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Friday, Aug. 25, 2006 | Mayor Jerry Sanders embraced point-by-point a 121-step remediation plan laid out earlier this month in the Kroll report, calling for a fundamentally smaller government – in both employees and services – in order to fund reform efforts and bring the city’s basic costs in line with its revenues.

The plan, the mayor said, is a necessary step in returning the city to fiscal credibility. He stressed, however, that it would not solve the city’s financial troubles. Instead, it would satisfy the two auditing firms working on the city’s financial statements, a key milestone for a city struggling to regain its credit rating and return to Wall Street.

The recommendations would significantly alter the city’s financial structure with the goal of increasing accountability and quality controls in the wake of one of the worst municipal accounting scandals in modern U.S. history. The Kroll report found that elected officials and city staff violated a bevy of state and federal laws over the course of a decade, detailing an Enron-like fraud and mismanagement in which hundreds of millions of dollars of potential liabilities went unreported to investors.

“For too long, San Diego has been held up as the example of how not to do things,” Sanders said today. “We now have an opportunity to embrace reform and serve as an example of how a city can credibly get its affairs in order and move on to a very productive future.”

Before the release of the report, the Mayor’s Office had expressed trepidation about embracing Kroll’s entire anticipated remediation plan, reserving the right to disagree or postpone expensive recommendations. That tune changed Thursday, as the mayor accepted carte blanche the recommendations of a group of consultants that he last month accused of holding a desperate city hostage.

The proposal would:

  • Appoint a monitor to oversee the remediation effort and report back to the Securities and Exchange Commission, which has been investigating the city and certain officials since early 2004. Sanders said the monitor has not yet been chosen, but that his office has spoken with three former SEC commissioners, including Harvey Pitt.
  • Create a full-time audit committee – comprised of two mayoral appointees and one City Council member – to oversee the city’s financial reporting and handle whistleblower complaints. The proposal would also create a mayor-appointed auditor general, who would serve a term of 10 years and be responsible for the city’s internal financial controls and financial reporting.
  • Identify the true costs of the city’s deferred maintenance backlog, which has been pegged at anywhere between $300 million and $1 billion, and has grown as the city has failed to properly maintain its facilities.
  • Replace the city attorney with the chief financial officer as head of the Disclosure Practice Working Group. The recommendations also include maintaining an independent legal counsel for the pension system, something the mayor had originally opposed when pushing for City Attorney Mike Aguirre to take over that role in January.

Aguirre panned the plan, saying that such a massive shift in the city structure shouldn’t have been put together without input from the public. He said an auditor general should be elected by the public, not appointed by the mayor and approved by the City Council if it is to truly have the independence to be free from political influence to fudge the numbers.

The city attorney said “massive” changes to the City Charter – and therefore a public vote – would be needed in order to establish the monitor and audit committee because they will be performing “basic governmental functions.”

“What this essentially does is give us a strong-Kroll form of government,” he said. Aguirre and members of the audit committee, including former SEC Chairman Arthur Levitt, have shown an open and unabashed dislike for one another.

The battle exposed one of the few major public rifts between Aguirre and Sanders since the mayor took office. Aguirre has already used a legal opinion once to stall a Sanders proposal. In April, he opined that voters must approve the mayor’s plans to borrow $574 million.

“Those who obstruct reform do so at their own peril,” said Fred Sainz, Sanders’ spokesman. “There has been a clear pattern here at City Hall of delaying reform. The mayor can’t allow that to happen – the mayor won’t allow that to happen. This is bigger than any one person.”

The Mayor’s Office then arranged for media interviews with Levitt following Aguirre’s public statements.

The mayor conservatively pegged the remediation efforts at $45 million over a seven-year period. The retention of a monitor is expected to cost up to $4 million for a three-year period.

“This isn’t cheap, but it is critical. These are things the city has needed for a long time,” said Chief Financial Officer Jay Goldstone, who was appointed by Sanders.

Sanders also acknowledged a list of additional costs that the city will face as a result of a batch of anticipated changes to its pension system. For example, the city will likely need to repay $41.3 million over the next five years to the pension system to comply with the Internal Revenue Service’s tax code, as it has been determined that the city wrongly used the pension system to for pay retiree health costs.

The city is also, in two years, scheduled to change the timeframe in which it must pay down its $1.4 billion pension deficit from 30 years to 15 years, a shift that would cost the city tens of millions of dollars annually in its pension contribution. When that shift happens, the city’s annual pension contribution is expected to jump up from $173.3 million in fiscal year 2008 to $229.2 million in fiscal year 2009 – a spike of nearly $60 million.

As he has in the past, Sanders dispelled any talk of tax increases – at least for the time being – saying the public wouldn’t support such a measure until trust in City Hall is regained. Instead, he said he will evaluate what core services the city can and should provide to its residents considering its financial situation. Sanders has previously said he will cut 500 positions from the city and said today that the figure could now grow.

“I think the cost of benefits that we provide to our employees combined with the costs of the services that we provide to our citizens are unsustainable,” Sanders said. “It’s simply not realistic to believe that we can continue to operate in this kind of chaotic budgetary environment. We end up doing nothing right.”

That means city services likely face severe cuts for years to come. The mayor didn’t divulge where cuts and layoffs would be found, be they in libraries, parks or other departments. The Mayor’s Office promised the release of a five-year budget plan in spring that will chart out more specifics in cuts and layoffs.

Joan Raymond, president of Local 127, which represents blue-collar workers, said there won’t be much to cut from the lower levels of the city’s ranks. “It’s a drop in the bucket,” she said.

Raymond urged the mayor to drop the city’s lawsuits challenging more than a decade’s worth of employee benefit boosts on the grounds they are illegal.

For his part, Levitt said there are only two elements to reviving city finances: tax increases and cuts. Neither option should be taken off the table by the city’s leadership, he said.

“What the community has to decide is what ratio of each of those will be applied in this situation,” Levitt said.

In his response to the Kroll remediation plan, Sanders didn’t address Kroll’s warnings regarding the $547 million in pension obligation bonds planned by the Mayor’s Office. The mayor said Levitt simply warned not to use the bonds to replace annual payments into the system.

However, Levitt said in an interview Thursday that pension obligation bonds do not carry the attraction they once did now that interest rates have risen. “I think their use right now is problematic,” he said.

Sanders was joined at the press conference by Goldstone and Council President Scott Peters, who was found in the Kroll report to have “knowingly and improperly” caused the city to violate state and federal laws and been negligent in the city’s bond disclosure process.

“I must tell you the audit committee report was a tough read for me,” Peters said. He embraced the mayor’s reform efforts, although he said he didn’t agree with everything in the report.

The city has yet to fully account for its revenues, expenses and liabilities dating back to fiscal year 2003, a fact that has left it unable to borrow money on the public markets for basic infrastructure projects such as mandated upgrades to its water and sewer systems.

With the plan now in hand, Sanders hopes to finish the first of the backlogged audits by October and begin borrowing money by June.

KPMG, the auditor of the fiscal year 2003 financial statements, requested in early 2004 an independent investigation into allegations of wrongdoing. That resulted in the Kroll report, which found that eight former top staff members likely committed securities fraud and a host of elected officials acted negligently in approving bond disclosures.

The auditing firm has said it is now interested in seeing the city’s reaction to Kroll’s recommendations. A KPMG spokesman said Thursday that it had yet to review Sanders’ plan and couldn’t comment.

In large part, the Kroll recommendations centralize much of the city’s financial power under the control of the mayor. Not only would his hand-picked CFO be in control of the city’s financial-reporting backbone, he would appoint the other key player in internal controls, the auditor general.

The mayor would also appoint two of the three members of the audit committee. The nominations would be subject to City Council approval.

Other recommended changes would:

  • Make it a criminal offense to improperly influence or mislead any independent certified public accountant auditing the city’s finances.
  • Upgrade the city’s information technology at a cost of $35 million to improve the disclosure and accounting processes. The city would also switch to one central e-mail system under Microsoft Outlook/Exchange.
  • Place a measure on the ballot the to reconfigure the pension board to nine members, with five mayoral appointees, two union representatives and two retiree representatives. Voters in 2004 reconfigured the board to give greater heft to mayoral appointees over union representatives.

Peters has called a special City Council hearing at 1 p.m. on Sept. 6 to address Sanders’ plan.

Please contact Andrew Donohue directly with your thoughts, ideas, personal stories or tips. Or send a letter to the editor.

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