When the crisis surrounding the UBS Puerto Rico closed-fund losses was at its peak in 2015, it was hard to predict how the chips would fall. Now that some of the issues are being settled, the picture is getting more clear, and it may make some people unhappy.
Of the $3.4 billion that customers allegedly lost, only a fraction has been paid out. In addition to fines and restitution to the SEC and FINRA, only about $34 million has been repaid.
At the center of the controversy was UBS banker Jose G. Ramirez, whose career ended when the Justice Department, in coordination with the SEC, accused him of intentionally misleading customers about the risks or terms of closed-end bond funds and the illegal use of Regulation U non-purpose UBS Bank loans to purchase securities (primarily high commission proprietary closed-end bond funds).
Ramirez, who served time in federal prison stateside after pleading guilty to one count of bank fraud, received close to $13 million in total compensation from 2011 to 2013. Of that amount, a federal court found that $5.5 million came directly from customer lines of credit which Ramirez used to illegally purchase securities.
But when a succession of rating downgrades struck Puerto Rico in 2013, many of these same customers received maintenance calls of over $37 million as a result of huge market capitalization losses to closed-end funds. Ramirez now suggests it was the financial instability of the Puerto Rican government that was to blame for the downgrades, and that Switzerland-based UBS served him up to the Justice Department to prevent further scrutiny of current practices.
The unique market that created the debacle
The main broker-dealer on the island, UBS Puerto Rico, has offered both open-end and closed-end funds to investors since the mid-1990s. While open-end funds allow investors access to add or withdraw funds without a limit to issued shares, Puerto Rico closed-end investments have liquidity issues and issue a fixed number of shares.
Thanks to a unique loophole in U.S. law, closed-end funds in the U.S. territory are not registered with the SEC, allowing third-party transactions that would not be allowable on the mainland. These highly leveraged and overconcentrated funds ultimately led to the meltdown of Puerto Rican bonds in 2013.
Whether or not what Ramirez claims is true, that he was not the only broker involved in the scandal, it is undeniable that illegal activity has led to financial harm to many investors. When a broker does not warn customers of risks relating to a recommended investment i.e. liquidity risk, concentration risk, risk exacerbated by leverage, conflicts of interests etc., they are violating the obligation they owe to provide recommendations that are in the best interest of the customer and may be liable for losses that result from such investment recommendations.