SEC Charges State of Illinois with Misleading Investors

The SEC charged the State of Illinois with misleading investors when selling about $2.2 billion in municipal bonds over a four year period beginning in 2005. The proceeding alleges violations of Securities Act Sections 17(a)(2) and (3). In the wake of substantial remedial steps initiated by the State of Illinois beginning in 2009 and its cooperation during the investigation, the proceeding was resolved with a consent to the entry of a cease and desist order based on the Sections cited in the Order. In the matter of State of Illinois, File No. 3-14237 (March 11, 2013).

The action centers on the chronic underfunding of Illinois' pension plans for state workers. In 2011 the Illinois pension systems were, collectively, underfunded by about $83 billion. System assets covered only about 43% of its liabilities. This deficiency is rooted in years of chronic underfunding. Until 1981 the State funded pensions by paying the benefit obligations as they became due. This approach was abandoned in 1982. Over the next thirteen years contributions remained constant. In the face of rising costs however the system was underfunded by about $20 billion by 1995 when it had assets sufficient to cover only about half of the obligations.

In 1994 the State Assembly passed legislation designed to rectify the situation. Essentially the statutory plan called for achieving a 90% funded ration for each system by 2045. Part of the plan called for the State's contributions to ramp up over a fifteen year period. This permitted Illinois to shift the burden associated with its pension costs to the future, creating a structural underfunding. From 1996 through 2010 the unfunded liability increased by $57 billion. Significant financial stress resulted.

In its bond offering documents the State disclosed the Illinois statutory funding provisions. The documents did not disclose the fact that the contributions required by the statutory plan significantly underfunded the State's pension obligations. Likewise, the fact that pension funding was deferred into the future was not disclosed.

Beginning in 2005 the State amended the statutory plan, lowering the contributions or it borrowed to cover the payments. Although the basic facts were disclosed, the State did not inform investors that these actions exacerbated the structural underfunding, according to the Order. This resulted from the fact that the State failed to adopt or implement sufficient controls, policies, or procedures to ensure that material information was collected and disclosed.

In 2009 the State undertook to reform the system. In June of that year a Modernization Task Force was created. New personnel have been retained. Following the resolution of this action the State began implementing a series of remedial measures.

This is the second action brought by the Commission against a state focused on the failure properly disclose pension obligations in municipal bond offerings. The first was brought against the State of New Jersey three years ago. In the Matter of State of New Jersey, Adm. Proc. File No. 3-14009 (Aug. 18, 2010). There, however, the Order alleged that the State created the "illusion" that a statutory plan was being implemented to fund the obligations. In fact the state knew that the funding plan had been abandoned. The Order in that proceeding charged violations of the same Sections cited here.

For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

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