Tuesday, August 12, 2014

Kansas Failed to Disclose Significant Underfunding of Pension System While Conducting Bond Offerings

[This story previously appeared in Securities Regulation Daily.]

By Jacquelyn Lumb

The State of Kansas has consented to an SEC cease-and-desist order in connection with its failure to disclose, in the offering documents for a series of bond offerings, that its pension system was significantly underfunded. The failure to disclose the underfunding, by some estimates the second-most underfunded statewide public pension system in the nation, made the official statements materially misleading, according to the order. The SEC accepted the state’s offer of settlement after taking into account the remedial actions that were promptly undertaken.

Years of underfunding. The SEC said the Kansas Public Employees Retirement System (KPERS) experienced financial difficulties as a result of years of insufficient contribution rates to cover normal costs and unfunded actuarial accrued liability. The need for increased funding was both reasonably predictable and within the control of the state, according to the SEC. At the end of the 2008 calendar year, KPERS had a total retirement system unfunded actuarial accrued liability of $8.3 billion and a 59 percent funded ratio. The SEC noted that the liability was substantial since, by comparison, the state’s tax-supported debt was $3.1 billion in 2008.

Heightened risk. The SEC also noted that the Kansas legislature must annually appropriate money to pay the principal and interest on the debt issued by the Kansas Development Finance Authority (KDFA) on its behalf. The major credit rating agencies routinely reduce the rating assigned to bonds by one level where there is a risk, as here, of non-appropriation.

Lack of communication. The SEC found that the KDFA believed that the Kansas Department of Administration (KDA) was responsible for providing the information and disclosures in the official statements relating to financial issues that affect the state, while the KDA though the reverse. The lack of clear communications and the absence of effective written policies and procedures at either organization resulted in neither one identifying the absence of the KPERS unfunded liability or the need to add the disclosure to the official statements.

Remedial actions. Soon after the SEC began its nationwide review of municipal bond disclosures and began questioning the disclosures related to the Kansas bond offerings, Kansas began to adopt new policies and procedures to improve its disclosure about its pension liabilities. The SEC reported that Kansas has now fully implemented those remedial actions.