Articles Posted in Puerto Rico Debt Crisis

Merrill Lynch Fined For Involvement In Puerto Rico Bond Fraud Case

In a recent award, a Financial Industry Regulatory Authority (FINRA) arbitration panel has decided that Merrill Lynch must pay a former professional baseball player and his wife $1.7 million in compensatory damages, plus $88,758 in costs, for losses they sustained from investing in Puerto Rico bonds and closed-end bond funds.

The retired MLB player is Angel Pagan and his wife is Windy Pagan, a former Ms. Puerto Rico. Angel was an outfielder for the NY Mets, the Chicago Cubs, and the San Francisco Giants before retiring to live on the island.

Two different groups of investors were recently awarded nearly $9.3 million in their respective Puerto Rico bond fraud claims against UBS Financial Services (UBS). These are just the latest Financial Industry Regulatory Authority (FINRA) arbitration claims where the Swiss giant and its Puerto Rico-based brokerage firm have been ordered to pay customers after selling over $10 billion of closed-end funds that were heavily invested in the island’s municipal debt. To date, UBS has paid hundreds-of-millions-of-dollars to investors in either arbitration awards or settlements.

In one of these latest Puerto Rico investor fraud cases, the claimants are three investors and their related businesses and trusts. The customer claimants contend that UBS violated FINRA’s rules and the U.S. territory’s securities laws, as well as committed other fraudulent acts. Now, the FINRA arbitration panel has awarded them $4.25 million in compensatory damages, interest, and $170,000 for costs.

In the other Puerto Rico bond fraud claim, the claimants were customers alleging constructive fraud, common law fraud, breach of fiduciary duty, negligent misrepresentation, negligent supervision, breach of contract, and fraudulent concealment. The FINRA arbitration panel awarded them $4.8 million in damages.

The Puerto Rico Government Employees and Judiciary Retirement Systems Administration, a pension plan for retirees of the U.S. territory’s government, has filed a proposed securities class action in federal court against Bank of America (BAC), Goldman Sachs (GS), Citigroup (C), Barclays Capital, Inc. (BARC), BNP Paribas Securities Corp., Bank of America Securities, Credit Suisse Securities, FTN Financial Securities, Deutsche Bank Securities, JP Morgan Securities, Morgan Stanley (MS), Merrill Lynch, Pierce, Fenner & Smith, and UBS Securities. The retirement fund is accusing the defendants of rigging bond prices to keep the prices up on Freddie Mac and Fannie Mae bonds.

Freddie and Fannie, both U.S. government-sponsored entities (GSEs), offer bonds to raise money for loans. According to the Puerto Rico pension plan’s bond fraud case, the trading desks of the various banks worked together to artificially raise the prices of the GSE bonds when the market took a hit after the 2008 financial crisis and Fannie and Freddie started reducing the number of bonds issued for sale. This decrease led to a loss in profits for those underwriting and trading in Fannie Mae and Freddie Mac bonds. The plaintiff contends that instead of the banks opting to lower the difference between their purchasing and selling prices and competing for clients, they worked together to fix the bond prices so they could “maximize” their profits at the expense of customers.

The Puerto Rico retirement plan’s complaint comes weeks after another proposed class action was brought by two other pension funds also accusing banks of rigging the price of GSE bonds. The pension fund plaintiffs in that fraud case are the Trust and Sheet Metal Workers’ Local 19 Pension Fund and the Dallas Area Rapid Transit Employees’ Defined Benefit Retirement Plan. The defendants are Bank of America NA, Barclays Capital, Wells Fargo Securities, LLC, Citigroup Global Markets, Inc., BNP Paribas Securities Corp., Deutsche Bank Securities, JPMorgan Securities, HSBS Bank Plc, HSBC Securities, JP Morgan Chase Bank, TD Securities, Nomura Securities International Inc., and Merrill Lynch, Pierce, Fenner & Smith.

According to The Wall Street Journal, three hedge funds that own Puerto Rico general obligation (GO) bonds have set up their own committee in an effort to get paid back the money they are owed. Court records indicate that GoldenTree Asset Management, Monarch Alternative Capital, and Whitebox Advisers, which collectively own about $800 million of GO debt, want to distinguish themselves from the other bondholders whose claims have recently come under question.

Their committee formation comes just weeks after Puerto Rico’s fiscal oversight board,known as the Financial Oversight and Management Board (the “Board”), raised questions about whether $6 billion in general obligations are valid. The bonds at issue were sold after March 2012, including $3.5 billion of high yield general obligations that the island sold in 2014. Monarch, Whitebox, and GoldenTree purchased their GO bonds prior to March 2012.

Puerto Rico Continues to Owe Over $70 billion in Debt.

Although many of the thousands of cases investors in Puerto Rico bonds and closed-end funds have brought over the last five years have focused on UBS Financial Services Incorporated of Puerto Rico (“UBS-PR”), other brokerage firms in the Commonwealth engaged in the same wrongful sales practices. One such firm that has also been the subject of many new FINRA arbitrations and other lawsuits is Santander Securities, LLC (“Santander”), a division of Banco Santander Puerto Rico. The large number of cases against Santander are not a surprise given the public information about Santander. For example, Bloomberg reports that between the ends of 2012 and 2013, Santander marketed and sold over $280 million in Puerto Rico municipal bonds and close-end funds while reportedly selling its own holdings of these same securities.

Santander also has a regulatory history that suggests ongoing problems with the Puerto Rico operations for the bank. For example, in 2011, Santander settled allegations from FINRA of deficiencies in Santander’s structured product business, including those involving the sale of reverse-convertible securities to Puerto Rican retail customers when such investments were often unsuitable for them. FINRA also accused the brokerage firm of inadequate supervision of structured product sales. Santander agreed to pay a $2 million fine for these alleged deficiencies. More recently, in 2015, FINRA fined Santander $2 million and ordered restitution to Santander customers of an additional $4.3 million for Santander’s sales practices related to Puerto Rico bonds and closed-end funds. In particular, FINRA found that Santander’s supervisory system did not accurately reflect the risk of Puerto Rico investments in the period leading up to the collapse of the Puerto Rico market in 2013 and 2014. However, Santander was aware of the increased risk, and according to FINRA, instead of informing its clients of these increased risks, used that knowledge to sell its entire inventory of Puerto Rico investments by the end of October 2013, and thus missing much of the losses Santander’s own clients suffered.

In other Puerto Rico news, the 1st Circuit court of invalidated the PROMESA board which provides oversight for restructuring local debt. After the board placed Puerto Rico in a bankruptcy like process, many hedge funds and institutional corporate investors were unhappy as their investments were now in jeopardy. These entities filed a constitutional challenge to the way the board was appointed and eventually won on appeal. The ruling was not much of a win however, as the 1st Circuit refused to invalidate the board’s prior actions, which included placing Puerto Rico in the bankruptcy like proceedings, even though they invalidated the board itself.

U.S. District Judge Laura Taylor Swain has approved a plan to restructure nearly $18 billion of Puerto Rico’s Sales Tax Financing Corp. (COFINA) debt. Judge Swain, who is based in New York but oversees Puerto Rico’s bankruptcy-like proceedings, said the Court believes that the COFINA plan is essential to the island’s financial recovery efforts.

The approval from Judge Swain required a two-step process. First, she had to determine whether the settlement agreement between COFINA bondholders and the Commonwealth was fair and reasonable. The agreement effectively provides a 53.65%/46.35% allocation of Puerto Rico’s Sales and Use Tax (“SUT”) revenue between COFINA and the Commonwealth, respectively. Judge Swain determined that the settlement “was a fair and reasonable settlement and compromise of the Commonwealth-COFINA Dispute given the substantial risks of litigation ….”

In total, Puerto Rico owes over $70 billion to bondholders and other creditors, as well as another $50 billion in unfunded pension obligations. The territory has been attempting to restructure this $120 billion of liabilities since it filed for bankruptcy-like protection in May of 2017.

The Financial Oversight Management Board for Puerto Rico (the Board) is asking a federal district court judge to invalidate over $6 Billion in general obligation (GO) bonds by disallowing any claims brought by the bonds’ holders. The legal action, brought by the Board and the island’s unsecured creditors’ committee, focuses on GO debts that the U.S. territory sold in 2012 and 2014.

The Board and the committee contend that the debt at issue violates Puerto Rico’s Constitution, including the balanced budget clause as well as the debt service limit provision. According to Law360, both parties claim that previous administrations of the island’s government engaged in different “accounting gimmicks” to get around these provisions.

For example, the petitioners maintain that bonds issued through the Puerto Rico Public Buildings Authority were an attempt to get around the 15% debt service limit when, in fact, the bonds should have been factored into that limit. If that had been done, the Board and committee are now arguing, then bonds issued after March 2012 should be rendered invalid and taken off the balance sheet of what the island owes.

According to Puerto Rican local new site, the US Territory’s Financial Oversight and Management Board, which has chosen Brown Rudnick as its claims advisor, will pay the law firm $790 an hour—a figure that reportedly will rise 4% annually and does not include its team’s travel expenses that the island’s government will also pay for. Considering that the Fiscal Oversight Board was appointed to help Puerto Rico restructure its financing and deal with its over $70 billion of debt, there are significant questions as to whether this is the best allocation of the island’s limited financial resources.

Another local news source, Caribbean Business, reports that Brown Rudnick’s job will be to help the Board’s Special Claims Committee look into possible claims that may result from the findings in the debt probe recently conducted by Kobre & Kim. The disputes and investigative international law firm had put together a 600-page report on its investigation, which was published a few months ago.

News of Brown Rudnick’s appointment came almost immediately after the Official Committee of Unsecured Creditors asked for discovery to look into possible claims. According to Caribbean Business, the Committee wants to know if the Puerto Rican government has “claims toward third parties,” which the Committee feels that Kobre & Kim did not look into during its probe.

In the U.S. House of Representatives, lawmakers have introduced a bipartisan bill that would require advisers and others contracted to help with the debt restructuring proceedings in Puerto Rico to abide by stronger reporting requirements. The move comes in the wake of an article in The New York Times reporting that McKinsey & Company, one of the advisers to the island’s federal oversight board, had bought millions of dollars of Puerto Rico bonds at a huge discount but did not disclose the purchases.

McKinsey, claims that it has satisfied all disclosure requirements. The company contends that it was MIO Partners, its investment division, that purchased about $20 million of Puerto Rico bonds. The consulting firm maintains that MIO Partners is separate from the consulting arm and McKinsey consultants having no control over MIO Partners or involvement in any of its investments.

Under the proposed bill, called the Puerto Rico Recovery Accuracy in Disclosures Act, consultants and others hired by the fiscal oversight board must submit verified disclosures noting any connections they might have before they can receive payment for their services. These disclosure requirements already apply to other bankruptcies, but they have not been part of the island’s bankruptcy proceedings so far. Because the U.S. territory is not a municipality, it was unable to file for Chapter 9 bankruptcy protection and instead sought relief under the 2016 Puerto Rico Oversight Management and Economic Stability Act (PROMESA).

A Financial Industry Regulatory Authority (FINRA) arbitration panel is ordering UBS Financial Services (UBS) and UBS Financial Services of Puerto Rico (UBS-PR) to pay investor Jose F. Pastrana $693K, including at least $564,559 in damages, legal fees, and other costs in its Puerto Rico bond fraud case. UBS also must buy back from Pastrana some of the illiquid closed-end funds that he purchased from the firm at what their market price was at the end of July. AdvisorHub says that this amount will total $128K.

Pastrana had accused the broker-dealer of:

  • Negligence
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