By Simone Baribeau
The Puerto Rico Electric Power Authority’s (PREPA’s) warnings of a possible restructuring have renewed investor interest in bringing securities cases against brokerage firms because of bond fund losses, said Lawrence L Klayman, senior partner at Klayman & Toske.
The influx of cases comes as an investor brings a separate complaint against the Office of the Commissioner of Financial Institutions of Puerto Rico (OCFI), asking for documents related to a settlement the regulator made with UBS, one of the brokerage firms involved.
Claims spurred by the possible PREPA restructuring are piling on to the hundreds that have been filed over the past year with the Financial Industry Regulatory Authority (FINRA) against brokerage firms in Puerto Rico. UBS and others misled investors into believing their investments in closed-end funds with large holdings of Puerto Rico municipal bonds were safer and more conservative than they proved to be, according to the claims.
“In general what these cases involve is … unsuitability and misrepresentation,” said Klayman.
And now, after a year in which the declining value of Puerto Rico bonds led to the arbitration cases, news that PREPA may be restructuring and may not be able to make all of its payments on time has led more investors to file claims, said Klayman.
“Our lines are inundated with people calling us because of this event,” said Klayman, who represents more than 100 individuals and expects his caseload to grow to 500. “[We expect an] exponential rise in filings as a result of this warning of default.”
PREPA’s situation is also starting to generate calls at Sonn & Erez, which represents 150 families that invested in the closed-end funds, said attorney Jeffrey Sonn.
OCIF settlement with UBS an ‘insult’
Local investors in closed-end funds have lost USD 6bn as the value of the investments has declined, according to the lawsuit against the OCIF brought by attorney Harold Vicente, of the firm Vicente & Cuebas, which also represents more than 100 investors.
The closed-end funds were heavily invested in Puerto Rico municipal bonds because those that had at least two thirds of the fund invested in local securities had tax advantages for investors, including no income or capital gains taxes, said Sonn.
Puerto Rico’s OCIF, which regulates financial institutions in Puerto Rico, came to a settlement with UBS on 9 October, after the regulator found that UBS may have recommended that clients with “a conservative risk tolerance profile” and with a high percentage of their assets invested in the closed-end funds, increase their risks by borrowing with “non-purpose loans” to further leverage their investments.
UBS Puerto Rico had agreed to pay USD 26.6m in May 2012 in a settlement with the Securities and Exchange Commission after being charged with making misleading statements to investors and concealing a liquidity crisis. UBS did not admit guilt in that case.
Under the OCIF settlement last month UBS agreed to pay USD 5.2m, in part to compensate 34 clients for their losses in the closed-end funds. UBS did not admit guilt.
Vicente called the settlement “outrageous,” saying that the amount paid was tiny compared to the size of the losses.
“To me it’s an insult to the intelligence of the investing public in Puerto Rico,” Vicente said.
He is representing an investor who is suing the OCIF seeking confidential documents, in part to find out if his broker was one of the six that would receive “enhanced supervision” under the terms of the deal.
Commissioner of Financial Institutions Rafael Blanco said that his office planned to fight the lawsuit because their investigations were confidential.
“This is an agency much like the SEC, much like FINRA, they don’t divulge their investigations,” said Blanco.
Lots of loss, limited resources
He said that their investigation only covered 34 investors because they had limited resources and so they looked for a sample of people who had not filed a case with FINRA and were senior citizens with a large portion of their assets in closed-end funds and had a conservative investment profile. He noted that under the settlement UBS was required to determine if any other clients fit this profile and required restitution.
Blanco said that the “next time we have resources” to look at UBS, the OCIF would make sure that UBS had complied with the agreement.
Blanco said that so far 33 of the 34 UBS clients have agreed to the settlement and a check has gone out to two of those clients.
UBS said that the settlement with the OCIF was separate from the FINRA arbitration process.
“Arbitrations are independent processes, the firm looks forward to vigorously defending these arbitrations,” said spokesperson Gregg Rosenberg.
In the meantime, with PREPA at risk of skipping a payment, the situation is getting worse for investors with closed end funds that hold PREPA bonds, said Klayman.
“When they skip interest payments the damages will be increased,” said Klayman. “There’s going to be less of a return, less of a value.”
And PREPA bonds make up a significant percentage of some investors’ portfolios, said Klayman.
The Puerto Rico Commonwealth Employees Association (AEELA by its Spanish acronym), for instance, had 30% of its portfolio, or USD 170m, invested in Puerto Rico government bonds, a full 20%, or USD 35m, were in PREPA bonds dated from 2032 to 2040, said Klayman, who is representing the AEELA.
UBS didn’t divest from the bonds, even after putting out a March 2012 report that said that sales-tax backed bonds were stable and resilient compared with PREPA, said Klayman. UBS declined to comment on the report.
Klayman said his first case involving the closed end funds is set for 2015.
“There’s going to be a long and nasty fight, I’m sure,” he said.
A USD 3.5bn tranche of Series 2014A 8% Puerto Rico general obligation bonds last sold in round lots yesterday at 87.5, yielding 9.378%, according to Electronic Municipal Market Access. Standard & Poor’s last rated the bonds BB on 11 July; Moody’s Investors Service last rated them B2 on 1 July; and Fitch Ratings last rated them BB- on 9 July.