SEC Probes Illinois Pension Statements
Meanwhile, Mary Williams Marsh of the NYT reports that the SEC may be looking into Calpers:
When Gov. Pat Quinn signed pension reform legislation in April, he estimated the new law would save taxpayers more than $200 billion over nearly 35 years.
And the relief would be immediate, lawmakers projected at the time. They estimated that $300 million to $1 billion could be trimmed from the state's required pension contribution in fiscal 2011, which began July 1.
Now, the Securities and Exchange Commission is conducting an inquiry into the state's projected savings, the governor's office confirmed Tuesday.
The probe, which began in September, is looking into "communications relating to the potential savings or reductions in contributions by the state," the state disclosed in preliminary documents related to the planned sale Feb. 17 of $3.7 billion in pension obligation bonds. Proceeds would fund the state's pension contributions for this year.
"This is not an investigation; this is an inquiry," said Kelly Kraft, Quinn's budget spokeswoman. "The SEC has stated this is not an indication of any violation. We feel our disclosures have always been accurate and complete."
Quinn said the SEC inquiry won't affect the planned bond sale.
"It's a nonpublic confidential inquiry. They wanted to just look at the (pension reform) bill that we passed ... and the pension borrowing," Quinn said. "But I don't see any problem there at all."
SEC spokesman Kevin Callahan declined comment.
The new pension law increases the retirement age and places a cap on the salary level on which pension benefits are based. The changes apply only to new hires and took effect Jan. 1.
The reduction in future benefits "will cause an immediate reduction in the amount the state will be required to contribute to the retirement systems," the state said in its bond offering document, dated Jan. 21.
An accompanying table shows estimated reductions in annual contributions through 2045. The reductions begin later and are more modest initially than projections for the same period made last summer by the Legislature's bipartisan Commission on Government Forecasting and Accountability.
The table in the bond document shows a reduction in the state's contribution beginning in fiscal 2012, shaving $83 million from the tab that year. The table does not give a total cost-reduction estimate through 2045.
The legislative commission's projections from last summer show reductions in contributions amounting to $488 million this fiscal year and another $868 million in fiscal 2012. Through 2045, reductions in state contributions are estimated at $71 billion.
The SEC is looking into how the state values pension reform savings and how it applies them to the present, said Robert Kurtter, managing director for state and local government ratings at Moody's Investors Service. Moody's noted the SEC inquiry in a report it issued late Monday on the state's debt rating.
Illinois employee pension funds are severely underfunded, and the situation continues to deteriorate, according to the Moody's report. The funded ratio for the five plans dropped to 45 percent from 50 percent in the last fiscal year, as combined liabilities grew to $138 billion from $126 billion, Moody's stated.
The state has been paying a premium in its borrowings because of its fiscal crisis, and the news of the SEC inquiry could worsen the situation, some observers say.
"Any bad news will put more pressure on prices of existing bonds and put interest rates higher than for a state that doesn't have those self-inflicted dilemmas," said bond portfolio manager and author Marilyn Cohen, president of Envision Capital Management Inc.
Others say, given Illinois' ongoing woes, the news may not matter much.
"In this case, negative headlines are a given," said Matt Fabian, managing director at Municipal Market Advisors, an independent research firm. "It's like smelling something bad at the zoo. You know it will smell, no matter how many times the elephant goes."
Quinn, on the other hand, said investors may be more receptive now that the state has hiked income taxes for the next four years, creating an increased revenue stream.
"We've never had a problem going into the market and getting plenty of bidders to lend money to Illinois, and I think that'll be even more so in light of our most recent action," Quinn said.
In fact, the state got a bit of positive news from Standard & Poor's Ratings Services on Tuesday, when the rating agency removed Illinois from its credit-watch status, citing the tax increases.
The SEC has been focusing greater attention on the municipal bond market. In August, it accused New Jersey of not adequately disclosing that it was underfunding its two largest pension funds when it sold $26 billion in municipal bonds. New Jersey agreed to settle without admitting or denying the SEC's findings.
"The New Jersey action was a warning to all states that they ought to look carefully to their documents in selling their securities," said David Ruder, a former SEC chairman who is a professor at Northwestern University's law school.
Quinn's budget spokeswoman said the New Jersey case led Illinois to be cautious in its disclosures.
"In light of the New Jersey order, and prior to being contacted by the SEC, the state took proactive steps to update its disclosures, and we now feel our disclosures exceed the new, more rigorous standards," Kraft said.
It's not just Illinois and California. Reuters reports that Loop Capital Markets recently said half of the 50 states were unable to make full contributions to their pension funds in fiscal 2009, and New Jersey put in the smallest amount -- 9 percent of its expected contribution.
Federal regulators are examining disclosures by Illinois about its unorthodox pension funding method, trying to determine whether the state misled bond investors about the risks.
The Securities and Exchange Commission has said it has a special team devoted to investigating public pensions, and last year it brought its first case ever against a state, accusing New Jersey of securities fraud for claiming to have pension assets that did not really exist.
If the commission decides at some point to bring a case against Illinois, it would send another warning.
Some other states, including Arkansas, Ohio, Rhode Island and Texas, have used variations of Illinois’s method, which reduces their annual contributions to their pension funds. The effect is to save money at a time of tight budgets, but it can also weaken the pension funds.
The S.E.C.’s inquiry was disclosed in a prospectus for a $3.7 billion bond offering planned by Illinois for February. The state wants to use the proceeds from the sale to make its annual contribution to its pension funds, which are among the most poorly funded in the country. Illinois must sell bonds to come up with the cash because the state is low on money.
The prospectus said that the S.E.C. contacted the state last September and that Illinois was cooperating with the inquiry.
The state also disclosed that even before it heard from the S.E.C., it had decided to improve its pension disclosures. The prospectus said officials had made that decision as a precaution last August, after the S.E.C. accused New Jersey of securities fraud for making false statements about its pension fund. The New Jersey case was the S.E.C.’s first enforcement action against a state, and the state settled without admitting any wrongdoing.
“We feel our disclosures have always been accurate and complete,” said Kelly Kraft, a spokeswoman for the Illinois governor’s office of management and budget, which handles communications with the capital markets.
The S.E.C. contacted Illinois after an article appeared in The New York Times about an unusual actuarial technique the state had been using to save money by shrinking its annual pension contributions.
The method, enacted last year, is based on sharp cuts in benefits for state workers who have not yet been hired. Although the cuts will not produce an appreciable savings until far in the future, Illinois has begun funding its plans as if its current workers were already earning the smaller benefits of the future.
For more than a decade, Illinois failed to put into its pension funds the amount needed to cover the promised benefits. The gap between how much is needed and how much is actually in the funds has grown so big that the state is overwhelmed by the required contributions. The benefit cuts were presented by state officials last year as a reform that would get the situation under control.
Some actuaries who have studied the funding method have said they doubt it meets the standards of their profession. Some have called it reckless when used by a state with a severely stressed pension system, like Illinois. That is because it deprives the pension fund of the substantial yearly contributions it needs now, to pay for the benefits already earned by today’s workers.
Because the calculations are esoteric, it is hard for anyone besides a seasoned actuary to see that a program that Illinois ushered in as a reform could be harmful.
Actuaries have also expressed concern that other states and cities will adopt methods like the one Illinois is using, because many of them are cutting benefits for future workers, to save money and close budget gaps.
Rather than cutting benefits of existing workers, governments usually cut benefits for future workers. Laws and state constitutions make it very hard to do otherwise.
Illinois’s method does not appear to comply with current governmental accounting standards, but governmental accounting rules are voluntary.
The S.E.C. has no direct jurisdiction over public pension funds and cannot order a government to follow any particular funding method. Its interest is in protecting investors, and making sure they have enough information to make well-informed decisions. It appears to be trying to determine whether Illinois adequately explained its method to bond buyers, giving them an understanding of how the reduced contributions may ultimately affect the state’s finances.
News of the S.E.C.’s Illinois inquiry comes at a sensitive time. Many economists have been reviewing public pension disclosures and challenging the way governments calculate their obligations, saying the method in use tends to hide debt. The governments have generally responded that their accounting methods are correct and that long-term obligations should not be measured the same way as bills the states must pay right away.
Moody’s Investors Service issued a report on Monday holding the state’s rating steady, with a negative outlook. Along with its long-term pension funding problems, Illinois is grappling with a short-term budget deficit, largely stemming from reduced revenue, that it is trying to close in part with big tax increases.
Members of Congress have recently begun looking into whether a new chapter of the federal bankruptcy code, or some other legal framework, could be created to allow states with the most troubled finances to restructure their long-term debts.
The California state treasurer, Bill Lockyer, on Monday held a conference call in which he took issue with the critics of the current pension system. “They’ve confused the near-term budget shortfalls with the long-term funding obligations, and grossly inflated the size of the long-term liabilities,” he said.
Mr. Lockyer, who has a seat on the board of California’s big public pension funds, is also responsible for signing the state’s disclosures to investors. California does not use the unusual Illinois method that is drawing attention from regulators. But the S.E.C. has been looking into disclosures by the state’s biggest pension fund, known as Calpers, under the tenure of a previous state treasurer, according to officials with knowledge of the inquiry.
State pension woes are fast becoming the political topic of the day. The concerns are understandable, but I think that politicians like to blow things way out of proportion (what else is new!). In the end, it's not state pension plans that will bring down state budgets (try healthcare costs), but the politicization of pensions will continue as states scramble to contain costs.