UBS quietly kept selling to clients; States, SEC investigate role in market crash - Wall Street firm told only some about risk

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Richard Stahl's bonds have started paying zero percent.
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THE BOSTON GLOBE Online

"Wall Street firm told only some about risk: Files show UBS quietly kept selling to clients; States, SEC investigate role in market crash"

By Beth Healy, (Boston) Globe Staff, June 9, 2008

UBS Financial Services Inc. knew as early as December that a segment of the municipal bond business was in trouble, but the Wall Street firm kept selling the investments to some clients without warning them of the risk, according to documents reviewed by the Globe.

By February, the $330 billion auction-rate securities market had collapsed, locking out the nonprofits and municipalities that had used the market for years to issue inexpensive debt, as well as the investors who had purchased it. UBS brokers have said they were as surprised as anyone about the market's shutdown.

But on the other side of the firm, UBS was advising some large investment banking clients of the looming problems at least three months before all trading stopped, according to a letter to investors by one of those clients, a New Hampshire bond issuer.

It is a conflict that could mean UBS bears more responsibility for its role in the auction-rate securities debacle than it has acknowledged so far. The Swiss firm is under investigation by Massachusetts and New Hampshire regulators, and the Securities and Exchange Commission for allegedly misleading investors in the auction-rate market. These officials are also examining whether UBS played a role in allowing the market to fail.

"Investment banks were principals in this whole thing," said Secretary of State William F. Galvin, head of the Massachusetts Securities Division. "There had to be more knowledge or more planning on their part."

UBS declined to discuss why it told some clients but not others about the risks of auction-rate securities. These are debt securities sold by nonprofits, arts institutions, and local government entities, which use the money to fund their operations. They offer low interest rates for the borrowers, which are reset at frequent auctions run by brokerage firms.

In one instance to date, UBS has admitted that it did not provide enough warning to investors. The firm is repaying 18 Massachusetts cities and towns and the Massachusetts Turnpike Authority for $37 million in auction-rate securities, under a settlement last month with Attorney General Martha Coakley.

Securities lawyers said evidence that one side of the firm knew about the impending market collapse without telling the other could pose legal trouble for UBS.

Philipp A. Uhlmann, assistant professor of finance at Bentley College in Waltham, said he believes investors share responsibility with brokers for making sure they know what they are buying. But to the extent the securities were misrepresented, he said, "A retail investor would have a very good argument."

Richard Stahl of Hollis, N.H., may be one of those investors.

He is among the many individuals, businesses, and small-town treasurers who have $250 billion still trapped in the auction-rate market, according to Capital Advisors Group Inc. in Newton.

Stahl, a retired car dealer, has $650,000 stuck in the auction-rate bonds of a nonprofit student lender in New Hampshire. He said his UBS broker, Christian Parker, told him the investments were in municipal bonds of his state, the same kind of holdings that make up about 30 percent of his portfolio. So on Jan. 10, without much deliberation, Stahl bought them.

On his UBS statement, the investment appeared under the heading "municipal securities." But what he thought were municipal bonds, paying 4.6 percent interest, actually were the debt of the New Hampshire Higher Education Loan Corp.

Five weeks later, on Feb. 13, Stahl learned that he could not sell those bonds - not that day and not any time since. then. His broker seemed as confused as he was, Stahl said. The buyers who had come to the auction market routinely for 20 years had suddenly vanished; now there were only sellers. Spooked by the subprime mortgage crisis, they feared student lenders and other bond issuers might also default on their debts.

Parker, Stahl's broker, declined to be interviewed.

"I was told explicitly that it was a New Hampshire municipal bond," Stahl said of his investment, which is being investigated by state and federal securities regulators. Stahl blames UBS for failing to inform its brokers that the securities were not, as he was told, as safe as cash.

Indeed, a letter to investors on the website of the New Hampshire student loan group shows that UBS was not a hapless bystander when the auction-rate market failed. The firm knew far more about the market's prospects than it has let on publicly.

The conflict arose last December. UBS had been the investment banker to the New Hampshire Higher Education Loan Corp., since 1997, handling $773 million in debt offerings for the student lender. It was by now several months into the mortgage lending crisis and the resulting credit crunch that was damaging a host of debt markets. And UBS had bad news for its client: the money it had borrowed so cheaply for years was about to get harder to come by.

The Concord, N.H., loan group was paying investors about 5.2 percent, on average, across its outstanding bonds. But to keep investors and rating agencies happy amid a difficult market, UBS advised the group to offer a special supplement, according to the letter and an interview with a top executive of the lending group. Under the arrangement, if the lender's bonds ever stopped trading, they would pay a much higher rate - 17 percent or 18 percent, based on the particular bond.

The loan group, in its letter to investors, says it agreed to the high emergency rates "at the suggestion of UBS Securities LLC, its investment banker and broker-dealer, in order to respond to disruptions in the auction-rate securities market and attempt to prevent 'failed auctions.' "

That deal took effect on Dec. 17, more than three weeks before UBS sold some of these bonds to Richard Stahl. Stahl said there was no mention of the potential of "failed auctions," or he would never have bought the debt. And he was not told of the 17 percent rate in case the market failed. He was aware only of the 4.6 percent he was promised.

And Stahl was not alone. Here in Massachusetts, the City of Holyoke Retirement System, one of the groups involved in the attorney general's settlement, bought student loan auction-rate securities in December 2007, according to officials there, when UBS was apparently aware that there was trouble afoot in the market.

A UBS spokeswoman, Karina Byrne, said, "UBS is committed to addressing our clients' concerns about the market events that caused the breakdown of liquidity for auction rate securities." The firm is offering cash loans to clients, using their locked-up investments as collateral.

But the firm is not offering a sunny outlook. Last month, UBS said it was leaving the municipal bond business.

Stahl, 73, just wants his money back - as UBS is doing for the Massachusetts municipalities. But his request was flatly turned down, a letter from Kenneth A. Christie, UBS assistant general counsel, shows.

"I feel like Don Quixote fighting windmills," Stahl said.
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Beth Healy can be reached at bhealy@globe.com.
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www.boston.com/business/markets/articles/2008/06/09/wall_st_firm_told_only_some_about_risk/
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"Ex-UBS broker sues, alleging firm retaliated"
By Beth Healy, (Boston) Globe Staff, July 3, 2008

A former UBS broker who sold $30 million in auction-rate securities to Massachusetts towns and cities has filed a whistle-blower lawsuit against the Wall Street firm, alleging it retaliated against him for cooperating with regulators and forced him to resign.

In a complaint filed with the US Department of Labor in New York, Timothy P. Flynn alleged UBS Financial Services Inc. locked him out of his office and shut off his e-mail access shortly after he provided testimony for state Attorney General Martha Coakley's investigation of the firm in the spring. UBS settled with Coakley's office in May, agreeing to buy back $37 million in investments sold by Flynn and others at UBS to 17 towns and cities and the Massachusetts Turnpike Authority.

UBS spokesman Kris Kagel said, "The firm has taken no improper actions against Mr. Flynn. Mr. Flynn made the decision to resign of his own volition. UBS therefore denies the allegations in his claim and plans to defend itself vigorously."

According to Flynn's complaint, he agreed to speak with the attorney general after receiving a request in March. At an April 16 meeting, he told investigators UBS had led its brokers to believe that auction-rate securities were cash alternatives, similar to money markets.

Auction-rate securities are bonds issued by municipalities and nonprofits, such as student lenders. The market for the bonds shut down in February, when there were more sellers than buyers and UBS and other firms stopped using their funds to support trading. As a result, individuals, companies, and small-town treasurers were left with an estimated $220 billion stuck in securities they had been told were as safe as cash.

According to the complaint, "Flynn's testimony implicated UBS in a fraud perpetrated upon not only UBS employees but also UBS clients."

His testimony foreshadowed the fraud suit filed by the Massachusetts Securities Division last week against the firm, alleging UBS misrepresented the risks of auction-rate securities to customers and failed to disclose its conflicts in selling them. UBS said it would defend itself against the allegations.

Immediately following Flynn's testimony, a UBS lawyer offered to settle the case, according to Flynn's lawyer, Jason A. Archinaco, in Pittsburgh. At the time of the settlement, on May 7, UBS said it agreed to reimburse the cities and towns, as well as the Turnpike Authority, because state law bars those entities from putting short-term cash in anything but the safest accounts.

Flynn, 42, had worked at UBS since March 2006, according to his broker record, and was a senior vice president. After the settlement, the complaint alleges, he was twice locked out of his Manhattan office and told not to communicate with his many municipal clients in Central Massachusetts. By early May, his hard drive was taken from his computer and his access to client files was restricted, the complaint says. He was ultimately suspended, the complaint says, then told he had to resign, or face being fired.

In May, when the Globe first wrote about Flynn, the firm refused to say whether he was being disciplined. A friend of Flynn's at the time said in an interview that Flynn's superiors were not communicating with him in the days following the attorney general's announcement.

Flynn had informed his UBS superiors ahead of the meeting, in an April 2 e-mail, that he intended to cooperate with the attorney general, the complaint says. He lamented the difficulties he was facing with clients in light of the frozen auction-rate market: "Day by day, I am watching a niche market and my credibility deteriorate."

The lawyer for UBS, Kerry A. Zinn, responded to his note and in closing said, "I do not believe e-mail is an appropriate forum or vehicle for memorializing these discussions."
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Beth Healy can be reached at bhealy@globe.com.
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