Tom Murphy
RedwoodAge.com

In what should be a wake-up call to cash-strapped states and cities nationwide, the Securities and Exchanges Commission charged New Jersey with failing to tell bond investors that it is underfunding the state's two largest pension funds.

The unprecedented action - New Jersey is the first state ever charged by the SEC for security law violations - was settled Wednesday with state officials, without the state admitting or denying the allegations. But the impact is far reaching. 

The SEC order is likely a shot over the bow of local governments, who varied sources have estimated are at least $1 trillion behind in funding pension obligations to their employees. Federal agencies also are believed to have at least another $1 trillion liability in underfunded pension liabilities. 

While states, cities and other government agencies routinely raise money through bond offerings, most do so without warning investors that they may need to divert funding from other purposes to satisfy their pension obligations. Meanwhile, new public employees are being hired with promises of pensions in the future.

To be sure, the problem isn't limited to public employees. Private pension funds are a source of growing concern. In May, the GAO reported that millions of retired Americans may see shrinking pensions as a result of the failure of funds operated by companies and unions.

The SEC declined to comment on whether it is conducting similar investigations across the country, but suggested obliquely that it's aware of the broader problem. "We hope all municipalities - city, state and local - will review the order and understand the importance of disclosure," said Mary Hansen, an assistant regional director for the SEC, who helped lead the investigation.

79 Offerings
In New Jersey's case, the SEC claimed the state sold more than $26 billion in 79 municipal bond offerings between August 2001 and April 2007. 

The offerings "created the false impression that the Teachers' Pension and Annuity Fund (TPAF) and the Public Employees' Retirement System (PERS) were being adequately funded, masking the fact that New Jersey was unable to make contributions to TPAF and PERS without raising taxes, cutting other services or otherwise affecting its budget," the agency said in a statement. As a result, the SEC said investors weren't able to judge the state's ability to fund the pensions.

"All issuers of municipal securities, including states, are obligated to provide investors with the information necessary to evaluate material risks," said Robert Khuzami, Director of the SEC's Division of Enforcement. "The State of New Jersey didn't give its municipal investors a fair shake, withholding and misrepresenting pertinent information about its financial situation," said Robert Khuzami, director of the SEC's Enforcement Division.

Specifically, the SEC said New Jersey didn't explain that it increased retirement benefits during 2001 or that it also created special benefit enhancement funds that were intended to underwrite costs associated with the increased benefits. It also failed to disclose or misrepresented information retlating to a five-year plan to begin using those special funds and about the eventual abandonment of that five year plan, the SEC said.

"The state was aware of the underfunding of TPAF and PERS and the potential effects of the underfunding," the agency said in its statement. "Furthermore, the state had no written policies or procedures about the review or update of the bond offering documents and the state did not provide training to its employees about the state's disclosure obligations under accounting standards or the federal securities laws."