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Tuesday, April 8, 2008 | The Securities and Exchange Commission filed civil securities fraud charges against five former top city of San Diego officials Monday, a sudden revelation that jolted the years-long investigations into City Hall, which once appeared dormant, back into full view.
A year and a half after sanctioning the city of San Diego as an entity on similar charges, the federal regulators went after public officials for the first time in Monday’s filings in San Diego federal court, zeroing in on the upper levels of city management in connection with the release of faulty financial information to the investing public.
The SEC accused former City Manager Michael Uberuaga, former Auditor and Comptroller Ed Ryan, former Deputy City Manager Patricia Frazier, former Assistant Auditor and Comptroller Teresa Webster and former City Treasurer Mary Vattimo, with participating in the release of information that failed to disclose the city’s rapidly deteriorating fiscal health.
The officials, according to the charges, put together false and misleading financial statements, disclosure documents and presentations to rating agencies in connection with the borrowing of $261.8 million in bonds. Those documents are meant to give investors a clear picture of an institution’s health.
“During 2002 and 2003, the five Defendants knew, among other things, that the City faced severe difficulty funding its future pension and retiree health care obligations unless new revenues were obtained, pension and health care benefits were reduced, or City services cut,” the charges state. They continue: “Nevertheless, Uberuaga, Ryan, Frazier, Webster, and Vattimo acted recklessly in failing to disclose these and other material facts to investors and to rating agencies.”
The charges represent a rebirth of sorts in the series of investigations that once consumed City Hall. As the city’s financial and political structure collapsed in 2004 and 2005, state and federal criminal investigations into the pension system and the SEC’s securities fraud probe served as a powerful reminder of the severity of City Hall’s troubles. But, with criminal charges filed by the district attorney and U.S. attorney in 2005 and 2006, respectively, and the 2006 SEC settlement, the full force of the government investigations appeared to be spent.
But, as it said at the time of the settlement, the SEC said again Monday that its investigations into individuals were continuing, though it wasn’t as absolute as its previous statements. “I guess at this point our investigation is still continuing,” said Kelly Bowers, senior assistant regional director in the SEC’s Los Angeles office.
Four sitting City Council members, Scott Peters, Toni Atkins, Donna Frye, Jim Madaffer and Brian Maienschein, served at the time when the financial statements were approved by council and released. Their roles in the city’s disclosure problems became a matter of great scrutiny, but Peters said last year that he believed the probe would leave the council members unscathed. Bowers refused to comment on the status of elected officials.
In what they are calling a rarity for government officials, federal regulators are seeking unspecified financial penalties from the five charged Monday, as well as an injunction, which would lead the defendants to be found in contempt of court should they be found guilty of similar charges in the future.
The decision to seek penalties is, Bowers said, “partly to send a message to other government officials.” It comes at a time when municipal securities, and government pension systems, have received increased scrutiny nationwide.
Frank Vecchione, Webster’s attorney, said in a statement that city officials acted in good faith and honest intention.
“It is equally clear that no individual lost money with regard to investment in San Diego bonds. At no time did Terri Webster act inappropriately or with intent to deceive any potential investor,” his statement reads. “The time has come to put the misperceptions and misrepresentations regarding Ms. Webster and these bonds to rest. We intend to do so.”
Webster also faces criminal charges in both the state and federal cases; Vattimo faces criminal charges in the state case. Monday’s charges, however, aren’t criminal; they’re civil. The case, if contested, would be handled in the federal courts as any civil lawsuit would be handled.
The legal and financial troubles stem from a horde of problems in the city’s pension system, primarily agreements made in 1996 and 2002 between the city and its pension board that boosted employee benefits and allowed the city to skimp on its annual pension bill. The system was also using its investment earnings to pay extra benefits to employees.
The result: A growing shortfall in 2002 and 2003 that threatened to hit $2 billion by 2009.
The charges allege that the city’s disclosures were rife with misleading statements, including the claim that its unorthodox funding plan was considered sound. The documents failed to disclose a $1.1 billion retiree health care deficit, according to the charges, and also stated that another pension obligation was being funded by a reserve when it was not.
The SEC claims, for example, that Webster participated in making false and misleading statements in disclosures and in presentations to the rating agencies that judge an entity’s creditworthiness. She “knew or was reckless in not knowing” that the city’s statements on its pension system were misleading and she failed to correct the misstatements, according to the charges.
Vattimo recklessly participated in making false and misleading disclosures to investors, the charges claim, as she was a member of the finance team that prepared the city’s offering documents. She also edited the 2003 presentation to rating agencies regarding the city’s pension obligations.
Both Webster and Vattimo were quite familiar with the pension system, the charges state, as both served on the pension board.
For his part, Uberuaga, the former city manager, advised the City Council on the bond issuance and was reckless in certifying the statements as true, the charges state. Likewise, Ryan, the former auditor, failed to ensure that the statements were true, according to the SEC.
Frazier oversaw the preparation of one section of the city’s financial disclosures and participated in the presentations to rating agencies. She either knew or should’ve known that the statements and presentations contained misleading information, the charges state.
In securities fraud, an individual’s intentions are central to the case. There are generally three stages that the actions are measured by. If an individual knowingly deceived, a finding known in the field as “scienter,” then they are deemed to have intentionally committed fraud. Likewise, they are considered to have committed fraud if they reasonable should’ve detected the error by showing significant care — a finding known as “reckless.” The last, which is negligence, doesn’t generally draw SEC sanctions.
The elected officials, for example, were found by private consultants to have acted negligently in approving the financial disclosures.
All five of the defendants exited the city between 2004 and 2005 as the city’s problems mounted. In that time, a mayor resigned, investigators were frequent sights at City Hall, and the city’s credit rating was suspended upon word of the securities problems.
That started a chain reaction that has yet to completely come full circle. The city spent more than $26 million on three private investigations into its disclosure issues in an attempt to placate the SEC and its outside auditors, who refused to sign off on its financial statements.
Though the city has now finally caught up on its audited financial statements through the year 2006, the process to completion was costly and fraught with delays. To this day, the city remains locked out of Wall Street for lack of a credit rating, leaving it without access to the relatively inexpensive loans that municipalities use to complete basic infrastructure and other projects.
Correction: The original version of this article failed to include Councilman Jim Madaffer as one of the sitting council members who served at the them when the financial statements were approved by council and released. We regret the ommision.