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Exclusive: Pension fund slams San Bernardino for "sham" bankruptcy

Cracks in the parking lot are seen in front of the Carousel shopping mall in San Bernardino, California September 11, 2012. REUTERS/Lucy Nic
Cracks in the parking lot are seen in front of the Carousel shopping mall in San Bernardino, California September 11, 2012. REUTERS/Lucy Nic

By Tim Reid and Jim Christie

LOS ANGELES/ SAN FRANCISCO (Reuters) - A high-stakes legal battle intensified Friday as the largest U.S. pension fund filed court papers denouncing the financially troubled California city of San Bernardino for what it called a "sham" bankruptcy and accused the city of "criminal behavior" in withholding payments to the pension plan.

The filing by the California Public Employees' Retirement System, or Calpers, came 10 days after San Bernardino city officials traveled to Sacramento to plead with top Calpers executives for more time to make its payments.

At issue is whether the pensions of government workers take precedence over other payments in a municipal bankruptcy - which could have ramifications for municipal creditors, including Wall Street bondholders, as more cities and towns have trouble meeting their obligations.

No agreement after the Calpers and San Bernardino meeting was reached, and Calpers officials told Reuters they have little latitude to allow San Bernardino — or any other city that pays into its pension fund — to alter the payment schedule.

In a closely related action, bond insurers who are responsible for the debt of Stockton, California, filed papers in that city's bankruptcy case denouncing Calpers' efforts to be treated differently from other creditors. Stockton has continued to make payments to Calpers while halting payments to some bondholders.

Both cities went bankrupt in the wake of the housing bust and years of financial mismanagement, and the two comparatively rare municipal bankruptcy cases are expected to set important precedents as to who gets paid when a government goes broke.

But while Stockton was well prepared when it filed for bankruptcy protection last June, San Bernardino's finances and government operations are in deep disarray as political factions battle one another, according to an ongoing Reuters investigation. The city filed for bankruptcy on August 1 with no plans as to how it would meet its obligations.

SAN BERNARDINO EMERGENCY BUDGET 'NO PLAN AT ALL'

Calpers, which manages $241 billion in assets and serves many California cities and counties, said in its legal filing that San Bernardino appears to have been operating for more than a decade without necessary financial controls and lacks even basic mechanisms such as monthly cash-flow reports.

Calpers said San Bernardino's proposed plan for operating in bankruptcy, filed last month, was "no plan at all."

"It is merely an attempt to buy time, at the expense of Calpers and other post (bankruptcy) petition creditors," Calpers said in arguing the city was not entitled to bankruptcy protection. Calpers has already filed actions in state court, which could end up arbitrating the situation if bankruptcy protection is denied.

Calpers accused the city of "criminal" conduct for not making pension payments that are part of employee compensation agreements.

In markedly aggressive language, Calpers said the city had "buried its head in the sand," rather than deal with a long-standing financial crisis.

"The city gravely needs to get its house in order... Ten years of history suggest that the city is not going to implement meaningful change until forced to do so. This court needs to hold the city's feet to the fire."

Calls and emails to San Bernardino's city manager and budget chief went unanswered. Most city employees do not work on Fridays.

San Bernardino, a city of 210,000 about 60 miles east of Los Angeles, is broke and can barely make payroll, city officials have said. It has not made its $1.2 million biweekly payments to Calpers since the bankruptcy filing and now owes at least $8 million, in addition to a long-term debt to the fund that the city pegs at $143 million.

Calpers argues that under California law it has primacy as a creditor, asserting that it is in essence an "arm" of the state and must continue to be paid in full, even in a bankruptcy.

Wall Street bondholders and insurers vehemently disagree, arguing that federal bankruptcy law trumps state authority and should allow them to fight with Calpers in court as equal creditors.

Both sides have told Reuters they are willing to fight this issue all the way to the U.S. Supreme Court, which could take years.

STOCKTON HAMMERED BY BOND INSURERS

In a filing late Friday in the Stockton case, bond insurers Assured Guaranty Corp and Assured Guaranty Municipal Corp argued that Stockton should not be eligible for bankruptcy because the city "cannot provide sufficient, persuasive and credible evidence of insolvency."

The bond insurers also hammered the city for not seeking concessions from Calpers.

Stockton aims to unfairly restructure its finances "on the backs of those from whom it previously borrowed hundreds of millions of dollars," the insurers' lawyers said in their objection.

A Calpers spokesperson said the bond insurers were aiming to "cover their business losses by raiding the retirement funds of hard working employees who serve the people of California."

Stockton, a city of 300,000, in June became the largest city to file for bankruptcy in U.S. history after its leaders said deeper spending cuts would endanger public safety services.

A statement issued by Stockton's spokeswoman said the city's elected leaders and staff must "maintain the city's ability to deliver critical health and safety related municipal services to Stockton residents."

In San Bernardino, the first city ever to deliberately halt payment to Calpers, city officials are in a desperate scramble.

On December 5 senior finance officials from San Bernardino met with Calpers' chief executive officer and chief financial officer at the pension fund's Sacramento headquarters. The meeting lasted about 90 minutes.

According to Calpers officials, the meeting was cordial and the city officials stressed that their plan to defer payments is made in good faith.

But in its court filing Friday, Calpers alleged just the opposite, accusing the city of acting in bad faith in failing to propose a viable plan to meet its obligations.

Calpers officials say it is highly unlikely they can accede to any proposal to defer payments.

"Calpers does not have the power to 'negotiate' the amount of employer contributions owed by the city," Peter Mixon, Calpers' General Counsel, told Reuters. "The city of San Bernardino cannot alter the requirements of state law."

(Reporting by Tim Reid in Los Angeles and Jim Christie in San Francisco. Editing by Jonathan Weber and Lisa Shumaker)

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