Local Media Fall For Kroll Heist

— Imperiously, Arthur Levitt Jr. says that San Diego suffers from a "prevailing culture of political expedience" and employs "artful manipulation" in its financial reports. Levitt should know. The $20.3 million report that his company, Kroll Inc., presented to the city last week was a classic example of artfully manipulated political expedience. It gave a gentle spanking to the people authorizing the $20.3 million -- the city council -- while thrashing people who are already out of city government, some of them under indictment.

Levitt, former head of the federal Securities and Exchange Commission, says San Diego must rid itself of its culture of corruption. Actually, Levitt and Kroll are contributing to it. First, if a society punishes the little people who take orders and exonerates the big people who give orders, however cryptically, it breeds and rewards corruption. Second, Levitt on August 8 kept talking about putting aside the past (the favorite song of crooks) and working together for the future. But Kroll's report emphasized that pressure for conformity -- smothering dissent -- created the mess in the first place. Hmm.

The report by Kroll and its New York law firm took 18 months to complete. But it covered very little new ground. It attempted to be something old, something new, something borrowed, something blue, without the new and the blue -- just the old and borrowed. Ironically, it borrowed the substance of reports that were written by Kroll's biggest enemy, city attorney Mike Aguirre. In attacking the City for illegally overcharging residential sewer customers to subsidize big business, Kroll borrowed liberally from another of its critics, Councilmember Donna Frye, who, after months of prodding, had forced the City to admit its sins in early 2004. Aguirre had issued a report on that topic too. Kroll regurgitated old news and charged dearly for it, and the San Diego media didn't seem to notice.

Kroll found that the City and pension board acted illegally in adopting plans to underfund the pension system in 1996 and 2002. Aguirre had already reported the illegalities. Kroll found widespread securities violations, as Aguirre had in earlier reports.

Aguirre charges that former mayor Dick Murphy and current council president Scott Peters could be charged with committing securities violations knowingly, or in legal terms, with scienter. With other councilmembers, "It's more difficult; several lacked sophistication," he says, and they may not have knowingly violated securities laws. Councilmembers Jim Madaffer, Toni Atkins, and Peters "affirmatively tried to disrupt efforts by the city attorney to do something, conduct a proper investigation."

Kroll concluded that the violations by all councilmembers and Murphy did not constitute scienter, but rather negligence. And although Kroll acknowledged that the remunerative benefits granted city retirees were illegal, it deemed that they could not be taken away. Aguirre is in court arguing that the illegal benefits should be erased.

Levitt compared San Diego with private-sector frauds, such as those at Enron and HealthSouth. "But how can councilmembers like Scott Peters and Jim Madaffer be so deeply involved in wrongdoing but still be running the city?" asks Aguirre. If boardmembers in a private-sector scam were found negligent, "they would be gone." But the Kroll pickpockets first call the councilmembers negligent, then say they will straighten out the mess. Huh? Did I hear that correctly?

The accounting firm KPMG said it would probably accept the Kroll report. It had earlier refused to bless a report by the law firm Vinson and Elkins, which charged $6 million for mush. At the August 8 council meeting, Aguirre pointed out that Kroll did not answer questions that KPMG had criticized Vinson and Elkins for dodging. KPMG and Kroll's law firm tried feebly to circumlocute questions. Levitt magisterially denounced Aguirre's "carping," "contentiousness," and "bullying." Local media fell for Levitt's ruse. It looks as if Kroll and cronies may get away with this heist.

When a subject gets too hot to handle, Kroll runs away. For example, its report deals with a sacred cow: the ballpark. The mayor's Blue Ribbon Committee on City Finances was to complete its report in September 2001. But Murphy was trying to get the ballpark bonds to market. "It is clear that the committee's work was postponed, and that the language of its report was toned down, in order to avoid interfering with the city's ballpark offering," says Kroll's report. "The bond offering closed February 14, 2002, and the city was plainly concerned that a public report highlighting serious problems with the funding of [the pension system] would make the bond offering more difficult or impossible."

So far, so good. Kroll cites several sources. Former deputy auditor and comptroller and former pension boardmember Terri Webster, a member of the Blue Ribbon Committee, wrote in a memo that the report's timing shouldn't "mess with the ballpark bonds." She wanted to dissuade a committee member who was gloomy about the pension morass. Later, then assistant city manager Lamont Ewell congratulated her for "mastermind[ing]...an incredible attitudinal turnaround of the committee." Dennis Gibson, Murphy's gofer on ballpark matters, admitted to Kroll that there was a perception that the committee's report might "implicate" the ballpark bonds.

The trail was getting hot. But Kroll, which began life as a detective agency, decided not to pursue the leads for obvious political reasons. The ballpark bonds are at the center of the City's financial mess. They have always been a mystery. The City shelled out an astounding 7.66 percent interest rate to issue AAA-rated insured bonds at a time when similar bonds were going for 4 to 5 percent. There was no competitive bidding. Merrill Lynch bought the bonds and kept them for itself instead of selling them to customers. It has always smelled to high heaven -- and Kroll never probed further.

Former banker and mayoral candidate Peter Q. Davis points out that there were clues aplenty to pursue. For example, Kroll says that former deputy city manager Patricia Frazier and former auditor Ed Ryan acted with wrongful intent. "They were at every ballpark meeting," says Davis. Ditto for three accused of negligence: former city manager Michael Uberuaga, former city attorney Casey Gwinn, and former executive assistant city attorney Les Girard.

Davis and one other prominent San Diegan told the City how it could finance the bonds much more cheaply, but they were told to shut up. "Murphy was being politically expedient. He had decided he wanted the bonds sold, and so he was not going to let the developing situation affect that," says Davis.

The City went on to peddle other bond issues that omitted mention of the pension deficit. To Aguirre, that's proof of scienter -- deliberately covering up the pension shortfall. That conclusion is undeniable.

Kroll drops the ball in several other places. For example, it notes that outside pension counselors such as the actuary and fiduciary counsel were initially opposed to the underfunding schemes but were pressured to change their minds. But in some cases, Kroll doesn't specify who pressured the outside counselor. The mayor? Councilmembers? For $20.3 million, it would seem Kroll could follow the trails.

Some people who have been involved in the pension imbroglio are not as critical as I am. "It's pretty thorough, found a lot of fault, came down on the side of securities violations, doesn't pull any punches," says attorney Mike Conger, who has won key pension-related suits against the city. "It's time to stop looking for goats and move forward."

Carl DeMaio, president of the Performance Institute, a government-reform group, says that when the Securities and Exchange Commission reviews the report, it may well lift the culpability classification on securities violations from negligence to a tougher level, such as recklessness. Kroll found councilmembers "felony stupid, not felony criminal. People have their own views on whether there was intent or this was just incompetence," says DeMaio. The Securities and Exchange Commission will use San Diego as the canary in the coal mine for other cities ailing from pension woes. "San Diego will be a model of what to do and what not to do."

In my opinion, it's the Kroll report that will become a model of what not to do -- namely, swindle a strapped city. The report was a $20.3 million scissors-and-paste job, and anyone who studied Levitt's all-bluster/little-action history should have expected it.

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