City of Rochester

Involvement with the Fast Ferry Operation - Executive Summary

In 1998, former Mayor Johnson¹ and the Common Council of the City of Rochester (City) began the process of bringing a fast ferry service between Rochester and Toronto, Canada. This process led to the September 2001 selection of a private operator, Canadian American Transportation Systems, LLC (CATS), to manage the Port of Rochester and operate a fast ferry service between the two cities. The capital requirements of this operation required the direct investment of $15.3 million of financing by the City and New York State.

CATS commenced fast ferry service in June 2004, and discontinued it 11 weeks later in September. The operation was plagued by a variety of problems, including higher-than-planned operational costs, less-than-expected ridership, mechanical breakdowns, and an accident while docking in New York City (while en route to Rochester). The accident delayed the start of operations by several weeks. When CATS failed to pay its bills as they came due, a creditor began an arrest proceeding under maritime law, which is similar to a foreclosure under real estate law. In January 2005, the City created the Rochester Ferry Company (RFC) to purchase the ferry at a Federal foreclosure auction, and to oversee the operation of a ferry service. In February 2005, RFC purchased the ferry at auction with a bid price of $32 million.

The City’s operation of the ferry was plagued by many of the same problems as CATS’ operations. In early January 2006, current Mayor Duffy proposed and the Common Council adopted policies that permanently suspended ferry operations. In May 2006, the City agreed to sell the ferry to Euroferries, Ltd. for $29.8 million, leaving taxpayers with $20 million in remaining debt on the Fast Ferry Project (Project). As of the release of this report, the sale has not been finalized.

Scope and Objectives

The objective of our audit was to review the City’s involvement in the Project. Specifically, our audit sought to answer the following questions regarding City officials’ actions from September 19, 2001 to April 15, 2005:

• Did City officials provide adequate due diligence when approving and monitoring the Project?
• Were appropriate safeguards in place to protect the public’s interest?

Audit Results

We recognize that new opportunities for economic growth can present some risks that are hard to predict exactly. Sometimes government officials need to accept some level of risk to achieve potentially significant results. However, the City started the fast ferry service with a start-up company whose principals had never before performed these services. This type of project, with individuals who have no track record in the field, required a significant level of due diligence by City officials. We have tried to be careful in this audit to avoid second-guessing the decisions made by City officials based on information that has become known since the project began. Rather, we tried to review what City officials knew, or what they reasonably should have known, at the time they made decisions, and to evaluate the information they had and the actions they took in initiating the ferry service.

As a result, we found that there were a variety of clear warnings that were known, or should have been known, by City officials during the approval process of the ferry project. These red flags should have alerted City officials to the extremely risky nature of this venture, and should have caused them to increase their review of various aspects of the Project’s plan before proceeding and committing public funds to the Project.

For example, the City requested proposals for a two ferry operation and accepted the only formal response they received, a proposal from CATS that included a more than $100 million plan. However, shortly after the City accepted the proposal, CATS changed its plan to include only one ferry. Despite this significant change in project scope and the fact that the City received only one proposal, the City did not call for a new round of competitive proposals.

Also, City officials obtained two reviews of CATS’ plan from outside consultants that contained several critical and cautionary statements, yet we found no evidence that City officials heeded the warnings in the evaluations. Those evaluations highlighted a number of concerns with the plan, including the mismatch between vessel capacity and demand, serious deficiencies in the financial model included in the proposal, concerns about CATS’ existing equity, low profit margins, the lack of enthusiasm by the Toronto market, and unrealized time savings in comparison with other transportation options. Despite these strong cautions, City officials did not perform any further analysis of the subsequent plans.

Further, CATS revised its business plan several times during the start-up process. For example, a version dated January 2002 showed total resources and expenses of $62 million, including $10 million in funding from Canadian government sources. When the Canadian funding did not materialize, CATS issued a new $57.7 million plan without making any actual changes to the Project. For example, CATS reduced the pre-launch/reserves expenses in the plan from $20 million to $15.2 million. However, City officials did not provide us with any written documentation that explained which specific expenses that CATS eliminated in the revised plan, or what – if any – action they took to ensure that CATS’ plan was still viable with $5 million less in funding.

Additionally, City officials should have heeded several red flags with regard to the Project’s equity position. One of the red flags was the fact that another public agency, the Rochester Genesee Regional Transit Authority (RGRTA), experienced difficulty in attempting to verify a portion of the Project’s equity. Rather than supporting that effort to verify CATS’ plan, which also was required by the City’s $1.3 million loan agreement with CATS, City officials replaced RGRTA with the Rochester Urban Renewal Agency (RURA), a City-controlled agency, as the conduit for the loan. City officials then did not verify CATS’ equity prior to releasing the loan.

From our efforts, we know that such verification would, at best, have been extremely difficult. We were unable to verify $1.7 million in equity contributions that CATS’ partners claimed. In reality, CATS had an inadequate amount of equity at the start of the Project. As a result, the Project was undercapitalized and therefore ill-equipped to meet pre-launch expenditures, unforeseen events, and deviations from the business plan. For example, CATS indicated that it would set aside $3.5 million of the equity contribution from part of the positive cash flow expected from the first three years of operations – an optimistic projection at best for a risky start-up venture. Of course, the positive operating cash flow never actually materialized. Furthermore, if this equity had materialized, it was earmarked for reserves committed to protecting the senior lender, and not for operations. Thus, CATS would not have been able to use the $3.5 million for unforeseen events and deviations from the business plan, both of which occurred.

We also found that a commitment letter from the City to CATS stipulated that City officials would contract with outside legal counsel who would be charged with ensuring the City’s lien on the ferry was enforceable and in compliance with relevant law, and overseeing the loan process to ensure that CATS fulfilled specific contractual obligations. The commitment letter called for CATS to pay for this oversight. However, the City did not retain outside legal counsel for this purpose. This lack of oversight allowed CATS to spend over $2.8 million more than the Project’s budgeted amounts without the City’s knowledge. Also, the City was unaware that CATS had obtained $7.4 million in short-term loans to finance operations during the pre-launch phase of the Project. This short-term financing was not anticipated in the business plan and was indicative of the Project’s growing financial problems. Because City officials provided no oversight, they apparently were not aware of this red flag.

We found that City officials used more than $975,000 of additional City funds on behalf of the Project, funding that was not publicized and was not included in the business plan. Some of these funds were provided to CATS against the express resolutions adopted by the City Council. All of this funding was done in a manner – including funneling payments to CATS through a third-party contractor – that would appear to be an attempt to hide the transactions from outside scrutiny.

Finally, City officials did not thoroughly investigate assertions and representations made by a CATS affiliate before making concessions under a lease agreement which allowed that affiliate to retain the lease on the port after CATS failed. Prior to entering into the license and lease contract, City officials made no attempt to determine the value of the economic benefits provided under the contract, thereby making it difficult to demonstrate that the City acted in the public’s interest by entering into the contract.

Comments of Local Officials

The results of our audit and recommendations have been discussed with City officials and their comments, which appear in Appendix A, have been considered in preparing this report. Except as specified in Appendix A, City officials generally agreed with our recommendations and indicated they had initiated corrective action.