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Tuesday, January 17, 2006 | City Attorney Mike Aguirre and former Mayor Dick Murphy agreed on perhaps only one thing in the tumultuous period between Aguirre’s inauguration in December 2004 and Murphy’s resignation last July: the hiring of the audit committee.
Eleven months ago, on Valentine’s Day, the two warring officials came together to bring forth what was hailed as the final resolution of the city’s pension and securities nightmare.
Instead, the group of outside consultants investigating the city’s much-investigated past has found itself not only analyzing San Diego’s problems, but accused of being part of them.
On Tuesday the audit committee, a group of outside consultants and lawyers, will ask the City Council to give it up to $13.3 million to complete an investigation that has encountered hitches and delays at nearly every turn. The request would increase the audit committee’s total budget to nearly $20 million – up from the previous mark of $6.2 million.
The new bill is a bitter pill to swallow for a growing throng of critics. The audit committee’s bills and timeline have grown repeatedly throughout their nearly year-long stay in San Diego. And a previous firm’s costly, and unsuccessful, attempt to complete a similar investigation already pulled about $6 million from a tight city budget that this year saw the closing of swimming pools, libraries and other community services.
Others say that the audit committee is San Diego’s only shot at salvation in a time when tougher accounting standards have made the city a test case in the post-Enron world.
Robert Inman, a professor of finance and economics at the University of Pennsylvania’s Wharton School, said San Diego’s pension and securities ills mirror in structure the meltdowns of many municipalities in the last three decades – Miami, Philadelphia, Washington, Cleveland and New York, to name a few.
“San Diego’s problems are not unfamiliar problems, but the resolution strikes me as unique and expensive,” Inman said.
But the city, stuck without a credit rating and a complete audit of its books since 2003, is desperate.
Without a complete report, the outside auditors working on San Diego’s 2003 audit won’t bless its books and the Securities and Exchange Commission won’t get the independent report they desire from entities under investigation. The city will remain sidelined from Wall Street, and the cash to complete vital infrastructure projects, without the completed audit.
The U.S. attorney and district attorney have brought criminal charges against a number of officials connected with the city’s pension system, which suffers from a deficit nearing $2 billion. The city’s annual payment into the pension fund has climbed considerably in recent years and threatens to chew up as much as one-third of the city’s entire operating budget this year.
In similar cases through the modern history of U.S. cities, those municipalities were saved by state governments or high-profile private citizens who provided low-cost, publicly minded oversight, Inman said.
But no such group has come together in San Diego. And the corporate accounting scandals such as Enron’s high-profile demise have placed an acute, new focus on bookkeeping and forced the stringent regulations of the Sarbanes-Oxley Act for the corporate world.
The city, for better or worse, is being held to these private-sector standards, although Sarbanes-Oxley doesn’t legally apply to municipalities. The creation of the audit committee nearly one year ago is a vivid – and costly – example of the city’s life under Sarbanes-Oxley standards.
Critics say the audit committee, staffed largely by the risk management firm Kroll Inc., has used any excuse possible to delay its investigation and keep a desperate city over the billing barrel. Supporters of the audit committee say the city must pay the bill for its previous wrongs and attempt to move on – hopefully by May, the audit committee’s new estimated completion date.
New Mayor Jerry Sanders said the city has no choice but to continue on the current course.
“I honestly believe this is the only option or else I wouldn’t move forward,” he said.
The council’s decision Tuesday will likely map the future of the audit committee’s existence in San Diego. Lynn Turner, the SEC’s former chief accountant and an audit committee member, said as much in a letter Friday to Council President Scott Peters: “If the Council determines not to approve the funding, we assume that will be consistent with a decision not to complete the investigation.”
The City of San Diego as a Corporation
The investigative analysis of legal and accounting issues is used to test the veracity of the city’s reporting of its liabilities and assets, and the reliability of those officials involved in its financial matters.
Without the report, KPMG won’t release a certified audit of the city’s 2003 financial statements and San Diego will remain stranded with a suspended and downgraded credit rating.
Those were the rules when the Kroll group entered the picture. A previous consultant, law firm Vinson & Elkins, had been tasked with the same job. However, its two investigative reports were left with little credibility when KPMG and the SEC rejected them for their lack of independence.
Kroll was originally contracted to review reports by Vinson & Elkins and Aguirre, reconcile differences between the two and conduct any additional probe as needed. Audit committees are commonplace in the corporate world to monitor a company’s internal controls. The group led by Turner and former SEC Chairman Arthur Levitt chose the audit committee model to deal with what appears to be the first municipal case post-Sarbanes-Oxley.
“I can imagine that Arthur and Lynn are saying there’s no model like this. They didn’t have to choose this model, but since Lynn was chief accountant, they tend to think of things like the SEC does,” said Roman Weil, a professor at the University of Chicago Graduate School of Business.
Audit committee officials soon determined neither report to be sufficient and hired their own attorneys to assist with an investigation. That is when they lost Aguirre as a supporter and gradually became a public target for the size of their bills.
Pulling the Sarbanes-Oxley model over from the private sector and laying it atop the city hasn’t made for a perfect match, especially in a city where an atmosphere of governmental distrust prevails in the aftermath of so many governmental failings.
The committee has refused to act as other government contractors do, saying that such deference is necessary to preserving the independence KPMG and the SEC so desire.
For example, the firm won’t provide detail for its bills. Its members say such secretiveness is necessary for the integrity and confidentiality of its investigation.
However, as the city will be forced to further cut basic services to accommodate the committee’s billing needs, such attitudes have drawn rebuke from people such as Aguirre and Councilwoman Donna Frye. Specifically, the audit committee came under heat when it was revealed that audit committee members were billing the city – at as high as $900 an hour in Levitt’s case – to meet with the editorial board of The San Diego Union-Tribune, a local newspaper.
The audit committee’s budget has also grown incrementally as it has faced a litany of delays in accessing documents and dealing with the city’s document storage. Aguirre has said the committee has more than enough documentation to issue a report.
Its request for more funding was delayed in December after Sanders, the new mayor, sought an exact timeline and final budget for the audit committee’s work.
However, audit committee members refused to budge. “For the investigation to accomplish its goal,” Turner wrote in the letter to Peters, “and to have value to the City, it is important the integrity of the process be maintained including the independence and where appropriate, the confidentiality of the investigations.”
Setting drop-dead budgets and guidelines are an infringement on the committee’s independence, members say.
Aguirre has said that the audit committee violated the city’s internal controls by billing as it does. Troy Dahlberg, an audit committee member, said they have billed as instructed by former City Manager Lamont Ewell.
But for all his criticism of the audit committee, Aguirre has chosen to support its request for funding this time. It is a stroke of compromise in his early alliance with Sanders. So, nearly a year later, Aguirre finds himself in agreement with a mayor over the audit committee, again.
“My personal feelings have not changed, but I think it’s important that Jerry be allowed to follow a process and that his judgment as a duly elected mayor is certainly supportable and reasonable under the circumstances,” Aguirre said. “I mean, he can’t fire Kroll as one of the first acts of his administration.”
Please contact Andrew Donohue at