The SEC on Tuesday today charged UBS Financial Services Inc. of Puerto Rico and 2 executives with making misleading statements to investors, concealing a liquidity crisis, and masking its control of the secondary market for 23 proprietary closed-end mutual funds.  UBS Puerto Rico agreed to pay $27mn, to settle the SEC charges; the monies will be placed in a fund for harmed investors. SEC Findings and Allegations. UBS Puerto Rico allegedly knew about a significant “supply and demand imbalance” and discussed the “weak secondary market” internally. But investors were misled and were not informed that UBS, itself, controlled the secondary market, where investors sought to sell their shares in the funds.  Further, UBS Puerto Rico further increased its inventory holdings in the C/E funds significantly, in order to prop up market prices, bolster liquidity, and promote the appearance of a stable market.  Yet, UBS Puerto Rico later withdrew its market price and liquidity support in order to sell 75% of its C/E fund inventory to unsuspecting investors.

[C-I Note: In some ways, this case has a familiar ring to it - i.e., somewhat akin to the Auction Rate Securities (ARS) markets scandals of several years ago.  In the ARS cases, firms for years had supported the weekly or monthly ARS auctions by buying holdings from customers whenever demand was lacking.  This enabled firms to tout ARS securities as being safe and liquid - much like money market funds - only they carried higher interest rates.

All was fine or, at least, not objectionable to the regulators.  However, by early 2009, the public's demand for those securities dried up, and firms stopped decided to no longer support the periodic auctions.  This left ARS investors stuck with their investments with no secondary market.  The price of ARS securities dropped precipitously.  However, many broker-dealers continue to market the ARS securities as they had in the past - as substitutes for money market funds - which was misleading because such marketing claims no longer were accurate.]

“UBS Puerto Rico denied its C/E fund customers what they were entitled to under the law – accurate price and liquidity information, and a trading desk that did not advantage UBS’s trades over those of its customers.” -- Robert Khuzami, Enforcement Director.

SEC Findings Pertaining to 2 UBS-PR Executives. The SEC also instituted contested administrative proceedings against UBS Puerto Rico’s vice chairman and former CEO Miguel Ferrer and head of capital markets Carlos Ortiz.  In 2008, UBS Puerto Rico began soliciting thousands of retail investors by promoting the C/E funds’ market performance and continuously high premiums to net asset value (up to 45%) as the result of supply and demand in a competitive and liquid secondary market. When investor demand began to decline, UBS Puerto Rico sought to maintain the illusion of a liquid market by buying shares into its own inventory from customers who wished to exit the market.  Despite a falling market, UBS Puerto Rico continued to sell shares by conducting primary offerings in order to grow its C/E fund business. Throughout this period, UBS Puerto Rico failed to disclose the true state of the market to investors. In the spring of 2009, UBS Puerto Rico’s parent firm determined that its business unit growing C/E fund inventory represented a financial risk, and directed the firm to reduce its inventory by 75% to reduce that risk and “promote more rational pricing and more clarity to clients . . . [so] prices transparently develop based on supply and demand.”  To accomplish the reduction, UBS Puerto Rico executed a plan dubbed “Objective: Soft Landing” in one document, which included:

• Undercutting numerous marketable customer sell orders to “eliminate” those orders and liquidate UBS Puerto Rico’s inventory first, preventing customers from selling their shares.
• Not disclosing that UBS Puerto Rico was drastically reducing its inventory purchases.
• Soliciting customers to sell recently purchased primary offering shares back to the C/E fund companies, so UBS Puerto Rico could then sell C/E funds to those customers from its highest inventory positions.
• UBS Puerto Rico also increased solicitation efforts to further reduce its inventory while making misrepresentations and failing to disclose UBS Puerto Rico’s withdrawal of secondary market support.

According to the SEC’s order against Ferrer and Ortiz, Ferrer made misrepresentations and did not disclose numerous material facts about the C/E funds - e.g., although Ferrer was well aware of the supply and demand imbalance and privately discussed UBS Puerto Rico’s growing inventory and support of the market, he caused UBS Puerto Rico to conduct new primary C/E fund offerings while directing financial advisors to represent to customers that the market was experiencing “low volatility” and providing “superior returns.” Ferrer also repeatedly made misleading statements about C/E fund market prices and touted that the funds would always trade at high premiums to net asset value, even while UBS Puerto Rico was substantially reducing its inventory and causing huge investor losses. Ortiz falsely represented that C/E fund shares were priced based on supply and demand while in reality he and the firm concealed the inventory increases and rarely changed prices, allowing UBS Puerto Rico to promote the façade of a liquid, stable market. As UBS Puerto Rico was reducing its inventory in 2009, Ortiz touted increased C/E fund secondary market liquidity and superior price performance to investors at a UBS investor conference. At the same time, Ortiz was executing UBS Puerto Rico’s inventory reduction scheme that involved “eliminat[ing]” marketable customer sell orders to dump UBS Puerto Rico’s inventory first, putting UBS Puerto Rico’s interests ahead of their customers’ orders. Rule Violations and SEC Sanctions. For allegedly violating Section 17(a) of the Securities Act of 1933, Sections 10(b) and 15(c) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, the SEC ordered, and UBS Puerto Rico agreed, the payment of $11.5mn in disgorgement, $1.1mn in prejudgment interest, and $14mn in penalties. UBS Puerto Rico also was ordered to retain an independent consultant at the firm's own expense.  Among other things, the independent consultant will review the adequacy of UBS Puerto Rico’s C/E fund disclosures and trading and pricing policies, procedures, and practices. UBS Puerto Rico shall abide by the determinations of the consultant and adopt and implement all recommendations. SEC Staff Credits. Investigation by Jason Berkowitz, Sean O’Neill of the Miami Reg'l Office;  initial exam by Carlos Gutierrez,  Brian Dyer, as supervised by Nicholas Monaco, John Mattimore, also of Miami office.  Robert Levenson, Edward McCutcheon will lead the SEC’s litigation. For further details, go to:  [SEC PR 12-81, 5/1/12] along with:

• Order Against UBS Financial Services Inc. of Puerto Rico
• Order Against Miguel A. Ferrer and Carlos J. Ortiz