San Diego Playing a Blame Game

As Michael Aguirre moved into the San Diego city attorney’s office in December, he was surprised to find that documents related to the city’s $1.5-billion pension shortfall were moving out -- a dozen floors down to a locked room in the city manager’s suite.

Aguirre, whose campaign had taken aim at what he saw as cronyism and double-dealing at City Hall, said no one had told him about a need to move the files from the conference room where they had been kept for months.

“They wanted to relocate the documents outside the city attorney’s jurisdiction,” he said, contending it was one of a series of attempts to keep him from unearthing the truth. “This city is staggering into the financial abyss, and the people who should be cleaning it up are instead obfuscating.”

City Manager Lamont Ewell dismisses Aguirre’s story about the files. “I have no idea what he’s talking about. I never gave any such direction. It never happened. I don’t have any access to his office. This is another of his fabrications,” he said in a statement released by his spokeswoman, Gina Lew.

Accusations are in the air these days in California’s second-largest city -- where Aguirre, the district attorney, the U.S. Securities and Exchange Commission and the U.S. Justice Department all are probing possible wrongdoing in connection with the pension deficit.

A federal grand jury has issued seven subpoenas for documents and testimony, and at least five key city officials, including Mayor Dick Murphy, have announced their resignations or moved to other positions.

“The city has been in an utter state of paralysis for more than a year,” said Carl DeMaio, president of the Performance Institute in San Diego, a nonpartisan think tank. He said his group began advising the city on how to deal with state budget cuts last year, and gradually realized the problems were far worse than described at that time.

“If we don’t take immediate action, the city of San Diego will be forced into bankruptcy,” he said.

But so far, there has been more finger-pointing than problem-solving.

Aguirre has issued a series of reports blaming top city officials and city employees union leaders for the deficit, saying they failed to act after the stock market plunged in 2000, hammering a retirement system that promised ever-greater benefits without identifying how to fund them.

Indeed, Aguirre said, city officials made things far worse in 2002 by striking a deal that again sweetened retirement benefits while allowing them to ignore a financial “trigger” that would have required them to pay hundreds of millions of dollars to bail out the system.

“Together, these officials decided not only to keep the people of San Diego in the dark about the situation, but also to withhold the adverse facts from investors in the city’s bonds,” he said in one report.

Critics say Aguirre is creating chaos by grandstanding, usurping authority from the mayor and City Council, and inserting himself where he has little jurisdiction. “Clearly there is something wrong in San Diego, but things were being investigated long before he was elected,” said former Deputy City Atty. John Kaheny. “His continued involvement only serves to hinder the process.”

As the fighting among public officials plays out publicly, however, federal investigators are quietly grinding away on two fronts, according to Aguirre and others with knowledge of the probes.

One inquiry involves the city’s failure to warn investors in its municipal bonds until January 2004 of a growing pension shortfall. The troubles came after the city tapped into higher-than-expected stock market profits in the pension system, leaving it vulnerable when the market hit bad times.

Critics say the investors had a right to know because the deficit made it less certain that they’d get promised bond payments.

Randall Lee, the SEC’s Pacific regional director in Los Angeles, declined to comment on the probe. But a failure to alert investors to bad news is something his agency would investigate. After Orange County’s 1994 bankruptcy, the SEC sanctioned county officials and their advisors for failing to disclose the risks in investments that lost $1.6 billion.

The lack of disclosure in San Diego’s SEC filings was brought to light by Mark Conger, a lawyer who sued the pension board and city in January 2003 on behalf of retirees who feared their benefits were being jeopardized. That lawsuit resulted in a commitment from the city to restore full funding.

Conger said the SEC called him in February 2004, and he briefed lawyers for the agency on the allegedly misleading statements.

Robert C. Friese, an attorney for eight San Diego employees with knowledge of the city’s bonds, said his clients also have been interviewed by the SEC.

Based on questions asked of his clients, Friese said, the agency appears to be examining bond offerings in 2002 and 2003 for sewage, ballpark and other improvements. Friese said disclosure problems stemmed mainly from poor coordination, but he acknowledged one clear misrepresentation in filings connected to the offerings: that the pension fund had about 97% of the assets needed to pay for future liabilities, when in fact the ratio had fallen below 90%.

“That was wrong,” he said. “And it should have been caught.”

Friese said the mainly lower-level employees he represents were witnesses, not targets, in the SEC probe and a related criminal investigation of political corruption by the FBI and the U.S. attorney’s office in San Diego.

Conger and Aguirre said they thought this second line of inquiry was examining potential conflicts of interest involving powerful players on the pension board and the City Council. Aguirre said as many as 10 current and former employees of his office have been interviewed by the SEC or the FBI, and some of them have been given immunity.

Among the most damaging evidence, Aguirre contends, are e-mails showing that the pension board voted during labor negotiations in 2002 to let the city ignore a trigger requiring balloon payments when the fund’s assets dipped below 82.3% of its projected liabilities.

With the trigger waived, the city was able to skip more than $500 million in special payments that were supposed to have been made over the next two years to keep the fund healthy.

In return for the waiver, Aguirre alleges, employees were promised even more retirement pay, including 11% higher basic benefits. Compounding the potential conflicts of interest, union presidents on the pension board got special financial favors, he said.

In one report, Aguirre cited a May 21, 2002, e-mail from pension board member and then-Assistant City Auditor Terri Webster to Labor Relations Manager Dan Kelley. In the note, Webster said it was especially important to win support for the waiver of the trigger from firefighters union President Ron Saathoff, an 18-year veteran on the board, “since he runs the show.”

In the end, changes in pension rules allowed Saathoff to count his $45,000 annual union stipend, as well as his $84,000 salary as a city fire captain, toward his pension. That yielded the labor leader a pension of $116,000 a year for life when he retired soon afterward at age 55. It was an increase of $32,000 over the $84,000 a year he otherwise would have received, Conger said.

Aguirre noted that state law bars public officers or city employees from participating in making a contract in which they have a financial interest. A violation can be prosecuted as a felony. Six pension board members -- including Saathoff and Webster -- had a “prohibited financial interest” in the deal struck in 2002, Aguirre’s third report said. All six voted to waive the trigger provision, a proposal that passed on an 8-2 vote.

Webster and Saathoff couldn’t be reached for comment. Webster now works in the city’s sewage department.

Carol C. Lam, the U.S. attorney in San Diego, declined to comment on the criminal investigation.

After taking office on a reform platform, Aguirre plowed through hundreds of e-mails, memoranda, actuarial studies and city documents exchanged over the last decade -- documents tracing the series of decisions by city and retirement board leaders that preceded the financial crisis.

A 1996 agreement increasing pension benefits contained the supposed safeguard, stipulating that if the pension fund’s ratio of assets to liabilities ever fell below 82.3%, the city would have to make balloon payments to close the gap.

Adding to the fund’s burden was a city policy dating to 1980 of diverting earnings from the pension trust to pay for other benefits. Retirees were given a 13th check in any year that earnings exceeded expectations. The city also paid for retirees’ health benefits out of excess earnings.

And in an unusual twist, employees were able to “buy” pension credits at a discount, enabling some to qualify for a pension reflecting 10 years of service after having worked for just five years.

If San Diego had been following sound financial and actuarial principles, that money should have stayed in the pension trust to generate even more income, the city’s Pension Reform Committee concluded in a report last September.

But in 1996, the retirement system was more than 90% funded. Buoyed by earnings created by the stock market boom of the late 1990s, it stayed that way despite more pension enhancements approved in 1997 and 2000.

By late 2001, however, the financial picture had begun to change, with pension trust earnings falling 71% from the previous year.

As the funding level continued to plummet, city and retirement officials exchanged numerous e-mails discussing the impending meltdown.

By June 30, 2002, the funding level had dropped to 77%, triggering the balloon payment required by the 1996 agreement. The city’s Pension Reform Committee later calculated that the city should have paid at least $203 million into the fund the next year to ensure its soundness. Instead, it paid $85 million, the committee found.

Also in 2002, the mayor and City Council agreed to sweeten pensions again, giving city employees one of the best plans in the state. Police and firefighters on the job long enough could retire at age 50 with a 90% pension for life, plus health benefits. General employees finishing a 30-year career were entitled to a 75% pension at age 55.

The problem, according to Aguirre, is that the city granted these benefits without providing a source to pay for them. He put the combined cost of the enhanced pensions at $467 million.

“It is precisely this lethal combination of underpayment while simultaneously increasing contractually obligated benefits that put the city in the financial crisis it is in today,” Aguirre said in one report.

After the 2002 labor contracts were signed, the pension fund level continued to fall. By last June, it had fallen to 66%. Aguirre said the shortfall now comes to more than $1.5 billion.

Given the pension’s massive deficit, San Diego would have to devote 20% to 25% of its budget to catch-up payments over the next three to four years to get the system in balance, said Scott B. Ehrlich, a bankruptcy law professor at California Western School of Law.

“No city can afford that,” he said.

If San Diego could get its bond ratings restored, it could potentially float pension obligation bonds to finance the debt, noted Mary Beth Syal, a bond portfolio manager at the Los Angeles investment firm of Payden & Rygel. But the city would be forced to pay substantially higher interest because these bonds are not tax-exempt.

The result, she said, would be that the city would pay about $75 million a year to finance $1.5 billion in pension obligation bonds, versus about $45 million for tax-exempt bonds.

But it is not clear whether San Diego can even float the bonds. Standard & Poor’s won’t rate the city’s bonds because the city has no audited financial statements. Outside auditor KPMG says it won’t certify the financials until a thorough investigation determines whether laws were broken.

If the city is not able to borrow its way out of the crisis, its options would include raising taxes, getting city workers to agree to a cut in pension benefits, or even filing for bankruptcy -- an option no city officials are considering at this point.

The latter would be an especially costly option, said Orange County Treasurer John Moorlach, who was elected in the backlash that followed Orange County’s 1994 bankruptcy. County taxpayers wound up shouldering $100 million for lawyers, accountants and interest payments, Moorlach estimated.

And even bankruptcy may not end San Diego’s pension obligations, Moorlach said; municipal bankruptcies are so rare that there is little precedent for what might be allowed.

If there’s one consolation for San Diego in its litany of woes, it might be this: It’s not the only city whose pension obligations are underfunded.

California public agencies borrowed more than $2 billion last year to cover pension costs; it was the biggest amount in more than a decade, according to the state treasurer’s office. If San Diego were to successfully renegotiate its pension contracts through bankruptcy, Moorlach said, other cities and agencies might line up behind it.

“If they are successful, you might see a domino effect, where a lot of other cities that have similar problems say, ‘Here’s the road,’ ” Moorlach said.

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Times researcher Scott Wilson contributed to this report.