Monday, August 11, 2014
The Securities and Exchange Commission today announced securities fraud charges against the state of Kansas stemming from a nationwide review of bond offering documents to determine whether municipalities were properly disclosing material pension liabilities and other risks to investors. According to the SEC’s cease-and-desist order instituted against Kansas, the state’s offering documents failed to disclose that the state’s pension system was significantly underfunded, and the unfunded pension liability created a repayment risk for investors in those bonds.
Shortly after its nationwide review of municipal bond disclosures began, the SEC brought its first-ever enforcement action against a state when it sanctioned New Jersey for failing to disclose to investors that it was underfunding the state’s two largest pension plans. New Jersey offered and sold more than $26 billion worth of municipal bonds in 79 offerings between August 2001 and April 2007. The offering documents for these securities created the false impression that the Teachers' Pension and Annuity Fund (TPAF) and the Public Employees' Retirement System (PERS) were being adequately funded, masking the fact that New Jersey was unable to make contributions to TPAF and PERS without raising taxes, cutting other services or otherwise affecting its budget.
The SEC also charged Illinois last year for its misleading pension disclosures. An SEC investigation revealed that Illinois failed to inform investors about the impact of problems with its pension funding schedule as the state offered and sold more than $2.2 billion worth of municipal bonds from 2005 to early 2009. Illinois failed to disclose that its statutory plan significantly underfunded the state’s pension obligations and increased the risk to its overall financial condition.
In 2006, the SEC sanctioned the City of San Diego for securities fraud by failing to disclose to the investing public important information about its pension and retiree health care obligations in the sale of its municipal bonds in 2002 and 2003. The SEC also charged five San Diego city officials with securities fraud, at least four of whom paid disclosed financial penalties as a result, including the City Manager, City Treasurer, City Auditor & Comptroller, and Deputy City Manager for Finance. The SEC alleged that the San Diego officials knew the city had been intentionally under-funding its pension obligations so that it could increase pension benefits but defer the costs. They also were aware that the city would face severe difficulty funding its future pension and retiree health care obligations unless new revenues were obtained, benefits were reduced, or city services were cut. However, despite this extensive knowledge, they failed to inform municipal investors about the severe funding problems in 2002 and 2003 bond disclosure documents.
According to the SEC’s order against Kansas, the series of bond offerings were issued through the Kansas Development Finance Authority (KDFA) on behalf of the state and its agencies. According to one study at the time, the Kansas Public Employees Retirement System (KPERS) was the second-most underfunded statewide public pension system in the nation. In the offering documents for the bonds, however, Kansas did not disclose the existence of the significant unfunded liability in KPERS. Nor did the documents describe the effect of such an unfunded liability on the risk of non-appropriation of debt service payments by the Kansas state legislature.
“Kansas failed to adequately disclose its multi-billion-dollar pension liability in bond offering documents, leaving investors with an incomplete picture of the state’s finances and its ability to repay the bonds amid competing strains on the state budget,” said LeeAnn Ghazil Gaunt, chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit. “In determining the settlement, the Commission considered Kansas’s significant remedial actions to mitigate these issues as well as the cooperation of state officials with SEC staff during the investigation.”