Severn Trent Water apologised to customers yesterday after "deliberately miscalculated or poorly supported" data inflated bills by £42 million.
The utility, which serves eight million customers in the UK, is already in the process of refunding households but is now likely to find itself punished with a further cap on its previously agreed price rises.
Ofwat reprimanded Severn Trent in an interim report after income data submitted to the regulator for a price review covering the period 2005 to 2010 turned out to be incorrect.
The final penalty will only be known once an ongoing investigation by the Serious Fraud Office into reliability of leakage data is known.
Ofwat said the errors being dealt with today would have resulted in customers being overcharged by a total of £42 million by 2010, the equivalent of between £2 and £3 each year on an average household's annual bill.
It said poor internal processes and controls led to the incorrect income data - costing consumers £40 million - while deliberately miscalculated bad debt data added £2 million as part of a separate price review held in 2002.
Philip Fletcher, Ofwat's director-general of water services, said: "Customers have the right to expect companies to maintain the higher governance standards, including effective processes and controls, at all times. Severn
Trent Water's approach fell significantly below these standards."
Severn Trent said it had begun to put the matter right by raising prices £7 million less than allowed under 2006-07 price limits. A rebate averaging £2 to £3 a year per customer will follow over the next three years.
Chief executive Colin Matthews said: "We apologise unreservedly to our customers for poor internal processes and systems of control which unintentionally led to price limits for the period 2005-2010 being set too high.
"We also deeply regret failures in our internal processes, controls, ethics and culture."
He added that a new management team at Severn Trent had already made changes to the organisational structure and processes. The matters came to light after a senior employee complained to a newspaper about the way leakage data was reported.
Severn Trent pointed out that Ofwat found no evidence of a company-wide attempt to mislead on issues of bad debt or metered customers bills.
However, it did find evidence of a limited number of staff who became aware of wrong behaviour but did not raise any concerns.
Mr Matthews added: "A number of our employees were disciplined as a result of our own thorough internal disciplinary investigation." ..SUPL: