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Lawmaker calls for House hearing on UBS bonds sold in Puerto Rico, following CNBC investigation

  • A senior member of the House Financial Services Committee is calling for a congressional hearing following a CNBC investigation.
  • The investigation found that UBS was not forthcoming about the risks associated with its proprietary bond funds sold to residents in Puerto Rico.
  • "The reported claims... are egregious, unethical, and potentially illegal," Nydia Velázquez (D-N.Y.) wrote in a letter Thursday to Rep. Jeb Hensarling (R-Texas).

A senior member of the House Financial Services Committee is calling for a congressional hearing, following a CNBC investigation that found UBS was not forthcoming about the risks associated with its proprietary bond funds sold to residents on the island.

Rep. Nydia Velázquez (D-N.Y.) wrote a letter on Thursday to Rep. Jeb Hensarling (R-Texas), the chairman of the committee, urging him to convene a hearing to investigate the marketing and sales practices of investment companies operating in Puerto Rico.

"The reported claims of deception, mismanagement, and coercion highlighted in the CNBC article, if true, are egregious, unethical, and potentially illegal," said Velázquez in the letter. "All Americans deserve honesty, integrity, and trust when it comes to investing in our capital markets -- they are the fundamental truths that our free-enterprise system is based upon."

"A culture of deception and deceit erodes that trust and could lead investors to lose faith in our institutions and markets," she wrote.

Read Velázquez's full letter below:

CNBC obtained 2,000 pages of documents, which detailed the dialogue among executives at UBS related to the firm's proprietary bond funds, which were majority comprised of Puerto Rico debt. The funds, which were not traded on a public exchange, collapsed four years ago, causing thousands of residents on the island to lose their savings. CNBC's investigation, "Broken Bonds," was published Monday.

Due to a loophole in a 77-year-old piece of U.S. legislation, none of the funds was regulated by the Securities and Exchange Commission. The Investment Company Act of 1940 allowed funds offered outside of the mainland — in this case, the U.S. territory of Puerto Rico — to avoid restrictions, such as leverage standards and certain affiliated party transactions.

Velázquez sponsored a bill that is seeking to close that loophole: The "U.S. Territories Investor Protection Act of 2017" was passed in the House earlier this year and is still awaiting a vote in the Senate.

She has said that if Puerto Rico had the same regulatory oversight as the mainland had, much of the residents' losses from the bond funds may have been prevented. The legislation would amend the Investment Company Act of 1940 to repeal the exemption to ensure that financial institutions that operate in Puerto Rico, the U.S. Virgin Islands and elsewhere operate under the same rules as their stateside counterparts.

When Congress first enacted the Investment Company Act of 1940, it was deemed too expensive for regulators with the SEC to travel to U.S. territories — which then also included Alaska and Hawaii, in addition to Puerto Rico and the U.S. Virgin Islands. Since then, both Alaska and Hawaii have become states, air travel to and from Puerto Rico has become less expensive, and a large portion of financial activity takes place electronically. Therefore, it would be far easier to patrol financial activities in U.S. territories than it was 77 years ago, Velázquez has argued.

This is Velázquez's third attempt at proposing a bill that would close this loophole. Her first effort was in 2015, after she first heard about the substantial losses residents had on the island.

That version would have closed the loophole immediately.

She tried again in 2016 with an updated version of the bill that included a three-year safe harbor period, with the option for the SEC to grant an additional three-years if warranted. The bill was later approved with bipartisan backing in the House, sending it to the Senate where the bill stalled, unable to get approval before the end of the 114th Congress.

"Lobbyists retained by UBS Puerto Rico have tried relentlessly to gut the bill or block it," a Velázquez spokesman said. "What they call modifications would actually prevent the bill from safeguarding Puerto Rico's most vulnerable investors. One need only follow the money and they can draw their own conclusions."

Rep. Nydia Velázquez, D-N.Y.
Manuel Balce Ceneta | AP
Rep. Nydia Velázquez, D-N.Y.

Velázquez said that an anonymous senator put a hold on the bill at the end of that year. So she reintroduced her bill on March 6 of this year with eight bipartisan co-sponsors, including Rep. Sean Duffy (R-Wis.), Rep. Jose Serrano (D-N.Y.), and the sole congressional representative for Puerto Rico, Rep. Jenniffer González-Colón, a Republican.

González-Colón spoke about the bill over the spring on the House floor, saying that "investors residing in Puerto Rico and other territories have experienced investment losses, some of which likely would have been prohibited had the 1940 Act applied to the territories."

González-Colón notes that UBS was able to serve as an adviser to the Puerto Rico's pension agency, the Employee Retirement System (ERS) and then, in 2008, also led the underwriting of $2.9 billion bond issuances for ERS. UBS Puerto Rico then sold approximately $1.7 billion of those bonds directly into funds managed or co-managed by the firm and sold exclusively to customers on the island. ERS's bonds are currently undergoing bankruptcy-like proceedings.

Publicly filed documents reveal substantial lobbying efforts related to the Investment Company Act of 1940. Luis Fortuño, who served as governor of Puerto Rico from 2009 to 2013, was hired as a lobbyist for "advocacy work in relation to proposed amendments to the Investment Company Act of 1940 and related matters," lobbying disclosure documents show.

Fortuño, who is a partner in Steptoe & Johnson's Washington office, along with his colleagues, have been paid $485,000 for lobbying services related to the Investment Company Act of 1940 since being hired in July 2016, according to quarterly disclosure statements.

Lopez Sanchez & Pirillo LLC, a San Juan-based law firm, is listed as the client who hired Steptoe & Johnson in 2016 and 2017.

That same firm has previously represented UBS Puerto Rico in a 2016 lawsuit, a court filing shows. José Sánchez-Castro, a co-founding member of Lopez Sanchez & Pirillo, has represented UBS Financial Services, UBS Puerto Rico Family of Funds, and the Government Development Bank for Puerto Rico under the "representative cases/matters" portion of his bio page on his firm's website.

Neither Sánchez-Castro nor a representative for UBS responded to multiple requests for comment.

"Our client is a group of Funds. UBS Puerto Rico-sponsored funds are members of that group ," Kathy King, a spokesperson for Steptoe & Johnson, said in a statement to CNBC. "Steptoe represents a group of mutual funds that represent more than 95 percent of the mutual funds of Puerto Rico. These funds all have local independent boards of directors with a fiduciary duty to their specific fund's Puerto Rican shareholders."

"We support the bill and want to protect Puerto Rico investors, but the potential consequences of approving the bill without an amendment to the safe harbor provisions could further harm the local Puerto Rican investors that the bill purports to protect," Steptoe & Johnson's King said in the statement. "We have consistently offered to work with Rep. [Velázquez's] staff to assist in the approval of the bill in a way that will not harm the local investors in hopes to protect."

Fortuño also has his own ties to UBS. The firm is listed as Fortuño's third biggest contributor to his campaign to be governor in 2008, according to election-contributions database, OpenSecrets.org. The site notes that for the contributor category, the organizations themselves have not donated, rather the money calculated in the total is from the organizations' PACs, their individual members or employees or owners, and those individuals' immediate families.

Velázquez's bill has passed the House Financial Services Committee by a unanimous 58 to 0 vote and was passed, in a voice vote, by the full House in May. It was received by the Senate the next day.

The Senate read the legislation twice and then referred it to the Committee on Banking, Housing and Urban Affairs on May 3. That was the last public action taken on the bill.

If Rep. Jeb Hensarling does agree to convene a hearing, it would be the first related to the recent issue of financial sales practices in Puerto Rico.

"If enacted, this legislation would provide fundamental protections for the mutual fund investors living in Puerto Rico and the other U.S. territories," Velázquez wrote in the letter. "Such oversight is critically necessary."