Feds, SEC Charge NJ With Running Fraudelent Municipal Bond Ponzi Scheme

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Leave it the mainstream media to water down a story and downplay the facts when the Government is ripping off taxpayers and running a ponzi style scheme to defraud investors.

This time around the scam involved the NJ Governor’s office, the NJ treasury and the NJ legislation lying to investors about the value of tens of billions of dollars of NJ municipal bonds and the state’s funding of those debt obligations over the last decade.

CNN reports in their watered down version of the story that  NJ has agreed to settle fraud charges for withholding and misrepresenting pertinent information about the sale of 79 municipal bonds.

According to the SEC, offering documents connected to a total of 79 bond sales created the false impression that the state could fund certain pension funds. In reality, the regulators said, New Jersey could not make contributions to the pensions without raising taxes or cutting services that could impact its budget.

As a result, investors were not given adequate information to gauge the state’s ability to fund the pensions or assess the impact on its financial condition, according to the SEC.

“The State of New Jersey didn’t give its municipal investors a fair shake, withholding and misrepresenting pertinent information about its financial situation,” Robert Khuzami, Director of the SEC’s Division of Enforcement, said in a statement.

In response, New Jersey said the state has never missed a bond payment and stressed that the state is focused on improving its disclosures.

Reading the stories in the main stream media you would be led to believe that all NJ was doing was failing to make proper disclosures about the municipal bonds sold by the state.

As usual digging into the story reveals NJ was doing far more than failing to proper  disclosures and in fact was running a multi-level ponzi scheme that involved stealing tax payer money and lying to investors about paying off the debt on the bonds it was selling.

In fact every news report on this story that I have read has failed to reveal the most pertinent details of the story.

Not a single one has mentioned that the billions of dollars of municipal bonds that NJ has sold still remain unfunded or that the SEC has found that the scam has led the NJ pensions system so broke that the state will not be able to pay off the debt on the bonds with out causing residents serious financial and economic hardships.

News reports also fail to reveal that NJ actively participated in  falsely over valuing the bonds it was selling and used the fraudulent overvaluations  to make it appear like the state was paying off its debt obligations for the bonds.

There are also no mentions that NJ actively participated in publishing false made up information to investors that tricked investors into believing it was paying off the debt on the municipal bond obligations and in the process of doing so the Governor’s office, the treasury and the state legislative branch to knowingly participated in scam that violated scores of laws.

Here’s a run down of the scam that NJ was running and it would not be surprising if many other states are running such similar scams.

Cooking the books to create billions of dollars of assets that didn’t exists

To hide that fact that the state could not pay it’s debt obligations NJ came up with a scam that made bond assets to appear to be worth billions of dollars more than what they were really worth.

To accomplish this the scam first revalued the market value of bond assets based on their all time high at the height of the bull market in 1999.

Then a second scam was used to hide the fact that the assets were losing their value by using a 5 year smoothing average as the value of the assets instead of their real market value.

By making the assets appear to be worth billions of dollars more than what they where really worth it created the illusion of billions of extra dollars in the account of the NJ treasury.

NJ told investors that it would use the billions of extra dollars that really didn’t exist to pay off the debt obligations using a 5 year plan.

The legislative branch came up with the scam and the Governor’s office played along with the scam by signing off on the budget every year and the treasure provided and publish the false information to keep the scam going.

Then under a specter of smoke and mirrors the state discontinued the imaginary 5 year plan while continuing to represent to investors that the imaginary funds in the “5 year plan” where being used to pay off the debt obligation.

NJ Transfers Money Between Two Funds To Make It Appear Like It Was Paying Off The Debt

Faced with having to make severe budget cuts to pay off  the skyrocketing  municipal bond debt government officials instead came up another scam to keep up the appearance it was paying off the debt.

NJ set up two funds to be used to deposit taxpayer money and to pay out its debt obligations.

NJ deposited int the first account money that it claimed was being collected from tax payers.

No tax payer money was ever deposited into first account.

Instead the taxpayer money collected by the government was skimmed off the top by crooked bureaucrats and corrupt politicians.

Taxpayer money was often used to award lucrative contracts to cronies using schemes like pay to play and to fund other illegal and unethical activities like double dipping into the pension fund and bogus construction projects.

Instead the state withdrew money from the second account claiming it was paying off the debt obligations.

It was not paying off the money with those funds.

Instead the money withdrawn from the second account was then deposited back into the the first account.

This gave allowed the government to cover up it was stealing taxpayer money while also maintaining the illusion that it was paying off the debt on the bond obligations.

The whole time the scam continued while the state reported to investors that the state was fully paying the debt obligations while in reality the funds were literally disappearing out of the state treasury and state debt literally spun out of control.

NJ Purposefully Made False Representations To Hide Its Scam

The entire time that NJ  was running the scam the state continued to lie to investors that it was fully funding its debt when in reality little or none of the debt obligations were being paid.

Many branches of the Government participated in covering up the scam and producing and certified falsified documents that were given to investors during information disclosure and municipal bond sales.

The charges brought forth by the SEC say that NJ published falsified information about its municipal bonds  to cover up the scam and several agencies signed off on the false information without verifying the accuracy even though the state officials certified the information was correct and did not contain material misrepresentations or omissions.

The SEC also found that state officials  did not provide training for those responsible for releasing information and that state did nothing to make sure the  information being released was was accurate.

The SEC charged the state with publishing inaccurate, false and misleading information both  funding disclosures and in the municipal bond offerings to cover up the ponzi scheme.

SEC Finds NJ Budget Problems Caused By This Scam

The scam ran by the state government gave the illusion that made it appear that funds were being fully contributed and led to a 7 year period during which the state not contribute to its debt obligations.

The SEC found that the fraud left NJ faced with the fact that it could not pay off the debt obligation without creating severe economic hardships for state residents.

Instead of paying off the debt obligations NJ government officials then came up with another scam to make it appear to investors that that state was paying off the debt obligations.

NJ Continued To Raise Taxes To Pay Off Debt – But Increased Taxes Were Stolen

During this time the state continued to raise all kinds of taxes on residents and businesses  including sales taxes, income tax and property taxes under the false pretense that the increased tax revenue would be used by the state to pay off the debt and balance the budget.

But that never happened.

Instead NJ continued to run the ponzi scam and very little and in most cases no money was used to pay off the state debt.

The SEC revealed that the if the state had originally payed back its debt like it was supposed to instead of stealing money from the taxpayer NJ would have avoided financial troubles in the first place and there would not have been a need to raise taxes or cut much needed services..

Yet even after continuing to raise taxes and steal more money from the taxpayer the state still did make the contributions toward the debt that it had promised and the additionally collected taxes also evaporated out of the state treasury.

NJ Lied For Years About The True Value Of Assets

In addition to evaluating assets based on its value in 1999 at the height of the bull market NJ also using a 5 year smoothing method to falsely inflate the value of assets.

The use of the 5 year smoothing method also helped the state hide from investors that the assets true market value started to decline in 2002.

The use of the smoothing method made that state assets appear to worth anywhere between 101.9% and 131.0% of their actual market value.

NJ Lied To Investors About Funding Municipal Debt Obligations

State law requires that the contributions to funding the debt obligations be evaluated annually and that the state’s contribution to those debt obligations be adjusted every year based on the annually calculated rate.

Instead of that happening the NJ government cooked up a several different scams over the last decade o hide the fact it was not making the required contributions and lied to investors year after year publishing disclosure information that showed the state was paying it’s obligations.

In the process of lying about making contributions the  corrupt politicians and bureaucrats in Trenton lied about the outstanding liabilities that the state owed toward the debt.

While the debt obligations were originally fully funded well the scam allowed the state’s unfunded liabilities to grow to over $26 billion by 2009.

SEC Press Release About The Municipal Bond Fraud Charges

The SEC Press Release provides much more detail on the charges.

SEC Charges State of New Jersey for Fraudulent Municipal Bond Offerings

Washington, D.C., Aug. 18, 2010 — The Securities and Exchange Commission today charged the State of New Jersey with securities fraud for misrepresenting and failing to disclose to investors in billions of dollars worth of municipal bond offerings that it was underfunding the state’s two largest pension plans.

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“The State of New Jersey didn’t give its municipal investors a fair shake, withholding and misrepresenting pertinent information about its financial situation.” – Robert Khuzami, Director, SEC Enforcement Division

According to the SEC’s order, New Jersey offered and sold more than $26 billion worth of municipal bonds in 79 offerings between August 2001 and April 2007. The offering documents for these securities created the false impression that the Teachers’ Pension and Annuity Fund (TPAF) and the Public Employees’ Retirement System (PERS) were being adequately funded, masking the fact that New Jersey was unable to make contributions to TPAF and PERS without raising taxes, cutting other services or otherwise affecting its budget. As a result, investors were not provided adequate information to evaluate the state’s ability to fund the pensions or assess their impact on the state’s financial condition.

New Jersey is the first state ever charged by the SEC for violations of the federal securities laws. New Jersey agreed to settle the case without admitting or denying the SEC’s findings.

“All issuers of municipal securities, including states, are obligated to provide investors with the information necessary to evaluate material risks,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “The State of New Jersey didn’t give its municipal investors a fair shake, withholding and misrepresenting pertinent information about its financial situation.”

Elaine C. Greenberg, Chief of the SEC’s Municipal Securities and Public Pensions Unit, added, “Issuers of municipal bonds must be held accountable when they seek to borrow the public’s money using offering documents containing false and misleading information. New Jersey hid its financial challenges from the very people who are most concerned about the state’s financial health when investing in its future.”

The SEC’s order finds that New Jersey made material misrepresentations and omissions about the underfunding of TPAF and PERS in such bond disclosure documents as preliminary official statements, official statements, and continuing disclosures. Among New Jersey’s material misrepresentations and omissions:

  • Failed to disclose and misrepresented information about legislation adopted in 2001 that increased retirement benefits for employees and retirees enrolled in TPAF and PERS.
  • Failed to disclose and misrepresented information about special Benefit Enhancement Funds (BEFs) created by the 2001 legislation initially intended to fund the costs associated with the increased benefits.
  • Failed to disclose and misrepresented information about the state’s use of the BEFs as part of a five-year “phase-in plan” to begin making contributions to TPAF and PERS.
  • Failed to disclose and misrepresented information about the state’s alteration and eventual abandonment of the five-year phase-in plan.

The SEC’s order further finds that New Jersey failed to provide certain present and historical financial information regarding its pension funding in bond disclosure documents. The state was aware of the underfunding of TPAF and PERS and the potential effects of the underfunding. Furthermore, the state had no written policies or procedures about the review or update of the bond offering documents and the state did not provide training to its employees about the state’s disclosure obligations under accounting standards or the federal securities laws. Due to this lack of disclosure training and inadequate procedures for the drafting and review of bond disclosure documents, the state made material misrepresentations to investors and failed to disclose material information regarding TPAF and PERS in bond offering documents.

The SEC’s order requires the State of New Jersey to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933. New Jersey consented to the issuance of the order without admitting or denying the findings. In determining to accept New Jersey’s offer to settle this matter, the Commission considered the cooperation afforded the SEC’s staff during the investigation and certain remedial acts taken by the state.

Mary P. Hansen and Suzanne C. Abt in the SEC’s Philadelphia Regional Office conducted the SEC’s investigation in this matter.

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For more information about this enforcement action, contact:

SEC’s Philadelphia Regional Office — (215) 597-3100

  • Elaine C. Greenberg — Chief, Municipal Securities and Public Pensions Unit and Associate Regional Director
  • Mary P. Hansen, Assistant Regional Director

http://www.sec.gov/news/press/2010/2010-152.htm

Snippets From The SEC Fraud Charges Against NJ

Here are some snippets from the actual charges filed against NJ by the SEC for municipal bond fraud.


This matter involves New Jersey’s violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act in connection with the offer and sale of over $26 billion in municipal bonds from August 2001 through April 2007. In 79 municipal bond offerings, the State misrepresented and failed to disclose material information regarding its under funding of New Jersey’s two largest pension plans, the Teachers’ Pension and Annuity Fund (“TPAF”) and the Public Employees’ Retirement System (“PERS”). More specifically, the State did not adequately disclose that it was under funding TPAF and PERS, why it was under funding TPAF and PERS, or the potential effects of the under funding.

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In disclosure documents prepared in connection with each of the bond offerings, including preliminary official statements, official statements,1 and Treasurer’s Annual Reports2(collectively, “disclosure documents” or “bond offering documents”), the State made material misrepresentations and omissions regarding: (1) legislation adopted in 2001 (the “2001 legislation”) which increased retirement benefits for employees and retirees enrolled in TPAF and PERS; (2) special Benefit Enhancement Funds (“BEFs”) created by the 2001 legislation initially intended to fund the costs associated with the increased benefits; (3) the State’s use of the BEFs as part of a five-year “phase-in plan” to begin making contributions to TPAF and PERS; and (4) the State’s alteration and eventual abandonment of the five-year phase-in plan.

These misrepresentations and omissions created the fiscal illusion that TPAF and PERS were being adequately funded and masked the fact that New Jersey was unable to make contributions to TPAF and PERS without raising taxes or cutting other services, or otherwise impacting the budget. Accordingly, disclosure documents failed to provide adequate information for investors to evaluate the State’s ability to fund TPAF and PERS or the impact of the State’s pension obligations on the State’s financial condition.

As of June 30, 2001, TPAF had a funded ratio of 108 percent and the State portion of PERS had a funded ratio of 112.5 percent. As of June 30, 2009, TPAF had a funded ratio of 63.8 percent and an unfunded actuarial accrued liability of $18.7 billion, and the State portion of PERS had a funded ratio of 56.4 percent and an unfunded actuarial accrued liability of $8.2 billion.9

Various divisions and offices within Treasury were responsible for the pension funding disclosures in the State Appendix. The updating of the pension funding sections generally occurred three times a year – following the issuance of the Governor’s budget message, after the passage of the Appropriations Act, and following the issuance of the actuarial valuations. At these times,various divisions and offices within Treasury updated their sections of the State Appendix. They viewed the updating of the pension funding sections as a routine process, requiring the insertion of new numbers or facts into an existing document. The DPB updated the pension disclosures at the request of the Office of Public Finance (“OPF”), another office of the Treasury. The OPF inserted the new information into the State Appendix without verifying the information. The Office of Management and Budget (“OMB”) included in the State’s CAFR the pension fund related excerpts which were also found in the State Appendix.

Prior to the release of an official statement, the State Treasurer, or his designee, signed a Rule 10b-5 certification, certifying that the official statement did not contain any material misrepresentations or omissions. During the relevant time period, the Treasurers did not read official statements, and relied on their staff to ensure the accuracy of information contained in the documents.

Treasury had no written policies or procedures relating to the review or update of the bond offering documents. In addition, Treasury did not provide training to its employees concerning the State’s disclosure obligations under the accounting standards or the federal securities laws. Accordingly, the State’s procedures were inadequate for ensuring that material information concerning TPAF and PERS or the State’s financing of TPAF and PERS was disclosed and accurate in bond offering documents.

On June 29, 2001, the State legislature approved legislation (P.L. 2001, c. 133) that, effective November 1, 2001, increased retirement benefits for employees and retirees enrolled in TPAF and PERS by 9.09 percent. In order to fund the enhanced benefits, without increased costs to the State or taxpayers, the legislation revalued TPAF and PERS assets to reflect their full market value as of June 30, 1999, near the height of the bull market.13 Bond offering documents did not disclose the retroactive mark-to-market revaluation of the pension assets under the 2001 legislation until March 2003 or the reason for the reevaluation. More specifically, bond offering documents did not disclose that the State used the market value as of June 30, 1999 in order to make it appear that the State could afford the benefit improvements.

The legislation created “benefit enhancement funds” or BEFs in TPAF and PERS to set aside a portion of the increased assets or “excess valuation assets”14 to pay the future annual normal cost associated with the enhanced benefits. After the increased assets were used to fund the accrued liability, a portion of the remaining excess valuation assets were placed in the BEFs to cover the future costs associated with the enhanced benefits. Bond offering documents did not disclose the creation of the BEFs until March 2003.

The BEFs were special accounts within TPAF and PERS. Each of the BEFs was credited with excess valuation assets, from the Contingent Reserve Funds, which are existing funds within TPAF and PERS used to hold employer contributions, which excess valuation assets resulted from the revaluation in 2001.

On July 11 and 13, 2001, approximately two weeks after the passage of the 2001 legislation, the Office of Legislative Services (“OLS”)15 issued fiscal notes analyzing the impact of the Assembly and Senate bills which had been adopted as the 2001 legislation. The fiscal notes acknowledged that valuing the pension assets as of June 30, 1999 did not reflect recent market losses in TPAF and PERS. The fiscal notes further acknowledged that, had the 2001 legislation revalued the pension assets as of April 30, 2001 rather than June 30, 1999,the remaining balance of excess assets in TPAF and PERS would have been $2.4 billion less. Bond offering documents did not disclose the $2.4 billion decline in the market value of the pension assets used to create the BEFs.

Bond offering documents did not disclose the reason for and impact of the retroactive mark-to-market revaluation of the pension assets. By revaluing TPAF and PERS assets and creating the BEFs to fund the ongoing costs of the benefit enhancements, the State gave the false appearance that it could afford the increased benefits. The revaluation of the pension assets to reflect their full market value as of June 30, 1999 resulted in a significant difference between the actuarial value and market value of assets in TPAF and PERS. Because the State’s contributions to TPAF and PERS are based on the actuarial value of assets, the revaluation created the false appearance that the plans were “fully funded” and allowed the State to justify not making contributions to the pension plans despite the fact that the market values of the plans’ assets were rapidly declining.

On May 25, 2005, the State’s Acting Governor created the Benefits Review Task Force to examine and make recommendations regarding employee benefits. On December 1, 2005, the New Jersey Benefits Review Task Force issued its final report (the “Benefits Review Task Force Report”) which offered strong criticism of the State’s pension funding practices. In particular, the report recommended that the State stop using actuarial and valuation “gimmicks,” like the State’s alteration of the valuation method in the 2001 legislation. The report advised that “[m]ethodologies for determining pension fund values and contribution requirements should not again be changed in order to mask the true cost of benefit enhancements.” The Benefits Review Task Force Report also concluded that the State must regularly contribute to its pension plans and end its use of “pension holidays” – not contributing to its pension plans.

The Benefits Review Task Force Report was publicly available and published on the Benefit Review Task Force’s website. New Jersey, however, did not disclose the existence of, or the findings from, the Benefits Review Task Force Report in its bond offering documents.

After a seven-year pension holiday, during which virtually no monies were appropriated in the State’s budget for pensions, the State recognized that it would have to begin contributing to TPAF and PERS. The State, however, now faced significant budget pressures which made it difficult for New Jersey to fund its pension plans absent cutting other programs and services, or raising taxes. Following Treasury’s recommendation, the Governor requested and the legislature provided in the annual Appropriations Act that the BEFs be used in lieu of the State contributing to TPAF and PERS.

Disclosures in bond offering documents regarding the State’s five-year phase-in plan and use of the BEFs likely falsely led investors to believe that: (1) the State would be contributing to TPAF and PERS in fiscal years 2004, 2005, and 2006; (2) the State had a plan for making its full statutory contributions; and (3) the State would begin making full statutory contributions in fiscal year 2008.

Rather than making phase-in contributions to the pension plans, beginning in fiscal year 2004, the State began using the BEFs in conjunction with the five-year phase-in plan. The State continued to use the BEFs as part of the phase-in plan in fiscal years 2005 and 2006. As a result, the State did not contribute any monies to TPAF and PERS in fiscal years 2004 and 2005. In fiscal year 2006, the State did not contribute to PERS, but did contribute a minimal amount to TPAF to cover the portion of the State’s contribution not covered by the BEF.

Bond offering documents did not disclose that the State was not contributing to TPAF and PERS during this time. When assets from the BEFs were used to fund the State’s pension contributions in fiscal years 2004, 2005, and 2006, funds were transferred from the BEFs back to the Contingent Reserve Funds, the original source of the assets in the BEFs.These inter-fund transfers created the false appearance that the State was making contributions to TPAF and PERS, when no actual contributions were being made. Bond offering documents did not disclose that the BEFs allowed the State to forego making contributions to TPAF and PERS. Rather, disclosures in bond offering documents created the false impression that the BEFs were being used to make New Jersey’s pension contributions even though no incremental funds were being received by TPAF and PERS. Disclosure documents misleadingly referred to the BEFs as “reserves” that were being utilized to fund the State’s contributions to TPAF and PERS which created the misleading impression that the State was making cash contributions to its pension plans.

Although bond offering documents referenced the BEFs in connection with the State’s contributions, they never disclosed what they were, how they were being used, or why they were being used. Bond offering documents did not disclose that the State was using the BEFs in conjunction with a five-year phase-in plan because of significant budgetary constraints, and was unable to contribute to TPAF and PERS. In addition, bond offering documents did not disclose the impact of using the BEFs as part of the five-year phase-in plan. The State recognized that delaying the resumption of the State’s contributions could result in substantially increasing the pension plans’ unfunded liabilities in the future. The State also recognized that by depleting the BEFs, the State would now be faced with paying the normal costs of the enhanced benefits granted by the 2001 legislation. More than $704.2 million was used from the BEFs to fund the State’s fiscal year 2004, 2005, and 2006 pension obligations, and thus this amount was no longer available to offset the future costs of the benefit enhancement legislation.

By the end of fiscal year 2006, the State had depleted the BEFs. Bond offering documents did not disclose that the State, during each budget cycle, intended to forego making contributions to TPAF and PERS until it had exhausted the BEFs. By disclosing that the State had adopted a five-year phase-in plan, the bond offering documents gave the impression that the State would be contributing its full statutory contributions to TPAF and PERS by fiscal year 2008.

The State abandoned its five-year phase-in plan in approximately May 2006. Bond offering documents did not disclose that the State had abandoned the five-year phase-in plan. Rather, the State stopped using the term “five-year” when referring to the phase-in plan in disclosure documents. The State’s continued use of the term “phase-in plan” gave the false impression that New Jersey still had a plan to achieve full statutory contributions. Moreover, bond offering documents did not disclose that New Jersey was unable to fully implement the five-year phase-in plan without causing New Jersey to suffer severe economic hardship.

The State’s bond offering documents contained inadequate information regarding the State’s present and historical contributions to TPAF and PERS. Statistical tables for TPAF and PERS found in Appendix I-D set forth the amount of the State’s contributions for the most recent fiscal year and the prior five fiscal years. This information, however, was misleading to investors because the amounts set forth included pension contributions, if any, as well as payments made by the State to members of TPAF and PERS for post-retirement medical benefits.17 This contribution information conflicted with other statistical information found in the Retirement Systems footnote of Appendix I-A, which showed the actual pension contributions made by the State, but did not include payments for post-retirement medical benefits, for the most recent fiscal year as well as the two prior fiscal years. In addition, the State’s bond offering documents lacked sufficient information for investors to understand the State’s historical failure – since 1997 – to contribute to TPAF and PERS.

The bond offering documents failed to provide information regarding the actuarial methodology used by the State to calculate the actuarial value of assets, and the impact of using this methodology on the State’s funding of its pension plans. The bond offeringdocuments did not disclose the effect of the State’s use of a five-year smoothing method to measure the actuarial value of assets. As a result of the 2001 legislation and market declines, the actuarial value of assets exceeded the market value of assets for TPAF and PERS, resulting in net unsmoothed losses in both plans beginning in fiscal year 2002.

Categories: ECONOMY

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