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Saturday, March 17, 2007 | The city of San Diego completed its fiscal year 2003 audit Friday, marking a major turning point in a three-year slog defined by repeated delays and burgeoning consultant contracts.

The announcement moves the city one step closer to regaining the fiscal credibility it lost when its credit rating was suspended in 2004. With city officials now working to release the 2004 and 2005 audits, the Mayor’s Office hopes to be able to return to the good graces of Wall Street by as early as the end of the summer.

The release of the three backlogged audits would be a watershed moment in the city’s long financial struggle. The city has been unable to borrow money on the public markets because of questions surrounding the veracity of its financial statements. That has forced the city to postpone vital infrastructure projects and seek private, more costly, loans.

“This was probably the most scrutinized audit in municipal history,” Mayor Jerry Sanders said.

The sordid journey began with the hiring of accounting firm KMPG in 2004 amid concerns that the city had failed to properly disclose its looming pension and retiree health liabilities.

The city has since waged a costly and oftentimes frustrating battle to release its financial statements, employing two separate firms at the cost of $26 million to conduct independent investigations into allegations of wrongdoing at KPMG’s behest. Ultimately, a team headed by former Securities and Exchange Commission Chairman Arthur Levitt completed a report satisfactory to KPMG’s needs.

Still, the city and KPMG continued to engage in what became a testy back-and-forth for the six months following the release of Levitt’s report as they worked through 17 drafts. In the end, the city reassessed its assets by a combined $1 billion.

The CAFR: A History in Links

Normally an arcane annual publication noticed by only those whose job it is to read it, a local agency’s Comprehensive Annual Financial Report, or CAFR, has never had as much attention — nor cost its issuer more in time and treasure — than the city of San Diego’s 2003 version.

After three years of delays and wrenching political turmoil, city officials jubilantly announced that outside auditors had finally approved it for publication Friday.

But it’s been a long road.

It became clear in late 2004 that the audit was being delayed. Around that time, credit rating agencies began downgrading their opinion of the city’s ability to pay off its many debts. Finally, Standard and Poor’s suspended the city’s credit rating indefinitely.

This effectively paralyzed the city’s efforts to borrow money on the open market from Wall Street investors. Many efforts — to refinance costly bonds, and initiate important infrastructure projects — were frozen.

The magnitude of the annual report — and the significance of its delay — became quickly apparent to the city officials, to local business groups, labor representatives and activists of all stripes; and to the media.

Below is a history of the municipal accounting saga through links to stories:

  • A lack of independence poisons the city’s first effort to contract an investigation into its own past financial conduct — a special report.
  • The board that oversees the retirement funds of the city’s employees defines a summer of controversy by steadfastly refusing to release documents that a new group of investigators deem vital to their efforts. It later relents.
  • Those investigators begin to run up a tab with the city of San Diego that led the mayor to claim they were holding the city “hostage.”
  • Months later, the investigators from the firm Kroll Inc. produced their long-awaited report claiming the city was among a historically elite group of financially fraudulent organizations. Kroll and its lawyers, known as the “audit committee,” ended up charging the city $20.3 million.
  • All the while, the city’s exile from Wall Street caused it to miss out on the chance to save millions.

“It took way too long,” Councilman Kevin Faulconer said.

Sanders, City Attorney Mike Aguirre and others offered congratulations to Faulconer for repeatedly bringing KPMG officials before the city’s Audit Committee for questioning. They offered equal praise for Deputy Comptroller Greg Levin, who spearheaded the audit effort.

The detail of elected officials and staff members assembled at an afternoon press conference was positively giddy at the news. Applause abounded. Handshakes and back-pats were exchanged. That such a celebration was in order for what otherwise might be a mundane, rudimentary function of government is testament to the grief endured at City Hall in recent years.

A return to Wall Street wouldn’t fix the city’s financial troubles. But it would give the city the ability again to borrow money to bring its water and wastewater up to health codes, build fire stations and borrow money to plug into its pension system, as required by its contracts with labor unions.

The news wasn’t the only sign that progress was being made in the city of San Diego’s financial reform efforts.

Earlier in the day, the retirement board voted to accelerate the city’s payback of its $1 billion pension deficit. Doing so ensures that the deficit doesn’t grow as the city attempts to work through a number of looming liabilities, but will likely put a greater strain on annual budgets in the coming years.

The pension switched to a 20-year payback schedule, thereby eliminating what had been a 30-year schedule that allowed the deficit to grow because payments could fall below the simple interest accumulated on the pension debt.

In 2004, voters chose to move to a 15-year schedule by 2009, but attorneys for the pension system said the voter initiative was unenforceable. Supporters said their proposal held to the spirit of the 2004 initiative because it included a special provision that will force the city to pay enough annually to keep the deficit from growing.

Sanders also announced a formal list of 22 properties he hopes to sell in the coming fiscal year in order to raise more than $30 million. The proceeds can’t legally be plugged back into the budget — they must instead go toward capital projects. But the revenues will free up other funds for other areas that might otherwise have been devoted to an infrastructure deficit estimated to be at least $800 million.

City officials believe they can go to credit rating agencies as soon as they complete the audit of their 2005 financial statements — reports detailing an entity’s revenues and liabilities. The Mayor’s Office plans on releasing the 2004 audit by mid-May and the 2005 audit by mid-August.

The city’s chief financial officer, Jay Goldstone, said he doesn’t expect the city to return to the AAA credit status it once held. He said would be pleased with a simple A rating.

Officials said they have a good relationship with the auditor of the 2004 and 2005 statements, Macias Gini & O’Connell. Sanders said there is no indication that there are any issues that would delay the release of those two audits. The city also plans to release the 2006 audit in November and the 2007 audit in February 2008.

“As I see it, the nightmare for San Diego and its audits is over,” Councilman Jim Madaffer said.

That nightmare was a costly one, and much of it occurred as local and federal investigators probed City Hall.

The city and KPMG butted heads early on in 2004 after the auditing firm questioned the ability of the city’s law firm, Vinson & Elkins, to conduct the type of independent investigation into allegations of wrongdoing in the city’s pension system and financial reporting.

The law firm released a report in fall 2004 critical of the city’s handling of its pension system, but KPMG said it didn’t go far enough in assigning individual culpability. KPMG asked for a second investigation and, over the firm’s objections, the city again retained Vinson & Elkins.

With questions continuing into the work of Vinson & Elkins work, the city in 2005 hired Levitt and a group of consultants from Kroll Inc. That investigation, too, was beset by delays and cost overruns. After 18 months and $20.3 million, the Kroll investigation was released last August. It opined that elected officials had caused the city to break local and federal laws and that eight former staffers had committed securities fraud.

The costs have manifested themselves in other ways, too. The city has been forced to delay vital infrastructure projects or borrow money on private markets at higher rates. The city had planned to refinance the ballpark bonds since 2003, but only completed the transaction earlier this month.

The refinancing saves the city about $3.7 million a year; it could save as much as $4.1 million if the bonds are refinanced on the public market.

Two months after the release of the Kroll report, the SEC ruled in a settlement that the city as an entity had committed securities fraud in failing to accurately report its looming liabilities.

But KPMG’s audit remained outstanding until Friday as the city and KPMG continued to work through a list of open questions. The inspections included everything from the value of the city’s buildings to what it will owe its retirees in the future. The final hole was closed Friday when the retirement board voted to authorize its top administrators to sign a letter verifying its financial reporting.

“We have turned the corner,” Aguirre said.

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

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