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The Securities and Exchange Commission on Monday charged the state of Illinois with securities fraud for misleading municipal bond investors about the state’s approach to funding its pension obligations.
An SEC investigation revealed that Illinois failed to inform investors about the impact of problems with its pension funding schedule as the state offered and sold more than $2.2 billion worth of municipal bonds from 2005 to early 2009.
“Illinois failed to disclose that its statutory plan significantly underfunded the state’s pension obligations and increased the risk to its overall financial condition,” the SEC says. “The state also misled investors about the effect of changes to its statutory plan.”
Illinois, which the SEC says implemented a number of remedial actions and issued corrective disclosures beginning in 2009, agreed to settle the SEC’s charges.
“Municipal investors are no less entitled to truthful risk disclosures than other investors,” said George Canellos, acting director of the SEC’s Division of Enforcement, in a statement. “Time after time, Illinois failed to inform its bond investors about the risk to its financial condition posed by the structural underfunding of its pension system.”
The enforcement action against Illinois is the second time that the SEC has charged a state with violating federal securities laws in public pension disclosures. The SEC charged New Jersey in 2010 with misleading municipal bond investors about its underfunding of the state’s two largest pension plans.
Illinois’ state employee pension system faces a $100 billion hole that is growing by $17 million per day, The Associated Press reported in January.
Elaine Greenberg, chief of the SEC’s Municipal Securities and Public Pensions Unit, added in the same statement that “regardless of the funding methodology they choose, municipal issuers must provide accurate and complete pension disclosures including the effects of material changes to their pension plans. Public pension disclosure by municipal issuers continues to be a top priority of the unit.”
According to the SEC’s order instituting settled administrative proceedings against Illinois, the state established a 50-year pension contribution schedule in the Illinois Pension Funding Act that was enacted in 1994. The schedule proved insufficient to cover both the cost of benefits accrued in a current year and a payment to amortize the plans’ unfunded actuarial liability. “The statutory plan structurally underfunded the state’s pension obligations and backloaded the majority of pension contributions far into the future. This structure imposed significant stress on the pension systems and the state’s ability to meet its competing obligations—a condition that worsened over time,” the SEC found.
The SEC’s order finds that Illinois misled investors about the effect of changes to its funding plan, particularly pension holidays enacted in 2005. “Although the state disclosed the pension holidays and other legislative amendments to the plan, Illinois did not disclose the effect of those changes on the contribution schedule and its ability to meet its pension obligations. The state’s misleading disclosures resulted from various institutional failures. As a result, Illinois lacked proper mechanisms to identify and evaluate relevant information about its pension systems into its disclosures.”
For example, “Illinois had not adopted or implemented sufficient controls, policies or procedures to ensure that material information about the state’s pension plan was assembled and communicated to individuals responsible for bond disclosures. The state also did not adequately train personnel involved in the disclosure process or retain disclosure counsel,” the SEC says.
According to the SEC’s order, Illinois took multiple steps beginning in 2009 to correct process deficiencies and enhance its pension disclosures.