Thursday, December 01, 2005 | A malpractice lawsuit filed Wednesday by the city of San Diego claims that hired auditors and attorneys failed to catch inaccuracies in financial statements the city used to sell more than $1 billion in bonds to investors.

The suit seeks up to $100 million that attorneys say the city lost as a result of financial statements that inaccurately portrayed the funding methods and fiscal health of the city’s now-troubled pension system.

The erroneous financial statements, and the subsequent revocation of its credit rating by one of the three major credit rating firms, are key elements in the fiscal crisis that grips city government. Because of the disclosure problems, the city has been exiled from Wall Street for more than a year and spent more than $18 million on consultants to untangle the resulting mess.

The city’s long-delayed 2003, 2004 and 2005 financial audits remain on hold pending the completion of an internal investigation into alleged misdeeds.

“With the filing of this lawsuit the people of the city of San Diego are going to begin to fight back and hold the professionals responsible for their roles in creating and covering up the financial irregularities,” said Dan Stanford, a private attorney representing the city.

The legal maneuver is one in many the city has or likely will execute as it reaches for compensation from the professionals involved at all levels of its fiscal collapse.

The suit focuses on two firms, Orrick, Herrington & Sutcliffe LLP, the city’s San Francisco-based bond counsel, and Calderon, Jaham & Osborn, the San Diego auditing firm that examined the city’s books for a decade leading up to the 2003 discovery of disclosure errors.

The suit also names accounting firm Caporicci & Larson, which merged with the Calderon firm in 2003, and co-disclosure counsel Webster & Anderson.

Gary Caporicci of Caporicci & Larson was out of town and couldn’t be reached for comment.

“This lawsuit is entirely baseless as well as factually wrong,” said Tim Larimer, Orrick’s director of communications. “The extensive public record including the City Council’s own independent investigation demonstrates that it was Orrick who ensured the city’s pension problems were disclosed. It is unfortunate that the city needs funds, but this is no way to go about it.”

Officials from the Securities and Exchange Commission and the Justice Department are investigating possible civil and criminal securities fraud violations by city officials in connection with the financial statements.

The city’s disclosure statements and practices are now being scrubbed and probed by a new outside auditor, KPMG; an audit committee headed by top former SEC officials that charges $800,000 a month; and the SEC.

Without a completed audit, the city remains locked out from public finance markets and has been forced to borrow money privately through a special agreement with Bank of America in order to complete basic projects such as sewer maintenance.

The lawsuit contends that if private auditors and accountants had done their job, the city could have avoided the legal and financial troubles that followed the first discovery of reporting errors in September 2003.

According to the suit, the city hired outside professionals for specific purposes – to ensure that the “city’s financial condition was accurately disclosed to investors who bought the city’s bonds.”

Many disclosure and legal issues now frame the discussion surrounding the city’s financial practices. However, the first known questions surrounding the credibility of its financial statements surfaced when pension whistleblower Diann Shipione alerted an attorney at Orrick that the city’s financial disclosure didn’t accurately describe its peculiar funding arrangement with the pension system.

For example, as previous investigations and reports have detailed, the city’s disclosures stated that the pension system hoped to gain government approval for the “corridor” funding method it used to annually pay its pension bill. In reality, according to the reports, the method had already been determined not to live up to governmental reporting standards.

Under this corridor method, the city paid a set amount annually into its pension system regardless of its true costs that year. That method departs from usual pension funding practices, in which an actuary determines what the city annually owes based on the actual costs of the benefits incurred in that fiscal year.

In essence, the agreement allowed the city to annually underfund its pension system, the consequences of which were obscured at the time by robust returns on the pension system’s investments.

The corridor funding method, which was first approved in 1996 and later modified in 2002 in political deals now under criminal investigation, is one of several factors blamed for a pension deficit that’s estimated to be at least $1.37 billion.

In addition to the disclosure problems, the deficit is also central to the city’s fiscal woes. A lawsuit settled last year abolished the corridor funding method and now the city’s annual pension payments dominate its annual budget and has even led to talk of bankruptcy.

The lawsuit states that the city’s disclosures “since 1996 failed to provide investors and other interested readers with adequate information to enable them to understand clearly a variety of negative developments affecting” the San Diego Employees’ Retirement System.

The professional consultants named in the suit either knew, or should have done the proper work to know, that the financial documents they blessed were inaccurate.

The Calderon accounting firm also audited the pension system’s separate financial statements, where it provided “relatively accurate” descriptions of the funding method, according to the complaint.

“CJO made schizophrenic disclosures of the City’s pension under funding, depending on the identity of its client,” according to the suit.

The city dropped Caporicci & Larson as an auditor in 2004 after the disclosure errors were uncovered. The lawsuit also faults the accountants for declaring all of the uncovered disclosure errors as “immaterial.”

Potential investors use financial statements, which detail an entity’s revenue, assets and liabilities, to measure its fiscal health.

A report commissioned by the City Council and released last year portrayed an Orrick attorney as a diligent advocate of full disclosure after the first reporting errors were uncovered. He is portrayed as being at loggerheads with reluctant city employees in attempting to correct disclosure issues.

Larimer, the Orrick spokesman, said the firm relied on false representations made to them by city officials.

“I think as soon as we had indication that a disclosure may have been wrong we investigated it and worked to disclose it,” he said. Larimer added that Orrick wasn’t even bond counsel on some of the bond sales cited in the lawsuit.

The city filed voluntary disclosure corrections in January and March 2004.

Stanford, the attorney representing the city, said Orrick had an obligation to prevent the mistakes before they occurred.

“The Orrick law firm was the last line of defense hired to ensure that the statements made in the official documents were accurate. That’s part of their job,” he said.

The suit seeks the recovery of fees paid to the consultants and a number of damages triggered by the disclosure errors.

Please contact Andrew Donohue directly at

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