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I. SUMMARY
The City of San Diego [City] is currently facing a deficit of nearly $1.5
billion in the funding of the San Diego City Employees’ Retirement System [SDCERS]
Retirement Fund. This deficit is an obligation which threatens the fiscal health
of San Diego and the future prosperity of all San Diego residents. The deficit
arose not only as a result of gross oversight and inattention, but also,
unfortunately, by not following the requirements of relevant laws. Below, the
nature of the deficit is discussed, its causes, and what the City can do to
begin recovering from the crushing debt it has incurred.
II. OVERVIEW OF THE PENSION CRISIS
A. THE STRUCTURE OF THE PENSION SYSTEM
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There are two basic types of pension
plans:
defined benefit plans and defined
contribution plans. Defined benefit plans provide retirees an annual
allowance based on years of service and annual earnings. By contrast, defined
contribution plans do not specify an annual retirement allowance but rather
provide benefits based on employee and employer contributions plus the
investment returns earned. Typically, defined contribution plans do not impose a
loss in pension benefits for early retirement. As a result, this type of plan
will have higher turnover rates as compared to defined benefit plans. The City
of San Diego, like many other public entities, has a defined benefit pension
plan. The City is obligated to make annual contributions to SDCERS in order to
provide a pension for its employees. San Diego City Charter art. IX.
Historically, most private and public plans have been defined benefit plans.
However, in the last 25 years, there has been a pronounced shift by businesses
to defined contribution plans.1
SDCERS functions as a trust
whose beneficiaries are three classes of employees
and former employees with three different types of benefits: general members,
safety
members and elected officials. The City Council is responsible for determining
the level of benefits and required contributions for its members. The trust is
administered by the SDCERS Board, not the City Council.
The Board has a fiduciary duty to
the members to ensure that the plan remains actuarially sound
which includes overseeing the proper investment of the assets as well as
ensuring the timely payment of retirement benefits. The SDCERS Board retains an
actuary to evaluate its assets and liabilities. It is part of the Board’s
fiduciary duty to approve the methodology and assumptions made by the actuary.
Each year the actuary determines the annual amount that must be contributed to
the plan in order to cover the plan’s annual costs. This annual cost should
include both the amount necessary to pay the benefits which accrue in that year
(normal cost) as well as the amount necessary to amortize any
shortfall between the assets and liabilities (unfunded actuarial accrued
liability or “UAAL”).
Presently, a member’s retirement benefit is calculated
by multiplying three factors: the number of years of creditable service, the
highest year’s salary and the retirement multiplier. The retirement multiplier
is a set percentage that is based on age at retirement and class (general,
safety or elected). When the multiplier is increased, it has generally been
applied retroactively, as it was with the agreements between the
City and SDCERS commonly called Manager’s Proposal I [MPI] and Manager’s
Proposal II [MPII], and their associated side benefits, discussed more fully in
Part III. A, below. That is, with retroactivity, all employees are entitled to
receive an annual retirement allowance based upon this new multiplier for all of
their years of creditable service, rather than just those years after the
increase. Because the City and employee contributions over the prior years were
based upon the previously applicable smaller multipliers, this creates an
enormous additional liability.
By way of example, if an employee had worked for the City for twenty-five years,
he or she may have begun with a pension multiplier of 1.5% per year or less.
Assuming a final salary of $80,000 per year, that would imply a pension benefit
of (25 years x 1.5% per year x $80,000), which equates to $30,000 per year for
life. However, after the passage of MPI and MPII, the multiplier was changed
retroactively to 2.5%. The new benefit would be (25 years x 2.5% per year x
$80,000), which equates to $50,000 per year, a $20,000 increase which
represents a retroactive 66% raise in retirement pay.
B. PENSION FUNDING
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As with any financial plan, the health
or viability of SDCERS is determined by the relationship between its assets and
liabilities. The assets of the SDCERS system are the funds which have been
contributed by the City and the employees plus the return earned on investing
those funds. The liabilities of the system are the present
value of the estimated future annual benefits owed the
beneficiaries. It is important to note that a mathematical “smoothing process”
is used in determining the actuarial value of the assets in order to mitigate
the effects of dramatic changes in value in the short term. Therefore, when
there is a significant downturn in the market as there was in 2001-2003, once
these years “roll off” the five year smoothing period, there will be a
corresponding increase in the value of the assets. In calculating the
liabilities, assumptions must be made about a number of factors such as expected
retirement age, mortality rates, projected salary, anticipated employee
turnover, disability incidence, and pension fund increases.
The two most popular actuarial funding
methods are Projected Unit Cost [PUC] and Entry Age Normal [EAN].
SDCERS utilized the EAN method until 1991 when it switched to the PUC method.
The EAN method allocates the total value of a member’s expected benefit
liability as a level percent of payroll from the age of entry until retirement.
The PUC method calculates the actuarial liability for the covered group as a
whole, making a number of actuarial assumptions concerning population
demographics and returns on system assets. For an individual member, this method
allocates the cost as a percent of payroll that typically increases consistently
from age of entry until retirement, rather than remaining level as with the EAN
method. The EAN method would typically provide a more stable calculation for
systems such as SDCERS as cost fluctuations would not necessarily occur due to
age fluctuations in the active membership. However, as is discussed below, a
decision was made in 1991 to elect the PUC method specifically to reduce City
contribution levels in early years after this change.
C. THE PENSION DEFICIT [UAAL]
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As of June 30, 2004 (Fiscal Year 2004), SDCERS
had $4 billion in actuarial liabilities and $2.63 billion in actuarial assets
utilizing the PUC method. The difference is $1.37 billion.2
This pension deficit is the unfunded actuarial accrued liability [UAAL].
It should be noted that the deficit can continue to grow due to interest accrued
on the UAAL. As a result, it becomes even more crucial to reduce the UAAL as
soon as possible. The problem is aggravated by the fact that the City has not
been paying interest on the UAAL as part of its annual contribution.
The funded ratio is the actuarial value of assets expressed as a percentage of
the
actuarial liabilities. If SDCERS were 100% funded, the assets would equal the
liabilities. As of June 30, 2004 (fiscal year 2004), SDCERS was 65.6% funded.
The system was over 90% funded until fiscal year 2001. Significantly, in fiscal
year 2002 the funded ratio dipped to 77.3% and then 65.8% in fiscal year 2003
after implementation of MPII.3
The cumulative financial impact of MPI and MPII as of June 30, 2003 was
$467.3 million.4
This is due to the cost of the retroactive increase in benefits. This benefit
increase is reflected in the difference between the median annual allowance of
$28,184 for 5,723 retirees as of June 30, 2004 and $44,307 for the 313 new
retirees during that year.5
D. THE FACTORS GIVING RISE TO THE DEFICIT
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There are five factors which
have been the primary cause of the $1.37 billion deficit:
(1) the City Council created retroactive benefits without
increasing the annual contribution to fund them (41%);
(2) the SDCERS Board approved the use of inappropriate actuarial
assumptions and calculations (31%);
(3) the City Council’s decision to utilize plan earnings to fulfill
other financial obligations (12%);
(4) the City Council and SDCERS Board agreeing to a less than full
actuarial contribution by the City (embodied in the MPI and MPII
agreements)
(10%); and
(5) the City’s annual contribution to the plan not including
sufficient funds to pay either the principal or interest
on the UAAL.6
All five of these arise out of two primary problems with the management of the
plan: creation of benefits without providing a funding source, and
intentionally understating the problem with creative accounting.
When the City agreed to increase the annual
multiplier rate as it did in 1996 and
2002, this augmented pension benefit was applied retroactively to
all members of the affected class of employees, regardless of what they and the
City agreed upon when they were hired. This created an immediate cost to the
system which today totals almost $500 million for which no funding source
was identified.
The second most dramatic cause of the
huge pension deficit is the fact that the
actuarial assumptions and calculations approved by the SDCERS Board did not
comport with reality. The employee turnover was less than forecast and the pay
increases exceeded assumptions. In addition there were significant “purchases
of service credit” at a rate far less than the costs indicated
by the actuary.7
A purchase of service credit allows an employee to “buy years” thus
allowing a 15-year employee, for example, to be treated identically to a 20-year
employee for pension purposes, with a corresponding increase in benefits. The
use of unrealistic actuarial numbers was not mere inadvertent miscalculation.
Rather, it was a deliberate effort by the Board and the City
to mask the drain on the plan for the benefit of the City budget.
“[T]he City took advantage of certain vagaries of ‘actuarial science’ and
pension accounting to further minimize its contributions to
SDCERS.” 8
"The history of the relationship between the City of San Diego and SDCERS
plays out as a series of initiatives by the City to reduce (at least in the
short term) its contributions to the System, typically in response either to
economic conditions that caused budgetary strain or to concessions made to the
City’s labor organizations. Many of these initiatives have been supported
by the labor representatives on the Board. The result in each case was
the postponement of difficult budgetary decisions into the future, often
exacerbating the problems through the delay in confronting them."9
In order to produce reasonable results,
accounting and actuarial methods and assumptions must also be reasonably
applied. These can be manipulated to produce misleading results such as “creative
accounting.”
"Creative accounting involves the selective choice and/or corruption of
accounting principles to present a misleading impression. Corruption is
accomplished by applying accepted principles in inappropriate circumstances or
in an unacceptable or misleading manner. Creative accounting sometimes goes even
further and actually involves the structuring and implementing of transactions
primarily for the sake of presenting an attractive financial picture with little
or no regard for economic reality."10
Unfortunately, the SDCERS system has been the subject of open and obviously
manipulative pension accounting.
The history of the “creative accounting” began in 1980 when the
City began to
treat surplus earnings as available to use to reduce its contribution rather
than to support the soundness of the system as intended. The City adopted a
provision that allocated 50% of SDCERS annual return on its assets which
exceeded the actuary’s assumed rate of return (defined as “surplus”) to be used
to fund a 13th check to retirees.11
This decision to skim off the peaks in earnings not only left the plan without
those earnings, but also the corresponding earned rate of return on the funds.
By siphoning away these funds, there were no funds available to counterbalance
the downturns in the market.
A critical component of achieving stability in a pension system is the
assumed
rate of return on assets. The greater the investment return, the less
the participants must contribute to fund projected benefits. The projected rates
of return, like all actuarial assumptions, are not an exact science. Inherent in
the analysis is the assumption that over time the fluctuation or variation from
the assumptions will average out. The creation of “surplus” earnings flies in
the face of this bedrock concept. The reality is that any diversion of
earnings
from the system--no matter what label is attached to it--creates a liability
which will eventually require funding.
SDCERS Retirement System Administrator Lawrence Grissom obviously recognized
this and advised the Board in April 2002 “[I] believe there has come a
perception over the years that earnings are cash in pocket, which
is not the case.”12
This was echoed by SDCERS attorney who opined:
"Defining [s]urplus on a cash basis leads to draining off liquid assets and
reducing future earning power. It also undercuts actuarial assumptions about
earnings. An assumption of earnings is based on expected averages over a long
period of time. By draining off cash in good years, the structure
makes it harder to meet the long term earnings assumption."13
Use of this “surplus” (in spite of best accounting practices) became a recurring
theme as other uses were found for these funds through the years. In 1982 when
the City withdrew from the Social Security System, it was required to provide
medical benefits. Once again, rather than have this expense be borne by the City
budget, the surplus earnings were tapped.14
This practice continued until this fiscal year. As a result the SDCERS
Retirement Fund has been liable for these health care costs. From 1998 to 2000,
further uses were found for the surplus earnings, including funding cost of
living increase for retirees and to pick up a portion of the employees
contributions. These funds were also designated to fund settlement of a lawsuit
brought by some SDCERS members who asserted that the Board failed to include all
appropriate compensation in determining annual benefits (commonly referred to as
the “Corbett” settlement). All of these contingent commitments of
surplus earnings are arranged in a hierarchy referred to as the
“waterfall.”15
During 1996 labor negotiations, the
City and the Board entered into an agreement
with a two-fold disastrous impact. The City granted additional benefits
resulting in
significant increase in liabilities and SDCERS Board allowed the City to
contribute less than the full amount of its annual obligation to the system (MPI).
When MPI was entered into in 1996, the plan was more than 90% funded with many
years of record earnings exceeding expectations.16
However, the downturn in the market that began in 2000 resulted in an
expectation that the fund ratio floor of 82.3% (a floor put in place by MPI)
would be triggered, thus requiring the City to make up the shortfall. In order
to avoid this obligation and have the Board agree not to enforce MPI, the
City made matters worse by granting more benefits, adding yet further to the
plan liabilities (MPII).17
The fund ratio then dipped to 77.3% in Fiscal Year 2002.18
The amortization period for the
UAAL was used as another area for “creative
accounting.” In June, 1991 the 30 year amortization period was restarted
from that fiscal year end.19
This, of course, reduced the City’s contribution. Then in 2004, as part of the
Gleason lawsuit settlement, there was an agreement to restart the
amortization period yet again.20
Hence, the City has attempted to avoid its financial obligations to SDCERS and
its members through “creative accounting” involving readjustment of the
amortization period, creation of an artificial “surplus,” and cherry-picking
calculation methodologies.
In addition, the City began acting like a “credit card junkie” who charges to
the
card limit and only makes the minimum payments, because the City’s annual
contributions to the Retirement Fund have not included either the principal or
interest on the deficit. The Pension Reform Committee estimated that for the
then $1.167 billion UAAL, the additional amount which should have been paid was:
$93.3 million in interest on the UAAL, and $33.3 in contingent benefits
previously paid from the “surplus” earnings for a total, along with other
accrued costs, of $202.67 million. This figure does not include any funds to
reduce the UAAL, only to contain it.21
The City’s response: it paid only $85 million of the $202.67
million owed.22
The UAAL continued to grow exponentially as the City failed to pay even the
purposefully understated amount due and continued to grant additional benefits.
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.
III. THE FUNDING CRISIS WAS AGGRAVATED BY
NOT OBEYING THE REQUIREMENTS OF CALIFORNIA LAW
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As discussed above, in 1996 and later in 2002 the City and the Retirement Board
took several questionable actions in dealing with the duty to provide sufficient
contributions to the Retirement Fund. None of these actions dealt forthrightly
with the looming pension crisis, and in fact made the crisis substantially
worse. Each time, the City made a deal with the Board--in return for
underfunding (providing a contribution rate less than that of a neutral
actuary), City workers and Board members would receive enhanced benefits. These
actions were not only reckless, but also violated a number provisions of state
and local law.
Among the actions that violated provisions of
the law are the following: The
Retirement Board’s decisions to enter into MPI and MPII; the City Council’s
decisions to enter into MPI and MPII; the City Council’s actions in approving
resolutions and ordinances to carry out the agreements in MPI and MPII,
specifically resolutions R-297212 and R-297335, and ordinances O-19121 and
O-19126; the City Council’s approval of an amended SDMC section 24.0801, to
evade the duty under City Charter section 143 to provide actuarially-determined
contribution rates to the Retirement Fund; and the use of a “waterfall”
provision (SDMC § 24.1502) to divert funds for purposes unrelated to retirement.
These actions violated the California Constitution, state law, the
City Charter, and the Municipal code. Below, the specific manner in which each
of these actions violated California law is discussed.
A. FACTUAL BACKGROUND AND DEFINITIONS
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1. San Diego City Employees Retirement System [SDCERS]
SDCERS is a multi-employer, defined benefit plan established in 1927 by the
City to provide retirement benefits to its members. SDCERS operates as a trust
under California law. Cal. Const. art. XVI, § 17; City Charter art. IX, § 145.
The City is the plan sponsor. There is no "trust" document beyond the Municipal
Code sections that discuss the SDCERS fund. See Municipal Code, §§ 24.0100 et
seq.
SDCERS is governed by three main sources of
law: the California Constitution,
art. XVI, § 17; the San Diego City Charter, art. IX, §§ 141 through
148.1, and art. X, §1; and the Municipal Code, §§ 24.0100 et seq. Board
members have a constitutional duty to act in furtherance of three main goals:
providing benefits to plan members; keeping employer contributions low; and
minimizing the cost of system operations. The SDCERS Board's duty to its
participants “shall take precedence over any other duty." Cal. Const. art. XVI,
§ 17.
2. Manager’s Proposal I [MPI]
In the spring of 1996, the City conducted negotiations with its labor
unions for the
terms of the City’s labor contracts. Through the "meet and confer"
process, the City granted several new retirement benefits to the unions. Among
these benefits were, most notably:
(1) significant increases in the formula for calculating the basic
pension benefit, including an increase in the year multiplier from 1.45% to
2.00% for general city employees;
(2) the agreement of the City to implement the so-called Deferred
Retirement Option Plan [DROP], by which employees could “double-dip”
by banking retirement payments before they were actually retired, and receive
a guaranteed interest rate on those payments for life; and
(3) an expansion of the “purchase of service credit” under
which employees could buy “air time” and be treated, for retirement purposes, as
having worked more years than he or she actually had worked.
The granting of these new benefits was conditioned on the agreement of the
SDCERS Board to an "Employer Contribution Rate Stabilization Plan"
(commonly referred to as Manager’s Proposal I, or “MPI”), an agreement
required by the City Manager. This was in spite of the fact that the Board’s
fiduciary duties logically had nothing to do with the meet and confer process
between the labor unions and the City.
By MPI’s terms, rather than contribute to the Retirement Fund the legally
required
amount calculated by an actuary, the City made contributions to SDCERS based
on an artificial, negotiated rate. Using the non-actuarial rate,
the City's annual
contribution for fiscal year 1996 would remain at the prior year’s rate of 7.08.
In the next year, 1997, the rate would be 7.33 percent. In following years, the
City's annual contribution would increase by .5 percent each year until the City
reached an Entry Age Normal [EAN] contribution rate, which would be closer to an
actuarially-established rate. This transition period was to take ten years,
ending in 2008. At that point, the City would agree to use an actuarially-based
rate in all future years.
In addition, MPI added a “trigger” provision, set at 82.3
percent. If the funded ratio of the Retirement Fund dropped below 82.3
percent, the City contribution rate would be increased to an "amount
determined by the actuary necessary to restore a funded ratio no more than the
level that is 10 percent below the funded ratio calculated at the June 30, 1996
actuarial valuation." Notably, there was disagreement as to what this
provision meant. Using one interpretation, if the trigger were hit, the City
would restore the funded ratio to the 82.3 percent level by making a lump-sum
payment. Using another interpretation, the City would pay at a full
Projected Unit Credit [PUC] rate in the following fiscal year. Regardless of the
interpretation, MPI was designed to avoid having to pay an
actuarially-determined rate and to push debt onto future fiscal years.
3. Manager’s Proposal II [MPII]
The public financial markets began declining significantly in the spring
of 2000. This decline took a severe toll on the asset base and financial status
of SDCERS as well as other public pension funds. This decline, combined with the
extraordinary benefits granted under MPI and the related agreements described
above sent the SDCERS funded ratio into a freefall. By fall 2001, the
82.5% trigger had almost been reached. As the spring of 2002 approached, the
City was involved in labor negotiations with four of the City's municipal labor
unions. As before, the City viewed the labor negotiations, although not
logically tied to the duties of the SDCERS Board, as a way to extract
financial concessions from the Board.
In the meet and confer process with the labor unions, in order to yet again
avoid
paying an actuarially-determined contribution rate to the Retirement Fund,
the City
agreed to increase retirement benefits to an even greater degree than MPI had
done. However, those increased benefits were explicitly contingent upon
the SDCERS Board agreeing to a low contribution rate from the City. The proposed
agreement between the City and SDCERS Board was reduced to writing in a document
entitled “Agreement Regarding Employer Contributions Between the City of San
Diego and the San Diego City Employees’ Retirement System” commonly referred
to as Manager’s Proposal II [MPII].
Negotiations began with the City asking the Board to reduce the trigger 82.3
percent to 75 percent. In addition, the City wanted five years to increase
payments to a full actuarial rate. The SDCERS actuary and outside fiduciary
counsel both recommended against this first version of MPII. After further
negotiation, the MPII agreement approved by the Board retained the existing 82.3
percent trigger. However, the City could keep paying so-called “contract
rates,” rather than the legally-required rates calculated by an actuary.
The City agreed to increase its contribution rates 1.0% per year until 2008.
MPII would then terminate in 2009.
The SDCERS’ actuary observed that the Retirement Fund would be in better
financial shape if the contributions were based on actuarial considerations. The
actuary specifically noted that it would be preferable not to deviate from MPI:
"From a pure actuarial viewpoint, it would be best to hold the City to the
existing Managers Proposal [MPI] and the 82.3% trigger….[f]rom a pure actuarial
viewpoint, we would prefer it if the Board did not provide a transition period
to the City to reach the [full actuarial rate]."23
SDCERS’ outside counsel also agreed with the assessment of the actuary,
and
warned at one point that a court could find that the Board was not exercising
its fiduciary responsibilities, and could find individual Board members
liable for their actions.24
Despite these direct warnings, the SDCERS
Board and the City entered into MPII pursuant to a written and signed
agreement approved by the City Council on November 18, 2002. In
furtherance of that agreement, the City passed several resolutions and
ordinances, specifically resolutions R-297212 and R-297335, and ordinances
O-19121 and O-19126. The City also amended Municipal Code section 24.0801 so
that the City would not be required to make contributions to the Retirement Fund
as determined by an actuary (a requirement of §143 of the City Charter).
These resolutions and ordinances passed by the City Council were the “payback”
in return for the Board’s agreement to permit underfunding of the pension under
MPII. The most egregious benefits granted by the Council under this new
“quid pro quo” were:
(1) another increase in the
“retirement factor” from 2.0% to 2.5% for general members, and as before,
retroactive through all years of service;
(2) an exception from the 90% “retirement
allowance cap” for employees who joined the City before their 24th
birthday, which would directly benefit one Board member financially;
(3) a so-called “Presidential
Benefit” whereby presidents of the City’s four recognized labor
unions could have their salaries earned while serving as union presidents
counted as though they were City salaries for the purposes of retirement; and
(4) a City Council resolution (R-297335) specifically
indemnifying the Board members for
taking these actions.
Again, as before with MPI, the City induced the Board to abandon its logical and
fiduciary duties, and made the delivery of these new benefits contingent upon
the Board’s adoption of an inadequate contribution rate.25
The payment avoidance scheme of 1996 was therefore repeated in 2002, with
today’s nearly $1.5 billion funding deficit being the predictable and disastrous
result.
B. SPECIFIC VIOLATIONS OF LAW
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1. Violations of the California Government Code
California Government Code section 1090 [section
1090] precludes a public officer or city employee from participating in the
making of a contract in which he or she has a “financial interest.”
It provides in pertinent part: “Members of the Legislature, state, county,
district, judicial district, and city officers or employees shall not be
financially interested in any contract made by them in their official capacity,
or by any body or board of which they are members.” Cal. Gov’t Code §1090.
Although the term “financial interest” is not specifically defined in the
statute, an examination of the case law and the statutory exceptions to the
basic prohibition indicates that the term is to be liberally construed.
Thomson v. Call, 38 Cal. 3d. 633, 645 (1985).
A public officer cannot escape liability for a section 1090 violation merely by
abstaining from voting or participating in discussions or negotiations. Mere
membership alone on the board or council establishes the presumption that
the officer participated in the forbidden transaction or influenced other
members. Id. As the Supreme Court has explained:
"The statute is . . . directed not only at dishonor, but also at conduct that
tempts dishonor. This broad proscription embodies a recognition of the fact that
an impairment of impartial judgment can occur in even the most well-meaning men
when their personal economic interests are affected by the business they
transact on behalf of the Government. To this extent, therefore, the statute is
more concerned with what might have happened in a given situation than with what
actually happened. It attempts to prevent honest government agents from
succumbing to temptation by making it illegal for them to enter into
relationships which are fraught with temptation."
Stigall v. City of Taft, 58 Cal. 2d 565, 570 (1962) quoting United States v.
Mississippi Valley Generating Co., 364 U.S. 520, 549-50 (1961).
The purpose of the law goes beyond addressing actual fraud or dishonest
conduct
associated with contracting, and is intended to “remove or limit the
possibility of any personal influence, either directly or indirectly, which
might bear on an official’s decision.” Finnegan v. Schrader, 91 Cal. App.
4th 572, 579-80 (2001) quoting Stigall, 58 Cal. 2d at 569. It is aimed at
eliminating temptation, avoiding the appearance of impropriety, and assuring the
government of undivided and uncompromised allegiance from its officials. People
v. Honig, 48 Cal. App. 4th 289, 314 (1996). Hence, it has received a broad
judicial interpretation consistent with the Legislature’s broad intent. Id. at
314. The forbidden interests covered by the rule extend to expectations of
benefit by express or implied agreement and may be inferred from the
circumstances. Id. at 315.
In the case of the SDCERS Board, no less than six trustees had a prohibited
financial interest in MPII and the related side agreements, namely Ron
Saathoff, Mary Vattimo, Cathy Lexin, Terri Webster, John Torres and Sharon
Wilkinson, who were all City employees. Section 1090 would therefore
prohibit their participation in the multiparty deal to enhance benefits and
underfund the pension. Even if they had recused themselves, which they did not,
the law would deem them to have participated: “the element of participation
is present by the mere fact of . . . membership irrespective of whether the
employee or officer personally abstains from engaging in any of the embodiments
resulting in the making of the contract.” Fraser-Yamor Agency, Inc. v.
County of Del Norte, 68 Cal. App. 3d 201, 211
(1977). Any contract entered into in violation of section 1090 is void as a
matter of law (Thomson v. Call, 38 Cal. 3d 633, 646 (1985)), and therefore
both the Board’s and the City’s actions in furtherance of the illegal scheme
were void ab initio and of no effect.
No defense can be successfully raised that the pension
benefits are analogous to “salaries” and therefore exempt. If they were
considered salaries, they would not
necessarily be considered a financial interest causing a conflict of interest
under the
Political Reform Act (PRA). However, the Honig court rejected the argument that
suggests that the legislature intended the definition of a “financial
interest” in the PRA to control Section 1090. Honig, 48 Cal. App. 4th at
328. The court explained that under well-settled rules of statutory
construction, the more general provisions of the PRA do not control the more
specific terms of section 1090. Id. at 329. Therefore, the “salary”
defense will almost certainly not apply here. Furthermore, even if these pension
benefits were hypothetically considered to be salaries, and therefore a “remote
interest” under Government Code section 1091(b)(13), MPII and the related
side agreements would still be void because not one of the six
financially-involved individuals disclosed his or her interest or followed
the other steps required by section 1091(a):
"An officer shall not be deemed to be interested in a contract entered into
by a . . . board of which the officer is a member . . . if the officer has only
a remote interest in the contract and if the fact of that interest is
disclosed to the body or board . . . and noted in its official records,
and thereafter the body or board authorizes, approves, or ratifies the contract
in good faith by a vote of its membership sufficient for the purpose without
counting the vote or votes of the officer or member with the
remote interest."26
No member of the Board followed the duties outlined above, and thus the “salary
exception” cannot prevail when considering the Board’s actions.
Under section 1090 analysis, the intentional
underfunding (through MPI and
MPII) and the related side deals were a single transaction, with each
contingent upon the other. This principle of considering all related
transactions and acts together as part of one whole is embodied in the case of
Thomson v. Call, 38 Cal. 3d 633 (1985). In that case, Call, a councilman
of the City of Albany, sold his real property to the city, using a developer,
IGC, as a conduit. The city entered into a contract with IGC in which IGC agreed
to obtain land and convey it to the city for use as a park, or failing to
acquire the land, to convey up to $600,000 to the city to acquire the land
through eminent domain proceedings. Then, instead of Call selling land directly
to the city, IGC purchased Call’s land for $258,000 and conveyed it to the city
through a second transaction.
The California Supreme Court analyzed the situation and held that IGC’s
purchase of property from the Calls, and its conveyance of that property to the
city, were a single multi-party agreement. Id. at 644. Call contended
that the purchase of his property was not a term or condition of the contract
between IGC and the city, but rather, was a separate contract between IGC and
the city. In rejecting that argument, the Supreme Court reasoned that “the
prospect that performance of the contract would involve acquisition of the
Calls’ land and conveyance of that land to the city was contemplated by all
parties. . . . Purchase of the Calls’ parcel was clearly part of a previous
arrangement; the fact that the real estate purchase contract between the Calls
and IGC was entered into after the city’s acceptance of [IGC’s] $600,000 plan in
no way alters the fact that the transactions between the Calls, IGC, and the
city were part of a single agreement.” Id. at 644-45. “As part of the
transaction at issue, Call sold property to the city, using IGC as a conduit.
Whether we regard his interest as direct or indirect, it is clearly a pecuniary
interest forbidden by section 1090 and by the decisions applying
conflict-of-interest rules generally.” Id. at 646.
In this instance, there is clearly one
multi-party agreement even though MPI and
MPII were agreements between the City and SDCERS, and the “quid pro quo”
benefit enhancements arose from negotiations between the City and its labor
unions. As in the Call case, all parties knew that the benefit
enhancements were contingent upon a lower contribution rate from the City
to the Retirement Fund. In fact, one of the individuals most involved in the
negotiation of the benefit enhancements between City and the labor unions (Cathy
Lexin), was also a SDCERS Board member who voted in favor of MPII. Ron Saathoff,
similarly, was intimately involved in the negotiation of the benefit
enhancements on behalf of Local 145 and on behalf of himself for the notorious “Presidential
Benefit,” while simultaneously a member of the SDCERS Board that voted on
MPII. Simply put, it was impossible for the SDCERS Board members to
exercise “absolute loyalty and undivided allegiance to the best interests of
the city.” Stigall, 58 Cal. 2d at 569. All of the contribution rate
reductions and benefit enhancements were carried out in a manner contrary to
law, and are therefore void.
2. Political Reform Act of 1974
Violated
The Political Reform Act of 1974 [PRA] prohibits a public official from
participating in the negotiation, discussion or vote on any contract in which
the public official has a financial interest. The PRA is codified as Cal. Gov’t
Code §§ 81000 et seq. The purpose of the PRA is to prevent a government official
from participating in a decision where the official has a financial interest
which might be materially affected by his or her action on the matter. County of
Nevada v. MacMillen, 11 Cal. 3d 662, 668 (1974).
The PRA provides as follows:
"No public official at any level of state or local government shall make,
participate in making or in any way attempt to use his official position to
influence a governmental decision in which he knows or has reason to know he has
a financial interest."27
The law gives additional guidance on what
constitutes a disqualifying interest and
what happens if an official action is taken despite that interest. Under
Government Code section 87103, “[a]n official has a financial interest in a
decision…if it is reasonably foreseeable that the decision will have a material
financial effect, distinguishable from its effect on the public generally, on
the official [or] a member of his or her immediate family . . . .” If the
PRA is then violated, “[a] court may set the official action aside as
void.” Cal. Gov’t Code § 91003. Contracts such as MPI and MPII are the type
of “official action” that may be set aside as void under the PRA.
Affordable Housing Alliance v. Feinstein, 179 Cal. App. 3d 484 (1986.
The PRA applies here because certain board members
participated in decisions in
which a board member had a financial interest within the meaning of the statute.
Here, for both MPI and MPII, there are two agreements at issue — (i) the
agreement by the City to provide enhanced benefits as a result of the City's
meet and confer process with its labor unions, and (ii) the agreements to
underfund the system in MPI and MPII.
Here, the City's labor negotiators and not the
SDCERS Board negotiated and
entered into the labor agreements that resulted in enhanced benefits. The SDCERS
Board should not have negotiated or approved the enhanced benefits, nor could it
properly do so under its grant of power. The labor negotiations and collective
bargaining agreements were a City responsibility. Therefore, no Board member (in
their role as a member of the Board) should have participated in or entered into
an express or implied contract with the labor unions or the City for any
improvement in benefits.
For the reasons highlighted above, the benefit enhancements negotiated in the
spring of 1996 and the spring of 2002 were contingent upon the Board's approval
of MPI and MPII. As such, they must be treated as a single, multiparty
transaction under the PRA.
In undertaking a PRA analysis, the first question to be addressed is if
increased
pension benefits do indeed constitute a “financial interest.” Based on
the “public salary exception” an argument can be made that increased
pension benefits are normally not a “financial interest” under the PRA.
In 1977, the Fair Political Practice Commission [FPPC] found that under the PRA
a board member's participation in a decision that could affect that member’s
pension benefits was not a disqualifying financial interest. In addition, in
2002 the FPPC reasoned that pension benefits from a governmental agency are not
a “financial interest” within the meaning of the PRA.
Following the above reasoning, if a voting body or council makes ordinary
salary or pension adjustments, they might not be in violation of the PRA.
However, it should be kept in mind that although the SDCERS' Board members duty
was to discuss and vote on MPI and MPII, the Board's approval of MPI and MPII
was the deciding factor in whether the City would provide enhanced benefits. Due
to the nature of this scheme, the salary exception may not apply here. In that
case, the PRA analysis proceeds to examine whether the benefits were “distinguishable
from [their] effect on the public generally." Cal. Gov’t Code § 87103.
Government Code Section 87103 provides in relevant part that, “A public
official has a financial interest in a decision … if it is reasonably
foreseeable that the decision will have a material financial effect,
distinguishable from its effect on the public generally.” Under the PRA, the
language "the public generally" may be interpreted to mean members of a
particular trade, industry, or profession, if the agency is required or
expressly authorized by law to draw its members from the particular trade,
industry or profession. Consumer Union of U.S., Inc. v. California Milk
Producer, 82 Cal.App. 3d 433, 436-438 (1978); Cal. Gov’t Code § 87103.
When the non-actuarial reductions to the City’s contribution rate were being
considered, the SDCERS Board was required to have a number of city employees as
members. Therefore, it can be argued that a material financial interest would
not exist under the PRA because the financial interest felt by the general
members of the Board would be equally felt by a large number of other City
employees.
However, other pension and benefit
actions taken in this situation were anything
but ordinary, and did not affect a large group. As to the “Presidential
Benefit” that
allowed the four labor union presidents to include their union salaries as part
of their highest annual compensation for calculating the retirement allowance,
only four people were affected, one of which is Board member Ron
Saathoff. In addition, Board member Terri Webster (the Assistant City
Auditor) received a personal benefit similarly available only to a small
group of people, namely, not being held to the 90% retirement cap
because she began working for the City before the age of twentyfour.
Finally, beyond these two members, all the Board members were granted special
indemnity by the City Council in resolution R-297335, a benefit designed
for that group only. Although the PRA has a “public salary exception,”
that exception was not designed to cover to the egregious and flagrant
self-dealing seen here and would not likely apply. Taken as a whole, the PRA
was not followed, and the actions taken in contravention of that law are void or
voidable.
3. Violations of the
California Constitution
In agreeing to forgo the proper payments to the Retirement Fund, the SDCERS
Board and the City violated not only California’s conflict of interest laws, but
also the bedrock principles of the California Constitution. Below, three
violations of the
Constitution are discussed:
(1) the abandonment of the Board’s fiduciary duties (Cal. Const.
art. XVI, §17);
(2) the prohibition against incurring indebtedness without a vote of
the people (Cal. Const. art. XVI, §18); and
(3) the constitutional right of public employees to a fiscally-sound
retirement system.
The violation of any one of these Constitutional rules, much less all
three, would render the payment-evasion scheme of the Council and SDCERS
Board null and void. The violations were patent and intentional,
and therefore the underfunding scheme and its associated side benefits should
have no further force or effect.
The first important principle that was
violated is the fiduciary duty of the Board to
retirees and future retirees, embodied in article XVI, section 17 of the
California
Constitution. It reads, in pertinent part:
"Notwithstanding any other provisions of law or this Constitution to the
contrary, the retirement board of a public pension or retirement system shall
have plenary authority and fiduciary responsibility for investment of moneys and
administration of the system, subject to . . . the following: . . . (c) The
members of the retirement board . . . shall discharge their duties with respect
to the system solely in the interest of, and for the exclusive purposes
of providing benefits to, participants and their beneficiaries. . . . A
retirement board’s duty to its participants and their beneficiaries shall
take precedence over any other duty."
top^
Cal. Const. art. XVI, §17 (emphasis added). As discussed in the case of Westly
v. CALPERS Board of Administration, 105 Cal. App. 4th 1095 (2003), Article XVI,
section 17 was enacted primarily to give pension boards independence so their
funds would not be “raided” by legislative bodies. Id. at 1111. However,
the authority of the board is to be used for “the protection of the . . .
assets, benefits, and services for which the [b]oard has a fiduciary
responsibility.” Id. at 1110 (emphasis added).
However, when the board goes beyond its legal mandate, it has no authority.
Westly, 105 Cal. App. 4th at 1099-1100; see also In re Retirement Cases, 110
Cal. App. 4th 426, 471 (2003). Considering the actions of the SDCERS Board, the
inevitable conclusion is that the Board improperly considered the ongoing
labor union “meet and confer” negotiations when considering the
contribution rates under MPI and MPII. And the City improperly influenced the
Board by “sweetening the deal,” including granting special
benefits for specific Board members (Saathoff and Webster), and specifically
indemnifying the whole Board for their actions. The Board’s desire for
such indemnity is understandable, considering that their actions directly
violated their constitutional duties.
Another key California constitutional
principle is the idea that no debt can be imposed on the citizens of a
city without a vote. This provision was violated as well. Article
XVI, section 18 of the California Constitution states in relevant part, “No .
. . city . . . shall incur any indebtedness or liability in any manner or for
any purpose exceeding in any year the income and revenue provided for such year,
without the assent of two-thirds of the voters of the public entity voting at an
election to be held for that purpose.”
The adoption of MPI and MPII in 1996 and 2002 by the City Council which
allowed for the under-funded status of the City’s Retirement system created a
long-term indebtedness for the City that exceeded the income and revenue
necessary to sustain the indebtedness on a yearly basis. By agreeing to
under-fund the plan on a yearly basis and using the surplus and earnings to
provide for increased benefits, the City was incurring a real debt that it did
not have sufficient funds to support. According to the Constitution, the only
way the City could have legally created such a financial liability was through a
citywide election. This did not occur. Therefore, the ordinances that
allowed for such under-funding and possibly the increased benefits that such
under-funding made possible were in violation of the Constitution and are
void as a matter of law.
Finally, in addition to the protections
of article XVI, sections 17 and 18 of the
California Constitution as discussed above, public employees have a
constitutionally protected contract right to a financially sound retirement
system. Board of Administration v. Wilson, 52 Cal. App. 4th 1109, 1131, 1135
(1997); Valdes v. Cory, 139 Cal. App. 3d 773, 783-84 (1983); Betts v. Board of
Administration, 21 Cal. 3d 859, 863 (1978). This right was violated when the “quid
pro quo” of MPI and MPII were carried out which deliberately underfunded the
SDCERS pension plan.
In Wilson, the California legislature attempted to modify the funding of the
California Public Employees' Retirement Fund [PERS]. In an effort to
balance the state's budget by shortchanging the PERS fund, between 1991 and 1993
the California legislature changed the payment schedule for funding PERS to an "in
arrears" financing system and in doing so moved away from a "level
contribution" system that paid for pension liabilities as they accrued.
Wilson, 52 Cal.App.4th at 1117-1122. The court in Wilson held that such a
financing scheme, which delayed funding of the retirement system to balance the
state's budget, was in effect an impairment of the employees' vested contract
rights. Id. at 1144.
top^
The court in Wilson also determined that the California Constitution protects
the
public employees’ right to an actuarially sound retirement system.
Wilson, 52 Cal.App.4th at 1135. Whether or not a pension fund is “actuarially
sound” is a question of fact. Id. at 1139. Here, MPI and MPII depart
from the principles of level cost financing because current liabilities are
shifted to later years. Under their non-actuarial contribution methods, SDCERS
funding ratio had plummeted to 65.8% percent by June 30, 2004. Only two years
earlier, on June 30, 2002, the system had a funded ratio of 77.3%. This
precipitous drop represented a severe threat to the fiscal health of the
Retirement Fund. As this decline in the funded ratio was a result of
deliberate underfunding as part of a scheme between the City and the Board,
it therefore violates the constitutional rights of the employees of the City of
San Diego.
A final Wilson violation can be found in
the use of so-called “surplus earnings” to
pay benefits outside of the SDCERS retirement plan violates the principles of
actuarial science. This technique is codified in the “waterfall”
provision of section 24.1502 of the SDMC. Through the waterfall, funds earmarked
for retirement are diverted into uses unrelated to retirement such as health
care benefits. As discussed above, public retirement system beneficiaries are
entitled to an actuarially-sound system. Thus, the waterfall provision, SDMC
section 24.1502, violates the constitutional requirements of Wilson and is
also void.
4. San Diego City Charter Violated
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The San Diego City Charter provides the City with clear guidelines as to the
creation and funding of future City debt and the manner in which the City is
obligated to contribute to the retirement system. It has been firmly established
by California case law that a City Charter represents the “supreme law of the
City, subject only to conflicting provisions in the federal and state
Constitutions and preemptive state law.” Domar Electric, Inc. v. City of Los
Angeles, 9 Cal. 4th 161, 170 (1994). The charter operates as an “instrument
of limitation and restriction on the exercise of power over all municipal
affairs which the city is assumed to possess.” Id. The California Supreme
Court held in the Domar case that a charter city may not act in conflict with
its charter and that
any
act that is not in compliance with the city charter is void. Id. at 171
(emphasis added).
Below, three violations of the Charter are discussed:
(1) the creation of long-term indebtedness for the City that
exceeded the income and revenue necessary to sustain the debt on a yearly
basis (Charter Section 99);
(2) the City’s intentional deviation from actuarially computed
retirement system contribution rates in favor of “negotiated” rates-- an
action that the City attempted to legitimize by formally manipulating the
Municipal Code and which violated Charter Section 143; and
(3) the creation of benefits without a corresponding funding source
(Charter Section 39). Similar to the violations of the California Constitution
outlined above, these Charter violations render the underfunding scheme and its
associated side benefits void and without further force or effect.
San Diego City Charter section 99
mirrors the language of California Constitution
article XVI, section 18, discussed above, regarding public finance. City Charter
Section 99 provides:
"The City shall not incur any indebtedness or liability in any manner
or for any purpose exceeding in any year the income and revenue provided
for such year unless the qualified electors of the City, voting at an election
to be held for that purpose, have indicated their assent as then required by the
Constitution of the State of California, nor unless before or at the time of
incurring such indebtedness provision shall be made for the collection of an
annual tax sufficient to pay the interest on such indebtedness as it falls due,
and also provision to constitute a sinking fund for the payment of the principal
thereof, on or before maturity, which shall not exceed forty years from the time
of contracting the same…"
City Charter Section 99 further states:
"No contract, agreement or obligation extending for a period of more than
five years may be authorized except by ordinance adopted by a two-thirds’
majority vote of the members elected to Council after holding a public hearing
which has been duly noticed in the official City newspaper at least ten days in
advance."
As stated above, the adoption of MPI and MPII in 1996 and 2002 by the City
Council which allowed for the under-funded status of the City’s Retirement
system created a long-term indebtedness for the City that exceeded the income
and revenue necessary to sustain that debt. Without the requisite vote, by
incurring a real debt that the City did not have sufficient funds to support the
City violated Charter Section 99. As such, the ordinances that allowed for such
underfunding and the related side benefits were in violation of the City
Charter. By doing that which the Charter expressly prohibits, the City took
action which exceeded its power such that the action is void as a
matter of law.
Beyond the vote requirement of
Charter section 99, San Diego Charter section
143 imposes a duty to use actuarially-based contribution rates.
Charter section 143 states, in relevant part:
"The mortality, service, experience or other table calculated by the
actuary and the valuation determined by him and approved by the board shall
be conclusive and final, and any retirement system established under this
article shall be based thereon…" (emphasis added.)
This Charter section mandates that the City’s contributions to the system must
be
based on rates computed by the system’s actuary and not based on
rates otherwise negotiated between the City and the Board. The clear text
of the Charter evidences the fundamental need to maintain an actuarially sound
system. Notwithstanding this, the City, by way of MPI and MPII, created an
unlawful funding strategy based on negotiation with the Board, and not based
on actuarial science. Furthermore, prior to November
18, 2002, SDMC section 24.0801, which was consistent with Charter section 143,
prohibited the City from deviating from the Board’s actuaries computed
contribution rate.
As such, on November 18, 2002, the City simply went beyond its power by
amending SDMC section 24.0801 so that it permitted their funding scheme
but conflicted with the Charter. The amended section stated that the City’s
contribution would be “amounts agreed to in the governing Memorandum of
Understanding between the City and the Board.” While this change may have
allowed the City to adopt funding mechanisms not based on actuarial science,
those funding mechanisms continued to violate the Charter. Further, this illegal
SDMC change evidences an attempt by the City to legitimize the
underfunding mechanisms created by MP I and MPII.
In addition to the violations of Charter sections
99 and 143 described above,
Charter section 39 was also violated by the City’s failure to
provide funding sources for the aforementioned benefits. In relevant part, City
Charter section 39 provides: “No contract, agreement, or other obligation for
the expenditure of public funds shall be entered into by any officer of the City
and no such contract shall be valid unless the Auditor and Comptroller shall
certify in writing that there has been made an appropriation to cover
the expenditure and that there remains a sufficient balance to meet the demand
thereof.” By approving the MPI and MPII ordinances and associated side
deals, the City acted in violation of the requirements provided in Section 39 in
that no written certification was made regarding the appropriations for
the real costs to the City of MPI, MPII and the related side deals.
5. San Diego Municipal Code
Disobeyed
top^
Beyond the violations of California conflict
of interest laws, the Constitution, and
the City Charter, the SDMC itself was also not followed. First, as discussed
above, before the City Council modified SDMC section 24.0801, it required the
City to contribute to the Retirement Fund and amount “as determined by the
System’s actuary pursuant to the annual actuarial evaluation.” Former SDMC
section 24.0801 (prior to Nov. 18, 2002). Thus, the City’s actions were not in
compliance with this provision from the 1996 inception of MPI to the
change in the SDMC in 2002.
Second, San Diego’s
local conflict-of-interest rules were violated as well. SDMC
section 27.3560 prohibits City officials from participating in any contract made
by them when that official has a “financial interest” in the subject of
the contract. Section 27.3560 prohibits the type of activity described in
Government Code section 1090 discussed above. Municipal Code section 27.3560
states:
"(a) It is unlawful for any City Official to be financially interested in any
contract made by them in their official capacity.
(b) It is unlawful for any contract to be made by the City Council or any
board or commission established by the City Council if any individual
member of the body has a financial interest in the contract."28
As discussed earlier with regard to Government Code section 1090, in the case of
the SDCERS Board no less than six trustees had a prohibited financial interest
in MPII and the related side agreements, namely Ron Saathoff, Mary Vattimo,
Cathy Lexin, Terri Webster, John Torres and Sharon Wilkinson, who were all
City employees. SDMC section 27.3560 would therefore prohibit their
participation in the multi-party deal to enhance benefits and underfund the
pension. Further, as highlighted above, at least two Board members, Ron Saathoff
and Terri Webster were granted exclusive benefit enhancements that offered them
a financial subsidy that clearly did not reach to the members of the system at
large. And the whole Board was given indemnity for their participation in the
scheme. These actions did not comply with the requirements of the SDMC.
IV. LEGAL AND FINANCIAL CONCLUSIONS
top^
The City Council induced
the SDCERS Board to violate its fiduciary duties to its retirees by enticing
the Board with special benefits. Unfortunately, the Board responded to this
pressure and allowed the City to underfund the pension from 1996 to the present
day. This unchecked abuse not only violated state law, the California
Constitution, the San Diego City Charter and the SDMC, but also caused the
collapse of the fiscal health of Retirement Fund, now running an approximately
$1.5 billion deficit.
All of the following agreements and actions--MPI and MPII, designed to
shortchange the Retirement Fund; Resolutions R-297212 and R-297335, and
Ordinances O-19121 and O-19126, the “side deals” of MPII; SDMC section
24.0801, enacted to evade City Charter section 143; the “waterfall” of
SDMC section 24.1502, which diverts funds for purposes unrelated to retirement;
the DROP program; the buying of cheap “air time” below market rates; the
notorious “Presidential Benefits”; and other inducements and unearned
benefits are all void as they blatantly violated legal requirements, fiduciary
duties, and the trust of the public, and in fact were void from their inception.
In recognition of this, the City has, within the last year (July 7th, 2004),
entered
into a legal settlement under which it has agreed to no longer use the
artificially low contribution rates of MPI and MPII, and to rework SDMC section
24.0801 to conform with the Charter.29
This is a good first step, but the City continues to provide the “quid pro
quo” benefits that were part of the unlawful scheme. These continued
benefits were void, and the City should cease observing the terms of these
agreements.
On an ongoing basis, the options available
to solve the pension deficit are:
increase plan assets, decrease plan liabilities or a combination of both.
There are financial limitations on increasing assets and other legal limitations
on reducing liabilities. However, if these hurdles are not overcome the only
option remaining is bankruptcy.
There are only two potential sources of funds for the City to increase
SDCERS
assets:
(1) revenues in the current budget; and
(2) additional new revenues, i.e., taxes.
This of course translates into an additional expense for the citizens of San
Diego. Given the magnitude of the deficit, it is not realistic to believe
that taxes or budget cuts alone can solve the problem in the near term.
Therefore, liabilities must be reduced. This means previously granted
employee
benefits must be changed. There are limitations in doing so. Benefits can only
be changed through labor negotiations or a Chapter 9 reorganization. If labor
negotiations are to be successful, it must be recognized that the employees
unions will not agree to bear the entire burden of the City’s failure to fund
previously negotiated benefits. Hence, the necessity to develop a “share the
pain” plan that provides for parity among those impacted. That is, both City
employees and taxpayers must contribute to resolution of the problem. If the “share
the pain” plan is not pursued promptly and diligently, the only remaining
solution is a Chapter 9 proceeding.
As discussed above, and as is true with any debt, the sooner the approximately
$1.5 billion deficit is paid off, the less it will cost. However, two things
must be kept in mind:
(1) it is unrealistic to expect to reverse the damage incurred over
several years in a single year; and
(2) a plan funded at 90% is considered healthy. If the plan were to be
funded at 90% in one year, that is $1.058 billion as of July 1, 2005. If the
goal was to fund it at 90% over two years, $529 million would be required each
year and if it were amortized over three years, $353 million
annually is needed.30
There are a number of sources of revenues and a number of options available to
reduce benefits. The most equitable plan would be to have the
employees and the taxpayers share responsibility for the deficit equally
with half of the funds obtained through liability reduction and half through an
increase in assets.
In order to avoid bankruptcy, the
Mayor and Council need to:
(1) determine the time period for repayment;
(2) designate the source of additional revenues and budget cuts to fund
50% of the resulting annual obligation;
(3) allow the labor unions to select among the benefit reduction options
to achieve their 50% obligation;
(4) enact legally binding mechanisms to ensure that each of these three
essential elements are accomplished; and
(5) establish oversight procedures to ensure that the plan is adequately
funded in the future.
The City Attorney’s Office also encourages the Mayor and City Council to adopt
new municipal ordinances which would require the Board to operate within the
standards of the Employee Retirement Income Security Act [ERISA]. Changing our
municipal law in this manner would better serve the present and future retirees
by making the financial footing of the Board more secure. The City Attorney’s
Office will, at a later date, present the Mayor and City Council with an ERISA-compliant
proposal fashioned to fit San Diego’s circumstances.
MICHAEL J. AGUIRRE, City Attorney
By______________________________
Michael J. Aguirre
City Attorney
By______________________________
Don McGrath II
Deputy City Attorney
Exhibits
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1 Robert L. Clark, Lee A. Craig, and Jack W. Wilson, A
History of Public Sector Pensions in the United States, pp. 12–23 (2003). (Exhibit
1)
2 “SDCERS Annual Actuarial Valuation,” June 30, 2004, p.
9. (Exhibit 2)
3 Id. at 13. (Exhibit 3)
4 Letter from Rick Roeder to City of San Diego Pension
Reform Committee of
4/20/04. (Exhibit 4)
5 “SDCERS Annual Actuarial Valuation,” June 30, 2004, p.
35. (Exhibit 5)
6 City of San Diego Pension Reform Committee Final
Report, September 15, 2004, p. 28. (Exhibit 6)
7 Letter from Rick Roeder to Pension Reform Committee of
5/4/04. (Exhibit 7)
8 Paul S. Maco and Richard C. Sauer, Vinson & Elkins,
Report on Investigation,
The City of San Diego, California’s Disclosures of Obligation to Fund the San
Diego City Employees’ Retirement System and Related Disclosure Practices
1996-2004 with Recommended Procedures and Changes to the Municipal Code, [Vinson
& Elkins Report], September 16, 2004, p. 5. (Exhibit
8)
9 Id. at 38. (Exhibit 9)
10 Denzil Y. Causey, Jr., Duties and Liabilities of
Public Accountants 12 (Rev. ed. 1982). (Exhibit
10)
11 San Diego Ordinance O-15353 (Oct. 6, 1980). (Exhibit
11)
12 SDCERS Board Meeting, Minutes, April 19, 2002, p. 26.
(Exhibit 12)
13 Letter from Constance M. Hiatt, Hanson Bridget Marcus
Vlahos and Rudy
(“Hanson Bridgett”) to SDCERS, General Counsel Loraine Chapin of 4/16/02. (Exhibit
13)
14 San Diego Ordinance O-15758 (June 1, 1982). (Exhibit
14)
15 San Diego Municipal Code [SDMC] §24.1502. (Exhibit
15)
16 “SDCERS Annual Actuarial Valuation,” June 30, 2004,
p. 13. (Exhibit 16)
17 Michael J. Aguirre, San Diego City Attorney, “Interim
Report No. 2 Regarding Possible Abuse, Illegal Acts or Fraud by City of San
Diego Officials,” February 9, 2005, pp. 9 – 17. (Exhibit
17)
18 “SDCERS Annual Actuarial Valuation,” June 30, 2004,
p. 13. (Exhibit 18)
19 Vinson & Elkins Report, p. 39. (Exhibit
19)
20 Settlement Agreement, in James F. Gleason, et al. v.
San Diego City Employees Retirement System, et al., San Diego Superior Court
Case No. GIC803779, part II.3(a). (Exhibit 20)
21 City of San Diego Pension Reform Committee, Final
Report, September 15,
2004, p. 9. (Exhibit 21)
22 Id. at 10. (Exhibit
22)
23 Letter from SDCERS Actuary Rick Roeder to SDCERS
Board, November 5, 2002; see also Vinson & Elkins Report, pp.82-86 (emphasis
added).
(Exhibit 23)
24 See Letter from SDCERS’ counsel Robert Blum to
Lawrence
Grissom, SDCERS Plan Administrator, June 2002 (draft). (Exhibit
24)
25 Vinson & Elkins Report, pp.80-81. (Exhibit
25)
26 Cal. Gov’t Code §1091(a). (Exhibit
26)
27 Cal. Gov’t Code § 87100. (Exhibit27)
28 SDMC §27.3560 (emphasis added). (Exhibit28)
29 Settlement Agreement, in James F. Gleason, et al. v.
San Diego City Employees Retirement System, et al., San Diego Superior Court
Case No. GIC803779, part II(b)-(c). (Exhibit 29)
30 Letter from Rick Roeder to Deborah Berger and Bruce
Herring of 2/4/05. (Exhibit 30)
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