduct of your chamber. For example, when you're taking a vote, or making a discretionary decision, or making a legislative decision. The same laws apply in that fashion to local members of governing boards, city councils, county commissioners, et cetera. When it comes to enforcement of ethics laws, there is a key difference between the law as it applies to state officials and the law as it applies to local officials. At the state level, you are subject to criminal penalties as are local government officials also subject to criminal penalties for violations of criminal laws.

You all of the general assembly constitutionally seeing that you are the members of your own chamber. So you all have the constitutional authority to not seat a member, to sanction member, to censure a member of your own chamber, and even expel a member of your own chamber. Local governing bodies do not have that same authority. The only real action that a city counsel or county board of commissioners could take against one of its own members on its own authority would be a motion of censure, which carries no legal penalties. Then there are of course sanctions that the general assemblies have to take against other state elected officials, primarily through impeachment. The mode of impeachment constitutionally does not apply to locally elected officials or locally governed board members and then finally you both are subject to the will of the voters. Conflicts of interest standards that are applicable to local government you all enacted legislation years ago that applied requirement debt may local governing boards adopt local codes of ethics and also engage in mandatory training. And Some of you may remember this legislation when it was enacted in 2007, I can't quite remember. There are also a number of statutory conflicts of interest standards that apply to a variety of specific local boards and particular local employees. Focusing specifically on city counsels and board of commissioners, there are specific statutory limitations on voting when your taking a vote as you are sitting as a body,there are conflicts of interest prohibitions against voting where the individual member has a financial interest matter or that matter will impact his or her personal conduct. There are similar limitations voting on zoning matters which would be legislative decsion making as well as judicial matters when the county board will be sitting as a personalization or review. And there is a limitation on voting when there is a self on a contract. Moving onto criminal laws that are applicable to local governments... you are interested in public funds. As I understand you have been focusing on that alot. There are several criminal statutes that are all criminal which means that in addition to the actual offense an individual an be subject to penalties for aiding and embedding or conspiracy to commit. There are criminal penalties for embezzlement. Several different categories for embezzlement interfering with audits. The requisit duties that subscribe under the local government fiscal control act. Which my colleages will be speaking to in a little bit. And violations of other local governments and fiscal control requirements like the pre audit requirement. In the context of public contracting which is an area that I work in. There are criminal penalties that are attached to ... train of trade, self benefiting under a public contract, in other words using public authority to influence the award of or to make the award of contract that you or your spouse benefit from. There are limitations that are not accepting gifts and favors from vendors of contracts and other limitations that are near to the contract of public contracting all of which carry criminal penalties. The next category is the abuse of office. Some of these I believe you may have already heard about in the last presentation in the last committee meeting made by the state bureau of investigation. Bribery. which is self evident in accepting money or some sort of payment in exchange for participating in some sort of duties, performing public and official duties. Extortion, there a specific penalty against buying and selling offices. There is a.. against using confidential information, non public information for personal gain. And a number of other criminal penalties that attach to performance or failure to perform a variety of specific duties and responsibilities. In the context of public records, there are also several criminal penalties that attach to the destruction of those criminal records or to the misuse of confidential information that is contained in an otherwise confidential document like certain tax information, certain personal information. Finally there are a number of criminal statutes I just briefly summarized. If anyone is interested I have my four page criminal statutes. We would be happy to...

From them in any level of detail you wish, but for purposes of this morning I just wanted to highlight that there are a number of criminal penalties that attach to specific public officers that relate to either the performance of their duties, the misuses of funds under their custody or control, disclosing of information, etcetera. With that, Mr. Chairman, I hope I've achieved the goal of brevity and I realize I have gone through this information very quickly and I'm happy to answer any questions. Of course, we'll stay here for the remainder of your committee meeting to take some additional questions from them. [SPEAKER CHANGES] Very well. Thank you Ms. Houston. As far as that four page information that you have regarding the statutes, we'll actually get a copy of those directly with the members and we'll post it on our website. [SPEAKER CHANGES] I'd be happy to provide to Eric then to your staff. [SPEAKER CHANGES] That would be great. Thank you very much. Members of the committee, do you have any questions for Ms. Houston? I just, I have one question. In regards to the voting by city and county officials, you indicate at your first bullet point regarding a financial interest in any matter. Does that also mean a salary increase? [SPEAKER CHANGES] No, it does not. The duty to vote statue, which imposes a statutory obligation to vote, unless there is a conflict created by financial interest ?? judicial, specifically exempts from the definition of financial ?? compensation. [SPEAKER CHANGES] Would that be compensation regarding their outside employment if there's an increase in the appropriation? [SPEAKER CHANGES] Outside employment. [SPEAKER CHANGES] If an official makes a vote to the affirmative of a budget that includes an increase and an appropriate to an entity in which they're employed and they receive a salary increase as part of their private employment. Is that a conflict of interest? [SPEAKER CHANGES] That is potentially actually a void of contract. Am I still getting picked up on the mic? [SPEAKER CHANGES] You are. [SPEAKER CHANGES] I don't want to talk to the back, make you look at the back of my head. That's a somewhat different matter. The compensation exclusion in the duty to vote statutes is specific to their compensation as a member of that governing board. [SPEAKER CHANGES] Correct. [SPEAKER CHANGES] However, lets take a scenario, if I understand your question. Lets say you have a member of a county or city governing board who also works for, lets say a nonprofit organization. They then get elected to that city or county governing board and that governing board appropriates a grant of funds to that nonprofit. It's not a conflict of interest simply to serve in both positions. That in and of itself is not a conflict of interest. A different statute, 14-234, which is the prohibition in public contracting, it's listed in the public contracting slide, may be applicable because...so we're not in the duty to vote category, we're now in the conflict of the public contacting because technically, legally, the award of the grant funds from the unit of government to the nonprofit would take the form of a contract. Under 14-234, if a public official or employee is involved in making or administering that contract, neither they nor their spouse can receive a direct benefit under that contract, which includes compensation or income. If the governing board member works for the nonprofit, but their salary would not be effected by that grant of appropriations, then 14-234 is not triggered. However, if the grant of appropriations would directly benefit either that governing board member or his or her spouse, then 14-234 would kick in. Under that statute, it's the class one misdemeanor to violate the statute and the contract itself is rendered void by operation of the statute. You would though have to have a direct showing, a direct nexus between the appropriation of funds and the increase or direct income to that governing board member. [SPEAKER CHANGES] Very good. That answers my question. Now there's any additional questions for Ms. Houston? Seeing none. Thank you very much for your presentation. Glad you made it here safely and reasonably on time. [SPEAKER CHANGES] Thank you. [SPEAKER CHANGES] All right. [SPEAKER CHANGES] Thank you. [SPEAKER CHANGES] Next up we have Mr. Greg Allison with the School of Government. He's going to be giving us an overview of the accounting principles that are utilized in public enterprise oversight. Mr. Allison, you have the floor. [SPEAKER CHANGES] Well thank you Mr. Chairman for the opportunity to be...

...members of the committee. It’s my pleasure. My name is Greg Allison. I’m a senior lecturer with the School of Government in Chapel Hill. And nothing says a perfect Monday morning topic than governmental accounting so we’re going to spend just a few minutes talking about the unique accounting and financial reporting environment that state and local government officials across the nation follow and explain just a little bit the hows and whys of that structure. So what we’re going to try to do or what I’m going to try to do in a very short period of time, my colleague set the bar here so I think I’m going to stay with brevity as much as possible. I’m going to describe first of all what we refer to as GAP in the governmental environment, talk a little bit about the theory of fund accounting, what our structure of external financial reporting is, what the requirements are both statutorily as well as in accordance with GAP. Talk a little bit about some of the unique characteristics and issues that we deal with in the fund accounting environment and finally talk specifically about intra-fund transactions which of course is unique to a fund accounting structure. First of all let’s talk about what do we mean by ‘GAP’. ‘GAP’ stands for Generally Accepted Accounting Principles. Both the public sector and the private sector have their own respective GAP, if you will. Our general statutes, the Local Government Budget and Fiscal Control Act specifically, require that all local governments and public authorities in North Carolina follow generally accepted accounting principles which basically means once a year their external financial statements have to follow what the GAP requirements are. These requirements are established at a national level. The Governmental Accounting Standards Board is the resource, if you will, the standard setting body for state and local governmental entities nationwide; just as the Financial Accounting Standards Board is the standard setting body for the private sector. Like I said earlier those are two separate forms of GAP depending upon the sector that we’re dealing with. Our sector, governmental GAP, specifically requires state and local governments to at least once a year prepare financial statements that follow a fund accounting structure. Fund accounting is unique to our environment; I’ll talk a little bit about where it came from but more specifically how it is utilized. The whole theory behind fund accounting and its evolution, if you will, is a structure to literally segregate unrelated functions and services and those particular resources. Historically it’s based upon a century old practice of governments and I’m not talking about crossing over into 2000. From the late 1800s to the early 1900s what was a popular method of accounting for governments in order to segregate unrelated resources was to utilize the banking system. Basically at that time since we did not have extensive obviously or any technology for that matter and everything was handled manually, we did have the banking system that allowed governments to isolate, if you will, unrelated resources. So for example, many of the restricted resources that a government would receive they would simply place those in separate bank accounts. Now it was very, very cumbersome but it did segregate these unrelated resources. Fund accounting as we know it now is basically an evolution of that practice. It’s ironic that most governments now typically only have one bank account for all of their resources but we have the mechanisms internally to segregate those resources and identify them with the specific funds and functions that they are associated with. Like I said, this structure of accounting and financial reporting is a requirement for governments nationwide so any government, state or local, that wants to have an unmodified audit opinion which is critical in order to operate in the debt market or the grant market must follow the fund accounting structure. And this is the elusive structure. We have three broad categories of funds: governmental, proprietary and fiduciary and then within each of these categories there are sub-categories or often referred to as fund types. I’m going to spare you; we’re not going to go through all those individual fund types. I’ll just talk very, very briefly about the three categories and zero in on the funds that are most common within each of these categories. The governmental category I often refer to as the category to account for traditional, typical governmental functions and services: administration, public safety, public works, transportation, recreation. Those are very common government...

Mental activities, if you will. The most commonly used fund within that category, is the general fund. As everyone knows, every governmental entity will have a general fund, it’s their main operating fund. Here we have the proprietary category. The proprietary category is a category used to account for those activities that are manageable like a business or service in that capacity, similar to the private sector, not exact, but similar. The most common fund type that we see within the proprietary category is going to be the enterprise funds. That’s where you are going to see the water, the waste water, the electric, the natural gas, the convention centers. All of those are examples are common examples of enterprise funds. The absolute most common being water and waste water funds. Finally, the fiduciary funds. The fiduciary funds represent those resources that the government has a legal trustee relationship for but it’s actually not the government’s resources. One of the most common examples of that we can point to the state of North Carolina’s fund structure. Both the state and local government retirement systems are accounted for as fiduciary funds. Those are not legal resources of the state itself, but the state is responsible for managing those resources. We’re going to zero in specifically on the governmental and proprietary funds and the inter-fund transactions that often will take place. Just as a reminder, we are required by not only state law, but generally accepted accounting principals, to prepare external financial statements that follow these principals at least once a year. The local government budget and fiscal control act requires all governments to undergo an independent annual audit. The result of that audit, hopefully, is going to be an unmodified audit opinion, which basically states, does not give any opinion on the financial condition of the government, but simply whether or not the governmental entity is following the required reporting standards. If they are following the required reporting standards, the financial will speak for themselves. All financial statements, and in your handouts I actually underlined the word all, all financial statements issued by local governmental entities and public authorities in North Carolina are reviewed by staff of the local government commission. It is not a sampling review. Every financial statement is reviewed every year. Certain types of information that they zero in, which I will talk about in a few minutes, is going to be caught because every individual entity is going to be subjected to this. Remember, the audit opinion simply is rendering an opinion on whether or not the financial statements follow gap. As most of us could attest to personally, and I often use this as an example with many of my students when I am trying to describe exactly what gap is, all of us are well familiar that once a year we are all individually required to file a 1040, which forces us to get all of our financial information into a standardized format. That certainly doesn’t mean that throughout the year we all maintain our individual records the same. We all have different ways of maintaining our personal financial information. We are required to funnel it into, if you will, a standardized format. That’s very often what we have to do in the local government environment, state and local government for that matter, where the budgetary practices that the government has throughout the year, which is basically ?? to the balancing of resources and appropriations and ensuring that the resources are available throughout the year to meet those appropriations. We manage that on a cash basis throughout the year. Theoretically speaking, it’s modified ?? That’s very close to a cash basis set of accounting standards. However, our external financial reporting does not follow cash basis. Very often, what has to happen during the year, is that the budgetary practices that we have, will actually be a little bit different and will have to be modified to prepare the external financial statements. In order to do that, certain inter-fund transactions are often required. Let’s talk a little bit about the different types of inter-fund transactions that we see. I think the most important thing that we want to focus on is the, not only the terminology but the definitions behind the terminology, because.

...one reporting issue that we do see nationally is that certain interfund transactions are mischaracterized. They're often mislabeled and when that occurs there can be misleading information you will see. Let's talk about the concept of an exchange transaction. An exchange transaction is where you have an equal exchange between two willing parties. I was a finance director many years ago with a local governmental entity in North Carolina and we had several of these very common examples. We managed a water and a wastewater fund as well as an electrical distribution fund, and our city hall and fire department and public safety center got our water and wastewater services from the city's utility. So we would actually have the utility fund bill the governmental fund for the water that those departments used, just like we were billing any of the customers. That is an exchange transaction that has taken place between two funds but it is certainly not a transfer. It is a legitimate exchange of purchasing services from one fund to another. Those types of transactions happen on a regular basis. Many governments will maintain their own central motor fleet department, a central garage maybe to manage and repair all of the vehicles in the city, and that will often be accounted for as a separate internal service fund which is considered a business type activity but is required to be on a break-even basis. It cannot make money. It is required to be on a break-even basis, but the different functions and services that utilize that garage will pay that garage for those services. It's a way to accurately reflect the internal activities and it is certainly very beneficial for cost allocation purposes. Some of the terminology that you may very often see with those types of transaction: it is a revenue or expense or expenditure depending upon rather you are a recipient fund or provider fund. If at the end of the fiscal year there is an outstanding bill that hasn't been paid yet, instead of being reflected as an accounts payable, it is reflected as a due from and instead of an accounts receivable, it is reflected as a due to. Users of these external financial statements can easily see on the financial statements if they see that terminology they know the nature of the transaction. It arose because of an underlying exchange. Now, reimbursements. Reimbursements are literally legitimate reimbursements from one fund to another. These are not cost allocations necessarily in an indirect manner but literally a way to reconcile very often the differences between the budget actions that occur and what must be reported for external GAAP reporting purposes. I'll give you one very common example of this. As I mentioned earlier, I was a finance director with a local government. We had three enterprise funds: water, wastewater, and electric. We had a business office that was responsible for billing and collecting not only our tax bills, but our water, wastewater, and electric. We centralized that all in our business office. Well the business office was part of the finance department, and the finance department was part of the general fund. So that entire dept was budgeted within the general fund, however close to 75% of the activities that occurred within the business office was related to water, wastewater, and electric. Because of the billing and collecting that the staff did on behalf of those funds so budgetarily throughout the year we would reimburse the funds so that in the external financial reporting the appropriate costs were reflected in the individual funds. I think everyone will agree you want to have the ability to reflect the appropriate expenses within those funds because you are going to be using those expenses to determine the rates that are necessary. This is where you see a critical bit of misinformation from time to time where governmental entities nationwide as well as in many cases the independent auditors mislabeled these types of transactions. This type of reimbursement is not a transfer and should not be labeled as such.

I have personally have worked with several different governments in North Carolina over the years where they have misapplied the terminology and reflected as these inter-fund transactions, transfers that were truly legitimate reimbursements. Why do I say we need to make sure we do not characterize those types of transactions with a true transfer? Transfers as defined by generally accepted accounting principals are literally resources flowing between funds that have absolutely nothing to do with reimbursements or reallocation. I've often made the comment before, transfer is like free money. It comes with no stipulations its not a loan its basically one fund giving another fund money. There are limited legal limitations in North Carolina on transfers between funds there are some and my colleague Carolina Bellasi will be talking about a few of those later this morning but they are very limited ones. There are basically no limitations within a gap reporting structure. Gap does not set policy and I think that's a very important point to remember. But if you have a transfer, gap gives us the mechanism on how to report that. However policy implications do practically limit transfers again not only on a local level in North Carolina but nationally as well. First of all any significant transfers that are identified in the financial statements that the local government commission is reviewed and again they review every individual financial statement each year, that will raise flags with them especially in their debt management section. They are concerned about excessive transfers occurring between funds because of policy implications and more importantly the red flags that it raises with the bond??? analysts. Rating analysts scrutinize very closely and again sometimes legitimate reasons why a transfer would occur but we've seen many instances when flags were raised and questions were raised where the transfer was not transferring money from one fund to am other just because one fund has it and one fund doesn't it was a legitimate reimbursement and that needs to be reflected as such and not reflected as a transfer. What we would say is transfer is limited more by the debt market and by policy questions that may be raised by local government commission not because there's a legal limitation or limitation with accordance to generally accepted accounting principals. Finally we will often, its not something that happens on a daily basis but occasionally governments will look internally for financing mechanisms and its possible for some funds to have the resources to actually loan resources to another fund for possible capital purchase or similar type transaction. These arrangements may be formal or informal in nature, I will say from my perspective most of these types of inter-fund transactions being formalized where there are agreements that are adopted by the local boards and one fund is paying back the other fund in a manner similar to the way it would do by getting that loan from an external resources, paying interest but instead of having to rely upon going to the outside if you will, they are able to finance certain transactions internally. There's nothing in GAP that restricts these type of transactions but again generally accepted accounting principles have a mechanism that show us how to reflect those type of inter-fund loans. Common terminology you might see in the financial statements or these type of transactions are obviously inter-fund loans, inter fund receivables or payable and very often you will see terminally that reflects advances to or from funds. Inter funds receivables and payable's typically that terminology is used to reflect loans that are short term in nature. One year or less. The term advance to or from funds is very often used to reflect longer type loan arrangements between funds. Again there is nothing in GAP our statute that limits those but again if a government has that type of transaction it should be clear on the face of the financial statements. All of this information, transfers and inter-fund loans have to be reported in detail and described in the note disclosures . Any government that does report a government transfer in or out

- between a fund. You should be able to go to their note disclosures and see exactly why that transfer occurred. Same thing with any other type of inter-fund transaction. And with that, I will conclude my initial comments, Mr. Chairman, and I'm more than happy to take any questions that anyone has. [SPEAKER CHANGES] Thank you, Mr. Allison. You have succeeded in taking something that should be very clear, and confirmed for us that it's very fuzzy and very loose. Representative Dixon. [SPEAKER CHANGES] Thank you, Mr. Chair. In your comments about county audits, the general fund audit for the county commissioners, is there any standard suggestion of when those audits should be due? [SPEAKER CHANGES] Actually, there is no standard in generally accepted accounting principles that dictate deadlines for those audits. We have a legal requirement in North Carolina that is statutory in nature, it's actually embedded in the administrative code, that requires local governments to have their independent annual audits completed by October 31st. Now, there's absolutely, it's absolutely true that not every government is not able to meet that. There are extenuating circumstances that may occur, but that's something that the local government commission monitors very carefully. And there are a handful of governments that have problems with getting these audits in on time, but the vast majority of them do. I don't have the statistics, but they do keep very close watch on the time limits of those audits. [SPEAKER CHANGES] Follow-up? [SPEAKER CHANGES] So if an audit in a particular county came in like the middle or end of January of the following year, that wouldn't be exactly in alignment with the suggestion that you just referred to. [SPEAKER CHANGES] No, I mean that's not directly in accordance with what the statutes require. Now, there may be, again, extenuating circumstances why that occur. We've seen, for example, and this is an extreme example, but in 1999, following Hurricane Floyd, which was in September, basically no government east of I95 was able to get their audits completed before the first part of the next year. That's an extreme example, but those type things can happen. You can have changes in staff, finance officers, you can have changes in auditors, that will cause a delay in these audits. It's all individualized, everyone's got an individual circumstance. While there are no penalties that happen because of these audits being late, there are practical effects. Governments that are interested in going to the debt market, for example, are not gonna be able to go to the debt market until these audits are completed, because the financing agencies require timely information. [SPEAKER CHANGES] Representative Martin? [SPEAKER CHANGES] Thank you, Mr. Chair. This is very interesting financial information, and I'm wondering why we're hearing about it. Are you seeing, or is the local government commission seeing a lot of mis-reporting and misunderstanding, or misuse of these funds that we're concerned about? Or, what are you seeing when you see the reports each year? [SPEAKER CHANGES] There's not been an increase, if you will, in reporting being misinterpreted. It's definitely something on a regular basis that the local government commission in their review is very concerned about, because they wanna make sure, for example, that if a government has a transfer, there's a legitimate reason for it, because there are going to be policy questions related to transfers. Likewise, other types of transactions, like reimbursements and things of that nature, need to be appropriately reported. I would argue that, in years past, over the past ten or fifteen years, there was a higher incidence of that than there is today, and part of that reason is that, both in the work that I do with the local governments across the state and advising them on how to prepare their financial statements, and basically training the finance officers and the reporting managers on how to do this, coupled with the oversight that the local government commission has with those financial statements, we've actually seen less of it. We have to stay diligent with that. We have a treasured reputation in the national debt market, and one of the reasons we have that is that we are considered to have timely financial statements state-wide, and information that's reported appropriately. You're always gonna have outliers, but it has certainly gotten much better. [SPEAKER CHANGES] Thank you, Mr. Alison. Any additional questions from members of the committee? I have a couple for you. In regards to the financial statements that are reviewed by the local government commission, approximately how -

How many annually do they review? Ok, like I said, not only cities, counties, school districts, and public authorities have to prepare these financial statements once a year, but these financial statements all have the same fiscal year end, with just very few exceptions, and the total number is approximately twelve hundred. You've got obviously one hundred counties, close to six hundred municipalities, about a hundred and thirteen school districts, and the rest are public authorities. Approximately how long does it take them to go through all of those? The review process starts as soon as these financial statements start coming in, I would say that many governments are able to get their financial statements completed and audits completed by the August time frame, but they're still reviewing these up through the mid, the late part of the following spring. during that time. And one thing that I should point out is that governmental gap is obviously a specific type of accounting and financial reporting. The independent auditors that these units are using have to have knowledge in that type of accounting and reporting. Just like you have specialists in the medical field, you have specialists in auditors, and so you've got all of these entities at the same time requiring audit services from a limited community. So it's taxing on those auditors as well to get everything done. Ok, very good. Lastly, in regards to, your information's been very helpful, but when you have these public enterprises and similar type entities that are serving multiple jurisdictions, I understood you clearly when you said gap does not set policy, but it seems as if that the only protection that a lot of the rate payers have is perhaps the debt market that would raise an objection as to the conduct of the folks overseeing the enterprise versus anything that we currently have set in policy or anything that gap would necessarily bring to the surface. Is that a fair statement, or? With some nuances, I would argue, but that is a fair statement, that there's no question that probably one of the biggest arbiters out there is going to be the debt market. But they get that information directly from the financial statements,and that's the only place they can get it. So the financial statements will present the information that's necessary, it's just, do the right people read it and see what the information is? Very good, thank you! Any additional questions? Representative Dickson? Mr Chair, I have an additional question. I don't know if this is. I'll just ask the question. If it's not now, it'll come later. Solid waste enterprise funds, my understanding is that they are established to cover cost. My question is, is there a limit to the amount of fund balance that these enterprise funds can have since they're supposed to just cover the cost of the enterprise, and I know of instances where fund balances are very high. I don't know if this, maybe the next or whenever ?? Mr. Allison, is that something? I can answer part of that, and then my colleague, Karen M??, can talk a little bit further about solid waste in particular. The equity that we have in the enterprise funds which is for gap purposes we refer to as ?? assets. Fund balance is equity terminology we see with like the general fund, with the governmental funds. But solid waste, water waste, water, those funds that are enterprise in nature, that equity, there's no legal limitation on what that amount can be. There's not a gap limitation on what that amount would be. But in practice, because enterprise activities are considered to be similar to business-type activities, it's common to see equity built up in those funds to allow for capital, infrastructure needs, thing of that nature, because it's such an ongoing, capital-intensive activity. Representative Cleveland? Are there any restrictions on enterprise funds being transferred into a municipality or a county general fund for other uses? Are you talking about for reporting purposes, reporting enterprise funds as part of the general fund or are there limitations or transactions between the two. Are there limitations between transactions between the two? There are no limitations between say an enterprise fund and a governmental fund that ??

...GAP establishes. There’s none there. There are some limited legal limitations that my colleague, Carol Malonsey will be able to talk about a little bit later, but the biggest limitation we see is like I say the practical one where excessive transfers occurring between funds that are not legitimate reimbursements will raise flags in the debt market. [SPEAKER CHANGES] The chair has an additional question for you. When you were giving your example regarding the water and waste water system that you’re associated with and the business office about 75% of the work that they did was attributable to the enterprise would it not be more clear for the rate payers if that function was strictly housed in the enterprise itself instead of blurring the lines by trying to allocate on a percentage basis what amount of time these folks are spending across these different areas? [SPEAKER CHANGES] That’s a very good question. You could do it either way. The primary reason we chose to report it in that manner is that when you do that for external reporting purposes, I understand completely that would be clear, but then for internal monitoring purposes you would be adopting a budget taking one, and I’ll just use an example, one individual salary and splitting that up in your internal records between two or three ??? funds which for payroll purposes, to be quite honest, makes it more difficult ???. It can be done either way. What we tried to achieve is within the note disclosures clearly describing what that budgetary interflow was. We thought that that created transparency but there are multiple ways it could be done. [SPEAKER CHANGES] I think it creates transparency but I don’t think it makes it clear. I think it’s very difficult for the average person to look at that particular scheme and really assess whether or not the enterprise that they’re a rate payer of, which is governed by a jurisdiction that they’re not a part of, is actually being managed in a way that’s objective and to the benefit of the rate payer versus to the benefit of the taxpayer and the entity that has oversight. Very concerned about the fact that although it’s transparent I’m not exactly sure that it’s clear having reviewed a number of these allocated cost scenarios. Any additional questions from members of the committee? Mr. Allison, thank you very much for your time this morning. The committee will stand in recess for about ten minutes. I’d like to call the meeting back to order. Our next presenter has arrived. I would like to recognize Miss Carol Malonsey with the School of Government. She’s going to be giving us an overview of the legal aspects of public enterprises. Miss Malonsey, welcome to our committee. [SPEAKER CHANGE] Thanks very much. Good morning. I’m happy to pause at any time and take questions if you would rather get into the details than stick to this general overview. I've got a few slides just to set the context. A public enterprise, at least in North Carolina, is a set of activities that local government entities have authority to perform that are what we would describe of a commercial nature. Because they’re of a commercial nature the authority of local governments to provide these services or undertake these activities is much broader. Local governments have much more leeway in how they structure, run, operate, maintain their public enterprises than they do their traditional government services. Local governments are still subject to the notion of this is a non-home rule state and so they derive all their authority from the statutes. But the set of statutes that authorize public enterprise activities themselves give much broader authority to local governments. A couple of characteristics of a public enterprise activity that I think are important to note. One, it’s generally voluntary, and I'll come back to the notion of why I say generally, but it’s generally voluntary and also a fee-for-service set-up. Again, unlike what we might think of as traditional government services, police, fire, public school education, where people pay mainly through their tax revenues whether they directly benefit from...

Whether they directly benefit by going to the library or whether they ever need to call on the police for various reasons, citizens will pay. That's not true for the public enterprise realm. In the public enterprise realm it is generally you pay for what you benefit you generally derive. How that benefit is derived measured is varied in the across the spectrum across the public enterprise spectrum, but it is generally notion that it is a fee for service. now i keep saying generally, because there are exceptions. And the exceptions for this have been written into the statues and we'll come and talk about the few exceptions where local governments can actually require property owners to participate in their public enterprise activities. Before I get there and im gonna come back to that.. just a couple of preliminary remarks about setting the framework for public enterprise is that i think that it is important to understand that there is no duty for equal service. This is actually true for all local government services whether they are in the public enterprise realm or what we would refer to the general government realm. There is a case out of the early 1990s from the North Carolina Supreme court, I think it was out of Cleveland county, in which the court sort of adopted this common law principle that unless a statue says otherwise.. if and when a local government chooses to provide services in it's territorial jurisdiction, the is no duty to provide services to the entire territory.. there is no duty to make the service available to all citizens or property owners.. like i said, this applies to all government services unless a specific statue says other wise. Local governments by in large can pick and choose where they provide service. Couple of quick public enterprise as we see in North Carolina, the framework of a public enterprise is this notion that it's self supporting and that ties back in the fee for service. Unlike our general government service, our public enterprise services should pay for themselves and the people receiving these services directly should bare the full cost of providing those services. The reason I say Aspire to be is the law in North Carolina is clear right now. All counties, cities, towns, villages and our other entities that provide public service have the authority to transfer money from their general funds to any of their public enterprise funds. so you have the ability to transfer money that you collected as tax revenue to your enterprise fund to support that fund. I think more and more in practice we see local governments trying not to do that. The transfers tend to go the other way from the enterprise fund to the general fund. But we still have a number of units whose enterprise funds are not self sustaining. And some of that is by choice. the local board has made a decision that it does not want the enterprise customers to bear the full cost of the operating and the capital expense. It wants to subsidize this through general property tax or other general revenue sources.. In the final framework peace for public enterprise is that it is not only governed by statue but we also, if you are a local government entity, this is a strange area that fills in common law that fills in the gaps and its not just general common law. it's common law of utilities. Which leads to strange results... For those of you who are students of law you may have heard of the notion of equal protection where you have to treat ????

...tuated persons, entities, property owners, etc, similarly but you can't unlawfully discriminate. Well if you're looking at equal protection in it's traditional sense, in it's constitutional sense that derives both from the U.S. Constitution and from our State Constitution what it really means is that you cannot discriminate unlawfully against certain protected classes of individuals. The common law of utilities, however, takes it farther. So the common law of utilities makes the ability to differentiate amongst different groups or classes of individuals or in this case classes of customers, it's much more restrictive. You're more limited in how you can quote-unquote "discriminate" It's not just you can't discriminate against protected classes of individuals, it's actually that you have to have rational utility rate reasons for differentiating at all, differentiating at all amongst your customers or your customer classes. And so that's an additional layer that we don't see in other government realms, this common law of utilities applies. And then finally what makes this a little bit different than what our local governments traditionally deal with is that much of the relationship, much of what defines the public enterprise activity is done by contract. It's done by contract with the customer. It is a voluntary fee-for-service, these are the terms of the contract, if you want service this is what you must accept. So the government actually can frame it's rules, regulations very broadly and a customer or a potential customer can choose to accept those rules and regulations and buy into the service or if the customer or potential customer doesn't want to accept those terms and conditions they can look elsewhere for service. Now, we could say that in some realms that that's a false choice but that's the way, legally, it's structured, that much of this is defined by customer relationships and therefore by contract. So that's the general framework of a public enterprise activity and you can, you're not going to be able to see this that well but I thought it might be helpful and my guess is you've already looked at this to some extent, this is the legal structures for all the different ways that local government entities can provide what we would refer to as "public enterprise activities." And so we have our general purpose governments, counties, and municipalities and they have the broadest authority to provide a number of different public enterprise activities, the most significant of which are water, sewer, and solid waste. But certainly many of our governments are now picking up storm water, for example, and we do have some electric cities and cities that provide natural gas as well. And then we have a number of what we would refer to as "single purpose local governments" that generally have been created to provide water and sewer services but that also, in more recent years, have been created for things like parking, public transportation, solid waste, and then, of course, a variety of different airport authorities. So these are the ones that are authorized under general law and I should mention there's, you know, ten, fifteen, twenty more that are authorized by local act and so we're not going to get into the local act ones today but the general law provisions are represented up there just to give you a sense of the variety of entities that have been created to provide public enterprise activities. Focusing in on county and municipal enterprises as well as water and sewer authorities, which, going back here were your top three on, well I should say your top two and your fourth one on this chart, these are the ones that we, the legal structures that we most often see across the state providing water, sewer, and solid waste services, which is our, again, the largest public enterprise. Their not regulated by the utilities commission, we have a state utilities commission that regulates certain public enterprises but only those in the private sector. It's when the government, whether it's a county, a city, a town, a village, or a water and sewer authority, provides public enterprise, it's not regulated or governed by the utilities commission. Instead the unit itself and the unit's governing board, for example a county if it provides water services, it's the counties' governing board that adopts the rules and regulations subject only to the statutory authority and, as I mentioned, the common law of utilities. Now, coming back to something I had on that first slide where I kept saying, "generally this is a voluntary relationship," I wanted to point out the one situation where it's not. There is -

...acitory authority for counties, municipalities, and water and sewer authorities, these three entities, to mandate connection to water and sewer systems. There also is authority for municipalities only to mandate curbside collection of solid waste. Now, I'm going to treat that separately,that's a slightly different requirement than the water and sewer. So focusing only on the water and sewer what the statute says, or what the statutory authority says, and it's largely parallel authority for these three types of entities, is that a local government can mandate that properties located within a reasonable distance of it's water and sewer infrastructure, water and sewer lines, the trunk lines, must connect. It can require those property owners to connect to the system and that's true even if those property owners have perfectly well functioning wells and/or septic systems. The statute goes on, the statute's very specific, goes on to state that the government can also charge the property owner for the costs of making that connection and what local governments refer to or call that charge varies widely. Some call it a tap-on fee, a connection fee, an impact fee, an infrastructure fee, the name doesn't matter but the authority is clearly there to require that the property owner bare the cost of connecting. Now, the statutes differ a little bit in the next respect and I'm going to focus first on the municipal statute. So in the same statute that allows the local government to require connection it goes on in the city statute to say, "if the governing board chooses, in order to mitigate against a harsh result of forcing property owners to connect to the system, the governing board of a municipality can instead require those property owners who don't want to connect to instead pay what we call an availability fee. And so if a property is not connected, if a property owner otherwise would have been forced to connect by ordinance adopted by the governing board, the governing board in that ordinance can give an alternative. Okay, if you really don't want to connect you pay a monthly or periodic availability fee and the statute says that availability fee cannot exceed the monthly minimum base charge that everybody else pays who is connected. So little lesson on utility bills if you haven't looked at yours lately, it typically is comprised of two different charges, sometimes more than two but two at a minimum. One will be a fixed minimum fee regardless of usage and then one will be a usage fee that will be scaled based on the amount of water, for example, that you consumed in a given month or a given billing cycle. And so what this statute is saying that that fixed portion of that fee, the availability fee cannot exceed that but it would be the li-, but it becomes the liability of the property owner to pay that monthly or periodic fee if they choose not to connect. That's the city statute, the municipal statute. The county and water and sewer statute, much more limited in their authority to impose availability fees in lieu of connection. In those scenarios both the county and the water and sewer authority absolutely can mandate connection but they can only charge in lieu of availability fee in very, very limited circumstances. What the statute says is that if a property is suitable for development and in fact has been given, received the proper approvals for development, and what we might interpret that is if you've received your building permits but development hasn't yet been completed, for that limited period of time, in some ways during the construction phase, a county or a water and sewer authority can charge that availability fee and that makes sense because it doesn't really make sense to require a property that isn't actually built yet to connect. So during that limited period of time but once that period of time is up the county or the water and sewer authority's only option to get that customer, if you will, is to require them to connect. They no longer have that mitigating availability fee option like municipalities do. So the authority is slightly different under current law. Talking, going on to talk a little bit about fee authority, Erica specifically asked me this morning to cover the notion of how, what is the fee authority and then break it up into the operating and capital components and talk about the, specifically the authority to charge fees for operating costs and fees for capital and so that's what I'm going to finish with this morning. One, again, just like everything else that I've talked about this morning, the authority

I’m focusing in on county municipal enterprises as well as water and sewer authorities because, again, they are the most common route for providing these services. But the authority is equally broad on the fee side for all our other single purpose government. The North Carolina Supreme Court in a case in the early 80’s interpreted what we would already have thought of as this broad fee authority. But the fee authority, if you read it, It goes something like this. It will say for example, the municipal statute will say that the unit has the authority to charge rates, fees, rents, charges and penalties for the public enterprise services. It’s just this laundry list of terms thinking about every possible way that you might label a charge. And the Supreme Court looked at that laundry list in the context of a specific case in which a local government was charging entities not only for the operating expenses, folding the operating expenses into their rates, fees charges, expenses, but also folding in a depreciation factor and a capital expansion factor--not to fund current capital but to fund future capital. Labels meaningless. So whether it’s called a capacity fee, a tap fee, an impact fee, convenience fee, you gotta look past the label and you’ve gotta look what the local government is actually charging for. And if what the local government is charging for is a charge, a fee, whatever they call it, is used to either cover the current operating costs or cover future capital expenses or cover depreciation, then at least under current law there’s authority to do that. And so I think local governments kind of get hung up on the fee, and think that an impact fee is different than a convenience fee, it’s different than a capacity fee. The underlying authority is the same. There isn’t separate authority for an impact fee, a capacity fee, a tap fee, etc. The underlying authority is the same and it’s very broad. The fees that are charged, whether they are for operating or for capital, can vary by customer class. And again this is a statutory directive. The statutes say that fees can vary by customer class. But this is where the common law of utilities comes in. I’ve already talked about this so I won’t go into it in detail at this point. The statute says you can vary fees by customer class. But the common law of utilities says, but wait a minute. When you make those distinctions amongst your different customers, you have to have a valid utility basis for doing so. Kind of a modified equal protection clause, if you will. This raises an issue, though for the times about transfers. I already talked about transfers in-- that there’s broad authority to do transfers in and we still have a number of governments that for a variety of reasons sometimes by policy choice, sometimes by necessity are transferring monies in. What about transferring monies out? And I hinted, that this is where we are seeing more activity is in the transferring of monies out. Particularly from our bigger enterprise activities like water and sewer. Solid waste, right now most solid waste systems, it’s hard to make those self-sustaining. There’s statutory limits on solid waste that require that the unit collects no more money than is necessary than to support the solid waste activity. So I’m going to mention now a broad statute that generally allows transfers out from an enterprise fund to any other fund. But that only applies to monies that are not otherwise legally restricted. And so it would not, for example, apply to solid waste monies even though those are public enterprise monies accounted for generally in a public enterprise fund. Because there’s a statute applying to that solid waste that says that the fees collected for solid waste services cannot exceed the cost of providing those services. Effectively that’s a prohibition on transferring money anywhere else because the money has to be used effectively for solid waste. We do not have that kind of restriction right now on our water and sewer activities. We have it on solid waste. We have a restriction on storm water. And there’s some various restrictions on some of our other enterprise activity. But water and sewer we don’t have

...those types of restrictions, and so we default to this general provision, which is actually found in the local government budget and fiscal control act, which is the act that governs how local governments manage their money. How they budget. How they manage. And how they disperse their funds. And in that act, in 15913, one of the subdivisions in that statute, it's actually written as a prohabition, but if you read closely, it's actually an authority in disguise. It says that no appropriation may be made from a utility or enterprise fund to any other fund. So it starts with no you can't do it, but then of course you get to the unless. Unless the total of all other appropriations in the fund equal or exceed the amount that will be required during the fiscal year. And so, if you read this, what it says, is that if you have enough money in your fund, and in this case in an enterprise fund, whether it be a water, a sewer, or a combined. Sometimes you can do a combined water sewer fund. If you've got enough money to cover your current operating costs, your current depreciation, your current capital outlay,plus anything else that you are saving for future capital expenses, and you still have money left over. For whatever reasons. Because you brought it in from your rate payers. Or because you've received a grant. Or because in this given year, your expenses were less than you thought they would be. Then you can transfer that money to any other fund. And most often those transfers occur to the general fund. And that money is not legally earmarked for any purpose. Alright? So it's generally unrestricted money in the enterprise fund, it will be generally unrestricted money in the general fund as well, and it could be used, for example, to fund a library, or pay a police chief's salary, or for just general government expenses. The big caveat though, and I already got into this. I kind of jumped ahead of myself in talking about the solid waste fees, is that legally earmarked funds cannot be transferred. Because they can't be used for any other purpose than what the statute has designated for their use. And so, I already went into the example of the solid waste. What about impact fees, right? So that becomes the big question, and as I've already said, I'm using the word impact fee because that's the issue that often arises. Impact fee unfortunately has many meanings. In the public enterprise context, it actually has a very different meaning than in the general government context. In North Carolina, our local governments do not have general impact fee authority under general law as we've come to understand that term in the common sense. What local governments have is the authority if they choose to do an enterprise activity. If they choose to engage in a public enterprise utility, local governments can charge for the current capital costs, either the current capital costs or the future capital costs associated with that public enterprise activity. Local government sometimes referred to that fee, particularly when they're assessing it on new development, as an impact fee. But how it differs from how we generally understand an impact fee, is if a new development is coming on board in, let's say, a city, and that new development has it's own well. It's a fairly unlikely scenario, but this is how it differs. If that new development, perhaps has it's own mini water treatment system, which believe it or not we've seen, has it's own mini water treatment system, it's own sewer system, it wants to create it's own self sustaining community. So it will never tie on, nor will the government ever force it to tie on, because in this scenario that I've created, the government's lines don't currently run in front of that development, so it can't force that development to tie on. If there's going to be no chance, at least in the current term of that new development tying onto the system, then the local government can't charge an impact fee on that new development. The authority's not there. And so that's what makes it different. If we were looking at what we generally think of as impact fees, all new development pays the fee, because the fee's going to be used for general infrastructure needs down the road that are necessitated by the new development. This is slightly different because regardless of what we call it, it can only be assessed on properties that are going to be customers, whether voluntarily or forced customers, of the enterprise system. And so under current law, we

Question and I phrased it here, are impact fees legally earmarked? Because the next question that gets asked typically is if we collect these impact fees from these new developments, in particular, to be used for public enterprise capital expenses down the road, do we consider those impact fees to be legally earmarks? Similar to what I said about solid waste and what that would mean is that once impact fees, a particular type of charge, is collected then we couldn’t transfer at least that pot of money to any other fund. Similar to the solid waste fees and this is where the answer’s not clear. I tend to think under the current law under the current framework looking at the court cases that have dance around this issue and ?? context, that generally money’s fungible. And this does not impact fees, capacity fees, whatever you’re going to call this charge, the fee that is collected, as I explained it, from whether it’s new development or existing development that’s associated with capital for the enterprise system is fungible in the same way that operating expenses are fungible. And our default is that you can transfer any true profit, any money that’s left over other than what’s needed to cover your operating capital and depreciation costs in the current fiscal year. It doesn’t mean a government has to transfer it, but the authority’s probably there under current law to transfer even what local governments are referring to as impact fees. And part of that is because, again it’s an unfortunate term that they’re using, but it’s not a true impact fee in the way that we think about impact fees in the way the law defines impact fees in other context. This is truly a capital infrastructure charge that is derived from the same authority as the operating cost charge and this statute makes no differentiation between the two. The last question I’ll raise and answer is you may be familiar with a recent Supreme Court case; the Koontz case and this had to do with development exactions. And so, this issue of we often think about impact fees as a type of development exaction. It’s a forced exaction paid by developers in order to get the building permit or the authority or the approval to go forward with new development. And so, this recent Supreme Court case raised this issue, basically double downed and said if something is a traditional exaction, meaning either the developer’s being forced to do something or forced to pay money in lieu of doing something, usually infrastructure related, in exchange for getting approval to develop the property, then there’s some parameters around that. There’s some constitutional parameters that has to be rationally related and proportional to the development and whatever that money’s going to be used for, whatever that exaction is, has to be connected to that private development. So, it would be sidewalks that’ll be around the development, not sidewalks installed on the other side of town. All right, so it’s the development exaction has to be rationally related and proportional to the development itself. This Koontz case though, raises this issue of well impact fees as we traditionally know them. Are they development exactions? And the court actually dances around this issue. Justice Alito who writes the majority opinion says no there is a difference exactions, at least as he thinks of them, and fees and charges like impact fees. And he said that this rule, this proportional rationally related rule, only applies to exactions. It does not apply to fees and taxes. The dissent in that case which was written by Justice Kagan, she was a little more skeptical of that division. She was a little more skeptical of that well isn’t an impact fee an exaction and she didn’t quite buy this line that the majority in the case was drawing. And what that means and I want go into more detail, but what that mean for us is it’s a little unclear, regardless of the label here, as to whether any money collected from new development, whatever you call it, can only be used for infrastructure that directly benefits that new development. If in fact in a future case the court were to decide the Koontz actually applies to any fee that’s charged on new development, whether you call it an impact fee, capacity fee, whatever, can only be used for infrastructure associated with that development. Then, impact fees are legally earmarked and they couldn’t be transferred. They would only be able to use.

[0:00:00.0] …Very specific infrastructure related projects necessitated by that particular development but it’s an open question right now. So, this is where we have got Gray Area so that the legislature can stepped in and define this but in the absence it’s a little unclear in that I’m not sure I can give any more guidance in that to a local unit trying to figure out whether they can transfer impact piece or not I think we just don’t know. So, I’m gonna stop there. [SPEAKER CHANGES] If there is any question? [SPEAKER CHANGES] Thank you Miss. Movansi any questions from the members of committee? [SPEAKER CHANGES] I have a couple of you. [SPEAKER CHANGES] Sure. [SPEAKER CHANGES] On yours I guess the first major slide you talked about no duty of equal service, you also talked about common log utilities. It seem like those are different, could you explain little bit on that? [SPEAKER CHANGES] Sure. So, the no duty of equal service has to do with the actual determining where you will provide service and so what the North Carolina Supreme Court is said is when they, unless a stat specifically says otherwise, unless <01:01> specifically says local government, “If you choose to undertake this activity you must do it throughout your jurisdiction.” And the one example we have is municipalities all have to do building code enforcement that’s the one statutory duty that municipalities have and they have to do it throughout the unit, alright. They can’t choose to only enforce the building code in certain areas of not in ___[01:25]. But aside from that local governments don’t have the duty are not required when they choose to undertake a particular project or service, they are not required to provide it or make it available to all their citizens. They can choose strategically to say, “Well, it only make sense from a cost prospective, a policy prospective or otherwise to provide water sewer in the eastern part of town right now.” We might expanded to the western part of the later date but we are only gonna provided in the eastern part of town. And they have the legal authority to make that decision. The Common Log Utilities on the other hand comes in and deals with how to you treat your customers. So, once you have customers and this comes up most often in rate setting, when you have your body of customers what the common log utilities says is, “When you are making differentiations amongst those customers for purposes of charging different rates or fees you have to have a valid utility reason for doing so.” So, for example you can differentiate between residential customers, commercial customers or industrial customers and you can charge higher or lower rates to those different classes but you can’t differentiate between your low income customers and your high income customers because that has no relationship to the utility ___[02:52]. So, you actually can’t provide senior citizen discounts or low income discounts, you don’t have the authority to do that because the utilities law would say, “That’s not the utility reason for differentiating the fees amongst your customers.” So, does that helping… [SPEAKER CHANGES] Very much so, I do have an additional question. In regards to the profits made by the enterprises or similar entities currently there is no statutory requirement that the profits be directed to the infrastructure improvement, right reduction, or the retirement, is that correct? [SPEAKER CHANGES] That’s correct. [SPEAKER CHANGES] Okay, thank you. ___[03:28] [SPEAKER CHANGES] Thank you Mr. Chairman. If we have a private water sewer corporation and an area, can the municipalities lay lines and require those people that are serviced by the private industry that hookup to the Municipal Water Service? [SPEAKER CHANGES] Yeah. So, the question, just repeat the question if there is a private company that’s providing water and sewer in a certain area, could the municipality run lines next to that private companies lines and then force the property owners in that area to connect to the municipalities lines the answer is legally yes, practically I’m not sure we have seen that happen because the cost of expanding infrastructure is pretty high and so for most local governments the decision is to whether to expand infrastructure or not if there is already a unit, if those properties are already being served the infrastructure cost is pretty prohibitive to run the lines parallel but legally they could, legally they could. [SPEAKER CHANGES] Follow up. [SPEAKER CHANGES] Yeah, temp fees, are temp fees totally arbitrary or do they have some relation to what it cost to run a line and put a tap in? [SPEAKER CHANGES] So, I can’t speak to the actual fees that are charged. So, I deal with the legal aspect of legal authority… [0:04:59.9] [End of file…]

I don't track data, so I don't know what's actually being charged out there as tap fees. And again, the label is kind of - what some call "tap fees" others call "convenience fees," which others call "impact fees," and so the label varies substantially and I imagine the amount - there's no legal restriction that says that the amount of the tap fee/convenience fee/etc. has to be capped at a certain level or has to be directly related to the cost. Theoretically, local government could charge a much higher or much lower fee than what it actually costs to connect someone to the system. Whether they do that or not, I can't answer. [SPEAKER CHANGES] Any additional questions from the members of the committee? Thank you very much for your presentation, it was very informative. Lastly, our final presenter is Mr. J.D. Solomon. He represents CH2M Hill and the title of his presentation is Optimization of Public Utilities: An Overview of Trends and Dust Practices. Mr. Solomon, welcome to our committee. You have the floor. [SPEAKER CHANGES] While she's getting me ready, thank you guys for having me today. You're going to hear me talk much more as a practitioner. My current job is I do utility consulting throughout the eastern United States for my firm. So I walk everywhere from Minnesota to Boston - I'm on my way there after this meeting - down to Puerto Rico and all those parts in between. What I do in managing that for CH2M Hill in the eastern US is we do financial consulting, we do what we call asset management, which I'll talk about today, we do operations and management consulting or assessments and we also do strategic planning and regionalization type projects. So you're going to hear a little bit of that. I think when we were talking about the presentation today - I'm a native North Carolinian - but you'll hear me talk a lot about things that other people are doing from the outside. I will say heretofore we have had a great state. I love North Carolina, that's why I live here, that's why I was born here, I guess. But we've done a good job with our utilities to this point but I do think, as you'll hear from the presentation today, we are kind of at a watershed moment in the industry and we've probably been moving that way for a decade and so the things I say today will be how do we stay there for the next 30 years or what not. The first thing I guess I'll do is I'll start with what we call the "triple bottom line" in the business, it's something that's been adopted by EPA, it comes from the 1990's, but it basically says this: to be sustainable, to be viable, our water and wastewater utilities have to blend these three things, it can't just be about the natural environment, it can't just be about the people or the social aspects and it can't just be about the financial. All three of those have to work in a tandem. I think that's a little bit of the problem that we have, if there is a problem. The utility director from North Carolina, who I will keep nameless, told me a couple of years ago, we were doing a big asset management program for him, and he said "J.D., when I broken into this business 30 years ago, it was really to keep the water safe in the rivers, so we're not putting dirty water in the rivers, and we got more clean water to drink." "Nowadays, that job is totally different. Back then, we had government money, we had federal money to come in to help us, we had state money to help us and I was a hero for just doing the basic things. Now that's taken for granted. In fact, we're running it like a business now and people want real time information all the time, they want me to have it analyzed and funded to the tee and they've got to be socially and environmentally responsible all the time. It's a different job. I don't think I'm quite capable of doing that all the time." When you look at that, and I think Jeff Hughes, who spoke to you guys in the first session, I think there's about 400 water and wastewater utilities out there. When you look at the potential for gaps in the ability to manage these utilities, there's a pretty big gap of not having all the right people to do all of these different things we ask utilities to do. On the optimization question, the private side has been doing that for a number of years. From our manufacturing, from our private sector, we do things and you can see the classic Plan, Do, Check, Act loop for continuous improvement but things like lean, which gets away, focuses on waste in our private facilities to get rid of waste, things like Six Sigma that focuses on quality and defect minimization, the private side has been doing those types of things for 100 years. So what's happened over recent years, probably in the last two decades, a number of guidance(?) documents have come out. This is for the US, this is for Australia and New Zealand and this is the new ISO 55,000, it's the international standard that says how do we take care of water and wastewater utilities and what are all these things we're supposed to be doing and how we optimize those things

more efficiently. You can see from those three definitions from those documents, typically we talk about life-cycle cost here. We talk about acceptable levels of risk. We talk about some basic level of service that we have to identify. And it's going to wrap into a bunch of processes and procedures, that's the moment we're sure of it. North Carolina, we have this 159G20 defines asset management as this: Strategic and systematic application of management practices for infrastructure of local government to minimize total costs of acquiring, operating (the whole life-cycle bit), efficiently, reliably, and value of assets. And we do have a definition of that for North Carolina. And if we look through the books here are some of the things that you have to do, so there's a lot of different parts to managing utility. EPA came together with some of the national organizations and said what does it constitute, this was done about 4 or 5 years ago, what are the attributes of a well-run utility/effectively-managed utility? And you can't read all those and that's for a purpose. I want you to see them on one slide because again, my thrust here is to say there's a lot of stuff that utilities have to do to really optimize and do things efficiently. We also have for those utilities, not just guidance documents of what to do in the industry now, but also have a self assessment tool. Actually my firm developed this for the industry, we don't sell it, this was a pro bono type of thing, but actually helps people gap analysis of where they're at and all those different categories so they can assess where they're at. So if I kind of stop at this point, or conclude this little section to say, we know what asset management is, we've got standards for it. Most utilities can go to these documents and do self assessments and they can figure out what they need to be doing. And that's usually not where the problem is. We went out, Mcgraw Hill Construction came and asked us to joint venture on this about a year and a half ago to say let's go out and survey and see what practically speaking are most water and waste water doing. So we went out and surveyed 451 utilities and we said we got all these books and all these great stuff we recommended. What are you guys actually doing? And to what degree are you doing it? And what we found out was pretty interesting: Why do you do it, two main reasons why you do it, because someone has asked me can I defend my budget decisions (that's the first reason we do it, most people said that's the main reason), and the others said better focus on priorities. Better focus on priorities. I will tell you from the study the practitioners, what he call the practitioners that are doing eight-fourteen of these things is how we defined it, they're only about 35 or 40% of all the utilities we survey. So there's hundreds of them out there that aren't even doing these things. And I go around and help people put these programs in, so that's what I do. People ask me, they say: I'm not doing asset management, is that okay? And I said, well, tongue and cheek, if nobody's asking you to be accountable and you know what your priorities are you probably don't need to do it. The truth is everybody needs to do it. And most people are doing it to some degree, it's just how good they're doing it is the question of how formal. We looked at it from the stand point of practices and said, across U.S. and Canada, is there any difference in folks that just do water or just the new-waste water, or do water and waste water, or maybe do water and waste water and storm water, based on size is there any difference? And basically, no. There's no little hot spots. The one observation we did have is the smaller you are, the fewer of the standard practices you do. And to some degree that makes sense. It's not as complicated. It's not as big. Sometimes you can run it a little like you do at your house; more than you do a big thriving business. So there's a little bit of 'that' to it. But, generally speaking everybody is equally good or bad. Now some of the things that were kind of shocking, not shocking to me but maybe shocking to you, is number one up there was a computerized maintenance management system which is basically how we assign work orders to different assets and how we track our work and our activities. Only 55% of utilities are doing that. Okay? Just over half are doing that and that's the leading practice. So most folks can't figure out what work they're doing to which assets; they just kind of go about their business and fix things as they break. And they have very little predictive maintenance on their utilities. The other thing that's interesting if you dig down on that list is, this is in your packages or on your website, but most people don't have a list of the actual assets they own. They have it some kind of financial form you talked about, how they acquired them, but from a really functioning list, they don't know how many pumps they've got or what types they've got. They don't know how many motors they've got and what types. There's not a single list in their utility. So that's a little shocking if you're going to run a utility. Some current trends we'll say, I gave you five here, the one thing we see and I think we're dealing with that in North Carolina, a couple different places, is new delivery platforms.

And we're seeing this all around the country, all around the East. The folks are coming up and asking for em, and this has happened Pittsburg, New York, San Diego, Fort Worth Texas, Baltimore. Basic going to the private side and saying is there some private entity that will come in and take me over and bring me a big wad of cash and bail me out. And those proposals are coming out. The reasons they typically do that, this is what I call lease your utility, not sell it. The reason they do that is they are in a bad position and they need some more money to the general fund. Sometimes they need it in your utility but they need more money. And the value the private sector sees, like in Texas and the Midwest, is there may be some kind of reserves, mineral reserves, underneath the property where the utility is sitting. So if I lease that utility for fifty or a hundred years somebody may pay me $10 million or $20 million just for the right to mine where the local government wouldn't do it. Another reason they do it is, depending on your state, is pension funds. Quite frankly those pension funds are running out of control and they know they don't have the money to pay for those in the utility so they say I want to get out of the pension fund business, just take it away from me. And the last reason, that's a little more subtle, but it's related to an aging workforce and maybe some of the benefits we offer. But I deal with the utility of Florida right now and we're looking at 2080 hours in a year, give people two weeks off for vacation, that's 2000 work hours. And then you've gotta back your way down, maybe 18, 19 hundred on private side. They're telling me to run it at about 1500 hours a year. That's their effective, of all the staff they've hired and how many hours they actually worked toward running the utility they get about 1500 out of them. So what I'll tell you is don't think that privatization project is bad just because somebody is making profit, they're probably not making profit at the expense of the ratepayers, they are probably closing gaps that exist in how the utility operates. Regionalization and partnerships everybody's looking at those, I've got one probably in every state. The biggest one probably that I'm kinda tangentially working on is Louisville Water which is a private company with Louisville MSD which is a public. They're looking at how they form together and find more money. Category two is really about how we might merge, how we might not merge but how do we work together to get more revenue in, find revenue. Poor asset management practice, I'll mention there, some of them are just saying we're gonna make ourselves better. Aging workforce and fewer high school graduates. We don't have as many folks coming out of tech colleges and community colleges that wanna do maintenance and turn wrenches. There is a huge gap there, so how do they address that, do they need to go to the private market to do that or is there something most water and wastewater utilities can do to get the next image of this smaller group of maintenance and operators? And finally stormwater is a growing topic. That's an interesting one in the sense of the controversies around stonewater, do you have your own stormwater utility or not and what are the taxes for that in the enterprise fund for that? The speakers talked about the transfer out of money kind of out of the enterprise fund to the general fund. And I would say that is definitely true the stream is definitely going more around the east out of the enterprise fund to the general fun. I don't think it used to always be that way but it definitely is now. But the more subtle way this happens is on projects, they'll come to you on a project and say if I'm part of the city government we need to improve our sidewalks in downtown, so when you guys, while you're doing the water and sewer, pay for the additional sidewalks. We need to repave the street, so instead of bringing out of the stormwater fund or out of a transportation fund, now the utility is paying all of that cost. And the problem that runs in now is you see more of these merged utilities where you've got ratepayers living outside the municipal boundary. And that practice and that standards happen in the municipal boundary, then those outside ratepayers are paying for these improvements in a municipality of a general fund. And I'm not picking on anybody in North Carolina particularly I'd see it everywhere I'd go in the east or examples of that are happening. And they are happening here. I'm gonna break down a little bit different. I know Jeff he's talked about this earlier and our speaker Ms. Alonzo, she did a good job of this. I'm gonna break it down in three different ways and maybe a little bit different and tell you what we're seeing. By far and away the traditional practice is what they call a unit of local government. In North Carolina that's the most common. I think there's only eight authorities in the whole state. So we're that way. If you go to South Carolina or Georgia there's probably an equal amount of authorities or public service districts than there are units of local government doing this. That's some that had to be the way they were formed and initially financed. But, never the less, it's very common for it to be part of local, unit of local government anywhere we go. Those units of local government keep their powers, if you will, and at some point you have an inner local agreement and I think most of you guys are familiar with that

They basically say they will sell sewer and water back to each other until we get into a crisis, then we will take care of our own, but basically we have a contract. The other two entities in this category and again the speaker spoke about this earlier in detail. There are districts and authorities and there are fine lines here, the thing I want to leave with with the districts that I see. Whether they are water and sewer districts or public service districts, normally they do have some taxing authority; or in many states they can raise the general taxes and authorities definitely can not. That is layman speak for what I generally see around the east. Normally when we look at those two entities we have to be real careful with our authorities. Sometimes an authority will form from a couple of different members and then they will realize, "wow, the only we can finance this is some kind of revenue bond. We need to go back and get some different kind of legislation to do something different to fund any holes we're in." I like authorities but you have to be careful when you form authorities that make sure you have the revenue streams and the legal constructions to get the money you need from the bond market. We have a number of those in North Carolina, as I mentioned. Merged utilities are common, Charlotte and Mecklenburg Counties did those in the eighties. I worked with all the utilities in eastern Wake County to merge into the City of Raleigh. Morrisville and Cary merged together. Basically what that is, is one seceding all their interests to that base owning public entity; and that public entity basically finances everything and manages everything. ?? union local government, I would put them all into that category. There are powers that have been amply discussed earlier about what those folks can and can't do. The other thing that we see and we have one of these in every state and I think you'll call these the local acts or the local authorities. Some kind of unique structure that exists in basically about every state to say two entities want to come together, they want to bring their money together but they want to stay independent. The example in North Carolina I'll bring up, right here is Cary and Apex. Two independent utilities, Apex brings in 26% of the money to fund the waste water plant, Cary brings in the balance. They work almost like a private company without finance they pay each other back, Cary operates it and pays Apex back for it. But other than that water plant and their big waste water plant everything else is totally independent. Everything state that I go into has to have some thing from the general assembly that says they can do that, and authorize that. Those are not uncommon and I am working on one now in Wisconsin where they are going to do exactly that. So they like that construction moving forward. The last one I'll say is full privatization and I'll talk a few minutes about that. This forms in some entity where it could be sold, a lot of places it it sold, other states. Typically not here but in a lot of other states. Especially the midwest, you've got private water companies that basically own the assets and charge back to the customers. Those are always managed by the State Utilities Commission and go through same as you would any investor owned utility. They can also take the form of a public/private partnership. Typically, the private part of this public/private partnership means money is being exchanged. Contract operations is simply where you have a third party operator come in and operate your facility but they are just a contract operator, you are renting labor basically and there is no purchase or lease of the utility that's done. P3 options you guys have done some of that in this general assembly but you can see this is a transportation slide. You can see a growing number of P3 opportunities that exist out there. On the privatization this is for a project, internally this is The Water Project, LLC. It could be the Water Utility, LLC. If you look on one side the public interest brings some support and interests. It may be condemnation rights, it may be property rights to your land. The private entity brings the balance of the money and there is some term that they will work together to operate that utility and then convert it back over. Why are we looking for alternative solutions now? I think I said all three of those reasons, but basically our traditional funding resources are not there, and they are not going to be there in the future. So, this is a lot of like I would call when your kids grow up and I've got a couple kids right now in college, but at some point they realize that the rent's not going to be paid for them anymore and the rents not going to be made; now, they are going to go out and look for sources of income. Utilities are figuring our the Federal and State Government are not going to bail them out at this point so they have got to go out and do something different than they have traditionally done in the past. The other thing that has happened is...

They had deferred a lot of investment, I think that's been explained to you guys previously as well as this for me. But it is in the rates and fees of the water and sewer utility that do not have to reflect the fully deprecated cost. Which means they're not building up the bank in a lot of places for capital replacement funds. So things are being worn out, and the funds help balance it out quite a bit. Some of the utilities I work with have a billion dollars worth of assets out there. And they've got very little in money sitting there for capital replacement funds. They're waiting for that next check to come in from the Federal government and they're going to blow up. And they know they're going to blow up. They're trying to figure out how to get out of it. So I think that's what really going on out there in the market with deferred investment and what happens in the municipal environment. As was explained previously, the money seems to flow back from the enterprise fund into the general fund a lot more if it's part of the local government. Different ways it does that. Doesn't happen everywhere but it does happen enough for three speakers today to talk about it. So it must be happening somewhere to some extent. But it is moving back that way and what happens is if somebody builds up enough capital replacement money to really do you your utility right like you might do on the private side, that money can get scraped off in different ways. Maybe it's a loan, maybe it comes back, but there's some hesitation of folks that their money's going to get raided if they really build up their capital replacement fund. Four or five things that I leave you with, going to wrap it up. Become much more complex over the years, utility management has been in some ways outstripped. Folks who got into this business their ability to deal with it—I think that you've heard a lot of legalistic arguments about how the business has gotten more complicated, or how operations and maintenance side and receiving have gotten more complicated with new technologies and looking at the useful life of equipment. Optimization, greater efficiencies and less funding really has kind of outstripped and what I think and what I see in other parts of the country traditional public utilities from being able to keep up with what's going on, they've needed that outside money to keep going. No single solution, but if I leave you with anything don't think that JD's bashing either the municipal structures or the private structures. There is a right fit for the right environment and it has to do with a pretty—you need to look into all these details and know what's right but you need as I say kind of down at the bottom bullet you need to have all the tools available to you and my opinion is to do this. So you can't favor just the local government structure, you've got to look at public/private and privatization all need to be equally viable in the state if we're going to have the full window. We're seeing all of these being used in other states, and being talked about, and just because a structure doesn't in place now, Ms. Mallanzo showed that picture of all the districts that can offer water, and Wisconsin I think the list was at least twice that big. And they were talking about how we run legislation just to get a new construction if that's what fits. So the thing that I say is that if there's something that seems to be working better in another state, that seems to work better, let's try it! So, that's usually what I tell people in other states. So with that, I'll conclude my remarks. [SPEAKER CHANGES] Thank you Mr. Seldman. Any questions from members of the committee? Seeing none, thank you very much Mr. Seldman for your presentation and sharing your time with us this morning. [SPEAKER CHANGES] Representative Cleveland. [SPEAKER CHANGES] Yes. They do have to have a tap fee. The tap fee's supposed to have a basis for it. In most places it's capped and the full recovery of the tap fee is not taken into account. So if you see some that have 3 or 4 thousand dollars for a tap and others have 800, the 800's probably not enough. [SPEAKER CHANGES] Representative Graham, did you have a question? You did not, OK. Very good. Thank you Mr. Seldman. [SPEAKER CHANGES] Thank you. [SPEAKER CHANGES] One question I do have for not for Mr. Seldman but maybe Ms. Mallonzi, in regards to the obligations of local elected officials, is their primary obligation to the taxpayers or to the right payers when ti comes to their oversight responsibilities on a multi-jurisdictional public enterprise? You have to hold it down. [SPEAKER CHANGES] Oh, sorry. Different. OK. I think that's a difficult question. I think that their obligation is to the unit. The governing board's obligation is to the unit and the unit provides an array of services and performs an array of functions, some of which may be public enterprise activities. So I think that the ultimate oversight responsibility is for the unit as a whole. The law does not set up a distinct responsibility if you will just for the public enterprise activities. So the way it's currently designed they're just among the array of functions that the local government provides. Or serves. [SPEAKER CHANGES] OK.

Thank you. Mr. Solomon, you have a comment? [SPEAKER CHANGES] Yeah, I was just going to say. If it's a new merger and, the Raleigh mergers and stuff, when Wake Forest, Roseville, those communities agree to come into Raleigh, there was a merger agreement and there were terms that were specified out that Raleigh was, it's elected officials were obligated to fulfill in that contact. Now, if it's not a former merger agreement and things have just kind of evolved that way over 50 or 60 years, then I know she's right, but they really do have it for their jurisdiction first and their other rate payers second. But normally, if we do a modern merger, a lot of this terms and conditions are spelled out. [SPEAKER CHANGES] Very good. Thank you. Any additional comments from members of the committee? I'd like to thank all of our presenters this morning. Yes, our good folks at the school of government. We always appreciate your willingness to attend and share your thoughts and history with us. Mr. Solomon, thank you for being here. As I mentioned at the beginning of the meeting, this will be our last meeting of this committee until after the short session. We'll be taking up some recommendations in the fall. We'll vote on those and we'll push those recommendations into the long session of next year. Until then, we stand adjourned.