Jim Eccleston: UBS Faces Legal Fight Over Puerto Rico Bond Funds | Investors

Posted on October 16th, 2013 at 9:06 AM

From the Desk of Jim Eccleston at Eccleston Law:

            UBS faces arbitration and regulatory exposure connected with its Puerto Rico Bond Funds.

            So far, the focus has been on the Puerto Rican arm of UBS and its 132 financial advisers face a legal fight with investors who purchased proprietary closed-end bond funds heavily invested in Puerto Rican municipal debt and created by a unit of UBS AG.  Specifically, the UBS Puerto Rico family of funds consists of 14 such closed-end funds, sold exclusively through registered representatives and brokers with UBS Financial Services Inc. of Puerto Rico.  According to marketing materials, UBS has sold more than $10 billion of the funds through the end of 2012.

            Moreover, according to a report by the New York Times, UBS has put one broker on administrative leave after claims emerged that the adviser encouraged clients to buy securities on a line of credit.  The eroding municipal bond market has taken a toll on UBS’s proprietary closed-end funds.  For example, at the end of August 2013, the Puerto Rico Fixed Income Fund Inc. reported a net asset value (NAV) of $5.46 per share.  Less than a month later, on September 25, 2013, the fund reported a NAV of $3.74 per share, which is a decline of 31%.

            Like the other series of UBS Puerto Rico funds, the Puerto Rico Fixed Income Fund mandated an allocation of at least 67% of its assets to local securities, which exist in a thinly traded market.  In particular, closed-end municipal bond funds domiciled in the U.S. can only have leverage of up to 30% of the fund’s assets.  Since the UBS Puerto Rico municipal closed-end funds are not domiciled in the U.S. and have different rules regarding debt, the funds can have leverage of up to 50% of total assets, and extra 5% in special circumstances.  Leverage on such investments can magnify losses.

            UBS clients who invested in the closed-end municipal bond funds were heavily invested in these funds, with retirees or near retirees investing as much as 100% of their portfolios in them, along with individual Puerto Rican municipal securities.  Some UBS clients reportedly even borrowed on margin or used credit line to buy individual Puerto Rico bonds and the UBS closed-end funds.

            One general weakness, of many, is the lack of liquidity of these securities.  UBS has been monitoring this situation and continuously provided its clients with research and insights on interest rates risks and municipal bond price fluctuations.  Over a year ago, the SEC flagged UBS Financial Services Inc. of Puerto Rico for sale practices surrounding the municipal securities.  Further, in 2008 and 2009, UBS’s former CEO and its head of capital markets made misrepresentations and omissions of material facts to numerous retail customers in Puerto Rico regarding the secondary market liquidity and pricing of the UBS Puerto Rico non-exchange traded closed-end funds.  UBS ended up paying $26.6 million in fines and restitution to settle the SEC action.

The attorneys of Eccleston Law represent investors and advisers nationwide in securities and employment matters. Our attorneys draw on a combined experience of nearly 50 years in delivering the highest quality legal services.

Related Attorneys: James J. Eccleston


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