ERS bondholders seek validation of $3 billion in pension bonds
By The Star Staff
Holders of nearly $3 billion in Employees Retirement System (ERS) bonds have asked the U.S. District Court to issue a summary judgment declaring that their claims are valid, a petition opposed by the Puerto Rico government, the Unsecured Creditors Committee (UCC) and the Financial Oversight and Management Board’s special claims committee.
At issue is whether the ERS was authorized to issue $3 billion in bonds in 2008. As part of the ERS’s bankruptcy process, which began in 2017, the government parties sought to invalidate the claims of the ERS bondholders, who are for the most part hedge funds and financial institutions.
According to the bondholders in a motion last week, ERS borrowed nearly $3 billion in 2008, via a sale of three series of ERS bonds to a syndicate of underwriters. The transaction was authorized by ERS’s board of trustees and by the Government Development Bank. Virtually every Puerto Rico financial institution of any size participated in the offering. The validity of the resulting debt was confirmed repeatedly by legal opinions from the island Secretary of Justice, from ERS’s general counsel, and from the Puerto Rico law firm Fiddler, González, & Rodríguez. All three nationally recognized bond-rating firms rated the bonds investment grade. At the time of the issuance, there was no hint, from any quarter, that the bonds might not be valid, the bondholders said.
Under an initial proposal discussed between 2004 and 2006, the commonwealth itself would have issued $2 billion in bonds payable from the commonwealth’s General Fund, and transferred the net proceeds from that issuance to ERS. That initial proposal discussed between 2004 and 2006, like other issuances of general obligation bonds by the commonwealth itself, required approval by the island Legislature, the bondholders said. The necessary legislation to issue bonds from the commonwealth’s General Fund and transfer the proceeds to ERS was introduced but was never approved.
Beginning in 2006 and 2007, ERS considered an alternative proposal under which ERS itself, rather than the commonwealth, would issue bonds and be the direct obligor on the bonds. In March 2007, ERS received a legal opinion from Fiddler, González, & Rodríguez that concluded that “[t]he System is authorized pursuant to Section 4-105(d) of Act 447 [codified at 3 L.P.R.A. § 779(d)] to incur debt secured by the assets of the System, and the Bonds are such a debt,” and that no additional legislative approval was needed for ERS to issue the ERS bonds.
The bondholders submitted expert testimony saying that the English translation of the statute was incorrect. The statute reads: “The Board of Trustees may authorize the Administrator to seek a loan from any financial institution of the Government of the Commonwealth of Puerto Rico or the Federal Government of the United States of America or through the direct placement of debts, securing said debt with the assets of the System.” The bondholders argued that instead of “to seek a loan” the statute should have read “to borrow,” which is the correct translation to English of the Spanish “tomar prestado.”
“The [Unsecured Creditors and Special Claims] Committees and Government Parties’ own expert witness admitted that the sale of bonds is both borrowing and a loan, and it is undisputed that ERS sold all of the ERS Bonds directly to a syndicate made up of indisputable financial institutions,” the bondholders argued. “The ERS Enabling Act therefore expressly authorized ERS to issue the ERS Bonds, so the ERS Bonds are valid and enforceable, requiring summary judgment for the Bondholders.”
The island government enacted laws dismantling ERS and currently pensioners are being paid through a Pay-Go system.
The UCC noted that ERS was allowed to seek a loan under the law but that instead it went with bond issues.
The bonds were sold by the usual publicly offered bond minimum denomination of $5,000 in principal amount (or for capitalized interest Bonds, $5,000 maturity amount). The issuances were marketed and sold by underwriting syndicates, led by UBS. ERS did not engage in any direct negotiations with the public investors in setting these terms or establishing bond prices. Instead, ERS provided necessary documentation — ERS’s Official Statements, Bond Resolutions and other Bond documentation — to UBS and the other underwriters to use in their direct discussions and negotiations with public investors. The ERS bond issuances contemplated that UBS and the underwriting syndicates would fulfill an intermediary function by buying ERS bonds for resale to public investors.
“ERS used the underwriting syndicates not as lenders in a borrowing or a loan, but as intermediaries who would distribute and offer the ERS Bonds for sale to the public,” the UCC said.
In 2011, the Legislature amended the ERS Enabling Act to ensure ERS would not engage in another public bond issuance. In the statement of motives for the 2011 amendment, the Legislative Assembly recognized that the issuance of the ERS bonds “was illegally made by [ERS] even though such transaction was submitted to the Legislative Assembly for approval and rejected by the House of Representatives for deeming it detrimental to the System.” The Legislature amended the ERS Enabling Act to prohibit public bond issuances like the ERS Bonds as part of ERS’s ability to engage in “direct placements of debt” — the purported basis for the ERS Bonds — thus clarifying the intent of the original language of the statute.