Ron Penney David Vardy

10 Inglis Place 215-66 Churchill Avenue

St. Johns, A1A 4L7 St. Johns, A1A 0L8
NL, Canada NL, Canada

May 8, 2017

Terry Paddon
Auditor General
Office of the Auditor General
5 - 7 Pippy Place
St. John's, NL, A1B 3X2

Dear Mr. Paddon:

Your decision to undertake an audit of the Muskrat Falls project is welcome news. Would you be
so kind as to make your audit plan available, as was requested in an email a week ago?

An effective and expedited audit can play an important role in the oversight process by providing
information which can be used to make corrective adjustments in real time.

Your audit can become an important part of a revitalized oversight process to be conducted by
the newly expanded Oversight Committee, chaired by the Clerk of the Executive Council. It can
also be an important tool to be used by Nalcor management and by the new Board of Directors.

The Premier has indicated that consideration by government of a public inquiry into Muskrat
Falls will be held in abeyance pending the outcome of your review. This comment by the Premier
leads us to believe that your audit will be comprehensive in nature and not simply a financial
audit.

In the interest of ensuring such a comprehensive audit we suggest that the following six
principles be embraced in your audit plan. These principles encompass the following:

1. Timeliness
2. Probity
3. Minimizing cost
4. Verification of data
5. Inclusion of project management, governance and oversight, and
6. Quality control

Under each of these principles we recommend action measures for inclusion in the audit.

1. Timeliness
The audit should be a timely and vital component of management, governance, and regulatory
oversight.
a Action recommended: The audit should be designed so as to make the project
better and to improve the final outcome. The timeliness of audit reporting will be
important in adding value to the oversight process by facilitating course
 correction and learning from past mistakes. This argues in favour of a robust audit
but one which is conducted in stages, with interim reports released on a timely basis.

2. Probity
The audit should test the probity of project management, recognizing that there have been
allegations of falsification of cost estimates.
b Action recommended: The audit should assess the quality of the original cost
estimates, particularly the DG2 and DG3 estimates, and the adequacy of the
allowances for cost escalation and for contingencies. You will note the concerns
expressed by Ernst and Young in their April 8, 2016 interim report, with respect to
the strategic risks versus tactical risks and the exclusion of strategic risks from
Nalcors contingency reserves.
c Action recommended: Assess contract management with reference to best practices.
d Action recommended: Assess whether hiring practices have been fair and
competitive.
e Action recommended: Review the employment contracts given to members of the
management team which have been hidden from public view by their use of
privately owned corporations.

3. Minimizing cost
Minimizing and controlling project costs, recognizing that Nalcor has been exempted from
compliance with the Public Tendering Act.
f Action recommended: Assess whether competitive bids were solicited and awarded
in order to minimize project cost.
g Action recommended: Examine the structure of Nalcors contracts to ensure that
there are incentives to minimize, rather than maximize costs? Ernst and Young
(section 5.8) pointed out a major discrepancy in the incentive structure relating to
Astaldi, as disclosed by the Nalcor CEO at the 2015 AGM, compared with the
incentives which EY found in the actual contractual arrangements with Astaldi,
which suggested that the payment mechanism is based on person-years expended
rather than m of concrete poured.
h Action recommended: You should direct particular attention to the Astaldi contract,
which has grown from $1.1 billion to $1.830 billion, with little explanation to the
public of the reasons for the escalation.

4. Verification beyond Nalcor

Extending the audit and verification process beyond Nalcor, recognizing that the Ernst and Young
review (section 4.1) was based solely on data supplied by Nalcor, without any independent
verification.
i Action recommended: The audit should extend into the relationship between
contractors and subcontractors and should not be confined to Nalcor.

5. Inclusion of project management, governance and oversight

Governance and project management should be included in the audit, recognizing that the Ernst and
Young review (section 1.7) did not include a formal review of the Project governance
arrangements.

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 j Action recommended: Assess the governance structure within Nalcor and its
capacity to manage a project of this magnitude and scope.
k Action recommended: Review the decision of the new CEO to continue with the
same management team, with modest realignment, along with his decision to
maintain Nalcors lead role in project management.
l Action recommended: Assess the role of SNC-Lavalin in the projects engineering,
procurement and construction management (EPCM) process.
m Action recommended: Assess the increased equity participation by Emera Energy in
the Labrador Island Link, which has grown from 29% to 59%.

6. Quality control
Quality control should be included, recognizing that there are numerous examples of lack of quality
control relating to popped transmission wire strands, leaking coffer dams and collapsing
formwork at the powerhouse to suggest that quality control may be an issue.
n Action recommended: Review quality control systems to ensure they are adequate.

Conclusion

We believe it is important that you make a public disclosure of the audit plan for this audit project
as soon as possible so the public can be aware of its scope and make comments before it is
finalized. The credibility of the audit will depend upon the qualifications and experience of the team
as well as the quality of the audit plan itself. How will you build an audit team which has the
capacity to review a major hydroelectric project of this magnitude? Will you be seeking outside
audit expertise?

This letter is being forwarded to the Honourable the Premier, to the Minister of Natural Resources
and to the Chair of the Muskrat Falls Oversight Committee.

Sincerely,

David Vardy

Ron Penney