Jon Henes: State Disclosures Ahead for Municipal Bond Market

States and local governments, like corporations, issue bonds to the public. Yet, unlike corporations, states and municipalities are not held to the same requirements for disclosing financial information, including pension and OPEB (other post-employment benefits) liabilities, when issuing bonds.

As a result, the public, when making a determination on whether to invest in municipal bonds, does not necessarily have adequate information to make an informed decision.

Currently, there are three noteworthy items that suggest that there will be better financial disclosure by states and local governments in the future.

First, Moody’s is recalculating the states’ debt burdens to include public pension liabilities. Second, the SEC has set up a group to investigate public pension funds, as well as statements made by state officials regarding the health of such funds in connection with the issuance of municipal bonds. Third, Congressman Devin Nunes of California has proposed a bill to make the health of public pension plans transparent to the public.

Transparency and appropriate disclosure will allow municipal bond investors to make informed choices with respect to the yield they need to provide a state or municipality with funds. And, the public will be able to understand the gravity of the states’ and local governments’ fiscal situation.

Moody’s Change of Practice

This week, Moody’s Investor Services reported, for the first time, both bond debt and unfunded pension liabilities in calculating the states’ total debt burden. Moody’s stated that it always considers unfunded pension liabilities when it rates states but wanted to disclose the information publicly to help investors understand the impact of unfunded pension liabilities on the states’ debt levels. By including pension liabilities in the debt of the states, Moody’s is looking at the states’ finances similar to a corporation’s finances.

Notably, however, Moody’s is using the value of pension plans provided by the states, while acknowledging that the unfunded portions of pension plans may be higher than states disclose. Thus, while getting closer to disclosing the actual amount of debt and other liabilities burdening states, the public investor still needs to do some guess work to understand the total unfunded status of public pension funds and OPEB liabilities. Nonetheless, as discussed below, new legislation may help public investors obtain the true amount of unfunded pension liabilities in the future.

SEC Investigations

As Moody’s is reporting pension liabilities in its ratings, the SEC has been investigating the public disclosure by states and municipalities of their financial information in connection with municipal bond issuances. These investigations should incentivize public officials to disclose more information, rather than less, and provide a more comprehensive picture of their states’ fiscal health.

In April of 2008, the SEC charged five former San Diego city officials with securities fraud. The SEC charged these officials for failing to disclose to the investing public that there were funding problems with San Diego’s pension and retiree health care obligations and that those liabilities placed San Diego in serious financial jeopardy.

In a public disclosure, the SEC stated that “[m]unicipal officers responsible for municipal bond disclosure play a key gatekeeper role in protecting investors. It is therefore imperative that they honor the public’s trust by ensuring investors are provided with accurate, material information about the issuer’s fiscal health.”

"Currently, the SEC is investigating Illinois concerning public officials’ statements about the state’s underfunded pension plan. Specifically, “the SEC is investigating whether Illinois was taking future savings and treating them as current reductions in the cost of the pension fund.”"

In October of 2010, four of the five officials agreed to settle the charges, without admitting wrong doing, paying $80,000, which was one of the first times ever that city officials paid fines related to SEC charges.

The SEC now has a group devoted to investigating public pensions. Last year, the SEC commenced its first case against a state, when it accused New Jersey of securities fraud for claiming to have pension assets that allegedly did really exist. Currently, the SEC is investigating Illinois concerning public officials’ statements about the state’s underfunded pension plan. Specifically, “the SEC is investigating whether Illinois was taking future savings and treating them as current reductions in the cost of the pension fund.”

New Legislation

Congress is also focused on appropriate disclosure of public pension plan liabilities. Specifically, Congressman Devin Nunes of California proposed a bill, the “Public Employee Pension Transparency Act.” The policy of the Act is:

  • to protect the interests of participants and beneficiaries in State and local government employee pension benefit plans and the interests of the Federal government and the general public in the fiscal soundness of such plans, to minimize the threat of a possible adverse impact of the operation of such plans on Federal revenues and expenditures and the national securities markets, and to encourage the sponsors of such plans to examine the problems which may be experienced by their plans and to expeditiously implement those remedial measures which may be necessary to guaranty meaningful disclosure of the assets and liabilities of such plans as well as fiscal soundness, by providing meaningful disclosure of the value of State and local government employee pension benefit plan assets and liabilities.

Specifically, the Act would require states and local governments to disclose a schedule of their pension plan funding status, including a statement of current pension plan assets and liabilities, the unfunded liability of the plan and the funding percentage of the plan. In addition, states and local governments will need to state their actuarial assumptions and their investment returns, including the rate of return for the plan year and the 5 preceding plan years.

Consequently, if the Act, or some version of it, becomes law, state and local governments will begin to provide the market with a better picture of their financial health, which will allow for better investment decisions by municipal bond players and a true understanding of a states financial issues.

As states and local governments continue to struggle with fiscal issues, they will be required to begin making better disclosure of their unfunded pension liabilities. This is good news that the depth of the fiscal problems can be analyzed and the investing public will have full disclosure on which to make prudent and informed investment decisions.

Jon Henes is a partner in the Restructuring Group of the law firm of Kirkland & Ellis. Jon's practice involves representing debtors (including portfolio, privately-held and public companies), creditors' committees and distressed investors (including hedge funds, private equity funds and companies) in acquisitions, restructurings and bankruptcy cases.