SEC, Illinois Settle Fraud Case Centering on Pensions Reporting

Published March 11, 2013

Illinois government officials have announced a settlement of securities-fraud charges the Securities and Exchange Commission filed after an investigation that began last fall.

Without admitting or denying wrongdoing, Illinois officials agreed the state would “cease and desist from committing or causing any violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.”

The SEC complaint centered on Illinois’ reporting of pension obligations. It is the second time the SEC has charged a state with securities fraud. In 2010 the SEC also filed fraud charges against the State of New Jersey over its pension obligations reporting.

‘Failed to Disclose’

According to the SEC, 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. The state also misled investors about the effect of changes to its statutory plan.”

Illinois is widely recognized as having the nation’s worst-funded pension system. Conservative estimates place the underfunding at nearly $97 billion. The state also has nearly $10 billion in unpaid bills. Credit rating agencies have given Illinois the nation’s lowest credit rating.

“Municipal investors are no less entitled to truthful risk disclosures than other investors,” said George S. Canellos, acting director of the SEC’s division of enforcement, in a statement. “Time after time, Illinois failed to inform its bond investors about the risk to its financial condition posed by the structural underfunding of its pension system.”

Gimmicky Funding Plan

In the mid-1990s Illinois established a 50-year funding plan for its pension system. At the time, many critics pointed out it put most of the funding burden decades in the future, absolving lawmakers then of much of the responsibility to properly fund the pensions.

The SEC noted that plan in its statement outlining its complaint:

“The statutory plan structurally underfunded the state’s pension obligations and backloaded the majority of pension contributions far into the future. This structure imposed significant stress on the pension systems and the state’s ability to meet its competing obligations – a condition that worsened over time.

“The SEC’s order finds that Illinois misled investors about the effect of changes to its funding plan, particularly pension holidays enacted in 2005. Although the state disclosed the pension holidays and other legislative amendments to the plan, Illinois did not disclose the effect of those changes on the contribution schedule and its ability to meet its pension obligations. The state’s misleading disclosures resulted from various institutional failures. As a result, Illinois lacked proper mechanisms to identify and evaluate relevant information about its pension systems into its disclosures.”

The SEC noted Illinois in 2009 began improving pension disclosures and reporting procedures. The Commission took those efforts into account in its settlement agreement.