School District Client Advisory: Spiking Litigation has Spiked! What Can You Do?

School districts and administrators are seeing a precipitous increase in California State Teachers Retirement System Pension (“STRS”) spiking cases. Pension spiking occurs when an unusual salary increase takes place in the final years of government service for the purpose of enhancing benefits upon retirement. Make no mistake about it; preventing suspect pension spiking is a laudable goal. In many cases pension spiking findings are valid. However, sometimes good-faith errors occur. Unfortunately, those errors have far-reaching consequences for teachers and administrators. Consequently, it is important to understand the reasons behind spiking litigation, the process, and how to best protect your district and administrators from erroneous retirement pension reductions.

I.    Historical Overview and Current Climate

Pension spiking is a relatively recent issue in California. In 1913, the Legislature established STRS to provide a retirement pension for certificated employees. During the economic upturn of 1999, Democratic Gov. Gray Davis and lawmakers from both parties approved SB400 giving State workers enhanced benefits on the assumption that the cost would be covered by investment gains. However, with more difficult economic times the pendulum began to swing back against retirement pensions. In 2009-10, Republican Gov. Arnold Schwarzenegger proposed to roll back SB 400’s enhanced retirement package and reduce benefits for new employees by raising the retirement age. Simultaneously, headlines were saturated by the City of Bell scandal. The City of Bell scandal involved misappropriation of public funds in Bell, California over a period of several years in the late 2000s. Coming shortly after the Enron scandal, public entities and public employee pensions came under close scrutiny.

In September 2011, California State Controller Jon Chiang publicly criticized STRS for a lack of pension spiking oversight calling it a “form of public theft.” Thus, California moved quickly to curb spiking. The State Controllers office (“SCO”) reviewed five school districts to determine whether they had controls in place to provide reasonable assurance that pension spiking could be prevented or detected. The SCO identified the following concerns: 1) STRS did not provide adequate oversight of the reporting entities it monitors; 2) school districts lacked the level of transparency and management controls that public entities should exercise on behalf of their constituencies; and 3) STRS did not review or verify the results of electronic audits put in place specifically to identify potential pension spiking.

In response to the SCO’s findings STRS quickly implemented reforms. First, they established a Pension Abuse Reporting Hotline to allow anonymous reports of suspected abuse. The Hotline is part of a multifaceted reporting system comprised of: 1) a toll-free telephone number; 2) an online submission form; and a separate confidential postal mail station to receive reports of suspected spiking. STRS also established a Compensation Review Unit (“CRU”). The CRU, comprised of creditable compensation experts and attorneys, is authorized to perform district wide audits, identify pension spiking and conduct an administrative review thereof. Staff is responsible for managing the due process obligation to notify members of determinations, and provide them with an opportunity to appeal the decision or rebut the presumption of spiking. (See CCR, Title 5, §27101 (1)(c)(ii).). Consequently, a bureaucratic structure was established to aggressively combat pension spiking.

STRS recently announced an approximately $71 billion unfunded pension liability. This announcement set off shockwaves throughout the education community. Governor Brown wants school districts to increase their contribution from 8.25 percent to 19.1 percent! There are now loud voices calling for the complete elimination of the pension that has provided security for California’s educators for the last 100 years. Whether the shortfall was caused by poor investments, benefit enhancements or unrealistic prognostications, one thing is for certain, STRS will do anything to maintain the fund. This means maintaining the laser-like focus on pension spiking reform. This could impact each and every one of California’s educators. Be it right or wrong, districts and members must be prepared for what comes next.

II.    The Administrative Hearing Process and Litigation Atmosphere

After STRS performs an initial audit, a decision is issued by the Program Executive. The administrative review process, set forth in CCR, Title 5, §27101 commences if an applicant requests “Executive Review” within forty-five (45) days. The applicant must state all facts and legal bases that are relevant to the disputed finding. If Executive Review is granted, the process takes approximately ninety (90) days. After which, the Program Executive issues findings; if the member or employee disagrees with the findings they must request an administrative appeal within ninety (90) days. If the appeal is denied, the applicant can request an administrative hearing. (Currently, it takes approximately twelve (12) to fifteen (15) months to obtain a hearing.)

After an administrative hearing decision is rendered, the decision is either approved or reversed by the STRS Board: the same Board that was criticized for allowing pension spiking in the first place. If a spiking determination is not reversed, an applicant’s only recourse is a Writ of Mandate in Superior Court. In many jurisdictions it takes over twelve (12) months to obtain a court date. Consequently, the administrative review process may take as long as three (3) years to complete. It is extremely difficult for most applicants to bear litigation costs over such an elongated time frame. When there is a final determination that money has been paid for the principal purpose of enhancing a member’s benefit, that compensation is subtracted from the member’s retirement benefit. STRS has the authority to adjust benefit levels and/or collect overpayments.

A confluence of the above-referenced circumstances creates a litigation atmosphere that is challenging to say the least. Pension abuses and media saturation created a righteous cause, the prevention of pension spiking. The SCO conducted an investigation, issued a report and proclaimed a governmental mandate to halt spiking. A bolstered bureaucracy and more resources were devoted to the effort. The state devised a regulatory scheme that not only presumes pension abuse, but also makes it difficult to challenge the findings. Finally, STRS staff must conduct voluminous review of highly complex, yet somewhat repetitive issues. STRS operates as the judicial and executive branches simultaneously.

III.    Measures to Improve Applicants’ and Districts’ Position and Pension Spiking Cases

As former Secretary of State James Baker once opined with regard to the Bush v. Gore litigation, the only thing that matters is the Supreme Court. Similarly, in regard to pension litigation, the Superior Court is the last best chance to prevail. Therefore, taking steps to improve the administrative record before that court is critical. More importantly, maintaining, organizing, and preparing documentation as though you were going to court can help resolve these matters in the early stages. There are five (5) things districts and applicants can do to improve the document trail. Each will be discussed separately.

A.    Review the Basic Definition of “Creditable Compensation”

STRS members receive retirement credit for “creditable compensation.” If STRS determines that the reported amount is not creditable it is removed from a member’s retirement benefit and placed in a separate fund. One of the underlying premises in pension spiking litigation is consistency. STRS reviews consistency throughout a member’s career and consistency within the job classification. STRS’ decisions invariably include Education Code §22119.2 which states in relevant part, “This definition of ‘creditable compensation’ reflects sound principles that support the integrity of the retirement fund. Those principles include, but are not limited to, consistent treatment of compensation through member’s career, consistent treatment of compensation among an entire class of employees, preventing adverse selection and excluding from compensation reportable remuneration that is paid for the purpose of enhancing a member’s benefits under the plan…” (Emphasis added). Consistency is a principle to maintain the integrity of the fund. However, the primary purpose of the section is to prevent pay intended to spike the retirement benefit. Unfortunately, that is not always the case. Simply put, if one is paid differently than other people within the same classification, STRS will presume that your compensation is “spiked.”

Although the code requirements appear to be conjunctive, STRS tends to rely on the argument that a compensation snapshot is either inconsistent with an entire class, or inconsistent with previous compensation. At times, STRS does not address the second portion of the statute, “… paid for the purpose of enhancing a member’s benefit under the plan.” Many decisions do not consider valid reasons for increased compensation such as additional duties, funding reductions, rapidly increasing ADA, reorganizations, exigent circumstances or other reasons completely unrelated to increasing an employee’s compensation. What’s more, the burden of proof is on the applicant to show that enhancements were not intended to increase pension benefits. Accordingly, when a district gives an administrator a pay increase there should be board approved documentation providing justification for the pay increase.

B.    Understand the Statute of Limitations

A sound statute of limitations argument is the best and easiest way to prevail in any legal proceeding. In STRS pension litigation the relevant statute is Education Code Section 22008. However, unclear drafting has led to different interpretations of the language. Statutory vagueness is a fertile ground for litigation. Consequently, legislative, regulatory or judicial language clarification is necessary.

Education Code section 22008 essentially says that no action can be brought by either party three (3) years after all obligations have been discharged. Therefore, if someone has received retirement benefits for four (4) years, STRS cannot recover that money. If the “system” makes an error that results in an incorrect payment, STRS has only has three (3) years to commence recovery from the incorrect payment date. However, if the incorrect payment is due to inaccurate or omitted information about a member’s eligibility, or is based on fraud or intentional misrepresentation, that 3-year period commences with the discovery of the incorrect payment.

Consequently, having clear documentation about when an action was taken, and maintaining that documentation is necessary to prevent tolling the statutory period. If STRS is not in possession of documentary evidence that a board action was taken, or compensation was distributed, they take the position that the 3-year statutory period has not begun. Consequently, they may attempt recovery of benefits, allowances, and salary distributions many years outside of the statutory 3-year cutoff. At the very least, this increases the work on overburdened district staff. At worst, it increases litigation expenses for the State, district and member.

C.    Document, Memorialize and Retain all Communications

All communications with STRS must be maintained and memorialized as though they are exhibits in an Executive Review or Writ proceeding. It is equally important to maintain all district documents that substantiate any duty change or pay enhancement. On occasion, applicants’ benefits are reduced because the district does not maintain documentation such as board dockets or salary schedules. If STRS audits a district and they do not have the necessary documentation to justify a salary increase, STRS may order a commensurate pension benefit reduction. This embarrasses the district, but financially harms the applicant. The district and member should maintain and review all payroll and personnel documents with fidelity.

Some members have the foresight to consult with STRS staff concerning contract language or personnel actions that may impact pensions. STRS staff often offers verbal approvals. However, STRS subsequently audits or otherwise scrutinizes the personnel action. Therefore, it is critical to retain a record of the communications. Applicants’ counsel may offer contradictory evidence of STRS verbal approval by way of declaration. However, STRS often takes the position that the verbal assistance is nonbinding. This position is less compelling when the advice is confirmed in writing. It is important to memorialize all conversations to prevent retractions. When memorializing a communication, restate your question, the reason for the question, the answer received and reliance on the answer. Implementing these four easy steps will help you create strong evidence.

Of equal importance is that the communications are memorialized in close temporal proximity to the personnel action. This is relevant to the statute of limitations defense or other equitable doctrines. If STRS staff is contemporaneously notified of a member’s or organization’s actions, intent and reliance upon STRS’ advice, it will be difficult for them to extend the statute of limitations based on lack of information, fraud or intentional misrepresentation.

D.    Forward All Personnel Actions to STRS Immediately

As the foregoing demonstrates, applicants often have trouble reconstructing the record. STRS successfully argues that without documentation of pure intent there is evidence of bad intent. Subsequently recreation of exculpatory, explanatory documents is often dismissed as self-serving. Also, STRS successfully tolls the statute of limitations by claiming that they have insufficient or inaccurate information. Stated differently, if STRS does not have it, it does not exist.

As such, it is prudent to forward all personnel actions to STRS as they take place. STRS conducts exhaustive reviews of personnel files. They review employment contracts, memoranda of understanding, board minutes, resolutions, job descriptions, correspondence, etc. If employers forward these documents to STRS immediately, with a polite cover letter, two benefits will accrue: 1) STRS will have possession and control of the document and will be less able to argue that they did not have the information; and 2) applicants will have another repository of evidence to recreate the record. Although STRS is likely to return the document, or inquire about the reason it was forwarded, it can only help districts or applicants if they can demonstrate that STRS had the relevant documentation all along.

E.    Create a Uniform “Master Contract” for Administrators

Some administrator contracts contain outstanding language concerning “spiking” issues. The Association of California School Administrators and other administrator-based organizations should combine resources to create a library or database of contracts so that the best provisions of each can be widely incorporated. By achieving contract uniformity the best possible situation can be achieved for the districts and members.

IV.    Retirements are Earned, They Should also be Protected

STRS members confront an uphill battle if STRS sees fit to reduce a retirement benefit for any reason. It is quite difficult to reverse these decisions. STRS’ mandate is justified and its staff talented. However, sometimes facts are misinterpreted and mistakes are made. It is absolutely critical to maintain contemporaneous documentation to protect the district and the member. Teachers and administrators dedicate their lives to their calling. They bargained for a fair retirement. It would be a shame if that retirement was lost due to a simple mistake. In summary, pension litigation is a “no-win” landmine that can only be avoided through discipline, diligence and most of all, documentation.

This document is intended to provide you with information about public entity/school district related developments. The contents of this document are not intended to provide specific legal advice. This communication may be considered advertising in some jurisdictions.

June 11, 2014