SEC Charges Illinois With Securities Fraud And Lets It Off With A Warning

This week, Illinois became only the second state in U.S. history to by charged with securities fraud by federal regulators (New Jersey was the first, in 2010). On Monday, the Securities and Exchange Commission (SEC) accused Illinois of deceiving investors regarding the health of its state employee pension funds, in a series of bond offerings from 2005 to 2009. In its cease-and-desist complaint, the SEC claimed:

Specifically, in numerous bond offerings from approximately 2005 through March 2009, the State misled bond investors by omitting to disclose information about the adequacy of its statutory plan to fund its pension obligations and the risks created by the State’s Structural Underfunding of its pension obligations. During this same time period, the State also misled bond investors about the effect of changes to that plan, including the Pension Holidays in 2006 and 2007.

Illinois settled immediately, without either admitting or denying the charges. The state did not have to pay a penalty, which, considering the extent of its pension funding shenanigans, is surprising, to put it mildly.

The problem had been building up for a long time. In 1994, the Illinois legislature enacted the Statutory Funding Plan for state pensions, which went into effect the following year. The plan established a 50-year schedule to reach 90 percent funding (by 2045). Instead of requiring the level of state contributions needed to bring that about, the plan phased in the state’s contribution over a 15-year “ramp” period, during which pension liabilities continued to grow.

But that’s not all. The state compounded the damage through “pension holidays” in 2006 and 2007, during which it significantly reduced its contributions. Then it borrowed, through 2005-2009 series of bond issues, to help cover its pension obligations, and that’s where it — finally — got into trouble.

In its complaint, the SEC accuses Illinois of failing to disclose to investors that the Statutory Funding Plan did not adequately fund pensions and deferred contributions well into the future. That raises the question: Would the SEC agree to a similar no-guilt, no-penalty settlement with a private firm?

And the SEC’s complaint doesn’t even address the issue of the discount rate that Illinois uses to calculate contributions. Based on annual investment returns of 8.2 percent, it’s high even by the near-fantastic return projections used by many public pension funds. As a primer on Illinois pensions by the Commercial Club of Chicago explains, “one of the dangers of using such high discount rates is that public pension plans must achieve equally high rates of return on their assets each year – otherwise the value of the assets in their plans slips below the value of the liabilities, and the unfunded liabilities grow rapidly.”

Springfield’s pension shell games are serious. They’ve led to the state’s pension funds having a funding level of only 43% and an $83 billion unfunded liability — for which Illinois taxpayers will be on the hook one way or another. As Forbes‘ Edward “Ted” Siedle notes, “The SEC apparently needs reminding that it actually has the power, some might even say responsibility, to impose fines as a deterrent to multi-billion frauds.”

If there is a trace of optimism in this, it is that public pensions’ crushing pressure upon state finances is forcing state lawmakers to move toward reform, including in such places as heavily Democratic Rhode Island. Recent pension reform legislation was fairly modest, but as the underfunding crisis continues, it may embolden some Springfield lawmakers to look for more robust, long-term solutions. They would do well to consider the Illinois Policy Institute‘s proposal to freeze the current defined benefit pension system and move future state workers toward a defined contribution retirement savings system.

For more on labor policy, see workplacechoice.org.