San Diego Who dines on filet mignon when pension accounting is baloney? The Securities and Exchange Commission may look at that question, now that it is probing how phony pension accounting is used to inflate companies' profits. This month, three business professors (two at Harvard, one in Chicago) published a paper looking into the motivation behind corporate pension accounting deceit. Pensions are manipulated "when managers are most interested in inflating profits and stock prices," say the authors. That's most likely to happen when the company is making an acquisition or the chief executive officer is exercising his or her stock options. "Managers are inflating profits to enable empire-building and self-enrichment through option exercises."
Ah, those words: empire-building, self-enrichment. The City of San Diego's pension morass, if not the nation's worst, is its most publicized. So the question arises: who advanced their careers and lined their pockets as they played a role in worsening the crisis? As interviews reveal, city officials reaped political capital as well as financial capital.
For city councilmembers, "It was raw political gain," says Carl DeMaio, head of the Performance Institute, which is trying to introduce reforms into city government. "The city politicians were driven by two major things: they wanted to give candy to unions, but they didn't want to go to the taxpayers, so they concocted an elaborate and illegal scheme to not pay the mortgage."
City attorneys, financial personnel, auditors, and managers also deserve scrutiny: they were raking in the generous benefits the council handed out. "There is personal financial gain. It's the oldest motivation in the world besides sex," says DeMaio. These bureaucrats should have raised red flags, but there is a mitigating factor, he concedes. "A manager is not to say 'no' to a majority on the council. If they do, they will be on the next bus out of town."
Mike Conger, the attorney who successfully sued the city over the pension scandal, blames both politicians and bureaucrats. In November of 2002, the council voted to continue the underfunding of the pension system. The city faced making a balloon payment of $500 million over the following two years. "The mayor [Dick Murphy] was trying to avoid financial Armageddon on his watch," says Conger. The councilmembers knew the balloon payment "might mean bankruptcy or dramatic cuts in services. By 2002, every member of that council knew the magnitude of that situation, so they were furiously covering it up." Only Donna Frye voted against the measure.
Says Conger, "The city manager, city auditor, city attorney had the additional motivation of knowing the balloon payment would alarm Wall Street." Also, they knew that the underfunding had not been revealed in bond prospectuses, and the city was vulnerable to fraud charges, he says. They were protecting their own rear ends.
Then there were the labor-union representatives who were on the pension board. They were granted large pension benefits in 2002, apparently as a quid pro quo for getting the pension board to go along with the council's November 2002 vote to extend the underfunding. Those union members must share the blame, and some may be held legally accountable, Conger says.
Frye blames the many officials who contribute to city government's "culture of secrecy." One example was the critical vote in November of 2002 being placed on the so-called consent agenda -- normally, quickie votes without discussion. "It's standard procedure -- putting critical issues on the consent agenda to discourage public discussion."
Who should have prohibited that? "The city attorney [Casey Gwinn] allowed that to go on the consent agenda," says Jim Gleason, who served 12 years on the city pension board, including two terms as president. Overall, "I do blame city management; they were the proactive people causing this to happen." (Gwinn would not comment.) But employees took gleeful advantage of the goodies they were offered. "They could purchase service credits for pennies on the dollar; guys with 15 years of service all of a sudden had 20. You contributed to the system at a lower salary, but you got your pension at the higher salary of your last year."
This mentality goes back years, says Gleason. In 1996, city manager Jack McGrory began the underfunding to finance the Republican convention. Also that year, the voters approved Proposition D, a measure that would fund healthcare benefits by skimming surpluses off portfolio earnings in good investment years. On the ballot argument, voters were assured that "it would save taxpayers between $5 million and $6 million a year," says Gleason. This strategy was a disaster because there are good years and bad ones, and skimming the cream off good ones guarantees poor long-term performance. The reports by the Pension Reform Committee and by city-hired Vinson & Elkins indicated this skimming was one of the major factors that got the city into trouble.
In 1996, then-city attorney John Witt refused to let his department rule on McGrory's underfunding proposal because it was an obvious conflict of interest, says Gleason.
Witt says he can't remember the incident, but such a refusal "might have been a logical response," he says. McGrory claims that the city attorney's office was in on the consideration of the moves at the time, which he refuses to call "underfunding" and denies had anything to do with the Republican convention -- positions that veterans such as Gleason find unsupportable. "McGrory personally benefited, everybody in management benefited; it was the start of the culture of corruption," says Gleason. A number of people, such as former city auditor Ed Ryan, could have blown the whistle but didn't. They were too busy raking in the escalating benefits, says Gleason.
"It's like an addiction," says Conger. "In 1996, the city started smoking cigarettes. By 2002, it was on crack cocaine." DeMaio compares it to the proverbial frog that will leap out when dumped in a pot of hot water, but will remain if the heat goes up to the same temperature gradually. "It was a culture of people year after year taking more license. It started getting outrageous, but no one noticed there was a culture of mismanagement."
Rob Butterfield, pension attorney who was on the Pension Reform Committee, agrees that the situation got worse, "but there is not a smoking gun," he says. "People were carried along by the stock-market bubble. There was a false sense of euphoria." Also, both the city administration and the pension board had been told that, if the system were actuarially funded over 30 years, "it was acceptable. But the pension reform committee was able to analyze" that methodology and show that it put the system in the hole. "I'm not sure it's proper to assign blame to any one person or group," continues Butterfield. "I have a hard time believing people have criminal problems," although the U.S. attorney's office has a criminal investigation to go along with the Securities and Exchange Commission's civil probe.
Former councilmember Bruce Henderson says that the city used the Deferred Retirement Option Plan (DROP), by which employees' pay is doubled in their last five years, "to buy off almost every single person in a position to know what was going on. Did any of these people have a duty under the law to step forward and blow the whistle? Did they have conflicts of interest? There needs to be a thorough investigation of who got what, when, and how much." State government codes 1090 and 87,100 and city charter section 94 ban officials from influencing decisions that would advance their own financial interests, yet city employees and their labor-union leaders vote on their own benefits as members of the pension board.
And there was a more pernicious consequence: because of the culture of secrecy and corruption, "it was open season on city money. Wherever you looked, everyone who had access to the public trough was told there was room," Henderson says, citing big spending by the Data Processing Corp. and Convention & Visitors Bureau, along with till-tapping by professional sports teams, real estate developers, and the rest of the corporate-welfare crowd.