San Diego Likened to Enron

A long-awaited audit released Tuesday blames San Diego’s pension fund debacle on mismanagement and illegal financial manipulations that recall the fiscal crises of Orange County and Enron Corp.

The 266-page report concludes that some former city and pension board officials violated state and federal laws in their ill-advised pursuit of short-term solutions for a pension fund deficit that now approaches $2 billion.

“The evidence demonstrates not mere negligence, but deliberate disregard for the law, disregard for fiduciary responsibility and disregard for the financial welfare of the city’s residents over an extended period of time,” said Arthur Levitt Jr., the former chairman of the Securities and Exchange Commission who oversaw the independent audit.

The report, which cost $20 million, is considered a key step in San Diego’s bid to restore its once solid reputation for conservative fiscal management. City officials hope that the report by Kroll Inc., a risk management firm in New York, will win back Wall Street’s trust.

“This is a chance to once again be masters of our own fate and destiny,” said Jerry Sanders, who became mayor in December.

Immediately after the report’s presentation at a special meeting of the City Council, a representative from the city’s outside auditor, KPMG, said it would resume work to certify the city’s 2003 financial report.

The firm had refused to complete that report until after a full investigation had been finished.

Earlier this year, a federal grand jury indicted five former and current city pension board officials for their roles in approving the pension fund investment scheme. The SEC is also investigating whether laws were broken when the city filed reports with Wall Street that did not mention the bad news about the pension funds.

KPMG’s audit could help the city, which now is saddled with credit ratings as low as junk bond status, return to the bond market to borrow money.

“This is a very important day for San Diego,” said Council President Scott Peters, adding that the Kroll report is a “guide” that will help taxpayers and markets regain confidence in the state’s second-largest city.

At the council meeting, City Atty. Michael Aguirre, a longtime opponent of the probe’s cost and scope, criticized the Kroll investigators for not going far enough in assigning blame.

Some council members, the report concluded, were negligent in their duties, but did not willfully or knowingly violate laws.

Aguirre, who fears that the report could undercut his plan to roll back pension benefits, suggested that Kroll had whitewashed the report to suit the council’s interests.

Levitt angrily denied the charges at the council meeting. He accused Aguirre of engaging in the same kind of political factionalism that he said got the city into trouble in the first place.

“You are taking us back to the past. You are continuing to demagogue a process, to embarrass your colleagues, to embarrass yourself in a way that I think is demeaning,” Levitt said.

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.

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

“San Diego city officials fell prey to the same type of corruption of financial management and reporting that has afflicted municipalities such as Orange County and such private sector companies as Enron,” the report states.

Orange County filed for bankruptcy in 1994 after $1.7 billion in losses from highly speculative securities. Enron, the Houston-based energy firm, collapsed in 2001, and its top officers were convicted of fraud for engaging in creative schemes that inflated its value.

The 18-month San Diego investigation, which reviewed more than 1 million documents, found that the pension board made false and misleading statements to disguise the extent of the funding shortfall.

And it concluded that the city misrepresented to investors that it was making contributions to its pension system at appropriate levels when it was not.

“Under the pressure of short-term needs, city officials gave expedience a higher priority than fiscal responsibility and came to view the law as an impediment to be circumvented through artful manipulation,” the report states.

The wide-ranging audit also found that San Diego homeowners were improperly overcharged on their monthly sewage bills, with the excess being unlawfully used to subsidize the sewage costs of large industrial users.

The Kroll report is the second in two years to harshly criticize the city. In 2004, lawyers from the Washington firm of Vinson & Elkins concluded that the city suffered from chronic bad management and an almost dysfunctional environment, ignoring a fiscal crisis that it compared to a “snake in the garden.”

Since the scandal erupted, the city has made sweeping changes to its reporting and accounting systems, and adopted stricter financial disclosure rules. Several officials have resigned or been forced out.

And voters approved a strong-mayor form of government that gives the city’s top official more power and responsibility over financial matters.

The Kroll report said, however, that San Diego had yet to come to terms with its need for fundamental reform.

Among other things, it recommends that the city create a permanent audit committee, appoint an independent monitor to oversee the reforms and create more accountability by strengthening the chief financial officer’s role.

Carl DeMaio, president of the Performance Institute, a local watchdog group, said the report should allow the city a fresh start, but cautions that the council must follow through on recommended reforms.

“Now is the time for the City Council to demonstrate through action its commitment to reform,” DeMaio said, “and in doing so send a strong message to the SEC and Wall Street.”