San Diego The City of San Diego doesn't know its assets from a hole in the ground, and neither does the San Diego City Employees' Retirement System, we learned last week. So what else is new? Sloppy and/or dishonest accounting is part of the San Diego tradition, perpetrated by both the private-sector overlords and their public-sector puppets.
This month, the city council was told that it may have to shave its 2002 assets by more than 9 percent because of such sins as overcounting and underdepreciating assets. Meanwhile, the pension system's outside auditor found 29 deficiencies in the accounting mechanisms.
Yawn. Ledger-demain goes back decades in San Diego. In the 1960s, C. Arnholt Smith was the city kingmaker, having mayors, judges, and prosecutors in his pocket and downtown real estate in his portfolio. To evade state and federal income taxes, Smith would remove money from one of many companies he controlled, explains Steve Davis, deputy district attorney, who prosecuted Smith back in the 1970s. "He had to pay that money back. He would claim he was selling assets to retire his debt, but he was still retaining ownership and possession of the assets. In one case it was stock he held in the San Diego Padres."
That brings us to the present. Last week, Hewlett-Packard announced it would pay $425 million for San Diego-based Peregrine Systems, which was once controlled by John Moores, the current majority owner of the Padres, downtown real estate mogul, and as powerful today as Smith was in his day.
Back in mid-2001, Peregrine was riding high, having reported 17 straight quarters of sales growth that met or exceeded Wall Street's expectations. In March of 2000, as the bull market peaked, the stock soared to $79.50. It had gone public at $2.25 in 1997. In mid-2001, when the stock was at $29, the company was worth $4.72 billion on the stock market, more than ten times the price that it agreed to sell out for last week. Why the deflation? From April 1999 to February of 2002, sales had been pumped up through numerous ruses by half a billion dollars. Some former executives have pleaded guilty to fraud, and investigations by the Securities and Exchange Commission and Justice Department continue.
But has the so-called new Peregrine -- the one Hewlett-Packard is buying -- cleaned up its accounting? One has to wonder -- and wonder whether Hewlett-Packard read Peregrine's annual report to the government this year. Confesses the document, "We have not completed our assessment of the effectiveness of our internal control over financial reporting for the fiscal year ended March 31, 2005.... Our internal control over financial reporting is not effective.... Our inability to remedy our material weaknesses promptly and effectively could have a material adverse effect on our business, results of operations and financial condition." Advice to Hewlett: watch out for land mines.
On August 20, 2005, John Mutch, Peregrine chief executive, told the New York Times, "When I joined the company, there was no accounting system."
The Times reporter asked, "None?"
Replied Mutch, "None that was essentially integrated, operating and able to reconcile financial results of the company in a timely, accurate way. The company was organized in a very complex labyrinth of international subsidiaries. It was a Bermudian entity, organized clearly to optimize the tax issues for the company."
Now that Moores and his board cronies, who dumped half a billion dollars' worth of stock during the fraud period, have departed, Mutch's management team has been spending its time "unwinding much of these 150 international subsidiaries to simplify the flow and process of our accounting treatment," he said.
I requested an interview with Mutch. He wouldn't grant one. Thus ensued an e-mail colloquy between financial management of the company and me. Bottom line: I still don't know what Mutch meant by "Bermudian entity," other than that the company has never been based there, à la Tyco, and it has not had special purpose entities for hiding losses and debt offshore, à la Enron.
Peregrine has trimmed down to 49 subsidiaries, but 5 are in offshore tax havens Barbados, the Cayman Islands, and Switzerland. Does the company run its sales through those subsidiaries to avoid paying certain taxes? I did not get a satisfactory answer. I asked if the prior management had set up a dysfunctional accounting system for Machiavellian reasons: see no evil, hear no evil. There is no way current management can psychoanalyze past management, replied the company. Mutch mentioned the cumbersome subsidiary structure to illustrate how time-consuming it has been to unscramble the mess, say his minions.
Pat Meyer, a lawyer pursuing civil suits against the prior board and management, says the dysfunctionality had a purpose: "They used their corporate disorganization to keep the fraud going," she says. "Those in charge created pockets of lower-level personnel that were aware of improper activities at their own level but unaware that it was happening on a much grander scheme."
Agrees James M. Finberg, who is pursuing another civil suit (and is president of the San Francisco Bar), "The accounting system was not set up to detect what they were doing."
Charles La Bella is receiver for San Diego's Global Money Management, charged with fraud by the Securities and Exchange Commission. A related company is LF Global. Says La Bella on his website, "LF Global maintained no coherent or complete financial or administrative systems at any time. By any definition, this business was dysfunctionally informal." Hmmm. Sounds like Mutch talking about Peregrine. As a personal attorney for Moores, La Bella had overseen a report blaming the Peregrine fraud on management and exonerating Moores and his board cronies. Could La Bella compare the LF Global and Peregrine accounting dysfunctionality? He did not respond to my queries.
Dennis Schmucker, who is often called in to clean up San Diego accounting messes, remembers one company: "These guys had a huge computer; they had put it on a boat and taken it to sea and dumped it," he recalls. "I was able to recover records through some hard copies they had overlooked." Schmucker was among those who had to sort out U.S. Financial, a fraud that sent several to jail in the 1970s. "They set up shills that were controlled by U.S. Financial. They ran transactions through these companies at huge profits. It was like you selling something to your wife." Under proper accounting, such in-house deals would be cancelled out -- but then, this was San Diego.