The Morning Report
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Friday, Dec. 22, 2006 | For the fourth consecutive year, the city of San Diego will likely greet the New Year without a certified accounting of its financial health, with its outside auditors informing the Mayor’s Office on Thursday that they would not meet a Friday deadline.
Jay Goldstone, the city’s chief financial officer, said at the beginning of the week that auditing firm KPMG appeared to be on track to complete its audit, but began to soften on that stance by midweek.
“Then, I had a conversation this morning with (KPMG partner) Steve DeVetter, and there was no waffling. They said they were not ready to release,” Goldstone said.
On Dec. 1, KPMG set Friday as its anticipated completion date after requesting $2.2 million more from the city. A month earlier, it had delivered a long list of outstanding issues to the city only days before Mayor Jerry Sanders’ estimated completion date of Oct. 27.
The mayor had set that date after the Kroll investigation drew to a close in August. The private probe, which found an Enron-like pattern of fraud and mismanagement, faced its own series of delays and budget overruns and was undertaken in hopes of satisfying KPMG’s audit needs.
Thursday’s news marks the latest delay in a painful saga fraught with missed deadlines, disputes and hold-ups — one that has become a comedy of errors with serious consequences. Without the audits, city leaders have been unable to easily and inexpensively borrow money from Wall Street since 2004 for such simple tasks as building fire stations and performing mandatory health upgrades to San Diego’s water and wastewater systems.
The Mayor’s Office said it would begin to seek private financing starting in January for water and sewer systems and the refinancing of Petco Park’s bonds — a task that former Mayor Dick Murphy first proposed in 2003.
KPMG has now billed the city $6.6 million since its engagement in early 2004, when it was brought in on $250,000 contract. City officials have indicated their reluctance to pay any other invoices that the firm may put forward.
City Attorney Mike Aguirre accused the firm of toying with the city’s financial well being. “They know they have us in a vulnerable spot and are taking advantage of us,” he said.
Goldstone, the city’s CFO, said the firm’s newest excuse was “wishy-washy” and amounted to “wordsmithing.” KPMG spokesman Tom Fitzgerald referred all questions back to the city of San Diego.
“It’s very nebulous in terms of why they’re not meeting their original commitment,” Goldstone said. “We have met every deadline that would lead them to issue an opinion letter.”
KPMG will provide the city with an update on its progress next week, Goldstone said.
Early in its engagement, KPMG requested that the city finance an independent investigation into allegations of securities violations and misconduct in its pension system. The city paid law firm Vinson & Elkins $6 million to complete two probes that were shelved for their perceived lack of independence, both by KPMG and the investigating Securities and Exchange Commission.
The city had its credit rating, and therefore its access to Wall Street, suspended after the release of the first Vinson & Elkins investigation.
The city then brought in a group of consultants from Kroll Inc., led by former SEC Chairman Arthur Levitt. The Kroll investigation, originally estimated to cost in the hundreds of thousands of dollars and to take a few months, ended up lasting 18 months and taking $20.3 million.
KPMG had requested the investigations as a prerequisite to its completion of the audits and, as such, it was long thought that the investigation was the final piece to the audit puzzle. However, the day the investigation was presented to the City Council, KPMG officials said it wasn’t interested in the report so much as it was in the city’s response to it.
Last month, the city reached a settlement with the SEC in one of the largest securities fraud cases in U.S. history. The regulators found that city officials withheld material information from investors regarding looming liabilities in its pension fund and the health care benefits it owed its employees.
The settlement was for the city as an entity and didn’t name specific individuals; the SEC said investigations into individuals continue.
Some had hoped that settlement, too, would help clear any final entanglements for KPMG.
Even after the 2003 financial statements are audited and released, the city must also complete its similarly delayed 2004 and 2005 statements.
The delay may also push that sequence of events far back enough to cause the rating agencies to require the city to finish a 2006 audit before they grant a new opinion on the city’s fiscal standing.
“Every day we inch closer to the end of this fiscal year, the more likely it is that we may be held accountable for the release of the 2006 audit,” Sanders spokesman Fred Sainz said.
In the meantime, while the city is frozen out of the public bond market, the mayor is likely to ask the City Council to pursue private loans for the city’s water and sewer systems, beginning in January.
A $57 million private loan is needed to improve the city’s water treatment plants, Goldstone said. The City Council is expected to consider this bond at its Jan. 16 meeting. J.P. Morgan firm would serve as the investor after offering the lowest interest rates in a bidding competition, Goldstone said.
Also at that meeting, the mayor will propose refinancing the Petco Park bonds through a private loan that could save the city $3.7 million annually, Goldstone said. Bank of America won the bid for that loan, he said.
Two other private loans, for the water and sewer systems, would be taken out in the early spring if the council approves rate increases proposed by Sanders, Goldstone said.
These two bonds, which amount to $277 million for the Water Department and $200 million for the Metropolitan Wastewater Department, represent the first chunks of the $1.4 billion borrowing package that Sanders said is necessary in order to bring the two systems’ infrastructure in line with state and federal law.
While the Mayor’s Office appears comfortable with pushing ahead with private loans that are more costly than borrowing from the public markets, officials said they are not abandoning their quest to reach Wall Street.
In the meantime, the city has no ambitions of firing KPMG at the present, but may take stock of the situation at a later date.
“If they come back with another list of 119 items, then we are going to have to reevaluate where we go from here,” Goldstone said. “But we don’t think it will be 119 things. It will probably be one or two items.”
He added, “We have no reason to believe that they do not want to complete this audit as much as we want to complete this audit.”
An earlier version of this story incorrectly named Jay Goldstone as the city’s chief executive officer. The story has since been corected.