Cooperativa Lawsuit Claims Coercion

Puerto Rico’s cooperativa system is thriving despite a regulatory process that is filled with conflicts of interest as well as the devastating hurricanes and fiscal crisis the island has suffered, according to records filed in federal court and the regulator’s own fiscal plan.

The cooperativas are insured by the territory’s Corporation for the Supervision and Insurance of Cooperatives (COSSEC). These institutions are in addition to the island’s credit unions that are insured by the NCUA.

The problems with the regulatory process have been detailed in a report by the regulator itself and in a lawsuit filed by cooperativas in which they charge they were coerced into purchasing government bonds that officials should have known were poor investments.

In an interview with CU Times in April 2016, attorney Jose Sosa-Llorens leveled similar charges.  At the time, Sosa-Llorens, a former commissioner for Financial Institutions of the Commonwealth of Puerto Rico, represented 25 of the largest cooperativas on the island.

Attorneys for the five cooperativas have leveled similar charges.

The cooperative system is well established in Puerto Rico. COSSEC said there are 115 cooperativas on the island that hold $8.1 billion in shares and deposits for almost one million members. Banks, on the other hand, hold some $45 billion in deposits from customers on the island.

“Cooperativas have gained popularity in Puerto Rico as customers feel a greater sense of loyalty to their local institution, especially given that the Cooperativas are owned by their shareholders rather than stockholders,” the regulator wrote in its fiscal report. “The individual Cooperativas are significantly smaller than banks in Puerto Rico and often offer a more personalized banking experience; the Cooperativas are viewed as an important institution in many Puerto Rican municipalities, with the management of the local Cooperativa often serving as leading figures in the community.”

At the same time, Bloomberg recently reported the number of banks operating on the island dropped by a half over the last decade.

COSSEC said 15 days after Hurricane Maria, 90% of the cooperativas were open, and one month after the hurricane, there were 17 communities where the only functioning financial institution was a cooperativa.

“Cooperativas located in rural and remote locations in Puerto Rico overcame severe communications and devastated infrastructure issues, and helped members have access to cash needs to meet basic needs such as food, water, gasoline and medicines,” COSSEC continued in its fiscal report.

The agency said in an effort to help cooperativa members, COSSEC allowed the institutions to impose a moratorium of up to 90 days on outstanding loans.

However, COSSEC has also conceded that its ability to supervise and guarantee the cooperativas is hampered by a series of conflicts of interest. The corporation is governed by a board that is heavily dominated by officials from the credit unions themselves.

“The Cooperativas have a majority in the composition of the Board,” COSSECC wrote in a fiscal plan prepared for the oversight committee. “This has restricted COSSEC’s ability to act as an independent regulator of the Cooperativa System.”

It added the cooperativas have “significant and at times, determining participation,” and this conflict of interest may cause problems where “these representatives may vote for actions that are in the best interest of the Cooperativas but not necessarily in the best interest of Corporation and the system as a whole.”

The oversight board, which has been certifying fiscal plans presented by the Puerto Rican government, has refused to certify COSSEC’s plan, citing structural changes that are needed.

“COSSEC’s board must be able to act independently,” Natalie Jaresco, executive director of the oversight board, said at an April 20 meeting. “This is a clear and unacceptable conflict of interest.”

Such changes must be approved by the island’s legislature, COSSEC officials told the board. They said the agency and legislators are attempting to agree on the legislative language needed.

The board also said it wanted more information about stress tests that have been conducted on the system. COSSEC had told the board that the tests showed the cooperativa system could withstand financial problems on the island.

The NCUA has assisted COSSEC in conducting those tests.

Meanwhile, seven cooperativas have filed suit against the island’s government, the oversight board and COSSEC, contending they have been coerced into purchasing government bonds whose value is questionable following a bankruptcy filing by the island’s government.

The cooperativas are asking the U.S. District Court for Puerto Rico to rule that the debts they are owed based on those investments cannot be discharged by the bankruptcy filing because they were based on false representations and fraud.

“Maliciously, in a calculated way and under false pretenses, Defendants offered and sold to Plaintiffs unsound Puerto Rico Debt Securities availing themselves (Defendants) of the Cooperatives’ assets,” the cooperativas said in filing the suit. “This resulted in an undue concentration of bonds in the cooperatives’ portfolios and created a systemic risk for the Cooperatives.”

The government ignored its responsibility and induced the sale of “unsound” securities, they charged.

“These entities incurred in the reckless disregard of the systemic risks to cooperatives and failed to comply with statutory mandates, and ministerial and fiduciary duties,” the lawsuit said.

The government coerced the cooperativas by delivering “threats” and “warnings” of possible revocation of the tax-exempt status of cooperativas, which has been in effect since the 1940s, the lawsuit said.

The government agencies have not yet responded to the lawsuit.