Recovered for Investors
Puerto Rico bond prices fell dramatically in 2013 after a financial crisis in Puerto Rico. Since the government has spent more than it collected for years, it meant that there was a significant likelihood that principal and interest payments would not be made.
Significant government deficits, a contracting economy, and the government’s inability to finance debt repayment led to that conclusion. Customer losses were made worse by leverage. The closed-end funds that held the bonds were leveraged, and customers bought Puerto Rico bonds and bond funds on margin in their brokerage accounts – and overconcentration of PR bonds and bond funds in investor portfolios.
Estimates to date indicate that over $600 million has been paid out by the selling brokerage firms in settlements and arbitration awards. Many more cases are pending at this time, but time is running out for investors to file arbitration claims to recover their losses.
UBS Financial Services Inc. of Puerto Rico was the principal underwriter of PR bonds. It reportedly made hundreds of millions of dollars in underwriting fees and millions more by selling its inventory of PR bonds and bond funds as safe investments when it knew or should have known that they were risky. At one time, UBS was the largest wealth management business in Puerto Rico with an estimated 20,000 household accounts.
The majority of arbitration cases (about 68%) have been filed against UBS Financial Services Inc. of Puerto Rico.
Approximately 17% of the cases so far have been filed against Santander Securities LLC. Of the remaining 15%, about 7% of the cases have been filed against Popular Securities LLC, 5% against Oriental Financial Services Corp. and 3% against Merrill Lynch.
In May 2012, the SEC sued UBS PR over its sales practices associated with closed-end PR bond funds. The SEC alleged in part that UBS was propping up the closed-end mutual fund market by buying up shares at the same time it promoted the funds as highly liquid and safe. UBS PR was ordered to stop its improper sales practices related to the bonds and bond funds.
By March 2014, PR bonds and bond funds had plunged to half their original value. Some investors who purchased on margin (i.e., had taken out loans to buy the bonds) were forced to sell at the lower prices to maintain the required collateral asset value. Others who did not buy on margin saw their investment cut in half.
UBS PR settled with the SEC in 2012 for approximately $26.6 million, and in 2015 for another $15 million. UBS PR settled with FINRA in 2015 for $18.5 million. In 2014, UBS PR settled with Puerto Rico’s local regulator, the Office of the Commissioner of Financial Institutions, for $5.2 million.
Criminal fraud is part of this PR bond story. In 2019, a former UBS PR broker pled guilty to a fraudulent scheme which allegedly involved others at UBS PR. The firm fired back at the whistleblower claiming he misled the firm and was trying to escape his responsibility.
UBS PR allegedly misrepresented the risks associated with the PR bond funds to customers who wanted stable, consistently-priced securities and primarily engaged in market manipulation.
UBS PR reportedly failed to inform investors that it controlled the secondary market for these funds. UBS PR allegedly knew investor demand in the funds was significantly declining relative to supply. So, UBS PR purchased millions of dollars of fund shares into its own inventory while promoting the appearance of a liquid market with stable prices, without disclosing UBS PR’s actions were propping up prices and liquidity. In sum, UBS PR allegedly did this to disguise the lack of demand and prop up PR bond prices.
All Puerto Rico bonds went into default years ago when credit rating agencies downgraded Puerto Rico bonds to junk status, thus triggering acceleration clauses that were breached. The government of Puerto Rico has since restructured its debt. As noted, PR bond investors took a significant loss (“haircut”) as a result.
Investors can either do nothing and take a 35% to 45% haircut (accept the losses) or file an arbitration claim against the brokerage firm that sold the PR bonds and bond funds. Investors can file arbitration claims through FINRA (the Financial Industry Regulatory Authority) instead of going to court. If a brokerage firm sold the bonds, FINRA arbitration is mandatory (i.e., no court litigation). Arbitration is far less expensive and time-consuming than court litigation. As noted, the amount of money that investors have recovered from brokerage firms that sold the bonds is substantial.