The SEC filed its first action against a state, charging New Jersey with fraud in connection with multiple offerings of municipal bonds dating back to 2001. In the Matter of State of New Jersey, Adm. Proc. File No. 3-14009 (Aug. 18, 2010).

The Order for Proceedings alleges fraud in violation of Securities Act Section 17(a)(2) & (3) in connection with 79 municipal bond offerings from August 2001 through April 2007 for $26 billion. The cases center on the failure of the state to make certain disclosures regarding the financial condition of two large pension funds, the Teachers’ Pension and Annuity Fund (“TPAF”) and the Public Employees’ Retirement System (“PERS”). Specifically, the state created the fiscal illusion, according to the SEC, that the two pension funds were being adequately funded when in fact they were severely under funded. The illusion was created through a series of misrepresentations regarding legislation adopted in 2001 which increased benefits, subsequent legislation intended to fund the costs associated with the increased benefits, the adoption of a so-called five year phase in plan under which the plans were to be funded and the fact that the phase in plan was abandoned.

New Jersey was aware of the underfunding, according to the Order, but took no steps to correct the misleading documents used in connection with the bond offerings. Indeed, its disclosure regarding contributions to the plans omitted present and historical information about the contributions.

During this period the state did not have any written policies and procedures regarding the review or update of the bond offering documents. No training was given to its employees regarding disclosure obligations. This resulted in material misrepresentations.

Following an April 2007 news article which raised questions about the adequacy of the disclosure by New Jersey, the state retained disclosure counsel. During 2007 and 2008 the state, with the assistance of disclosure counsel, reviewed, evaluated and enhanced its disclosures. The state has also adopted formal, written policies and procedures. A committee now oversees the entire disclosure process and an annual mandatory training program has been implemented.

To resolve the proceeding the state consented to the entry of a cease and desist order from commencing or committing or causing any violations and any future violations of the Sections on which the Order is based.

Although this is the first proceeding against a state, others have been brought against governmental entities. For example, in 2006 an administrative proceeding named the City of San Diego as a respondent. The Order there is based on fraud allegations made in connection with municipal bond offerings, discussed here.