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Wednesday, Dec. 12, 2007 | The Securities and Exchange Commission charged the first individual involved in the city of San Diego’s financial reporting scandal this week, and it wasn’t a city official.
Thomas J. Saiz, former owner of the accounting firm that drafted financial disclosures, was fined $15,000 for breaching federal securities fraud rules, the SEC announced Tuesday. He and the firm, known as Calderon, Jaham and Osborn, also agreed not to engage in future securities fraud, the commission said.
The settlement resuscitates a long-dormant discussion over the SEC’s probe into City Hall, as the commission had yet to follow up its November 2006 sanctions against the city government until this week.
The SEC’s actions raise the specter that other individuals will be pursued by securities regulators for the overly rosy picture the city painted of its financial footing, despite the year-long interval between the city’s settlement and those for Saiz and his firm.
The 17-page complaint doesn’t identify other individuals who helped contribute to the errors and omissions that appeared on the documents Calderon helped prepare. SEC officials on Tuesday declined to comment on the remaining targets of its investigation, saying only that the commission’s scrutiny of the city’s past disclosure problems is ongoing.
But attorneys for the SEC and the firm provided hints that other individuals bear responsibility too.
Kelly Bowers, the senior assistant regional director in the SEC’s Los Angeles office, noted that “typically there are several individuals that contribute to an entity’s violation.” Jim Schnieders, a lawyer for Saiz, noted that any mistakes his client would have made would have been based on the information that provided to him by the city. Saiz and his firm were involved in drafting the footnotes that explained the city’s financial health to investors.
“Financial statements are prepared on the basis of management representations,” Schnieders said.
After 33 months of investigating, the SEC last year settled securities fraud charges with the city government as an entity for the downplaying of its pension and retiree health care deficits to the investing public. The SEC left unidentified the officials whose decisions resulted in the city’s securities fraud.
Although no officials were charged last November, it was speculated that city accountants, administrators and lawyers could be charged. Consultants at Kroll Inc., led by former SEC Chairman Arthur Levitt, concluded that eight city officials likely committed securities fraud. In early 2006, sources close to the case said targets of the commission’s probe were invited a last chance to settle with the SEC before charges were brought.
But since the city’s settlement, chatter about the investigation has been much quieter and the sums of money spent representing city officials in front of the SEC has declined significantly. Council President Scott Peters has said earlier this year that council members involved in the decisions under scrutiny would be untouched by SEC action.
In the case of Saiz and his firm, the SEC found they committed securities fraud for including false and misleading information about the city’s retirement costs when drafting the financial documents that accompanied five bond offerings in 2002 and 2003.
The SEC alleged that Saiz and his accountants incorrectly stated on the disclosures that the city’s method for funding the pension plan assured that the deficit would never grow beyond a point the fund’s actuary would deem acceptable. The city had information that this was not true, the SEC said.
Additionally, the firm stated that the pension fund’s actuary believed the city’s funding strategy was an excellent method and superior to certain generally accepted accounting principles. But the actuary was concerned with the method once funding for the plan fell beyond a certain level, the SEC said.
The city and its retirement board struck deals that allowed the city to avoid making budget-busting payments into the pension plan as long as the fund was 82.3 percent funded. In exchange for the relief from its bill, the city promise its employees — some of whom sat on the retirement board — enhanced pension benefits. Those agreements led to a $1 billion deficit, spawned a flurry of criminal charges and civil lawsuits, and were at the heart of several of the SEC’s claims of securities fraud.
The SEC also said Calderon continued to use an outdated figure of $39.2 million for the city’s annual net pension obligation when it had jumped to a less-manageable $51.9 million between 2001 and 2003. The SEC also said the firm wrote in the city’s disclosures that the city had a reserve set aside to fund its net pension obligation, when no such reserve existed.
Also, the firm neglected to disclose that health benefits for retired employees were paid out of a reserve fund at the pension system that was running out of money and that the city would have to begin paying retiree health expenses out of its own budget when the reserve ran out, the SEC said.
Together, the statements the firm helped draft wouldn’t have fully foreshadowed the mounting financial challenges faced by the city due to its pension and retiree health care liabilities.
The settlement stipulates that Saiz and his firm not defend or affirm the SEC’s allegations, a condition that allowed the parties to avoid the costs and heartburn of a trial. Experts called the fine a token punishment.
“My impression is that this is a pretty modest slap on the wrist,” said University of San Diego law professor Hugh Friedman, who specializes in corporate securities law. “It’s never good for a certified public accountant or a firm to be sanctioned this way, but … it’s a pretty soft landing to me.”
But SEC officials said the firm’s conduct equated to securities fraud.
“Investors rely on, among other things, auditors for ensuring investors receive material information about the offerings,” said Andrew Pettilon, an assistant regional director for the SEC.
The faulty information appeared on documents that accompanied $260 million worth of loans the city took out in 2002 and 2003 to help bridge its expenses while it anticipated tax revenue and to pay for expenses related to light rail projects, the Fire Department and capital improvements at Balboa Park and Mission Bay Park.
When those defective financial statements were later discovered, the financial ratings agencies suspended or slashed the city’s standing in the financial market, effectively barring the municipal government from borrowing money on Wall Street. That has forced the city to endure a years-long ordeal in which it has had to borrow money more expensively in the private market, postpone projects and spend tens of millions of dollars on lawyers, consultants and accountants.
Before the city can reenter the markets, it must return to the good graces of the ratings agencies by clearing its backlog of yearly financial audits. Right now, the city of San Diego is working on completing its audits for fiscal year 2006 when it would be completing its 2007 statements under regular circumstances.