New York Attorney General's Complaint Against UBS Securities Seeking Relief For Auction Rate Securities Purchasers Nationwide

By James Eccleston

ollowing on the heels of a similar complaint filed by Massachusetts securities regulators, New York Attorney General Cuomo's complaint against UBS Securities and UBS Financial Services ("UBS" collectively) alleges that UBS deceived its customers, its own financial advisors and the issuers of auction rate securities ("ARS"). When UBS decided to stop participating in the ARS market in February, 2008, UBS had 50,000 customer accounts holding $37 billion in ARS. Let's examine the key allegations of the complaint.

First, it is undisputed that UBS marketed and sold ARS as safe, highly-liquid, short-term investments that were equivalent to cash or money market funds. The complaint alleges that these representations were false, given the manner in which the ARS auction system actually had worked. Specifically, UBS failed to disclose, to either its customers or to its financial advisers apparently, that it "routinely" submitted "support bids" in order for ARS auctions to not fail. According to the complaint, from at least January, 2006, "UBS's auction rate securities could not function without UBS support." From January, 2006 through February, 2008, UBS placed support bids of between $4 billion to $14 billion each month. The complaint alleges that, "UBS did not disclose to its customers that its auction rate securities offerings required UBS's support in order to function, or that cessation of UBS's support would cause widespread failure." And, as time went on, the complaint alleges that UBS "was selling an increasingly illiquid investment as a liquid one."

Second, UBS allegedly did a poor job of educating their own financial advisors as to the true nature and risks of ARS. According to the complaint, "UBS financial advisors readily admit that they represented auction rate securities to be cash equivalents, as that was their understanding." This lack of knowledge existed despite the fact that "most UBS financial advisors sold auction rate securities on a solicited basis, meaning that it was the UBS financial advisor that suggested that the customer purchase the auction rate securities."

Third, when UBS placed support bids at ARS auctions, UBS then would own the ARS. The complaint alleges, "When UBS purchased auction rate securities through support bids, auction rate securities were then owned by UBS and the holdings were recorded on UBS's balance sheet." Further, "[f]or risk management purposes, UBS imposed limits on the amounts of auction rate securities inventory it could hold." Importantly, these were internal limits that the firm chose to place. According to the complaint, during 2007 and the beginning of 2008, those inventory limits were between $2.1 billion and $2.5 billion.

According to the complaint, UBS exceeded its inventory caps in August, 2007 and again in December, 2007, when UBS exceeded the cap by several billion dollars. This prompted UBS to convene an internal working group in December, 2007. The complaint alleges that UBS "contemplated several courses of action but consistently implemented only one: a re-doubled sales effort to its customers." According to the complaint, UBS found itself in an "inherently conflicted position". That is, "UBS could disclose its marketplace problems and risk further inventory on its balance sheet or it could hide the mounting risks in the auction rate securities markets and try to offload the risk by selling its auction rate securities inventory to its customers." Unfortunately, the complaint alleges that, "Time and time again, UBS put its interests above those of its customers, continuing to sell auction rate securities in spite of the problems in the auction rate securities market without making appropriate disclosure to its customers."

Fourth, emails obtained by the New York Attorney General reveal that UBS considered abandoning its support of the ARS market as early as December 12, 2007. On that date, UBS's Global Head of Municipal Trading received an email from the Trading Desk Manager stating: "The auction product does not work and we need to use our leverage to force the issuers to confront this problem [sic] our options are to resign as remarketing agent or fail?" The complaint alleges that, "This fact was not shared with UBS's customers nor was the fact that the auction rate securities market was dependent on UBS's ever-increasing support." The UBS working group likewise "discussed allowing the auctions to fail as a potential solution to inventory levels" later in December, 2007, again unbeknownst to UBS customers.

Fifth, it appears that UBS likewise concealed this material information from its own financial advisers. The complaint alleges, for example, that in the nationwide conference calls with financial advisers to encourage them to sell ARS to their customers, UBS failed to disclose to them the firm's "inventory levels or the amount of support UBS was providing to support the [ARS] market." Additionally, while UBS emails privately categorized ARS as "torture", a "complete loser" and a business UBS "will be leaving anyway", UBS continued -- as late as February 8, 2008 -- to encourage advisers to sell the product and "continued to paint a promising picture of the auction rate securities market to financial advisors." Nonetheless, on February 13, 2008, UBS chose, abruptly and without notice, to cease supporting ARS auctions, which then immediately failed.

Sixth, all the while that customers and UBS financial advisors were being kept in the dark, UBS executives covertly sold their own ARS holdings. According to the complaint, between November 1, 2007 and February 12, 2008, at least seven UBS executives who participated in the working group sold at least $21 million from their personal auction rate securities holdings!

Notably, other financial services firms chose the same course of action -- to abandon the ARS market -- in February, 2008. Undoubtedly, UBS will not be the only financial services firm subject to legal action. However, for now, the substantial evidence of nothing less than an old-fashioned "pump and dump" of securities has made UBS the focus of attention!

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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.