When the Securities and Exchange Commission last week accused the state of Illinois of misleading investors about the condition of its public pension program, it was only the second time in history that the federal agency has taken action against a state for securities fraud.
That could soon change.
The SEC’s head of municipal securities said this week he’d like to see the agency step up its enforcement measures, as he seeks to define his office’s role.
“Expect in the future that the SEC may have a bigger footprint in enforcement of municipal securities,” Director of Municipal Securities John Cross told an audience of state treasurers this week in Washington, D.C. Cross, who was a speaker at the annual legislative conference for the National Association of State Treasurers, noted that the SEC’s newly nominated director, Mary Jo White, is also known for being no-nonsense.
“She has a strong reputation as a tough prosecutor, a quick … attorney and a hard worker,” he said.
Cross’ office was established last year as part of the recommendations made by a 165-page report on the municipal securities market released in July 2012. The report called for broad reforms to the municipal market in the area of disclosure, including requiring issuers to supply bond investors with audited financial statements. The report also highlighted the lack of information about municipal bonds available to investors, making it harder for buyers and inexperienced issuers to determine a fair price for the bonds.
SEC watchdogs have been critical of the agency’s oversight of public finance, saying it hasn’t done enough to protect taxpayers from bad government deals. By its own count, the SEC has charged more than 150 firms and individuals and secured $2.6 billion for investors. But similar enforcement actions in the municipal securities market have been few and far between.
Sheila Weinberg, founder of the nonprofit Institute for Truth in Accounting, said action like the recent charge against Illinois was long overdue.
“Their major concern is whether the governmental entity has enough money to cover bonds [it issues]. They’re just starting to pay attention to these long term obligations,” she said. “I think they dropped ball on highlighting the fact that these governments are getting into long-term obligations that obviously they don’t have enough money to meet.”
In the Illinois case, the SEC 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." In addition, Illinois used an amortization period of 50 years, which had the effect of reducing its pension liability. Although states are not required to use the generally accepted 30-year amortization period recommended by the Governmental Accounting Standards Board, they are supposed to explain their reasons for not following them, if they choose to do so.
“They were found to be lacking on that,” Cross said this week.
The result, according to the settlement announced by the SEC, was that Illinois issued municipal bonds that were marketed under false pretenses: Investors 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.
“I think they’re starting to pay attention to these long term obligations because they’re starting to realize that eventually these long term liabilities will come to roost, probably in the next five to 10 years,” Weinberg said. “But they have not been paying attention for some time now.”
Other than following a cease-and-desist order, Illinois was given no other reprimand. The settlement noted that since 2009, the state "has taken significant steps to correct these process deficiencies and enhance its pension disclosures." The step included retaining a disclosure counsel; instituting written policies and procedures, disclosure controls, and training programs; and designated a disclosure committee.
Still, Illinois' pensions are today among the lowest-funded plans in the nation. By SEC figures, from 1996 to 2010, the state’s unfunded liability increased by $57 billion. 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).