Originally Posted - July 27, 2006

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ROCHESTER---A State Comptroller's audit of the Rochester fast ferry found that former Rochester city officials ignored many clear warnings that the project had a very high potential for failure and made several missteps that hindered the city's ability to protect itself when the project went awry, according to State Comptroller Alan G. Hevesi.

The audit reviewed the initial stages of the project through the first year of operation, as requested by Assemblymen Brian Kolb (R-Canandaigua) and Joseph Errigo (R,C-Conesus). The audit found:

--Red Flags Were Ignored. Despite clear indications that the project had a high chance of failure, including reports from outside consultants identifying serious deficiencies with Canadian American Transportation Systems' (CATS) financial plan as well as difficulty verifying that CATS had adequate private equity, former city officials moved the project forward and did not take critical steps to protect the public's investment in the project.

--Spending Not Disclosed to Public. It is widely known that in the first year of the ferry operation the city provided a $1.3 million loan to CATS. However, auditors found that the city also spent nearly $1 million on the project that appears to have been hidden from the public. Some of these expenditures were not approved by the city council. This spending includes paying for equipment to operate the ferry, a fuel storage system and funneling payments to CATS through a third-party contractor.

--Insufficient Oversight. After the project was underway, city officials did not adequately monitor CATS' fiscal condition and were unaware that CATS was experiencing growing financial problems, such as taking out a short-term loan for $7.4 million for pre-launch expenses.

"Supporting economic development means accepting that some projects will fail. But government officials must increase the chances for success by making sure there is a solid plan and by closely monitoring progress," Hevesi said. "The best way to deal with risks is not to ignore them, but to make plans to deal with them. Officials must define acceptable losses for taxpayers and make sure actual losses do not exceed that amount. Unfortunately, because they were so determined to make the fast ferry work, city officials did not demand a solid plan and ignored warnings. I hope other officials will learn from these mistakes when they take on other projects."

Auditors specifically reviewed the public funds associated with the fast ferry project, including a $1.3 million loan from the city and a loan and grants totaling $14 million from the state. The audit covered the City of Rochester's management of the project from Sept. 19, 2001, when the former city administration and the Rochester City Council selected CATS to operate a ferry service, through April 15, 2005 ? right after the city purchased the ferry.

Auditors made every effort to avoid second guessing city officials. They did not base their judgments on information that has become known since the project began. Rather they looked at what city officials knew or reasonably should have known at the time they made decisions. During the course of the audit, auditors had some difficulty getting access to records and to individuals from CATS, which is not uncommon after a company goes out of business, and as a result the release of the audit was delayed. In response to the audit, the new administration of Mayor Robert Duffy generally agreed with the report's findings and indicated that it has taken a number of steps to ensure that necessary due diligence is performed before projects are undertaken and that contract terms are met.

The audit findings detail how former Rochester city officials:

--Did Not Heed Warnings from Independent Consultants. Auditors found no evidence that city officials took into account warnings from two separate consultants hired to evaluate the project for the city. These reports detailed serious deficiencies with the company's financial model, including the lack of financial commitments from the company, low profit margins, the lack of enthusiasm from the Toronto market for the ferry, and other problems ? issues that ultimately resulted in the rapid demise of the ferry operation. Despite these strong cautions, city officials did not perform any further analysis of these issues or develop a strategy to manage these risks.

--Did Not Verify Business Plan Changes. The city did not thoroughly review the company's business plan, even though outside consultants identified red flags and the plan was modified several times. For instance, when $10 million in funding from the Canadian government did not materialize, CATS issued a new financial plan without making any actual changes to planned operations. Auditors were unable to identify that city officials took any action to ensure that CATS business plan was still viable without this funding. The plan was also overly optimistic. An example is CATS' plan to set aside $3.5 million from the positive cash flow expected from the first three years of operation, which was unlikely given the nature of the venture.

--Did Not Verify Equity. When the Rochester Genesee Regional Transit Authority (RGRTA), the original pass-through agency for the state loan totaling $6.6 million, had difficulty verifying that CATS investors had put up their own funds, the city requested that the state replace the agency with the Rochester Urban Renewal Agency (RURA), a city-controlled agency. RURA did not verify CATS' equity prior to giving the state loan to CATS, even though verifying the equity was also one of the requirements of the city's $1.3 million loan agreement with the company. In reality, auditors found that CATS was undercapitalized from the start of the project and ill-equipped to meet pre-launch expenditures, unforeseen events and deviations from the business plan. Auditors found that it would have been extremely difficult to determine how much private equity CATS had because CATS principals Dominick DeLucia and Brian Prince claimed to have paid $5 million in expenses from their personal bank accounts, not with CATS accounts. Auditors could not verify that these expenses were for CATS or one of the other businesses run by the principals.

--Spending Not Disclosed to Public. Auditors found that the city made purchases for the project without clearly identifying that those purchases were being made for the ferry, which made it nearly impossible for taxpayers to identify the true cost of the project. Auditors found that city officials handled these transactions in a manner that made it appear that they intended to hide the transactions from public scrutiny.

Details include:

The city used funds from its furniture, fixtures and equipment budget to purchase approximately $497,000 of equipment for use by CATS, such as a forklift, ticket printers, ovens for the ferry and computers. Nowhere did the city identify CATS as being connected with these expenses. These items remain assets of the city, but the majority of them were placed in storage and have not been used by the city. The city council passed an ordinance that authorized the city to enter into an agreement with CATS to construct a fuel system. While the ordinance required CATS to pay the full amount for the system, up to $421,000, the former city administration signed an agreement with CATS to reimburse the city only $210,500 for the system that ended up costing $440,000. The former city administration signed the agreement well after the completion of the fuel system and without city council approval of the amended amount.

In May 2004, one of the city's consultants, LaBella Associates, paid CATS a lump sum payment of $250,000 for sub-consultant work performed for shore infrastructure. The city reimbursed LaBella for this expenditure, essentially paying CATS through LaBella. The invoice from CATS did not contain details as to what type of work it performed or how much time was spent. When auditors probed this expense, they found that it appears to have been for typical duties during the normal course of work, not for extra work that justified this payment.

Failed to Exercise Due Diligence. The city did not adequately evaluate CATS' ability, capacity and skill to perform the scope of the work, even though CATS was a start-up company whose principals had no experience in the ferry industry.

Did Not Solicit Competition. The city did not call for a new round of competitive proposals, even though CATS significantly modified its original proposal from operating two ferries to a single ferry operation. This was a significant change in the project scope, and other potential competitors should have had the opportunity to compete on the amended plan.

No Independent Oversight. The city never hired outside legal counsel, as required by its agreement with CATS, to ensure that the city's lien on the ferry was enforceable and in compliance with state law and contractual obligations. The agreement stipulated that CATS was to pay for this counsel. When CATS refused to pay, the city chose not to hire outside counsel at its own expense. This lack of oversight allowed CATS to spend $2.8 million more than was budgeted and obtain a short-term loan for $7.4 million to cover pre-launch costs ? both actions the city was unaware of but were red flags of CATS growing financial problems.

Did Not Adequately Secure Loans. Auditors found that the city allowed a loan agreement that left the city and RURA with unrecoverable third and fourth priority liens that were not prudent based on the high-risk nature of the project and lack of equity invested by Prince and DeLucia. This left local and state taxpayers bearing all the financial risk of the ferry operation.

Entered into Bad Port Lease Agreements. The city made no attempt to determine the fiscal implications of the 2001 lease agreement with CATS to run the port. The original ferry terminal lease between the city and CATS included a provision that the lease agreement would be void if CATS was not operating the ferry. As permitted under the lease, CATS sublet the port terminal to an affiliate, Maplestar Development Company. In 2004, the former city administration signed a new agreement with CATS and Maplestar. The clause requiring that CATS be the ferry operator in order to keep the 40-year port lease was pulled out of the 2004 agreement with the approval of the former city administration. City officials claimed that this change was necessary because Maplestar could not get bank financing for port improvements if the stipulation remained. Auditors did not find any evidence that city officials investigated this assertion or explored other financing alternatives.

Auditors recommended that the city conduct a comprehensive evaluation of the process it uses to review financial agreements before obligating city resources. The city should also ensure that all duly executed contracts are properly supported and that all necessary liens and collateral have been obtained to protect taxpayer resources. In addition, all changes to agreements should have prior approval from the city council before the mayor signs them and all alternatives should be explored before concessions are made.

Click here for a copy of the audit. 7-27-06

© 2006 North Country Gazette