PHOENIX — The Financial Industry Regulatory authority has censured and fined UBS Financial Services $750,000 for falsely representing to its customers that the interest on its municipal bond payments was tax-exempt when it was taxable.
New Jersey-based UBS agreed, without admitting or denying FINRA's findings, to settle charges that it violated multiple Municipal Securities Rulemaking Board rules between July 2009 and December 2013 when it failed to have an adequate system in place to address "short" positions caused by trading errors at the firm.
FINRA brought a similar case against two divisions of Morgan Stanley in April, fining that firm $675,000 for its conduct.
The authority issued a regulatory notice on July 30 to remind firms that "their written supervisory procedures should identify the process for detecting, resolving and preventing the consequences of firm short positions."
During the examination period for UBS, FINRA said, the firm paid out to about 4,371 customers at least $1.165 million dollars of interest that the customers believed was tax-exempt from muni bonds held by the firm in customer accounts. In fact, FINRA found, the firm was short on its positions and the interest they were paying was actually taxable.
Short positions occur when a firm sells bonds that it does not own at the time. A dealer who executes a short sale must then go to the market and subsequently purchase the securities from a third party in order to make delivery on the transaction. When a short position corresponds to a customer's "long" position, the dealer makes a substitute interest payment to the customer. But because only interest from municipal issuers is tax-exempt, interest generated from a short position is taxable.
The firm failed to maintain a supervisory system reasonably designed to prevent rule violations, misstated the nature of interest payments to its customers, and failed to maintain a record of customers in short positions, FINRA examiners found. That conduct violated MSRB Rules G-27 on supervision, G-17 on fair dealing, and G-8 on books and records, FINRA said.
UBS became aware of the problem and took some steps to address it, but those efforts were not enough, the authority found.
"Beginning in 2012, the firm recognized that short positions were not being covered in a timely fashion and undertook efforts that reduced the number of short positions," FINRA said in the settlement documents. "Nevertheless, during the relevant period, UBS often did not cover municipal short positions for a month or more, and some of the short positions were not covered for more than a year."
UBS agreed in principal with the Internal Revenue Service to make a payment to prevent its customers from having to file amended tax returns and paying additional federal income tax. The firm also implemented revised procedures to minimize its short municipal bond positions and to properly report firm-paid interest as taxable, FINRA said.
A UBS spokesman said that the firm is "pleased to have resolved this matter."
