What’s Next in Wake of Puerto Rico Municipal Bond Crisis?

As some of Puerto Rico’s municipal bonds are slipping into “junk” territory and brokerage firms are warning their brokers to steer clear of about $70 billion of Puerto Rican debt on the market, the logical question is what is next for investors already stuck in this quagmire. Puerto Rico’s debt has for years been popular with U.S. investors because of its high yields and special tax benefits. However, the plunge in Puerto Rico’s bond values has tracked Puerto Rico’s worsening economic troubles. The problems are not exclusive to direct municipal bond investments either. According to Morningstar, some 77 percent of U.S. municipal-bond mutual funds hold bonds sold by Puerto Rico.

So how far will the impact of Puerto Rico’s worsening economy go? Investors are already seeing losses in funds over-concentrated in Puerto Rico municipal bonds. UBS’s family of Puerto Rico Funds, for example, heavily invested in Puerto Rico municipal bonds and some of these funds are already seeing significant price decreases. For example, according to their quarterly reports, the NAV (net asset value) for the UBS Puerto Rico Tax-Free Target Maturity Fund and UBS Puerto Rico Tax-Free Target Maturity Fund II are down 88.9 percent and 83.6 percent, respectively.

It was only last year that UBS’s (NYSE:UBS) Puerto Rico subsidiary settled Securities and Exchange Commission claims that it defrauded Puerto Rican mutual-fund customers by concealing a liquidity crisis, artificially propping up market prices and masking its controls of the secondary market for proprietary closed-end funds that it managed on the island.

UBS’s family of Puerto Rico Funds does not appear to be the only funds with exposure to the declining Puerto Rico municipal bond market. The Massachusetts Secretary of the Commonwealth said he is investigating two other fund managers in addition to UBS, Fidelity Investments and Oppenheimer Funds. The investigation is reportedly intended to determine how these companies sold mutual funds with heavy concentrations of Puerto Rico debt and how they disclosed the risk.

Given that 77 percent of U.S. municipal-bond mutual funds hold bonds sold by Puerto Rico, it appears likely that other funds have similar exposure to both downside risk and regulatory scrutiny.

Individual investors in Puerto Rico municipal bonds or funds that invested in these bonds are also looking at their options. One avenue of recovery may be a FINRA arbitration claim against the broker or brokerage firm that recommended these investments. FINRA (Financial Industry Regulatory Authority) is the regulatory body that governs U.S. brokerage firms and it offers a dispute resolution forum for disputes between customers and firms.

Brokerage firms and financial advisers are required to disclose the risks of any investment and to insure that each investment recommended is appropriate in light of the investor’s age, net worth, income, investment experience, and investment objectives. If a broker or brokerage firm fails in these responsibilities the investor may have a claim to recover their investment losses through a FINRA arbitration claim.

It is also possible that class actions could be filed, although such claims can take years and often result in only nominal compensation for the investor.

D. Daxton White is the managing partner of The White Law Group, LLC, a national securities fraud, securities arbitration, and investor protection law firm. He has represented investors in virtually every U.S state and litigated over 500 FINRA arbitration claims. Find out more about White at www.WhiteSecuritiesLaw.com. He tweets at @SecuritiesAtty and can be found on Facebook here.