The case pits the Board of Retirement of the Orange County Employees Retirement System (OCERS) and the Association of Orange County Deputy Sheriffs (AOCDS) and others against Orange County, California.  The legal context pivots around the authority to raise pension benefits without taxpayer approval.  As the state has a constitutional mandate that Orange County and similar governmental entities not encumber future year tax revenue streams, the issue is whether the benefit enhancement creates liabilities that must be paid out of future years’ taxes.  If it does, then the action is voidable because such action requires taxpayer referendum; if the amendment does not increase the entity’s liabilities, then the actions by the OCERS and the AOCDS were appropriate.

In December 2001 the former County Board of supervisors, among other things, voted to increase the retirement benefits from 2% to 3% of annual compensation multiplied by the total years of service if the employee retired at age 50 or over. This pension benefit enhancement was applied to all years of service, both past and future.  The cost was estimated to be $100 million, but this cost has grown to at least $187 million.  The current Board of Supervisors for Orange County decided to sue OCERS and AOCDS because they believe that the state constitution requires approval by the taxpayers.

This pension benefit enhancement was applied to all years of service, both past and present.  The change that applies to future years of service will give rise to an accounting liability if and when the employee has earned that additional benefit by providing future years of service—a fact not contested in this case.  On the other hand, the nature of the benefit enhancement as it applies to past years of service is contested.  Accordingly, the remainder of this column focuses on this pension benefit enhancement as it applies for past years of service.

The argument is simple.  The increase to pension benefits is a liability that must be paid for in future years.  Incurring such liabilities may take place only if the taxpayers approve.  They were not given a chance to vote on this increase to liabilities brought about by the pension enhancement, so the pension increase should be nullified by the courts.  The defendants argue that the increase to pension benefits is not a liability and so there is no constitutional violation.

The court tossed out the case, accepting the arguments by the defendants.  Orange County has appealed the case.  As I think this case is very important to governmental units in this country and because I think too many politicians are defrauding voters with unctuous, illogical gobbledygook, I played an active role in preparing a brief, together with various colleagues and associates.  To us, accounting and economic logic are straight-forward in this case.

We begin our amicus curiae in support of the appellant by recalling the definition of a liability.  Definitions by the FASB, the IASB, and the GASB are essentially the same—a liability is a probable future sacrifice that arises from a present obligation of a particular entity to supply assets or services to another entity sometime in the future because of a past transaction.  The pension enhancement clearly meets this definition of a liability.

• It is a present obligation of Orange County because the employees who stand to reap those benefits do not have to do anything else in order to receive them. 
• Orange County has little ability to avoid having to sacrifice resources in the future unless some extraordinary event occurs, such as a court’s overturning the legality of the pension obligation.
• The obligating event has already occurred; the former Board of Supervisors has already agreed to the transaction.

The FASB and the IASB already have pronouncements that require such amendments to be included as part of the projected benefit obligation (FAS 87 and 132; IFRS 19).  The GASB requires the disclosure of this liability (GAS 50), though it does not require it to be booked on the balance sheet.  The AICPA has criticized this GASB pronouncement in a letter dated August 12, 2009, and argued strongly that the “employer’s unfunded accrued benefit obligation meets the definition of a liability” and that “it should be reported on the face of the financial statements…”

The Orange County case is both simple and exasperating.  It is simple because the economics of pensions clearly demonstrate the creation of a liability that must be borne by the county.  It is disturbing because some court cases have tamped down economic reality by politicizing the issues and allowing irresponsible politicians to create huge liabilities that possess the potential to destroy state and county economies.

I make no comment about the pension plan itself; that is beyond my purview.  But, I wish governmental leaders would quit acting recklessly when it comes to our money.  If politicians are required to disclose economic and accounting truth, the voters will be in a better position to know whether they can afford these changes.