The U.S. Securities and Exchange Commission announced Monday that the state of Kansas violated investment disclosure laws in selling bonds – and the federal agency issued a cease-and-desist order against the state.
A Wichita State University expert said he doesn’t think the order will have much immediate effect on the state’s ability to borrow money, but noted that the SEC seemed to be sounding a note of caution because of the state’s system of requiring annual appropriations by the Legislature to pay off long-term bond debts.
The SEC ruled that the Kansas Development Finance Authority didn’t adequately disclose the poor financial shape that the state employee retirement system was in when it sold $273 million worth of bonds in 2009 and 2010 to pay for state projects.
The KDFA is a governor-appointed panel that acts as an arm of the state to finance borrowing for projects authorized by the Legislature.
The SEC found investors who bought the bonds were at greater risk of not getting paid back than Kansas disclosed, a violation of federal laws regulating investments, the SEC order said.
“Reasonable investors would have considered information regarding the state’s structural underfunding of its pensions, the risks created by that underfunding, and the financial condition of the pension plans to be important factors in the investment decision-making process,” the SEC order said. “Such information allows investors to weigh and price the risk associated with the state’s debt obligations.”
The state has since made changes in its disclosures and is now complying with the law when it sells bonds, according to a statement by Kansas Secretary of Administration Jim Clark.
“The SEC has considered these changes and we are pleased that the SEC did not seek any financial penalties or make any claims of intentional misconduct based on the actions of former administrations,” Clark said.
The SEC seldom levies financial penalties against government agencies, because any fines levied would come out taxpayer money anyway.
The SEC order praised the state for changing its policies and cooperating in the investigation.
However, the SEC also noted that unlike in many states, money to pay back bonds is subject to annual appropriations by the Kansas Legislature.
“Because of this requirement for annual appropriation, bond holders are at risk that the Legislature may choose, for any reason, to not appropriate funds for debt service over other competing budget demands, such as state services, school funding, or pension obligations,” the SEC order said.
The fact that the SEC brought that up – and separated KDFA bonds from other state finance – could signal some uncertainty over the Kansas Legislature choosing to appropriate money for the debts at some time in the future, said Ken Kriz, regents professor of public finance at Wichita State’s Hugo Wall School of Urban and Public Affairs.
Uncertainty generally increases the risk associated with bonds and with it, the interest rate the government has to offer to get investors to buy its bonds, Kriz said.
The state’s overall credit rating has been downgraded by both Moody’s and Standard & Poors in the past year because the Legislature has prioritized tax cuts over maintaining state revenue, he said.
Moody’s especially was critical of the Legislature for raiding the state Highway Fund – which is supposed to be used for long-term road improvements – to pay ordinary year-to-year general-fund operating expenses.
Monday’s SEC order “is another shot across the bow for what the state has been doing,” Kriz said. “All that other stuff goes along with the concerns over long-run fiscal sustainability.”
Gov. Sam Brownback issued a statement saying that the pension system is now substantially healthier than it was four to five years ago.
At the time, the system was reeling in the wake of the national recession and huge investment losses.
“Since taking office, I have made restoring the health of our KPERS system a priority,” Brownback said. “Reforms passed by the legislature in 2012 resulted in an improved KPERS system.”
Reach Dion Lefler at 316-268-6527 or firstname.lastname@example.org.