Deficits Trigger Reform Efforts

Seeking to limit damage from its pension deficits, the San Diego City Council today will consider adopting financial disclosure reforms similar to those imposed on public companies in the wake of high-profile corporate scandals.

City officials hope an overhaul could help placate the U.S. Securities and Exchange Commission, which began an investigation after the city admitted earlier this year that it had failed to tell prospective buyers of its municipal bonds that the city has a pension deficit approaching $2 billion.

The pension deficit and the city’s failure to disclose the problem promptly to Wall Street have led to the biggest financial debacle in San Diego’s history.

Three agencies have downgraded San Diego’s credit rating, causing the city to delay bond sales, including a possible $200-million sale of pension bonds to begin to whittle down the deficit.

“To the extent the SEC values honesty and cooperation, they should appreciate what we’ve done,” Mayor Dick Murphy said at a news conference. “We are on the cutting edge of what may become standard for cities across America.”

City officials and securities experts say the measures being considered would make San Diego the first city in the nation to take on the sort of responsibilities that officials at public companies have had to shoulder since reforms were adopted by Congress in 2002 after financial scandals at Enron Corp., WorldCom Inc. and other companies.

“We’re providing a template for them,” Murphy said.

Other local governments would be wise to follow San Diego’s lead, said John C. Coffee, a business and securities law professor at Columbia University’s law school in New York.

“This is a constructive proposal in a field -- municipal finance -- that has long been opaque and nontransparent,” Coffee said. “While defaults have been few, the practice of raiding public pension funds in times of fiscal scarcity is sadly well established.”

San Diego got into trouble by increasing employee pension benefits to satisfy politically powerful labor unions and then counting on a soaring stock market to keep the pension plan fully funded, according to a report done for the council by the Washington office of Vinson & Elkins, a law firm hired by the City Council to investigate why the growing pension deficit was not disclosed until it was out of control.

The report found that when the stock market plunged in the dot-com collapse, the City Council did not compensate by raising the city’s contribution to the pension fund. The fund now has a deficit approaching $2 billion if health benefits for retired employees are included.

Vinson & Elkins made a series of recommendations that mirror those imposed on public companies in the 2002 Sarbanes-Oxley Act. They would establish clear responsibilities for filing financial statements and require review by an outside auditor. The city manager would have to certify the accuracy of financial statements, just as chief executives of public companies are required to do under the Sarbanes-Oxley law.

In addition, the recommendations call for creating a three-person Financial Reporting Oversight Board to include experts in finance, accounting and federal securities law to check and recheck disclosures.

Though endorsing the changes overall, Coffee noted that the oversight board would be advisory. He said this falls short of a key reform for public companies that gives an independent committee of directors authority over outside auditors, including the ability to hire and fire auditors.

Paul Maco, the attorney who headed the Vinson & Elkins investigation of San Diego, said it isn’t possible to set up a committee that independent to oversee municipal finance because oversight power can’t be stripped from the City Council, the elected representatives of the citizens.

The proposals are meant to eliminate what Vinson & Elkins described as a system in which no one took responsibility for the accuracy of financial disclosure documents and key officials seemed to adopt a “minimalist” attitude toward disclosure.

City Manager Michael Uberuaga, hired in 1997, delegated authority for such reports to others, never bothering to check for accuracy, the report said. He resigned under pressure from Murphy and City Council members this year.

Uberuaga’s management style “had the effect of insulating him from any direct involvement in or knowledge of matters relating to the city’s disclosures,” the Vinson & Elkins report said.

Although the mayor and council members are applauding the Vinson & Elkins recommendations, others are not. San Diego County Supervisor Ron Roberts, who is challenging Murphy for reelection, said a far more thorough shakeup of officials is needed.

And Carl DeMaio, president of the Performance Institute, a local watchdog group, said the reforms would have done nothing to avoid the pension deficit. He blames that on coziness between council members and labor unions and on an inherent conflict of interest that exists when city officials are involved in regulating their own pension plans.

“What this boils down to is this: Would these things have helped us avoid this mess?” DeMaio said. “Sadly, the answer is no.”