Securities Law

Illinois Settles SEC Disclosure Charge it Misled Investors on Pensions

CHICAGO — Illinois settled a fraud charge Monday with the Securities and Exchange Commission that it misled investors with shoddy disclosure between 2005 and 2009 about the significant financial risks posed by its pension funding system.

The SEC's two-and-a-half-year probe into the state's pension disclosure concluded Monday with the announcement of a civil charge of fraud against Illinois for violating federal securities laws in its public pension disclosures in offering statements on $2.2 billion of general obligation bonds.

The state settled the charge by agreeing to a cease-and-desist order in which it neither admitted nor denied the order's findings. Illinois does not face any fines or penalties.

The order offers a stinging assessment of the state's past disclosure practices for failing to provide investors with material information about its pension funding system and the stress it posed to the state's fiscal condition.

The action Monday is the second taken by the SEC against a state. New Jersey entered a settlement order in 2010. "Municipal investors are no less entitled to truthful risk disclosures than other investors," said George S. Canellos, acting director of the agency's Division of Enforcement. "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 state established a 50-year funding schedule in 1994 with payments based on a statutory formula, not an actuarially required contribution. The SEC found that the methodology structurally underfunded Illinois' pension obligations and backloaded the majority of pension contributions far into the future.

"The resulting systematic underfunding imposed significant stress on the pension systems and on the state's ability to meet its competing obligations," the order reads.

The state misled investors about the effect of changes to the funding plan after pension-payment holidays in 2005 and other years by failing to disclose the effect of those changes on the contribution schedule or on the state's ability to meet its obligations.

"Reasonable investors would have considered information regarding the state's structural underfunding of its pensions, the risks created by that underfunding, and the financial condition of the pension plans to be important factors in the investment decision-making process," the order reads. "Such information allows investors to weigh and price the risk associated with the state's debt obligations."

Illinois faces a staggering $95 billion of unfunded liabilities for a funded ratio of just 40.4%, the worst among U.S. states.

The poor disclosure occurred between 2005 and 2009 on $2.2 billion of general obligation borrowings.

After taking office in early 2009, Quinn's finance team implemented some initial changes to the state's disclosure practices and in 2010 hired Chapman and Cutler LLP to overhaul its pension reporting.

That move came after a New Jersey case was resolved in August 2010 and amid escalating national calls by the SEC and bond lawyers for improved pension disclosure.

Illinois in September 2010 received a request for information from the SEC which had launched an inquiry into its pension disclosure and impact of pension reforms adopted in 2009 on the funding schedule.

The state debuted an expanded disclosure section that doubled its reporting to 20 pages in an offering statement in January 2011. It also later departed from past practice in its selection of bond counsel from a qualified list to use one firm — Mayer Brown LLP — for more continuity in disclosure.

In a statement Monday, Gov. Pat Quinn's administration outlined the changes adopted since 2009 after he took office and its position in agreeing to the order. "The state believed it to be in its best interests to enter into a settlement with the SEC. The state has cooperated fully with the SEC throughout the inquiry," it read.

The SEC noted the state's advances and considered them in reaching the settlement. They also included the implementation of written policies and procedures as well as disclosure controls and training programs.

The state also designated a disclosure committee to assemble and evaluate pension disclosures.

"It's clear that the significantly enhanced disclosure the state now has in its bond offering statement stands in stark contrast to the type of disclosure or lack thereof in previous documents," Elaine Greenberg, chief of the SEC's municipal mecurities and public pensions unit, said in an interview.

Greenberg said adequate pension disclosure, which remains voluntary, is still under regulatory scrutiny and the hope is it "will continue to serve as a warning to municipal and state issuers."

The National Association of Bond Lawyers last year released a document containing guidance and suggestions to help issuers provide appropriate disclosures about their public pension systems in bond documents.

The SEC action Monday offers a mixed bag for Illinois. It's a positive in that the state resolves an issue that has loomed for more than two years without fines or penalties or the need to take further action.

But the fraud charge provides another negative headline for investors to digest as the state grapples with daunting budget woes that include skyrocketing pension payments and a $9 billion backlog of bills.

The state's rating already has suffered several rounds of downgrades and further deterioration could occur if lawmakers don't act in the coming months on pending pension reform.

Fitch Ratings has the state's A rating on negative watch. Standard & Poor's earlier this year downgraded Illinois to A-minus and assigned a negative outlook. Moody's Investors Service assigns a negative outlook to the state's A2 rating.

The state pulled a bond sale set for January over concerns that investors would demand too steep an interest-rate penalty than the state wanted to pay over recent negative credit action. The sale has not been rescheduled.


(1) Comment



Comments (1)
Just think what the settlement would have been if fraudulent disclosure had been committed by a corporate issuer!
Posted by mdwjr | Tuesday, March 12 2013 at 9:36AM ET
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