'California Rule' Case Could Bring National Pension Ripples

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PHOENIX – The Supreme Court of California has a case before it with the potential to alter the political and legal conversations about pensions in the Golden State and beyond.

Within a few months, the state's top court is expected to hear an appeal of a landmark pension ruling out of Marin County that challenges the decades-old precedent known as the "California Rule."

An appellate court ruled unanimously in August that the Marin County Employees' Retirement Association was free to modify the pension formula to reduce unearned benefits for current employees, a decision that flies in the face of the state Supreme Court's 1955 ruling granting employees the right to continue earning pension benefits throughout their careers that are at least as good as those offered when they were hired.

A date for arguments has not been set, as the Supreme Court is waiting for another similar case from Alameda County to work its way through the appellate process before it takes up the question itself.

The case arose in the aftermath of California's Public Employees' Pension Reform Act, or PEPRA, which took effect in January 2013.

The law was an effort by reform advocates to crack down on pension benefit "spiking," which is the practice of inflating pension benefits by calculating things like unused vacation time or various bonuses into the formula at the end of an employee's career to raise the amount employees are entitled to after retirement.

California Gov. Jerry Brown vigorously attacked spiking in supporting PEPRA, labeling the practice "abusive."

PEPRA said that pensions had to be calculated based only on an employees' regular pay, but MCERA's move to apply the anti-spiking change to existing employees rather than only new hires landed the issue in court.

Experts on pensions and bankruptcy said that the ruling has the potential to be far-reaching not only in how pension benefits are negotiated in California, but also in other states because of how influential the California Rule decision has been nationally.

In a May 2012 paper critical of the rule published in the Iowa Law Review, Amy B. Monahan noted that courts in at least twelve states have cited the California Rule in their own pension decisions. She cited Alaska, Colorado, Idaho, Kansas, Massachusetts, Nebraska, Nevada, Oklahoma, Oregon, Pennsylvania, Vermont, and Washington.

"In nearly all of these jurisdictions, the courts adopted the California Rule without much discussion, appearing to merely find it the most attractive of the available non-gratuity options," Monahan wrote.

Some states went on to subsequently modify the rule, and some states, such as New Jersey, explicitly rejected it, Monahan noted.

But the California Rule remains influential, and lawyers and pension reform advocates are closely watching the MCERA case to see if the state's top judges, themselves public employees entitled to pensions, will alter the landscape Californians have been living with for 60 years.

Moody's Investors Service said in August that the initial appellate ruling was positive not only for Marin County, but also California and its other local governments.

"It is potentially far-reaching," said Marc Levinson, a municipal bankruptcy expert and attorney in the Sacramento office of Orrick, Herrington & Sutcliffe. "Everyone is watching it very carefully."

Levinson said the national implications of the MCERA case are not clear, noting that federal bankruptcy judges in Detroit and Stockton have indicated that pension rights can be altered in a municipal bankruptcy proceeding.

"It would be dependent on local law," Levinson said, stressing that the decision will have no effect on the benefits of any pensioners who have already retired.

Former San Jose Mayor Chuck Reed, a pension reformer and board member of the pension reform advocacy group Retirement Security Initiative, said that the decision won't alter California's political reality but has the potential to alter the legal framework that informs the California pension landscape.

"The legal framework affects the political framework," Reed said.

The case does not affect benefits accrued during a public employee's previous or current years of work, but rather whether formulas or rules can be adjusted for future years.

Right now, Reed said, California labor unions generally refuse to even have a discussion about reducing future benefits for current employees. The conversation is a total non-starter because of the California Rule. That can be a frustration for officials who see their long-term pension obligations as unsustainable and who want to institute reforms to protect the fiscal health of their localities.

Those pressures were accentuated this week when the California Public Employees' Retirement System, the nation's largest pension system and one that includes more than 3,000 state, local government and school district employers, voted to lower its expected investment returns, a decision that will require even higher contributions from employers and, maybe, employees.

"The cities in trouble right now, there's not much they can do," Reed said. "Changing the legal framework completely changes where you start the discussion."

Reed said he is still planning to back a bipartisan pension reform ballot measure aimed at limiting the benefits of new employees, saying that a pro-reform ruling out of the Supreme Court could potentially be beneficial to his own initiative's prospects.

Reed, a Democrat, and former San Diego city council member Carl DeMaio, a Republican, had originally hoped their measure to give voters some power over pension benefit changes would be on the ballot in 2016.

But they announced in January that they were pulling the measure for a possible re-attempt in 2018 because donors backing the initiative believed the effort's prospects would be better then.

Reed emphasized that even if the Supreme Court does rule that changes to the existing benefit formula are legal, it would not force those changes to be made.

While the process is moving forward, it will not be swift.

Levinson said that the Supreme Court could take several months to make a ruling even once oral arguments are held.

"It could be a while, is the bottom line," said Levinson.

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