Wednesday, June 15, 2005 | The officials brought in to revamp the city of San Diego’s legal and financial disrepair again articulated the need for the pension board to turn over documents to auditors and federal investigators Tuesday, warning the City Council that the failure to do so will end in grave financial consequences for the city and retirees.
“Failure to act on this issue does a huge injustice to the people who are the pensioners, that this could – would – interrupt the flow of funds that go into this system and they would be the ultimate losers,” said Arthur Levitt, former chairman of the Securities and Exchange Commission.
In response, city officials appeared willing to place the troubled pension system under a court-supervised receivership if the pension board fails to open its archives during its monthly board meeting on Friday.
Levitt warned that the receivership option, which places the system under a court’s control, would be a final, costly and lengthy choice.
In a sign of a bit of political hardball rarely shown by the council, they voted 8-to-1 to postpone the pension system’s budget hearing by a week in order to wait out the board’s decision. Councilman Michael Zucchet cast the lone “no” vote.
The pension system stands at the center of the city’s current woes. It is saddled by a deficit estimated to be between $1.37 billion and $2 billion, which has attracted investigators from the SEC and the U.S. Attorney’s Office concerned over possible errors in the city’s financial disclosures to investors and possible political corruption.
Questions surrounding these two issues have long delayed the city’s fiscal year 2003 and 2004 audits. Officials say the audits cannot be released until the pension board releases documents that are currently protected by the attorney-client privilege.
The city’s long-term financial health is tied to the release of the audit. Without it, the city has little access to funds for water, sewer and other construction projects.
As part of his plan to turn around the pension system and city finances, Mayor Dick Murphy appointed seven new nominees to the 13-member pension board. The updated board has refused to waive the attorney-client privilege in its first two monthly meetings in April and May.
At the time, Murphy said it would be inappropriate to condition their appointment on an agreement to a waiver of attorney-client privilege; however both Levitt and City Attorney Mike Aguirre appeared to approve of such an approach with new appointees.
The pension board’s recalcitrance to date appears to be at least partly rooted in trying to avoid the mistakes of the past.
The pension deficit is a result of a practice dating back to 1996 whereby the pension board allowed the city to annually contribute less than recommended to the pension system, while the city continued granting substantial benefit increases to employees. The troublesome mix was obscured by years of strong investment returns.
But when markets soured in 2000, the consequences of the practice were revealed. The previous board is blamed for its lack of independence in putting the city’s financial needs before that of the pension system.
Now, some pension board members are standing strong, saying they won’t be bent by political pressure. Many have said they worry that such a waiver would expose the system – or themselves – up to litigation.
Indeed, some council members were sharp in their language.
“I want to send a message to SDCERS that your time has run out. Either waive the privilege or serious things are going to start happening real quick starting Monday morning,” said Councilman Jim Madaffer.
Aware of the sensitivities surrounding the issue, Councilman Scott Peters attempted to distance himself from Madaffer’s comments. A memo he sent to pension trustees this week discussing the waiver was met with strong resistance by at least one outspoken pension trustee, Thomas King.
Levitt, hired in February to help cure the city’s ills, spoke of an unnecessary “atmosphere of fear.”
“I wish they would understand that the alternative of taking what limited risks that are involved in providing us with those documents is far greater than the series of events that are to be triggered by their not providing. Their not providing it suggests an outcome that I think none of us really desire,” he said.
To that end, Aguirre repeatedly advised the council to urge the pension board to waive the attorney-client privilege because it was in the best interests of retirees and employees – not the city. Such an argument allows the city to articulate the need of the waiver without compromising the board’s independence.
Throughout the process, a lack of communication between entities also appears to have been pervasive. In May, Troy Dahlberg, one of Levitt’s associates, said that no one ever told the pension board why the waiver was important.
And up until recently, some council members were under the impression the audit could be finished without the waiver.
Now, pension board members appear to be worried that they could be held personally liable for their actions should they waive, something that Levitt’s attorneys say isn’t the case.
Pension Trustee Bill Sheffler, said he favors waiving the attorney-client privilege even though the “the city’s problems are not those of its pension plan.”
But, Sheffler said the city has now taken “the low road.”
“The City Council is aware of the liabilities that the SDCERS board would assume if it approved the waiver, but the city attorney has threatened board members with personal liability for performing their duty and the City Council has declined to provide indemnity for any resulting risk,” Sheffler said.
Aguirre, in an interview, said only that each board member’s individual risk was irrelevant.
“Whether they have liability or don’t isn’t the issue, they can’t put their own interests ahead of the pension system’s participants, and it’s in the pension system’s best interest that the illegal acts audit be completed,” Aguirre said.
Like the city, the pension system should not have proceeded with past reports and audits of its funds without conducting an illegal acts investigation of its own, which would have included a release of the coveted documents.
Sheffler said the independence of the pension board should be respected.
“The citizens of San Diego voted to reconstitute the board last year, because the City Council puppets on that board had not lived up to their fiduciary obligations,” he said. “Now, there’s an independent board and the City Council can’t abide it.”
Levitt was in town to apprise the council of the progress of his audit committee, which is tasked with being a go-between for the city and its outside auditors, KPMG, as well as federal investigators.
He said bankruptcy shouldn’t have to be an option for San Diego because of the strength of the local economy, but warned that no solution should be discounted at this point.
“This is not an economic problem, in my opinion. It’s a political problem. It’s a problem of will. It’s a problem of mobilizing the assets of the community to come to a solution,” Levitt said.
He estimated that the audit committee, comprised of three accountants and two attorneys, is costing the city about $800,000 a month. He said he expects such a charge for the coming months and hopes to be done by the start of 2006.
The waiver must be attained soon, Levitt said. He and his colleagues also stressed an immediate change in actuaries for the pension system.
However, pension administrators chose not to place the item on the docket last week after the audit committee had called for a new actuary over concerns of the actuary’s actions and assumptions.
Scott Lewis contributed to this report.
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