MINUTES OF THE MEETING

OF

THE AUDIT COMMITTEE

January 26, 2010

A meeting of the Audit Committee was held at the Authority’s offices at the Clarence D. Rappleyea Building, 123 Main Street, White Plains, New York, at approximately 9:50 a.m.

The following Members of the Audit Committee were present:

Trustee D. Patrick Curley (Chairman)

Trustee Elise M. Cusack

Vice Chairman Jonathan F. Foster

Also in attendance were:

Michael J. Townsend. Chairman

Eugene L. Nicandri Trustee

Gil Quiniones Chief Operating Officer

Terryl Brown Executive Vice President and General Counsel

Elizabeth McCarthy Executive Vice President and Chief Financial Officer

Donald Russak Senior Vice President- Corporate Planning and Finance

Lesly Pardo Vice President – Internal Audit

Karen Delince Corporate Secretary

Brian McElroy Treasurer

Thomas Concadoro Director - Corporate Accounting

Michael Saltzman Director – Media Relations

Mary Jean Frank Associate Corporate Secretary

Lorna Johnson Assistant Corporate Secretary

Ken Deon Managing Partner, KPMG

Jamie Cote Senior Manager, KPMG

Bryan Mahoney Manager, KPMG

1. Minutes of the Regular Meeting of July 27, 2009

The proposed minutes of the Committee’s Regular Meeting of July 27, 2009 were adopted as amended

2. KPMG 2009 Audit Plan

Mr. Ken Deon of KPMG LLP (“KPMG”) provided an overview of KPMG’s 2009 Audit Plan. He said that the audit team had been assembled consistent with the audit proposal KPMG had submitted to the Authority. According to Mr. Deon:

· Audit risk is defined as the combination of the possibilities that (1) material errors or irregularities may occur in the Authority’s financial records, (2) such errors will not be discovered through the Authority’s own controls and (3) audit procedures performed will fail to uncover them.

· KPMG’s approach to reduce risk to an acceptably low level is to focus on understanding and assessing the Authority’s (1) organization and operational risks, (2)”tone at the top,” control environment and monitoring controls, (3) core business processes and related internal controls and (4) significant accounts and disclosures.

· Detailed procedures at the Authority to mitigate audit risk to an acceptable level include (a) an evaluation and review of entity-level controls and the control environment, including fraud, (b) an evaluation of management’s risk assessment process to assess and test key controls over financial reporting and (3) tests of controls and tests of details over significant Authority risks, accounts and disclosures as identified.

Mr. Jamie Cote of KPMG highlighted the following significant audit risks and related issues:

· Current economic conditions (KPMG will design audit procedures to understand the Authority’s exposure to the current economic environment and perform appropriate procedures to ensure account balances are appropriate stated and proper disclosures are made. The following issues will be addressed: (1) impaired investments, (2) access to credit markets, (3) derivative collateral requirements and (4) accounts receivable aging and the related allowance for doubtful accounts).

· New accounting pronouncements (Application of FAS No. 161 Disclosures About Derivative Instruments and Hedging Activities).

· Fuel and purchase power derivatives (fair value accounting of derivatives associated with fuel and purchase power price fluctuations, settlements and mark-to-market accounting).

· Interest rate derivatives (appropriateness of hedge accounting, deferral of gains/losses on existing contracts).

· Revenue recognition (appropriate revenue records as energy is delivered, including unbilled revenue accounting).

· Management judgments and accounting estimates (appropriate methodologies and assumptions in assessing exposures/liabilities: ISO reserves, bad debt reserves, OPEB obligations, self-insured reserves, legal injuries and damage).

· Top-side journal entries throughout the year (appropriate accounting for existence and accuracy of unusual, nonrecurring transactions).

· Debt obligations (compliance with accounting-related covenants).

· Others considerations – Authority’s business risks (transactions with New York State [Power for Jobs, other budget actions; volatility of fuel due to macroeconomic factors regarding oil, natural gas prices and power and its impact on the derivatives or risk management model used by the Authority [i.e., exposure to new risk]).

Substantive audit procedures will cover the following areas:

· Cash and investments: (1) confirm all balances in cash and investment accounts, (2) test investments on a sample basis for compliance with Authority investment guidelines and (3) value investments on a sample basis with KPMG’s pricing department to determine if recorded at fair value.

· Purchase power and fuel expense: (1) review purchase power and oil and natural gas invoices and (2) perform analytical and substantive procedures of account balances from year to year.

· Revenue: (1) review and recalculate bills based on contracts and applicable tariffs, (2) send confirmations for a sample of accounts receivable balances, (3) perform analytical and substantive procedures of account balances from year to year and (4) recalculate and evaluate the allowance for doubtful accounts and management’s methodology.

· Fuel and materials inventory: (1) perform an inventory observation (in conjunction with internal audit) at selected locations (site visits were made to the Clark Energy Center and the St. Lawrence/FDR Power Project) to verify the quantity of inventories held and (2) perform a weighted average cost based on consumption and oil price test work to determine the value of inventory held at year end.

· Derivatives: (1) confirm all derivatives with counterparty, (2) reperform the valuation for a sample of derivative positions, (3) perform process walk-through for a sample of derivatives and engage KPMG’s Financial Risk Management group to review disclosures and valuations.

· Debt: (1) confirm all outstanding debt, (2) review transactions related to debt refunding/refinancing, if any, (3) review debt compliance related to all existing debt and (4) select a sample of interest expense payments and obtain audit evidence to support expenditure.

· Plant and property: (1) select a sample of invoices to ensure proper accounting treatment for additional to Electric Plan in Service and CWIP accounts, (2) select a sample of retirements to ensure proper accounting treatment for retirements and (3) perform analytical procedures of account balances from year to year.

· Journal entries: Obtain audit documentation for a selection of manual journal entries for authorization, appropriateness and compliance with adopted accounting principles.

KPMG’s audit approach is to rely on the Authority’s key entity-level and senior management’s monitoring controls, identified as follows:

· A code of Conduct has been effectively implemented and the control environment has appropriate policies in place.

· A Board of Trustees and Audit Committee exist that are independent of management.

· Management has undertaken a detailed risk assessment and monitoring controls exist to mitigate the risks identified.

· Management has controls in place to ensure effective compliance with laws and regulations, including areas affecting financial reporting.

· Management has information and reporting systems that are responsive to achieving entity-wide and activity-level objectives and produces the necessary information to manage the Authority’s operations.

· Results of the Authority’s operations are measured against objectives and expectations, including analyzing variances and key performance indicators on a monthly basis.

· Key controls exist for safeguarding the Authority’s assets.

Mr. Deon said that the entity-wide and management controls are very important. In response to a question from Ms. Elizabeth McCarthy, Mr. Deon said that much of the work connected with this had been done at the interim testing stage of the audit.

KPMG’s approach to mitigating fraud risk includes:

· Conducting management interviews and discussions that include existing management fraud controls (planned interviews include ones with the Audit Committee, the President and Chief Executive Officer, the Chief Operating Officer, the Executive Vice President and Chief Financial Officer, the Executive Vice President and General Counsel, the Senior Vice President – Corporate Planning and Finance and the Vice President – Controller).

· Reviewing journal entries, including large, unusual and non-recurring journal entries.

· Involving a KPMG forensics team to assess potential illegal acts or fraud allegations, when necessary.

With respect to fraud risk, KPMG has designed audit procedures that focus on the following company-specific risks: (1) internal pressures i.e., financial performance], (2) third-party pressures (i.e., customers, elected officials), (3) revenue recognition, (4) related party transactions, (5) non-automated journal entries, (6) propriety of various accruals (e.g., legal, etc.), (7) new significant customer contracts and/or agreements and (8) business travel expense reporting. In response to a question from Vice Chairman Foster, Mr. Deon said that KPMG would have the option of interviewing other staff beyond top management.

The timetable for the audit is as follows:

· Planning – October 12, 2009

· Interim/evaluation of controls and interim substantive testing – October 19 through November 13, 2009 and week of December 28, 2009

· Year-end substantive testing – January 18 through February 14, 2010

· Completion – February 7 through February 19, 2010

Key dates include:

· February 16, 2010 – draft financial statements to be provided to members of the Audit Committee (Mr. Deon said that KPMG had looked at last year’s financial statements and suggested changes).

· February 23, 2010 – KPMG’s formal presentation to Audit Committee members.

New accounting matters that will affect the Authority include:

· GASB 53 – Accounting and Financial Reporting for Derivative Instruments (following GASB 133 on derivatives). This is the most significant new standard as far as the Authority is concerned. It addresses the recognition, measurement and disclosure of information regarding derivative instruments for state and local governments and will affect the Authority’s financial statements due to fuel and purchase power contracts and interest rate swaps. It is effective for fiscal years beginning after June 15, 2009 (i.e., for the Authority’s financial statements ending December 31, 2010) and Ms. McCarthy is addressing this now.

· GASB 55 – The Hierarchy of Generally Accepted Accounting Principles for State and Local Governments

· GASB 56 – Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements on Auditing Standards

Trustee Curley said that he hadn’t realized that GASB 53 was the critical new standard as far as the Authority was concerned. Mr. Deon said that complying with GASB 53 would be more work if it weren’t for the fact that the Authority is already following FASB 133 and FASB 71. Trustee Cusack said that KPMG’s presentation had been very helpful.

3. 2009 Internal Audit Activity Report

Mr. Pardo presented an overview of Internal Audit’s (“IA”) activity through December 31, 2009. He said that as of the end of the year, 34 audits had been completed, including 23 financial/operational, 5 information technology and 6 special projects. Two audits in progress as of December 31 had been completed in January 2010. All audits in the 2009 plan have been completed or are in progress. Mr. Pardo said that 26 audit reports containing 60 recommendations had been issued and that 3 reports were under review as of December 31. All of the recommendations in the audit reports had been accepted by management. By December 31, approximately 55% of the recommendations had been implemented and are being actively tracked, with the rest scheduled to be implemented in 2010. To ensure that issues raised in the audit are properly addressed, implementation of critical recommendations is being verified by observation and testing rather than reliance on verbal confirmation. Mr. Pardo also said that IA had received full cooperation and support from management. Implemented in 2009, the Special Investigations audit function will primarily perform fraud investigations and work with management to enhance the Authority’s entity-wide fraud controls. The Special Investigations unit is working closely with the Authority’s Ethics Office and they are currently collaborating on a fraud case. In response to a question from Vice Chairman Foster, Mr. Pardo said that the Special Investigations unit consists of one newly hired manager and, depending on the case, other existing staff from Internal Audit will participate.

Mr. Pardo said that three audits (New York City Energy Billings, SAP – CATS and WPO Data Center) had been added to the 2009 plan and four had been postponed to 2010 (NYISO Settlements, Corporate Compliance, NERC CIP Reliability Standards and Network Security). Also, special projects not included in the plan were Stimulus Audit & Reporting Project, Navigant Internal Audit Transformation Project, Recovery Act Reporting (report to New York State). Other scheduled projects were Assistance to KPMG for Interim Work on the 2009 Audit of the Authority’s Financial Statements, Internal Audit/Special Investigation Activities and Economic Development Customer Job Commitment Audits (an outside firm is auditing approximately 100 customers).

In response to a question from Vice Chairman Foster, Mr. Pardo said that the Succession Planning audit report had identified quite a few gaps in the Authority’s succession planning efforts. He said that within the next five years, 40% of the Authority’s workforce (including 70% of its executives) would be eligible to retire. Responding to a question from Trustee Cusack, Mr. Pardo said that the Authority’s internal controls had significantly improved between 2008 and 2009. Vice Chairman Foster requested that the audit reports be included as electronic attachments to the Audit Committee meeting materials in order to make it more efficient for review and to save paper.

4. 2010 Internal Audit Plan

Mr. Pardo said that the 2010 Internal Audit Plan is based on the results of a risk assessment survey and management input provided in November and December. The process begins with an examination of the Authority’s Strategic Plan, business activities and related control systems to determine auditable entities (the audit universe). Managers were interviewed to obtain feedback on critical business objectives and risks. A risk assessment was performed on all auditable entities based on the following risk factors: (1) profit/loss impact of the business function (bottom line), (2) perception/reputational risk, (3) changes in operations or systems/known control issues, (4) customer impact from process disruption/failure, (5) business model complexity/organizational size, (6) legal/regulatory compliance, (7) level of impact on financial reporting and (8) strategic alignment. Audits are ranked from high to low in terms of the relative risk they represent.

A total of 35 audits are scheduled, including 25 financial/operational and 10 Information Technology audits covering all Authority business units. Seven of the audits will be conducted at the Authority’s facilities. Key audits scheduled include Generation Resource Management, SENY Long-Term Agreement, NERC Reliability Compliance and follow-up reviews of Energy Hedging and Succession Planning. Other projects include Special Investigation activities, work on economic development job commitment audits and the usual support of KPMG and Ethics Office activities.

The performance goals for 2010 audits are as follows:

· Completion of high-risk audit areas – goal of 100%

· Competion of the Audit Plan – goal of at least 90%

In response to a question from Vice Chairman Foster, Mr. Pardo said that he plans to fill the two vacant positions in Internal Audit by the end of the first quarter of 2010.

5. Office of the State Comptroller Audit

Mr. Thomas Concadoro provided an overview of the scope of the planned audit of Authority 2007-09 overtime costs to be conducted by the Office of the State Comptroller (“OSC”). In addition to the Power Authority, OSC is auditing the Metropolitan Transportation Authority and some smaller authorities. The opening conference for the audit was held last week and the auditors are currently on site looking at overtime authorization and the cost-monitoring process. Ms. McCarthy said that overtime costs, particularly as they affect retirees’ pension calculations, are a hot issue right now. Mr. Concadoro said that the Authority averages about $10 million in overtime costs per year, or 7% of its total payroll. In response to a question from Chairman Michael Townsend, Mr. Concadoro said that he doesn’t know how these numbers compare with other authorities’ overtime expenditures. Mr. Deon said that the 7% figure seems reasonable to him and Mr. Mahoney said that these things are hard to benchmark. Ms. McCarthy said that the audit itself would take approximately four to six weeks, after which a draft report would be issued. In response to a question from Trustee Nicandri, Mr. Concadoro said that emergency vs. planned overtime is not differentiated in the payroll system, although the reason for the overtime should be in the MRM system. Ms. McCarthy said that the Authority has a strong overtime reporting system and controls. Mr. Concadoro said that the auditors will also be visiting the Authority’s facilities.

6. Committee 2010 Calendar

On motion made and seconded, the following schedule of regular Audit Committee meetings was adopted by the Committee:

Date Time Topic

February 23, 2010 9:30 a.m. Results of 2009 Independent Audit

July 27, 2010 10:00 a.m. Interim Results for Six Months

Ended June 30, 2010

October 26, 2010 10:00 a.m. KPMG 2010 Audit Plan

7. Next Meeting

The next regular meeting of the Audit Committee will be held on Tuesday, February 23, 2010, to commence at approximately 9:30 a.m. at a location to be determined.

Upon motion duly made and seconded, the meeting was adjourned at approximately 10:35 a.m.