The SEC Gums New Jersey

If the government does it, it's not fraud?

Having been criticized at length for not catching Bernie Madoff or any number of other financial scam artists, the Securities and Exchange Commission was rewarded for its failures by being given a vast array of new powers and a large budget increase by the recent 1000+ page financial "reform" act.  You'd think that they'd be out there putting the bite on evildoers right and left.

Indeed, the intrepid porn-loving investigators at our SEC leaped into action against the forces of evil - but ended up biting no one, thereby bringing a whole new meaning to the term "gumshoe."  Reuters reports:

U.S. regulators said on Wednesday they charged New Jersey with securities fraud for not disclosing to municipal bond investors that it was underfunding its pensions.

New Jersey, the first state ever hit with securities fraud charges by the Securities and Exchange Commission, agreed to settle the case without admitting or denying the findings, the SEC said. The state was not required to pay any civil fines or penalties, but ordered to cease and desist from future violations. [emphasis added]

When any would-be borrower wants to sell bonds or any other security to anyone else, they fall under SEC regulations.  The SEC is supposed to make sure that the borrower tells the truth about the conditions surrounding the proposed loan.  The idea is to help investors decide whether the interest rate being offered is enough to offset the risk that the loan might not be paid back.

There is a huge body of rules about "material facts" that must be disclosed and "immaterial facts" that need not be mentioned.  The basic rule is that any business, city, or any other organization wanting to borrow money is required to tell the truth about what other obligations they have that might make it hard to pay back the new loan they're trying to sell.

A government entity, like any other borrower, is supposed to talk about significant outstanding obligations so that prospective lenders can make an informed decision whether to invest or not.  Forcing prospective lenders to tell the truth is supposed to fight fraud.  Reuters went on to tell us what had happened:

New Jersey offered and sold more than $26 billion of municipal bonds in 79 deals between August, 2001 and April, 2007, according to the SEC.

The offering documents "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 SEC said. [emphasis added]

New Jersey isn't alone in lying to investors, as it turns out:

U.S. states face a total shortfall of at least $1 trillion in their funds for employees' pensions and retirement benefits, according to a report released by the Pew Center on the States in February. The report found that states did not save for the future or manage costs well, but they also typically expect an 8 percent return on investments. [emphasis added]

Many states aren't putting money aside to cover state employee pensions and they're making wildly optimistic assumptions about the rate of return on the inadequate investments they have set aside.  It's pretty clear that various people who work for the State of New Jersey lied like rugs in asking people to lend them money.

When you apply for a mortgage, you're supposed to be honest about your income and about any other debts you owe, or at least you were until the government got into the home lending business.  In theory, lying to a bank about your income to get a loan is fraud which can get you into big trouble.

Even the New York Times, generally all in favor of providing money for government spending by any means necessary, was disappointed in the outcome:

... Nor did the S.E.C.'s order name any individual state officials, nor the bond underwriters and other professionals whose job it was to vouch for the state's financial statements. New Jersey's largest bond underwriters during the period in question include Citigroup, J. P. Morgan Securities, Morgan Stanley, Bank of America, Merrill Lynch, Goldman Sachs and Barclays Capital.

The commission said that from 2001 to 2007, New Jersey claimed to have money set aside in a "benefit enhancement fund" as part of a "five-year plan" to pay for new benefits for teachers and general state employees. In fact, the fund was an accounting illusion and no such money was available. [emphasis added]

The SEC didn't name any of the state employees or point out that the organizations that underwrote the bonds were also supposed to make sure that the loan prospectus told the truth.

"Yes, they charged the State of New Jersey with fraud, but there's no price paid here," said Lynn E. Turner, a former chief accountant for the S.E.C. who helped with the pension investigation in San Diego. "There's no fine, and no accountability on the part of any individuals."

Without accountability there's no reason for state employees to tell the truth.

Contrast this "we promise not to do it again" attitude towards a massive misstatement of the state's financial condition with how the SEC treated two minor players at Bear Sterns.  Instead of asking them not to do whatever they were supposed to have done again, the SEC brought criminal charges against them.  Fortunately, the jury didn't buy it:

Not so fast, this Brooklyn jury declared.  "The entire market crashed," one juror explained. "You can't blame that on two people."

As a practical matter, there's no difference between a state falsely claiming that they're getting an 8% return on their pension fund and Bernie Madoff telling investors he's getting 10% on their money.  Both sets of liars are trying to put over the same sort of fraudulent Ponzi scheme.

So why, given their experience with Madhoff, didn't the SEC actually put the bite on the people who made false statements?  Why were they content with a toothless promise that New Jersey wouldn't do it again?  If they didn't want to go after state employees, they could go after the Wall Street types who'd signed up to the lies.

Has the SEC suddenly become toothless?  Or is that part of a larger process by which our society is becoming more and more tolerant of fraud?

  • Timothy Geithner was approved as Secretary of the Treasury - overseeing, among other things, the IRS - in spite of cheating on his income taxes, even though as an experienced banker and financial wizard he ought to know better.
  • Rep. Charlie Rangel hasn't even been censured for not paying his income taxes even though as the head of the committee that writes tax legislation he ought to know better.

Is the SEC telling us that honesty in government circles has become obsolete?  Both the Times and Reuters reported that New Jersey's fraud started under a Republican administration in 2001 and continued through two Democratic administrations.

This can't be a purely partisan phenomenon even though the most famous crooks who've gotten off have been Democrats, because the SEC also ignored wrongdoing by Republicans in this case.  Maybe it's becoming acceptable for government employees to squeeze out all they can and act as they please regardless of the law.

If that's how things are, we're in trouble, and progressively more of it as the word gets around.

Reader Comments

Reuters says they're contemplating gumming California:

The U.S. securities regulator is examining whether the state of California violated securities laws by failing to disclose the risks attached to its public pension fund, the New York Times reported, citing a person with knowledge of the investigation.

California Public Employees Retirement System, also known as Calpers, suffered steep losses during the financial meltdown. The value of the fund's assets had plunged to $160 billion from a peak of $260 billion in 2007, though they have since recovered to about $220 billion.

It is unclear whether investigators are focusing on the failure to disclose risks and the amount of money it might need to cover any shortfall or on any possible conflicts of interest in steering investments to related parties, the subject of a separate investigation by the attorney general of California, it said.

Securities and Exchange Commission officials declined to confirm an investigation to the New York Times. A spokeswoman for Calpers said it had not been contacted by the SEC about its accounting or about financial disclosures, the news daily said.

SEC and Calpers did not immediately respond to emails seeking comment by Reuters outside regular U.S. business hours.

January 7, 2011 7:15 PM

They've tried again!


In announcing a settlement with the state on Monday, the Securities and Exchange Commission accused Illinois of claiming that it had been properly funding public workers’ retirement plans when it had not. In particular, it cited the period from 2005 to 2009, when Illinois also issued $2.2 billion in bonds.

The growing hole in the state pension system put increasing pressure on Illinois’ own finances during that time, raising the risk that at some point the state would not be able to pay for everything, and retirees and bond buyers would be competing for the same limited money. The risk grew greater every year, the S.E.C. said, but investors could not see it by looking at Illinois’ disclosures.

In effect, that meant investors overpaid for bonds of a lower value than they were made out to have, although the S.E.C. did not measure any loss in dollars, and it did not impose fines or penalties in Monday’s settlement. Illinois agreed to a cease-and-desist order without admitting or denying the accusations.

The charges put the state’s pension system, generally thought to be the weakest of any state, back in the national spotlight. In his budget address last week, Gov. Pat Quinn, a Democrat, issued a clear warning that the system had to be fixed.

“Without pension reform, within two years, Illinois will be spending more on public pensions than on education,” said Mr. Quinn. “As I said to you a year ago, our state cannot continue on this path.”

March 12, 2013 7:46 AM
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