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Wednesday, August 24, 2005 | City officials have determined at least 30 corrections must be made to their stalled 2003 financial statements, adjustments that will lower the city of San Diego’s reported assets by at least $642 million, according to a memo from its outside auditor.
The errors in the city’s financial statements to the public and investors require restatements in the following areas: pension accounting, assets of the water and wastewater funds, infrastructure, capital accounting and revenue recognition, according to the Aug. 5 memo from auditor KPMG to the City Council and its audit committee.
The city reported total net assets of $6.8 billion in its 2002 Comprehensive Annual Financial Report; a lowering of assets by $642 million would reflect a decrease of 9.4 percent in the city’s total reported assets for 2002.
Unresolved issues surrounding pension accounting and the true depth of the city’s pension deficit could still require further review and evaluation of the financial statement, the memo states.
Auditors are awaiting the release of documents that have to date been protected by the pension board’s invocation of the attorney-client privilege, as well as the hiring of a new actuary to redo the pension system’s 2003 and 2004 annual financial reports.
The outside audit committee brought in to assist in the cleanup of the city’s legal and financial woes has recommended a new actuary look at the pension system’s books over concerns the current actuary has employed aggressive accounting that could downplay a deficit already officially stated at $1.37 billion.
Additionally, the KPMG memo states that “the city has not yet concluded that the 2003 financial statements are complete and prepared consistent with generally accepted accounting principles” because of questions raised by KPMG, city staff and Macias Gini & Co., the firm hired to complete the city’s 2004 fiscal year audit.
In the auditing process, a professional firm verifies and certifies financial statements first compiled by the municipality. A KPMG official gave an oral presentation explaining some of the information in the memo to the City Council on Aug. 9.
“It does sound like a big number,” Steven Heyental, a staff member in Deputy Mayor Toni Atkins’ office working on the audits, said of the $642 million in corrections. “But I think what needs to be said is it is a standard procedure for an auditor to come in and look at how we value our assets.”
Many of the errors have to do with the devaluation of city assets, changes in accounting procedures and the timing of the recognition of revenue, Heyental said.
Amy Doppelt, who monitors the city of San Diego for Fitch Ratings, said it was too early to tell what effect the restatements could have on the city’s bond ratings. She said a number of the restatements appear to be in hard assets, such as errors made in the devaluation of assets, which are less troublesome to credit agencies than other discrepancies.
However, the existence of errors in the financial statements could eventually provoke litigation from those who purchased the city’s bonds while relying on inaccurate documents.
Errors and omissions were originally unearthed by pension whistleblower Diann Shipione in late 2003, causing the city to pull back on a $500 million wastewater bond offering. The city eventually also restated its financial statements.
This led to an investigation into the city’s disclosure practices by the Securities and Exchange Commission, which is now more than a year-and-a-half old. The U.S. Attorney’s Office and the FBI are also investigating possible political corruption at City Hall.
The SEC could levy fines or sanctions against the city as a whole, or against certain individuals, in relation to the erroneous disclosures. In settlement talks, SEC officials also expect to see remediation plans in place to remove those who contributed to the faulty disclosures and establish safeguards to ensure proper disclosure practices.
The financial report for the fiscal year ending June 30, 2002, was submitted by former City Auditor Ed Ryan on Nov. 27, 2002.
The city released four bond offerings to the public after the 2002 report on the city’s financial state was released, according to City Attorney Mike Aguirre’s Interim Report No. 2.
In early 2003, the city offered more than $140 million in bonds to the public for such things as parks and infrastructure. The $500 million wastewater bond offering was approved by the City Council on June 30, 2003, but was never completed.
Vinson & Elkins, the law firm hired to represent the city before the SEC and complete an independent investigation into its disclosure practices, has released two investigations into the city’s disclosure practices.
The reports have found the city’s disclosure practices to be wanting and acknowledged the city’s failure as an institution to accurately report the financial burden of its pension problems. However, both have found no officials at fault for the erroneous disclosures.
The subject of much scrutiny, Vinson & Elkins has chosen not to continue as the city’s counsel.
Its two reports have been decried as “whitewashes” by Aguirre, who in his own report into the disclosure practices of the city found it likely that former Mayor Dick Murphy and current and former council members violated securities laws in approving the bond sales.
In the Aug. 5 KPMG memo, partner Steven G. DeVetter states that KPMG first expressed its concerns regarding the sufficiency of the Vinson & Elkins probe to city staff and the law firm’s investigators on May 7, 2004. KPMG officials followed up with letters to city officials stating the same concerns.
However, city officials chose to continue with the Vinson & Elkins investigation and hoped it would satisfy KPMG. It didn’t, as concerns regarding the independence of Vinson & Elkins arose. The firm was both investigating the city and serving as its defense counsel in front of the SEC.
The auditing firm requested a subsequent investigation, which city officials again assigned to Vinson & Elkins.
“It is fair to say that … we have shared our concerns regarding the critical importance of independent oversight of the investigation,” DeVetter states at the conclusion of the paragraph addressing Vinson & Elkins’ work.
Vinson & Elkins received $3.8 million for its investigations and $5.6 million in total, including representation and investigation.
The memo then states that KPMG views the retention of the audit committee, which is headed by two top former SEC officials, as a “very positive step toward achieving the independent oversight for which we had been pressing and the resolution of the issues obstructing completion of our financial statement audit.”
The audit committee was formed in April to oversee the investigation and costs the city about $800,000 a month.
“We would view any action by the city or any of its officials to limit the audit committee’s ability to execute its obligations in a timely and complete manner as reflecting either an inability or unwillingness on the city’s part to complete the independent and thorough investigation that is necessary,” the memo states.
“On a positive note, we have observed more progress toward the completion of an independent and thorough investigation in the past three months than in the entire preceding twelve months,” the memo continues.
The city’s credit rating was suspended by one of the three major credit rating firms in September 2004 following Vinson & Elkins’ first report.
In early 2004, KPMG was brought in to audit the city’s fiscal year 2003 financial statements. The audit has remained stalled since last fall pending a complete investigation into alleged wrongdoing by city officials in connection with the pension system and disclosure practices.
Members of the audit committee have said they cannot complete the investigation without access to documents currently being protected by the pension board. Without the audit, the city cannot regain its credit rating and access capital markets to raise the cash for construction and infrastructure projects.
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