SEC settles with Illinois over fraudulent bond offering – But "Where’s the Beef?"

On March 11, 2013 Illinois entered into a consent “cease and desist” order with the Securities and Exchange Commission (SEC).  The order was in settlement of an allegation that Illinois made material misrepresentations in connection with 2.2 billion dollars in bond offerings from 2005 to 2009 understating the degree of risk.

This is unacceptable because the order simply requires the State of Illinois to do what it should have been doing from the beginning, that is, comply with the law.

The absence of any substance to this order reminds me of that 1984 Wendy’s commercial where the character cries out “Where’s the Beef?”  If this were simply a technical violation with no real harm,  the order could be viewed as adequate.  However, to be sure this was not victimless fraud.  The investing public either paid too much for these bonds, or it received too little in return for the risk they were taking.  If a private sector company engaged in fraud on the securities market we would be talking about substantial fines and maybe serious penalties for the responsible individuals. 

Let’s assume that the order was adequate under the circumstances.  What assurance does the investing public have that the State will comply with the cease and desist order going forward? And what is there about this order that would cause any other public authorities issuing bonds to care about the SEC or complying with the securities laws? There is no requirement in the order that the state have an ongoing management process to detect and prevent similar violations in the future, i.e., an effective compliance and ethics program.  While the order recognizes some efforts in the past to deal with problems, there is an anticipation that those efforts (unsuccessful as they were) will continue into the future but no requirement.  Considering the State’s track record, that assumption is misplaced, and would certainly be considered unacceptable in the private sector.

In contrast, the private sector has been sent the message loud and clear with regard to taking steps to prevent non-compliant behavior in the first place, with the issuance of the Federal Sentencing Guidelines for Organizations (FSGO) in 1991.  Those rules tell corporations that if they wish to mitigate exposure to criminal liability they need to have effective compliance and ethics programs that call for the steps outlined in the guidelines to prevent and detect violations of the law.   Additionally, the Department of Justice will take those practices into consideration in making a decision whether to charge the organization.  Even the SEC has said publicly that it will consider the existence of compliance programs in its enforcement decisions.  While states would fit the definition of “organizations” under the Federal criminal code and Sentencing Guidelines standards, there is no indication that any of them have accepted the full responsibility for policing their own conduct, as is expected of companies in the private sector.  Maybe this failure to take meaningful steps to prevent misconduct in the public sector is because, if and when they do get caught, they are subject to toothless consent orders issued in situations like this.

The implementation of the FSGO in the private sector is not a cure all for the prevention of corporate fraud, but it is big start.  Government enforcement policies and practices encourage these in the private sector and would typically impose tough programs on those who broke the law as the state of Illinois has done.  Rather than be exempt from having to make any such compliance efforts, the government should lead by example.  And certainly in this case the SEC should have required the State of Illinois to undertake honest reform and implement a strong compliance and ethics program.  The Rutgers Center for Government Compliance and Ethics is championing the effort to implement the FSGO in government agencies.  We don’t need more meaningless court or regulatory orders, but government ethical leadership that values the duty to uphold the law along with accomplishing their mission.  What message does that send to the public when the government breaks the law and cheats the market, and when caught only needs to promise that it will simply follow the law in the future?  We must do better than this.

Joe Murphy, Chairman, Rutgers Center for Government Compliance and Ethics
Emil Moschella, Executive Director, Rutgers Center for Government Compliance and Ethics