Monday, Nov. 27, 2006 | San Diego Mayor Jerry Sanders laid out two key proposals to help reboot the maligned city government in recent weeks, revealing plans to fund long-neglected areas of the city’s budget and upgrade the city’s aging water and sewer systems.

But Sanders’ hearty plans – just like the strategies offered up by city leaders before him – come with a familiar caveat: they remain on hold as outside auditors continue to withhold their approval of the city’s books.

The city is still waiting for accounting firm KPMG to issue a long-overdue audit of the municipal government’s fiscal year 2003 financial statements. A parade of delays, including two costly investigations, has resulted in the city’s lengthy banishment from Wall Street, where public agencies such as the city can court a wide field of investors for loans that are often less expensive than the backing of a single private financier.

“The audit is the biggest priority of the city and has been for about two years,” City Council President Scott Peters said. “Everything we’ve done since has been directed toward getting this audit done.”

San Diego’s absence from the public bond markets has caused the city to hold off on repairing its crumbling infrastructure. The city’s exclusion also stirred up enough uncertainty to help derail pension borrowing plans floated by current Mayor Jerry Sanders and his predecessors, former Mayor Dick Murphy and former City Manager Lamont Ewell. All had designs to use borrowed money to pay down the city’s looming pension deficit, now estimated to be $1.4 billion, dating back to 2004. All needed the pending audits to be completed in order to realize their proposals.

Now, with plans that Sanders unveiled this month to right the city’s waning fiscal ship, the elusive audits appear again to be the fulcrum on which another financial-reparation plan hinges.

The mayor forecasts that the day-to-day budget for the next fiscal year, which begins in July, will have an $87.4 million shortfall. As part of that spending plan, Sanders envisions repairing and building city streets, storm drains and buildings at a $38 million cost. If able to return to Wall Street, the city could borrow some of the funds, spreading those expenses over several years and allowing the city to free up $22.3 million in cash to pay for other everyday functions – libraries, recreation centers and street sweeping – that might otherwise be cut.

Also, Sanders wants to gradually raise sewer and water fees by 35 percent and 29 percent, respectively, to pay for legally required improvements to both systems. The fees would be used to pay back the loans it plans to seek on the public markets. While Sanders said the city will seek private financing in the meantime before it can access Wall Street, he noted that the lower interest rates found in the public market would allow the city to “stretch its dollars further.”

But city leaders are shrugging their shoulders over the audit’s continued delay, claiming they are uncertain what requirements remain to satisfy KPMG’s needs. They now say they have no expectations about when the 2003 audit will be completed – a marked departure from solid deadlines offered by the Mayor’s Office.

After the conclusion of the investigation by private consultants from Kroll Inc., which KPMG set as a prerequisite for its audit, concluded in August, Sanders predicted that 2003 audits would be wrapped up by Oct. 27. The completion of that audit would soon lead to the Macias, Gini & O’Connell firm’s certification of the 2004 and 2005 audits, and the city could regain its currently suspended financial rating by February, Sanders predicted. That timeline would allow the city to begin borrowing on the public markets by June.

Now, Sanders has abandoned the timeline, saying the completion of the audits is out of his control and squarely in the hands of a private company.

“We hope to have something in the not-too-distant future,” Sanders said.

Earlier this year, Sanders accused Kroll, authors of the $20.3 million report that KPMG requested, of holding the city hostage by demanding more money and more time throughout its 18-month probe, but Sanders said he would not draw parallels with KPMG.

“I’m not willing to say that at this point, but I am getting frustrated,” Sanders said.

Auditing the city’s 2003 financial statements has proved to be topsy-turvy almost from the beginning.

After federal investigators began looking into problems into the city’s release of faulty financial information to investors, the firm originally hired to perform the 2003 audit was quietly fired and the reins were handed over to KPMG.

As the city’s law firm, Vinson & Elkins, wrapped up its outside investigation of the city’s past dealings in September 2004, KPMG announced it would withhold the audits. One of three major financial clearinghouses summarily suspended the city’s credit rating, causing the city to lose its standing on Wall Street, and KPMG called for a more in-depth investigation of the city’s financial practices – a process that just finished in August, nearly two years and more than $26 million later.

The investigation was completed by Kroll Inc. under the guidance of former Securities and Exchange Commission Chairman Arthur Levitt. It found that several former city staff members likely committed securities fraud and accused others, including sitting council members, of acting negligently with respect to the disclosure errors.

It was expected that the completion of the investigation would be the final piece of the audit puzzle, as KPMG had requested the probe.

KPMG officials, who have been tight-lipped about their auditing process, applauded Kroll’s report at the Aug. 8 council meeting where the findings were made public.

However, KPMG partner William Morris was characteristically hesitant to divulge whether the investigation was satisfactory. He said KPMG could conclude its fieldwork with the Kroll report in-hand, but that his firm was more interested in the city’s response to the investigation than it was in simply receiving the investigatory report.

“This is the step we had to get to at this point in time … but let me also state that the next, most immediate step is for the city itself … to receive this report, to determine how to go about repairing the financial statements of this city” and to institute sound accounting and disclosure practices, Morris said. He and other KPMG officials have been unavailable for comment since the meeting.

In the months following the Kroll report, city officials have continued to believe they are on-track to meet KPMG’s demands. Sanders embraced wholesale the 54-point remediation plan the Kroll consultants recommended, and the council is slated to finish its hearings on the remedies in December.

But some officials acknowledged in interviews last week that they are befuddled as to the auditors’ delays.

“It just reminds me of ‘The Wizard of Oz,’” Peters said. “It seems to me we’ve delivered the broom of Wicked Witch of the West, and I’m not quite sure what else there is.”

Jay Goldstone, Sanders’ chief financial officer, said he is waiting to hear what remaining information the firm needs, if any, before it can sign off on the audits. About a month ago, KPMG contacted the city with a list of 114 comments – most of which were grammatical corrections – about a version of the financial statements the city submitted months ago. The news prompted Goldstone to say that the firm was dragging its feet.

His office has been playing “phone tag” for about a week with the auditors, Goldstone said.

Councilwoman Donna Frye said she still laid some blame for the delays with the Sanders administration. Last month, she sent the City Auditor’s Office a list of 40 questions and criticisms about a draft of the 2003 financial statements. She said she has only received answers to 25 of her questions, and wondered if that was characteristic of KPMG’s experience.

“I had 40 questions, and I only got to look at [the draft] for two weeks,” Frye said.

City Attorney Mike Aguirre said the city’s settlement with the SEC last week shows the city has atoned for its missteps with the federal authorities over the same disclosure errors that Kroll investigated. KPMG should not be far behind, he said.

“KPMG has absolutely no further excuse to allow them further delay. We’ve given them the worst-case scenario,” he said.

Aguirre accused the firm of having “breached its fundamental duty to the city of San Diego.” He said the City Attorney’s Office does not have plans to file a lawsuit against KPMG, as he has with other outside consultants.

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