Federal regulators have accused the state of Illinois of misleading investors about the condition of its public pension program, marking just the second time in history that a state has been fingered for securities fraud.
In announcing a settlement with Illinois on Monday, the Securities and Exchange Commission said the state's 1994 Illinois Pension Funding Act "established a pension contribution schedule that was not sufficient to cover both (1) the cost of benefits accrued in the current year and (2) a payment to amortize the plans’ unfunded actuarial liability."
The payment schedule "structurally underfunded the State’s pension obligations and backloaded the majority of pension contributions far into the future," the notice of settlement continued. "The resulting systematic underfunding imposed significant stress on the pension systems and on the State’s ability to meet its competing obligations."
The law meant that for 15 years, Illinois was allowed to legally pass muster with its pension funding, even as the pension fund's unfunded liability increased. Additionally, the state in 2005 passed another law allowing it to take pension holidays, meaning there were years following that passage that the state did not fund its pension at all.
As a result, the SEC said that between 2005 to 2009, Illinois issued $2.2 billion worth of municipal bonds, which were marketed under false pretenses. Investors, the SEC said, could not see the increasing risk of investing in Illinois state bonds even as the state's unfunded liability grew and placed financial pressure on public coffers. For example, Illinois did not explain the implications of its decision to spread its pension costs over 50 years instead of the typical 30-year amortization period used by states. Nor did it disclose that the payment holidays it took increased the state's unfunded liability.
Elaine Greenberg, chief of the SEC’s Municipal Securities and Public Pensions Unit, said public pension disclosure is a top priority of her unit.
"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," she said in a statement.
As part of the settlement, Illinois agreed to a cease-and-desist order, although it did not admit any wrongdoing.
Today, Illinois' pensions are among the lowest-funded plans in the nation. By SEC figures, from 1996 to 2010, the state’s unfunded liability increased by $57 billion and as of 2011, the systems collectively were underfunded by $83 billion with an unfunded liability of 43 percent, (although some credit ratings agencies have pegged that ratio closer to 40 percent).
Earlier this year, ratings agency Standard & Poor's downgraded Illinois general obligation bonds. The downgrade came after Illinois closed its legislative session in January and failed to pass pension reform.
In his budget address on Friday, Illinois Gov. Pat Quinn warned the pension system had to be fixed or "within two years, Illinois will be spending more on public pensions than on education." Quinn's attempts at reform have stalled in the state legislature.
The settlement marks only the second time that the SEC has charged a state with securities fraud. In 2010, the agency charged New Jersey with similar misdeeds and a settlement was also reached.
Read the official cease-and-desist order below.