The SEC continues to crackdown on Regulation M - Rule 105 short selling violations throughout the country. Yesterday, the SEC announced its largest Regulation M settlement to date. Jeffrey W. Lynn and his company Worldwide Capital agreed to pay a total of $7.2 million to settle all charges. According to the SEC's allegations in an Order Instituting Administrative Proceedings, Mr. Lynn and many traders working for him at Worldwide Capital engaged in an investment strategy to purchase new shares of public issuers in secondary offerings and follow-on public offerings. The Worldwide Capital traders had numerous accounts with many of the broker-dealers involved in the offering where they purchased much of the stock allocated to them. The stock was then delivered to a prime broker and then sold short through a Worldwide Capital account. The large number of traders that Mr. Lynn employed allowed him to obtain large allocations of shares of the soon to be publicly offered issuer. In anticipation of declines in the market price of the shares of the issuer on the effective date of the offering, Mr. Lynn and his traders would sell those shares short and reap huge profits when they delivered the stock allocated to them in the secondary and follow-on offerings. The SEC alleged that Mr. Lynn directly and indirectly participated in over 60 public stock offerings and sold stock short during a restricted period that resulted in Rule 105 violations.
Robert Wayne Pearce, P.A. filed another claim against UBS Financial Services Incorporated of Puerto Rico (UBS Puerto Rico). A summary of the client's allegations against UBS Puerto Rico is below.
The client is an 80 year old retiree living alone in San Juan, Puerto Rico. He was introduced to the UBS Puerto Rico broker 10 years ago, believing at the time that the broker worked for Oriental Financial Services, Corp. Upon the recommendation of the broker, the client purchased a Sunlife annuity from him and held that annuity for many years. Thereafter, the UBS Puerto Rico broker solicited client to make other investments, but the client had a long standing relationship with a Santander Securities and later Popular Securities broker and declined the stockbroker's solicitations until last year.
In Spring 2013, the UBS Puerto Rico broker persuaded the client to review his Popular Securities investment portfolio, discussing the substantial losses he had suffered because of his prior stockbroker's recommendation. The UBS Puerto Rico broker then pointed to the client's investment in Puerto Rico Commonwealth Aqueduct & Sewer Authority (PRASA) bonds and claimed that the client would suffer huge losses if he continued to hold them.
The UBS Puerto Rico broker convinced the client to open an account at UBS Puerto Rico, sell his annuity, withdraw his bank savings, and transfer Popular Securities account assets and the PRASA bonds to UBS Puerto Rico and to sell his Scotiabank CDs to invest at UBS Puerto Rico. Although the UBS Puerto Rico broker urged the client to transfer his entire Popular Securities account to UBS Puerto Rico, he refused because of his relationship with his Popular Securities stockbroker.
Will someone please explain to me how the UBS Puerto Rico sponsored closed-end bond funds (UBS Funds) managed to increase their Net Asset Values (NAVs) after most, if not all, of the Puerto Rico government and agency issued bonds held in the UBS Funds were downgraded to "junk" status? I am questioning whether the NAVs that UBS Puerto Rico reported for the week ending February 19, 2014 in the prior two weeks truly represent the actual NAVs of the UBS Funds. First, how did they manage to fairly price the bonds with the small number and size of Puerto Rico bond transactions in the marketplace? Most of the Puerto Rico bonds in the UBS funds are very thinly traded. Further, the prices of many of the Puerto Rico bond transactions have been all over the place because the trading is very volatile. Did UBS Puerto Rico get these prices from a matrix? Or has UBS Puerto Rico manipulated the Puerto Rico bond market through transactions with their closed-end bond funds? With the increasing number of arbitration claims relating to the UBS Puerto Rico closed-end bond funds, I am wondering whether UBS Puerto Rico is engaging in a trading strategy to pump up the NAVs and prices of the UBS Funds to reduce the Claimants' damages in those arbitration proceedings. Whatever the reason, there is a slight upward trend in the NAVs of most of the UBS Funds as set forth below:
The Law Offices of Robert Wayne Pearce, P.A. filed its first claim against UBS Financial Services Incorporated of Puerto Rico (UBS Puerto Rico). A summary of the allegations its client made against the Puerto Rico based brokerage firm follows.
The client is 70 years old, retired and residing in San Juan, Puerto Rico. UBS Puerto Rico developed, marketed and managed the investments in the case.
A UBS Puerto Rico financial advisor allegedly made unsuitable recommendations that the client hold an excessive concentration of Puerto Rico securities, namely the Puerto Rico bonds and bond funds, leaving the client's investment portfolio undiversified by both asset allocation and geographic area, i.e., Puerto Rico. UBS Puerto Rico and its representatives continuously gave misleading information to the client about both the nature and risk of the investments in his account, alleging that holding Puerto Rico bonds was "safe" because they were "constitutionally protected." Consequently, the client suffered substantial losses.
The UBS Puerto Rico broker and the client met in 2009 to review the client's portfolio, discussing the substantial losses he suffered as a result of his prior broker's unsuitable recommendations. The client told the UBS Puerto Rico broker he only wanted to invest in low risk securities. With the assurances of the broker, the client agreed to open a UBS Puerto Rico account.
The client and the UBS Puerto Rico broker met again and reviewed every security in the account transferred to UBS Puerto Rico, discussing at length the UBS Puerto Rico bond funds and allegedly claiming the bond funds had an excellent track record, were highly recommended, ideal retirement investments and mustn't be sold. The UBS Puerto Rico broker even recommended that he take out a loan to purchase more of them.
Yesterday Fitch Ratings, the last of the big three national credit rating services, Moody's, Fitch or Standard and Poor's, downgraded multiple issues of Puerto Rico debt to what the Puerto Ricans describe as "Chatarra"; that is, "Junk." Moody's and Standard & Poors had cursed Puerto Rico bondholders with that same rating just last week. Fitch downgraded the Puerto Rico General Obligation bonds to BB from BBB- along with the Building Authority, Aqueduct & Sewer, and Retirement System bonds. Fitch spared the prized Puerto Rico Sales Tax Financing Corporation Bonds (COFINA Bonds) from any downgrade; they are the only general category that still hold an investment grade rating. However, Fitch's outlook (direction of ratings over the next 1-2 years) for all of these bonds remains negative.
The key drivers for Fitch's ratings of the Puerto Rican bonds were reportedly: 1) the reduced financial flexibility of the Commonwealth due to the deterioration in credit ratings; 2) fiscal management or rather mismanagement; 3) economic performance due to the 7-year recession; 4) high debt and retiree benefit liabilities; and 5) impaired capital market access. Fitch noted that Puerto Rico's constitutional general obligation bond pledge is strong but the Commonwealth cannot file for bankruptcy. Fitch indicated its future rating sensitivities will again depend on: 1) market access; 2) hitting the budget targets; and 3) future credit profile changes.
We told you months ago that Puerto Rico debt was going to be downgraded by one or more of the three national credit rating services, Moody's, Fitch or Standard and Poor's before June 2014. On Wednesday Standard & Poor's downgraded multiple issues of Puerto Rico debt to what the Puerto Ricans describe as "Chatarra"; that is, "Junk." This afternoon Moody's Investors Service joined in and downgraded the Puerto Rico General Obligation bonds to Ba2 from Baa3 and all of the other agency linked debt two more notches except the Puerto Rico Aqueduct and sewer Authority bonds which only went down one more notch to Ba1. In addition, Moody's downgraded the prized Puerto Rico Sales Tax Financing Corporation Bonds (COFINA Bonds) another notch which still leaves them with an investment grade rating. Moody's outlook for all of these bonds remains negative.
Moody's rationale for the continuing downgrade of Puerto Rican debt is the problems that have confronted the US territory for many many years including the continued financing of the deficits to the issuance of new bonds, the underfunding of all the public service workers pensions since inception, the continuing imbalance of the budget's and over 7 years of economic recession taking its toll on the Island. Moody's attributes the economic weakness due to the long-term decline in its once dominant manufacturing sector, expiration of federal tax benefits to many of its industries and high energy costs. The ratings agency is still worried about the unfunded pension liabilities relative revenues even after the government acted to reform its pension system. Moody's is very concerned about the high level of government debt which it cites to be more than 50% of gross domestic product. According to Moody's, its debt load and fixed costs and insufficient liquidity make it difficult for Puerto Rico to access the markets for additional financing in the future
You read it on this blog months ago, Puerto Rico debt was going to be downgraded by one or more of the three national credit rating services, Moody's, Fitch or Standard and Poor's before June 2014. Well two days ago Standard & Poor's won the race to the finish line. It downgraded multiple issues of Puerto Rico debt to what the Puerto Ricans describe as "Chatarra"; that is, "Junk." For example, Standard & Poor's lowered the ratings from investment grade rating "BBB" to speculative junk bond rating "BB" on the following bonds:
|Name of Bond Issuer||S & P Rating|
|Puerto Rico General Obligation||BB+|
|Puerto Rico Aqueduct and Sewer Authority||BB+|
|Puerto Rico Convention Center||BB+|
|Puerto Rico Infrastructure Financing Authority||BB+|
|Government Development Bank of Puerto Rico||BB|
|University of Puerto Rico||BB+|
|PPuerto Rico Ind Tourist Edu Med Environ Cntl Facs Financing Authority||BB+|
|Puerto Rico Municipal Financing Agency||BB|
|Puerto Rico Hwy. and Transportation Authority||BB+|
|Puerto Rico Public Buildings Authority||BB+|
The explanation given by Standard & Poor's for the downgrades was the liquidity problem in Puerto Rico and a reduced capacity to obtain liquidity from the Government Development Bank of Puerto Rico which was also downgraded. The ratings agency does not believe that Puerto Rico will be able to finance its deficits directly in the market or indirectly through the Government Development Bank. Thus, the liquidity risk and the market access risk were the driving forces behind the downgrade.
Governor Alejandro Garcia Padilla published an article in the Huffington Post's Latino Voices section today spinning his administration's accomplishments in the past year. He claimed "Puerto Rico's Economy Is Stronger Today Than It Was a Year Ago." He cited the so-called improvements in pension reform, revenue improvement and restructuring of public corporations as the reason for his claims. The article read more like another politician speech than a realistic account of the state of the economy on the Island. The constitutionality of the pension reforms measures are under review by the Supreme Court. He claimed that his administration created over 25,000 jobs but the latest federal report indicated that Puerto Rico has lost more than 40,000 jobs over the last year. He didn't say anything about the Government Development Bank's latest Economic Activity Index report that the economy continued to contract in November 2013 over 5.7% on a year-to-year basis (the 12th consecutive monthly contraction in the last year). The Puerto Rico economy has been contracting in greater and greater amounts every month over the last year. Nor did he say anything about the fact that his own administration had dropped its own expectations for any growth this year. He was also silent about the fact that revenues from the sales and use tax (funding the Covina bonds) are also short of estimates this year. Nor did he say anything about the $688 million increase in the fiscal budget for this year. And so, what is his basis for the spin? Hope and Prayers?
Notwithstanding the Governor's positive spin, we believe all of the credit rating agencies will still be downgrading Puerto Rico debt securities later in the Spring. Maybe the Governor's comments were based on the pop in the net asset value of the UBS Puerto Rico bond funds! Not a very reliable index since the UBS Puerto Rico trading desk controls the pricing. Up, down and sideways, however they feel that day. The most recent NAVs, published January 15, 2014, put the value of the funds as follows:
Yesterday, the Puerto Rico Supreme Court temporarily stopped the enforcement of the law signed by Gov. Alejandro Garcia Padilla on Christmas Eve with reformations to the teacher pension system. The Supreme Court blocked the reforms to the pension system that the government insists it needs to avoid a downgrade of Puerto Rico debt securities to junk status. Gov. Garcia Padillo stated "saving the teacher pension system and guaranteeing them sufficient pensions in line with the Island's fiscal realities is an issue that demands a deep sense of responsibility, as does saving Puerto Rico's credit rating," a credit rating that is just one step away from junk status. Today the Supreme Court held a hearing on a lawsuit challenging a separate reform of the pension fund for the judicial system in Puerto Rico. You don't have to think too hard as to what their decision will be in light of their ruling on teacher pension reform.
The Financial Times reported yesterday that creditors to Puerto Rico are meeting in New York with lawyers and debt restructuring specialists in anticipation that the Puerto Rican government will be imposing a moratorium on payments of over $110 billion in public sector debt and unfunded pension liabilities. As the fear of suspension on payment of the debt grows, the anticipated expense to service that debt also increases. This is becoming a self-fulfilling prophecy of doom to the Island. We are hearing from our clients that Puerto Rico stockbrokers have been contacting them and spreading a rumor that the Puerto Rico Government Development bonds are going to be restructured through a write-down of over 35% on the face value of the bonds.
Thomas Mikolasko, Registered Principal formerly with HFP Capital Markets, LLC (HFP) of New York, New York, was fined $75,000 and suspended for 18 months by the Financial Industry Regulatory Authority (FINRA) for his participation in the sale of Senior Secured Zero Coupon Notes which were sold to HFP customers for the entity Metals Millings and Mining, LLC (MMM). Mr. Mikolasko was an investment banker with HFP and was involved in the firm's sale of $3 million of MMM Notes which have defaulted, leaving investors with neither their principal repaid nor the promised 100% return on their investment.
According to FINRA's findings, Mr. Mikolasko participated in the due diligence (or lack thereof in this case) performed by HFP with respect to the sales of the offering and, therefore, should have known that there were multiple red flags and the need for further due diligence. Further, the firm's investment committee did not even approve the offering, a fact that Mr. Mikolasko allegedly knew or should have known. Additionally, Mr. Mikolasko allegedly helped facilitate the sales of the Notes by signing MMM Notes and Repurchase Agreements as the supposed "Managing Member" of MMM, a position which he did not hold and an authority which he did not have.