According to Bloomberg, the retirement system of Puerto Rico has joined a lawsuit against UBS Financial Services, Inc. (UBS) for poor returns that the retirement system received on $3 billion the it borrowed on UBS’s recommendation. Six beneficiaries originally brought this Puerto Rico bond fraud case in 2011 against UBS and two smaller broker-dealers.UBS was the underwriter of bonds sold by the judiciary retirement systems and employees eight years ago. UBS also served as investment consultant, adviser, and bond fund manager. The bond proceeds were supposed to earn a positive return as compared to the interest paid on the bonds. According to UBS, this would help Puerto Rico resolve some of its pension shortfall. However, UBS, according to the complaint, put too much of the bond proceeds toward low-yielding accounts that made “negative income.”
Now, Puerto Rico’s pension funds are in financial trouble and could go broke as early as 2018. System administrator Pedro R. Ortiz said that the system’s board is looking to obtain a “significant recovery” for pensioners and participants.
The Financial Industry Regulatory Authority announced that UBS Financial Services and its Puerto Rico subsidiary (UBS) must collectively pay three investors $750,000 in damages for losses they sustained from investing in UBS’s proprietary Puerto Rico closed-end bond funds and Puerto Rico bonds. The claimants are Jenny Robles Adorno, Desarrollos Jarra SE, and Jose A. Rivera.
The investors accused UBS of recklessness, fraud, and negligence. They sought compensatory damages, punitive damages, and reimbursement of commissions that they said were unlawful. In San Juan, the FINRA arbitration panel awarded Rivera $562,500, Robles $30,000 and Jarra $157,500. UBS said it was “disappointed” with the panel’s decision to award any damages to the claimants.
This is not the first Puerto Rico bond fraud arbitration case in which UBS has been ordered to pay investors. Just this March, the firm had to pay over $470,000 to three investors who said their accounts were over-concentrated in the same Puerto Rico focused investments. The claimants in that case alleged negligent supervision and fraud. Similarly, UBS was ordered to pay a former television executive over $1,400,000 in the fall of 2015 for over-concentrating the former customer in UBS’s proprietary funds and misrepresenting the risks of those investments.
The U.S. Securities and Exchange Commission said that BOK Financial Corporation subsidiary BOKF NA will pay over $1.6M to resolve charges accusing the Oklahoma-based bank of ignoring signs that businessman Christopher F. Brogdon was engaged in suspect activates related to his management of municipal bond offerings for investors. Brogdon was charged by the regulator with fraud last year and he must pay back investors $85M.
The federal government accused him of collecting almost $190M through private placement offerings and muni bond offerings. Investors thought they would earn interest from money made by assisted living facilities, nursing homes, or another retirement community project. Instead, Brogdon commingled accounts and redirected investor funds to other ventures and his own expenses.
According to the regulator, BOKF and ex-senior VP Marrien Neilson found out that Brogdon was taking money out from reserve funds for the muni bond offerings and not replacing the money. They also became aware that he had neglected to file annual financial statements for the bond offerings.
The White House has appointed seven people to the Fiscal Control Board tasked with helping Puerto Rico deal with its $70B of debt. The appointees, named by President Obama, include: Jose Ramon Gonzalez (Federal Home Loan Bank of NY CEO/President), Arthur Gonzalez (Ex-bankruptcy Judge), Ana Matosantos (Ex-California Dept. of Finance Director), Carlos Garcia (Ex-Puerto Rico Government Development Bank president and CEO/Founder of BayBoston Managers LLC), Jose Carrion III (Puerto Rico insurance executive), Andrew Biggs (Scholar) and David Skeel (University of Pennsylvania Law Professor). Three of these board member are Democrats, four are Republicans. The eighth member of the board is Puerto Rico’s governor Alejandro Garcia Padilla. He is an automatic member because of his position but does not have a vote.
The creation of the federal control board was part of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). The legislation was passed by the U.S. Congress to help the U.S. territory with its financial woes. Puerto Rico has been defaulting on its debt payments that have been due. Just last week, the Government Development Bank of Puerto did not pay almost $10 million of interest that was due on it outstanding bonds. According to a recent report by the ReFund America Project, which has been investigating the U.S. territory’s debt, approximately $1.6 billion of the island’s debt are the fees earned by Wall Street firms, such as Citigroup (C), UBS (UBS), Barclays Capital (BARC), and Goldman Sachs (GS). Even worse, the ReFund America Project said that about $323 million of the money paid to Wall Street firms was for “scoop and toss” deals involving UBS as the main underwriter.
The report also stated that close to half of the $134 million in debt Puerto Rico and its public corporations have issued over the last 16 years is refunding debt. Puerto Rico’s financials purportedly show that the territory had been putting out new refunding bonds to pay back bonds that had been issued earlier. The use of refunding bonds to delay current debt payments for later is what is involved in “scoop and toss” financing.
Two investors, seeking to recover the investment losses they sustained in Puerto Rico municipal bonds, are pursuing a FINRA arbitration claim against Santander Securities LLC. According to the case, the Puerto Rican investors are claiming breach of fiduciary duty, violation of common law fraud, negligent supervision, and the unsuitable investment of their money in the Puerto Rico Public Finance Corporation RFDG Commonwealth Appropriation Series A Bond. Santander Securities is a Banco Santander (SAN) subsidiary.
These investors are among the thousands seeking to recover the money they lost in Puerto Rico bonds and Puerto Rico closed-end bonds after brokerage firms, such as Santander Securities, Banco Popular, and UBS Puerto Rico (UBS-PR) recommended that they invest in these securities. Many investors were never equipped to handle the risks involved in Puerto Rico bonds yet their broker encouraged them to invest, ignoring suitability rules and often misrepresenting the investment.
Last October, Santander agreed to pay $6.4 million to settle allegations related to Puerto Rico bonds, including $4.3 million in restitution to clients in the U.S. territory, as well as a $2 million fine. FINRA, which announced the settlement, said the brokerage unit would repurchase the Puerto Rico bonds from a group of customers that were still holding them. The self-regulatory organization had pursued an enforcement action against Santander Securities because of the way the firm’s brokers sold and bought the bonds during a more than three-year period beginning in 2010.
For many investors, Puerto Rico bonds seemed like a good investment because of the tax benefits they offered, along with a yield that was higher than comparable bonds that were issued by U.S. cities and states. Unfortunately, when the price of the Puerto Rico municipal bonds dropped in 2013, many investors sustained huge losses.
On August 1, the U.S. Commonwealth of Puerto Rico and its agencies will owe roughly $346 million in bond payments. This latest deadline comes one month after the U.S. Territory defaulted on nearly $1 billion of bond payments that were due on July 1. According to Bloomberg, here is what is due:
· The Puerto Rico Sales Tax Financing Corp. (often called “COFINAs”) owes about $256 million of principal plus interest in COFINAs. S & P Global Ratings has said that the bond trustee has the money to pay the debt that is due next week. COFINAs are paid back from the Commonwealths’ sales tax. This local agency has $15.2 billion of outstanding debt.
· Every month, the territory owes $13.9M of interest, which Puerto Rico has not defaulted on yet.
A group of hedge funds that are holding Puerto Rico debt are suing the U.S. territory and Governor Alejandro García Padilla. Monarch Alternative Capital, Aurelius Capital Management, Stone Lion Capital Partners, Covalent Capital Partner, Aurelius Capital Management, Fundamental Credit Opportunities, and a number of other funds claim that Puerto Rico and Governor García violated PROMESA, which stands for the Puerto Rico Oversight, Management and Economic Stability Act. President Barack Obama signed the new debt restructuring law on June 30, which is when García issued a debt moratorium on the nearly $800 million in general obligation debt that was due on July 1 (along with other Puerto Rico debt for a collective total of about $2 billion). The hedge funds say that Governor García had no legal right to call a debt moratorium in the wake of PROMESA.
The bondholders want the court to stop the island from “unlawfully dissipating” assets before a federal oversight board is appointed. PROMESA places the U.S. territory under the supervision of the board, which is tasked with pressing for fiscal reform and supervising spending. However, the board won’t be in place for at least two months.
In their complaint, filed in United States District Court for the District of Puerto Rico, the creditors claimed that Governor García took advantage of this time gap in implementation and is spending hundreds of million dollars in ways that garner “political favor.” The hedge funds argued that certain expenditures would have been challenged by the board if it were already in place.
The plaintiffs, as holders of general obligation bonds, say they are entitled to some of the money being spent because Puerto Rico still owes them the debt payments. They want the district court to freeze the payments that have been issued and mark them as invalid until the board can take a look at them.
According to Bloomberg.com, in the wake of Puerto Rico’s default on July 1 of $911 million of bond payments it owes creditors—including $779 million of general obligation bonds—Ameriprise Financial Inc. (AMP) is recommending that clients sell their OppenheimerFunds (OPY) municipal bond funds that are holding any of the island’s debt. In a report this week, Ameriprise senior research analyst Jeffrey Lindell said that with the acceleration of Puerto Rico bond defaults—as the island tries to lower its $70 billion debt via bondholder losses—mutual funds holding these bonds could end up having to “cut dividend rates.” He also wrote that as Puerto Rico bonds respond to “speculation and news,” the mutual funds’ net asset value could turn “volatile.”
In its recent article, Bloomberg provided data from Morningstar Inc., which reports that as of the end of March, Oppenheimer held $3.5 billion of Puerto Rico securities in 19 funds, which is more than anyone else. Now, Ameriprise wants clients to look at investment options that are not as risky as the funds holding Puerto Rico municipal bonds. The firm is suggesting that clients sell investments involving 16 Oppenheimer muni funds. Included in the recommendation to sell are a number of state specific municipal bond funds, including the:
· Oppenheimer Rochester Virginia Municipal (ORVAX)
· Oppenheimer Rochester Pennsylvania Municipal (OVPAX)
· Oppenheimer Rochester Maryland Municipal (ORMDX)
· Oppenheimer Rochester North Carolina Municipal (OPNCX) and
· Oppenheimer Rochester Arizona Municipal (ORAZX)
Several days after the July 1 default, credit rating agency Standard & Poor’s (SP) reduced the U.S. territory’s credit rating to “default” status. The default was not the first time Puerto Rico was unable to cover debt payments that were due—although it was the first default involving Puerto Rico’s general obligation debt, which was supposed to have a constitutional guarantee.
It was in May that NY City Council Speaker Melissa Mark-Viverito asked the SEC to investigate whether OppenheimerFunds played a part in causing Puerto Rico’s financial crisis to worsen. Mark-Viverito believes that banks, hedge funds, and other investors who bought into Puerto Rico utility debt and general obligation bonds contributed to the territory’s debt woes.
The U.S. House of Representatives has voted to pass legislation that would get rid of exemptions from federal securities law for registered securities offered in U.S. territories, including Puerto Rico. The bill is called the U.S. Territories Investor Protection Act of 2016. Rep. Nydia Velazques (D-NY), who sponsored the legislation, said that if passed into law it would give key protections to American citizens in the territories. The bill would also put an end to long standing exemptions that were granted to territorial securities under the Investment Company Act.
Rep. Velazquez believes that had there been such a law previously, certain investment losses that have been sustained in the U.S. territories could have been prevented. She recently noted that certain issuers of securities in Puerto Rico have allegedly become their own underwriters, allowing them to sell and package the securities without letting investors know of this conflict of interest.
Unfortunately, this exact situation is what played out in Puerto Rico over the last decade. Many residents in Puerto Rico have suffered because they were not told of conflicts of interest and about how risky the bond funds they bought were. Their losses have been further compounded by the U.S. territory’s debt crisis. Puerto Rico owes $70 billion to investors, many of whom purchased the bonds indirectly through bond funds.
With Velazquez’s bill, investment companies on the island and other U.S. territories would have to deal with the same rules as their counterparts on the mainland. The legislation includes a three-year grace period for companies to get into compliance with new rules. (It also grants the SEC the authority to extend that timeframe via rulemaking if necessary.)
Last month, U.S. President Barack Obama signed into law PROMESA, the Puerto Rico Oversight Management and Economic Stability Act, which will help the island restructure its debt. On July 1, Puerto Rico defaulted on $911 million of bond payments that were due to creditors that day. At least $799 million of that was general obligation debt, which was supposed to be constitutionally guaranteed. However, Puerto Rico Governor Alejandro Garcia Padilla issued a debt moratorium that made the default on these debt payments possible.
The U.S. territory of Puerto Rico did not pay $911 million of bond payments due July 1, as expected. At least $779 million of that is general obligation bonds, which are constitutionally-backed debt and supposed to be guaranteed.
However, Puerto Rico Governor Alejandro Garcia Padilla has issued a debt moratorium that allows the territory to default on the general obligation bonds also. This is not the first time Puerto Rico has defaulted on payments due on its debt. The Commonwealth started defaulting on smaller payments last year for several agencies. In May, the government defaulted on the majority of the $422 million of debt that it owed.
The island had $2 billion in bond payments that was due on July 1. In total, the Commonwealth and its agencies owe over $70 billion of debt.
News of the default comes just as President Barack Obama signed the Promesa legislation into law to help Puerto Rico deal with its debt load. Because the territory is not a U.S. state, it has not been able to file for municipal bankruptcy protection under Chapter 9. Promesa, which is the Puerto Rico Oversight, Management and Economic Stability Act, will establish a several-member federal board to oversee Puerto Rico’s finances. The board will be able to postpone lawsuits from creditors seeking payments owed and restructure the U.S. Commonwealth’s debt, including make bondholders go to court, if necessary, to lower the territory’s debt obligations. (The U.S. Senate had passed the bill on Wednesday, making it possible for Mr. Obama to sign the legislation.)