Securities Arbitration Lawyers BlogSEC Investigation Of Morgan Stanley And Puerto Rico Bond Investments
When Hurricane Maria landed in Puerto Rico, it caused devastation to the island’s infrastructure, crops, homes and power grid that will take many years to repair. But the damages to Puerto Rico include losses in municipal bonds and the mutual funds that hold them, which were close to default even before the storm.
While the island still struggles to recover, it wasn’t the first catastrophic event to hit the island territory. In 2014, Puerto Rico was already headed for a severe financial crisis, with bond sales from Morgan Stanley brokers as the catalysts.
Morgan Stanley and Barclay’s were responsible for underwriting the island’s $3.5 billion sale in March 2014. This sale was the last major issue by Puerto Rico before declaring bankruptcy on May 3, 2017, for a debt restructuring amounting to $3.8 trillion. The island’s debt stood at $70 million, and it needed to restructure pensions of $49 million. This municipal bankruptcy was even bigger than the city of Detroit’s 2013 restructuring of $18 billion.
Four individuals involved are under investigation by the SEC for their roles in the financial crisis and a municipal bond offering underwritten by Morgan Stanley and Barclay’s in 2014:
- James Henn of Barclay’s Capital;
- Luis Alfaro Martinez of Barclay’s Capital;
- Charles Visconsi of Barclay’s Capital;
- Jorge Irizarry of Morgan Stanley.
The first two, Henn and Alfaro Martinez, are being investigated for violating fair dealing in selling Puerto Rico bonds. Additionally, they are being investigated for alleged violations of securities rules and municipal bond rules pertaining to misrepresentation, deception and fraud related to these securities according to various reports.
The SEC is considering issuing a sanction against the second two, Visconsi and his former colleague, Irizarry, because of disclosures about Puerto Rico sent to investors in documentation. The SEC has not charged these individuals with any intentional wrongdoing. However, the SEC is interested to know if the broker-dealer sufficiently reviewed the representations made by the government of Puerto Rico. Many retail investors were sold Puerto Rico bonds by their stockbrokers and have suffered substantial losses.
Another Morgan Stanley broker, Angel Aquino-Velez, was also identified in as separate FINRA investigation, and his broker registration ended in July of 2017. There is no indication that he is still working for Morgan Stanley, and the firm offers no explanation for his change in employment status.
Miami-based Aquino-Velez sold Puerto Rico Cofina bonds, backed by the island’s sales tax revenue, to investors. Allegations include “unsuitability and misrepresentation” in the purchase of these municipal securities and closed-end funds. FINRA claims the damages are approximately $7 million.
Morgan Stanley previously settled claims filed against Mr. Aquino-Velez worth $2.4 million, also from Puerto Rico municipal bond investments. Morgan Stanley and other firms still have many securities arbitration claims alleging damages relating to Puerto Rico bonds.
How Did This Happen?
A CNBC investigation explains that a 77-year-old piece of legislation allowed a loophole for investors who invested heavily in these municipal bonds. Puerto Rico is a US territory, and not a US state. PR residents have special tax protections because of the fiscal jurisdiction separate from the ones on the US mainland. This means that an investor who lives on the island and has earnings from a bond that’s issued by the Commonwealth pays no US taxes.
Should that same investor purchase a security based in the US, he or she will pay US income taxes just like a US citizen living on the mainland, and subject to the same protections. Islanders had favorable tax conditions, but didn’t have the same legal protection. Furthermore, these funds were not regulated by the SEC.
Several funds created by UBS contained up to 67% PR obligations to keep the tax-free status, but investors could make up the rest in US-based securities if they wanted. This meant that only 33% of the holdings were guaranteed by the US government. They were extremely popular, and paid high rates of return until they collapsed in 2013.
Because of an exemption in Investment Company Act of 1940, these closed-end funds were offered in a US territory, not a state, so they weren’t listed on any exchange. The exemption also allows the funds to be leveraged higher, and also free from some other restrictions that wouldn’t be allowed on the US mainland. Many of these funds generated returns of 12% or more between 2010 and 2012.
UBS had the largest wealth management brokerage on the island. Their investors $10 billion invested in these funds, about 10% of the island’s GDP. Clients were also offered lines of credit that they could use to purchase homes or invest in a business, using these investments as the collateral. But UBS wasn’t completely forthcoming about the risks involved in these investments, and even while the value steadily decreased. Most investors lost most, if not all, of their retirement savings.
Closing The Loophole
Rep. Nydia Velázquez (D-N.Y.) has tried three times to have this loophole closed. Her third attempt, “U.S. Territories Investor Protection Act of 2017”, introduced on March 6, 2017, has passed the House and is awaiting a vote in the Senate.
Previous PR Broker Frauds
This wasn’t the first time Puerto Rican investors have had trouble with investments in Commonwealth securities. The SEC previously investigated UBS Financial Services Inc. of Puerto Rico when it failed to supervise a broker who instructed investors to use money borrowed from a USBPR-affiliated bank. The broker engaged this practice knowing it was prohibited, and was also able to reap profits from these transactions.
In February, an all-public arbitration panel of FINRA awarded five clients of USB a total sum of $521,000 in compensatory damages. These investors were all residents of Puerto Rico, and originally requested $840,000, which included attorneys’ fees, expert witnesses, FINRA fees and other expenses. Many other investors have prevailed in FINRA arbitration claims against UBS and others resulting in millions of dollars in settlements.
In a separate incident, the SEC also investigated broker Jose Ramirez, an employee of UBSPR at their branch office in Guaynabo. The SEC alleged that the broker misled investors about the safety of certain closed-end funds, and the risks of using borrowed money to purchase them. As a result, those investors lost significant sums in the scheme. UBSPR terminated Ramirez in January 2014.
You May Be Able To Recover
If you are an investor who has suffered losses in Puerto Rico bonds that may have been inappropriately recommended to you by financial representatives for Barclays, Morgan Stanley, UBS Puerto Rico (UBS-PR), Santander Securities (SAN), Banco Popular, H.J. Simms, Wells Fargo or other firms, you may be able to recover some or all of your losses. We are experienced in recovering investor losses due to broker/brokerage firm misconduct and mismanagement through FINRA arbitration.
Silver Law Group represents the interests of investors who have been the victims of investment fraud. If you have questions about your legal rights, please contact Scott Silver of the Silver Law Group for a free consultation at ssilver@silverlaw.com or toll-free at (800) 975-4345.