Illinois pension charged by SEC

The Securities and Exchange Commission said Illinois didn’t put enough into its state pension and charged the state with securities fraud. It’s most noteworthy because it’s only the second time the agency has gone after a state.

Here are the details from the Wall Street Journal”

For years, Illinois officials misled investors and shortchanged the state pension system, leaving future generations of taxpayers to foot the bill, U.S. securities regulators allege.

The Securities and Exchange Commission on Monday charged Illinois with securities fraud, marking only the second time the agency has filed civil-fraud charges against a state.

But the agency and the state also announced that a settlement had already been reached in which Illinois won’t pay a penalty or admit wrongdoing.

The action was part of a broader push by the SEC to bring greater transparency and accountability to the municipal-bond market, as the agency alleged the state failed to adequately disclose to investors the risks of its underfunded pensions systems.

The action also shows in detail how political decisions left the state with only 40 cents of assets for every dollar of pension liabilities—a financial hole Illinois officials are now scrambling to fill.

Yet no matter how harmful the pension practices were to the state’s finances, SEC officials say they could only pursue charges against Illinois for what it failed to tell bond investors, who bought bonds worth $2.2 billion.

The New York Times explains how the SEC is able to come after the state for not funding its retirement plan:

In announcing a settlement with the state on Monday, the Securities and Exchange Commission accused Illinois of claiming that it had been properly funding public workers’ retirement plans when it had not. In particular, it cited the period from 2005 to 2009, when Illinois also issued $2.2 billion in bonds.

The growing hole in the state pension system put increasing pressure on Illinois’ own finances during that time, raising the risk that at some point the state would not be able to pay for everything, and retirees and bond buyers would be competing for the same limited money. The risk grew greater every year, the S.E.C. said, but investors could not see it by looking at Illinois’ disclosures.

In effect, that meant investors overpaid for bonds of a lower value than they were made out to have, although the S.E.C. did not measure any loss in dollars, and it did not impose fines or penalties in Monday’s settlement. Illinois agreed to a cease-and-desist order without admitting or denying the accusations.

The charges put the state’s pension system, generally thought to be the weakest of any state, back in the national spotlight. In his budget address last week, Gov. Pat Quinn, a Democrat, issued a clear warning that the system had to be fixed.

“Without pension reform, within two years, Illinois will be spending more on public pensions than on education,” said Mr. Quinn. “As I said to you a year ago, our state cannot continue on this path.”

Many states, counties and cities are struggling with shortfalls in their pension systems, and because large numbers of people now qualify to draw benefits, the expense is wreaking havoc with budgets. Still, securities lawyers are not predicting a wave of S.E.C. pension enforcement actions. The states are legal sovereigns, and federal securities regulators have much more power to police corporate wrongdoing than potential violations by the states and municipalities.

The S.E.C. does have the power to step in when it believes that there has been a fraud, but that means meeting a tough standard of proof. Many of today’s troubled public pension funds got that way through missteps that, while harmful, do not necessarily constitute fraud: overly rosy investment assumptions, failure to take into account that Americans are living longer, and bad calls about how much benefits actually cost.

Reuters provided these details on how Illinois was able to skip out on its payments:

In official statements accompanying bond offerings Illinois explained that factors such as market performance had contributed to the increase in its unfunded pension liability, but it “misleadingly omitted to disclose the primary driver of the increase – the insufficient contributions,” the SEC said.

In order to keep its contributions low, Illinois had developed a complicated system that included “ramp-ups” and “pension holidays,” the SEC said.

Instead of paying to pension funds what actuaries had determined to be the annual contributions, Illinois followed a funding plan approved by the legislature that deferred the payment of pension obligations, compounding its pension burden.

The legislature phased in the state’s contribution over a fifteen-year “ramp” period, where the amount Illinois put in gradually grew until in 2011 it made the full amount. It then had to put in a level amount so the pension system was funded by 2045.

The state went further, amortizing pension costs over 50 years, instead of the typical 30, which gave it a longer window to pay off the liability. Then, it lowered the contributions in 2006 by 56 percent and in 2007 by 45 percent in “pension holidays.”

The Times said that the state has taken some measures to correct the problems, but significant pension reform hasn’t been undertaken. Seems like it’s time to get started.