The Securities and Exchange Commission (SEC) charged the State of Illinois with securities fraud March 11. Illinois failed to disclose the underfunding of its pension system, thereby misleading municipal bond investors.
George S. Canellos, Acting Director of the SEC’s Division of Enforcement said: “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.”
The issue is regarding $2.2 billion in state bonds sold during 2005-2009. By not disclosing the true situation of its pension system—underfunded by $96.8 billion as of 2012, according to Reuters—the state prevented the investors from making accurate risk assessments. In the event of default, bondholders and pension funds would compete to get whatever funds are left with both sides likely losing out.
The SEC did not put a number on the damage suffered by investors. The damage until this point is confined to loss in income, due to lower than normal bond yields.
If Illinois had disclosed the true numbers behind its pension system, investors would have demanded a higher yield for its bonds to compensate them for the higher risk of default. What yield precisely that would have been is very hard to estimate in retrospect, making it difficult to calculate a precise damage figure.
“The statutory plan structurally underfunded the state’s pension obligations and back-loaded 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,” reads an SEC statement.
Because Illinois cooperated with the investigation launched in 2011 and made amends to the disclosure of its financial data, the SEC did not slap it with a fine. Illinois accepted the cease and desist order and neither admitted nor denied any wrongdoing.
Since the SEC’s primary concern were the bonds issued from 2005-2009, Illinois has to sort out its pension system on its own, as the SEC does not have jurisdiction there.
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