SEC Charges Illinois With Securities Fraud -- and Settles Immediately


You may want sit down for this one. In an announcement that's certain to leave the good citizens of Illinois feeling shocked -- shocked! -- it appears their politicians have not been entirely honest with them about the state of the state's finances.

On Monday, the Securities and Exchange Commission published a notice that simultaneously charged the state of Illinois with committing securities fraud and also settled the charges, without requiring Illinois to either "admit or deny" the agency's findings.

As laid out in the SEC's announcement, the findings go more or less like this: Between 2005 and 2009, Illinois sold investors $2.2 billion worth of municipal bonds to finance government operations. Problem was, Illinois neglected to inform the investors buying its bonds (who often were local individual and corporate taxpayers themselves) that the state has gotten itself into perilous financial straits.

It turns out, when Illinois enacted a 50-year schedule for making contributions to its pension fund back in 1994, it backloaded the payments it was obligating itself to make so as to reduce its financial burden in the early years. As a result, from the start, planned contributions weren't sufficient to cover the state's eventual pension obligations.

Over time, this "condition ... worsened" says the SEC, and in particular, it took a turn for the worse when the state enacted certain "pension holidays" in 2005, exempting itself from the obligation to make its regularly scheduled contributions.

In so doing, alleged the SEC, Illinois set up a "statutory plan [that] significantly underfunded the state's pension obligations and increased the risk to its overall financial condition. The state also misled investors about the effect of changes to its statutory plan." In other words, the state failed to advise investors that the moves made in 2005 significantly increased the underfunding of the pension plan, which increased the risk of an eventual default, both on the pension promises and potentially on the payments it is obligated to pay to its bond investors as well.

In 2009, the SEC required Illinois to take "multiple steps" to fix the problem, primarily by improving its disclosures -- but not, notably, by requiring the state to fix its finances.

Without admitting or denying the SEC's charges, Illinois agreed to "cease and desist" from misleading investors. As for the underlying fiscal problems, those remain in full force.

Rich Smith is a Motley Fool contributing writer. Try any of our newsletter services free for 30 days.