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Top Firms Settle with SEC over Puerto Rican Junk Bonds

The U.S. Securities and Exchange Commission announced this week that 13 top financial firms have settled charges against them alleging that they inappropriately sold Puerto Rican junk bonds to retail investors. The firms, including Charles Schwab, JP Morgan, and UBS, have all agreed to pay penalties ranging between $54,000 and $130,000, without admitting any fault.

Allegedly, the firms sold high-risk municipal bonds issued by the Puerto Rican government to retail investors, in violation of a new SEC rule. The Puerto Rican government has been struggling financially as of late with upwards of $70 billion in government debt. This is the first case the SEC has brought under a new rule meant to protect retail investors from being sold very risky municipal bond investments by dealers.

Municipal Bonds

When states, cities, and local governments need to raise money for capital expenditures, they issue municipal bonds, often referred to as a “muni.” Investors are often attracted to munis because the interest income earned on the bond is exempt from federal income taxes, and sometimes even state and local taxes as well. A public that is interested in investing in their community may purchase municipal bonds as a way of supporting their roads, schools, housing development and other public works.

Given the difficult economic times, some state and local governments must issue municipal bonds that are have a higher default risk compared with investment grade municipal bonds. These munis are known as junk bonds. Junk bonds are given a lower credit rating and are considered highly speculative based on the probability of the issuer to default when payment comes due. Still, even with these, an investor may be attracted to junk bonds based on the high coupon, or interest, paid on the bond.

The Minimum Denomination Rule

Municipal bond issuances always include a “minimum denomination,” or the lowest number of the bonds that a dealer firm may sell to a retail investor in one transaction. Municipal junk bonds very often have high minimum denominations in order to ensure that firms only sell these risky bonds to retail investors prepared to bear the high risk involved in investing in the junk bond.

The U.S. Securities and Exchange Commission charged the above-mentioned firms with a violation of Municipal Securities Rulemaking Board (MSRB) Rule G-15(f). MSRB Rule G-15(f) sets the minimum denomination for municipal bond issuances. In the case of Puerto Rico, the government intended to issue $3.5 billion in junk bonds. The minimum denomination for this issuance was set at $100,000 per transaction. The SEC alleges that the dealer firms sold retail investors the junk bonds in amounts below the $100,000 minimum.

With regards to the SEC’s charges against the firms, the Director of the SEC’s Division of Enforcement, Andrew J. Ceresney stated in a press release “these actions demonstrate our commitment to rigorous enforcement of all types of violations in the municipal bond market.” Attorney Gregory Tendrich, P.A. is also committed to helping the victims of financial exploitation or municipal bond fraud. Please contact the Boca Raton offices today to discuss your legal options.

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