Sunday, August 18, 2019

Bond insurer MBIA sues Wall Street banks for ‘misconduct’ as Puerto Rico debt underwriters

By on August 8, 2019

(By Roberto Júnior)

Among those sued are UBS, Citigroup, Goldman Sachs, J.P. Morgan, Morgan Stanley, Merrill Lynch and Santander 

SAN JUAN – National Public Finance Guarantee Corp. and MBIA Insurance Corp. filed suit in the Court of First Instance, Superior Court of San Juan, Puerto Rico, against eight Wall Street banks, seeking to hold them accountable for what the bond insurers called “inequitable conduct” in Puerto Rico’s municipal bond market that contributed to the island’s “economic collapse.”

The insurers said they have been presented with, “and fully honored, over a billion dollars in claims after the municipal debt underwritten by the banks became unsustainable on their terms for the Commonwealth and its agencies and they defaulted on their obligations.” 

The lawsuit names as defendants UBS Financial Services Inc.; UBS Securities LLC; Citigroup Global Markets Inc.; Goldman Sachs & Co. LLC; J.P. Morgan Securities LLC; Morgan Stanley & Co. LLC; Merrill Lynch, Pierce, Fenner & Smith Inc.; RBC Capital Markets LLC; and Santander Securities LLC.

MBIA and National argue that the banks underwrote bonds issued by the island government, the Puerto Rico Electric Power Authority, the Puerto Rico Highways and Transportation Authority, and the Puerto Rico Sales Tax Financing Corp. The complaint alleges that, for more than a decade, the banks “urged Puerto Rico and its agencies to issue massive amounts of this debt, allowing the banks to profit from underwriting and selling the bonds, as well as from related interest rate swap, refinancing and other transactions. In their capacity as underwriters, the banks had a fundamental ‘gatekeeper’ responsibility that assured the markets that these municipal bonds could be repaid,” a release issued Thursday reads. 

However, the insurer’s added, “as shown by a Special Investigation Report prepared for Puerto Rico’s Financial Oversight and Management Board, the banks did not conduct appropriate due diligence, resulting in key disclosures being materially false or misleading. These diligence failures concealed essential facts that would have demonstrated that the debt was not sustainable and could not be repaid in accordance with its terms.” 

The plaintiffs stressed that the debt “forced the Commonwealth from the municipal markets, leaving it and its public institutions—like power utilities, hospitals, schools, and essential infrastructure on which millions of Puerto Ricans rely—in financial distress,” adding that bond insurers “have paid billions of dollars in claims payments,” while uninsured municipal bond investors, “including many Puerto Ricans, have suffered” substatntial losses. 

The complaint is based upon two equitable doctrines of Puerto Rican law—”doctrina de actos propios,” or unilateral acts, and “declaración unilateral de la voluntad,” or unilateral declaration of will. 

“Defendants through their acts assured National that they were conducting reasonable investigations regarding the terms of the bonds that National insured, and National relied on those acts in issuing its insurance. But Defendants frustrated National’s legitimate, good faith expectations by choosing not to conduct those investigations and utterly failing to ensure that they had confirmed the truthfulness and completeness of the integral materials in the insurance applications….These extraordinary circumstances warrant application of ‘doctrina de actos propios’ and/or the unilateral declaration of will,” Federico Hernández Denton, former Puerto Rico chief justice and counsel for National, said about the complaint’s allegation.  

As the bonds defaulted, National “has paid every cent of every claim on its policies— over a billion dollars—to cover the losses of insured investors,” the insurer said. 

“Just like the Commonwealth, and the people of Puerto Rico, National was misled by the underwriters of the Commonwealth’s bonds,” said Bill Fallon, CEO of MBIA Inc., the parent company of the plaintiffs. 

National “insured its first Puerto Rico government bond more than 30 years ago and to date has insured more than $15.7 billion of debt for Puerto Rico issuers,” Fallon added. “Our insurance has helped Puerto Rico raise the money to build schools and hospitals and other vital public services. We’re proud of that. The future of Puerto Rico and the integrity and transparency of the capital markets demand that the underwriters be held accountable.” 

Philippe Selendy, a founding partner of Selendy & Gay and former lead counsel for the Federal Housing Finance Agency in its RMBS litigations, is National’s counsel. 

Access the translated complaint here