UBS Financial Services of Puerto Rico faces the threat of a legal action for allegedly giving incomplete and deceptive information to clients, 16 months after the unit of the Swiss banking giant paid a fine to the Securities and Exchange Commission to settle a claim it misled Puerto Rico investors.
San Juan, Puerto Rico, law firm Vicente & Cuebas is threatening to file cases on behalf of at least 15 clients who live in the commonwealth and invested in closed end funds created by UBS, the firm's partner Harold Vicente Sr. said.
The cases probably will be filed as a claim for arbitration with the Financial Industry Regulatory Authority. Alternately, he said he may group the cases together as a single class action suit in a federal court.
The developing action follows similar complaints that led to a settlement with the SEC in May 2012. The regulator alleged UBS had made misleading statements to investors, concealed a liquidity crisis, and masked its control of the secondary market for 23 proprietary closed-end funds. UBS Puerto Rico did not acknowledge wrongdoing but did pay $11.5 million in disgorgement, $1.1 million in interest, and a penalty of $14.4 million.
UBS said it has kept clients apprised of the risks of their investments.
"General weakness in municipal markets across the U.S. and Puerto Rico and apprehension about the direction of interest rates have led to steep declines in Puerto Rico municipal bond and closed end fund prices and a lack of liquidity for these securities," UBS spokeswoman Karina Byrne said. "UBS has been monitoring this situation and continuously provided our clients with research and insights on interest rate risks and municipal bond price fluctuations."
The funds in question are for Puerto Rico residents, because they are structured to produce income exempt from Puerto Rico taxes.
A Puerto Rico law requires that at least 67% of a fund has to consist of Puerto Rico munis for the fund to be exempt from Puerto Rico taxes.
According to Vicente, UBS's professionals did not advise their clients that there would be substantial risks to their money if Puerto Rico bond prices went down. They also recommended that some of the clients buy shares of the funds through the use of margin loans, increasing their risk, he said.
The funds were not registered securities, Vicente said. The 1940 Investment Company Act did not cover securities from the United States territories. If companies based in Puerto Rico issue the securities to Puerto Rico residents, the securities don't need to be registered with the Securities and Exchange Commission.
UBS has been valuing the funds above true market valuations in monthly statements provided to investors, Vicente said.
The funds themselves are leveraged, Vicente said. Many investors were encouraged to buy using their own leverage.
With market prices of Puerto Rico bonds having declined on the secondary market in the last few months, call provisions of some of the closed-ended funds have kicked in for some investors with leveraged positions, Vicente said. Investors have been asked to pony up additional money.
Many of Vicente & Cuebas' clients in this case are retired and have been "essentially wiped out," Vicente said. The clients with the most money invested in the funds each had $15 million, $7 million, or $6 million in their accounts.
The closed-ended funds are not liquid right now, Vicente said, so clients cannot get out of their positions.
In the 2012 case, the SEC censured UBS Puerto Rico over similar violations and ordered the firm to comply by retaining an independent consultant.
"We will aggressively prosecute firms that use conflicts of interest for their own financial gain," Eric Bustillo, director of SEC's Miami Regional Office, said at the time.
Vicente said while he knew of the SEC action, he had not heard of an independent consultant having being appointed to keep an eye on UBS Puerto Rico.
After the May 2012 settlement with the SEC, UBS Puerto Rico has had an independent consultant, Byrne said. UBS has cooperated with the consultant and is implementing his or her recommendations, Byrne said.
In the 2012 case, the SEC made accusations of wrongdoing against two executives as well as UBS Puerto Rico. The executives contested the SEC charges and this case is still continuing.
Regarding Vicente's claim that his clients were not advised of the risks of investing in the funds, Byrne said every quarter the firm sent investors a statement of what was in the funds and which specified the leverage and liquidity risks in the fund.
From 2012 to the present the UBS Puerto Rico office hosted about 10 seminars in its office that at least partly covered closed ended funds and the muni market, she said. Attendance at these seminars would have provided an additional opportunity for participants in the closed ended funds to understand the risks, she said.
In an unrelated development, in the past week or two UBS started to require its advisors to attest that clients who wanted to buy Puerto Rico muni bonds were appraised of the risks, UBS spokeswomen said. The Wall Street Journal has reported that other financial firms have also taken steps over the last several months to provide additional warnings to clients interested in buying these munis.