SEC cites San Diego's intentional underfunding of its pension plan

On November 14 of last year, the Securities and Exchange Commission, after probing the City of San Diego's deliberate concealment of ugly financial facts in its bond filings, concluded that "The City, through its officials, acted with scienter." That means San Diego acted with the intent to deceive, manipulate, or defraud. It committed willful securities violations. It did not simply act recklessly.

The agency noted that in its bond prospectuses, the City had failed to reveal the intentional underfunding of its pension plan that would result in an unfunded liability of $2 billion by 2009. Its annual pension contribution would quadruple by 2009, and the City would need new sources of revenue. "The City, through certain of its officials, knew that its disclosures were misleading," said the federal commission.

You would think City financial officials would be chastened. One has to wonder. At this year's April 19 city council meeting, officials were boasting about how the pension system's unfunded liability had been reduced by more than $390 million because of several factors, one of which was an improvement in the stock market. Councilmember Donna Frye noticed that one reduction was for $22.8 million because of "proper treatment of IRS benefit limitations." She asked Jay Goldstone, the City's head bean counter, what that was all about. Well, a lot of San Diego retirees and potential retirees will receive benefits so fat that they exceed Internal Revenue Code Section 415 limits for the City's pension plan. These include, for example, top-level bureaucrats who retire with an annual payment that is more than 100 percent of their yearly working years' pay.

Because the IRS sets limits on the amount a retiree may receive from a 401(a) pension plan such as the City's, the obligation to pay benefits that exceed IRS Section 415 limits has to be shifted from the pension system to a separate pension fund, called the Preservation of Benefits Plan. That money will come from the City's ailing general fund. Frye asked Goldstone how much the City would have to ante up to the fund in the current year. Oh, said Goldstone, he had budgeted half a million dollars. After the April council meeting, she wrote a memo to Goldstone asking for more information on this general fund obligation. Goldstone responded in September but never told Frye that in February, two months before the April city council meeting, the pension folks had informed him that this year's obligation was estimated to be $639,000. Now, says Frye, it's at least that much and possibly more than $1 million. And she did not get that information from Goldstone. She had to track it down herself.

She had also requested the information from David Wescoe, chief executive officer of the pension system, who, similarly, had failed to disclose what the officials knew back in February. She took him to task in a letter, and he wrote back that he didn't like her tone.

The $22.8 million relates to future retirement payments to employees currently on the payroll. But there is also $8.2 million that has already been paid from the pension system in excess of Internal Revenue Code Section 415 limits. That sum has gone to 102 mainly high-ranking retired bureaucrats. The payments include $213,000 between 2005 and 2007 to former city attorney Casey Gwinn, $201,306 to former deputy city manager Bruce Herring, and $376,830 to former assistant police chief Keith Enerson. Herring was formerly on the board of the San Diego City Employees' Retirement System (SDCERS), and Enerson had once been its president. That $8.2 million will likely become a City liability also.

In a letter to Councilmember Scott Peters, Wescoe referred to the $8.2 million as "a modest sum," points out Frye. After all, pooh-poohed Wescoe, it was less than 1 percent of the total pension debt. "To me, it's an arrogant statement and reflects a cavalier attitude about the public's money," says Frye. "We sit here at council meetings trying to cobble together $50,000 to fund basic services, and then I see a memo that essentially says, 'What is $8 million?' Well, that $8 million would help pay for a fire helicopter, brush management, sidewalk and pothole repairs, or community plan updates."

Then there is the deferred retirement option plan, known as DROP. It is double-dipping at its worst. Employees at the average age of 55 say they will retire in five years. They continue drawing their salaries. At the same time, 90 percent of their highest one-year salary is plopped into their personal retirement kitty, growing at 8 percent a year and adjusted for cost of living. So they retire not only with a monthly annuity payment, but also a fat lump sum. And that pot of gold comes even though they enjoy considerably higher salaries and benefits than workers in the private sector.

On November 2, Frye wrote a memo to the City administration, noting that on July 14, 2006, the Internal Revenue Service had written to the pension system (in response to a letter from a pension system attorney) suggesting that it obtain a private letter ruling regarding these DROP benefits. The IRS sent a second letter February 13 of this year, suggesting the same thing. The pension system flatly says it won't request a private letter ruling from the IRS, and the City has not answered Frye's letter. So she wrote another memo December 7 requesting that Peters docket the matter for a city council meeting. "Has anyone ever determined if we have tax status under DROP?" asks Frye. "We need to ask the IRS if DROP complies with all the applicable provisions of the Internal Revenue Service code. SDCERS tells me it is not aware of the IRS questioning the legality of the DROP program. That is like saying the sewage out of Point Loma is safe even though we have never tested it for viruses."

City Attorney Mike Aguirre recently learned that the City's outside auditor neglected to state in the newly completed 2005 financial report that the 102 retired bureaucrats had received the $8.2 million in defiance of IRS regulations. Aguirre wrote to the auditing firm, Macias Gini & O'Connell, noting that it had said in the transmittal letter for the report that the amount of the excess payments was unknown. But the firm, which also represents SDCERS, had been aware of the information for two months, Aguirre stated.

On December 5, Goldstone said he would attach a cover letter in the financial statements that will include the information. "SDCERS had illegally paid out benefits in excess of Section 415 limits from the pension plan, but at the time, the system was managed by people who have been terminated," said Goldstone. "Nevertheless, this was wrong. SDCERS' new management recognized the errors." He said the errors had a "small impact on the City's financial statements." Small?

The upshot: on December 7 the Union-Tribune wrote a silly story, moaning that Macias Gini & O'Connell was afraid Aguirre might sue it. This could impact the timing and costs of future audits. In both the story and a sillier editorial the next day, the newspaper heaped all the blame on Aguirre for insisting that the disclosure be correct. Does anyone remember that the SEC said last year that the City committed willful securities violations? It seems the message has already been forgotten by the City administration and its toady, the Union-Tribune.

But on December 13, Goldstone relented. He said he would open up the 2005 audit and include the information Aguirre and Frye wanted.