• What brought the City's pension system to a crisis was a number of completely foreseeable financial challenges to a pension system debilitated by years of reckless and wrongful mismanagement involving any number of City and pension board officials.
• In enacting the pension system modification commonly referred to as "Manager's Proposal 1" or MP-1," the City's pension board and the City acted illegally and improperly and thereby allowed City, with full knowledge and acquiescence of numerous participants in the approval process, to avoid financial obligation imposed by state and local law.
• In enacting MP-1, the City pension board, with the active encouragement of City officials, reduced the flow of funds to the City's pension system in order to benefit the City while creating no compensating benefit for the pension system itself. In so doing, the City pension board violated its fiduciary responsibilities to protect the financial stability of the system and its independence from political influence.
• With the active encouragement of City officials, the City pension board also violated its fiduciary duties with the passage of the pension system modification commonly know as "Manager's Proposal 2" or "MP-2."
• The passage of MP-2 was unlawful for a number of reasons including that it was predicated upon the fiction that the modification would provide some benefit to the City pension system. In fact, the effect of MP-2 was to further erode pension system viability and the supposed benefits to the pension system from MP-2 were illusory.
• The approval of MP-2 was obtained only through the award of new retiree pension system "benefits," on of which, when stripped of its descriptive veneer, was made available only to a single individual then serving on the pension board whose support was viewed as critical to the passage of the MP-2 modification.
• The City further eroded the financial soundness of its pension system by using pension system assets to finance City retiree healthcare costs.
• Subsequent to the enactment of MP-1 and MP –2, the pension board made false and misleading public statements to disguise the extent to which pension system assets would be insufficient to pay the promised benefits to City retirees.
• Beyond violations of law as to its pension system, the City knowingly failed to comply with federal and state requirements applicable to its municipal wastewater system which mandated that sewer rates reflect the costs of treating sewage and be proportionately allocated to residential and industrial users. Not only did this result in City homeowners being overcharged on their monthly bills for sewage costs with the excessive payments being used to subsidize the City's industrialized water users; the City thereby breached arrangements with the state and rendered itself liable for the return of $265 million in state funds.
• The City's dereliction as to both its pension and wastewater treatment systems resulted in numerous violations of the federal securities laws and the City repeatedly obtained money from public investors through financial statements and related disclosures that were false.
• Among its fraudulent misrepresentation to investors, the City: (1) falsely claimed that it was making contributions to its pension system at actuarially determined rates, when in fact it was not; (2) falsely claimed that it was using an "excellent method" of pension funding when in fact its funding method was not in accordance with legal requirements; (3) falsely stated that the City had amended its municipal cod to accommodate the pension system modification know as MP-1 when in fact it had not; (4) failed to disclose the conflicts of interest resulting from the participation of members of the pension board in decisions that both threatened the pension system's soundness and increased their own individual benefits; (5) falsely stated that the cost of a settlement of a lawsuit calling into question the City's pension system funding would not be borne by the City's "general fund" thereby fraudulently implying that the settlement would have no impact on the City; (6) failed to disclose that the funding method used to pay for the retiree healthcare benefits was from the pension system's surplus earnings; and (7) falsely stated that the City believed it was "in compliance with all federal and state law" relating to its wastewater sewage treatments system.
SAN DIEGO—Negligence, deliberate disregard for the law, disregard for fiduciary responsibility, and long-term disregard for the financial welfare of citizens lead to San Diego's $1.4 billion pension deficit and the city being barred from accessing financial markets. Fundamental and immediate reforms are needed in the city's financial reporting system.
The Audit Committee of the City of San Diego unveiled these findings to city officials on Tuesday in the long awaited report of their investigation of the San Diego City Employees' Retirement System (SDCERS), and the City of San Diego Sewer Rate Structure.
Kroll Inc., a forensic accounting and litigation consulting firm, produced the 266-page report. The city hired Kroll in 2005 to perform an independent investigation into allegations made by the City Attorney's Office of possible wrongdoing by city officials in preparation of San Diego's 2003 financial statements.
"The Kroll report is a precondition to the release by KPMG of audited financial statements for 2003. The statements for 2004 and 2005 would then follow," said San Diego Mayor Jerry Sanders. "These developments will allow us to once again have access to public credit markets so that we can make critical improvements to our infrastructure and begin stabilizing our city's finances."
Senior member of the three-person audit committee and former chairman of the U.S. Securities and Exchange Commission Arthur Levitt presented Kroll's discoveries to the City Council.
"Evidence made available in this investigation demonstrates numerous failures of San Diego City government to conform to the law, to adhere to principles of sound governance and financial reporting, and to protect the financial integrity of the City's pension system and thereby the welfare of the City itself," read Levitt from the report.
"The evidence demonstrates not mere negligence, but deliberate disregard for the law, disregard for fiduciary responsibility, and disregard for the financial welfare of the City's residents over an extended period of time." According to Levitt, the City now faces a $1.4 billion pension deficit and is barred from accessing financial markets.
"Among the laws violated were the California Constitution, the San Diego City Charter, the San Diego Municipal Code, and the federal securities laws."
The Audit Committee alleges that city officials acted unlawfully by underfunding the pension system, using pension system assets to finance City retiree healthcare, and making false and misleading statements to disguise the extent of the pension deficit.
They also found the city knowingly violated federal and state requirements applicable to its municipal wastewater system, and is therefore liable for the return of $265 million in state funds.
Kroll concluded that gaps such as lack of transparency and lack of accountability plague San Diego's entire political and financial systems, and that key players exploited those gaps.
"City officials gave expedience a higher priority than fiscal responsibility and came to view the law as an impediment to be circumvented through artful manipulation," stated the Kroll report.
"Even today, there are serious indications that the City government has not completely come to grips with the depth of its problems and the need for fundamental reform," states the Kroll report. "The City still has not found a way to successfully perform such fundamental bookkeeping tasks as reconciling the balance in its cash accounts with the cash balance on its financial statements for the fiscal year 2003."
Kroll's recommendations for reform are enhanced accountability, enhanced transparency and independent evaluations.
City Attorney Michael Aguirre was critical of several key issues in Kroll's report, including the assessment of legal liabilities, remedial recommendations, and the overall cost to the city.
"We've expended $20 million dollars of taxpayer funds on Mr. Levitt and his team, and have spent over $4.5 million dollars on KPMG in order to get an audit opinion that was supposed to cost $800,000 dollars when KPMG was first retained," said Aguirre.
"All the [recommended] monitoring, that's all well and good, but [your] fundamental recommendations are negligence only, keep all the illegal benefits, SDCERS keeps the same attorney—the same situation that got us in trouble to begin with, and the taxpayers pay for it all," continued Aguirre.
The City Council members and the mayor were more optimistic, each expressing their determination to do whatever it takes to resolve the fundamental problems and move forward as expeditiously as possible.
"Over the course of the next several weeks, my staff and I will be analyzing the report in great detail," said Sanders. "I will carefully consider all of the remedial recommendations made by Kroll."
The mayor's remedial actions work plan is scheduled for council consideration and approval on Tuesday, Sep. 19.
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