The Puerto Rico Electric Power Authority's decision in its forbearance agreement to disclose certain information to only some of its bondholders could put both PREPA and those investors at an increased risk of committing securities law violations, disclosure experts said Wednesday.
PREPA entered into the forbearance agreement earlier this month with bondholders and insurers representing more than 60% of the distressed utility's outstanding revenue debt. PREPA has about $8.5 billion in bonds outstanding and has signaled it may restructure its debt in March. Under the agreement, the bondholders give up their rights to sue PREPA for at least several months and sign non-disclosure agreements.
PREPA will continue to make principal and interest payments but will not make previously required transfers to either a revenue fund or sinking fund. PREPA will notify the forbearing bondholders if there is a default or termination on its bank lines of credit and Government Development Bank loans. The authority will also provide them with monthly cash reports on its general and construction funds, monthly bank statements, and other information.
Experts said disclosure of information to a select group of bondholders is permissible under the federal securities laws, which require little from issuers except complete and accurate offering documents, as well as compliance with their continuing disclosure agreements, which are usually included in official statements. In equities markets, the Securities and Exchange Commission's Regulation FD, or Fair Disclosure, prohibits issuers from disclosing material information to select individuals without publicly disclosing it. That rule does not apply to munis.
However, securities law experts said that the selective disclosure could create an insider trading problem for the bondholders who received the information, if they do anything besides hold the securities. Federal antifraud provisions apply to individuals who trade on the basis of "material nonpublic information" about a security or issuer in breach of a duty of trust or confidence. If investors are aware of nonpublic information that they are supposed to keep secret and trade on it, they could face fraud charges.
Municipal Market Advisors managing director Robert Donahue said MMA is concerned about the selective disclosure of information to bondholders. "It is unclear from the forbearance agreement whether information will be made public and whether the 'forbearing bondholders' will be restricted from trading on privileged information," he said. "The Government Development Bank for Puerto Rico will be pressed to disclose how it will work to satisfy this potential selective disclosure issue."
PREPA is also at risk because the existence of a second set of non-public disclosures could create the potential pitfall of a "Harrisburg-like" situation, according to one securities lawyer who referred to the SEC's May 2013 charges against the Pennsylvania city for misleading investors. Harrisburg officials failed to make many of their promised continuing disclosures, and the SEC deemed information released to the market by other means, such as public speeches by city officials, to be misleading about the city's financial condition. The attorney said that if PREPA provides extensive information to the forbearing bondholders while simultaneously, on its web site, posts more materially limiting or misleading information, that would be a violation of federal securities laws.
The forbearing bondholders are a particular group that can't be changed. Bondholders who were not a party to the agreement cannot volunteer to be a part of the group at this point. Some of the forbearing bondholders can terminate the agreement under certain conditions, such as if they own or insure at least 25% of the bonds and elect to do so. Some of those bondholders can also exit the agreement individually under certain conditions. PREPA can terminate the agreement if the forbearing bondholders breach it and do not fix the breach within five days. The agreement otherwise terminates on March 31.
The GDB and PREPA wouldn't comment on the disclosure concerns.
