U.S. finds bond fraud in Kansas over pensions

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Federal regulators said Monday that Kansas had defrauded investors by bringing $273 million of bonds to market in 2009 and 2010 without disclosing that its pension system was deeply under water and that the investors ran a risk of not being fully repaid.

The Securities and Exchange Commission filed a complaint singling out bonds issued by the Kansas Development Finance Authority to raise money for a range of projects, including hospital improvements, public libraries, water systems, public housing and improvements at Kansas State University.

“Kansas failed to adequately disclose its multibillion-dollar pension liability in bond offering documents, leaving investors with an incomplete picture of the state’s finances and its ability to repay the bonds amid competing strains on the state budget,” said LeeAnn Ghazil Gaunt, head of the SEC’s municipal securities and public pensions unit.

The state was not fined, Ms. Gaunt said in a statement, because Kansas had already taken “significant remedial actions” and officials had cooperated with the SEC’s investigation.

Kansas Gov. Sam Brownback, a Republican, said in a statement Monday that he had taken steps to address the problems after taking office in January 2011. He said his administration had “improved transparency” and had increased the amounts that both workers and public employers in the state were required to set aside for pensions.

In addition, he said Kansas had set up a new retirement plan for public workers who will be hired starting in 2015. The governor said that would improve the pension system’s stability. “We have taken what was once the second-worst funded pension system in the nation and made significant strides,” he said.

The troubles with the SEC started several years before the bonds in question were sold, the complaint said, when Kansas officials removed critical pension information from the state’s audited financial reports as well as the official statements that underwriters use to market municipal bonds. The SEC said unidentified “outside accountants” had told state officials that they were not required to include the information.

By doing things this way, the regulators said, Kansas removed information that investors should have had — especially after the crash of 2008, when the state pension system developed an $8.3 billion shortfall and urgently needed more cash. The hole in the system had grown to more than twice the value of the state’s outstanding taxpayer-supported debt, $3.1 billion.

Kansas was, at that point, issuing a commonplace type of debt that required legislative appropriations before any principal or interest payments could be made. Although this type of debt was described in the bonds’ prospectus, the regulators said the description was inadequate because it failed to reveal the increasingly dire condition of the pension system and the growing likelihood that lawmakers might decide not to approve money for the debt service because they regarded the pension system as more important. The SEC also said state officials held meetings to discuss the pension predicament but decided not to alter the bond prospectus or explain their concerns to the ratings agencies.

Kansas is the third state to face SEC civil charges that it misled the public markets about the health of its pension system. Regulators went after New Jersey in 2010, after a report in The New York Times about its pension machinations, and sanctioned Illinois last year. The SEC said its action against Kansas was “stemming from a nationwide review” of what states and cities have been telling the markets about their unfunded pension systems.

Detroit’s bankruptcy has given bond investors a sobering lesson on what can happen when there is not enough money to pay everybody. The city is proposing haircuts for both its pensioners and its bondholders, and it even wants to repudiate one class of debt instruments entirely, $1.4 billion of certificates that it sold in 2005 to raise money for its pension fund. It will seek court confirmation for those proposals at a trial later this month.

United States - North America - United States government - Kansas - U.S. Securities and Exchange Commission - Samuel Brownback - Kansas state government


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