A Puerto Rico government-appointed commission is suggesting that much of the island's debt may have been sold illegally.
The Puerto Rico legislature ordered the commission to be set up in July 2015. The "
The commission had 17 members including many of the most powerful members of the Puerto Rico legislature. It also included Melba Acosta Febo, who is the president of the Government Development Bank for Puerto Rico, several prominent Puerto Rican economists, accountants, business leaders, and one union official.
In the report, the commission suggests that Puerto Rico's selling of bonds going back to 1979 may have illegally broken the Puerto Rican constitution's requirement for a balanced budget. The consequence of this may be that a court may bar it from borrowing in the future to finance operating deficits, the commonwealth may be forced to raise taxes, or "declare the debt unpayable for lack of authorization."
Puerto Rico's constitution states that it cannot spend more than 15% of "internal revenues" in its Treasury on GO debt. Depending on definitions, it may be exceeding this level, the commission stated.
On page 21 of the 32 page report (excluding appendices), the commission states: "We note that in years past, the commonwealth's independent auditors have consistently opined that the commonwealth has been in conformity with the debt limit." The report adds, "It is also important to note that the debt limit is difficult to calculate."
The constitution's prohibition against issuing debt with more than 30 year maturities may have been broken through the sale of refunding bonds, according to the report.
The commission questions whether the commonwealth and its advisors and underwriters complied with Securities and Exchange Commission Rule 15c2-12, which bars the sale of debt when an issuer is not disclosing financial information in a reasonable and timely manner.
"It seems as if this commission is trying to re-write history by questioning the commonwealth's ability and authorization to have entered into many of their recent debt agreements," said Howard Cure, director of municipal research at Evercore Wealth Management. "The idea of requiring a balanced budget is somewhat spurious since most states, as well as the commonwealth, don't distinguish between a balanced budget on a cash or an accrual basis. Since most states look at their budget on a cash basis, there have been various gimmicks to balance operations such as deferring salaries or leasing back facilities. States such as California and Connecticut have also deficit financed their operations at various points in time," he added. "Questioning the actual authority to have entered into these debt issuances seems dubious."
Court Street Group partner Robert Donahue called the pre-audit, "a sobering review of issues that, although obvious at the time of issuance, were largely disregarded [by] investors starved for triple tax exempt yield and third parties that garnered substantial service fees.… The warnings that I, and others, had been identifying for years of these risks were heeded by some, but not all, investors.
"Those investors who purchased bonds are now suffering the consequences," Donahue said. "Undoubtedly, the financial leaders and other intermediaries, too, will bear significant damages and consequences, as will innocent and unsuspecting Puerto Rico citizens. Similar to reviews of the New York fiscal crisis in 1970's, this pre-audit and further inquiries into Puerto Rico's fiscal collapse will provide critical lessons that will avert future municipal financial crises."
The commission reviewed the debt solely by looking at documents connected with the $3.5 billion general obligation bond sale and a 2014 $1.2 billion tax and revenue anticipation note sale. An examination of these documents allowed it to learn about prior debt sales as well. However, the commission limited its review because the government has not yet given it funds to do its work, it stated in the report.
The commission said that before an "audit" of the government's debt starts, the audit team should hire a "group of lawyers" to determine if Puerto Rico's debt exceeds its constitutional limits.
