WASHINGTON - In the first state-level lawsuit against an investment firm over auction-rate securities, Massachusetts Secretary of State William Galvin filed securities fraud charges yesterday against UBS Securities LLC and UBS Financial Services for selling retail investors auction-rate paper as "liquid, safe, money-market" instruments even though the defendants knew it was not.
In a 100-page complaint, Galvin said that UBS broker-dealers and financial advisers did not disclose to their clients the extent to which the Swiss-based bank bid in auctions to prevent them from failing and that no true auctions in fact existed because they would have failed without support from dealers. UBS also did not disclose to customers the conflicts of interest that UBS exposed itself to in its dual role in underwriting the securities and selling them to clients, Galvin said. Both units are part of parent company UBS AG.
The five-count administrative complaint, which will be heard by a hearings officer within the department's securities division, asks that UBS be ordered to return to investors the money they invested in auction-rate securities at par and make restitution to those investors who have had to sell at below part. It also asks that UBS be ordered to cease and desist from further violations of the state securities law, be censured, and be subject to an administrative fine.
The complaint reveals that UBS had considered getting out of the auction-rate market as early as last September, but placed tremendous pressure on its wealth management advisers to get their clients to invest in ARS last fall because the firm's inventories of the securities had ballooned well beyond a self-imposed $2.5 billion cap.
Despite the aggressive selling practices, David Shulman, who, as global head of UBS' municipal securities group and head of its fixed-income Americas operation, was responsible for marketing ARS to the firm's customers, liquidated his personal holdings of these securities and purchased safer variable-rate demand obligations.
"UBS pushed the sales of these instruments as 'cash alternatives' without telling their customers their vulnerabilities," Galvin said in a statement. "Nor did UBS tell them that the only ARS products being offered were what UBS had underwritten and that UBS was trying to unload at the 11th hour. The game was fixed; only the customers were in the dark."
The lawsuit comes about two months after state securities regulators investigating whether investment banks adequately disclosed the risks associated with the ARS they sold investors formed a task force to share their information and expertise with other states trying to address investor ARS complaints.
The creation of the task force - which included securities regulators from nine states and was headed by Massachusetts officials because of their expertise in this area - suggests that yesterday's lawsuit may be the first of many. Massachusetts is also investigating - and in late March subpoenaed - Merrill Lynch & Co. and Bank of America.
The other states involved in the task force are Florida, Georgia , Illinois, Missouri, New Hampshire, New Jersey, Texas, and Washington, though regulators have refused to say which firms they will each be focusing on. New York Attorney General Andrew Cuomo has opted out of the task force and is said to be conducting his own investigation of several firms.
Galvin's suit also comes after UBS in May agreed to give back $35 million to cities and towns in Massachusetts due to allegations that the investment bank led them into risky ARS investments. That decision was reached with Martha Coakley, the state's attorney general.
In a statement about the lawsuit filed yesterday, UBS spokesman Kris Kagel said the firm is "disappointed that the Massachusetts Securities Division has filed this complaint against us, as we, our peers, and the industry work toward solutions." He said UBS continues to support the ARS market longer than any other firm and has offered clients with illiquid ARS loans equal to the par value of their auction-rate holdings at "preferred lending" rates.
"UBS, our clients, and clients of other industry participants all share the impact of this unprecedented loss of liquidity in the ARS market," Kagel said. "We will defend the specific allegations of the complaint. Contrary to the allegations, UBS is committed to serving the best interests of our clients. We will continue to work with the industry toward broad solutions."
But the complaint contained e-mails between UBS bankers indicating that it was UBS' intention to heavily capitalize on the turmoil that began in February when the auction-rate market froze up, there were widespread auction failures, and issuers were forced to pay penalty rates of 15% of higher.
"After the fails - I am being bombarded!!! Every muni issuer (even just our [ARS]) are asking for [letters of credit] to convert," one banker wrote to Shulman on Feb. 14. "We have a money making opportunity!!! We are rarely in the leverage position. I think we should [sic] as much of our capacity as possible for core munis - [issuers] are desperate."
Shulman replied: "Am aware - sit tight - we are at the gates - great chance for us to step in." In a later e-mail, he characterized the situation as "a banker's dream market."
UBS recently announced that it was exiting the municipal securities market.
