Since the economic crisis, public finance commentators have urged caution in light of the troubles facing Detroit or Puerto Rico. Recent changes in accounting rules for public pensions have raised concerns about risks for managers of those pensions under federal securities laws.
The Government Accounting Standards Board (GASB) sets accounting standards for public pensions. It recently announced new standards that raise questions for public pensions and the governments that sponsor them. Newly enacted GASB Statements 67 and 68 govern financial reporting and accounting for public pension plans. They represent a shift from a funding-based approach to an accounting-based approach for public pension expense and liability recognition.
GASB statements historically classified an employer’s obligation to its associated pension plan as the amount that the employer contributed to the plan. Now, GASB 68 classifies the employer’s obligation to the pension plan as that employer’s share of the entire plan’s net pension liability. This net pension liability is the difference between the pension plan’s total liability and its net assets at fair value. Typically, a public employer’s contribution rate is set by statute: its proportionate share of the total liability will thus ordinarily remain on its balance sheet. Where the net pension liability is not entirely funded, public employers’ balance sheets reflect their proportionate share of the unfunded liability.
The new GASB statements require public pensions to disclose their collective net pension liability and associated public employers to disclose their proportionate share, represented as a percentage of the total. GASB 67 and GASB 68 also require disclosure of pension expense (or income), which was historically represented by the required contribution, but now represents the change in net pension liability from year to year. Finally, while public employers were previously able to include basic footnote disclosures in their financial statements referencing more detailed disclosures contained in any associated pension plan financial statements, GASB 67 and GASB 68 now require expanded employer footnote disclosures.
In complying with GASB 67 and GASB 68, public pension plans ordinarily calculate and disclose total net pension liability and each associated employer’s proportion of the net pension liability. These figures are normally calculated by actuaries and audited by independent public accountants. The figures that a public pension provides to associated employers under GASB 67 and GASB 68 may be used by the employers in their own financial statements. As such, the figures could be information relevant to investors if any of those employers issue securities (e.g., municipal bonds). Public pension fiduciaries are therefore inquiring about federal securities law risks if associated employers issue bonds after including information in their financial statements that was provided by the pension plan pursuant to the new GASB statements.
In complying with GASB 67 and GASB 68, public pension plans ordinarily calculate and disclose total net pension liability and each associated employer’s proportion of the net pension liability.
Municipal securities are exempt from the registration and civil liability provisions of the Securities Act of 1933 (the “Securities Act”). They are not, however, exempt from the Securities Act’s antifraud provisions. While government, and not private, enforcement is permitted under the antifraud provisions of the Securities Act, private enforcement is permitted for alleged violations of the antifraud provisions of the Securities Exchange Act of 1934 (“Exchange Act”). In 1971, the Supreme Court first recognized an implied private right of action for violation of the antifraud provisions of Section 10(b) of the Exchange Act. Thus, public bond offering documents containing disclosures pursuant to the new GASB statements could become the target of federal securities law enforcement.
The Securities and Exchange Commission (“SEC”) has recently prosecuted three enforcement actions focusing on material misrepresentations and omissions made in municipal securities offering documents concerning pension funding and unfunded liabilities.
- In 2010, New Jersey became the first state that the SEC ever charged with securities fraud when the SEC brought an action under the antifraud provisions of the Securities Act alleging that New Jersey misrepresented and failed to disclose to municipal bond investors that it was underfunding its two largest pension plans.
- In March 2013, the SEC brought an action against the State of Illinois, alleging that Illinois had misled bond investors by failing to disclose the adequacy of its statutory plan to fund its pension obligations, and omitting to disclose the risks created by the underfunding.
- And, in August 2014, the SEC brought an action against the State of Kansas alleging that Kansas failed to disclose the existence of a significant unfunded liability in the state’s retirement system, and the effect of such unfunded liability.
Each action was resolved through agreed-upon remedial measures designed to increase and enhance the granularity of public pension funding disclosures. Because the disclosures mandated by GASB 67 and GASB 68 address the identical subject-matter as these SEC actions, the resulting enforcement-generated disclosures are relevant considerations for public pension fiduciaries implementing GASB 67 and GASB 68, particularly those fiduciaries seeking to mitigate any risk from securities offerings by or on behalf of associated public employers making pension funding disclosures.
Public pension fiduciaries seeking to minimize risk associated with the implementation of the new GASB statements should consider best practices. Best practices may include:
- establishing a set of “due diligence” procedures for determining net pension liability and an associated public employer’s proportionate share;
- formalizing for this purpose the retention of an actuarial firm and an independent auditing firm;
- documenting procedures and mechanisms through which “due diligence” may be objectively determined; and
- indicating to employers that any estimate of proportionate net pension liability must be described as a forward-looking statement in securities offering documents. When stated with specificity, such cautionary language has been found effective in negating culpability.
These practices are important for fiduciaries considering how to best mitigate any risk from potential securities claims based on municipal securities offering disclosures under GASB 67 and GASB 68.