A controversial mediator’s decision that concluded the city did not need to provide more funding to the Warwick School Department to close its budget deficit for the fiscal year ending June 30 – and seemed to instruct the department to take up to $4 million from its private pension fund in order to do so – would violate federal law if implemented, according to a legal opinion released by the schools on Wednesday.
The opinion was concluded by attorney Cory Bilodeau, partner at McLaughlin Quinn LLC, and sent to the Warwick School Committee Chairwoman Karen Bachus on Friday, May 24.
In the letter, Bilodeau concludes that taking money from a pension fund and infusing it back into the operating budget of the pension operator would be in violation of the Internal Revenue Code of 1986, and would result in federal tax consequences and other penalties if implemented, including but not limited to the fund losing its tax exempt status and the incurring of fees and other financial penalties, which would cause significant financial harm to pension beneficiaries and the school district.
“The Withdrawal cannot be made without incurring ‘financial penalty or adverse tax consequences’ as discussed in the Decision,” the letter concludes.
The letter references a previous, similar case that occurred in Rhode Island in 1991, where the state attempted to withdraw about $20 million from the state’s pension fund to cover a budgetary shortfall. The IRS determined in that case the withdrawal violated the Internal Revenue Code, and Rhode Island was forced to repay the $20 million – with three year’s-worth of interest at 8 percent.
“If the School Committee proceeds with the Withdrawal in violation of Code § 401(a)(2), it is likely that any corrective action taken thereafter would require repayment of the Withdrawal with interest,” Bilodeau wrote.
At the root of the issue is an emerging battle of semantics that came to head during Tuesday night’s budget hearing, where the school department was questioned for the better part of four hours about, among many other issues, their contributions to the pension fund that have since come under significant scrutiny as regularly being above the annual recommended contribution (ARC).
To recap, the schools were set to pursue a lawsuit against the city to seek approximately $4.9 million in additional funding they felt they were owed by the city to properly fund their budget, which was filed shortly after Christmas in 2018. However, in an attempt at renewing positive negotiations, the newly installed school committee dropped the suit and the two sides began binding mediation sessions in February.
Those sessions were ongoing until May 1, when mediator Vincent Ragosta penned his decision that the city would not be responsible for any additional funds to the school department. That decision, he wrote, was based on financial testimony received by the city and an analysis of financial data provided by the schools – including a finding from accounting firm Marcum LLP, working on behalf of the city, that the schools had contributed about $4.1 million above the ARC since 2014 towards their pension fund.
Council President Steve Merolla, and Ragosta in his award, contend that all sides were in agreement of the plan to use the pension funds to cover the shortfall.
“While some may view the WSC’s [Warwick School Committee’s] overabundant payments to bolster the sustainability of its Retirement Plan as laudable, during the April 29 mediation session, the Parties agreed that the WSC’s largesse must now be tapped from the $53 million of Retirement Plan assets to provide adequate funding for fiscal year 2018-2019,” Ragosta wrote in the mediator award. “The WSC claimed a need of $4 million for such adequate funding.”
“When we walked out of that meeting, was there anybody in that room on the school department side or the city side that didn't agree on the outcome of that mediation?” Merolla asked Kyle Connors, director of assurance at Marcum LLP, who conducted financial analysis for the city during mediation.
“It felt as though everyone was in agreement,” Connors said.
However, school finance director Anthony Ferrucci said on Wednesday that this was not actually the case.
“Our position was that we understood the decision,” he said. “I’m not an attorney but the room was full of attorneys. Somebody should have known there was a state legal decision made years ago that would have predicated that an employer can't take money out of a pension plan.”
However, those on the city side allege that Ferrucci had indicated during mediation questioning that he had utilized similar pension fund withdrawals in the past without fees or penalties incurred.
Ragosta wrote in the award that, “at the April 29 session the WSC represented to the City and the mediator/arbitrator that there shall be no financial penalty or adverse tax consequences attached to any such withdrawal of assets from the Retirement Plan, and that such is legally permissible. This representation was made in the presence of all of participants to the mediation/arbitration, including the Parties’ respective legal counsel and financial experts.”
However, Ragosta was also sure to include the following language as well:
“No legal or regulatory authorities were cited by the WSC to support this representation, nor has the mediator/arbitrator been charged to vet its accuracy or legality.”
Merolla asked Ferrucci to clarify his position at the mediation sessions during Tuesday night’s hearing.
“In mediation you had mentioned you had taken money out previously of the pension with no penalty, can you follow up on that?” he asked.
Ferrucci contends that he was asked, broadly, whether there have been scenarios in the past where money was taken out of the pension fund and re-allocated without penalties or fees being incurred.
The answer, he told Merolla on Tuesday night, was yes, but only in two specific scenarios: 1.) When pension beneficiaries receive a pension check into their account, which necessitates the sale and redistribution of pension stock assets to do so; and 2.) When a Warwick Public School employee terminates their employment prior to 10 years and either receives their full pension contribution, plus the schools’ match, in a wire transfer or it is transferred to their new retirement plan.
“Have we ever taken money back as the employer?” Ferrucci said. “Never.”
Merolla, clearly frustrated with Ferrucci’s explanation, followed up.
“So, the very subject matter that we were talking about, which is how do we fund these changes, didn't cross your mind? You were just talking about that you could withdraw $4 million for some other reason that wasn't germane to the topic that we were talking about?” he said.
“Again, I'm not an attorney, so I didn't offer an opinion,” Ferrucci answered. “I was asked specifically and I answered specifically.”
Ragosta followed up with a response to the letter opinion on Tuesday morning, saying that his mediator award “did not order the Committee to withdraw funds from the Plan. Contrarily, the Decision was a ruling in favor of the City, relieving it of any further obligation to fund the Committee's budget for the fiscal year at issue.”
Ragosta reiterated his assertion that Ferrucci had indicated withdrawing funds from the pension account would not result in penalties, and that the school committee had agreed to do so.
“Mr. Ferrucci made those statements in a joint session of all participants to the mediation in response to pointed questioning by the City,” he writes. “However dubious those representations may have been, they were nonetheless plainly made. Moreover, there was agreement by the Committee that the Plan's funds would be accessed.”
Ferrucci said Wednesday that he was disappointed that the council seemed more focused on the pension issue during Tuesday night’s budget hearing, and didn’t address the need for next year, which regardless of what happens to conclude this budget year, still poses an immense challenge.
“Whether we take the $4 million out, or if we choose not to take the $4 million and we end in a deficit, that's a whole other issue to deal with,” he said. “I'm just disappointed we didn’t discuss more about what we can do next year.”
Superintendent Philip Thornton said that what happened next in the ongoing issue is yet to be seen. Mayor Joseph Solomon said on Wednesday that Ragosta would have to be involved, but Ragosta indicated he is out of state until the week of June 3 attending to personal matters.
"We'll have to work through that," Thornton said. "As of today, this is information that's out there and we have to see what's next."