After the $330 billion auction-rate market imploded in February and complaints from wealthy and modest investors who were unable to access their cash poured in, William F. Galvin, secretary of Massachusetts, subpoenaed documents from some major brokerage firms. Galvin wanted to see how these firms marketed these supposedly safe and liquid securities to investors. Galvin just released materials produced by UBS and filed a civil suit against the firm, accusing it of defrauding investors. UBS emails show UBS played dual roles in the auction-rate securities market and how its conflict of interest had a devastating effect on auction-rate investors.
According to Galvin's suit, UBS misled investors by marketing auction-rate securities as safe, cash alternatives and when the market started to go bad, UBS dumped these securities on individual investors to minimize its own exposure to the risks inherent in keeping them on its own books. If Galvin's allegations prove to be true and prevalent among Wall Street firms, then civil and criminal actions against these firms may become widespread.UBS denies Galvin's allegations but the evidence backing Galvin's claim is apparent in the email messages among UBS executives.
The problem facing UBS surfaced last August when the credit markets seized up. Corporations that used to be big buyers of auction-rate securities began to sell instead of buy so UBS, as underwriter and auction market manager, had to find new buyers or be stuck with the securities. At the same time, UBS was suffering from losses in the sub-prime mortgage market so an auction-rate securities mess would compound UBS' troubles.
Frantic e-mail messages flew among UBS executives during that time. “As you can imagine during these stressful times, the pressure is on to move our inventory,” wrote David Shulman, global head of fixed income distribution at UBS, on Aug. 30. “I am aware that JPM and Citi are on all ‘alert’ in the same fashion with their retail groups.”
Joel P. Aresco, chief risk officer for the Americas, sent this message on Nov. 15: “Why the continual increase” in the inventory of auction-rate securities? “What measures are being taken to reduce this exposure?” In response, on Dec. 11, Shulman wrote: “I am pushing every angle here to move product.” However, the product being moved was Shulman’s own stake in auction-rate securities. By Dec. 12, Shulman had dumped all his holdings.
On Feb. 12, just days before the auctions collapsed, another UBS executive wrote: “We need to beat the bushes harder than ever to unload this paper.” Meanwhile, UBS’ web site still said auction-rate securities are a highly liquid cash alternative.
However, it seems some UBS brokers were not told about the risks that auctions could fail and their clients could be stuck with their holdings. Complaining about UBS' auction-rate unit in an email on Jan. 10, one broker wrote "we continue to be frustrated by the lack of information that they are providing to us" and “given the strange and difficult environment, it is imperative that we are fully aware of the risk we are taking." The broker also wrote "we do not want to imperil any relationships over something as ‘simple’ as their cash investments. The lack of clarity regarding ARPS is contrary to our focus on ‘improving the client experience.’ ” (ARPS refers to auction-rate preferred shares.)
UBS' conflict of interest is most glaring in an email written by Joe Gallichio, a managing director in the municipal finance department at UBS, on Feb. 21, after the market for auction-rate securities had frozen. “As things change they also remain the same,” Mr. Gallichio wrote. “What we face now in the firm as related to muni short term is classic Wall Street. In its core, it is trading versus sales, risk management versus client franchise.”
“As a firm we tell people we are client focused,” Gallichio went on. “So if the client is always right, then we should fix the problem this product has created in WM,” the firm’s wealth management unit, which includes retail investors. “To let WM and the firm as a whole go through costly litigation, the loss of investor confidence and significant assets, the cost in management time, legal and compliance, IT spend, the total distraction from our core growth strategy and overall employee morale — will certainly be in excess of the multibillion-dollar hit to balance sheet we would take by just buying the rest of the assets from WM. I just don’t get it.”
Gallichio's email said it all.
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