Proposed claw back of fees for Puerto Rico GOs could backfire

Bonds

Municipal market analysts say that an effort to claw back fees paid for Puerto Rico general obligation bonds would be counterproductive to the commonwealth’s long-term interests.

Twenty-three members of Congress sent a letter Monday to the Puerto Rico Oversight Board urging it to claw back fees paid to underwriters, bond counsel and others involved in Puerto Rico’s general obligation bonds from 2012 to 2014. The Oversight Board argues that the $6 billion of bonds sold then are null regardless because they exceeded the island’s constitutional debt limit.

U.S. Rep. Nydia Velázquez, D-N.Y, wrote a letter calling for the claw back of municipal industry fees for Puerto Rico 2012 and 2014 GOs.

Bloomberg News

Miller Tabak Asset Management Chief Executive Officer Michael Pietronico said that given Puerto Rico’s financial problems the island will likely try to sell more bonds “sooner than later.” “While true Puerto Rico may not end up paying now [for its attempt to vacate bonds and claw back the associated fees] — the markets very well may make them pay later — and it seems unlikely investors will be quick to forgive this attempted sleight of hand.

“Ultimately, it feels as though Puerto Rico is making a big play over smaller stakes than necessary — and could pay later because of it,” Pietronico said.

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The underwriters alone charged $294 million, according to a report from Public Accountability Initiative, cited by the lawmakers.

The letter, dated Monday, was addressed to board Chairman José Carrion III and signed by six senators and 17 representatives. Among the signers are Senate Democratic Minority Leader Charles Schumer, D-N.Y.; Sens. Elizabeth Warren, D-Mass.; Kirsten Gillibrand, D-N.Y;Bernie Saunders, I-Vt.; Reps. José Serrano, D-N.Y.; Raúl Grijalva, D-Ariz.; and Nydia Velázquez, D-N.Y. Four of the signers are members of the U.S. House Natural Resources Committee that oversees Puerto Rico and the board.

“Congress gave the [Oversight Board] special powers to initiate claims that could return fraudulently transferred assets to Puerto Rico’s coffers including taking any action necessary on behalf of the debtor to prosecute the case of the debtor,” the Congressional letter states. “Considering no other entity may currently initiate such claims, the duty of the [board] to do so is paramount.”

The Congressmen and women say that a statute of limitations requires the board to act by May 2 and they ask the board to respond to its letter by April 11.

In response to a question about the letter, a board spokesperson said, “The Special Claims Committee of the Oversight Board is reviewing all potential claims.”

In mid-January the board filed a legal challenge to the validity of three general obligation bonds that Puerto Rico sold in 2012 and 2014. It told the United States District Court for Puerto Rico that the rightful resolution is for Puerto Rico’s government to not pay the bonds.

The lead underwriters of the GO bonds being challenged were UBS, Barclays, JPMorgan, Morgan Stanley, and RBC Capital Markets. Morgan Stanley and Barclays declined to comment for this story. The others didn’t respond to a request for comment.

Greenberg Traurig served as bond counsel for the bonds. O’Neill & Borges served as underwriter’s counsel. Neither firm responded to a request for comment.

O’Neill & Borges is a local legal advisor to the Puerto Rico Oversight Board.

“It’s similar, in a way, to how Orange County [California]’s swap counterparty wound up paying the county for getting it entangled in derivatives not allowed by the county’s investment policy,” said Matt Fabian, partner at Municipal Market Analytics. “But I haven’t heard of an issuer going after banking fees before in this way. You’d have to assume this will make it harder for the commonwealth to sign an underwriter in the future.”

Pietronico said, “It’s likely that underwriters will claim that the issuer (Puerto Rico) made false representations to them regarding the constitutional debt limit. We believe this scenario does not provide appropriate incentive for Puerto Rico to file an objection. The risk/reward ratio is far too high, given the relatively low stakes and the reputational costs.”

Triet Nguyen, managing partner at Axios Advisors, said, “Any effort to claw back fees, assuming there is any legal basis for it, should come after a formal invalidation of the 2012-2014 bond issues by the courts, not before. We believe the very process of trying to invalidate the GO issues would set a very bad precedent in the municipal market. Bondholders need to have confidence that the legal and constitutional representations made by [any] administration will not be used as a cover for actual unwillingness to pay by subsequent administrations.”

George Friedlander, Court Street Group Research Managing Partner, addressed the morality of the Congress members’ proposal. Friedlander rejected that the bonds were invalidly issued. Assuming that they were invalid, another issue the letter raises is whether that means the underwriting fees and other professional fees should be clawed back.

“The other issue seems more open, but still doesn’t seem well resolved by requiring repayment of underwriting fees: did the underwriters properly do their due diligence on late-stage Puerto Rico debt before offering it for sale to the public?” Friedlander asked.

“Even in this case, the harmed party if the due diligence were inadequate would seem to be investors, not the issuer,” Friedlander continued. For the issuer to claim that they had no obligation to assure the validity and viability of their own debt before it is offered for sale seems wrong. If that is the case, why would the underwriters have any obligation to unwind their underwriting fees?”

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