Mark Young was advising the school board on whether to take that risk. As a financial advisor, Young is supposed to help San Diego Unified reduce debt costs and risks, according to a contract signed with the school district in 2009.
But Young also had a financial stake in that decision. When San Diego Unified decides to sell more bonds, his firm—which helps get the bonds onto the market and earns a small percentage of whatever is sold—gets more money. During the last school year, his firm was paid $175,000 in such fees.
“He advises you on the sale of bonds. The bonds that he sells?” Leonard Pinson asked at a meeting last month. Pinson sits on the Independent Citizens Oversight Committee, which monitors school construction. “Anybody got a problem with that besides me?”
Young doesn't actually sell bonds himself, but he's paid more when more of them are sold. He's worked for San Diego Unified for years as a consultant through Gardner, Underwood & Bacon, whose role is to negotiate with underwriters, prepare legal documents needed to sell bonds and help select companies that get the bonds onto the market. That firm was purchased last year by Loop Capital Inc.; Young stayed and continued to do the same kind of work for San Diego Unified through Loop.
Pinson and others on the watchdog committee have long been concerned that the way the firm was paid could create a conflict of interest. They called for an independent, conflict-free opinion last year. The school district's external auditor agreed, saying San Diego Unified should hire another advisor to weigh in on the decision.
“The second financial advisor would be free of any potential bias that might arise from being compensated directly from the issuance of the Proposition S bonds,” the audit by Christy White Accountancy Corporation concluded in January 2011.
So, San Diego Unified hired another company last May to give a second opinion. The watchdogs were pleased. The school board had already decided to go ahead and use the longer-term bonds for a year, but the watchdog committee believed the board would get another opinion before ant future bond decisions.
But when the school board sat down in December to get advice on when and how to sell bonds, they heard only from Loop, the firm that Young now works for. The board asked Loop to come up with a new plan for the sale of additional bonds, allowing the district to fund more school construction projects while prices were low.
Some school board members didn't even know the other financial advisor existed. That company, Keygent, painted a dimmer picture than Loop in its report. It said it would end up costing much more to sell the bonds. Loop predicted it would cost less than $14 billion; Keygent pegged it at more than $19 billion.
“Keygent said, ‘You can't issue as many bonds,'” said John Gordon, a member of the watchdog committee. District officials “didn't give them a fair hearing.”
Ron Little, the school district's chief financial officer, said the second opinion reshaped the advice that Loop ended up giving the school board, even if Keygent didn't talk to the board directly. Little added that the Keygent report was released at a public meeting of the watchdog committee, so anyone could have picked it up if they wanted, including school board members.
But the fact that the school board was never presented with the second opinion throws into question whether San Diego Unified really fixed the problem that the watchdogs pointed out—that the district was relying on an advisor who had a financial stake in selling more bonds.
Now the school district is replacing Loop because the company wants to become an underwriter, which sells bonds to investors. Having the same company serving as advisor and underwriter is widely seen as a conflict of interest—indeed, the Municipal Securities Rulemaking Board proposed last year that companies shouldn't be able to act as financial advisors and underwriters on the same financial deal.)
But it's unclear whether San Diego Unified will keep paying the new advisor the same way—more bonds equals more money—or change the system to stop a possible conflict of interest.
How San Diego Unified compensates its bond advisors is common in the financial world. Financial experts sometimes call them “contingent fees.” That means how much the advisor earns depends on whether something else happens—in this case, how much funding the school district gets through bonds. governments sometimes prefer doing business this way because they won't have to pay if they don't have income.
“You have to be a little bit sympathetic toward the need to do it. Frequently it's just not possible for a local government to have those funds,” said Frank Hoadley, Wisconsin state director of capital finance. “But it's a problem.”
The Government Finance Officers Association says school districts and other government agencies should avoid paying their financial advisors based on how many bonds they sell, “to remove the potential incentive for the financial advisor to provide advice that might unnecessarily lead to the issuance of bonds.” Instead, it recommends paying them a flat fee or by the hour to avoid the conflict of interest.
“You want an honest, independent financial adviser who is going to tell you whether it's something you should be doing or shouldn't be doing, without any bias in giving you that advice,” said Jeffrey Esser, CEO of the government Finance Officers Association.
Lori Raineri, an independent financial advisor based in Sacramento, pointed out that just because a conflict of interest exists doesn't mean that someone is giving bad advice. They may still give the school district sound advice, ignoring how it impacts them personally. But Raineri added that it's risky to put the financial advisor in a position where what's best for them isn't necessarily what's best for the school district.
In San Diego Unified, the finance chief negotiates with the financial advisor and other consultants, before any bonds are sold, to determine how much the advisor will earn. The fees can vary depending on how much the district plans to sell and how complicated the financial deals are, but they come out to a share of the bond revenue.
Little said Keygent weighed in only once because it would be wasteful to have two financial advisors at all times; San Diego Unified hired Keygent only for six months for $7,500.
He argued that there was no conflict of interest because the financial advisors would ultimately get the same amount of money once all the bonds were issued. San Diego Unified is authorized to sell $2.1 billion in bonds, and they'll all be sold sooner or later, no matter what Loop does.
“It's not an issue,” Little said.
ut that assumes that the financial advisors will stick around to see all of the bonds sold. That isn't the case in San Diego Unified, which will replace Loop this year.
The school district is now weighing whether to do things differently with a new financial advisor, perhaps by paying a fixed fee or hourly wages. “I don't know which method is the best way,” said school board President John Lee Evans. “But I do want us to be careful that there is no conflict of interest—real or perceived.”
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