No Futilities for Utilities: CFEs' Roles in Energy Company Anti-Fraud Efforts

Some public utility companies still have a skewed set of incentives. As CFEs, we can help deter fraud and mitigate some of the inefficiencies with many of the same methods we've used to solve dilemmas for other industries in the past.

On April 6, 2001, San Francisco-based power supplier Pacific Gas and Electric (PG&E) filed for Chapter 11 bankruptcy in federal court. According to that day's CNN story, "PG&E Seeks Bankruptcy," it was the culmination of an extremely bizarre year in which the once-proud energy company became insolvent as a result of being charged higher prices for electricity than it was legally allowed to pass on to its customers. Baffled experts and other energy companies scrambled to determine the failure's cause. Certainly nothing in PG&E's history would have suggested that something like this was even remotely possible, and no company wanted to be the next to falter.

During the aftermath from this crisis, investigators would find that fraudulent practices in some of PG&E's suppliers were major catalysts for its collapse. Though the bad actors are no longer in the picture, many of the conditions that caused the bankruptcy are still prevalent. CFEs have the specialized skills municipality clients should seek to ensure public energy companies are doing their part to deter fraud and provide optimal service for customers at reasonable prices.

ENERGY DEALS GONE BAD 

In the late 1990s, California's vast energy deregulation essentially forced regional suppliers like PG&E, Southern California Edison, and San Diego Gas and Electric to sell off parts of their power generation operations to private and unregulated companies like Enron, Reliant, and AES. At the time, it seemed to be a worthwhile procedure because it purported to imbue a public good with the efficiencies and economies of scale provided by large private companies. Theoretically, it would save California taxpayers millions of dollars. However, according to a May 8, 2001 San Francisco Chronicle article, "Energy Crisis: How We Got Here," the state effectively put itself and its 30 million residents at the mercy of these energy juggernauts.

Energy expert Phil Harrington said, during a 2003 International Energy Agency (IEA) conference, that a 5 percent reduction in electricity demand would reduce energy prices by perhaps 50 percent. (Harrington is head of the energy policy analysis division for IEA.) Energy company representatives, behind closed doors, turned this theory around; if they could somehow increase demand for electricity, they would be able to charge oppressively high prices for their product, without any additional costs to the companies.

How, you might ask, does a company increase demand for a product like electricity that most people and businesses use without a second thought? It would seem that no one would ever consciously decide to increase their power usage without a compelling reason, and, barring periods of extreme temperature swings, demand should theoretically remain fairly constant.

However, the San Francisco Chronicle reported in its Dec. 24, 2001 article, "The Energy Crunch: A Year Later," that Enron, among others, was able to artificially impose higher demands on these regional electricity suppliers, like PG&E, using devious tactics such as planned blackouts, intentional over-scheduling of main power arteries, use of aliases to prevent the buyer from knowing where the electricity originated, and manipulation of spot-market prices.

The unscrupulous energy giants then were able to charge astronomical prices to local energy companies (deregulation had prevented any price caps on that end), which were forced to eat the losses themselves because they were restricted in how much they could charge residential and local business customers for electricity. By this time the federal government had intervened but not before the debacle had claimed many victims.

BAD PRACTICES PERSIST 

Now that so much time has passed since the fallout in California and the subsequent Enron bankruptcy, most casual observers tend to view the California Energy Crisis as something that happened in the dark ages of the pre-Sarbanes-Oxley era.

They believe it to be a type of one-off that would be impossible in today's economy with our increased regulation and stringent monitoring methods. After all, Enron is now out of the picture completely; it was the unscrupulous renegade element responsible for the crisis in the first place.

But while public utilities and municipalities have made improvements and weeded out particular unethical elements, many problems persist that no amount of legislation or accounting reform can combat.

Some public utility companies still have a skewed set of incentives. They attempt to appeal to politicians rather than end users and, in their drive to become bigger, better, and more efficient, they might have lost the ability to communicate with their customers. As CFEs, we can help deter fraud and mitigate some of the inefficiencies with many of the same methods we've used to solve dilemmas for other industries in the past.

CONFUSING BILLS 

Most gas or electric bills are confusing at best. We probably could figure out how many gallons of milk or cups of coffee we go through in a month, but few of us can really estimate how many kilowatt-hours we consume. We can't really confirm or deny responsibility for the charges, even if the bills seem excessive. That makes the bills difficult to dispute and far too insignificant to litigate in court. So imagine a municipality's difficulty in confirming bills from its energy company.

If a city is one of your clients, you can, of course, check fictitious billings and over-billings in the energy company's financial statements. You would attempt to trace revenues from the income statement all the way back to source documents, which should give you some evidence of the method in which billing amounts are tabulated. You can prudently determine the reasonableness of estimated charges and prevent the energy company from incorrectly billing its customers - both municipal and individual end-users.

Also, many of these companies - depending on state, local, or national laws - might be subject to billing disclosure rules, which require that they notify their individual customers about billing calculation methods. However, many customers probably aren't aware of these requirements and consequently don't notice violations. We can ensure, through sampling of customer listings and interviews with lower-level power company personnel, that these stipulations are closely followed.

Allegiances within the public utility sector often can be divided - to the individual customers' detriment. Customers generally don't decide which energy services they'll use. The local politicians inadvertently set up community monopolies by selecting natural gas, electricity, and cable services because a particular geographical area can't physically or economically accommodate more than one provider at a time. That means prospective companies might be more concerned with selling themselves to politicians than to their customers. Sure, disgruntled customers can threaten to have their gas turned off. But, of course, most wouldn't do that.

POLITICS AS USUAL 

Some say that politicians represent the public, and when the public is angered, those politicians will take action. The right to vote, they say, is sacred. But many citizens are apathetic and don't vote and some politicians will act in their own self-interests. So there's often a difference between what citizens want and what politicians believe citizens want.

While it's unfair to say that all politicians are unresponsive, it might be more accurate to say they're selectively responsive; they can't reasonably or fully respond to the needs of every constituent. But there are certain individuals who are particularly difficult to ignore: the most vocal and well-heeled. Chief among these can be big businesses and their management teams because their contributions and support can aid politicians when a few thousand votes can make a real difference. Of course, many politicians aren't greedy; they might just assume the interests of energy companies coincide with those of private citizens, and in smaller jurisdictions, this could be true.

Energy companies, no doubt, are fully aware how the political structure works, and this is reflected in their rate structures. There's no inherent injustice here; energy companies simply need to be responsive to those who have the most political clout.

We must train ourselves to better identify billing patterns and discrepancies so the financial well-being of important and politically connected industries doesn't come at the expense of the residential and small-business energy customer.

Folksy eco-pioneer and author S. David Freeman concluded in his May 15, 2002 testimony before a U.S. Congress subcommittee in the wake of the California energy crisis, "Such a well-concealed billing method is always inherently subject to manipulation." (Freeman had been appointed chair of California Power Authority during that time.)

PLAYING MONOPOLY 

It becomes difficult to remove energy companies once cities grant them monopoly status. These companies often lock local governments into long contracts through negotiating pressures and promises of long-term savings. Cities don't want to repeat the painstaking bargaining process, and they don't often have the clout necessary to go toe-to-toe with the powerful energy companies.

Of course, local communities also have expensive and cumbersome infrastructures they're loath to scrap or rebuild if they were to sign on new energy companies. Abandoned power plants and factories are eyesores and indicate post-industrial economic malaise. So sometimes a city will feel it's wiser to keep an inept and inefficient energy provider. However, this can sometimes encourage utilities to be inefficient and stagnant - all at taxpayers' expense. This can also adversely affect local economies, which will suffer their own inefficiencies if they don't have reliable power sources like their nearby competitors.

CFEs are qualified to consult with municipal and county governments because we know how to investigate financial inefficiencies and abuse resulting from sustained poor judgment. We also need to warn energy companies that their contracts with governments obligate them to specific energy and environmental standards, and breaches of these duties are potentially serious offenses.

We should also alert these governmental entities about the dangers and inefficiencies associated with industrial monopolies. Many governments still will choose to grant monopoly status to energy companies, but if they're warned in time they might install more stringent reporting and regulatory requirements in addition to frequent inspections.

After a local government grants a monopoly contract to an energy company in a certain region, the company is typically limited in the profits it can make from customers. Though its billing methods are somewhat mysterious, it often can't legally charge more for basic services without some kind of reasonable justification. Even if the energy company upgrades its infrastructure, it's difficult to justify charging more for a service in which the end product essentially remains the same. That leaves energy companies with little incentive to improve their facilities.

It would seem the only way energy companies can justify costly internal improvements would be for those renovations that save them money and increase their profits. But often the upfront costs of renovation and reconstruction are significant, and the periods of recovery long, so energy companies will rarely upgrade unless there's considerable pressure from the government. (Also, some utility companies are afraid of costly environmental liabilities if they expand or innovate.) The result is dated utility equipment without the latest user-friendly and environmentally sound devices.

These entities generally require heavy up-front investments in infrastructure, intellectual property, and human resources, making it difficult for competitors to unseat entrenched energy companies. The final result is an alarming deviation from the classic competitive model, which historically has worked to the customers' benefit.

KEEPING ENERGY GIANTS HONEST 

We need to ensure our clients - local governments and energy companies - meet regulatory standards and promote investment in assets that will help them sustain environmental and societal responsibility for years to come. We can emphasize that it's in their best financial interests, at least in the long term, to continually innovate and reinvent because it will help them stave off competition, and reduce costs, even if they don't want to be responsible members of the community.

Though power companies typically operate in monopoly environments and aren't subject to economic competition, we can still perform ratio analyses on them and use benchmark analysis to compare their efficiencies to similar companies operating in similar environments.

Obviously, this isn't an exact science and any analysis is subject to bias, but power companies that don't have to compete for market share should learn to compete so they can prevent fraud and avoid public embarrassment. No energy company wants to be revealed as the one that charges the highest rates in the state and spends the least on reinvestment and maintenance.

Similarly, we can use horizontal analysis when reviewing power companies to ensure they don't become less efficient as years pass and as they become further established within the community. By comparing efficiency from year to year, we can help verify they aren't wasting money, keeping more for themselves, or committing fraud just because they've earned the public's trust. Most companies' financial information is public because most of them are legally obligated to have some financial clarity. These accountability laws show that not everything that happens in corporate America is hidden behind closed doors.

PROTECTING CITIZENS  

In the past, customers believed energy companies were vital parts of community "families" and these companies genuinely heard their concerns. If citizens had invoice complaints or gas leaks they could appeal directly to employees who might be their neighbors or friends. However, U.S. energy deregulation over the last three decades has swept away the cozy, familial relationships and created adversarial relationships.

No one likes to contact impersonal customer call centers in unknown cities. Burgeoning energy conglomerates have used economies of scale to their advantage and usurped contracts from smaller companies, which, in theory, saves taxpayers' money. This might seem to be a more financially sound model, but it has alienated users and created social distrust and accountability gaps - all of which can lead to ripe conditions for fraud, waste, and abuse.

Many citizens have adopted a fatalistic attitude toward monopolized public utilities. As politicians seem to weed out sloth-like energy conglomerates, we can't hope to revert back to the days of the trusty mom-and-pop energy companies; the current energy companies wouldn't allow it and local governments would scoff at the price tag. So perhaps it's a bit too optimistic to think that the federal government, beleaguered with an entrenched energy lobby, will impose stringent regulations.

In the meantime, we CFEs can offer our services to protect citizens and help restore trust. We can advise our municipality entity clients to ensure public energy companies work to deter fraud and provide optimal service for customers at reasonable prices. We might need to expand our skills for these clients, but we certainly possess the required competencies to help alleviate consumers of the burdensome and inefficient practices carried out by some energy companies.

Michael Ferguson, CFE, CPA, is a senior consultant with FTI Consulting in Washington, D.C. He deals primarily with financial institutions and government entities. 

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