Friday, September 16, 2005 | City officials likely broke federal securities laws in concealing that the city of San Diego overcharged its residents for wastewater treatment and thereby jeopardized more than $300 million it had received in state and federal loans, according to a report released Thursday.

From 1998 to 2004, city residents were overcharged more than $120 million based on a sewage rate structure that violated the Clean Water Act, while one large company, for example, saved more than $2.7 million a year, according to a report by City Attorney Mike Aguirre.

City officials were repeatedly warned in memos and studies dating back to 1994 that the manner in which they charged industrial and residential wastewater users threatened more than $300 million the city had received in state and federal water treatment loans.

However, the City Council kept such reports from the public and approved bond disclosures claiming the city was in compliance with the terms of the state and federal loans, the report alleges.

In one 2003 memo included in the report, an official of International Specialty Products, Inc., a food ingredients manufacturer and the largest industrial user of the city’s wastewater system, boasted that former City Councilman Byron Wear had persuaded his council colleagues – with the exception of Donna Frye – in a closed hearing to kill a 2002 attempt to adjust the rate structure.

David McKinley, the company’s manager of environmental, safety and health, said that the new rate structure would have added annual costs of $1 million each to two of the company’s plants in San Diego. One plant is under the ISP name, whereas the other is CPKelco.

Aguirre alleged that members of the City Council and other city officials broke federal securities laws by acting “knowingly or recklessly to approve related disclosures to investors.”

However, he didn’t name specific officials in the report, titled “Wastewater Interim Report No. 1: City of San Diego Officials’ Failure to Disclose Material Facts in Connection with the Offer and Sale of Wastewater Bonds and Related Improper Activity.”

Aguirre said a further investigation will be necessary to pinpoint which officials he believes committed the fraud specifically.

The report is the seventh investigative report issued by the city attorney since taking office in December. The previous reports largely focused on the pension system and also found it likely that city officials, including former Mayor Dick Murphy and current and former council members, committed securities fraud in not revealing the depth of the pension deficit.

“At some point you see a pattern of recklessness and a way of doing business that serves the few at the expense of the many,” Aguirre said.

The Securities and Exchange Commission, U.S. Attorney’s Office and FBI have been investigating City Hall finances and politics since early 2004. The probes at first focused on pension issues, but appear to have expanded into the wastewater department in recent months based on subpoenas.

A consumer advocate has sued the city to recoup residents’ alleged overpayments in connection with the rate structure, which was changed by the City Council in 2004. The suit is expected to begin mediation this month. Residents saw about a 25-percent decrease on average in their sewer bills when the council made the switch, the report states.

Aguirre’s report was released Thursday evening and attempts to reach many officials were unsuccessful.

Jim Madaffer, a city councilman since 2000, said that the decisions that went into the sewer rate reports and bond disclosures were all made based on advice from city attorneys and outside experts.

“These are all things that the City Attorney’s Office and outside bond counsel are all privy to the details. I’m going to make decisions based on the advice of outside experts,” Madaffer said.

The wastewater rate system

The assistance came in the form of more than $300 million in loans and grants. In receiving the grants, the city agreed in 1991 to switch to what is known as a “user-based system” for charging wastewater users.

Under such a structure, users are charged based on the amount of organic material – food residue, human waste and plant matter – that it discharges into the system. The structure encourages conservation and means heftier bills for industrial users.

The city runs two wastewater systems, one for the city proper and one for a number of surrounding cities and water and sanitation districts.

In 1994, an inspector from the State Water Resources Control Board, the agency that oversees the state and federal loans and grants, first discovered that neither of the city’s two wastewater agencies had switched to the user-based rate structure.

According to the report, the city in 1998 implemented the user-rate structure for its metropolitan wastewater system, which serves the outlying agencies. The city’s own wastewater system continued to use the old rate system.

Concerns were raised in 1998 by an outside consultant and in 1999 by former Councilwoman Christine Kehoe, but no changes to the system were made. The report states that memos prepared for Kehoe by the City Attorney’s Office were never finalized. Instead, according to the report, she was orally briefed and told the City Manager’s Office would take action.

A 2002 memo from the city’s utilities finance administrator, Dennis Kahlie, states that “the municipal billing structure was not brought into compliance with SWRCB requirements in 1997 because of concerns about the adverse impact of doing so on certain large volume dischargers of organics in a then-soft economy.”

The memo also states that the water control board didn’t object because they were “under the mistaken impression” that both of the city’s wastewater systems were in compliance with the rate structure.

City officials received a study from outside consultants Black and Veatch on Jan. 15, 2002 stating the need to begin charging users for organic materials, according to the city attorney’s report.

Two weeks later, the City Council voted in closed session to withhold the sewer study. Councilmembers Toni Atkins, Brian Maienschein, Ralph Inzunza, Wear, Madaffer and former Mayor Dick Murphy voted not to release the study. Frye and former Councilman George Stevens voted in favor of its release, while Councilman Scott Peters was absent.

Madaffer recalled that attorneys advised the council not to release the report because of pending litigation related to the Point Loma Wastewater Treatment Plant, which was in violation of Environmental Protection Agency standards.

“I’m only as good as the advice I get from my attorneys,” he said.

McKinley, the ISP official, later wrote in an Aug. 4, 2003 memo to a labor union official that the company “received help from Councilman Byron Wear. He championed the issues, and persuaded all Council Members except Donna Frye to vote in closed session to table the study indefinitely … So we have a history of council support.”

He then articulates a strategy for spiking the rate system change again in 2003.

Former City Attorney Casey Gwinn also opined in 2002 that the city faced the possibility of litigation if it failed to comply with the mandatory user-based rate system.

Indeed, the city faced the prospect of having to repay the more than $300 million in state and federal grants and loans it had already collected, as well as the possibility of lawsuits from residents.

When the council did change its rate system in 2004, companies such as ISP and CPKelco began paying nearly double per month for their sewer services.

Bond disclosures

In his report, Aguirre opines: “Instead of advising the bond market of the lack of an organic component and thus the noncompliance of the sewer rate system, the 1999 bond disclosure glosses over the obvious noncompliance.”

The 2003 bond disclosure, which was aborted because of errors found in the pension section, relied on a statement similar to the 1999 disclosure related to the sewer rates.

In order to be considered securities fraud, violations of federal law must be committed either knowingly or recklessly. Additionally, the mistakes must be considered “material,” meaning that the omission or error in the financial document would have influenced or changed the investor’s view of the city’s financial condition.

“City officials and members of the City Council did not disclose the fact that the City was not in compliance with the user-based rate requirements for the wastewater system, contrary to California State and federal laws,” the report alleges.

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