Puerto Rico Municipal Bonds: Not Just Another Muni

Trying to navigate your way through the world of investing in an effort to not only make good investment decisions, but also to avoid the pitfalls of poor investment advice, can be a daunting task. Some investors struggle just trying to understand the everyday language of investments. Add to that the countless types of investment vehicles available and how investment rules differ among them, and it is easy to see why investment advisors play such a critical role in helping investors decide which investments are best for them.

One popular investment opportunity is municipal bonds, also known as munis. These bonds are issued to off-set the capital expenses of municipalities or for special improvement projects such as schools or airports. Munis are publicly traded, leveraged closed-end bonds that sell a fixed number of shares, as opposed to open-end funds which do not restrict the number of shares that are issued. The money for these closed-end funds is borrowed from the issuer and then listed and traded on an open stock exchange. One of the things that both advisors and investors find appealing about municipal bonds is that they are exempt from federal taxes and, often times, also exempt from state taxes for the residents of the state in which they are issued.

In 1940, Congress passed the Investment Company Act of 1940 to prevent abuses of mutual fund and closed-end fund shareholders by requiring investment companies to release information about material details and about the financial health of each investment company. Although it applied to the United States, it exempted Puerto Rico because any investments issued there are not considered to be issued by a “state”. According to then general counsel for the Securities and Exchange Commission, David Schenker, stated that Puerto Rico was, “so far away from America that the policing aspects are quite difficult.”

As a result of this ruling, one investment that seems to keep rearing its head in investment news over the last couple of years is the Puerto Rico municipal bond. How the Puerto Rico muni bonds differ is an interesting case. The basis of leveraged bonds is that they will yield enough in returns to repay the loan with a profit above and beyond the interest rate of the loan. Leveraging creates a much higher risk for investors in an investment than is generally considered safe.

The disparity between protection of investors of domicile-issued bonds and those issued in Puerto Rico leads to a significant increase for potential losses. The exemption provided by Investment Company Act for Puerto Rico muni bonds permits issuers to leverage up to 50% of the fund’s assets, as opposed to only a 30% leverage allowance for closed-end funds that are issued within the 50 fifty states. With these Puerto Rico muni bonds, an additional 5% can be leveraged for “special circumstances”, which can cause as much as 55% of Puerto Rico muni bonds to be leveraged. This can easily result in huge losses for an investor if these muni bonds don’t perform as well as anticipated.

Wading through such issues can be complex, especially when special rules apply dependent upon where it munis are issued. If you feel that you have been misled and/or suffered a financial loss as a result of these varying rules or by investing in Puerto Rico municipal bonds, please call the office of The Blum Law Group at 877-STOCK-LAW. We offer a free consultation to help you understand if you are entitled to recompense.

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