In 2021, we wrote a message to Gary Gensler in response to statements made at his confirmation hearing as the new chair of the Securities and Exchange Commission (SEC). During the hearing, he focused on protections for U.S. investors in the stock market.
However, the SEC’s job is much bigger than that, it is to protect ALL investors even those in the muncipal bond market.
This is our message to Paul Atkins, the next chair of the SEC.
Do not shy away from reviewing the politically driven statements and deceptive accounting practices used to prepare state and local government’s comprehensive annual financial reports.
The anti-fraud provisions guarded by the SEC apply to both corporations and governments. According to a 1994 SEC release, these provisions mean that “official statements need to be clear and concise to avoid misleading investors through confusion and obfuscation.” In February 2020, the SEC indicated that these official statements are not limited to those made in documents that accompany municipal bonds but also include public announcements, speeches, and press releases. The 1994 SEC release also highlighted, “Although municipalities have certain unique attributes by virtue of their political nature; insofar as they are issuers of securities, they are subject to the prescription against false and misleading disclosures.” For example, in its 2013 investigation of Harrisburg, Pennsylvania, the SEC cited omissions and misstatements in the city’s financial information, including within its annual report.
The state and local government’s annual financial reports are based on what we consider to be questionable accounting practices. There appears to be many confusing and misleading disclosures in state and local governments' annual reports.
Annual financial reports include governmental fund statements that are prepared using an accounting basis called the “modified accrual basis,” which in essence uses short-sighted cash accounting, while the consolidated financial statements are prepared using accrual accounting standards similar to those used by corporations.
It is confusing and misleading that before the pandemic Governor Gavin Newsom touted that California had a huge surplus. California’s governmental funds statements included in the state’s 2019 comprehensive annual financial report noted a positive balance of $54.9 billion, including a general fund balance of $18.6 billion. Yet the consolidated financial statements in the same annual report noted a negative net position of $60 billion. This means the state did not have a surplus. It was actually $60 billion in debt.
It is confusing and misleading that government officials have claimed balanced budgets, even surpluses, while according to our 2024 report the 50 states have accumulated $840 billion in pension debt and $493 billion in retiree health care debt.
It is confusing and misleading that states do not have to disclose billions of dollars of deferred maintenance costs and their share of unfunded Medicaid benefits.
The SEC charged New Jersey, Illinois, and Kansas with securities fraud for misleading municipal bond investors about the funding status of their pensions. In the Illinois case, the Commission's legal discussion pointed out, “Issuers of municipal securities are responsible for the accuracy of their disclosure documents. Proper disclosure allows investors to understand and evaluate the financial health of the municipality where they invest.”
State and local government’s annual financial reports appear to not provide proper disclosure that allows investors to understand and evaluate the financial health of the municipalities where they invest.
The SEC has stated that “high-quality, reliable financial statements form the bedrock of our U.S. capital markets.” Atkin’s background will be very valuable in addressing accounting fraud in government financial statements. In the wake of the Enron, and WorldCom accounting fraud, such as not reporting massive liabilities, we must learn from past mistakes.
The Financial Data Transparency is a big step in the right direction for transparency in the bond market. But if Atkins wants to solidify transparency and accountability in our markets and bring trust back to government, the SEC must examine the state and local government financial reports.
By doing so, he will protect not just the municipal bondholder but also the American taxpayers and citizens. After all, the municipal bond market is the lifeblood of state and local governments and serves as a reliable fixed income for retirees and other investors.