Testimony before the House Judiciary Committee Subcommittee on Commercial and Administrative Law Submitted by LSC Chairman Frank B. Strickland, June 28, 2005
Mr. Chairman, Mr. Watt, and Members of the Subcommittee, thank you for the opportunity today to testify with regard to the current leasing arrangement the Legal Services Corporation has for its headquarters at 3333 K Street, Northwest.
When I and seven of my fellow members of the LSC Board of Directors had the honor of being nominated by President Bush and unanimously confirmed by the Senate in 2003, our plan was to oversee the delivery of high quality and efficient legal services to the poor throughout America, and to faithfully enforce the intent of Congress as expressed by the various laws governing both LSC and our local legal services programs. I believe we are doing that.
One of our first tasks was to fill the two positions at LSC that report directly to the Board. The President, former Congressman John Erlenborn, a distinguished member of this body for twenty years, clearly indicated his desire to retire and we had an acting Inspector General. The Board brought on Helaine Barnett as President in January 2004 and Kirt West as Inspector General last September.
In February, the Inspector General delivered a draft report prepared by his Office regarding the lease of 3333 K Street. Because that report made no recommendations and did not question the conduct of either the current Board or President, the Board had no legal or substantive obligation to respond, a fact the Inspector General pointed out to us.
However, because the report stated that LSC was overpaying rent by as much as $1.9 million over 10 years compared to fair market value, and paying more than if it had remained in its previous offices, we decided to examine the report carefully. Moreover, because of vague allusions to conflict of interest and breaches of fiduciary duty, our President in consultation with me decided to appoint a new senior staff person, who had not been present during the transaction, to help the Board review the matter.
The Board concluded its review in the third week of March. We voted unanimously that, based on the information provided to us by the OIG, we could not conclude that the lease transaction was "inappropriate or fiscally unsound." In short, we rejected the draft OIG report. The final OIG report, basically unmodified from the draft, and the Board response were transmitted to Congress on April 22.
Let me quickly highlight the key findings of the Board. First, we had serious problems with the methodology employed by the two appraisers hired by the OIG as well as the manner in which the OIG analyzed those appraisals. The appraisers, on the apparent instructions of the OIG, used a static, retrospective analysis based solely on the state of the commercial real estate market in July 2002. It seems obvious, in reviewing the judgment of the prior Board and Congressman Erlenborn, the evaluation should be based on expectations of the commercial market from June 2003 through May 2013 (the life of the lease) and should take into account events that have transpired since mid-2002. In this regard, one of the OIG's appraisers noted that the retrospective analysis they employed is normally used for estate valuations, tax assessments, and condemnations. That kind of analysis is irrelevant to evaluating the merits of LSC's current lease.
Second, in comparing LSC's costs to those at its prior offices, the OIG ignored the fact that the prior Board and management had concluded that LSC needed additional space, and in fact acquired 5,000 additional square feet and 27 additional parking spaces as a result of the move. The OIG did not take into account what it would have cost LSC to get 5,000 additional square feet in its previous office building on First Street, even if such space was available. The OIG also ignored the fact that LSC's lease was expiring in 2007 and that LSC had would have had to renegotiate with its then-existing landlord or find new space in what is clearly now a very hot D.C. commercial real estate market. In fact, as of this moment, LSC is paying less, when taking into account the additional space and parking spots, than it would have been paying had it not moved, a point one of the OIG's appraisers acknowledged.
Third, with respect to the allegation that LSC is overpaying compared to fair market value, the Board concluded that the analysis employed by the OIG failed to take into account several key factors. I will not repeat all of them here; they are in our response. The key one is that LSC received tenant improvements of up to $2 million - well over what a typical market transaction would have provided for. Just like a car buyer gets a different price depending on whether he puts up cash or insists the dealer provide him with a no interest loan, when a tenant receives above market concessions from the landlord, they have to be paid for and that will reflect itself in the lease cost. The difference between tenant concessions assumed by one of the OIG's appraisers in estimating fair market rent and what LSC actually received is $1.6 million - $1.3 million in tenant improvements and at least $300,000 in parking concessions - over 80 percent of the alleged $1.9 million over-payment that the OIG calculated using that appraiser's assumptions. Even accepting some questionable assumptions on the part of the OIG and its appraisers, we are left with an alleged overpayment over ten years of $300,000 when the tenant concessions are accurately counted. That amounts to 1.7 percent of the total lease payments to be made under the contract.
A week after the OIG report was submitted to Congress, I was provided a copy of the contemporary appraisal commissioned by the Bank of America in 2002 before it agreed to finance the transaction. That appraisal concluded, taking into account the value of the above market build-out, that the proposed LSC rent was within the range of fair market value. The Board was not made aware of the appraisal during its consideration of the OIG draft report, although the OIG had the appraisal, and the Board subsequently voted unanimously that we should have had it and that it confirmed our conclusion. Accordingly, we believe the OIG failed to make his case and we consider this matter closed.
Finally, I would like to make a few observations. First, I will not try to assert that everything done by LSC from 2001 to 2003 was perfect. However, the OIG's suggestion that LSC overpaid by $1.9 million over ten years or somehow failed to adequately serve as a reasonable, fiscally prudent steward of public funds is incorrect. I would note that the then-Inspector General was at the time represented at virtually every meeting at which the lease transaction was discussed and was fully aware of all the details of the transaction, even requesting and receiving a private briefing. It is my understanding that no objections were raised with the previous Board or management by the previous Inspector General or the OIG.
Second, it is indisputable that this transaction will ultimately save LSC money. The only question is how much and beginning when. The OIG pegged the beginning of savings to be in the last couple of years of LSC's ten year lease with total savings only to be realized if there is an extension. Based on the evidence provided to the Board, it appears more likely that LSC is beginning to see savings now and will show significant savings during the current lease term. There is no question that, during a second ten year term and beyond, savings will be substantial compared to the alternative of continuing to rent commercial office space.
Third, there has been no evaluation by the OIG of the substantial benefits to LSC from the transaction. These include efficiencies from LSC's possession of space built to its needs and specifications; stabilizing LSC's cost of space and removing its dependence on the D.C. commercial office market; and the long- term advantage of having a nonprofit landlord which was specifically created for, and whose charter provides as its purpose, to benefit LSC and support its mission of delivering legal services to the poor. No other landlord fits this description.
This transaction was conceived by John McKay, who President Bush appointed as and is now U.S. Attorney for the Western District of Washington. The K Street building was found, the details negotiated, and the contracts executed under the direction of former Congressman Erlenborn, with every key decision approved by my predecessors on the Board. I cannot say everything was done perfectly; I was not here at the time. I am confident, however, that the prior LSC Board acted honorably and properly every step of the way and that, if any mistakes were made, they were miniscule compared to the overall long-term gains that are and will be realized by LSC. The current Board has reviewed the reports of the Inspector General suggesting that our predecessors, previous management and the former Inspector General all erred in approving this transaction and we unanimously rejected that finding.