There was a cardinal rule about the Southeastern Economic Development Corp.’s secret bonus system: You couldn’t talk about it. Do that, and you’d be fired.

That warning, issued by then-President Carolyn Y. Smith, came after two agency employees were overheard expressing their shock at the extra bonus checks. After chastising the employees in her office, Smith reportedly called the agency’s lawyer and asked if she could fire them for discussing their compensation.

She was told she could not.

SEDC’s policy of ordering employees to keep mum over the hundreds of thousands of dollars the agency paid out in secret bonuses is just one of a slew of new details revealed in the embezzlement and misappropriation of public funds charges filed Tuesday against Smith and SEDC’s former finance director, Dante Dayacap.

The state Attorney General’s Office accuses them each of five criminal felony counts: conspiracy to commit a crime, three counts of embezzlement of public funds and one count of misappropriation of public funds.

Each faces a maximum of seven years and four months in prison if convicted of all the charges. Dayacap was arrested Tuesday and is currently in the downtown county jail. Smith wasn’t immediately taken into custody.

Tuesday’s arrest and charges are the latest chapter in a story first uncovered by voiceofsandiego.org in July 2008. The culmination of years of investigation by the Federal Bureau of Investigation and the Attorney General’s Office, the court documents show the personal side of a story that has so far been told primarily in cold, hard numbers.

The documents reveal the sometimes tense, sometimes tragic behind-the-scenes conversations as the secret bonus scheme built up and, eventually, collapsed. They also show the sense of entitlement that drove one woman to declare herself and her agency above the oversight of the government that was paying her.

The Beginnings of a Bonus Scheme

Like so many schemes, SEDC’s bonus system started off small. Then it grew out of control.

The agency, which carries out taxpayer-financed redevelopment in some of San Diego’s poorest neighborhoods, historically paid employees a small holiday bonus. It was typically less than $1,000, according to the court documents.

Then, in 2003, employees began receiving extra payments from Smith and Dayacap. The “cost of living allowance” gave them a 4 percent boost twice a year. New bonuses began arriving with time, too, with vague titles like “year-end acknowledgement,” “longevity” and “incentive pay.”

“These bonuses were not based on years of service and there was no performance review prior to their issuance,” according to a revealing declaration from state Justice Department special agent Shannon Williams.

Bank accounts didn’t just get boosted. So did retirement plans. The agency’s board didn’t allow bonuses to be included in employees’ pension calculations. Dayacap, according to the prosecution, defied that rule and directed that all but the holiday bonuses go toward pensions.

“It was happy days at SEDC when the checks came round,” former employee Herb Cawthorne told us three years ago.

The money had to come from somewhere, though.

SEDC budgeted for jobs that it didn’t plan on filling, creating a de-facto fund for paying out secret bonuses. A vague and confusing budget hid the details. Dayacap had an accountant project SEDC’s salary savings in the middle of the fiscal year to find out how much unused salary could be passed out.

“He would take the chart to Smith who would review, sometimes alter, and then sign her approval,” the declaration states.

Smith handed out the checks to employees.

In fiscal year 2006, for example, SEDC budgeted $75,000 to $95,000 for its manager of projects and development. It didn’t fill the position the entire year. Early in the year, it fired Cawthorne, who as the vice president of operations made between $95,000 and $115,000. Two other employees left in the middle of the year.

SEDC accountant Maria Arguelles told the FBI all that money went into boosting bonuses.

The money came in waves.

“Employees were given a COLA (cost of living allowance) payment in July, a holiday bonus in November, a second COLA in December, and three ‘year-end acknowledgement’ bonuses in April, May, and June,” court documents say.

That year the agency handed out $116,472 in bonuses, according to the prosecution. More than half of it went to Smith ($33,440) and Dayacap ($32,300) alone.

Dayacap signed each check, according to the prosecution. So did Smith. Even her own.

‘One Way or Other’

In 2007, they got more creative.

Smith asked the City Council for staff raises, but the council didn’t oblige, making the agency tighten its belt like everybody else at the city.

Most of the employees at SEDC could still receive raises, however, since they weren’t yet receiving the maximum amount allowed under the budget for their salary range.

But Smith, Dayacap and Smith’s executive assistant, Kimberly King, were already capped out at their maximum salaries.

“We’re going to get our money one way or other,” Smith told Dayacap, according to Arguelles’ recollection.

Dayacap told Arguelles, the accountant, to create checks for Smith, Dayacap and King of $7,000, $5,000 and $2,230. They were called “lump sum salary adjustments.”

Those payments joined an expanding list of bonus programs. “SEDC employees also received COLA in July, two holiday bonuses in October and November, a second COLA in December, and four year-end acknowledgements in January, February, April, and June,” according to court documents.

A year after getting little more than $30,000 in bonuses in 2006, Smith and Dayacap turned it up a notch. Smith received $82,700. Dayacap, $67,300.

The agency’s hidden bonus program as a whole grew from about $115,000 to nearly $280,000 that year. Neither the SEDC board nor the City Council knew of the payments, let alone approved them.

The payments to Smith and Dayacap soon flew over the $10,000 limit that Dayacap was authorized to sign. Anything more, Smith and a board member had to autograph the checks. The rule didn’t matter. Dayacap later acknowledged knowingly breaking it, court documents say.

At the time, Arguelles, the accountant, had pointed out to Dayacap that he was breaking the rules, the declaration states.

“Oh shit,” Dayacap replied.

The Story Unravels

The next year, Smith again sought to increase SEDC’s City Council-approved official budget for salaries, a move that attracted the attention of the city’s Office of the Independent Budget Analyst.

Lisa Celaya, an analyst, studied the agency’s budget in 2007 and concluded that SEDC was asking for a 30 percent increase in its salaries. When she received only “incredibly vague” explanations from Dayacap, the court documents say, Celaya wrote a report stating that SEDC was seeking a 34 percent increase in salaries.

The report made Dayacap furious, the declaration states, and he called Celaya to express his displeasure. Smith went a step further. She sent the City Council a memo responding to the report. That memo, the prosecution alleges, “included a number of lies.”

Smith lied about the number of employees, misrepresented the amount she regularly paid out in bonuses and the amount employees were paid in COLAs, the declaration states.

Smith dismissed the assertion that the budget included a 34 percent spike in salaries, saying it was only 4 percent.

The City Council accepted Smith’s explanation and passed the budget.

The bonus system had entered a new realm. On March 3, 2008, for example, Smith and Dayacap signed checks giving themselves more than $20,000 in bonuses each for one-off “incentive pay,” according to court documents. Two months later, on May 7, they signed checks giving each other more than $22,000. The payments, again, were labeled as “incentive pay.”

Suspicious of Smith’s answers and unable to make sense of the numbers in the budget City Council approved budget, we kept looking into the story.

When VOSD filed requests for records under the California Public Records Act, the documents say, “Dayacap became nervous and edgy.”

It took a while. But the agency’s dual status as a government agency and as a nonprofit organization eventually betrayed it. Because it’s a nonprofit, SEDC’s tax returns are public record. By comparing Smith’s compensation in the agency’s tax return to her published salary in its annual budget, we found a significant discrepancy and confronted Smith about it. That’s when we began learning details about its clandestine bonus system.

Smith was, and remained throughout the scandal, unapologetic.

According to court documents, Smith told the mayor’s former communications director that the City Council had denied pay increases, so she found a way around that. In a later deposition, the court documents say, Smith said she felt SEDC employees weren’t paid enough compared to those at their sister agency, the Centre City Development Corp., “so we found ways to compensate them.”

After our original story broke, Smith and SEDC Board Chairman Artie M. “Chip” Owen responded with a letter to the mayor and City Council claiming that the agency’s board and the City Council had approved the bonuses by signing off of SEDC’s budget.

Owen subsequently admitted that the letter was “not entirely accurate,” according to the court documents.

Smith was fired on July 23, 2008 in an emotional meeting of SEDC’s board. She was the agency’s longtime leader and is the daughter of prominent community leader Rev. George Walker Smith.

The city temporarily cut off almost all funding to the agency and, as City Councilman Tony Young requested a performance audit of SEDC, Dayacap phoned then-City Comptroller Greg Levin to discuss the cut-off in payments.

“Dayacap began crying,” the special agent’s declaration states, “and asked if he was ‘screwed’ and if he would go to jail.”

Contact the reporters directly at andrew.donohue@voiceofsandiego.org and will.carless@voiceofsandiego.org or 619.325.0525. Follow them on Twitter: @AndrewDonohue and @WillCarless.

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