By Richard Satran of Thomson Reuters Regulatory Intelligence.
Arbitration claims filed with the Financial Industry Regulatory Authority have surged from customers who lost money in the fiscal crisis that hit Puerto Rico debt over the past half-decade. The increase in part reflects a resumption of FINRA hearings after a hurricane crippled the U.S. island territory's infrastructure and led to a halt in processing cases.
The number of arbitration claims jumped 45 percent in the first quarter, according to FINRA statistics. The total of 1,152 new filings puts FINRA on a pace for the highest number of cases filed since the post-financial crash. In addition to the Puerto Rico case, firms also were starting to be hit by a rising number of claims related to market volatility, especially in VIX and other volatility products.
Most of the increase came from customer complaints over suitability and concentrated sales of municipal bonds issued by Puerto Rico. The number of municipal bond-related cases tripled in this year's first quarter to 406 from 132 in the prior year's quarter.
The U.S. island territory had been mired in a multi-year recession that was capped with the largest municipal bankruptcy filing in U.S. history last year after the territory fell behind on repaying its $70 billion in bond debt.
Maria makes matters much worse
The fiscal crisis deepened last September as the island was slammed by Hurricane Maria, one of the worst Atlantic storms in recent history, which caused extended power outages and inflicted billions of dollars in damages. FINRA declared a stay on actions as it scrambled to continue hearings and complaint processes in the storm's aftermath.
The Puerto Rico debt crisis, which unfolded over the past five years, has spiraled into one of the largest recovery efforts by customers suing brokers over losses.The more than 2,500 claims have continued to rise despite efforts by FINRA to set up hearings on an expedited manner. But the rising number of cases filed has outpaced FINRA's efforts to streamline the process.
"Arbitration filings against brokerage firms in Puerto Rico have increased dramatically since 2012," said report by the Securities and Litigation Consulting Group. The island which accounts for less than one percent of the US economy has accounted for more than a third of overall customer claims in the U.S. market, the recently updated report said.
More cases on the way
The consulting firm's chief executive officer, Craig J. McCann, said in comments emailed to Regulatory Intelligence, "There were more cases filed in 2017 than in 2016, and I am certain more cases will be filed in 2018 than were filed in 2017. Far from abating, the new filings and backlog of filings in PR are both increasing."
The largest issuers of bonds in Puerto Rico were UBS and Santander. Bank of America's Merrill Lynch also has had an active presence in the difficult market. The island issued tens of billions of largely tax-free bonds to fund development plans for the island and promote industry, and firms sold them as individual bonds or in funds that used leverage. The new issues fell to steep losses amid concern over repayment as a recession enveloped the island and devastated its tourist trade. But other factors were at play in boosting FINRA arbitrations. FINRA also reported a 40 percent rise in intra-industry claims in which Puerto Rico's problems did not play a large role. Industry sources said market volatility cases ticked higher.
While the recent breakdown of the broker hiring protocol last year was not seen having much of an impact on the flow of cases, there were initial signs such cases may be on the upswing. The number of defamation in libel or slander jumped 50 percent. Defamation shows up frequently in legal fights between firms and brokers moving to new companies.
The surge in new cases so far this year has led to a rising number of open cases after nearly a decade in which FINRA was steadily reducing the number of arbitrations from the financial crash. FINRA has been whittling down the total from the 7,000 in 2009, the peak year for arbitration claims filed.
The industry self-regulator cancelled all actions in September as Hurricane Maria led to the closing of many businesses and hearing officers and participants in arbitration were unable to find lodging and meeting rooms for hearings. FINRA resumed those cases in December.
Richard Satran is a financial journalist covering daily and emerging issues for Thomson Reuters Regulatory Intelligence.