SEC fines 13 groups over Puerto Rico bonds

The US Securities and Exchange Commission has imposed sanctions on 13 financial institutions over the sale of Puerto Rico junk bonds that violated a rule designed to protect retail investors.

The regulator found firms including Charles Schwab, Interactive Brokers, JPMorgan, Oppenheimer and UBS sold bonds to investors below a $100,000 “minimum denomination” set in a $3.5bn offer of junk-rated Puerto Rico debt earlier this year.

“These firms violated a straightforward investor protection rule that prohibits the sale of muni bonds in increments below a specified minimum,” LeeAnn Gaunt, chief of the SEC’s municipal securities and public pensions unit, said in a statement. “[We] will penalise abuses that threaten retail investors.”

New offerings in the muni bond market include a minimum denomination that establishes the smallest amount of the bonds that a dealer firm is allowed to sell an investor in a single transaction. Municipal bond issuers often set high minimum denomination amounts for junk-rated debt – which carries a higher probability of default.

Because retail investors tend to purchase securities in smaller amounts, this minimum denomination standard helps prevent dealers from selling high-risk securities to those investors.

The SEC investigation found 66 occasions when the firms sold the Puerto Rico bonds in amounts below $100,000. The firms agreed to settle the SEC’s charges without admitting or denying the findings, and will pay penalties ranging from $54,000 to $130,000.

Muni bonds are one of the most popular asset classes in the US, in particular with wealthy individuals and retirees, who benefit from their tax exemptions.

Puerto Rico debt is a mainstay of muni bond portfolios given the island’s triple tax exemption, with over 60 per cent of US municipal mutual funds holding the securities, according to Morningstar.

But the bonds have been under pressure in recent years on concerns over its ability to service its $70bn debt load. The US commonwealth is one of the largest issuers of municipal debt, rivalling big US states such as California and New York.

Puerto Rico’s $3.5bn bond sale in March, attracted strong demand from investors as it offered higher yields compared with those of other municipal and corporate bond issuers with similar ratings.

The fines targeted Charles Schwab, Hapoalim Securities, Interactive Brokers, Investment Professionals, JPMorgan, Lebenthal, National Securities Corporation Oppenheimer, Riedl First Securities, Stifel Nicolaus, TD Ameritrade, UBS and Wedbush Securities.