Regulator's Complaint Against UBS Securities Exposes Significant Conflicts of Interest and Omissions In The Sale of Auction Rate Securities

By James Eccleston

n June 26th, Massachusetts securities regulators sued UBS Securities and UBS Financial Services for their role in the auction rate securities ("ARS") debacle that has plagued not only UBS but several other financial services firms. In addition to other relief, the 101-page complaint seeks an order requiring UBS to offer to rescind sales of ARS at par (purchase price), or to offer restitution to investors who already sold their ARS below par.

Much like the emails that Eliot Spitzer uncovered to expose Wall Street's widespread, undisclosed conflicts of interest in the research analyst cases, Massachusetts securities regulators have uncovered scores of emails from UBS executives that make UBS' denial of liability border on laughable if not absurd.

Let's examine the more important charges that Massachusetts securities regulators have lodged against UBS. First, "typically" UBS sold ARS to investors as "liquid, safe, money-market instruments", and UBS' marketing materials promoted and classified ARS as "Cash & Cash Alternatives Addressing our short-term needs" through February, 2008. Additionally, UBS listed ARS on client statements under the titles "cash alternatives/municipal securities" and "cash alternatives/money market instruments." Investors, according to the complaint, were told that interest rates were set in periodic auctions, and that either the ARS "were readily tradable in auctions" which typically occurred every 7 or 28 days, or that the instruments "matured" in 7 or 28 days. However, the truth (or material omissions) was quite contrary to the oral and written representations. According to the complaint, investors were not informed that:

UBS submitted a support bid for every auction for which it was the lead or sole broker-dealer to ensure that the auction would not fail;
UBS, in August, 2007, intentionally let certain auctions fail because there were not sufficient buyers and UBS did not want to own more of the ARS paper that it had been trying to auction off;
UBS offered only the ARS products that it had underwritten and was trying to distribute; and
UBS itself set the interest rate in most of the auctions with the bids it submitted, to actively manage the interest rates so that they would be just high enough to move the ARS it had underwritten but not so high as to make the issuers that were its underwriting clients unhappy.

Second, the complaint alleges that UBS' clients "were also in the dark concerning the dangerous increase in auction rate security inventory that UBS was carrying on its books beginning during the Fall of 2007 and continuing through to February, 2008." Indeed, UBS failed to inform clients that:

UBS' short-term trading desk had exceeded, multiple times in 2007 and early 2008, the amount of capital it was authorized to support the auctions and repeatedly had to request an increase in that cap;
UBS engaged in "extreme efforts" to decrease its inventory of ARS at the insistence of its risk management department;
UBS, as early as September, 2007, "was actively considering scenarios which included pulling out of its auction program altogether"; and
By the end of October, 2007, David Shulman (Global Head Municipal Securities Group and Head of Fixed Income Americas at UBS Securities) described the auction rate program as "a huge albatross", and in a December 11th email stated that "auctions aren't going to come back".

Third, to alleviate the "enormous amount of stress" that UBS' auction rate program was experiencing, given the buildup of its ARS inventory, the complaint alleges that UBS orchestrated a major marketing push to convince unsuspecting retail investors to buy ARS from UBS' inventory. Indeed, the complaint alleges that Shulman himself "orchestrated an all-out sales effort in order to get retail customers to see the 'value' in ARS at the prices at which UBS was willing to offer them" - all the while the Shulman was selling his own ARS holdings! In that regard, Massachusetts regulators "uncovered a profound disconnect between UBS' understanding to the ARS it was selling and the FA's [financial advisers'] explanations of these securities to their customers." UBS continued to promote the sale and did sell ARS to its customers right up until the day that it decided to abandon its auction program, February 13, 2008.

No doubt, other financial services firms involved in ARS will see similar charges of conflicts of interests and omissions as detailed by Massachusetts regulators against UBS. Likewise, other states, even the SEC and FINRA, may follow suit. In the meantime, it is most apparent that investors should consider their arbitration and litigation options to remedy the great wrongs that have been committed!

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About the Author:
James J. Eccleston is the president of Eccleston Law Offices, P.C. The Chicago-based firm represents investors and advisers nationwide in securities and employment matters. 312-332-0000 www.EcclestonLaw.com.