Corrupt and Contented

Philadelphia could learn a lot from DROP debacles in California and Wisconsin.

by Ralph Cipriano

Alyssa Grenning

In recent years, both the city of San Diego and the county of Milwaukee adopted expensive DROP programs, just as Philadelphia did. But in San Diego and Milwaukee, publicity over big DROP bonuses sparked taxpayer revolts, criminal indictments, court battles, recall drives and a negligence lawsuit against an actuarial consultant — Mercer Inc., the same company that set up Philadelphia's DROP — that resulted in a settlement of $45 million.

Philadelphia, it seems, could learn a lot from those experiences. But, so far, it hasn't.

San Diego passed its DROP program in 1997. Like in Philadelphia, the San Diego DROP was supposed to be cost-neutral. In 2009, the mayor and city council rescinded the program for all new employees.

"It was an interim program that was supposed to have a cost-neutrality study before it was approved," Jan I. Goldsmith, the San Diego city attorney, tells City Paper. Instead, San Diego officials waived that study and made the program permanent without knowing the price tag.

In Philadelphia, DROP was made permanent in 2004, even though no in-depth study was ever done about its future cost or effect on employee behavior. The program was supposed to be cost-neutral, but had already cost taxpayers at least $64 million.

In San Diego, DROP also provoked a legal war between the city and its police union that ended when a federal appeals court ruled that the city had the right to make DROP cost-neutral by reducing the salaries of workers enrolled in the program and a state superior court judge allowed the city to reduce the interest rate paid to DROP employees.

That wasn't the only fallout. Members of the San Diego pension board that approved DROP were hit with two waves of indictments: Six board members were charged with conflicts of interests for approving a program from which they would directly benefit.

In January, an appeals court dropped charges against five of six pension board members, ruling that they did not have an actual conflict because their interests in approving DROP were the same as the city workers they represented. But the San Diego pension board isn't clear yet. Three pension board members still face fraud charges in a federal indictment.

"San Diego has already had our crisis and we're dealing with it," Goldsmith says. "I just wish you luck, because these pension issues are difficult."

Goldsmith's counterpart in Philadelphia, City Solicitor Shelley Smith, declined to comment on whether actions undertaken by San Diego — or Milwaukee County — could be done here.

In Milwaukee, county officials filed a federal negligence lawsuit against Mercer Inc., the consultant that set up DROP programs both there and in Philadelphia, and last year collected a $45 million settlement. In their suit, Milwaukee county officials alleged that they had not been properly advised about the full cost of lump-sum DROP bonuses and related benefits.

"The county would have pulled the plug," the lawsuit alleged, "if Mercer had warned that the costs were too high for the county to pay or that it hadn't studied the costs."

After a brief review of Philadelphia pension and DROP records, James Southwick, the Houston attorney who negotiated Milwaukee's $45 million settlement with Mercer, says he recognizes a familiar storyline.

"It looks like here again, as in Milwaukee, Mercer blew it in terms of how it [DROP] would affect employee behavior," Southwick says.

His advice to Philadelphia officials: Call me. "You need to give it a look," Southwick says. "It's certainly worth it for the city to talk to lawyers and see, 'Do we have a claim here?'"

The big question, Southwick says, is, "Were we given bad information? Did [DROP] blow up in our face because we had been given bad information?"

Milwaukee County isn't the only government with complaints about Mercer, a giant human resources company with 4,000 employees and 150 offices around the world. In December, The New York Times reported on what it described as "a bombshell of a lawsuit," in which the Alaska Retirement Management Board, a state agency, is suing Mercer for allegedly making repeated mistakes in setting up the state's retirement plan for its workers, and then attempting to cover up those mistakes.

In response, according to the Times, Mercer conceded making an error in a calculation that it used to determine the cost of numerous employees' health care benefits, and said that its failure to disclose that error was "a mistake in judgment ... not consistent with the company's corporate culture." The state agency, however, says that mistaken calculation and the attempts to cover it up resulted in the state agency under-reporting the contributions needed to sustain the pension fund by $2.8 billion. So the state agency is seeking $2.8 billion in damages in a federal trial scheduled for July in Juneau. If the state wins, the Times reported, Mercer could also be liable for punitive damages.

In Philadelphia, city officials acting on Mercer's advice were wrong on several projections — on how many employees would sign up, on whether the program would be cost-neutral, on whether it would induce workers to retire later.

Attorney Southwick suggests that Philadelphia consider hiring a new actuary.

Since 1995, with the exception of two years, Philadelphia has primarily relied on the counsel of one expert. Kenneth A. Kent set up the Philly DROP as a Mercer employee, before he became a consulting actuary to Cheiron of McLean, Va., Philadelphia's current actuarial consulting firm. Between 2001 and 2007, the city paid $2.3 million to Mercer Inc., and from 2008 to 2010, another $834,086 to Cheiron.

In an interview, Kent defended his work in Philadelphia. He says it was up to the pension board to anticipate how many employees would retire under DROP, although Kent did advise pension board members on that subject, and is presently doing a study on how DROP affected employee behavior. He adds that over the past decade, "If you're looking at averages, statistically a lot of funds have an average return that's below their assumption."

HALF OFF DEPOT

Why live life at full price?

Philadelphia officials have remained loyal to Kent, even though Mercer didn't.

While at Mercer, Kent became embroiled in another negligence lawsuit filed in federal court in Atlanta, Ga., by the United Food and Commercial Workers Unions and Employers Pension Fund, which represented 130,000 grocery store workers. In the lawsuit, the pension fund charged that because of "incorrect information" received from Mercer, the fund had "increased benefits when it should not have," and that Mercer had "underestimated, omitted or mispriced" future liabilities by "tens of millions of dollars."

Kent was the lead actuary on the account from 1999 until Mercer fired him in December 2004, according to court papers; the documents say the union pension fund was "Mr. Kent's biggest account."

"According to Mr. Kent ... the cost of the benefits promised to participants exceeded the employer's contributions and the fund's investment returns were insufficient to make up the shortfall."

In a 2004 letter to the pension board trustees, Kent wrote that "programming errors in [Mercer's] valuation system" had resulted in a miscalculation that "undervalued the fund's liabilities by $54 million."

Mercer offered to settle for $2.25 million, but was turned down by the pension fund. The case went to trial in 2008; ultimately, a federal jury found the union and Mercer equally liable for negligence, and awarded no damages.

According to court papers filed in that lawsuit, "In early 2003, Mercer stripped Mr. Kent of his supervisory responsibilities, denied him any future promotions and limited his salary increases. To remain employed, Mercer required Mr. Kent to assign another senior consultant to each of his clients and fully comply with Mercer's quality control procedures. Mercer fired Kent due to his failure to adequately satisfy these conditions. Termed a 'downsizing' to clients, this moniker was merely Mercer's 'party line.'"

In an interview, Kent says he has dedicated his career to "maintaining the highest professional standards of practice and integrity." He says the allegations in court papers were "full of inaccuracies," that he lost his job as part of a downsizing at Mercer, and that he was never fired. He says he was never stripped of supervisory responsibilities and that he continued to receive raises. He adds that the client was so upset about Kent's departure that they promptly fired Mercer.

The city continues to defend Kent. "We are actually very comfortable with the work he's done for us," says Rob Dubow, city finance director and chairman of the city pension board.

In Milwaukee, angry citizens staged massive petition drives that gathered more than 70,000 signatures. They forced the resignation of County Executive F. Thomas Ament, who was scheduled to retire in 2008 with a $2 million cash bonus, but resigned under fire in 2002 without any DROP money. Citizens also voted to recall seven members of the county board of supervisors who had voted for DROP.

In 2004, the county's human resources director — the creator of Milwaukee's DROP program — was indicted and pleaded no contest to one felony count of misconduct in office, and two additional misdemeanors related to his role in the pension deal, according to the Milwaukee Journal Sentinel. He was fined $11,000 and sentenced to 30 days in jail.

In contrast, here in "corrupt and contented" Philadelphia, as muckraking journalist Lincoln Steffens famously described the city in 1904, there has been no citizen uprisings over DROP. Rather than reform the program or investigate the circumstances under which it was made permanent, elected officials, such as former Mayor John Street — who told City Paper in 2003, "We will ultimately end the DROP program" — have joined the parade down to the municipal feeding trough.

Street retired in 2008 and collected his DROP bonus of $456,963.

Three members of the city pension board that voted to make DROP permanent in 2004 have also retired and collected DROP benefits. Two former pension board members — city Personnel Director Lynda Orfanelli, who retired in 2006 and collected $367,041; and Charles Johnson, a union representative on the pension board, who retired in 2001 and collected $52,222, three years before he voted as a pension board member to keep DROP. Carol G. Stukes of District Council 47 retired in 2009 as a police officer under DROP and collected a $230,208 bonus. Stukes still serves on the pension board as a union rep. She did not return a call from City Paper seeking comment.