Por Gerardo Carlo Altieri*
Puerto Rico has been hit this past week with four apocalyptic events. First, the US Supreme Court decided that the island is not a separate and true sovereign for purposes of the double jeopardy clause; second, the same court decided that the local government cannot pass its own bankruptcy law to restructure its debt; third, the House of Representatives approved an oversight committee (Bill 5278 PROMESA) that basically takes over the budget and spending process of the insular government; and finally, a “Puerto Rico Commission for the Audit of Public Credit” published a “Pre-audit Survey Report” concluding that the two last government debt offerings (2014 and 2015) may be illegal.
The two Supreme Court decisions entered against the local government’s position this week, follow a pattern known as “kicking the can” down the road. Whenever a Puerto Rico status related question is raised the Court almost automatically places the Puerto Rico issue flat on the lap of Congress. The inhibition of one justice and the unfortunate and premature death of J. Scalia has not changed a pattern of geographic discrimination by the highest court.
The third event relates to the approval of a congressional bill creating a control board in an attempt to discipline the spending habits of the local politico-elites. This is a subject that requires more discussion. Suffice is to say that no one seems completely happy with the undemocratic tones and the awkward regulatory design of the bill.
The fourth dramatic event to hit the island this week, the so called comprehensive “Audit Survey Report”, is quite controversial since it uncovers highly sensitive local dirt. It appears that many of the 17 full committee members did not participate in its approval, maybe because some of the members actually signed-off on the laws authorizing these two bond offerings. This subcommittee is passing judgment and auditing the two bond sales recently fathered by the principal members of the Committee itself.
Surprisingly, no one in the Executive branch nor the GDB has championed this committee. In fact, the committee has done this initial demolition job with very little funding and using mostly volunteers. Members of the local government have distanced themselves from the forensic audit approach initiated by the audit sub-committee for the resolution of the PR debt crisis. Instead they remain silenced or repeat the official dogma, that the proper method to solve the crisis is by voluntary negotiations and creditor “haircuts” to reduce principal and interest on the total public debt in order to attain “sustainable” levels. The governor and his chief advisors have already said they have no reason to believe that any part of the debt was entered into in violation of the Constitution.
One has to admit that the Committee is dealing here in obscure and somewhat subjective fields of forensic public accounting, lenders liability, public bankruptcy policy, highly complex securities regulations and even fraud. However, the subcommittee jumps into the fray unabashedly and with gusto, actually mentioning specific advisors and names of the law firms that issued the opinions. Also implicated are the specific investment firms and banks that sold or managed the securities and even insurers.
The Survey Report indicates that these parties may have direct responsibility for the illegal issuance of the debt. The theory of liability is based on the fact that these two bond offerings have been done in violation of the local Constitution and of Securities and Exchange anti-fraud rules. The Report names the lawyers issuing the opinions, investment houses, banks and advisors which should be held responsible. The Report also questions relations between government, GDB, private banks (including Banco Popular), at least four law firms, financial houses and advisers, all getting paid up front in part from the offering proceeds.
The subcommittee points at the list of private advisors with hopefully deep pockets, but it carefully sidesteps the responsibility issues of local and federal entities, agency boards and government officers in the sale of these debt instruments supposedly issued in violation of the Constitution. They mention violations of the 15% constitutional debt limits, the balanced budget requirements, the limitations on debt terms and even violation of Securities Exchange Rule 15c-2-12 (disclosure requirements and required financial statements). The question of unproductive debt, misuse of receipts to fund operational deficits and the “scoop and toss” practices involved in one of the offerings since 1987, is also discussed.
The Report admits that a great deal of legal research and work has to be completed before they can conclude that any debt may be nullified due to violation of constitutional provisions. The cases cited from other jurisdictions in the Report don’t really shed direct light on the subject and probably weaken the seriousness of the matter. The discussion of the Detroit bankruptcy as an example in nullifying the local bond obligations is not decisive and does not set a precedent that can be followed.
Furthermore, comments made this week by local Representative Manuel Natal, one of the principal architects of the law creating the audit committee, explain the limitations this audit board will have. Aside from the fact that it is over-extended, unfunded, and taking-on a full audit review of no less than forty years of bond offerings, the committee is composed mostly of government employees and top politicians who are not considered neutral or objective.
Many of them directly participated in the legislative proceedings related to the offerings and have their own agendas. Unfortunately, the conflictive composition of the audit committee itself weakens the importance of its work and conclusions, which could be subject to suspicion and distrust.
The committee’s operations could also clash or be preempted by congressional Bill 5278 presented in the US Senate this week. This provision, if it becomes law, seems to avoid the territorial debt-audit alternative completely, even though last minute amendments have been introduced to save the possibility of a local debt audit. Also, Natal mentions that the committee cannot “adjudicate” responsibility, has no power to enforce its findings and lacks any mechanism to remedy violations it may find in the forty year plus audit saga.
This legislator rightly describes the role of the audit committee as one limited to making recommendations, which can only be resolved by other “authorities” or the judicial branch. Unfortunately, the local judiciary is not known for expertize in resolving complicated government insolvency, public debt forensic audits, securities fraud or third party recovery matters.
What needs to be discussed is whether a full forty-year forensic audit is the solution needed and which federal or local agency or group should carry this out. The creation of the local audit committee was seen by the present government as another “tool” to force creditors to the negotiation table, in tandem with the defunct creole bankruptcy act, but was probably never intended to be fully carried out. Everyone was surprised by the forceful and ambitious pre-audit survey that this group of unfunded and supposedly disorganized “volunteers” has produced. Moreover, they announce in this Report that they intend to carry out a full forty-year audit of bond issues based on a historical review of all past loan documents and creditor practices.
However, the real key to the resolution of the local over-indebtedness crisis, is not who can we find to blame for the mess, but rather: 1) what amount of debt restructuring or haircut of principal and interest is needed, and 2) what mechanisms do we have or can we create to achieve these goals. There is no doubt that an audit of past loans can help clarify the issues and pinpoint institutions or individuals responsible and even liable for unauthorized or illegal acts. But a non-judicial ad-hoc committee like the one here formed cannot take the necessary steps to establish legal responsibility and claim reparations from government or non-government third party entities that participated and profited from these bond offerings.
In this regard, the standard remedies for financial and sovereign debt resolution traditionally separated the tools needed in emerging markets from those used in advanced economies. A recent study by the IMF on sovereign debt crisis and the lessons learned in the past (Reinhart , Carmen M., Rogoff, Kenneth S., “Financial and Sovereign debt Crisis: Some lessons Learned and those Forgotten”, IMF Working Paper, December 2013, WP/13/266) concludes, that the traditional remedies for achieving debt sustainability and debt resolution in developing economies, that is the use of debt restructurings and conversions, capital controls and other forms of financial repression, are also useful in developed economies.
The notion that you could turn around a high income country in trouble by just austerity measures, mild forbearance of debt and resulting growth, has been shown to be historically incorrect by this recent IMF study. The study indicates that only through real debt restructuring, capital controls, significant financial repression and higher inflation, have developed economies been able to turn the tide around.
Puerto Rico does not have a “developed economy”, and up to now has been dependent on the US credit markets and federal transfers, but its economic crisis is not exempted from this rule. It has struggled with economic stagnation for more that 12 years, and requires deep restructuring and readjustment of debt at least in terms of substantial principal and interest relief and modification of work-out terms. Most students of Puerto Rico’s actual debt crisis seem now convinced, that the situation has deteriorated to the point that relying on traditional short extensions, exchanges of debt, mild moratoriums and dreams of future growth will not work. In fact, what professor Reinhart and Rogoff conclude is that overly optimistic short term projections and denial of reality in order to further the credibility factor, even in developed economies actually works to the reverse.
Therefore, as part of the restructuring process urgently needed, the audit of past public debt should be encouraged. This tool should be used in establishing responsibility as to third parties, but its role expanded to cover government agencies (local and federal) and their officials. The good intentions of the Puerto Rico pre-audit sub-committee in coming up with a survey report and audit planning at this stage should be highly commended. But this committee, due to its origin, composition, lack of effective investigative and prosecution tools and slim government backing, lacks the capacity and authority for such a daunting task. At the very least the committee should be fully funded and the composition of the same carefully revised to sort out the conflicting parties.
Also, a group of top US Senate democrats have just requested that an audit on Puerto Rico’s debt be conducted by the Securities and Exchange Commission (SEC). Another better alternative could be a full audit of questionable loan practices carried out by a special commission of Congress or by a US Department of Justice special task force, with the cooperation of the SEC and other federal and local regulatory bodies including the local audit committee already formed on the Island.
The SEC by itself is not enough. It has not shown much interest nor has it been effective in supervising the local financial institutions and transactions related to local bond issues in the past. In fact, the lack of supervision and oversight on the part of all agencies, local and federal, could turn out to be one of the leading causes for the excesses committed by creditors, government and private advisors in the local credit market fiasco. Hence the SEC should not be entrusted with the leading role in this investigation.
At the same time, any local or federal audit process should be specifically excluded from becoming preempted by any law coming out of Congress dealing with the present Puerto Rico bond crisis situation. Finally any type of audit mechanism that results should not be delegated to or supervised by any “oversight board” that may be created by Congress.
The autor was Former Chief Judge, US Bankruptcy Court for the District of Puerto Rico and former member of the US First Circuit Court of Appeals, Bankruptcy Appeals Panel (BAP); at present Partner – G.Carlo-Altieri, Law Offices, LLC., San Juan.
