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Thursday, March 17, 2005 | This is the second installment of a two-part series.
Within a week of learning about recorded inaccuracies, the company’s internal auditors conducted a review and had advised company management who, in turn, advised the board’s audit committee that controller Gisela de Leon-Meredith had caused the company’s books and records to be inaccurate and its financial report to be misstated.
City Manager Lamont Ewell, in an interview, credited the city’s auditing staff with identifying the disclosure problems. However, an internal review only came about after an e-mail from pension whistleblower Diann Shipione notified the city’s outside bond counsel of material errors in its financial disclosures related to its now-$1.37 billion pension deficit in Sept. 2003, according to the city’s own investigation.
The outside counsel, who expressed his frustration with what he deemed was a lack of cooperation by city staff, then prodded the City Auditor’s Office to conduct a full review of the disclosures made to potential investors. This review turned up more errors and omissions.
City officials then revised the city’s financial disclosures twice in early 2004, first in January and later in March to acknowledge its history of underfunding the pension system and the effect it will have on future city budgets.
The SEC doesn’t comment on investigations, but it is believed it began looking at the city after the Jan. 2004 financial restatement. Ewell said this evidence points to the city’s cooperation under the Seaboard guidelines.
However, Sullivan looked at the same timeline and deemed it “not good facts – not showing a responsiveness.”
Seaboard hired an outside law firm to conduct a thorough inquiry.
While city officials often trumpet the hiring of Vinson & Elkins and its investigation, the firm’s reputation and role in the proceedings were called into question by some securities attorneys interviewed for this story.
The firm released a much-heralded investigation of city financial disclosures in September that placed little blame in the faults found in the city’s financial reporting. After spending more than half of a year and charging more than $1.5 million on the first investigation, the firm was sent back to investigate the possibility of illegal behavior after its investigation wasn’t deemed sufficient by auditor KPMG.
McIntyre, who works as a defense attorney in securities cases, said the September investigation by the law firm now looks much like “a defense document.” This is in direct contrast with the Seaboard model, he said.
“One of the things I think the SEC makes clear is: ‘Don’t use litigation-style tactics and think we can just kiss and make up at the end,’” he said. “…They don’t want someone playing defense, fairly or not.”
Lawrence Byrne, an attorney in the New York office of White & Case, represented the Dutch company Royal Ahold last year when the SEC was investigating fraud and other securities violations. In bringing enforcement against three of the company’s top former executives, the commission noted the company’s extensive cooperation as one of its reasons not to seek a penalty against the company itself.
He said that since Congress passed stricter financial reporting laws in the form of the Sarbanes-Oxley Act in 2002, the same law firm generally doesn’t conduct an investigation while also representing the entity in front of the SEC – as Vinson & Elkins is doing – because it raises issues of independence.
“One of the things the SEC will look at is: ‘Was the investigation complete and independent?’” Byrne said.
City officials contemplated Vinson & Elkins’ duel roles, Ewell said, but concluded that the firm’s background and experience with the SEC were extensive.
But the firm’s track record was also troubling to McIntyre. The firm has been implicated in the Enron scandal and is part of the ongoing class action lawsuit against Enron because of its alleged role in covering up the former energy giant’s financial schemes.
Vinson & Elkins also conducted an investigation into Enron’s accounting practices after a whistleblower aroused concerns. The investigation was shunned by the whistleblower in that case, as it was in San Diego.
The investigation was criticized for a number of the same faults as its San Diego counterpart, including not finding any real guilt and not interviewing upper management figures such as former top executives Kenneth Lay and Jeffrey Skilling, both of whom are now on trial for fraud and conspiracy and are held up as the poster boys of runaway Wall Street deception.
“I guess if I were looking for someone to represent my entity, I’m not sure I would select a firm that itself was the subject of scrutiny for the same type of conduct,” McIntyre said.
Mayor Dick Murphy declined to be interviewed for this story. Instead, his spokesman sent the following e-mailed statement: “It is the city’s goal to follow the standards set by Seaboard in its dealings with the SEC to the best of our ability.”
Four days later, Meredith was dismissed, as well as two other employees, who, in the company’s view, had inadequately supervised the controller.
Ewell said the comparison gets tricky here, because the city is held to different labor laws than corporations. He said three people identified as having a hand in the errors and omissions have been reassigned to different areas of the organization. The city’s first investigation said that the errors were unintentional, and civil service laws set up certain procedural rights that give city employees rights that a private employee might not have.
Terri Webster, former assistant auditor and member of the San Diego City Employees’ Retirement System, has been moved to the Metropolitan Wastewater Department; Treasurer Mary Vattimo, also a member of the pension board, was reassigned to work strictly on budget issues; and Deputy City Manager Pat Frazier is now head of Development Services Department, Ewell said.
“I personally reassigned every one of those individuals who were alleged to do wrongdoing to make sure the city’s interests were being met,” he said. If an investigation reveals wrongdoing, their employment will be terminated, Ewell added.
City Attorney Mike Aguirre has led a growing chorus of people in and out of City Hall calling for the firing of those involved with the financial disclosure errors and omissions. Former auditor Ed Ryan has retired, and former city manager Michael Uberuaga resigned last year as well. In an interview, Aguirre also called for the firing of the three employees reassigned by Ewell, in addition to Human Resources Director Cathy Lexin, also a former pension board member, and Larry Grissom, the retirement system administrator.
The mayor and City Council “have really not replaced anyone except the manager, and (the) auditor resigned. The people on the (retirement) board were retained, and not only were they retained they were allowed to vote to sue the city and refused to turn over the records that are important for our audit and the SEC investigation,” Aguirre said.
Sullivan said corporations generally clean house and have an entire new team of leadership when they proceed with the SEC. However, in this case, the leadership is comprised of many of the same elected officials.
“The fact that we have these people kind of lingering around is a problem for the city as well,” he said.
The negative public treatment of Shipione, who brought to public light both the pension funding problems and the disclosure errors, will also likely be looked upon negatively by the SEC, McIntyre said.
“She’s been treated like dirt,” he said. “I think it’s hard if you are arguing for the city, ‘Gee, we really wanted to be open-handed and transparent, and at the same time treating the whistleblower like a pariah.’”
A day later, Seaboard disclosed publicly and to the SEC that its financial statements would be restated. The price of its shares did not decline after the announcement or after the restatement was published. One SEC consideration is the affect the entity’s actions may have on the shareholders.
Amy Doppelt of the credit rating agency Fitch Ratings said city bondholders continue to receive the principal and interest owed to them on their bonds, but the credit downgrades issued by all three ratings houses in the wake of the investigations and delayed fiscal year 2003 audit could drive down the market value of the bonds.
A recent report from a bond monitoring agency says that while there have been no changes to bond prices, “there continues to be a small contingent of market participants wary to participate in bidding any San Diego names.”
“We feel good that we protected the interest of our bond holders,” Ewell said.
The company pledged and gave complete cooperation to staff. It didn’t invoke attorney-client privilege.
The City Council has waived its attorney-client privilege to cooperate with investigators. However, cooperation in timely document production and the pension board’s refusal to waive its attorney-client privilege – thereby barring SEC access to closed session documents – are both central issues to the case.
“If you look at some of these other cases where the entities have gotten whacked, the reason is you didn’t respond quickly to the inquiry, didn’t turn in the documents promptly,” McIntyre said.
Aguirre said he has either received or seized boxes and boxes of documents from Webster and Frazier, two of the reassigned employees, long after they were due to be turned into authorities.
The city attorney, who has been making many of the accusations against city officials for lack of cooperation, has also been on the receiving end of at least veiled criticisms from Turner, the city’s hired accounting chief.
In his public comments last week, Turner hinted that federal authorities were displeased by the political climate at City Hall, including the lobbing of public allegations and personal attacks.
Since taking office in December, Aguirre has released two interim investigative reports, one of which accused the mayor and council members of securities fraud, and a growingly bitter relationship has formed between the city attorney and the mayor, city manager and some council members.
The mayor’s hand-picked pension board took official control of the embattled system this week, and all eyes will be on his seven appointees to see if they reverse the previous board’s decision to invoke attorney-client privilege. Murphy said he expects the board to revisit the decision, but didn’t speak with his appointees about the subject. He had asked the previous board to do so.
If the privilege stays put, both the purity of the city’s long-awaited fiscal year 2003 audit and the SEC’s investigation could be damaged. The city must complete the audit in order to regain access to financial markets and raise capital for long-term projects.
Seaboard strengthened its financial disclosure process.
The City Council voted to implement Vinson & Elkins’ recommendations in September to strengthen its financial reporting. These steps include the establishment of a three-person oversight board for financial reporting and a group of city administrators that will meet monthly to discuss reporting issues.
The move gives the city what Murphy has called the toughest reporting process of any city in the nation.