Thanks to OppenheimerFunds, Puerto Rico Municipal Bond Funds Continue to Cause Serious Investor Losses

            Recently, this blog reported on investigations into UBS’ sales practices concerning $10 billion worth of bond funds concentrated on Puerto Rico municipal debt.  Puerto Rico has been hit hard by serious economic problems, including slow economic growth as well as the unsustainable growth in its public pension obligations.  Any bond fund with sizeable holdings in the Puerto Rico municipal bonds can expect significant losses, as the S&O Municipal Bond Puerto Rico Index was down 21% year-to-date through October 10, 2013.

           OppenheimerFunds are the most recent example of municipal bond funds suffering large declines in NAV because of large bets on the same Puerto Rico municipal bonds that have afflicted UBS investors.  As reported by InvestmentNews, the Oppenheimer Rochester Virginia Municipal Bond Fund (ORVAX) held 33% of its assets in Puerto Rican debt as of the end of August 2013, which resulted in a decline in the fund’s value of 15% this year, nearly three times the average single-state municipal bond fund decline over the same time period. 

           While the Oppenheimer Virginia Fund had the largest holdings of Puerto Rico debt, several other Oppenheimer single-state municipal bond funds, including Oppenheimer Rochester North Carolina, Arizona, Massachusetts and Maryland funds, all hold more than one quarter of their assets in Puerto Rico bonds.  As a result, each of these bond funds is down more than 11%.

A Morningstar analyst quoted by InvestmentNews described Puerto Rico as “a risky credit. . .Taking on a lot of Puerto Rican bonds essentially turns a fund into a high-yield state municipal bond fund.  Investors need to be aware of that.” 

The problems with the various OppenheimerFunds harken back to 2008, when Oppenheimer Core Bond Fund plummeted 35% due to its concentration in mortgage-backed debt and which led to charges filed by the Securities and Exchange Commission. 

Warning to Advisers and Brokers: The SEC Is Putting You Under a Microscope

            Investment advisers and brokers can expect greater scrutiny for small infractions, according to interpretations of a speech recently given by the Chairwoman of the Securities and Exchange Commission.  During a keynote speech before the Securities Enforcement Forum 2013, Mary Jo White said, “retail investors, in particular, need to be protected from unscrupulous advisers and brokers, whatever their size and the size of the violation that victimizes the investor.”  Securities insiders believe this comment signals a new focus by the SEC on minor transgressions by advisers and brokers that may portend more serious violations.

            An article appearing in the publication InvestmentNews quotes several securities industry participants who believe this reflects a new direction for the agency and a commitment to enforcement in the realm of asset management.  Small violations for advisers may result in further investigation for the existence of more significant problems, such as misleading descriptions of investment performance and philosophy, improper fee disclosures and inaccurate registration information.  As for brokers, identification of minor violations may spur an examination looking for net-capital violations or selling away.  According to former SEC litigation attorneys quoted in the article, advisers and brokers should now consider a deficiency letter as a possible blueprint for follow-up actions by enforcement. 

One former enforcement official expressed his belief that a failure to follow appropriate supervisory and suitability procedures may lead to SEC enforcement action.  Another predicts that the agency’s enforcement staff will begin initiating cases against advisers and brokers that were previously handled as regulatory matters.  Overall, the SEC appears to be continuing its efforts to develop new responses to often undetected frauds that continue to threaten the financial security of retail investors.

The United States Supreme Court to Decide Whether Victims of Ponzi Schemes Can Bring State-Law Class Actions Against Defendants Who Aid and Abet Fraud

            An important decision on the ability of Ponzi scheme victims to use class action lawsuits to recoup their losses is expected from the U.S. Supreme Court.  At the opening of the current term, the Court heard oral argument in the case Proskauer Rose, LLP v. Troice, a consolidated appeal of a decision by the U.S. Court of Appeals for the Fifth Circuit involving claims by victims of the infamous multi-billion dollar Ponzi scheme perpetrated by Allen Stanford. 

In the Proskauer cases, the plaintiffs filed class action lawsuits in Louisiana state court against various defendants, including brokerage firms, insurance companies and law firms, for their alleged role in Stanford’s massive Ponzi scheme.  At the heart of his fraud, Stanford arranged for affiliates to sell certificates of deposit issued by the Stanford International Bank that were represented to pay above-market returns and which were falsely characterized as being backed by safe, liquid investments.  According to an earlier lawsuit filed by the SEC against Stanford, “[f]or almost 15 years, SIB represented that it consistently earned high returns on its investment of CD sales proceeds. . .In fact, however, SIB had to use new CD sales proceeds to make interest and redemption payments on pre-existing CDs, because it did not have sufficient assets, reserves and investments to cover its liabilities.” 

The investors’ lawsuits against the defendants alleged that, by their actions, the brokerage firm, insurers and law firms aided and abetting Stanford’s Ponzi scheme and misrepresented the validity of the CDs.  The lawsuits were filed in state court and alleged state-based claims, and the defendants removed the cases to U.S. District Court on the basis of the Securities Litigation Uniform Standards Act (“SLUSA”). 

            SLUSA was enacted in the wake of the Private Securities Litigation Reform Act (“PSLRA”), which Congress passed in response to the purported “rampant nuisance filings [of securities litigation], targeting deep-pocket defendants [and] vexatious discovery requests.”  The PSLRA restricted recoverable damages and attorneys’ fees and, importantly, imposed strict pleading requirements on class action securities lawsuits.  In order to avoid the PSLRA’s challenges, plaintiffs began filing securities class action lawsuits in state courts, alleging only state-based causes of action.  Congress responded to these efforts “to frustrate the objectives of the PSLRA” by enacting SLUSA, which provides for removal and dismissal of a state-based class action lawsuit that alleges a misrepresentation or omission of material fact “in connection with” the purchase or sale of a covered security. 

            At issue before the Supreme Court in Proskauer is the proper test to be used to determine the “in connection with” requirement of SLUSA where the CDs, which were admittedly not covered securities, were represented to be backed by fictitious securities.  The Fifth Circuit identified the proper test from the defendant-oriented perspective, and held that “fraud is ‘in connection with’ the purchase or sale of securities if there is a relationship in which the fraud and the stock sale coincide or are more than tangentially related.”  The court determined that “the heart, crux and gravamen” of the scheme was the representation that the CDs were a “safe and secure” investment because of its backing by other securities.  The court held that the representations about the purchase or sale of securities were only tangentially related to the fraudulent scheme, and thus were not “in connection with” such transactions.  As such, the Fifth Circuit concluded that SLUSA did not apply, and the cases should be remanded to the state court. 

            The U.S. Supreme Court’s anticipated decision has the potential to broadly affect the ability of Ponzi scheme victims to recoup their losses.  Typically, the individuals who perpetrate the fraudulent schemes have wasted the money entrusted to them, and the investors’ best chance to recover their losses is by establishing the liability of others who aided and abetted the fraud, or otherwise made the scheme possible in violation of state-law duties.  Victims of recent Ponzi schemes, including one that lead to the collapse of Peregrine Financial Group and another perpetrated by Scott Rothstein in Miami, may be directly impacted by the Court’s decision.  If the Supreme Court reverses the Fifth Circuit opinion, it will expand the reach of “in connection with” to imaginary securities with the effect of radically curbing investors’ ability to recover damages for losses suffered in Ponzi schemes.

U.S. Regulators Continue to Expand Actions Against Aiders and Abettors of Large-Scale Fraud

            Last month we wrote about the Commodity Futures Trading Commission’s unprecedented lawsuit against U.S. Bank for aiding and abetting the $1.2 billion fraud perpetrated by Russell Wasendorf, Sr., that resulted in the collapse of Peregrine Financial Group.  It was an opening salvo by a major U.S. regulator against a firm that did not fall within the traditional umbrella of the CFTC’s jurisdiction.

Adopting a similarly aggressive enforcement strategy, the Securities and Exchange Commission has charged TD Bank with violating several sections of the Securities Act for assisting the convicted Florida attorney, Scott Rothstein, in perpetrating a massive Ponzi scheme.  Rothstein’s scheme is now infamous.  Between 2005 and 2009, he used his South Florida-based law firm, Rothstein, Rosenfeldt and Adler, P.A., to sell non-existent discounted settlements to unsuspecting investors.  In particular, he claimed to represent plaintiffs who had reached confidential settlements that would be paid out in periodic distributions over an extended period of time.  He told investments that his purported clients wanted lump sum payments and were willing to sell their settlements at a discounted rate.  The settlements did not exist, and Rothstein’s investors lost enormous sums of money.

In furtherance of his scheme, Rothstein maintained several trust accounts at TD Bank, where the settlement proceeds were purportedly held.  A Regional Vice President of the bank falsely represented to investors that TD Bank restricted the movement of the settlement funds in those accounts for the exclusive benefit of the investors.  He also issued false “lock letters” stating that the accounts were irrevocably restricted so that the bank would distribute the funds only to specific bank accounts belonging to the investors.  Additionally, the bank also falsely assured investors that the trust accounts did maintained the account balances that Rothstein said they did.

Rothstein has been punished for perpetrated his vast Ponzi scheme.  He was disbarred by the Florida Supreme Court and convicted by the U.S. District Court and sentenced to 50 years in prison.  Federal regulators also sprang into action.  In 2012, the SEC initiated an enforcement action against two individuals who directed the largest number of investors to Rothstein.  Moreover, the Financial Crimes Enforcement Network (FinCen), an arm of the U.S. Department of Treasury, is the administrator of the Bank Secrecy Act that has the authority to assess civil monetary penalties against domestic financial institution.  FinCen hit TD Bank with a $37.5 million fine for the BSA failures that contributed to Rothstein’s fraud.

In an unusual move, the SEC, which does not regulate national banks, nonetheless has brought an enforcement action against TD Bank for violating various sections of the Securities Act in connection with its role in the Rothstein fraud.  For example, the SEC charged TD Bank with violating Section 17(a)(2) of the Act, which prohibits any person, in the offer or sale of any security, from obtaining money or property by means of any untrue statement or omission of material fact.  The agency also charged the bank with violating Section 17(a)(3), which prohibits any person, in the offer and sale of any security, from engaging in any transaction, practice or course of business that operates as a fraud or deceit upon the purchaser.

TD Bank chose not to fight the SEC’s charges.  Rather, it entered into a settlement with the Commission that agreed to entry of a cease-and-desist order and a civil monetary penalty of $15 million, in addition to the separately assessed FinCen penalty.  Additionally, TD Bank had to agree that, with regard to any lawsuit against it by a victim of Rothstein’s fraud, the bank would not argue for or benefit from any offset or reduction of any award of compensatory damages as a consequence of its payment of the civil penalty to the SEC.

While the SEC’s action stands alone as an important enforcement matter, it portends a welcome and broader effort by U.S. Regulators to aggressively pursue all those who are responsible for the mushrooming number of massive schemes to defraud that are devastating untold numbers of investors.

Block & Landsman Investigating Claims Regarding UBS Puerto Rico Municipal Bond Funds

            The law firm of Block & Landsman is investigating claims on behalf of investors in closed-end Puerto Rico municipal bond funds that were created by the brokerage giant UBS Financial Services.

            The closed-end funds, which are heavily invested in the Puerto Rico municipal debt, have seen rapid declines in value over the past several weeks.  The losses were compounded for unsuspecting investors who purchased the municipal bonds in margin accounts and who had highly concentrated positions in these bond funds.  As a result, these investors had to meet large margin calls as the value of the bonds decreased.

            UBS came under scrutiny of the SEC last year for the sale of these bond funds.  On May 1, 2012, the SEC accepted an Offer of Settlement from the firm that resulted in a cease-and-desist order and remedial sanctions.  According to the SEC Order, UBS personnel made misrepresentations and omissions of material facts to retail customers regarding the market liquidity and pricing of the closed-end funds.  For example, while investor demand was significantly declining relative to supply, UBS did not disclose that was purchasing millions of dollars worth of the shares for its own inventory while promoting the appearance of a liquid market with stable prices.  Subsequently, the firm determined that its growing inventory of the funds presented a financial risk, and it executed a plan to offer the funds for sale at prices that undercut pending customer sell orders. 

            Recent articles report the struggles affecting the bonds, including a weak Puerto Rican economy, rising interest rates and unsustainable debt including huge pension obligations.  The ongoing declines in the funds means that UBS customers who were encouraged to use margin to purchase concentrated amounts of the highly leveraged closed-end funds should consider pursuing arbitration claims before the Financial Industry Regulatory Authority to recoup their losses.

            Investigations are ongoing in several of the bonds, including:  Tax-Free Puerto Rico Fund, Tax-Free Puerto Rico Fund II, Tax-Free Puerto Rico Target Maturity Fund, Puerto Rico AAA Portfolio Target Maturity Fund, Inc., Puerto Rico AAA Portfolio Bond Fund, Puerto Rico AAA Portfolio Bond Fund II, Puerto Rico GNMA & U.S. Government Target Maturity Fund, Puerto Rico Mortgage-Backed & U.S. Government Securities Fund, Puerto Rico Fixed Income Fund, Puerto Rico Fixed Income Fund II, Puerto Rico Fixed Income Fund III, Puerto Rico Fixed Income Fund IV, Puerto Rico Fixed Income Fund V, Puerto Rico Fixed Income Fund VI, Puerto Rico Short Term Investment Fund, Multi-Select Securities Puerto Rico Fund, UBS IRA Select Growth & Income Puerto Rico Fund, Puerto Rico Investors Family of Funds, Puerto Rico Investors Tax-Free Fund, Puerto Rico Investors Tax-Free Fund II, Puerto Rico Investors Tax-Free Fund III, Puerto Rico Investors Tax-Free Fund IV, Puerto Rico Investors Tax-Free Fund V, Puerto Rico Investors Tax-Free Fund VI, Puerto Rico Tax-Free Target Maturity Fund, Puerto Rico Tax-Free Target Maturity Fund II, Inc., Puerto Rico Investors Bond Fund I.

            Investors who have suffered losses due to investments in Puerto Rico municipal bond funds should contact the securities attorneys at Block & Landsman for a confidential and free consultation.