New Jersey's Irish Luck

| About: PIMCO Intermediate (MUNI)

One of the headlines yesterday was that New Jersey became the first U.S. state sued by the Security Exchange Commission (SEC) for security fraud. Here is the low-down according to the WSJ (my summary):

The SEC cited that the case involved municipal bonds in 79 separate offerings, totaling $26 billion from 2001 to 2007, where the state didn't disclose it had abandoned a five-year plan to fund the pension plans. The filing described NJ used a series of accounting maneuvers to create an illusion that it was funding the two pensions totaling $62 billion, when it actually was just moving money around, and allegedly misled investors.

Now, here comes the part about the Irish Luck (my summary based on the NYT).

The SEC settled its suit with New Jersey by issuing a cease-and-desist (.pdf) order, which the state accepted without admitting or denying the findings. No penalties were imposed. No individuals, nor the bond underwriters were charged. New Jersey’s largest bond underwriters during the period in question include Citigroup (NYSE:C), J. P. Morgan Securities (NYSE:JPM), Morgan Stanley (NYSE:MS), Bank of America (NYSE:BAC), Merrill Lynch, Goldman Sachs (NYSE:GS) and Barclays Capital.

So basically, New Jersey pulled an Enron trick without any consequences. Can you imagine any corporations or private citizens getting off this easy? Some fines or penalties have got to be involved, at the minimum, and some employee(s) and the underwriters should be charged as well.

Well, as it happens, the SEC currently has authority over companies regarding disclosure, but with munis, all it can do is bring a case if it suspects fraud. Furthermore, no investors appeared to have been harmed, and imposing any sizable fines and/or penalties would probably bankrupt New Jersey. So this most likely explained why NJ got just a little slap on the wrist. (By the way, the SEC has asked Congress for expanded authority.)

However, what's more worrisome is that the WSJ noted that:

States as a whole face a trillion-dollar gap between the pensions, health care and other retirement benefits they have promised to public employees, and the money set aside to pay the benefits, according to a report by the Pew Center on the States. The SEC said it is concerned about how these problems are disclosed to investors.

Chart Source:
Click to enlarge

With New Jersey as a precedent, muni investors probably should not expect too much accountability and protection from the SEC.

Disclosure: No positions