The federally appointed Financial Oversight and Management Board (FOMB) announced that they will examine the issuing of Puerto Rico’s debt, including disclosure, and selling practices. To carry out the audit, the FOMB set-up a special committee that in turn will appoint an independent investigator. Findings will be made public.
The audit of Puerto Rico’s debt got entangled in partisan politics when former governor Alejandro García Padilla created a commission lacking the legal and forensic mechanisms to carry out their mandate, and subsequently when current governor Ricardo Rosselló decided to withdraw funding and support from the commission. Though many stakeholders are demanding the reestablishment of the audit commission, the reality is that the audit commission lacked the full legal authority and forensic expertise to conduct the audit, and it could affect any ongoing court-supervised debt restructuring process.
A year after PROMESA was enacted, the FOMB announcement couldn’t come at a better time.
The available evidence supports a more thorough investigation of the debt. An often-mentioned reason to audit the debt regards a portion of the debt that was used to finance deficits exceeding constitutional limits. Though the examination of this issue by the courts is unavoidable given pending litigation between COFINA and general obligation bonds, other aspects of the debt deserve equal attention.
According to FINRA (Financial Industry Regulatory Authority), “[a]s of January 31, 2017, nearly 1,900 cases involving Puerto Rican bonds have been filed; of these, more than 1,100 cases are pending and over 30 have been decided by award.” Cases have been filed against UBS Financial Services Inc. of Puerto Rico (UBS-PR), Santander Securities LLC, Popular Securities LLC, Merrill Lynch and Oriental Financial Services Corp among others. These cases claim that brokerage firms engaged in misrepresentation, breach of fiduciary duty, or other violations of legal and ethical guidelines.
Recently, the U.S. Securities and Exchange Commission announced that their staff was making a recommendation to take action against four bankers from Barclays Plc and Morgan Stanley for alleged violation of fair dealing rules for their roles in Puerto Rico bond sales. These allegations involve the underwriting of Puerto Rico’s $3.5 billion bond sale in March 2014 and disclosures made in documents circulated to investors. In a recent lawsuit against the Commonwealth of Puerto Rico, Ambac Assurance Corp. referred to these statutory violations and predatory practices as “theft.”
Giving mountain evidence of wrongdoing, the FOMB should be commended for the creation of a committee and the intended appointment of an independent investigator. Yet, there are critical questions that must be clarified and key factors that must be considered as this policy is implemented.
First, transparency is paramount to assure the public’s confidence in the process and the findings of the investigation. Given the list of the financial brokers already engaged in FINRA cases such as Santander Securities LLC, or the list or Puerto Rico bonds that resulted in millions of dollars of losses such as those from the Government Development Bank for Puerto Rico (GDB), FOMB members with disclosed historical professional links to these entities should recuse themselves from participating in any part of this investigation, let alone be appointed as members of the committee.
A second concern is that the FOMB investigation might be disconnected or could even interfere with the ongoing Title III bankruptcy-like case in federal court supervised by Judge Laura Taylor Swain. There is a simple solution to this dilemma. The FOMB could petition Judge Taylor Swain to appoint an examiner. A court mandated option, as recently suggested by Governor Rosselló, would be preferable to any other option divorced from the federal court proceedings.
An examiner is a professional with financial accounting and forensic expertise that will investigate the debt and produce a report to the court. The examiner will have the legal authority to request documentation and interview witnesses. In addition, the examiner would minimize potential conflicts with the bankruptcy procedures by engaging with both the committee set up by the FOMB and the committees already appointed by Judge Taylor Swain.
Besides avoiding interference, an examiner would be an integral part of the court procedures. This is important because many of the financial institutions involved in litigation as creditors are also targets of the FINRA investigations. Therefore, it is likely that settlement with the Commonwealth for some creditors might be affected by findings of their liability as financial intermediaries based on systematic violations of legal and ethical guidelines towards other creditors. In other words, creditors that were deceived by brokerage firms may receive a portion of the awards attributed to these financial institutions by the court as creditors.
In sum, the FOMB and Judge Taylor Swain have the opportunity to make the process of auditing the debt fully transparent, free of conflicts of interests, and relevant to the ongoing bankruptcy procedures through the appointment of an independent examiner. Increased transparency in the examination of the debt will go a long way in restoring public faith in our governing institutions.