WASHINGTON — State and local governments should develop standards to bolster public pension disclosure or federal regulators may mandate improvements for them, a Securities and Exchange Commission official warned Tuesday.
The remarks came during the opening session of a two-day public pension conference here, sponsored by the Pew Center on the States.
“I think it’s in everyone’s best interests here to come up with a voluntary method of adequately disclosing public pension-fund liabilities being faced by state and local governments,” said Mark Zehner, deputy chief of the SEC enforcement division’s municipal securities and public pensions unit.
“If you want someone within the Beltway to solve the problem for you and come up with a one-size-fits-all disclosure regime, one easy way of making that happen is for you guys not to step up and do it on your own.”
Issuers and pension experts gathered amid a surge of interest in pension disclosure by regulators and market participants, particularly the revised pension accounting and financial reporting standards slated for release early next month by the Governmental Accounting Standards Board.
That guidance, dubbed an exposure draft, has been anticipated for at least a year, since GASB floated its preliminary views.
In the interim, the SEC settled high-profile securities fraud charges against New Jersey last year, the first such settlement with a state. The commission alleged the state failed to disclose to investors — who bought more than $26 billion of New Jersey’s muni bonds between 2001 and 2007 — that it was underfunding the state’s two largest defined-benefit pension plans.
In his remarks, Zehner said SEC chair Mary Schapiro and the commission staff remain focused on public pensions’ financial reporting.
“That’s the bedrock,” he said. “That’s the basis upon which everything else we do is founded.” Still, he said, while compliance with GASB standards and generally accepted accounting principles is important, it does not insulate municipal issuers from SEC scrutiny if they fail to disclose their pension obligations adequately.
“My concern is for the investors,” Zehner said. “And you need to fully and fairly and accurately disclose the status of your pension fund and the implications for the rest of your budget.”
Specifically, Zehner said, the state of New Jersey created the false impression that its two largest public sector pensions were fully funded.
The SEC found that the state’s bond offering documents failed to provide the plans’ asset and funded-ratio information on a market-value basis, meaning what the assets would be worth if liquidated on that date. A plan’s funded ratio is the ratio between the present value of its assets and its accrued liabilities. If a plan has a funded ratio of less than 100%, it has an unfunded liability.
New Jersey’s disclosure documents benchmarked the plans’ assets and funded ratio based on an actuarial value, which reflects an actuary’s efforts to smooth annual investment returns over multiple years to reduce volatility. The documents did not accurately reflect the plans’ current value, the SEC contended, because they failed to fully reflect the effect of market declines.
Specifically, the agency said that in fiscal year 2002 the actuarial value of one plan’s assets was $35 billion, while the market value was $27 billion. Using an actuarial value, the plan boasted a funding ratio of 100%. Under a market value, though, the plan had only a 77.2% funded ratio.
As a result, the SEC said, investors — who only saw the more favorable actuarial value — lacked sufficient information to assess the plans’ current financial health.
“That’s the no-no,” Zehner said. “In short, New Jersey hid its financial challenges from the very people most concerned about its financial health — those who were investing in its future.”
During his remarks, Zehner cited draft pension guidance circulated last month by the National Association of Bond Lawyers. “I’m not trying to sell the National Association of Bond Lawyers,” he said, but added that a voluntary industry initiative is in the interest of all market participants.
“You guys, frankly, will do a better job than someone within the Beltway,” Zehner said.
Next week, a broad range of market participants will meet to discuss NABL’s pension-disclosure project, according to the group’s president, John McNally, a partner at Hawkins Delafield & Wood LLP in Washington. The meeting will feature representatives from various muni market sectors, including issuers, underwriters, accountants, actuaries, analysts and GASB.
In addition to Zehner, the morning panel, entitled, “Gauging the Risks: Public Sector Retirement Liabilities,” included GASB chairman Robert Attmore, who outlined several of the board’s proposed public-pension accounting changes.
GASB’s board is scheduled to vote on the recommendations later this month, he said.
According to Attmore, GASB will propose a key shift: that issuers report unfunded pension liabilities on their balance sheets, rather than in the footnotes of financial statements.
GASB also will propose changing how public sector pensions value their pension assets and liabilities. Typically, plans use historic rates of return from roughly 7% to 8%.
Under the new proposal, GASB will recommend that pension plans use the historic rate of return only to the extent the plan has assets set aside, in an irrevocable trust for beneficiaries, to pay future benefits. When a plan lacks adequate resources to pay beneficiaries, GASB will propose shifting to a lower, so-called risk-free rate of return pegged to a Treasury rate of, typically, 3% to 4%.
“What we’re interested about is transparency,” Attmore said. “We just think it should be clear.”
Among Attmore’s fellow panelists, GASB’s proposal drew a mixed response.
“Big picture, long term, I see this all as a positive,” Zehner said.
Another pension expert on the panel was more subdued.
“The underlying numbers don’t change here,” said Keith Brainard, director of research for the National Association of State Retirement Administrators. “It’s just how they are accounted for and disclosed.”