SEC Brings Another Bond Case Against A State

by Dorsey & Whitney LLP

The SEC’s nationwide review of municipal bond disclosures yielded another enforcement action, this time against the state of Kanas. The Order centers on claims that the state failed to disclose its huge unfunded pension liabilities. In the Matter of The State of Kansas, Adm. Proc. File No. 3-16009 (Aug. 11, 2104).

Beginning in August 2009, and continuing for about the next year, the Kansas Development Finance Authority or KDFA raised $273 million through eight series of bonds offered on behalf of the State and its agencies. KDFA is an independent instrumentality of the state. Its primary purpose is to enhance the ability of the state to finance capital improvements. As a conduit issuer, the instrumentality offers securities on behalf of underlying issuers. KDA, another component of the state, provided all financial and administrative services for it. Through two separate divisions it provided disclosure documents and comprehensive annual financial reports or CAFRs.

The pension fund in the state, KPERS, is an independent instrumentality. It covers most government and public service employees. It also covers local school districts. Annually it prepares and releases an actuarial valuation and comprehensive annual financial report or CAFR.

During the offering period KPERS was underfunded. At the end of 2008 its unfunded actuarial accrued liability was about $8.3 billion. It had a 59% funded ration. By contrast the tax supported debt of the state was $3.1 billion.

A significant limitation on the debt of the state was a constitutional provision. That provision requires that there be annual appropriations for general debt obligation. This creates a risk that each year the funds would not be appropriated. Rating agencies took this into account.

Beginning in 2004 there were changes made in the way the CAFRs were prepared. Outside accountants suggest that information not be provided on KPERS’s funding ration or unfunded actuarial accrued liability. Rather, certain information was provided regarding KPERS and the State’s expenditures to fund employer contributions to KPERS. After the change no reference was made to the State’s substantially underfunded pension plan.

The Official Statements for the eight series of bonds issued beginning in August 2009 included statements regarding the risk of non-appropriation. Information was also included regarding the amount of certain state indebtedness. There was no mention of the underfunded status of KPERS. At closing certificates were issued certifying that all material information was disclosed and correct.

Once the deficiencies in the disclosures came to light, Respondent undertook prompt remedial measures. Those included new procedures regarding the responsibilities for critical disclosers and closer communication and cooperation among agencies. A State Disclosure Committee was also established. The disclosures for fiscal 2010 resumed including information regarding KPERS contributions and a schedule of funding process. The Official Statements for the most recent revenue bond offerings included a separate appendix discussing KPERS and its underfunded status.

The Order alleges violations of Securities Act Sections 17(a)(2) and (3). The State resolved the proceeding by consenting to the entry of a cease and desist order based on the Sections cited in the Oder.

This is the third case brought by the SEC against a state based on unfunded pension liabilities. Previously, the Commission brought actions against the states of Illinois and New Jersey.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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