The Puerto Rico Oversight Board filed suits against hundreds of investors and public finance firms to claw back more than $1 billion in payments and fees on bonds issued since as early as 2004.
The board made a variety of legal arguments for the clawbacks, some connected with its claim that the Puerto Rico government exceeded its constitutional debt limit in sales of general obligation and Public Building Authority bonds.
The board’s suits, filed as “adversary complaints” in the commonwealth's Title III bankruptcy, addressed fees from PBA bonds issued as early as 2004 and GO bonds issued as early as 2007. It also addressed fees from Employees Retirement System bonds.
The board, which was criticized in Congress Thursday for its efforts to impose austerity measures on the territory as it seeks to restore fiscal and economic stability, also came under fire from the bond market for the clawbacks.
“In our opinion, the Board's decision to seek to clawback payments made to holders of the GO bonds would set a very bad precedent in the marketplace, even assuming that the debt is found to be unconstitutional," said Triet Nguyen, managing partner at Axios Advisors.
The board said it sued over 20 financial firms, law firms, and municipal advisors and is seeking the return of “hundreds of millions of dollars” in fees.
It also sued 459 individual bondholders who each held more than $2.5 million in the contested Puerto Rico bonds, seeking to claw back payments made on GO bonds issued from March 17, 2011 onwards and PBA bonds from Aug. 24, 2011 onwards. It doesn’t plan to sue those who held less than $2.5 million of the bonds.
The par value of the bonds that that the board is attempting to claw back payments on is more than $9 billion.
“The Oversight Board did not take the decision to claw back payments lightly,” said board member David Skeel. “However, Puerto Rico’s taxpayers should not have to shoulder payments the government made to big investors that should never have been made in the first place.”
Nguyen said the decision to only sue larger bondholders is problematic. "Many of those institutional holders are mutual funds that do have small investors. Investors should be able to rely on the legal representations made by the government officials at the time of issuance of the debt.
“It is also a fundamental violation of the credit market rules to penalize a bond issue depending on who owns it,” Nguyen continued. “Even if the board is successful in these efforts, which we seriously doubt, the Commonwealth will be paying the price later on when it tries to access the capital markets again.
“The potential claim against the firms who participated in the initial underwriting efforts should probably be considered in the context of whether or not they acted as ‘municipal advisors’ to the commonwealth,” Nguyen said.
“The board is creating an impossible standard of due diligence for Puerto Rico lenders going forward," said Municipal Market Analytics Partner Matt Fabian. "If the court allows this action, it is hard to see PR bonds ever becoming a suitable investment for traditional retail or small institutional accounts.”
In a written statement the board said: “Some bondholders may have relied on information provided by the issuers, underwriters, and other professionals and lenders when they invested in the bonds. The Oversight Board is sympathetic to these concerns.
“But the laws of Puerto Rico limit government borrowing authority for a reason: to prevent the government and its financiers from obligating the commonwealth and its instrumentalities, as well as taxpayers and legitimate creditors, to a level of debt that cannot be repaid without sacrificing services necessary to maintain the health, safety, and welfare of Puerto Rico and its people,” the board continued.
The board said it didn’t plan to “prosecute” the clawback litigation until the bankruptcy court determines that the board-challenged bonds are in fact invalid.
Among the firms the board is suing are: Barclays Capital, Bank of America Securities, Merrill Lynch Capital Services, Citigroup, Goldman Sachs & Co., JPMorgan Chase, Jefferies Group, Mesirow Financial, Morgan Stanley, Ramirez & Co., RBC Capital Markets, Santander Securities, UBS Financial Services, VAB Financial, BMO Capital Markets, Raymond James, Scotia MSD, TCM Capital, and Sidley Austin.
Several of these firms declined to comment, while some could not be contacted in time for the story.
A Santander Securities spokesperson said: “We believe the claims asserted against Santander Securities LLC lack merit. This is a legacy issue related to the unprecedented decline in the Puerto Rico bond market, culminating with the Puerto Rico government declaring bankruptcy in 2017.”
Linton Childs, the General Counsel of Sidley Austin LLP, said: “We believe that putative claims asserted against the firm are both untimely and entirely without merit.”
The court has kept the names of the sued bondholders confidential until 21 days after they have been notified and have had a chance to object to the disclosure of their names.
The Unsecured Creditors Committee is a plaintiff in all or most of the suits. Along with the law firms that have been representing the board and the committee, the filings show that the board has retained Estrella, LLC in Puerto Rico and the committee has retained Casillas, Santiago & Torres in Puerto Rico.
