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From Securities Regulation Daily, March 11, 2013

Illinois Settles Action for Nondisclosure of Pension Plan Underfunding

By Anne Sherry, J.D.

The State of Illinois and the SEC settled today an enforcement action alleging that the state misled bond investors by omitting disclosures about the inadequacy of its statutory plan to fund pension obligations and the risks created by the underfunding. Without admitting or denying the findings of the order instituting proceedings (OIP), the state agreed to cease and desist from violating Securities Act Sections 17(a)(2) and 17(a)(3) (Release No. 33-9389, March 11, 2013).

Pension underfunding. Illinois' five public pension systems are among the lowest-funded in the United States, with a collective underfunding of $83 billion as of 2011. The OIP found that the state's insufficient contributions to the pension plans were the primary driver of the underfunding. Specifically, according to the OIP, the Illinois Pension Funding Act, enacted in 1994, established a pension contribution schedule that was not sufficient to cover both the benefits accrued in the current year and a payment to amortize unfunded actuarial liability. This underfunded the state's pension obligations and backloaded contributions far into the future, creating significant stress and risks for the state.

Nondisclosure. The SEC alleged that Illinois omitted disclosure of the shortcomings in its pension contributions and the consequences of those shortcomings in bond offering documents from 1995 to 2010. The OIP also found that the state misled investors about the effects of changes to the statutory funding plan, including pension holidays in 2006 and 2007 during which the state's contributions were further lowered by approximately half.

Materiality and violation. Pension funding is a significant aspect of a state's budget and financial status, the order noted, and reasonable investors would have considered information regarding the structural underfunding and the risks it created to be important to the investment decision. The OIP concluded that the state's negligent conduct violated Securities Act Sections 17(a)(2) and 17(a)(3), which prohibit fraudulent or deceptive practices in an issuer's offer or sale of municipal securities.

Remedial measures. The SEC imposed only a cease-and-desist order, finding that the state took significant remedial measures including: enhanced disclosures; retention of disclosure counsel; institution of written policies and procedures, disclosure controls, and training programs; and designation of a disclosure committee.

TopStory: Enforcement FraudManipulation

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