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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.

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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.

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UBS Puerto Rico clients have reported over the last few days the receipt of unsolicited settlement offers from UBS Puerto Rico for losses in customer accounts. The letters, which appear to be dated August 20, 2015 and are from Roberto Fortuno, Managing Director of the UBS San Juan Complex, offer small amounts for losses. The letters appear to be a part of last year’s UBS settlement with the Puerto Rico Office of the Commissioner of Financial Institutions, whereby UBS Puerto Rico was ordered to pay some customers for losses in UBS’s proprietary closed-end bond funds. As a part of that settlement, UBS Puerto Rico was ordered to identify similar customers and also offer to pay them as well.

While an unsolicited offer from UBS may seem like good news, we at Shepherd, Smith, Edwards & Kantas caution any customers who receive such a letter to consult an attorney before signing anything. The letters indicate that an agreement to take the money will require customers to come to UBS’s offices in San Juan or Ponce and sign a release. Such releases are typically very broad and may result in customers losing rights that have nothing to do with the losses in the closed-end funds. Moreover, our experience with UBS in these cases is that UBS’s opinion of losses is very different than most clients. As a result, anyone who receives such a letter should contact counsel to make sure they have representation. According to the letters our firm has reviewed, the offers are only open for 30 days, so time is of the essence.

The attorneys at Shepherd, Smith, Edwards & Kantas have over 100 years of combined experience in securities law and the securities business. We represent clients all over the globe in investment losses. In particular, our Puerto Rico team has been working with dozens of clients for almost two years in these cases. If you receive a letter from UBS or have lost money in Puerto Rico investments with UBS, Banco Popular, Santander or any other firm on the island, please call us for a no cost, no obligation consultation about your rights.

After pleading guilty to two criminal counts of selling unregistered securities, The Financial Industry Regulatory Authority (“FINRA”), the agency primarily charged with regulating the nation’s stockbrokers, finally barred former stockbroker, Jerry A. Cicolani, Jr. (“Cicolani”) from the securities industry. According to FINRA’s website, “FINRA has permanently barred [Cicolani] from acting as a broker or otherwise associating with firms that sell securities to the public.”

Sadly, the bar came much too late for many of Cicolani’s former clients. For years, FINRA, had largely overlooked numerous customer complaints and other accusations of bad conduct in Cicolani’s formal record. By the time he was barred, Cicolani had amassed nearly 70 complaints over a 13 year period. The final straw seemed to be the suit brought by the U.S. Securities & Exchange Commission (the “SEC”) in May 2014 for Cicolani’s alleged role in a Ponzi scheme that defrauded dozens of investors out of roughly $7 million. Four months after the suit was filed, FINRA finally took action and barred Cicolani.

For the affected customers, FINRA did not take action fast enough, especially given the warning signs. A FINRA spokesperson, Michelle Ong, seemingly recognized this sentiment when noting, “[W]e regret that we did not bring a formal action against Mr. Cicolani earlier.” Many of Cicolani’s complaints originated from his time working for Merrill Lynch. From 1991 to his resignation from Merrill Lynch in 2010, Cicolani was named in over 60 customer complaints during that time period. Yet, time and time again, these complaints were largely overlooked by both his employer and regulators. In 2004, Cicolani was subject to an SEC inquiry based on his handling of customer accounts, yet Merrill Lynch did not terminate his employment because the SEC never sanctioned Cicolani for his conduct. Instead, Cicolani resigned years later after another investigation, this time initiated by Merrill Lynch.

Many of the people hit hardest by the massive collapse of the market for Puerto Rico bonds have been seniors and retirees, for two main reasons. First, seniors and retirees have the most amount of money available to invest on average. They have worked for their entire lifetimes, dutifully and diligently saving for a comfortable retirement. This means that these individuals are highly desirable and sought after clients for brokers, whose income is largely dependent upon how much money they are managing for people. This also means that when brokers give bad advice, seniors and retirees have the most to lose. Sadly, they are also the least able to recover from those losses, as they have little, if any, time left working to try to save and replace what was lost.

For the last several years, UBS Puerto Rico has been pushing Puerto Rico bonds and UBS’s proprietary Puerto Rico bond funds on many if not most of its clients. Previous posts have discussed what many of those recommendations have entailed, and why they were inappropriate for most people. The second reason seniors have been some of the hardest hit is that the sales pitch for those bonds were very simple. Brokers would explain that municipal bonds are traditionally one of the safest investments available. Brokers would explain that retirees could also use those bonds to generate regular income for themselves, and, best of all, the income was tax free! The bonds practically sell themselves.

However, what most seniors and retirees did not understand, and what the UBS brokers apparently were not telling them, is that Puerto Rico bonds were actually very high risk investments. UBS was artificially propping up the market for the bonds so that they appeared safer and more stable than they truly were. Moreover, the bonds are backed by Puerto Rico, in varying ways. UBS was well aware that Puerto Rico was suffering massive problems with its economy and tax base, making it very difficult, if not impossible, for Puerto Rico to support the debt it was carrying. Finally, UBS’s recommendations to invest heavily, if not exclusively, in Puerto Rico bonds changed what is commonly a conservative investment, municipal bonds, into a speculative investment.

The current quagmire of UBS Puerto Rico offloading billions of dollars in speculative Puerto Rico bonds onto its unsuspecting clients is by no means a new or limited occurrence for UBS. UBS has a history of taking huge gambles and often passing the bad bets onto its clients.

Between 2002 and 2007, UBS and its U.S. subsidiary UBS Real Estate Securities were issuing and underwriting massive amounts of investments backed by, and based upon, U.S. residential mortgages. In essence, UBS was bundling together groups of private mortgages where U.S. residents were buying or refinancing a home. UBS then turned around and sold those bundles to investors as safe and conservative investments, despite the fact that many of those loans carried tremendous risks and were very likely to default. All told, UBS faced potential liability approaching $45 billion in connection with this activity. Aside from the legal liability, UBS was also forced to write off approximately $50 billion in bad debt held in its own inventory in these securities.

In 2011, UBS lost another $2 billion as a result of a trader who was making massive bets trading in derivative securities. Generally speaking, derivatives are investments whose price is based upon the value of other securities. These include things such as futures, options, and swaps. All of these instruments are commonly considered high risk instruments. In this case, the UBS trader was betting on the direction that various exchange traded funds, or “ETFs” would go in the future. Except this trader was placing these bets on a massive scale with huge amounts of leverage, to the point that relatively small changes in the price of the ETFs resulted in massive losses to UBS.

The level of co-dependence between UBS Puerto Rico and Puerto Rico over the past several years is shocking. UBS Puerto Rico has been operating for almost 50 years. It has grown to the point that it manages almost as much money in Puerto Rico as every other brokerage firm combined. UBS Puerto Rico has simultaneously been a growing player with Puerto Rico’s government. Between 2008 and 2013, UBS helped Puerto Rico borrow over $13 billion for a variety of uses. This means that UBS Puerto Rico was involved in more of these bond offerings than the next three largest brokerage firms combined.

UBS Puerto Rico was also designated as the manager for Puerto Rico’s pension funds, which serve more than 200,000 current and retired government workers. This led to outrageous conflicts; UBS Puerto Rico underwrote bonds issued by Puerto Rico and backed by the pension system itself. UBS Puerto Rico then purchased approximately $1.5 billion of those very bonds for its proprietary investment funds. Those funds were in turn sold back to public investors. It would be surprising if the state pension did not own shares of these investment funds. So UBS helped create bonds to pay for government employee benefits, bought those bonds, and then sold those bonds back to the very same government employees who were supposed to be paid with the proceeds. UBS was loaning those employees their own money back, plus interest.

Similarly, UBS Puerto Rico was ignoring basic investment concepts like diversification. UBS Puerto Rico bragged that over 67% of its own assets were invested in Puerto Rico. Over half of the money investors had entrusted to UBS Puerto Rico were invested in UBS’s proprietary funds, the vast majority of which invested heavily, if not exclusively, in Puerto Rican debt. Many of those funds also were highly leveraged, meaning that they borrowed extra money to make even bigger investments. This greatly increases the risks of the investments.

Regardless of the research and industry standards that say that UBS should not have been selling Puerto Rico bonds the way that it was, inevitably UBS will still put forward a vigorous defense to the claims that investors are now bringing forward. Although each case will vary somewhat based upon the particular facts involved, almost surely UBS will raise three major defenses.

First, UBS will claim that the recommendations that its employees made to their clients to invest huge portions of their accounts in Puerto Rico bonds and UBS’s Puerto Rico bond funds was actually suitable and appropriate. According to industry standards, a broker is not actually required to make the “best” recommendation to a client; they just have to make a recommendation that is “suitable,” or essentially “good enough.” For these Puerto Rico bonds, UBS will point out that municipal bonds are generally considered relatively low risk investments, which is true, and that the bonds gave significant tax benefits to investors, which is also true. What this defense fails to account for, however, are very widespread concepts of asset allocation, which is essentially a finance term for “don’t put all your eggs in one basket.”

Secondly, no securities claim would be complete without the broker-dealer claiming that the investor is sophisticated in finance, with great experience and understanding of the intricacies and risks involved. UBS will argue that it disclosed the risks involved in these investments and that it disclosed the conflict of interest that UBS had in many of these transactions. Once again, to some extent these are true. Many, if not most, clients who purchased shares of UBS’s proprietary funds were likely given a prospectus, or formal statement of the security which included somewhere in it a difficult to understand statement of risks, and conflicts that UBS has. However, contrary to this statement, most investors rely heavily on the advice of their brokers, and lack the wherewithal to read and comprehend the risks located in a lengthy prospectus.

UBS’s continual, massive sale of Puerto Rico municipal bonds and UBS’s proprietary Puerto Rico bond funds involves a number of failures of its legal duties, some of which vary by the individual facts of each investor. According to the SEC investigation, UBS Puerto Rico was ordered by its parent company to massively sell off its inventory of Puerto Rico bond securities. In order to accomplish that, UBS Puerto Rico continually and intentionally undercut sell orders from its customers in these securities, ensuring that UBS’s securities sold, while other customers were unable to get out of their positions.

Despite the fact that UBS knew that these securities were becoming more and more illiquid, the SEC investigation indicates that UBS continued to sell massive amounts of the securities to its clients, in large part to ensure that UBS could offload its own holdings of the bonds before the bottom fell out of the market. This means that UBS was recommending that its clients buy securities that it knew were rapidly becoming difficult to sell, and which UBS knew had a seriously likelihood of significant value declines at the same time.

Many UBS clients were also being told to purchase these Puerto Rico bonds and bond funds in huge concentrations in their accounts. Many clients had 100% of their account in these securities. This type of investing violates very clear industry norms which require brokers to recommend that their clients diversify their portfolio, so that the failure or decline of one issuer or security, such as Puerto Rico, does not have a cataclysmic effect on the client’s entire account.

UBS Puerto Rico

A catastrophic collapse of life savings such as many investors in Puerto Rico bonds have been experiencing does not just happen on its own. There are inevitably a number of different parties that are involved, often to varying degrees. For most affected investors, the main party is UBS Financial Services Incorporated of Puerto Rico (“UBS Puerto Rico”). UBS Puerto Rico is a broker-dealer, meaning that it is a company in the business of buying and selling securities for clients, either by pairing together individuals looking to buy a particular security with a seller looking to sell that same security, and thus acting as a broker, or by buying and selling securities to investors out of its own portfolio, thus acting as a dealer. As a broker-dealer, UBS Puerto Rico is required to, and has, registered with the Financial Industry Regulatory Authority (“FINRA”), which is the regulator of broker-dealers in the United States and its territories. However, UBS Puerto Rico is licensed to operate solely within Puerto Rico.

Without delving into the legal issues involved, some of which have been discussed in previous posts and some of which will be addressed in subsequent ones, a broker-dealer can be legally liable for losses that its clients suffer under some circumstances. These situations can either because applicable laws and regulations covering broker-dealers in the United States require broker-dealers to properly supervise their brokers, and put in place various compliance systems to make sure the brokers are doing what they are supposed to be doing. Liability can also exist simply if the employees of the broker-dealer act improperly, even if the broker-dealer had no knowledge that it was going on, under legal theories such as respondeat superior.

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