Audit Report on the Compliance of Verizon New York, Inc. with Its Cable Franchise Agreement

AUDIT REPORT IN BRIEF

On May 29, 2008, the City of New York (City), through the Department of Information Technology and Telecommunications (DoITT), entered into a non-exclusive 12-year cable franchise agreement (“agreement”) with Verizon New York, Inc. (Verizon) to operate and maintain a cable system and deliver cable service throughout New York City.

The agreement requires Verizon to pay the City a franchise fee equal to five percent of gross revenue, which includes all subscriber revenues net of bad debts plus late fee charges, advertising revenues, commissions on subscriber home shopping purchases, and other miscellaneous items.  Additionally, Verizon is obligated to make certain payments to Community Access Organizations (CAOs) designated by the City.   Verizon is permitted to partially offset this cost by charging its customers Public, Educational, and Governmental (PEG) fees.  Verizon is also required to submit quarterly franchise fee reports with its franchise fee payments no later than 45 days after the end of each calendar quarter.  Following at least 30 days written notice that the franchise fee has not been paid, Verizon is required to pay interest at the applicable interest rate (nine percent annually).

Verizon outsources its advertising sales business to three third parties, Time Warner Cable Media Sales (Time Warner), Viamedia, Inc. (Viamedia), and National Cable Communications LLC (NCC).  Of the total advertising slots (availabilities) offered to Verizon, a portion is retained for its own marketing purposes, and a portion is allocated to Viamedia and Time Warner to sell.  In addition, each of the respective parties receives a percentage of the gross sale for the various functions performed.

Audit Findings and Conclusion

From July 2008 to June 2013, Verizon understated advertising revenue on the quarterly franchise fee reports it submits to the City by approximately $28.2 million, resulting in approximately $1.41 million in franchise fees owed to the City.  Specifically, Verizon understated $17.1 million in advertising commissions that should have been included in gross revenue and did not report $11.1 million in foregone revenue from the value of advertising availabilities retained for its own use, resulting in $855,000 and $555,000 in franchise fees due to the City, respectively.

Except for advertising revenue, our review of Verizon’s gross revenue was based on Ernst & Young LLP’s (E&Y) audit of Verizon’s Statement of Gross Revenues for the year ended December 31, 2012.  Accordingly, nothing came to our attention that suggests that Verizon’s Statement of Gross Revenues was not presented fairly, in all material respects, on the basis of the franchise agreement.

Moreover, Verizon did comply with certain non-revenue-related requirements of its agreement with the City, such as maintaining the required insurance.

On another issue, the Comptroller’s Office and DoITT both faced significant difficulties in obtaining the sufficient and appropriate documentation necessary to perform their respective oversight functions.  Some of these difficulties were due to limitations or complicating factors inherent to Verizon’s internal processes that may not have been anticipated when the franchise agreement was written.  Other limitations were due to non-disclosure clauses within the agreements entered into by Verizon with third parties, which do not grant the City access rights to records that are deemed confidential.

Audit Recommendations

Verizon should:

• Immediately remit $1.41 million in additional franchise fees due to the City.
• Report all advertising revenues at gross (including all advertising commissions) in the quarterly franchise fee reports it submits to the City, as required by the franchise agreement, and pay the appropriate franchise fees.
• Track the value of its internal marketing advertising availabilities, report the value of such advertisements in its quarterly franchise fee reports submitted to the City, and pay the appropriate franchise fees.
• Modify existing third-party agreements to allow the Comptroller’s Office and DoITT to obtain the records necessary to properly determine Verizon’s compliance with the terms of the franchise agreement.
• Provide DoITT with access to all records necessary to oversee Verizon’s compliance with the terms of the franchise agreement, including records that are considered confidential but are required to determine the accurate reporting of gross revenue.

DoITT should:

• Ensure that Verizon pays the $1.41 million in additional franchise fees due to the City.  As per the franchise agreement, if Verizon has not paid the franchise fees following at least 30 days written notice, DoITT should assess a nine percent late fee on the amount due.
• Ensure that Verizon accurately reports all revenue on its quarterly franchise fee reports and pays the appropriate franchise fees, as required by the franchise agreement.
• Ensure that Verizon complies with all of the recommendations in this report.

Verizon Response

Verizon officials disagreed with the audit’s findings and conclusions in their response.  As such, they did not address the recommendations in the report.  In their response, Verizon officials wrote, “Verizon reported and paid franchise fees on all advertising revenue in a manner fully consistent with the requirements of the Franchise and therefore does not owe the City $1.41 million in additional franchise fees…Verizon provided all books and records ‘reasonably necessary to ensure compliance with the terms of [the] Franchise.’”

DoITT Response

In their response, DoITT officials stated that they were in agreement with the report’s recommendations.