The regulator claims that Severn Trent Water deliberately misreported customer service data in an attempt to hide the company's poor performance prior to 2006.
The water company has admitted overcharging customers and failing to issue rebates to some customers when errors were identified.
Ofwat Chief Executive Regina Finn said: "Severn Trent Water's behaviour was unacceptable. The size of the proposed fine reflects how seriously Ofwat takes the deliberate misreporting of information."
Severn Trent Water's customer relations department has come under heavy criticism for attempting to deceive Ofwat, and the regulator is keen to ensure similar occurrences are prevented.
Commenting on the fine, Finn said: "This sends a clear message to the company and to the rest of the water sector – Ofwat will protect consumers and companies must comply with their legal obligations or pay the price."
She added: "Any further attempts to deliberately mislead Ofwat could lead to even bigger fines in the future."
In proposing the £35.8M penalty, Ofwat says it has taken into account Severn Trent Water's actions once the company discovered that incorrect data had been provided.
The company has begun the process of returning money for excessive bill payments to customers, and is cooperating with the regulator to properly monitor its future performance.