Time to Review Your Severance Agreements

In August 2016, the SEC issued cease-and-desist orders against two different companies for using severance agreements which required exiting employees to waive their ability to obtain monetary awards under the SEC’s whistleblower program.

According to the SEC’s order regarding BlueLinx Holdings Inc., beginning prior to August 12, 2011 and continuing through the present, BlueLinx entered into severance agreements with departing employees. While the agreements were not uniform, most contained language prohibiting the departing employees from divulging confidential information, unless compelled to do so by law or legal process. In or about June 2013, BlueLinx reviewed and revised each of its outstanding severance agreements and added provisions which (i) required such former employees to waive their rights to monetary recovery should they file a charge or complaint with the SEC or other federal agencies, and (ii) required such former employees to notify the company’s legal department prior to disclosing any financial or business information to any third parties.

According to the SEC’s order regarding Health Net, Inc., beginning prior to August 12, 2011 and continuing through October 22, 2015, Health Net entered into severance agreements with departing employees. In August 2011, after the whistleblower rules were adopted, Health Net updated its form of severance agreement to add language which prohibited former employees from filing an application for, or accepting, a whistleblower award from the SEC. This language was contained in severance agreement entered into from approximately August 2011 to June 2013. In June 2013, Health Net updated its form of severance agreement to remove the SEC-specific language; however, Health Net retained language that removed the financial incentive for reporting information. On October 22, 2015, Health Net updated its form of severance agreement and struck the restrictive language related to monetary awards.

The SEC charged each of BlueLinx and Health Net with violating Rule 21F-17 under the Exchange Act. Rule 21F-17, adopted pursuant to the Dodd-Frank Act, provides that “[n]o person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement. . .with respect to such communications.”

BlueLinx consented to the SEC’s cease-and-desist order without admitting or denying the findings. BlueLinx agreed to include in all of its severance agreements after the date of the order language which makes it clear that employees may report possible securities law violations to the SEC and other federal agencies without BlueLinx’s prior approval and without having to forfeit any resulting whistleblower award. In addition, BlueLinx agreed to make reasonable efforts to contact former employees who had executed severance agreements from August 12, 2011 through the present to notify them that BlueLinx does not prohibit former employees from providing information to the SEC staff without notice to BlueLinx or from accepting SEC whistleblower awards. In addition, BlueLinx agreed to pay the SEC a civil penalty of $265,000.

Health Net also consented to the SEC’s cease-and-desist order without admitting or denying the findings. Health Net agreed to make reasonable efforts to inform former employees who signed severance agreements from August 12, 2011 through October 22, 2015 that Health Net does not prohibit former employees from seeking and obtaining a whistleblower award from the SEC under Section 21F of the Exchange Act. In addition, Health Net agreed to pay the SEC a civil penalty of $340,000.

In light of the above orders, companies should review new and existing severance agreements that they have or enter into with former employees to make sure that such documents do not restrict such former employees’ ability to provide information to the SEC or from accepting SEC whistleblower awards. The mere existence of such restrictive language in severance agreements in and of itself could be found to be a violation of Section 21F of the Exchange Act.

Beware of Confidentiality Agreements with Employees; Make Sure They Don’t Stifle Whistleblowing

On April 1, 2015, the SEC announced its first enforcement action against a company for utilizing language in a confidentiality agreement which could discourage whistleblowing.

The SEC charged KBR, Inc., a Houston-based global technology and engineering firm, with violating Rule 21F-17 of the Exchange Act. Rule 21F-17, adopted pursuant to the Dodd-Frank Act, provides that “[n]o person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement. . .with respect to such communications.”

As part of its compliance program, KBR regularly receives allegations from its employees of potential illegal or unethical conduct by KBR or its employees. In looking into such matters, KBR would typically conduct an internal investigation which would include interviewing KBR employees.   In connection with such internal investigation interviews, KBR required witnesses to sign confidentiality statements which provided that such witnesses could face disciplinary action and even be fired if they discussed the matters discussed in the interview with outside parties without the prior approval of KBR’s legal department.  Because such investigations could involve violations of securities laws, the SEC claimed that the restrictive language in the KBR confidentiality statements violated Rule 21F-17. Notably, the SEC was not aware of any instance where (i) this restrictive language prevented a KBR employee from communicating with the SEC about potential securities violations, or (ii) KBR took any action to enforce such language in its confidentiality statements.

In order to settle the enforcement action, without admitting or denying the SEC’s charges, KBR (i) agreed to pay a $130,000 penalty, (ii) agreed to make reasonable efforts to contact KBR employees in the U.S. who had signed the confidentiality statement since August 21, 2011 to clarify that such employees are free to report possible violations of federal law or regulation to governmental agencies without obtaining the permission of KBR’s general counsel, and (iii) amended its confidentiality statement to include the following language:

“Nothing in this Confidentiality Statement prohibits me from reporting possible violations of federal law or regulation to any governmental agency or entity, including but not limited to the Department of Justice, the Securities and Exchange Commission, the Congress, and any agency Inspector General, or making other disclosures that are protected under the whistleblower provisions of federal law or regulation. I do not need the prior authorization of the Law Department to make any such reports or disclosures and I am not required to notify the company that I have made such reports or disclosures.”

In light of the above enforcement action, companies should review agreements that they have with their employees, as well as Company policies, to make sure that such documents do not contain language that would potentially stifle whistleblowing.

 

MD&A Lessons Learned from Broadwind Energy

On February 5, 2015, the Securities and Exchange Commission charged Broadwind Energy, Inc. (Broadwind), its former Chief Executive Officer and its Chief Financial Officer for accounting and disclosure violations that, as the SEC stated in its press release, “prevented investors from knowing that reduced business from two significant customers had caused substantial declines in the company’s long-term financial prospects.”  The penalties were not earth-shattering: subject to the court’s approval, Broadwind agreed to pay, $1 million penalty and its former CEO and its CFO agreed to pay approximately $700,000 in combined disgorgement and penalties.

The SEC brought various charges, including, but not limited to, the violation of Section 17(a)(2) of the Securities Act (in connection with an offering conducted by Broadwind) and the violation of Section 13 of the Exchange Act and Rule 13a-14 under such act, but this case is interesting because it deals with the eternal question that public company management and their securities lawyers are dealing with every day: how much disclosure is enough disclosure for the investors to make a reasonable decision whether to buy or sell the company’s securities?

Broadwind’s fact pattern, as outlined in the SEC’s complaint filed in the U.S. District Court for the Northern District of Illinois, makes it clear that during the third quarter of 2009, Broadwind began to plan more definitively for the impairment of its subsidiary’s intangible assets related to contracts with two major customers and Broadwind’s internal documents identified an expected impairment charge of $48 million related to the contract with one of such customers.  Broadwind shared this expectation and these documents with its outside audit firm, its investment bankers and the subsidiary’s primary lender. Broadwind also incorporated impairment in its planning for the upcoming audit of 2009 financial results. Broadwind’s revenues from the two major customers declined 43% and 25%, respectively, for the nine months ended September 30, 2009 compared to the same period ended September 30, 2008.

The SEC argued that Broadwind’s disclosure in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section of its Form 10-Q for the third quarter of 2009 was materially misleading.  Such disclosure read, in part, as follows:

[A] continued economic slowdown may result in impairment to our fixed assets, goodwill and intangible assets. We perform an annual goodwill impairment test during the fourth quarter of each year, or more frequently when events or circumstances indicate that the carrying value of our assets may not be recovered. The recession that has occurred during 2008 and 2009 has impacted our financial results and has reduced purchases from certain of our key customers. We may determine that our expectations of future financial results and cash flows from one or more of our businesses has decreased or a decrease in stock valuation may occur, which could result in a review of our goodwill and intangible assets associated with these businesses. Since a large portion of the value of our intangibles has been ascribed to projected revenues from certain key customers, a change in our expectation of future cash from one or more of these customers could indicate potential impairment to the carrying value of our assets.

Item 303 of Regulation S-K requires a public company to disclose in its MD&A “any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way.”  MD&A also requires a description of “any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.”

The SEC’s position outlined in the complaint is that, based on the revenue decline combined with the customers’ lower forecasts of revenue and other developments, Broadwind and its CEO (the CFO started at Broadwind in mid-August 2009) “should have known that the intangible assets were impaired.” However, Broadwind “failed to disclose the impairment of its assets in Form 10-Q” for the quarter ended September 30, 2009, but instead used a “generalized risk disclosure of the possibility of such a charge.”  The SEC also stated in its complaint that if Broadwind had conducted impairment testing in connection with its Form 10-Q for the 3rd quarter 2009, Broadwind would have concluded that its contracts with two significant customers were fully impaired and recorded impairment charges of approximately $60 million in connection with such contracts.” Broadwind ultimately disclosed the impairment in its Form 10-K for the fiscal year ended December 31, 2009. Following the disclosure of the impairment charge, the stock price declined by 29%.

Putting aside the speculation about when it was the right time for Broadwind to conduct the impairment testing, it has been the SEC’s position for more than a decade that MD&A “trends” disclosure should include the “[q]uantification of the material effects of known material trends and uncertainties,” which can promote better understanding of whether the company’s past performance is indicative of future performance.  The SEC’s 2003 Interpretive Release: Commission Guidance Regarding MD&A (Release No. 33-8350) made it clear that “[a]scertaining this indicative value depends to a significant degree on the quality of disclosure about the facts and circumstances surrounding known material trends and uncertainties in MD&A. … Quantitative disclosure should be considered and may be required to the extent material if quantitative information is reasonably available.”

In light of the current 10-K season, the SEC’s complaint in SEC v. Broadwind is a timely reminder that “boiler plate” generalized MD&A disclosure regarding known trends may be inadequate and misleading if management had an opportunity to provide more detailed and meaningful information.

Broker-Dealers Ignoring Red Flags Lead to SEC Releases and Enforcement Action

In October 2014, the SEC’s Division of Trading & Markets issued FAQs to remind broker-dealers of their obligation to conduct a reasonable inquiry when selling securities in an unregistered transaction in reliance on Section 4(a)(4) of the Securities Act. The FAQs explain that “[i]n order to rely on the Section 4(a)(4) exemption, a broker-dealer must conduct a “reasonable inquiry” into the facts surrounding a proposed unregistered sale of securities before selling the securities to form reasonable grounds for believing that a selling customer’s part of the transaction is exempt from Section 5.  . . . [W]hen conducting a reasonable inquiry into whether the transaction would violate Section 5, it is not sufficient for the broker-dealer merely to accept self-serving statements of his sellers and their counsel without reasonably exploring the possibility of contrary facts.  Nor, where there are indicia of an illegal distribution of securities, can a broker-dealer claim that its sales of a security were exempt from registration simply because the stock certificates lack a restrictive legend or a clearing firm or transfer agent raises no objections to the sales.” The FAQs provide a list of factors that the SEC will consider in assessing the reasonableness of a broker-dealer’s inquiry and its reliance on the Section 4(a)(4) exemption.

Simultaneously with the issuance of the FAQs, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert which summarized deficiencies which OCIE observed in examining 22 broker-dealers. Among other matters, the examinations uncovered deficiencies related to controls put in place to comply with obligations related to sales of securities, including the performance of a reasonable inquiry in connection with unregistered sales of securities in reliance on Section 4(a)(4) of the Securities Act.

In conjunction with the FAQs and the Risk Alert, the SEC announced an enforcement action against certain current and former E*Trade subsidiaries (the “Subsidiaries”) for ignoring red flags in connection with the sale of unregistered penny stocks. The SEC’s order finds that the Subsidiaries were not entitled to rely on the Section 4(a)(4) exemption because they did not perform a “reasonable inquiry.” The Subsidiaries agreed to settle the SEC’s charges by paying back more than $1.5 million in disgorgement and prejudgment interest from commissions they earned on the improper sales. They also must pay a combined penalty of $1 million.

In light of the above, broker-dealers should reexamine their policies and procedures related to the sale of unregistered securities and provide training to their personnel concerning what constitutes a “reasonable inquiry.”

FRIDAY AFTERNOON SMACKDOWN – THE SEC v. THE HOUSE OF REPRESENTATIVES

On Friday, June 20, 2014, the Securities and Exchange Commission filed an action against the Committee on Ways and Means of the U.S. House of Representatives and congressional staffer Brian Sutter seeking enforcement of subpoenas the SEC issued. The SEC is investigating whether laws against insider trading, specifically applicable to members and employees of Congress via the Stop Trading on Congressional Knowledge Act of 2012 (the “STOCK Act”), were violated by the disclosure of non-public information about Medicare reimbursement rates. This is pretty exciting stuff for securities lawyers. It isn’t everyday that one branch of the federal government sues another. (Generally, the facts set forth below are derived from the SEC’s court filing and have not yet been established as true in court.)

About a year after the STOCK Act became law, the SEC launched an investigation into whether information regarding the April 1, 2013 announcement by the U.S. Centers for Medicare and Medicaid Services (“CMS”) on the 2014 reimbursement rates for the Medicare Advantage program was leaked improperly prior to the official public announcement. In its brief filed with the United States District Court for the Southern District of New York, the SEC details the opening of a formal investigation to determine, among other things, the source(s) of information in an email sent from a lobbyist to a broker-dealer that issued a “flash report” indicating that certain Medicare reimbursement rates would actually increase, rather than decrease as had been expected. The flash report was issued approximately 40 minutes before the official CMS announcement regarding the reimbursement rates and was followed promptly by a dramatic increase in the price and trading volume of certain health care stocks.

On May 6, 2014 the SEC staff issued subpoenas to the House Committee on Ways and Means and Brian Sutter. Mr. Sutter is the Staff Director of the House Ways and Means Committee’s Healthcare Committee. Before becoming Staff Director, Mr. Sutter was a staff member to the Subcommittee. Both the Committee and Mr. Sutter have refused to comply with the subpoenas, citing a number of legal objections, including that the documents demanded are protected by the Constitution’s Speech or Debate Clause. The SEC is having none of that and, on June 20, 2014, the SEC filed an action to enforce subpoenas it issued in connection with its investigation, potentially setting up a Constitutional showdown.    

From my perspective, there are at least two interesting points here. First, the SEC appears to be aggressively enforcing the STOCK Act. Hopefully, the courts will find a way to support the SEC in its efforts to conduct the investigation. If the SEC cannot investigate, the STOCK Act may have little, if any, bite. (If you would like to read more about the STOCK Act, please see our summary in the April 2012 issue of Up to Date.) Second, it will be very interesting to watch the matter unfold from a Constitutional perspective.

Spreading Sunshine in Private Equity

Title: Spreading Sunshine in Private Equity

On May 6, 2014, Andrew J. Bowden, Director of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”), gave a speech entitled “Spreading Sunshine in Private Equity” to the Private Fund Compliance Forum (sponsored by Private Equity International) in New York.

The OCIE administers the SEC’s “examination and inspection” program, and oversees a multitude of registrants, including investment advisers, investment companies and broker-dealers. As a result of the Dodd-Frank Act, many private equity and other funds are now required to register with the SEC and are also subject to SEC inspection and certain other regulatory requirements. This statutory change brought an end to the minimal regulatory environment in which most private equity funds operated in for decades.

At the outset, Director Bowden presented an overview of the OCIE’s initial efforts to understand, and begin oversight of, the private equity industry. Director Bowden highlighted certain differences – some inherent and some borne of practice – in the private equity industry that pose different regulatory (including disclosure) challenges than those associated with regulating publicly-traded registrants. Some of these differences, certain of which have been addressed publicly by other SEC officials, include:

  • A private equity fund’s control over its privately-held portfolio companies, and the ability of the fund to influence the management and decision-making of such companies;
  • The typically “voluminous” limited partnership agreement that permits a fund a wide latitude of control and contains terms that are often subject to varying interpretations; and
  • That a fund typically is not subject to significant scrutiny by its limited partners (i.e., the lack of information rights).

Given these differences, Director Bowden described a number of observations from more than 150 examinations of private equity funds conducted by OCIE. In over half of the examinations, Director Bowden noted that OCIE found what it believes to be “violations of law or material weaknesses in controls” with respect to the treatment of fees and expenses. Director Bowden seemed to, at a fundamental level, take the position that private equity funds do not adequately disclose to investors the manner in which the funds allocate fees and expenses. For instance, the Director noted the typical practice of allocating “operating partner” expenses to a fund’s portfolio companies or to the fund itself, which the Director characterized as creating a “back door” fee that investors do not expect. In addition, Director Bowden spent some time discussing the inconsistent valuation methodologies that are sometimes used by a private equity fund, especially during the fundraising cycle, although he noted that OCIE only seeks to ensure consistency of valuation methodologies and has no intention of determining the type of methodologies employed by any particular fund.

In his concluding remarks, the Director stated that there is room for improvement in the overall compliance programs of many funds. In addition to promoting a culture of compliance, Director Bowden posited that funds would foster more effective compliance by involving compliance personnel in the deal-making process, including participating in investment committee meetings and reviewing deal memos.

Investing in Bitcoin? Think Twice Says the SEC.

Bitcoin has been in the news a lot recently and most of the news has been bad, including news of the bankruptcy of Mt. Gox, formerly one of the world’s largest Bitcoin exchanges. Most recently, on May 7, 2014, the SEC issued an Investor Alert to make investors aware of the potential risks of investments involving Bitcoin and other forms of virtual currency.

According to the Investor Alert, Bitcoin has been described as a decentralized, peer-to-peer virtual currency that can be exchanged for traditional currencies, or used to purchase goods or services, usually online. What most distinguishes Bitcoin and similar virtual currencies from more traditional currencies is the fact that they are not backed by any government and operate without any central authority or oversight.

In its release, the SEC discusses:

  • The heightened risk of fraud that investments involving Bitcoin may have, noting that “innovations and new technologies are often used by fraudsters to perpetrate fraudulent investment schemes.”
  • Potential warning signs of investment fraud, including “guaranteed” high investment returns, unsolicited sales pitches, unlicensed sellers, no net worth or income requirements for investors, and pressure to buy immediately.
  • Limited recovery options if fraud or theft results in the loss of Bitcoin.
  • Certain unique risks of investments involving Bitcoin, including lack of insurance usually held by banks and brokerage firms, historic Bitcoin exchange rate volatility, potential governmental restrictions, and the potential that Bitcoin exchanges may stop operating due to fraud, technical difficulties, hackers or malware.

If the SEC’s recent guidance is not enough to make you pause and think before investing in anything relating to Bitcoin, you may want to review the SEC’s July 2013 Investor Alert about the use of Bitcoin in Ponzi schemes, the Financial Industry Regulatory Authority’s recent Investor Alert cautioning investors about the risks of buying and using digital currency such as Bitcoin and the North American Securities Administrators Association listing of digital currency on its list of the top 10 threats to investors for 2013. In addition, the IRS has issued guidance stating that the IRS will treat virtual currencies, such a Bitcoin, as property, which has the potential to make transactions in Bitcoin far more complex than transactions in traditional currencies.

SEC Announces the Agenda of Its Cybersecurity Roundtable; Target Corporation Files Form 10-K Bleeding out Disclosures about Its Data Breach

We have previously blogged about March 26 SEC cybersecurity roundtable and the SEC paying close attention to cybersecurity issues, especially on the heels of the cybersecurity breaches faced by Target and other retailers.  On March 19, 2014, the SEC issued a notice about the coming cybersecurity roundtable shedding light on the topics that will be discussed at the roundtable.

The panelists will have a well-rounded discussion of the cybersecurity issues faced by different constituencies, including:

  • exchanges and other key market systems;
  • broker-dealers;
  • investment advisers;
  • transfer agents; and
  • public companies.

Panelists will also be invited to discuss industry and public-private sector coordination efforts relating to assessing and responding to cybersecurity issues.

This roundtable discussion will be very timely.  On March 14, 2014, Target filed its Annual Report on Form 10-K, which reads as Exhibit A to the SEC’s 2011 guidance on cybersecurity disclosures (CF Disclosure Guidance: Topic No. 2, Cybersecurity).  Among other disclosures, the company beefed up the risk factors to talk about its data breach and included a detailed discussion of the ramifications of this breach into its “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 

Some details of Target’s disclosure are quite interesting.  As a result of the data breach, Target recorded $61 million of pretax data breach-related expenses, some of which may be offset by its network-security insurance coverage.  Such expenses include costs to investigate the data breach, provide credit-monitoring services to its customers, increase staffing in its call centers, and procure legal and other professional services. More than 80 actions have been filed and other claims may be asserted against Target on behalf of its customers, payment card issuing banks, shareholders or others seeking relief in connection with the data breach. In addition, State Attorneys General, the Federal Trade Commission and the SEC are investigating events related to the data breach. Probably, one of the most important ramifications is the effect of the data breach on sales as Target believes that the data breach adversely affected its fourth quarter U.S. Segment sales.

Insider Trading Updates: Cuban Jury to SEC – No Cigar; Heinz Tippees Revealed (But Who Were the Tippers?)

The SEC loses some and wins some insider trading cases:

The SEC’s five year old insider trading case against Dallas Mavericks owner, Mark Cuban, came to a sad conclusion for the SEC on Wednesday when a federal jury acquitted Mr. Cuban of insider trading charges.

The SEC had accused Mr. Cuban of insider trading in the securities of Mamma.com, a publicly traded Internet search engine company. According to the complaint, in June 2004, Mr. Cuban sold his entire 600,000 share position in Mamma.com after learning from the CEO that the company was planning to conduct a PIPE offering. The complaint alleged that Cuban avoided losses in excess of $750,000 by selling his stock prior to the public announcement of the PIPE offering.

The SEC alleged that Mr. Cuban verbally agreed to keep confidential and not trade on the information that the CEO gave him about the private offering. Mr. Cuban denied any such agreement and the jury agreed. Possibly hurting the SEC’s position was the fact that their main witness, the Mamma.com CEO, did not testify in person.

And now for a win.

The SEC announced that they had come to a settlement with the previously unknown inside traders who pocketed 1.8 million in profits by trading call options in advance of the public announcement of the sale of the H.J. Heinz Company.

The SEC filed an emergency enforcement action earlier this year to freeze assets in a Swiss-based trading account used to reap the illegal trading profits in advance of the Heinz announcement.

In an amended complaint filed earlier this month, the SEC alleged that the order to purchase the Heinz options was placed by Rodrigo Terpins while he was vacationing at Walt Disney World in Orlando, and that the trading was based on material non-public information that he received from his brother Michel Terpins. The trades were made through an account belonging to a Cayman Islands-based entity. Rodrigo Terpins purchased nearly $90,000 in option positions in Heinz the day before the announcement, and those positions increased by more than 20 times the next day.

The Terpins brothers agreed to disgorge the entire $1.8 million in illegal profits made from trading Heinz options. The Terpins brothers also will pay $3 million in penalties.

Interestingly, the amended complaint does not reveal the identity of the “tipper” that provided the information to Michel Terpins, other than to say that the SEC believed that the “information source” had disclosed the information about the pending deal “in breach of a duty.”

Land of Honest Abe – Not So Honest?

In March, the SEC announced that it had charged the State of Illinois with securities fraud for misleading municipal bond investors about the state’s approach to funding its pension obligations. This marks the second time that the SEC has charged a state with violating federal securities laws in their public pension disclosures. The SEC charged New Jersey in 2010 with misleading municipal bond investors about its underfunding of the state’s two largest pension plans. Given the general problems facing state government pensions systems, hopefully the SEC’s action will serve as a wake-up call to the other 48 states and their counsel in drafting municipal bond offering documents.

Interestingly, the SEC’s order did make any direct findings that any investors had actually lost money, other than statements that, as more information became available, the state’s bond ratings were lowered and that the risk premium associated with Illinois bonds rose, which presumably would cause the price of outstanding bonds to fall.

An SEC investigation revealed that Illinois failed to inform investors about the impact of problems with its pension funding schedule as the state offered and sold more than $2.2 billion worth of municipal bonds from 2005 to early 2009. Illinois failed to disclose that its statutory plan significantly underfunded the state’s pension obligations and increased the risk to its overall financial condition. The state also misled investors about the effect of changes to its statutory plan. Illinois, which implemented a number of remedial actions and issued corrective disclosures beginning in 2009, agreed to settle the SEC’s charges.

According to the SEC’s order, the state established a 50-year pension contribution schedule in the Illinois Pension Funding Act that was enacted in 1994. The schedule proved insufficient to cover both the cost of benefits accrued in a current year and a payment to amortize the plans’ unfunded actuarial liability. The statutory plan structurally underfunded the state’s pension obligations and backloaded the majority of pension contributions far into the future. This structure imposed significant stress on the pension systems and the state’s ability to meet its competing obligations – a condition that the SEC determined worsened over time.

The SEC’s order found that Illinois misled investors about the effect of changes to its funding plan, particularly pension holidays enacted in 2005. Although the state disclosed the pension holidays and other legislative amendments to the plan, Illinois did not disclose the effect of those changes on the contribution schedule and its ability to meet its pension obligations. The state’s misleading disclosures resulted from various institutional failures. As a result, Illinois lacked proper mechanisms to identify and evaluate relevant information about its pension systems into its disclosures. The SEC cited, for example, that Illinois had not adopted or implemented sufficient controls, policies, or procedures to ensure that material information about the state’s pension plan was assembled and communicated to individuals responsible for bond disclosures. The state also did not adequately train personnel involved in the disclosure process or retain disclosure counsel.

According to the SEC’s order, Illinois took multiple steps beginning in 2009 to correct process deficiencies and enhance its pension disclosures. The state issued significantly improved disclosures in the pension section of its bond offering documents, retained disclosure counsel, and instituted written policies and procedures as well as implemented disclosure controls and training programs. The state designated a disclosure committee to assemble and evaluate pension disclosures. In reaching a settlement, the Commission considered these and other remedial acts by Illinois and its cooperation with SEC staff during the investigation. Without admitting or denying the findings, Illinois consented to the SEC’s order to cease and desist from committing or causing any violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.