WASHINGTON – The Securities and Exchange Commission's investment management division is urging funds, especially those with exposure to Puerto Rico debt, to monitor and continually update their disclosures based on the risks associated with their investments.
"The division believes that full and accurate information about fund risks, including risks that arise as a result of changing market conditions, is important to investors in mutual funds, exchange traded funds, and other registered investment companies," the division said in guidance it issued. "In the staff's view, any fund investing in Puerto Rico debt should consider, based on the nature and significance of its investments, whether such disclosure is appropriate."
The division's guidance applies to a wide variety of funds, but lists those with Puerto Rico investments as an example where special attention to risk disclosure is needed.
The commonwealth is currently struggling with roughly $70 billion of debt and its governor has made clear it will not be able to make future debt payments without restructuring authority. Puerto Rico has already defaulted on at least three debt payments, two of which were due on Jan. 1.
Unlike authorities in states, Puerto Rico's public authorities do not have access to Chapter 9 bankruptcy protections under federal law. Puerto Rico officials and others have been pressuring Congress to help the territory solve its debt and fiscal crises. House members are working under a March 31 deadline to create a legislative package that would help the commonwealth. Any package is likely to combine some form of restructuring with a federal oversight authority whose powers must be worked out by Congress.
Puerto Rico bonds have also been the subject of numerous Financial Industry Regulatory Authority arbitration cases, mainly between individuals and UBS' Puerto Rico branch. Those individuals invested with UBSPR and allege the bank's staff over-concentrated assets in closed-end bond funds with a large amount of Puerto Rico debt and didn't disclose enough information about the risks associated with such holdings. The investors then suffered significant losses when the value of the commonwealth's bonds plunged amidst increasing speculation that the commonwealth would eventually default on much of its debt.
The division said that, through its research on various funds' risk disclosures, it has noticed several with Puerto Rico debt exposure have informed investors of the commonwealth's significant financial difficulties, like budget deficits and ratings downgrades on debt. The division said "single-state funds" that are exempt from both federal income tax and the tax of the particular state are likely to have higher concentrations of Puerto Rico bonds and may be more interested in disclosing the risks involved.
However, the division also said funds should monitor for other risks associated with the current market, like interest rates and liquidity. The division found that many firms were already disclosing potential issues stemming from historically low interest rates and the potential rise of interest rates in periods of volatility as well as increased redemptions. It also noticed funds warn that longer-term securities may be more sensitive to interest rate changes.
The update offered three areas upon which fund managers could concentrate to make sure their risk disclosures were up to date, starting with making monitoring market conditions a part of normal day-to-day operations. That type of monitoring is "a part of prudent portfolio management by the adviser," the division said. It also recommended funds assess whether the changes to the market are material to investors. If they are, the funds should disclose those risks in line with current securities laws. The communication with investors could be through the prospectus, shareholder reports, or through less formal methods like website disclosure and letters to shareholders, the division said.
