WASHINGTON - In the first legal action of its kind, New Hampshire's top securities regulator has filed administrative proceedings against UBS Securities LLC for unethically misrepresenting auction-rate securities it underwrote and remarketed for the state's nonprofit student loan lender.
The 42-page complaint, which was filed yesterday by the state's Bureau of Securities Regulation, charges that the Swiss-based bank violated its fiduciary duty as underwriter, remarketer, and adviser to the lender, the New Hampshire Higher Education Loan Corp., and its conduit, the New Hampshire Health and Education Facilities Authority, by pushing them to remain in ARS and raise the rates on the securities when UBS knew the market was heading for collapse. The complaint is to be heard by the bureau.
The complaint follows last week's settlement between UBS and New York Attorney General Andrew Cuomo and other state and federal regulators to settle charges that the firm misled investors by marketing ARS as liquid, cash-like investments without disclosing their risks.
But unlike the settlement with state and federal regulators, which focused on sales practices, the New Hampshire complaint revolves around the remarketing activities of the firm. It comes as several nonprofit student loan lenders still have billions of illiquid ARS outstanding that were underwritten and remarketed by UBS and other firms.
"By this action today, New Hampshire is one of the first states to focus on the consequences of failed auction markets to other parties besides investors, specifically regarding students," said Mark Connolly, the state director of securities regulation. "Our goal with this action is to uncompromisingly enforce the securities laws to ensure that everyone is treated fairly in the wake of a failed process to bring these securities to market."
NHHELCO, which provided loans to nearly 50,000 students in New Hampshire in 2007, has lost about $66.5 million as a result of the February collapse of the ARS market, the complaint said. Since 1997, it has sold $1.5 billion of tax-exempt and taxable ARS though the NHHEFA.
Specifically, New Hampshire is seeking an order that UBS cease and desist from its alleged dishonest behavior, pay NHHELCO restitution, and pay for the cost of the state's investigation, among other things. UBS has 30 days to respond to the complaint, during which they may request an administrative hearing, said Kevin Moquin, a spokesman for Connolly.
In a statement, UBS disputed the charges and said it would vigorously defend itself.
"This complaint attempts to link a single client interaction with overall market conditions which affected all student loan issuers, and as such we believe there is no basis for these specific allegations," the statement by UBS said, adding that it is "frustrating" the bureau has filed the claim "given that we have been in discussions with them and NHHELCO regarding the unique issues being raised by the state, and have recently reached a comprehensive settlement with federal and state regulators to provide liquidity to all investors. This claim has no impact on that settlement and UBS clients in New Hampshire will be made whole under the settlement proposal."
In late November, NHHELCO approached UBS and requested that it underwrite $42 million of ARS to finance student loans for 2008. In early December, after UBS prepared to draft documents for the transaction, the firm refused to complete the deal due to what it referred to as a "tightening" ARS market, the complaint said. Exhibits revealed, in fact, that UBS' inventory of student-loan ARS had ballooned and the firm did not wish underwrite any more of them.
In mid-December, UBS told NHHELCO that the ARS market was experiencing a short-term upheaval and urged the lender's officials to sign amendments to its bond documents for existing ARS that would, for one month, increase the maximum rates on its outstanding taxable and tax-exempt ARS, to attract investors to the securities.
The amendments were deemed effective and extended from the end of January through the end of May, the complaint said, noting that as UBS pushed the firm to extend the higher maximum rates, it was considering getting out of the ARS market entirely, as it eventually did Feb. 13.
As of result of the higher maximums, NHHELCO believes it has paid over $25 million in excess interest payments and loss earnings on their trust estate investments, the latter of which are used to secure their bonds and usually had a liquid component that earns money but had to be used to pay interest, according to Stephen Weyl, counsel for NHHELCO and a partner at Hinckley Allen Snyder LLP in Atlanta.
When the ARS market collapsed, tax-exempt rates jumped from about 3.4% to as high as 7.75%, while taxable rates spiked from about 4% to as high as 18%, according to Dean Grondin, vice president and chief financial officer of the New Hampshire Higher Education Assistance Foundation, which oversees four nonprofit organizations-- including NHHELCO -- responsible for the origination, disbursement and servicing of student loans in the state.
Despite the state regulator's charges, the lawsuit includes, as an exhibit, a Dec. 13 memo from Weyl advising NHHELCO and NHHEFA to sign the maximum rate changes. The memo notes that UBS bankers informed the state officials that there was "a major upheaval" in the ARS market.
Asked why the memo doesn't undermine the state's charge that it was misled, Weyl said, "They led us to believe that this disruption would be brief. They never disclosed that they were considering exiting the market. The complaint by the bureau [is that it] relied on advice from UBS, which fundamentally was different from the path that UBS was taking."