By Joan Gralla

NEW YORK (Reuters) - The U.S. Securities andExchange Commission's settlement with New Jersey over flawedbond disclosures has left experts questioning whether thepenalties were severe enough to deter future wrongdoers.

Legal experts said it could open the door to investorlitigation or perhaps another federal probe.

In its Aug. 18 settlement, New Jersey neither admitted nordenied that it committed fraud by failing to tell investorsthat the state pensions were underfunded.

New Jersey paid no civil fines or penalties, although itwas ordered to cease and desist from future violations. Nocurrent or former state officials were charged or identified.

"I think the SEC should have named names and extracted agreater penalty," former SEC Chairman Arthur Levitt said aftera Bloomberg conference last week.

"I think this [disclosure] is an area of growing abuse --in some ways, it's worse than it has ever been," he said.

New Jersey is the first state the SEC has charged withfraud as part of a renewed drive to stamp out abuse in the $2.8trillion municipal market, where states, cities and towns raisetax-exempt funding for schools, roads and bridges.

The SEC is stepping up its oversight of munis. ElisseWalter, one of its commissioners, told Reuters the regulatorgot its "message across" by naming New Jersey.

The settlement has intensified investor concern about theaccuracy of bond disclosures. Since the credit crisis in 2008and 2009, most muni debt is no longer backed by insurers thatcould step in and cover missed payments or defaults. Meanwhile,the recession has shrunk tax collections, sharpening fears ofdowngrades and placing more focus on transparency issues.

This problem has already cropped up in an August debt saleby a Texas flood control district.

Edwin Harrison, director of financial services for HarrisCounty, in late August deleted the term "refunding" from bonddocuments after an investor questioned the term's use.

"Everybody is getting a little more picky; people arepaying more attention to bond disclosures," Harrison said.

The $183 million debt sale by the Harris County FloodControl District technically was a refunding that raised cashto repay commercial paper.

The confusion arose because the debt is not treated as arefunding from a tax or federal perspective but instead isconsidered new money.

"This is the first time that we have ever taken outcommercial paper that we did not say 'refunding' in the stylingof the issue," Harrison said.

Lawyers say some issuers are reviewing their financialstatements, although some big issuers said their documentsfully comply with the law.

"We feel that our pension disclosures are complete andaccurate," John Sinsheimer, Illinois' capital markets director,said late last month. "We have not been contacted by officialsand do not have any plans to revise our financial documents."

California, one of the biggest muni issuers, is confidenttoo. "We have full disclosure about our pension liabilities. Weprovide the picture to investors, warts and all," said TomDresslar, spokesman for State Treasurer Bill Lockyer. "We don'ttry to hide anything. We don't airbrush the numbers."

INVESTOR LAWSUITS POSSIBLE

But New Jersey may not be off the hook.

Private investors could file suit against the Garden Stateand former officials or use the settlement as a model to sueother states or localities for disclosure issues, according toMichael Ferachi, an attorney who handles class-action lawsuitsat McGlinchey Stafford in Baton Rouge, Louisiana.

Bondholders would have to clear various hurdles, includingproving that a state's failure to reveal its underfundedpensions cost them money.

They could argue that they should have been paid higherinterest rates because New Jersey's debt was not as safe asthey were told, said Mark Zehner, the Philadelphia-based SECdeputy chief of the muni securities and public pensions unit.

"You could argue -- and people have argued in the past --that by failing to disclose how risky the investment was -- youessentially were cheating an investor out of getting the returnthey ought to have got," he said, noting he was expressing hisown views.

The burden of proof may give potential plaintiffs pause,said Ferachi, the attorney. "I don't think it would stopsomebody from bringing a suit they feel strongly about; itreally comes down to whether you have highly motivatedplaintiffs who feel they have been wronged," he said.

However, New Jersey Attorney General Paula Dow does notappear inclined to seek redress.

"Since there were no losses to the bonds, the ratings wereunchanged and there were no downgrades, this case really inessence was about negligence," said Paul Loriquet, a spokesmanfor Dow, who was appointed by GOP Governor Chris Christie, whotook office after the bond disclosure problems occurred.

Others said a federal prosecutor could open a probe andlike the SEC, it would not have to prove that investors lostmoney.

"A U.S. attorney would not have to prove damages orcausation," said Christopher Clark, the co-head of the whitecollar criminal defense practice with Dewey & LeBoeuf in NewYork. (Reporting by Joan Gralla; Additional reporting by LisaLambert in Washington, Karen Pierog in Chicago, Jim Christie inSan Francisco and Michael Connor in Miami; Editing by DanGrebler)