Posted on 19 Aug 2010
In the first-ever securities fraud case filed against a state (with more to follow), New Jersey has been sued by the Securities and Exchange Commission of deliberately misleading investors regarding adequate funding -- or the lack thereof -- in the two largest pensions in the state, all the while selling bonds amounting to billions of dollars.
The case has been settled without New Jersey authorities admitting or denying any wrongdoing but saying the state wouldn't do it again. The SEC chose not to fine the state, citing its cooperation and remedial steps it has taken. No individuals were charged.
In the New Jersey case, the SEC cited municipal bonds in 79 separate offerings totaling $26 billion from 2001 to 2007. Many of those sales occurred after the SEC said the state abandoned a plan to bring pension funding up to snuff.
The SEC's filing described a series of moves that it alleged misled investors into believing the state was adequately funding the $34 billion Teachers' Pension and Annuity Fund and the $28 billion Public Employees' Retirement System.
The funds are the largest of seven funds in the $66.9 billion New Jersey retirement system. Among other things, the SEC said, the state didn't disclose it had abandoned a five-year plan to fund the pension plans. The pension system covers 689,000 current employees and retirees.
No investors appeared to have been harmed. "New Jersey has never failed to pay a bond holder and never will," said Andrew Pratt, of the state Department of the Treasury. The state "aims to have the best bond disclosure in the nation and will continue to strive to achieve that goal," he said.
The New Jersey Treasury and the state attorney general's office said that the state's credit rating hasn't been lowered since the SEC's inquiry began three years ago. The value of bonds held up through the recession and the investigation didn't push down prices, several large bond investors said.
Gov. Chris Christie's office referred calls to the Treasury. A spokesman for former Gov. Jon Corzine said that as governor he threw the spotlight on pension underfunding. "The state put in more money during [Corzine's] term than his predecessors had done in the prior 15 years combined," said the spokesman, Josh Zeitz.
New Jersey's pension problems were no secret. The state never contributed more than 30% of its required contribution between 2000 and 2006, according to the Pew report, and completely skipped its payment to the system last year.
New Jersey will continue with plans to sell $2.25 billion in short-term bonds today, Pratt said.
New Jersey's disclosure problems began in 2001 after passage of a law requiring the state to increase the benefits it would pay and requiring the state to set up benefit-enhancement funds to hold a portion of assets to cover future costs.
At the time, New Jersey's pensions were overfunded and flush with cash. The state revalued its assets in 2001 to create the benefit funds but used values from 1999, at the height of the tech bubble.
That overstated pension assets by $2.4 billion, the SEC alleged, and wasn't disclosed.
The state faces a $10 billion budget deficit next year, according to the Office of Legislative Services. About a third of that is unfunded pension liabilities.
The SEC says the state didn't contribute cash to the pension and used the benefit-enhancement funds to create an illusion that it was funding the pension when it actually was just moving money around.
Beginning in 2003, the state's budget and other factors drove the pension from being overfunded to falling short a combined $3.8 billion. The state outlined its five-year plan to bring its pension to fully funded status and disclosed the plan in bond offering documents, but the SEC alleged that the state abandoned the project without telling investors.
Steve Wollmer, a spokesman for the New Jersey Education Association, said the SEC charges "pull the curtain away and expose the state's malfeasance over the past 16 years" when successive governors failed to make required contributions to the pension system.
While New Jersey may have been the first to be singled out, the SEC is conducting several investigations into what other states disclosed about their weakened finances.
States ranging from California to Illinois to New York have been thrown into financial difficulty by the economy but have been able to avoid disaster by selling bonds to investors, many of them individuals seeking safe, tax-free income.
States as a whole face a trillion-dollar gap between the pensions, health care and other retirement benefits they have promised to public employees, and the money set aside to pay the benefits, according to a report by the Pew Center on the States. The SEC said it is concerned about how these problems are disclosed to investors.
"We want to make sure that states or municipalities who go out and raise money from the public are adequately disclosing all material information in connection with their pension liabilities," said Elaine Greenberg, head of the SEC's municipal securities and public pension unit, which was created in January.
Investor demand for municipal bonds has been strong, with yields low on other investments that are perceived as safe, such as Treasury securities, bank deposits and highly rated bonds. Yields on some of the safest municipal bonds are at their lowest since 1981, reflecting high demand, according to UBS Financial Services Inc.
Marilyn Cohen, president of Envision Capital Management in Los Angeles, said a "feeding frenzy" for munis may mute any impact of the SEC's case.
The SEC has long sought to win the same rule-making powers in municipal bonds that it enjoys over corporations. Currently, it can tell companies what they have to disclose, but with munis, all it can do is bring a case if it suspects fraud. The SEC has asked Congress for expanded authority.