Congress Ends Puerto Rican Banking Loophole

May 23, 2018
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Congress voted yesterday to require banks selling mutual funds in Puerto Rico to comply with key investor protections afforded to Americans on the mainland, doing away with a 78-year-old loophole that helped embroil the island in its current debt crisis.

The new rule, which is awaiting a signature from the president, requires that banks doing business in Puerto Rico comply with the Investment Companies Act of 1940, the central law that bars financial firms from double dipping on transactions and creating certain kinds of risky deals for ordinary investors.

Until now, deals in Puerto Rico, and other U.S. territories, were exempt from these kinds of protections. The result? They “created a lot of damage,” said Sergio Marxuach, policy director at the independent Center for a New Economy in San Juan. Marxuach said such deals were “one of the contributing factors to the debt crisis in Puerto Rico.” As FRONTLINE and NPR reported in the film Blackout in Puerto Rico, banks like UBS were able to underwrite billions of dollars of Puerto Rican bonds and package them into special bond funds sold to Puerto Ricans that were riskier than what was allowed on the mainland. These funds ultimately led to billions in losses for people on the island.

In the past, banks were “able to force-feed these deals to their own captive clients,” Marxuach said. “Now, they have to make sure there is real demand for these deals.”

The provision was tucked into broader legislation that rolled back key banking regulations passed in the Dodd-Frank bill after the 2008 financial crisis. The banking bill passed the Senate in March and was approved Tuesday in the House.

Ironically, the provision’s biggest champion, Rep. Nydia Velazquez, who first introduced the amendment in 2015, voted against this bill because of her opposition to the broader rollbacks of Dodd-Frank.

“On balance, these are poor choices that, in my view, heighten the risk of improper financial activities similar to those that precipitated 2008 financial crisis,” Velasquez said in statement on the broader banking bill.

But she called it “silver lining” that the provision she authored to protect Puerto Ricans was included. “I am heartened, at least, that by passing my legislation, as part of this larger package, we will no longer hear of the people of Puerto Rico being swindled out of their nest egg due to an antiquated loophole in federal investment law,” she said in the statement.

The bill gives financial firms three years to comply and allows them to petition the Securities and Exchange Commission for another three years if they can’t meet the time frame.

Ultimately, the bill doesn’t help investors recoup losses or change the precarious economic situation in Puerto Rico today, where it is in the middle of a bankruptcy proceeding. The island is in more than $72 billion in bond debt and even the government’s basic financial decisions must be approved by an unelected fiscal oversight board.

“It doesn’t fix what happened, but hopefully going forward we can avoid this story from repeating itself,” Marxuach said. “We can hopefully protect investors that live in Puerto Rico from being subject to these tactics.”

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