Monday, Aug. 7, 2006 | Councilwoman Toni Atkins says she’s not nervous. Same goes for Council President Scott Peters and Councilwoman Donna Frye.
But on the eve of the release of an investigative report into the financial failings of the City Hall of years’ past, all eyes will be on the five political holdovers from that era: Atkins, Peters, Frye and Councilmen Brian Maienschein and Jim Madaffer. The culpability of the council members – and former Mayor Dick Murphy – in the city’s release of faulty financial disclosures has long been an item of great speculation and accusation as investigators from the Securities and Exchange Commission, Justice Department and private firms have scoured City Hall for two and a half years.
The question of the council members’ role in the city’s Wall Street collapse could get answered Tuesday morning when the consultants from Kroll Inc. release their report – a report that is supposed to name names and assign a level of individual culpability for the misleading financial statements the city issued to investors and the public.
“Am I nervous? I wouldn’t say that,” Atkins said in an interview Friday. “I’m anxious to get to move forward. The report is going to be the report.”
“It is what it is,” Frye said. “I’d just like to know what it is.”
On the whole, the report means much more to the city of San Diego than simply answering the question of whether or not its elected officials were ultimately responsible for ensuring the accurate release of its financial details. The city’s financial future has essentially been on hold in the two-plus years that its outside auditors have been demanding an independent investigation into allegations of wrongdoing.
As Mayor Jerry Sanders has pressed for access to the financial markets to begin to borrow as part of his financial recovery plan, much of the focus of the report has shifted to its importance in the city’s return to Wall Street.
But another party has also requested the independent investigation: the SEC.
The SEC, which regulates the nation’s financial markets, has been investigating City Hall since February 2004, when city officials filed voluntary disclosures seeking to clear up inaccuracies in previous financial statements.
The Kroll report is expected to fold into the SEC probe, as the commission requests that troubled entities undertake an independent investigation on their own dime before the commission takes action. The report is being overseen by two top former SEC officials, former Chairman Arthur Levitt and former chief accountant Lynn Turner, and is expected to give a thorough legal analysis of who, if anyone, likely committed securities fraud in the preparation and release of the city’s financial statements.
“Their line of questioning was very similar to the interviews I had with SEC and the U.S. Attorney’s Office,” Atkins said.
Multiple sources close to the SEC probe said the commission has been quiet as of late; it is unclear how quickly the SEC will move on enforcement actions once the report is completed. Kelly Bowers, the senior assistant director for the SEC’s Pacific region, refused to comment on the investigation Friday.
The SEC probe intensified in late January and early February. At the time, sources told voiceofsandiego.org that the SEC had delivered what’s known as a “Wells call” to the targets of its investigation, a notification that essentially gives potential defendants a last chance to squelch suspicions that they committed securities fraud.
Multiple sources said that elected officials had been among those who’d received Wells calls. The sitting council members denied having received such calls. Invoices obtained by voiceofsandiego.org later revealed that attorneys for at least one council member, Atkins, had been engaged in settlement talks with the SEC in late January, a sign that the commission had at least considered taking enforcement action against an elected official in the course of its investigation.
Many other top city officials that were involved in the preparation and release of the city’s financial disclosures have since departed City Hall. Save for the five sitting council members who were in office in 2002 and 2003, the leadership and top management at City Hall have essentially experienced a wholesale turnover. Gone are a mayor, two former city managers, a host of top deputy city managers, the former top officials in the City Attorney’s Office, and the former auditor and assistant auditor.
Penalties assessed against individuals who are found culpable of securities fraud are far-ranging. There are essentially three levels of fraud, spanning from negligent to reckless to intentional. Responsible parties can be ordered to stop engaging in the practice that was found illegal, be forced to step down from their current position as an officer or director at the entity where the wrongdoing occurred, or barred from ever serving as an officer or director of an organization that issues securities publicly.
The Kroll report would only serve as a guidepost to what the SEC might do – the SEC would have to bring enforcement actions on its own and then successfully reach settlement or prove its accusations in court.
The city as an entity, meanwhile, has been engaged in settlement talks for nearly a year after City Attorney Mike Aguirre sought to sever the city as an entity from individuals.
The SEC and Wall Street
The SEC prizes cooperation when it is engaged in an investigation, and an independent investigation is one of the key benchmarks it uses in measuring an entity’s cooperation. The regulators consider an entity’s cooperation when handing out punishment.
The city’s record in this regard is spotty. In February 2004, it hired law firm Vinson & Elkins to complete an independent investigation into its disclosure practices. But it also hired the firm to represent it as defense counsel before the SEC.
Because of that dual role, and because the firm had previously worked with the city on disclosure-related issues, the firm’s two investigative reports – prepared at a cost of more than $6 million – were rejected by the SEC and KPMG for their lack of independence. Vinson & Elkins did not review the hard drives of council members or their top staff members.
The investigations were faulted for not assigning individual culpability and instead only assessing the city’s disclosure system as a whole. Last year, the SEC called in top city officials to scold them for a lack of cooperation.
Aguirre has issued his own reports that found that top elected officials – including the sitting council members and Murphy – likely committed securities fraud in approving financial statements. Murphy and others say they relied on the advice of paid professionals when approving the bond deals. Aguirre’s reports also appear not to have been sufficient for the SEC or KPMG.
The city attorney’s reports alleged that top officials were to blame for misrepresenting the city’s pension deficit and potential liabilities stemming from a wastewater user-fee structure that left residents subsidizing large industrial users. The city has been sued for up to $200 million by a consumer advocate for the rate structure and has since changed it.
In early communication, KPMG estimated that the city had issued $2.3 billion in bonds based on faulty financial disclosures.
In February 2005 the city hired Kroll to reconcile the two investigations, but it quickly determined that it would need to undertake its own investigation. Its probe has been beset by delays and cost overruns and has now cost the city $20.3 million.
The Kroll report is expected to offer upwards of 100 remediation recommendations on how the city can improve its disclosure practices and ensure that it doesn’t repeat the mistakes of the past. It is expected to assign culpability in the release of faulty information to the public markets. It also could touch on a number of issues already dealt with in previous reports into the pension system, such as if certain civil and criminal laws were broken in the 2002 deal that allowed the city to underfund its pension system while also granted benefit boosts to employee unions.
Peters said he wants sufficient time Tuesday to be able to address what remediation efforts need to be taken.
“I want to know, ‘How do we move the city forward from this?’” Peters said.
For KPMG’s purposes, the report is needed to assess what, if any, illegal acts occurred at City Hall, what impacts those acts had on the city’s bottom line, and what has been done or will be done to ensure that they don’t happen again.
One question, for instance, that KPMG asked Kroll’s predecessor, Vinson & Elkins, to answer in an Aug. 9, 2004 letter: “Whether or not the financial statements and or the disclosures in the financial statements were intentionally misleading and, if yes, what individuals were involved and what, if any, remedial action is recommended?”
Without the KPMG’s blessing on the last three years of its financial statements, the city has been essentially barred from seeking loans from Wall Street, a punishment that has left it unable to borrow money to complete the basic projects expected of a municipal government: water and sewer upgrades, road repairs and the construction of fire stations, for example.
City officials hope the release of the report will set off a chain of events that returns the city to public borrowing markets sometime in the early part of next year after audits for fiscal years 2003, 2004 and 2005 are completed and its suspended credit rating is reinstated. And although it has long been assumed that the city was waiting on the Kroll report to start that process, Chief Financial Officer Jay Goldstone said on Friday that the city is still working independently of Kroll to reconcile a list of bookkeeping issues that will need to be cleared up before outside auditors KPMG certify the city’s financial records.
“We still have work to do,” Goldstone said.
Goldstone said the city might not be able to enact every one of Kroll’s recommendations, saying that some might be too costly and city officials might not be in agreement with others. He said others might have to be deferred for because of their cost.
“I would imagine that they’re going to make a recommendation regarding our computer system, just because it’s really antiquated and really hard to get stuff out of,” Goldstone said.
He said city officials will take two weeks to assess the Kroll report and then release a timeline for reentry into the financial markets.