SEC's Jersey Score Gaining Momentum?

Leo Kolivakis's picture

Via Pension Pulse.

Mary Williams Walsh of the NYT reports, Pension Fraud in New Jersey Puts Focus on Illinois:

The federal government’s crackdown on the State of New Jersey this week for misrepresenting the condition of its pension funds raises a question: Who else might have pension numbers that could draw regulatory fire?


and states are scrambling to make sure their pension disclosures are
in order, and investors in distressed debt — who make money off
financial trouble — are scrambling too, sensing opportunity.


“No one knows exactly how to attack this market yet, but people are
going to be watching the New Jersey case and others like it very closely
from an investment
point of view,” said Jon Kibbe, a lawyer who specializes in distressed


Though some advisers are urging caution, New Jersey and other
states have continued to issue new debt at reasonable rates as investors
clamor for high-grade securities in a low-rate environment.


Harry J. Wilson, a Republican candidate for New York State comptroller,
said Friday that New York was not compliant with the standard that the Securities and Exchange Commission
established in its cease-and-desist order against New Jersey. Dennis
Tompkins, a spokesman for the current New York comptroller, Thomas P. DiNapoli,
who is running for re-election, said that “it’s ridiculous, it’s wrong
and it’s reckless to make those accusations” and added that the
state’s financial disclosures were complete and correct.


After two prominent S.E.C. pension cases, the American Bar Association’s new

disclosure bible for municipal bond lawyers is selling briskly.


“The cease-and-desist order has heightened awareness of the importance
of accurate pension disclosure,” said John M. McNally, a partner at the
law firm Hawkins Delafield & Wood, and the project coordinator of
the newest edition of


“Disclosure Roles of Counsel,” a treatise telling
municipal bond lawyers what is expected of their clients.


Mr. McNally has also been serving as a special disclosure counsel to San
Diego, the first government accused of securities fraud by the S.E.C.
for faulty pension disclosures. New Jersey was the first state.


S.E.C. and other regulators found that San Diego had numerous pension
problems, but in general, regulators said its government did not
adequately describe the size of its obligations to retirees. In
addition, there were discrepancies between the pension numbers in the
official statement distributed to bond buyers and the pension numbers in
other documents.


Mr. McNally said it was important to
give consistent information and to explain the status of the pension
fund’s condition in plain English. “One of the critical disclosure
points would be, what are the implications for an entity’s annual
budget,” he said.


Instead of bristling with acronyms, he said,
pension documents should tell an investor how much the government must
put in the pension fund every year and whether it can afford the
payments. At the moment, the municipal bond market’s players —
advisers, investors and underwriters — are more concerned about
Illinois than any other state. Its credit was downgraded this year, and
all the main ratings agencies said the poor condition of its public
pension funds was a primary factor.


A spokeswoman for Gov. Pat Quinn’s Office of Management and Budget,
Kelly Kraft, said Illinois believed its pension disclosures were
complete and accurate. The state has not hidden the fact that its
pension funds have big shortfalls, she said, and there was no reason to
think the S.E.C. might lodge a complaint against it, as it did with New


She added that investors had been calling with
questions in the wake of the S.E.C.’s action against New Jersey, but
said that Illinois had been telling them not to worry — the regulator
had not contacted state officials.


said the state had no plans to revise any of its financial documents.
Still, some actuaries are deeply concerned about Illinois’s pension
numbers, particularly because of a pension law enacted earlier this


State officials claimed the measure had sharply
lowered costs by cutting the benefits that will be earned by workers
hired in the future. (The current work force will continue to earn the
same benefits as before.)


When it enacted the reform, Illinois
issued a report, explaining in detail how it would work. Actuaries who
have reviewed the numbers say that report is at least misleading and
appears to be based on a type of calculation not authorized for pension
disclosures. The state has not issued new audited financial
statements since the law was passed.


Numbers in the report
show that the state will be able to reduce its contributions to its
pension funds, saving the state money, starting with $300 million in
its first year and adding up to tens of billions of dollars over time.
That’s because Illinois could make smaller pension contributions, on
the assumption that its work force would over time consist of people
earning smaller pensions.


Paradoxically, even though the state
will make smaller contributions, the report forecasts that Illinois
will get its pension funds back on track to a respectable 90 percent
funding level by 2045. It projects that costs will increase slowly and
an economic recovery will make cash available for the state to make the
contributions it has failed to do in the past.


that is even possible is contested by some actuaries who note that its
family of pension funds is now only 39 percent funded. (If a company
let its pension fund dwindle to that level, the federal government
would probably step in, but federal officials have no authority to
seize state pension funds.)

actuaries who have reviewed the state’s plans said that shrinking
contributions would make the pension funds shakier, not stronger.


Indeed, one of them, Jeremy Gold, called Illinois’s plan
“irresponsible” and said it could drive the pension funds to the brink.


Further, Mr. Gold pointed out that Illinois’s official
disclosures said that its pension calculations used an actuarial method
known as “projected unit credit,” but that the pension reform report
used another method, which had not been approved for disclosure.


“According to Illinois statute, the prescribed contributions are
determined under a method that may not be in compliance with the
pertinent actuarial standards of practice,” Mr. Gold said.


Actuaries from the two big firms that help Illinois with its pension
funds conceded that the report relied on another methodology. Larry
Langer of Buck Consultants said that a law allowed the state to use the
alternate method outside of bond offering documents. Investors can look
at both sets of numbers and draw their own conclusions, he said.


acknowledged that using the latest pension reforms would lead to a
lower funding level but said state officials were not concealing the
magnitude of the problem. “They almost laud it,” he said.


Brian Murphy of Gabriel, Roeder, Smith & Company, another of
Illinois’s actuarial consultants, said the numbers were for illustrative
purposes only and unlikely to reflect what the state would actually do
in coming years.


“They’re going to fund it at the proper level,” Mr. Murphy said.

In a separate article, the WSJ wrote an op-ed on the SEC's Jersey Score:

movement to clean up state pension funds is gaining momentum, and the
latest evidence is that even the Securities and Exchange Commission is
getting in on the action. In the Wonders Never Cease Department, the
SEC has scored the state of New Jersey for lying to bond investors that
its state pension funds were adequately funded.


In the summer of
2001, legislators in Trenton wanted to raise pension benefits 9% for
state and local government employees. But there wasn't enough money in
the pension system to fund the benefits and, only months before an
election, the pols didn't want to raise taxes. So the legislature
cooked the books, valuing the existing assets in the plan as of their
market prices on June 30, 1999, before the dot-com bubble burst. Voilà,
the two main state pension funds magically had enough cash to pay
higher benefits.


Rather than
disclosing this political fraud to the buyers of its bonds, the state
perpetuated it. In 79 offerings from 2001 through 2007, representing
$26 billion in bonds, New Jersey "misrepresented and failed to disclose
material information" about its underfunding of the pension plans,
says the SEC. In a settlement this week, New Jersey neither admitted
nor denied wrongdoing but promised not to commit such fraud in the


The New Jersey case is the
SEC's first-ever fraud charge against a state—amazing when you consider
that the market for municipal securities, including bonds issued by
states, is now roughly the size of the corporate bond market. It's
doubly amazing given that accounting by government issuers is
"uniformly dishonest," according to a former senior official at the
SEC. This particular probe began under former SEC chief Chris Cox, and
we hope current Chairman Mary Schapiro keeps it up, notwithstanding her
desire to please public employee unions.


One obvious target is
disclosures to investors about state retiree health and related
benefits. According to a recent report from the Pew Center on the
States, no fewer than 21 states have funded 0% of their retiree health
care and other non-pension benefits. This is the definition of a Ponzi
scheme, yet Pew charitably puts these states in a category labeled,
"Needs improvement."


The last two times Congress has legislated
heavy new requirements on private companies that participate in the
securities markets—the Sarbanes-Oxley Act in 2002 and this year's
Dodd-Frank bill—government issuers received a pass. Private firms that
serve these issuers face new rules, and Dodd-Frank authorized a two-year
study of the muni market, but the muni-bond issuers still have nowhere
near the same disclosure obligations as private firms.


get this: Congressman Barney Frank has been pressuring credit-rating
agencies to give better grades to government issuers of securities,
based on the fact that they've rarely defaulted in the past. Given the
poor disclosure from states and cities, we don't know how Mr. Frank can
even guess whether they will perform as well in the future.


SEC can't require governments to disclose anything. It can only
prosecute them for fraud after the fact, and while this week's action
against New Jersey is a promising first step, the double standard
between public and private fraudsters is still alive and well.


Goldman Sachs settled its far more dubious recent case on similar
charges to those New Jersey faced, it had to pay $550 million. But New
Jersey paid nothing. The SEC is apparently loath to make taxpayers foot
the bill for the sins of politicians and bureaucrats. We share that
sympathy but wonder why it doesn't extend to shareholders in companies
sued by the agency.


Beyond simple
justice for taxpayers and shareholders, deterrence against bad behavior
in business and government will only be effective when the SEC sues
people, not institutions. Those people should include politicians who
sell bonds under false pretenses.

In a related topic, Janet Morrissey of TIME reports, SEC Now Offering Big Payoffs To Whistle-Blowers:

what could give new meaning to the phrase — "If you see something, say
something" — a clause within the financial reform legislation is
offering big cash rewards to whistleblowers who report fraud and other
wrongdoing at U.S.-listed companies and Wall Street banks.


the program, which is already live, anyone who provides a tip that
leads to a successful Securities and Exchange Commission action will be
able to collect between 10% and 30% of the amount recovered — as long
as the total amount exceeds $1 million.
This means the minimum
payout is $100,000.


The whistle-blower could be a company insider or a
private investor, if they're able to offer information or analysis that
leads to an action. And with potential payoffs netting millions — or
even tens of millions — of dollars, experts are bracing for a surge in
tipoffs. (See the worst business deals of 2009.)


can be "extraordinarily effective" in getting people to blow the
whistle when they see fraud, says John Phillips, whose law firm
Phillips & Cohen LLP specializes in whistleblower cases. The U.S.
Government evidently agrees. "We expect the awards will prompt a
significantly greater number of insiders to come forward with
high-quality evidence of fraud," says SEC spokesman John Nester.


the past, the SEC's whistleblowing program was limited to insider
trading cases and offered only small discretionary, rather than
mandatory, rewards ranging from 0 to 10% of the money recovered. "It was
completely ineffectual, completely discretionary," says Phillips.
(Read about a whistleblower case involving ignorance.)


narrow scope and poor cash rewards generated little response: Since
the program's launch in 1988, only 14 applications led to actions
where a civil penalty was ordered, and only eight cash awards were
handed out totaling $1.16 million, according to SEC officials. The
largest award came last month when the ex-wife of a hedge fund adviser
at Pequot Capital Management was awarded $1 million for her role in
providing information that led to Pequot paying $27 million to settle
an insider trading case involving Microsoft securities. The ex-wife had
discovered a key email on her computer hard drive that led to the
action against her ex-husband's former employer. (Read about the new sheriffs of Wall Street.)


this legislation extends the program beyond insider-trading cases to
all securities law violations and, most importantly, offers bigger
payoffs and therefore bigger incentives to speak out. People can report
almost any securities violations, ranging from money laundering,
accounting fraud and ponzi schemes to bribery. Also, the SEC will be
looking at not only independent knowledge, but even analysis as proof.
The means an academic, private investor, or even a journalist or a
securities analyst who conducts independent research and uncovers fraud
based on that research could collect an award if their information is
new and leads to an action.


"So you can have people who might
have done analysis for academic reasons or personal trading reasons or
research that they sell, that they may now, in addition, provide to the
SEC with an eye toward getting a bounty," says Paul Leder, a partner
at Richards, Kibbe & Orbe LLP and former SEC official for 12 years.
He noted how the options backdating scandal in 2006 stemmed from
academic articles that described how the option grants to executives
and board members were extraordinarily well-timed. The SEC picked up on
the analysis and wound up filing dozens of cases against companies and
executives. (Comment on this story.)


a CEO could squeal on his own company as long as he wasn't personally
convicted in connection with the fraud. "Yes, to the extent that they
themselves are not culpable," says Phillips. "You can't initiate the
fraud and then go collect on it."


The legislation bars certain
people from receiving awards — officers or employees of a regulatory
agency, the department of justice, a self-regulatory organization, the
Public Company Accounting Oversight Board or a law enforcement
organization, as well as company auditors and anyone convicted of a
crime related to the securities violation.


The program also
protects squealers against company retaliation. Any whistleblower who
is fired, demoted, suspended, threatened, harassed or discriminated
against by a company for providing info or testifying in an SEC
investigation, can file an action in the U.S. District Court. If they
succeed in proving their case, the legislation guarantees the person's
reinstatement, two times the amount of backpay owed, and coverage of
all court and attorney fees—so long as the action is filed within a
certain time period.


The potential
payoff is high. The recent judgment against Goldman Sachs resulted in a
$550 million penalty. "If you got 10% of that, it's pretty good
money," says Leder.


Even a mid-cap company could wind up with a
consent order or suit in the millions of dollars, says Daniel Karson,
executive managing director and counsel at Kroll, a risk consulting
company. "So 10% for making a phone call is a pretty good payday," he


One obvious question overhanging this new lure for
whistleblowers is whether the SEC will have the staff to handle it.
"The government always has limited resources," says Karson. "I think
the SEC is going to be overwhelmed in short order with people bringing
these kinds of actions — they're going to have to sort through what
has substance and what doesn't." The SEC has indicated it will be
opening a whistle-blowing office and chairman Mary Schapiro told a
House committee the agency would need to hire 800 new people to fully
implement the financial reform bill's changes.


"There's real money to be made," says Leder. "I think it's a powerful incentive."

fraud is serious business and it's about time the SEC started
investigating state pension funds. The incentives for whistleblowers are
long overdue, but the legislation should also extend to state pension

I have long argued for robust and transparent whistleblower
policies for public entities, especially public pension funds. An
independent third party should investigate all charges and employees
must be protected if they blow the whistle on fraud or serious
mismanagement of pension assets.

Too much power concentrated in
too few hands leads to abuse, fraud and cover-ups. It's absolutely
insane that at time when so many people are demanding accountability
that the majority of public pension funds still do not have
comprehensive fraud and whistleblower policies. We need a major overhaul
in this area, not just in the US, but in Canada too.

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ZackAttack's picture

Many states are screwed. Scroll down to the tables:


I expect Illinois, Nevada, Arizona to cease functioning as governing bodies fairly soon. Anyone who buys municipal debt at current levels would only do so in ancitipation of a bailout because there's no other way these guys can make it.  

I have no position. However, it would amuse me to see municipal debt investors take a good reaming.

geno-econ's picture

 Leo,  You the expert in the pension business and have vast knowledge, but what can be done by you or group of experts collectively?  Some suggestions:

                 Call for Congressional hearings

                 Letter to President  with mass signatures and publicity      

                 Mass rally in Wash.DC

                 Enlist Ralph Nader as spokesman

                 Seek joint cooperation of interested NGOs

 Ask ZH for more suggestions to become proactive-- otherwise we are chewing gum             


Ancona's picture

The pension problem will prove to be insurmountable for many states and municipalities. In addition, there is zero chance that the tax paying public will swallow new taxes to support a pension system that is widely known to be corrupt and out of control. When the bottom falls out of tax revenues over the next few years, taxpayers will revolt en masse, yanking the rug out from under all of those retirees with big fat pensions and lifetime free health care.


A new paradigm will unfold, one where reasonable benefits will be paid, and the high end, 200,000 a year golden cushions are deflated. The people will not stand to be taxed out of existence.

max2205's picture

Talking about the SEC "doing" anything = a huge waste of your time.

kilroy's picture

hmmmm. Jersey, eh?  Interesting that the SEC chose to focus on Jersey when no doubt other states surely have the same thing going on.

It couldn't have anything to do with the fact that the Governor of Jersey (Chris Christie) is the most respected and attractive national level GOP candidate in the United States - could it?

Nah.  It can't be that.  Nothing to see here.  Move along...

mrdenis's picture

 I live in "Joisey" This 9% pension increase was done 10 years by a Governor that wanted to get re-lected ...didn't happen we elected that other embarrassment "I am a gay American ",but nobody ever mentioned that increase in any prosecutes ,or the failure to fund the pensions at all ! This didn't take a whistle blower it was well known .Our politician's have been giving away the state to the unions for years without any intention of ever really paying-up .We already have the highest property taxes in the nation ( my yearly contribution to the corruption is over 25K) .Our new (Christie) Gov. is squeezing the unions and wants to put a referendum on the ballot that insures the pension is fully funded by 2016 ,which the unions agree with in principal but know it will be defeated soundly and leave them in wonderland ,so they just want the assurances that the state fully fund the pensions anyway .At this point I see no way out of this mess but let the pensions go bust or bring a new bond issue to fund them ,which is just like a circle jerk ....or just send every taxpayer a bill for 50 K+ 

Hunch Trader's picture

39% funding level is just about par with many European state retirement funds...figures which are carefully kept out of the sovereign balance sheets, just like estimated future health care and assisted housing costs for the ageing population.


Number 156's picture

I have been waiting for this to happen. I am actually surprised because I wouldve thought that the SEC would ignore it. 

StychoKiller's picture

New Jersey:  "Augghh!  Where's my swimsuit?!  I was wearing it when I dived in..."

litoralkey's picture

The SEC's mandate has the implicit directive to protect the Federal Government's sovereign immunity.  TO protect the Federal government's sovereignty in this clusterf**k, agent conflicts of interest explicitly demand the SEC protect the sovereignty and immunity of the individual states from Federal sovereign oversight.

The pending collapse of the municipal bond market signals the collapse of the Republic.

I'm not talking about the zombified state currently being experienced, I'm talking about entering into a generally acknowledged collapse in the payment and debit system of the United States and sovereign component states.


So I do not expect anyone to do a dang thing against any local, county, regional or state municipal bond market ponzi at any time during the current Baby Boomer regime.  The youngest Baby Boomers turn 66.5 in 2030... the USA is looking at a good 20 years of zombification.




Number 156's picture

I agree and it doesnt make sense.

What doesnt make sense is that if the SEC, or the Feds for that matter, know of the gravity of the situation, why would they allow the light of day to shine on this?

On second thought, the Government will bailout the pension system and nobody will go to jail. ( if they think this will stop the USA's inexorable slide into hell, then they've got another thing coming..)

Move along, nothing to see here.

Fred Hayek's picture

Nice job Leo.

Talk about your target rich environments for enforcement and prosecution.  One imagines you'd have a harder time finding one of these jurisdictions that told the truth.

And I'm sure the SEC's waiving that bonus money for whistle blowers in front of HFT techs, right?


G-R-U-N-T's picture

"The first SEC security fraud case against a State"

Let's hope the first of many....But then again the concentration of power is in such few hands that they will figure out a way to manipulate the outcome in their favor. Their favor means more punishing and looting of the people to compensate for their losses.

Mitchman's picture

Dear Leo,

Articles like this impede the proper and smooth functioning of the Ponzi.  Please refrain from publishing material of this nature. <sarcasm off>

TBT or not TBT's picture

Yeah Leo, I'm short the euro and our stock markets in the short run, then profits on that go into bets against the dollar.   We don't need anyone going around making noise about the state and local ponzi on top of the federal one and the private debt piles....yet.   Timing!