Audit On The Payment By Empire City Subway Of License Fees Due The City And Compliance With Certain Provisions Of Its License Agreement

Audit Report In Brief

Empire City Subway (ECS), a subsidiary of Verizon, is the largest telecommunications conduit provider in New York City.  ECS has a franchise from the City of New York to design, construct, and maintain subsurface electrical conduit and manhole infrastructure in Manhattan and the Bronx, which ECS rents to telecommunications and cable television service providers. The franchise agreement was executed on May 15, 1891, for perpetuity, and is now administered by Department of Information Technology and Telecommunications (DoITT).  ECS maintains an inventory of more than 213,800 conduits under the streets of Manhattan and the Bronx.

We performed an audit to determine whether ECS accurately reported its annual profit and paid its franchise tax payments on a timely basis, and whether DoITT has ensured that ECS complied with the provisions of the agreement.

Audit Findings and Conclusions

ECS generally adhered to the requirements of the license agreement and paid all franchise tax payments that were due during the audit period in a timely manner.  However, ECS financial statements were not certified by an independent public accounting firm.  Moreover, ECS did not apply depreciation consistently and overstated gross conduit valuation for the purposes of calculating excess profits that may be due the City by including the costs of unassigned and unidentified conduits.  Therefore, since 1994 ECS annually reported less than 10 percent profit, which resulted in no payments due the City. In addition, because the deficits are cumulative, ECS overstated its accumulated deficit, which is used to offset any future excess profit payments due the City. This minimizes the probability of the City’s receiving additional payments under the excess profits contract clause.

DoITT has not ensured that ECS effectively manages, constructs, or retires conduits, which reduces the possibility of additional fees being paid to the City due to ECS excess profits (i.e., greater than 10 percent of gross plant value).

In a related matter, we believe that DoITT should consider seeking legislative change stating that it is just and reasonable to set the conduit rental rate at a competitive level that permits the contract to generate revenue for the City. A new rate should take into account the rate of inflation and be comparable to conduit rental rates charged in other cities.

Audit Recommendations

We make eight recommendations to ECS, including the following, that ECS:

• Apply depreciation consistently when calculating annual net profit and accumulated deficits.
• Readjust calculations of net income and associated deficit amounts.
• Maintain accurate and complete financial records as required by the agreement.
• Identify the tenants occupying all the unidentified conduits and bill those tenants. Once the tenants are being billed, the construction associated with those conduits can be added back to gross plant assets.
• Update the Duct Utilization System (ECS’s conduit-tracking system) to provide more appropriate information about the status of conduits.

We make two recommendations to DoITT, that it:

• Undertake a more assertive role in overseeing the construction and management of the overall conduit infrastructure system so that the plant valuation is not inflated with unnecessary construction costs for the purposes of calculating excess profits and payments that may be due the City.
• Consider seeking legislative change stating that it is just and reasonable to set the conduit rental rate at a competitive level that permits the contract to generate revenue for the City. A new rate should take into account the rate of inflation and be comparable to conduit rental rates charged in other cities.