Internal Documents Lead to More Scrutiny of Duke Power

Duke Power Co. documents show the electric utility may have developed an accounting strategy to avoid exceeding its profits limit and being forced to cut rates for 2 million customers in North Carolina and South Carolina, The Charlotte Observer reported Saturday.

Duke Power said it made 14 accounting changes and four were mistakes, but that it never intended to mislead regulators. The regulated public utility is a subsidiary of Charlotte-based Duke Energy Corp. and supplies power to about 1.5 million customers in North Carolina and 500,000 in South Carolina.

In exchange for the privilege of operating a monopoly in its service area and netting double-digit profits, Duke Power must provide power to everyone in its territory. The profit margins regulated utilities may earn are set by regulators. If a utility exceeds the profit limit, called allowed return, regulators can cut what the utility charges consumers.

The Observer said the documents it obtained indicate Duke Power knew its North Carolina operations had exceeded their allowed profit in 1998, and that prompted it to consider accounting changes.

"For the last two quarters in 1998, Duke Power has been earning a higher rate of return than allowed," one document states. "We have come up with the following strategies to reduce Duke Power's current rate of return."

That document lists three accounting changes that would reduce regulated profits by nearly $50 million. The changes — involving insurance payments, executive pay and rental lease expenses — were made, though in different amounts than listed on the document.

During 1999 and 2000, Duke continued the change for insurance payments totaling $58 million.

Last summer, an employee whistle-blower notified regulators of Duke Power accounting changes that reduced profits reported to regulators by $100 million from 1998 through last year.

The newspaper said it obtained the documents under the Freedom of Information Act from utilities regulators in both states, who are conducting a joint audit to determine whether the company's accounting changes were appropriate.

Duke Power characterizes the documents as "working papers" created by accountants making "notes to each other and themselves."

"To draw a conclusion (from the documents) and characterize it as an official decision is a mistake," said Cathy Roche, a spokeswoman for Duke Power's parent company, Duke Energy.

Duke Power's accounting changes followed a precedent-setting case involving an South Carolina utility that exceeded its allowed profit level in 1998.

South Carolina regulators cut the utility's customer rates in December 1998 by 1.5 percent, a reduction still in effect and costing the utility $23 million a year in reduced revenues.

Handwritten notes from a meeting at Duke Power nine days after the rate cut indicate a discussion of the South Carolina case, and the "red flag" of excess earnings. Two pages of notes list seven potential accounting changes. At least three were made.

Ellen Ruff, a Duke Energy senior vice president and formerly Duke Power's top lawyer, said after the South Carolina decision employees were "asked to look at costs and whether they were classified correctly."

She denied those requests were a strategy to reduce regulated profits. Ruff, who led an internal company investigation, said management did not direct employees to make accounting changes with the goal of reducing its allowed profit.

"We did not say `Go out and find dollars that will lower the allowed return,"' Ruff said.

But Duke did make changes that lowered its allowed return, as outlined in the documents.

"I can't for the life of me figure out how they can say there wasn't a strategy," said Gary Walsh, executive director of the South Carolina Public Service Commission, who began reviewing the documents during the summer. "They are not simply working papers."

Duke Power's largest change, which it defends, involved putting into nonutility accounts three years of insurance payments totaling $84.5 million from Nuclear Electric Insurance Limited. The mutual insurance company provides the coverage required for nuclear plant operators including Duke Power.

Federal rules, also copied among the documents, require utilities to put "dividends distributed by mutual insurance companies" in the utility accounts. That would reduce expenses — and increase profits.

In several documents, Duke refers to the payments as policyholder distributions. On others, the company calls them refunds. That may be significant because a note on a Duke document says that federal regulations "do not state how to recognize insurance refunds."

Raleigh-based CP&L and South Carolina Electric & Gas — both nuclear plant operators — say they credit the insurance payments to the utility accounts. Regulators from other states, while not commenting on Duke, said that's usually the right way to handle returns of utility expenses.

If Duke hadn't shifted its insurance payments, it would have slightly exceeded its allowed North Carolina profit in 1998, 1999 and 2000.

In North Carolina, Duke is allowed a 12.5 percent profit. In South Carolina, it is allowed a 12.25 percent return.