Regional News

N.Y. AG Files Charges Against UBS Securities

New York Attorney General Andrew Cuomo became the second state regulator to file securities fraud charges against UBS Securities LLC and UBS Financial Services yesterday, arguing that UBS executives sold $21 million of their personal auction-rate securities while the firm aggressively marketed to retail ARS they knew had liquidity risk.

As with a similar suit filed last month by Massachusetts Secretary of the Commonwealth William Galvin, Cuomo's suit shows that the underwriting and financial services subsidiaries of the Swiss-based bank realized as far back as last summer that the ARS market was fundamentally flawed and poised to collapse, and that ARS should not be treated as safe, liquid securities.

"Auction-rate securities were represented to be cash equivalents, except they weren't," Cuomo said at a news conference today. "UBS also continued the fraud after they knew the fraud was revealed for what it was after the auctions were failing they continued to sell the securities."

The civil suit seeks to force the Swiss bank to buy back ARS from its customers across the nation at par. UBS customers currently hold more than $25 billion of illiquid ARS, Cuomo said. The case is not limited to New York, he said.

"We believe we have nationwide jurisdiction and we're looking for recoveries not just on behalf of one state but nationwide," he said.

UBS spokeswoman Karina Byrne said in a statement that the firm would "vigorously" defend itself in the case and that the bank had acted in the best interest of its clients.

"UBS categorically rejects any claim that the firm engaged in a widespread campaign to move ARS inventory from the firm's own books and into private client accounts," she said. "UBS has dedicated significant resources and substantial effort to find solutions for its clients in this unprecedented ARS market crisis."

The spokeswoman said that UBS had been fully engaged in good faith negotiations with Cuomo's office to bring liquidity to its clients holding ARS. While certain individuals exercised poor judgment, their actions were not illegal, she said.

The suit alleges that UBS became aware of disruptions in the ARS market in August 2007 when three auctions it managed failed. The firm began to take on more inventory to support its auction, surpassing its $2.1 billion cap for ARS, according to the suit.

The bank had to repeatedly raise its inventory cap as investors began leaving ARS and it had to buy more securities to support the auctions. By December 31, the bank held approximately $6.2 billion of ARS. A week before the ARS market froze up in February 2008, UBS' inventory had risen to $10.5 billion, according to the suit. On February 13, UBS stopped supporting its auctions and they began to fail.

While this was going on, UBS had ramped up its efforts to market the securities to retail investors even as internally it was expressing concern about risks. Individual investors received account statements from UBS that identified their ARS as "cash alternatives" and some did not know they held ARS until the market collapsed in mid-February and their statements began to list "auction rate securities", the suit alleges.

A trading desk manager in December 2007 raised the possibility of widespread auction failures, according to an e-mail included in the suit.

"This forces the hand of every broker-dealer in the auction market to decide between supporting deals, taking inventories or at levels far below market rates or failing auctions (not supporting) which triggers a chain reaction of selling across all auction products ... Mark to market losses would be significant to all parties involved."

In 2006 the Securities and Exchange Commission sanctioned 15 firms for faulty ARS disclosures, though UBS was not one of them, after the commission investigated broker-dealer ARS practices.

The fact that UBS was not one of the firms sanctioned has led some market participants to wonder why. A bond attorney in Washington with knowledge of the situation said that "it would not be wrong" to assume that UBS may have been one of the first firms to alert the SEC to problems in the ARS market and was treated with leniency.

SEC and UBS officials have declined to comment on this issue.

Under the terms of the 2006 SEC settlement, 15 firms agreed to pay more than $13 million in penalties to settle securities law violations for engaging in practices like bidding in auctions that were never disclosed as a possibility in offering documents.

The settlement was unusual because it started with the commission asking firms to voluntarily provide information about their ARS programs and it differs from the UBS lawsuits because it focused on disclosures about the firms' auction programs and practices, not their sales practices for selling ARS.

Still, the suits come less than two years after the SEC sanctions and if the details in the New York and Massachusetts UBS suits are reflective of industry-wide behavior, future law suits by other states investigating auction-rate securities may reveal a widespread disconnect between what was going on within firms and what broker-dealers were disclosing.

Cuomo's suit, unlike Galvin's, does not name individual UBS bankers by name, but it does provide fresh details on the value of their personal holdings.

Between Nov. 1, 2007 and Feb. 12, 2008 at least seven high level UBS managers sold at least $21 million of ARS from their personal holdings, the suit alleges.

According to the suit, an e-mail from UBS's chief risk officer on Dec. 12, 2007 states that ARS were "experiencing digestion problems" and that each product has "potential trouble." An unnamed executive who was copied on the e-mail instructed his personal financial advisor to get him out of ARS. Within four days all of the executive's $250,000 of ARS had been sold. Other executives liquidated millions of their ARS.

"By failing to disclose market disruptions that were occurring while it was allowing its senior executive to reduce or eliminate their personal auction rate securities holdings, UBS betrayed its customers," the suit said.

The investigation is ongoing and the attorney general's office is looking into other banks' practices on ARS as well. Though the remedy sought in this case deals with investors, investor protection bureau chief David Markowitz said that the office could seek remedies for issuers of ARS as well.

The filing of the suit follows news on Wednesday that the state of Texas is considering suspending UBS AG's broker dealer and financial services license. A September hearing will consider whether the bank misrepresented and failed to disclose information about the liquidity and risks of the ARS market.

Among several revelations in the Massachusetts UBS suit is how reluctant officials at the firm were to continue to support the ARS market.

"I don't want to service this product either - quite frankly and am happy to responsibly dispose of it - we are trying for sure," wrote David Shulman, global head of the firm's municipal securities group and head of fixed income, according to the Massachusetts suit.

Shulman, who was responsible for pitching the securities to so-called wealth management, or retail clients, began to sell his personal stake in ARS in August and converted his investments to variable-rate demand obligations. By December he had liquidated his holdings, and told Galvin's investigators that he began selling them because of his lack of "risk tolerance."



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