UBS Financial Services, Inc., agreed to pay nearly $11 million in fines and restitution to settle FINRA charges they effectively misled some investors on 100% Principal-Protection Notes (PPNs) issued by Lehman Brothers Holdings prior to that firm's bankruptcy in September 2008.  FINRA focused on omissions and statements by the firm and its financial advisors as it related to the "principal protection" feature.  In settling this matter, UBS neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

PPNs are fixed-income security structured products with a bond and an option component that promise a minimum return equal to the investor's initial investment. 

        FINRA Allegations.    From March to June 2008 as the credit crisis worsened, UBS advertised and some UBS financial advisors ("FA's") described the structured notes as principal-protected investments and failed to emphasize they were unsecured obligations of Lehman Brothers, which eventually filed for bankruptcy in September 2008.   Specifically, UBS allegedly: 

• failed to emphasize adequately to some investors that the principal protection feature of the Lehman-issued PPNs was subject to issuer credit risk;
• didn't properly advise UBS FA's of the potential effect of the widening of credit default swap spreads on Lehman's financial strength, or provide them with proper guidance on the use of that information with clients;
• failed to establish an adequate supervision over the sale of the Lehman-issued PPNs;
• failed to provide sufficient training and WSP's;
• didn't adequately analyze the suitability of sales of the Lehman-issued PPNs to certain UBS customers;
• created and used advertising materials that had the effect of misleading some customers about specific characteristics of PPNs.

Brad Bennett, FINRA EVP and Chief of Enforcement, said:  "This matter underscores a firm's need to be clear and comprehensive in disclosing risks of the structured products it sells to retail investors. In cases, UBS' financial advisors did not even understand the complex products they were selling, and as a result, they neglected to disclose necessary information to customers about the issuer's credit risk so investors would understand the magnitude of the potential losses." 

        Incorrect Information Communicated to Customers.  Some UBS FA's didn't understand the product, including the limitations of the "protection" feature.   Consequently, certain of them communicated incorrect information to their customers. 

That was compounded by the fact certain advertising materials had the added effect of misleading customers re: the characteristics and risks of the PPNs, including the nature, scope and limitations of the 100% Principal-Protection Notes.  The materials suggested that a return of principal was guaranteed if customers held the product to maturity;  however, UBS didn't adequately address the importance that credit risk could result in loss of principal.

UBS's suitability procedures were also lacking - i.e., UBS lacked risk profile requirements for certain PPNs.  As a result, the PPNS sales to some investors were not suitable, including investors with "moderate" and "conservative" risk profiles.  These particular investors also were more likely to rely on UBS' representations about the "100% principal protection" feature of Lehman PPNs because of their risk averse investment objectives.

        FINRA Enforcement Staff Credits.    Senior counsels Audra Acquavella, Miranda Chatelain, Peter Schlossman;  Investigators Karina Bjelland, Pradeepta Roy;  Director Myles Orosco, Chief Counsel Linda Riefberg, with assistance of FINRA Advertising Regulation.   [FINRA News Release, 4/11/11]

For further details, go to:   [UBS AWC Letter, 4/1/11]