SEC Hits New Jersey With Fraud Rap

WASHINGTON — The Securities and Exchange Commission on Wednesday for the first time charged a state — New Jersey — with violating securities fraud laws by failing to disclose to bond investors that it was underfunding its two largest pension plans.

New Jersey agreed to settle the case without admitting or denying the SEC's findings and said it will cease and desist from committing any further violations. There was no fine.

The case should send strong signals to other states and localities, many of which are slowing or halting payments of unfunded pension liabilities as they struggle to balance their budgets during the recession.

One of the goals of the enforcement action is to put other states and localities on notice about the importance of being accurate with disclosures about pension plans, according to Elaine Greenberg, chief of the SEC's municipal securities and public pensions enforcement unit.

"All issuers of municipal securities, including states, are obligated to provide investors with the information necessary to evaluate material risks," said Robert Khuzami, director of the SEC's enforcement division. "The state of New Jersey didn't give its municipal investors a fair shake, withholding and misrepresenting pertinent information about its financial situation."

Greenberg said the case marks the end of the commission's inquiry into the matter. New Jersey officials said the SEC began looking into its pension fund disclosures in April 2007, though Greenberg declined comment on the probe's timing.

New Jersey sold 79 bond issues totaling $26 billion between August 2001 and April 2007 that created the false impression that its two largest pensions — the Teachers' Pension and Annuity Fund and the Public Employees' Retirement System — were adequately funded, the SEC said.

The faulty disclosures masked the fact that New Jersey was unable to make contributions to the two pension plans without raising taxes, cutting other services, or otherwise affecting its budget. As a result, investors were not given sufficient information to evaluate the state's ability to fund its pensions or to assess the plans' impact on the state's financial condition.

Though Wednesday's settlement was the first muni case the SEC has filed against a state, it comes as the SEC has beefed up its focus on the market. It formed the specialized muni and public pension fund enforcement unit earlier this year and has staffed it with more than two dozen attorneys charged with pursuing cases.

However, the commission only asserts that New Jersey officials acted with negligence rather than the more serious charge of recklessness, which requires proof of scienter, or intentional wrongdoing, bond attorneys noted.

New Jersey appears to have avoided more serious charges by taking proactive steps to improve their disclosure practices, prompted by an April 2007 New York Times story that raised questions about the pension-related disclosures, the attorneys said. After the story's publication, the state hired an outside disclosure counsel, Arthur McMahon of Nixon Peabody LLP, to help state officials review, evaluate, and enhance their disclosure process.

The state now has written policies and procedures that, among other things, require a committee comprised of senior officials and disclosure counsel to oversee the entire disclosure process and to review and make recommendations regarding its disclosure practices.

In addition, New Jersey has implemented an annual mandatory training program conducted by disclosure counsel for employees involved in the disclosure process to ensure compliance with the state's obligations and the securities laws.

The policies and procedures parallel those adopted by San Diego after the SEC settled with the city in November 2006 over pension disclosure failures.

Though New Jersey is set to price $2.25 billion of one-year tax and revenue anticipation notes via competitive bid on Thursday, state officials said there are no plans to delay the sale in light of the enforcement action.

The SEC said the disclosure fraud began in November 2001 when the Legislature enacted legislation that increased retirement benefits for employees and retirees enrolled in TPAF and PERS by 9.09%. However, the state resorted to accounting gimmicks to "fund" the enhanced benefits, rather than increase costs to the state or taxpayers. Specifically, it revalued TPAF and PERS' assets to reflect their full market value as of June 30, 1999, at the height of the bull market. As a result, the documents essentially masked a $2.4 billion decline in the market value of the pension assets between 1999 and 2001, the SEC said.

The SEC also found that the state failed to disclose and misrepresented information about special Benefit Enhancement Funds created by the 2001 legislation that initially were intended to fund the costs associated with the increased benefits, among other issues.

In some ways, the case is similar to the SEC's 2006 settlement against San Diego in that it addresses material misstatements and omissions concerning pensions in disclosure documents, sources said. But the San Diego case, which involved disclosures tied to five 2002 and 2003 bond issues, revolved around inconsistencies between notes to the financial statements and the text in the body of the city's official statements. The SEC also went further and charged San Diego with recklessness.

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