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BOARD OF SUPERVISORS

:
The Airport’s Investment in SFO Enterprises, Inc. Will Result in Losses of $667,000 and May Increase Up to $1.5 Million

FINANCIAL AUDITS

January 22, 2007

City and County of San Francisco
Office of the Controller – City Services Auditor
Board of Supervisors: The Airport’s Investment in SFO Enterprises, Inc. Will Result in Losses of $667,000 and May Increase Up to $1.5 Million Purpose of the Audit At the request of the Board of Supervisors of the City and County of San Francisco, we conducted a financial review of the City’s investment in SFO Enterprises, Inc. Highlights The Airport’s Investment in SFOE Will Result in a Loss The San Francisco Airport Department (Airport) will lose at least $667,000 from its investments in the private, for-profit corporation, SFO Enterprises, Inc., (SFOE). The Airport is now closing the operations of SFOE, and SFOE’s financial position consists of the following: • Recorded assets of $1,523,732, including a receivable of $787,200, which is contingent upon future events, from the sale of SFO Honduras, a subsidiary of SFOE. Recorded and unrecorded liabilities of $2,190,719. Recorded liabilities include $1,087,559 owed to the Airport for prior consulting services to SFOE. Unrecorded liabilities consist of unbilled costs of $760,673 that the Airport did not allocate to SFOE. • Recommendations The audit report includes six recommendations for the Airport to properly account for the closure of SFOE, and to manage outside contracts, including the following: • Retain SFOE’s liability of $1,087,559, plus interest, on the Airport’s books until SFOE receives the remaining proceeds of the sale of SFO Honduras or the receivable becomes uncollectible. Collect from SFOE any amounts received from the proceeds of the sale of SFO Honduras, in addition to any remaining cash in its bank accounts to reduce the debt owed to the Airport. Formally enter agreements with outside agencies before providing any services. Ensure that its employees adhere to the Controller’s travel policies even when they are working as consultants for private companies. January 22, 2007

If SFOE does not collect the receivable from the sale of its subsidiary, the Airport’s loss will increase to $1.5 million. The Airport Could Have Better Managed Its Relationship With SFOE The Airport did not consider potential internal control weaknesses when it assigned some of its upper management staff as officers of SFOE and then assigned some of the same staff to manage the agreement on behalf of the Airport. This may have resulted in such questionable actions where the Airport: • Provided services to SFOE before it had any formal agreements with SFOE and was 18 months late in formalizing the repayment agreement with SFOE to pay for past services. Did not consistently identify all its costs related to SFOE, as well as its other international services projects. Did not always follow city rules in conducting work for SFOE.

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CITY AND COUNTY OF SAN FRANCISCO OFFICE OF THE CONTROLLER

Ed Harrington Controller
Monique Zmuda Deputy Controller

January 22, 2007 Supervisor Aaron Peskin, President Board of Supervisors City Hall, Room 244 1 Dr. Carlton B. Goodlett Place San Francisco, CA 94102 Dear President Peskin: The Office of the Controller (Controller) presents its report on the audit of SFO Enterprises, Inc., (SFOE) a private, for-profit corporation, of which the City and County of San Francisco (City) is the sole shareholder. This corporation was formed in 1999 to allow city staff at the San Francisco Airport Department (Airport) to provide airport management consulting services through the corporation to other international airports. SFOE has been awarded only one contract to manage a foreign airport. The Airport is in the process of terminating the operations of SFOE, and SFOE has completed the sale of its only subsidiary, SFO Honduras, LLP. The fiscal year 2003-04 Annual Appropriation Ordinance directed the Controller to conduct this audit upon the termination of operations of SFOE. We believe this venture will ultimately result in a loss to the Airport of at least $667,000 growing to almost $1.5 million depending on whether the sale of SFO Honduras ever produces enough income to offset the costs of the venture. The actual cost of this venture is clouded by the interaction of the Airport’s International Services Division and SFOE. The Airport contends that the two entities are separate and while there is legal separation, their reason for existence, management, and staffing are virtually identical so we often viewed them as one entity for this audit. Both entities were created to provide management and advisory services to international airports. Accordingly, we identified additional costs that we believe could be attributed to the venture. The Airport’s response is attached to this report. The City Services Auditor-Financial Audits will be working with the Airport to follow up on the status of the recommendations made in this report. Respectfully submitted, Original signed by: Ed Harrington Controller

415-554-7500

City Hall • 1 Dr. Carlton B. Goodlett Place • Room 316 • San Francisco CA 94102-4694

FAX 415-554-7466

INTRODUCTION
BACKGROUND Over the past 10 years, the San Francisco Board of Supervisors and the Airport Commission, through a series of resolutions and ordinances, approved the concept of the Airport Department (Airport) offering management services of Airport staff to assist managing other international airports. This culminated in the Airport forming SFO Enterprises, Inc. (SFOE), of which the City and County of San Francisco (City) is the sole shareholder, in September 1999, to provide international airport management and other advisory services. In February 2000, SFOE organized SFO Honduras LLC as a subsidiary to participate in the consortium that eventually won the concession to operate four airports in the Republic of Honduras. In connection with its bid, the consortium organized InterAirports, S.A. (InterAirports), a Honduran company, to act as the actual operator of the airports. SFO Honduras and InterAirports entered a contract in May 2000 for SFO Honduras to provide operation and management services to InterAirports for an annual fixed fee of $750,000, adjusted annually by the consumer price index, together with a variable fee. The appendix shows the relationships of the various parties. Because SFOE did not have sufficient initial capital to hire its own employees and to pay for other services, SFOE planned to use the Airport’s employees to perform the corporation’s services. In return, SFOE agreed to reimburse the Airport for payroll costs, travel expenses, and other services performed by Airport staff and other vendors. In March 2001, critical articles concerning SFOE began appearing in the press. When the Board of Supervisors (Board) approved the Airport’s fiscal year 2002-03 budget, it placed on reserve 75 percent of the budget for the International Services Division. According to a letter from the City’s Office of the City Attorney (City Attorney), the Board decided to impose the reserve due to policy concerns about SFOE’s operations. By this time, SFOE was already exploring the possibility of selling its interest in SFO Honduras. According to the letter, throughout fiscal year 2002-03, the Airport director asked the chair of the Board’s finance committee to calendar the release of the funds on reserve. Subsequently, the Board included an administrative provision to the Airport’s fiscal year 2003-04 Annual Appropriation Ordinance which stated that the Airport could expend up to $115,000 of already appropriated funds in the Airport’s budget to complete the termination and/or disposition of SFOE no later than January 1, 2004. The administrative provision also required the City’s Office 1

of the Controller (Controller) to complete an audit of SFOE upon termination of its operations. SCOPE AND METHODOLOGY The purpose of our audit was to identify the Airport’s costs of operating SFOE from its inception in September 1999, and the revenues and expenses related to the termination and sale of SFOE’s subsidiary, SFO Honduras in December 2004. We focused our review on the financial results of operations of SFOE, and its subsidiary SFO Honduras. We did not perform financial audits of SFOE, or its subsidiary, because both entities are audited annually by an independent certified public accounting firm, and the firm has submitted to the Airport audited financial statements for each of the calendar years 2000 through 2004. To perform our audit, we inventoried and reviewed all of SFOE’s records made available to us at the Airport’s offices in South San Francisco. Although we reviewed these records, which included other international services ventures and projects which we make reference to in our report, we did not perform an audit of these other ventures and projects. We tested on a sample basis payroll records, travel reimbursement records, and professional services records for SFOE. We examined all relevant contracts entered into by SFOE, including its contracts with the Airport for repayment of services. Finally, we reviewed the relevant provisions of the sale of SFO Honduras to determine the proceeds due to SFOE.

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Chapter 1
THE AIRPORT WILL LOSE $667,000 AND ITS LOSSES MAY INCREASE TO ALMOST $1.5 MILLION SFO Enterprises, Inc., has assets of about $1,523,732, which includes the proceeds from the sale of its subsidiary, SFO Honduras, LLC. However, the likelihood of SFOE collecting outstanding sale proceeds of $787,200 is unknown and is dependent upon contingent events. SFOE’s assets are offset by outstanding recorded debts of about $1,430,046 for consulting services it provided to SFOE in prior years and outstanding attorney fees. Moreover, SFOE has additional unrecorded expenses of $760,673, which the Airport did not charge to SFOE. These include unbilled consulting services, attorney fees, expenses incurred in its efforts to obtain international airport management contracts prior to the creation of SFOE, as well as additional charges for not consistently charging SFOE for the cost of Airport employee benefit and service charges. If SFOE collects its outstanding receivable, the Airport’s loss will be reduced to about $667,000. However, if SFOE’s receivable of $787,200 is uncollectible, then the Airport is at risk of losing almost $1.5 million. The following table summarizes SFOE’s recorded and unrecorded assets and liabilities we identified in our audit. TABLE 1
SFOE Recorded and Unrecorded Assets and Liabilities As of September 30, 2005 Recorded Assets Cash in Bank Accounts (Note 1) Receivable from Sale of SFO Honduras (Note 1) Total Assets Liabilities (Note 2) Due to Airport Consulting Services Costs Incurred After Incorporation Costs Incurred Before Incorporation Due to Others Outside Attorney Fees Total Liabilities NET ASSETS Additional Loss if Above Receivable Not Paid TOTAL POTENTIAL LOSS $736,532 787,200 1,523,732 Unrecorded Total $736,532 787,200 1,523,732

1,087,559 $357,919 402,754 342,487 $1,430,046 $760,673

1,087,559 357,919 402,754 342,487 2,190,719 (666,987) (787,200) ($1,454,187)

Note 1: Includes the payment of $447,800 on April 4, 2006 for a portion of the receivable. Note 2: The Airport has advised us that SFOE has other insignificant liabilities that we have not included in this table.

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SFOE May Not Receive All the Proceeds From the Sale of Its Subsidiary Following the direction of the City and County of San Francisco’s Board of Supervisors, the Airport started closing the operations of SFOE by selling the corporation’s sole subsidiary, SFO Honduras in December 2004 for a total consideration of $1,482,836. As of April 4, 2006, the Airport had not received most of the sale proceeds from the sale to YVR General Services in British Columbia, Canada. According to the Airport’s deputy director of business and finance, SFOE had received $15,000 cash, and relief from liability associated with InterAirports’ equity calls totaling $232,836, and $447,800 in the par value of the transferred shares of InterAirports stock. Approximately $787,200 of the sale proceeds is still contingent upon future events. According to the Airport’s deputy director of business and finance, these payments are contingent upon InterAirports’ future profitability and dividends to shareholders. When asked of the likelihood of receiving the contingent payments, the Airport’s staff directly associated with SFOE could not give us an estimate. The Airport Has Not Recovered All Its Invoiced Costs for Providing Consulting Services to SFOE In providing Airport staff to conduct work for the corporation, the Airport and SFOE agreed that SFOE would reimburse the Airport for payroll costs, travel expenses, and professional services provided to SFOE by Airport staff, plus interest. During the five years SFOE conducted its business, the corporation and its subsidiary experienced a net loss of more than $863,000 and as a result did not pay the Airport for all the services its staff provided to SFOE. Although the Airport billed SFOE $1,938,619 during the five years, SFOE has paid the Airport only $851,060, and still owes the Airport $1,087,559, plus interest. The Airport Did Not Charge SFOE for Several Costs The Airport incurred a number of costs on behalf of SFOE that the Airport did not charge to SFOE. As shown in Table 2, we identified $357,919 in payroll, benefit, and service charges that the Airport could have billed SFOE, as well as several attorney charges.

SFOE owes the Airport $1 million in past due charges.

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TABLE 2
Other SFOE Expenses Not Billed to Airport Expenses Incurred Outstanding, Unbilled Charges Staff Benefit and Service Charges for FY 1999/00 Staff Payroll Not Billed for FY 2001 through 2003 Outside Attorney Fees Paid By Airport Outside Attorney Fees Split With Airport City Attorney Fees Paid by Airport International Services Development Costs (Travel) Amount $45,623 54,637 25,409 80,717 91,671 33,560 26,302 $357,919

1. 2. 3. 4. 5. 6. 7.

Total

(1) Outstanding Unbilled Charges. The Airport has advised us that it has not invoiced SFOE for services provided by the Airport from January 1, 2004, through June 30, 2004. (2) Staff Benefit and Service Charges. The Airport was not consistent in charging SFOE for the use of its staff. The Airport, while including a provision for the payment of staff benefits, did not charge the same benefit rates throughout the period it was providing staff services to SFOE. From September 1999, through June 2000, the Airport charged SFOE for staff benefits ranging from 7 percent to 40 percent of staff hourly rates. In subsequent years, the Airport charged staff benefits rates ranging from 36 percent to 41 percent of the hourly rates. We believe the higher rates to be more representative of the benefits paid to employees, and that the Airport could have recovered an additional $29,501 in staff benefit costs. The Airport also was not consistent in requiring the payment of a service charge. Although the Airport agreed to charge SFOE for service charges of 10 percent for July 2000 and after,1 the Airport did not require any payment of service charges prior to July 2000.2 Since the two agreements were signed on the same date, it appears reasonable for the Airport to have charged the same rate for both periods. We estimate that the Airport could have recovered an additional collected $25,136 in service charges.

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Letter Agreement Regarding Services Provided by SFO to SFOE, dated March 12, 2001. 2 Letter Agreement Regarding Repayment of Expenses, dated March 12, 2001.

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(3) Staff Payroll Costs. The Airport did not charge SFOE for all the time its employees spent conducting work for the corporation. In reviewing a sample of timesheets, we found that the Airport did not charge SFOE the following: • 115 hours spent by the Airport’s chief of staff when he also acted as SFOE’s chief executive officer from 2000 through 2003 ($12,703 in unbilled payroll, benefits, and service charges). 64 hours charged as Airport-related business when travel reimbursement vouchers showed the employee was in Honduras conducting work for SFOE, and attending a conference for which the Airport charged the travel expenses to SFOE ($5,105 in unbilled payroll costs). 81 hours spent by the Airport’s director of the International Services Division3 when he also acted as SFOE’s chief financial officer. This includes time spent attending SFOE board of directors’ meetings, attending meetings discussing SFOE matters, and conducting preliminary work for the sale of SFO Honduras ($7,601 in payroll costs and benefits).

(4) Outside Attorney Costs Incurred by the Airport. The Airport engaged the services of a law firm, Morrison & Foerster, LLP, to provide it outside counsel. The services specifically related to advice regarding SFOE incorporation costs and advice to Airport employees who also served as SFOE’s officers, and could be charged as an expense to SFOE. (5) Outside Attorney Costs Incurred by SFOE. The Airport unnecessarily agreed to pay for some of the legal services directly provided to SFOE. The corporation had also engaged the services of Morrison & Foerster to provide SFOE legal counsel. Although the law firm provided and billed for the services it provided SFOE in 2003, most of the law firm’s invoices remained unpaid. Although the law firm initially charged only SFOE for the legal services that were primarily related to the negotiations for the sale of SFO Honduras, Morrison & Foerster in December 2003 reissued new invoices, totaling $189,110, that split the amounts due and billed approximately 50 percent to SFOE and 50 percent to the Airport. In its letter accompanying the invoices, the firm noted that this allocation of costs to SFOE and the Airport reflects SFOE’s board of “directors’ judgment as to the reasonable allocation of costs of this activity in light of the need to protect the Airport from potential claims (however unfounded they might be) in connection with the termination of these activities.” Further, Morrison & Foerster acknowledged in its letter that the law firm was reissuing the invoices in accordance with the Airport’s direction. Nevertheless,
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The Airport unnecessarily agreed to pay more than $91,000 of SFOE’s attorney expenses.

Now deputy director of business and finance.

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since SFOE was created as a separate corporation to avoid liability to the City, we believe that SFOE should pay for these attorney fees. (6) City Attorney Costs. The Airport’s assigned deputy city attorneys provided legal services to the Airport’s International Services Division, but the Airport did not charge SFOE for any of the city attorney charges. According to one of the International Services Division managers, who also worked as a consultant for SFOE, the great majority of work done by the Airport’s legal team was performed to represent the Airport’s interests as opposed to SFOE, and for this reason the Airport generally did not charge SFOE for costs associated with the Airport’s legal counsel. However, since the Airport’s management agreement with SFOE allowed it to charge SFOE for professional services, the Airport’s costs for SFOE-related legal services could be included as a charge to SFOE. (7) Travel Costs. The Airport did not include in its invoices to SFOE any travel costs to conferences and other places for business activities related to privatization efforts, but not directly related to SFOE. According to the Airport’s assistant deputy airport director of capital planning, these amounts were considered development costs of the Airport. However, in the absence of an agreement that the Airport pay for development costs, we believe that the expenses paid after the incorporation date are development costs of the corporation and therefore could be charged to the corporation. The Airport Could Also Charge SFOE for Costs of Other International Airport Management Efforts We identified $402,574 in charges incurred by the Airport before the creation of SFOE that we believe could be charged to SFOE since the charges were related to international airport management services. Table 3 summarizes the costs we believe could be charged to SFOE. TABLE 3
Other Costs Incurred Prior to the Creation of SFOE Expenses Incurred 1. International Services Charges (net) 2. City Attorney Costs Paid by Airport 3. International Services Development Travel Costs Total Amount $309,723 53,631 39,400 $402,754

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(1) International Service Costs. Although the Airport did not allocate a budget for the International Services Division until fiscal year 1999-2000, the Airport had taken steps prior to this time to attempt to obtain airport management contracts and to perform other services. According to the Airport’s records, it spent about $636,914 from 1996 through 1999 in payroll, travel, and professional services costs related to research, technical, and bid preparation services that Airport staff and city vendors had performed in their attempts to win airport management and other contracts in such countries as Panama, Peru, Mexico, Uruguay, Jamaica, Australia, and Chile. According to the Airport, the only related income received during this period, was $327,191 for services rendered to the Perth Airport Consortium in Australia. Therefore, the Airport’s net expenses before the incorporation of SFOE totaled $309,723. The Airport disagrees with the auditors as to which activities are correctly billed to SFOE and what could be billed to the Airport’s International Services Division. According to the Airport’s deputy director of business and finance, staff costs and other expenses are charged to the International Services Division as these are Airport employees and their costs are covered by the rates and charges set to recover all residual Airport expenses from the airlines. Then if time is spent on SFOE work, which is done to provide the services specified in the Technical and Management Services Agreement between the Airport and SFOE, then that time is charged to SFOE. However, many of the expenditures incurred by the International Services Division were related to developing international airport management contacts. Since SFOE was specifically created to manage foreign airports, we believe these costs of the International Services Division could be added together with SFOE to establish the ultimate loss on the Airport’s venture to use its staff to provide management services to other airports. Moreover, although the Board of Supervisors authorized the creation of a private, for-profit corporation to provide international management consulting services in 1997, the Airport did not create the corporation, SFOE, Inc., until September 1999. If the Airport had established the for-profit corporation in July 1997, then clearly the costs would have been the corporation’s costs. According to the director of the International Services Division, the Airport deferred the creation of the corporation because there were no engagements immediately at hand that required that a corporation be in place to receive revenues for the City. (2) City Attorney Costs. According to city attorney records, the Airport deputy city attorneys incurred costs related to international services activities prior to the incorporation of SFOE in 1999. We believe that the Airport could charge these costs to SFOE since

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they are related to the primary business of SFOE to secure international airport management contracts. (3) International Services Development Travel Costs. The Airport incurred travel costs related to international services activities prior to the incorporation of SFOE. These costs could also be appropriately charged to SFOE since the Board approved the creation of the corporation two years before the Airport created SFOE. The Airport Did Not Fully Recover All Its Indirect Costs The Airport’s 10 percent service charge was insufficient to recover all of the Airport’s indirect administrative costs to manage the agreement with SFOE. While the Airport billed SFOE a 10 percent service charge for the period from July 2000 through December 31, 2003, this amount does not sufficiently reimburse the Airport for all indirect costs for managing the SFOE agreement. According to the Airport’s management services manager, during the five years that the Airport provided staff and services to SFOE, the indirect cost rates were between 300 and 350 percent of actual charges.4 Notwithstanding these rates, the Airport has also contracted with other outside entities, and has used an overhead rate for those contracts with a ceiling of 255 percent of actual charges. However, we did not include any additional indirect costs in calculating the final costs of the Airport’s venture with SFOE. RECOMMENDATIONS To ensure that the Airport Department properly accounts for the closure of SFO Enterprises, Inc., including the subsidiary, SFO Honduras, LLP, it should take the following actions: 1. Retain SFOE’s liability to the Airport of $1,087,559, plus interest, on the Airport’s books until SFOE receives the remaining proceeds of the sale of SFO Honduras or the receivable becomes uncollectible. 2. Collect from SFOE any amounts received from the proceeds of the sale of SFO Honduras, in addition to any remaining cash in its bank accounts, to reduce the debt owed to the Airport.

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These rates are based on the Airport’s annual Cost Allocation Plan prepared in accordance with the Office of Management and Budget, Circular A-87, which promulgates cost principles for state and local government units. They are used in conjunction with federal grant-funded projects.

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3. Consult with the Controller and the City Attorney on the proper treatment of any unpaid debt remaining on the Airport’s books.

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Chapter 2
THE AIRPORT COULD HAVE BETTER MANAGED ITS RELATIONSHIP WITH SFOE The City and County of San Francisco established SFO Enterprises, Inc., as a separate, private, for-profit corporation to provide technical, management advisory, and other services related to the operation of international airports. In providing both the staff to manage SFOE, as well as staff to consult part-time and to conduct their regular Airport responsibilities part-time, the Airport increased the likelihood of potential internal control weaknesses where the employees were both representing the interests of SFOE and the interests of the Airport. These conflicts may have resulted in some misreporting of staff payroll costs detailed in Chapter 1 and in some questionable actions we discuss in the following sections. Reimbursement Agreement Signed Late The Airport provided services to SFOE without a valid, signed agreement that detailed how SFOE would reimburse the Airport for the consulting services provided by Airport staff. The Airport incurred costs on behalf of SFOE for 18 months before it finally executed three letter agreements detailing how SFOE would pay the Airport. As a general practice, city departments should not provide any services to an outside agency without having a written agreement in place before providing the services. According to SFOE’s chief executive officer, the fundamental basis for paying the Airport was approved in the year 2000 but the agreements were finalized later, as extensive legal research was necessary to ensure that the structure of the business arrangements complied with all applicable laws. No Arms-Length Relationship Airport staff both represented the Airport and SFOE in entering agreements for the Airport to provide consulting services to SFOE. Representing the Airport, the Airport director executed the agreements and an Airport deputy city attorney initialed the agreements. Representing SFOE, the Airport’s chief of staff signed the agreements, and the Airport’s assistant deputy director of business and finance initialed these agreements, in their capacities as SFOE’s chief executive officer and chief financial officer, respectively. A contract is an agreement between two or more parties, but in this case the two parties are employees of the same department – the Airport. This creates a potential conflict because it may become confusing as to whose interest the parties are protecting if the parties are not separate.

Payment agreements signed 18 months late.

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Furthermore, we found no evidence that these agreements were ever brought before the City’s Board of Supervisors, Budget Analyst, or Controller for comment or approval by an independent city representative. While there is no requirement to have the agreements reviewed by an impartial party, a review might have uncovered, for example, the fact that the Airport did not include adequate reimbursement of its indirect charges in its letter agreements as we discussed in the previous chapter. No Separation of Duties in Preparing Bills According to an Airport accountant, an Airport employee working as an SFOE consultant prepared the summaries of expenses, including payroll, to be reimbursed to the Airport and submitted these to the Airport accounting section so that Airport accounting staff could send invoices to SFOE. This represents an internal control weakness in that the Airport’s accounting section could have independently compiled and summarized the expenses for the invoices. According to an Airport accountant, the Airport’s accounting section did not track the expenses or initiate the invoices; it only recorded in the City’s Financial Accounting and Management Information System (FAMIS) what the SFOE consultant had invoiced, but did not review the expenses for accuracy or for completeness. THE AIRPORT DID NOT CONSISTENTLY IDENTIFY COSTS ATTRIBUTABLE TO SFOE AND OVERSPENT ITS BUDGET Although the Board of Supervisors on January 1997 authorized the Airport’s new International Services Division to promote and market the services of Airport staff to manage international airports, the Airport did not record any significant expenditures for the division’s efforts in this endeavor for two years, and did not always consistently record expenditures related to SFOE and other international service projects in later years. Further, after it had created SFOE in 1999, the Airport still did not consistently record the amounts it spent for activities related to SFOE into one cost center in FAMIS. A comparison of the Airport’s budget for international services projects to the Airport’s costs incurred for SFOE shows that the Airport overspent its budget by over $800,000 for a five-year period. International Service Project Costs Not Identified The City’s FAMIS revealed that the Airport did not record any budgets or charges in the international services project code for fiscal year 1997-98, and only recorded $21,216 in salaries and benefits charges for fiscal year 1998-99. However, according to the Airport’s internal records, it had already spent more than $630,000 on various international services projects. Instead of charging these expenditures to the International Services Division, 12

the Airport charged other budgeted cost centers, such as the chief of staff, bureau of planning, director’s office, and marketing cost centers. The Airport’s deputy director of business and finance responded that the expenditures were not charged to the International Services Division since the payroll and expenses for those people working on international services projects in other divisions were already budgeted in those respective divisions. As such, we could not produce from FAMIS a report or record of all international services or SFOE expenses because many of those expenses were recorded in different cost centers. SFOE Travel Expenditures Not Consistently Identified The Airport did not accurately portray the actual expenditures made on behalf of SFOE. For fiscal year 1999-2000, the Airport recorded travel expenses for International Services Division staff in the International Services Division cost center for half of the year and travel expenses in the cost center for the chief of staff for the remainder of the year. For fiscal year 2000-01, during the second half of the fiscal year, the Airport charged all travel expenses to the chief of staff cost center. The Airport reported at least $193,718 in travel charges related to SFOE in cost centers other than the International Services Division; nevertheless, the Airport did correctly bill these expenses to SFOE. According to the Airport’s deputy director of business and finance, expenses were generally charged based on the regular section to which an employee was budgeted. He further stated that international services work at the time was handled through the chief of staff and bureau of planning cost centers. Airport Overspent Its Budget for International Services We compared the approved FAMIS budgets for each fiscal year with the total amounts billed to SFOE for services and other costs incurred on SFOE’s behalf by the Airport and recorded in different cost centers in FAMIS. Although we did not separate by fiscal year the unbilled expenditures we identified in our audit, in total expenditures for SFOE were higher than the approved budgets by over $800,000 for the five-year period, most of which were due to unbilled charges. The FAMIS budgets include all international services projects, not just the expenses actually billable to SFOE, and therefore the budget for SFOE is actually less.

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TABLE 4
Budget and Actual Expenditures for Airport Costs Incurred for International Services and SFOE Fiscal Year 1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 Total Unbilled (from Tables 2 and 3) Adjusted Total FAMIS Budget $537,300 353,479 810,585 73,395 115,000 1,889,759 Billed or Attributed to SFOE $565,089 699,857 315,093 281,697 76,883 1,938,619 760,673 $1,889,759 $2,699,292 (Over)/Under Budget $(27,789) (346,378) 495,492 (208,302) 38,117 (48,860) (760,673) $(809,533)

Note: The FAMIS budget is for all international services, of which SFOE was only one project.

Board of Supervisors’ Spending Restrictions By-Passed
The Airport’s inconsistent recording of SFOE-related expenses allowed the Airport to bypass budgetary spending restrictions.

In the fiscal year 2002-03 final Annual Appropriation Ordinance, the Board of Supervisor’s finance committee placed a reserve of $220,189 on the International Services Division’s total budget of $293,584. This meant that the Airport could only spend $73,395 for payroll, travel, and other expenses for SFOE through June 2003. In fact, although FAMIS records show that the Airport spent only $73,395 for fiscal year 2002-03 for its International Services Division, the invoices to the Airport showing SFOE expenses for reimbursement for the same period reflect $281,697 in expenses. AIRPORT EMPLOYEES DID NOT ALWAYS FOLLOW CITY RULES IN WORKING FOR SFOE In reviewing an 8-month sample of travel expenses, we identified several instances where Airport employees exceeded limits set for air travel and hotel stays. Further, one employee received a travel advance that was used for non-travel related purchases, including a car. Another employee took a leave of absence from his city job and carried out similar duties as a subcontractor and received more in pay. Travel Rules for Air Travel and Hotel Stays Not Followed Some of the Airport employees working as SFOE consultants flew business class, which at times cost more than twice as much as a regular coach flight. According to the Controller’s Travel and Official Business Expense Regulations (travel policy), city employees are to use the lowest published routine fare for travel 14

by the most efficient, direct and economical mode of transportation required by the occasion. In addition, many of the hotels at which consultants stayed during their trips cost more than the government-approved rates. We noted hotel daily rates that exceeded the government-approved rates by 32 percent to 112 percent. For travel within the United States, the Controller’s travel policy states that employees are to use the federal maximum rates for lodging. For foreign travel, employees are to use the most economical and practical accommodations available considering the purpose of the meeting, transportation costs, time and other relevant factors. Although Airport employees took these trips in their capacity as SFOE consultants, these employees are still City employees and thus subject to city rules. The letter agreement between the Airport and SFOE for reimbursing the Airport states that personnel of the Airport providing the services to SFOE are subject to all of the rules, regulations, policies, and procedures that are promulgated by the City and County of San Francisco with respect to its employees. We did not review all travel expenses and therefore we did not determine the total of excess travel costs. Travel Advance Used to Purchase a Car and Other Non-Travel Related Items In another example of disregarding travel policy, an Airport employee consulting for SFOE received a $40,000 travel advance on August 31, 2000, from the Controller’s Office, but the advance was never intended for travel. According to the Airport Commission’s Fiscal Year 2000/01 Travel and Training Guidelines, travel advances usually include lodging, meals and transportation expense. Upon completion of the travel, a travel expense voucher is used to list actual expenses and original receipts must be attached. Although the employee specifically indicated that the travel advance would be used for non-travel related expenditures, such as purchasing a car, computer, and office furniture, the Airport approved using a travel advance to obtain funds to pay for these items, and the Controller’s Accounting Operations and Systems Division (AOSD) approved the payment of the travel advance to the employee. Moreover, this employee failed to provide the Controller’s AOSD with the appropriate travel receipts and vouchers within 10 days after return from travel, as required by the Controller’s travel policy. On October 2, 2000, the employee, working as a SFOE consultant, used the travel advance to open a bank account in the amount of $40,000 in Miami, and proceeded to use the bank account funds for cash, payments on the purchase of a new Nissan Pathfinder, office furniture, computer equipment, and apartment rent in Honduras. Although the Controller’s AOSD had inappropriately approved the advance for these expenses, when 15

Travel advance used to purchase a car, office furniture, and a computer.

Controller’s accounting staff requested an accounting of the travel advance from the Airport in January 2001, SFOE subsequently paid the money back in April 2001, or seven months after the issuance of the advance, and five months after the Airport employee returned from the travel. City Employee Worked as a Subcontractor Finally, an Airport employee earned more in pay by working as a consultant for a non-city contractor than performing the same work as a city employee. The employee took a leave of absence from his employment with the City in October 2004, and worked as a subcontractor under the Airport’s contracted sale liquidator for SFOE. He earned approximately $17,600 for 162 hours of work in two and a half weeks of employment. According to the employee, this situation resulted from the Board of Supervisors’ direction that no Airport employees could work on any SFOE activities effective July 1, 2004 and therefore the Airport asked that he fly to Honduras as SFO Honduras’ professional representative on site as an outside consultant to the sale liquidator since SFO Honduras was still contractually responsible for providing services to InterAirports and maintaining a professional representative in Honduras. The Airport maintains that the $110 hourly rate paid to the Airport employee as a contractor was agreed to for the purpose of making the employee whole on an after-tax basis, considering the value of forgone benefits suffered by the employee. However, this rate includes the total cost of all of the employee’s legal holidays and floating holidays for an entire year, in addition to certain benefits, which the employee would not lose by taking a leave for 11 workdays. Using the methodology and assumptions provided to us by the Airport’s consultant, we calculated that an hourly rate of $85, instead of $110, which is more than fair compensation, resulted in an overpayment of $3,830. RECOMMENDATIONS The Airport Department should take the following actions to ensure that it protects the City’s interest in contracting with outside agencies: 4. Formally enter agreement with outside agencies before providing any services. The agreement should specify reimbursement rates for providing services and identify the recovery of sufficient overhead. 5. Reassess its procedures for identifying costs to different cost centers to give a more comprehesive summary of the costs involved for specific projects 16

6. Ensure that its employees adhere to the Controller’s travel policies even when they are working as consultants for private companies. We conducted this review according to standards established by the Institute of Internal Auditors. We limited our review to those areas specified in the scope section of this report. Staff: Elisa Sullivan, Audit Manager Robert Tarsia Kathy Buckley Lorita Chung Helen Vo Winnie Woo

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SAN FRANCISCO AIRPORT DEPARTMENT RESPONSE TO THE REPORT

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APPENDIX

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cc:

Mayor Board of Supervisors Civil Grand Jury Budget Analyst Public Library

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