* Illinois pension underfunding nearing $100 billion
* Institutional failures, complicated financing contributed
* Improvements began before SEC probe-Gov. Quinn
By Lisa Lambert
WASHINGTON, March 11 Illinois, which has the
worst-funded state pension system in the United States, agreed
on Monday to settle federal civil securities fraud charges
alleging it repeatedly misled municipal bond investors about the
underfunding of its pensions, the U.S. Securities and Exchange
Commission said on Monday.
Illinois neither admitted or denied the charges and was not
ordered to pay a penalty. It agreed to change its practices to
more fully disclose risks to bond investors.
The settlement of charges that Illinois failed from 2005 to
early 2009 to fully tell investors the risks of buying $2.2
billion worth of its municipal bonds is the latest blow to the
state's reputation as fiscally troubled and crippled by a
pension shortfall of $98.6 billion.
In official statements accompanying bond offerings Illinois
explained that factors such as market performance had
contributed to the increase in its unfunded pension liability,
but it "misleadingly omitted to disclose the primary driver of
the increase - the insufficient contributions," the SEC said.
In order to keep its contributions low, Illinois had
developed a complicated system that included "ramp-ups" and
"pension holidays," the SEC said.
Instead of paying to pension funds what actuaries had
determined to be the annual contributions, Illinois followed a
funding plan approved by the legislature that deferred the
payment of pension obligations, compounding its pension burden.
The legislature phased in the state's contribution over a
fifteen-year "ramp" period, where the amount Illinois put in
gradually grew until in 2011 it made the full amount. It then
had to put in a level amount so the pension system was funded by
The state went further, amortizing pension costs over 50
years, instead of the typical 30, which gave it a longer window
to pay off the liability. Then, it lowered the contributions in
2006 by 56 percent and in 2007 by 45 percent in "pension
Illinois "failed to disclose the effect of its unfunded
pension systems on the state's ability to manage other
obligations, the SEC said. "The state also did not inform
investors that rising pension costs could continue to affect its
ability to satisfy its commitments in the future."
It also did not explain to investors that its "inability to
make its contributions increased the investment risk to
bondholders," the SEC said, adding it "did not identify or
discuss how this underfunding compromised the state's
creditworthiness or increased its financing costs."
The state of Illinois has $19.67 billion pension obligation
bonds outstanding, out of a total of about $50.2 billion in
outstanding municipal bonds, according to Thomson Reuters data.
There were also institutional failures, according to the
regulator. The Illinois government relied on bond underwriters,
consultants and lawyers to advise them what to disclose but
those same groups were relying on the state for the advice, SEC
"The result was a process in which no one person fully
accepted responsibility for identifying and analyzing potential
pension disclosures," the settlement document said.
Beginning in 2009, the state took steps to address the
commission's concerns, the SEC said. Over the last four years,
Illinois has improved disclosures in the pension section of its
bond offering documents, retained disclosure counsel, and
instituted written policies on disclosure.
In 2010, the state also enacted a law that employees hired
after Jan. 1, 2011 would have a higher retirement age and lower
Governor Pat Quinn said the commission had acknowledged the
"proactive steps" Illinois took improve its pension disclosures,
and that "the state began these enhancements prior to being
contacted by the SEC."
Quinn and the state legislature are currently locked in a
political battle as to how best to fix the funding gap, which is
so large that it has led Illinois to have the worst credit
rating among U.S. states. All three rating agencies have raised
alarms that the swelling pension obligations and problems could
eat away at the state's credit quality.
Investors' concerns over credit quality has driven up the
amounts the state must pay to borrow - on Friday the spread of
yields on Illinois debt to Municipal Market Data's benchmark
scale was 140 basis points for a 10-year bond. For the last
year, the spread has averaged 149.8 basis points, the second
highest after financially troubled Puerto Rico.
Many states had long short-changed their pension funds, and
when their revenues collapsed during the 2007-09 recession, they
pulled even further back on contributions. At the same time the
leading source of revenues for pensions, investments, plummeted
in the financial crisis. According to Pew Center on the States,
the pension gap for all states is currently $757 billion.
Illinois Comptroller Judy Baar Topinka, a Republican who was
not in office when the alleged abuses took place, said the
state has done "the right thing."
"Unfortunately we will all be paying for the mishandling of
the pension funds for many years to come. At the time I warned
that raiding our pension funds and borrowing to make our
payments was a 'ticking financial time bomb' and sadly, that has
come to pass," Topinka said.
The case marks the second time the SEC has charged a state
in connection with public pension disclosure failures. The SEC
had previously charged New Jersey in 2010, for not adequately
informing investors of the costs of its pensions, saying at the
time the charges were a warning to all other issuers in the $3.7
trillion municipal bond market.
Elaine Greenberg, chief of the SEC's Municipal Securities
and Public Pensions Unit said in a statement on the settlement,
pension disclosure "continues to be a top priority."