Movong toward Municipal Bankruptcy’s Endgame

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eBlog, 6/17/16

In this morning’s eBlog, we consider the final stages of the process for exiting the longest chapter 9 municipal bankruptcy in U.S. history in San Bernardino, California; and we briefly review action relating to Puerto Rico yesterday by the House Financial Services Committee.

The Last Full Measure? The City of San Bernardino yesterday began the last full measure down the road towards a confirmation hearing to exit the longest municipal bankruptcy in history by October: the first of what could be multiple hearings on whether to confirm the city’s proposed plan of debt adjustment, approval of which by the federal court is the prerequisite for the city. That hearing has been scheduled for October 14th; albeit that process is unlikely to be smooth, as could be seen in a hearing before U.S. Bankruptcy Judge Meredith Jury yesterday involving the final objecting creditor, the Big Independent Cities Excess Pool, or BICEP, which raised objections in the federal courtroom to San Bernardino’s disclosure statement—which, in addition to the all-important Plan of Debt Adjustment, are the prerequisites for Judge Jury’s confirmation. The Pool is a group of six mid-sized cities which provide liability claim pool coverage, including for an unspecified number of civil rights creditor claims against San Bernardino, claims that total more than $1 million. San Bernardino’s plan of debt adjustment filing with the federal court includes a section which the city told Judge Jury was word-for-word the position of BICEP—eliciting unhappiness from the Judge, who yesterday said: “This is extraordinary, and I had never seen anything like it…where an objecting creditor is given the full opportunity to say whatever they wanted. The opponent adopted their language verbatim. And yet they’re still crying.” In response, an attorney representing the pool responded there was a simple explanation for that: The city was not testifying the truth with regard to the language being verbatim: “We gave them language. They did not put it in…They have misled the court today to our detriment. That’s not the only place.” These are not soothing words to a federal bankruptcy judge. San Bernardino’s bankruptcy attorney told the court that most of BICEP’s statement was included in the city’s filing; however, he added: “It is true we changed some of the language where we thought either was not true or did not make sense, but then we sent it back to BICEP and said, ‘Here’s what we’re proposing to put in.’” Then he told Judge Jury: “We did not receive a response back, nor did BICEP raise in any objection (in their filing);” in response to which Judge Jury suggested San Bernardino file the disclosure statement with the original language from BICEP, add a section explaining their disagreement, and work together with BICEP to include a summary paragraph saying that there is a disagreement, noting: “What they (the people with the claims against the city) need to know is that there is a dispute about how this is going to work, and they can’t count on it, if they happen to be in that class of more than a million, other than the city will pay what it promises for the unsecured class,” adding she would decide whether to favor the city or BICEP on that point before confirming the city’s proposed plan of debt adjustment. In San Bernardino’s proposed plan of debt adjustment, unsecured claims would receive 1 cent for every dollar owed, under the city’s bankruptcy plan. The next step for San Bernardino will begin next month when it will mail ballots to creditors seeking their approval of the proposed plan. Creditors will have until Sept. 2 to return those ballots.

Protecting Puerto Rico. The House Financial Services Committee yesterday unanimously approved the U.S. Territories Investor Protection Act of 2016 (H.R. 5322), which would amend the Investment Company Act of 1940 to terminate an exemption for companies located in Puerto Rico, the Virgin Islands, and any other possession of the United States—that is, that key sponsor Rep. Nydia M. Velázquez (D-N.Y.) believes would close a legal loophole that allowed broker-dealers to defraud Puerto Rico investors and extend to the U.S. territory of Puerto Rico the same protections under the Investment Company Act of 1940 as those afforded to investors residing on the U.S. mainland. Rep. Velázquez contends that, under a loophole in the Investment Company Act of 1940, some broker-dealers underwrote Puerto Rico municipal bonds and then repackaged them into mutual funds and sold them to Puerto Rican investors without disclosing the risks in some cases—an arrangement permitted under Puerto Rico law due to an exemption in the 1940 act, but barred in the U.S. mainland. Rep. Velázquez told her colleagues the situation has been compounded by Puerto Rico’s debt crisis, noting: “Retirees and other vulnerable citizens are being fleeced because of this outdated exemption in federal investment law: this bill would ensure statutory parity by ending this practice,” noting further that when the exemption was codified in 1940, Puerto Rico and other U.S. territories were considered to be physically located too far away for the Investment Act protections to be enforced. Since then, however, Hawaii and Alaska—U.S. states farther away from the mainland than Puerto Rico, have been granted statehood and, ergo, been beneficiaries of the protections granted in the 1940 Act, leading Rep. Velasquez to note: “It is absurd to suggest that we are unable to have a robust financial regulatory presence in Puerto Rico for geographical reasons,” she said. “All this exemption does today is enrich large financial companies at the expense of vulnerable retirees and working families.”

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