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California City Facing SEC Probe Drained Road Funds

San Bernardino, the bankrupt California city facing an inquiry by the U.S. Securities and Exchange Commission, masked its growing deficits by using funds meant for sewers, roads and construction to cover current expenses, according to city records.

In the year ended June 30, San Bernardino added $33 million to its $177.7 million general fund from a payroll trust fund and accounts designated for sewer-line maintenance, storm-drain constriction and other purposes, exhausting most of the special funds, according to a city budget document.

Now, as the city of 209,000 about 60 miles (100 kilometers) east of Los Angeles faces the scrutiny of a bankruptcy judge and the SEC, it’s $1 million in default on pension bonds issued in 2005 and late on $5.3 million owed to the California Public Employees’ Retirement System, of which $1.2 million is delinquent. The city’s broke because its leaders resorted to accounting tricks, rather than reduce spending as the recession drove down property taxes and sales levies, City Treasurer David Kennedy said.

“I didn’t say we were careening toward bankruptcy, but I told them we were hemorrhaging cash and needed to get our budget in order,” Kennedy said in an interview, referring to the mayor and City Council. “It was hard to ignore that, but they pretty much did.”

The SEC’s “informal inquiry” was revealed in an Oct. 11 letter from Robert H. Conrrad, a senior enforcement lawyer in Los Angeles, to City Attorney James Penman. The letter asked the city to preserve documents and data on bonds, underwriters, audits and financial information presented to elected officials.

Conrrad didn’t respond to a voicemail requesting details of the investigation. Judith Burns, a commission spokeswoman in Washington, said policy prevented her from confirming the existence of a probe.

SEC Enforcement

The SEC has stepped up enforcement of rules requiring public officials to disclose financial problems to investors in the $3.7 trillion municipal-bond market. In July, the agency said it may sue Miami over the issue. New Jersey agreed to settle with the SEC after accusations it misled investors by masking underfunding of pension plans. Four former San Diego officials were fined in a case involving similar issues.

In San Bernardino, investigators will probably scrutinize bond disclosures to see whether they reflected the true budget picture at the time, said Kennedy, the city’s part-time treasurer since 1991. He said the agency hasn’t contacted him.

San Bernardino’s bond disclosures have been accurate and complete “as far as I know,” he said.

‘Fishing Around’

“I don’t know that anything is going to come out of the SEC,” Kennedy said by telephone. “Most of this is just fishing around to see if they can find anything.”

San Bernardino has $90 million of outstanding general- obligation debt, according to an Aug. 29 report to the City Council. It’s responsible for another $200 million in securities issued for its redevelopment agency, closed this year under a law eliminating the function statewide.

The city last sold general-obligation debt in a 2005 offering of $50.4 million in pension-obligation bonds, the ones that went into default this month. The issue carried no official statement, which typically lays out city finances, because it was a private placement. The only continuing disclosure was the Oct. 16 notice of non-payment of $1 million due Oct. 1.

San Bernardino has been absent from debt markets because of its deteriorating credit, Penman said by telephone.

“The city was told informally in 2008 that the state didn’t want us involved in certificates of participation because of our credit situation,” said Penman, the elected city attorney since 1987.

Budget Illusion

In a July 10 City Council meeting, Penman said officials had “falsified” budget documents for 13 of the preceding 16 years to create the illusion of a balanced budget. Mayor Patrick Morris, in office since 2006, said Penman hasn’t offered evidence.

While Penman declined to provide details in a telephone interview Oct. 18, he said he hasn’t retracted the assertion.

San Bernardino has tapped single-purpose funds to balance its general fund, which is typically used for day-to-day operations such as payroll, city budget documents show.

For example, the city pulled $1.1 million from its workers- compensation fund, $1.5 million from liability insurance, $2.9 million from storm-drain construction and $6.1 million from regional mobility, emptying all of those accounts, a budget document indicates.

In July, the San Bernardino County Sheriff’s Department said it was investigating “allegations of criminal activity within departments of the San Bernardino city government.” A spokeswoman for the sheriff’s department referred questions about the status of the probe to the San Bernardino Police Department. Police Captain Gwendolyn Waters, an acting assistant city manager, said she isn’t aware of any “specific criminal allegations being investigated.”

To contact the reporter on this story: James Nash in Los Angeles at jnash24@bloomberg.net.

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net.

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