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Home > Cases > UBS Auction Rate Securities >E-Mails Once Again Tell Wall Street's Story

E-Mails Once Again Tell Wall Street's Story

“The words “conflicts of interest” and “Wall Street” have become almost indistinguishable from each other these days. Credibility was added to this notion last week courtesy of e-mail messages concerning auction-rate securities - messages that ultimately led to Swiss-based financial giant UBS becoming one of the first investment banks to face fraud and securities charges since the auction-rate market seized up in February.”

Risk management and accountability were the subject of a June 29 New York Times column by Gretchen Morgenson in which she laid out in black and white a seemingly elaborate subterfuge that UBS took part in to palm off auction-rate securities on unsuspecting investors when all the while the company knew the auction market was headed for disaster.

UBS is far from alone in its dealings with investors over auction-rate securities. As Morgenson writes in her Sunday column, every major brokerage firm that participated in the auction-rate securities market faced the same conflicts of interests as both underwriters of the securities and as managers of the auctions that set their prices, making it likely that the recent legal troubles of UBS will again reappear in the coming days and weeks as securities regulators continue their investigations.

Auction-rate securities are preferred shares or debt instruments with rates that reset every seven, 14, 28 or 35 days. The securities - which have long-term maturities or, in the case of the preferred shares, no maturity dates - typically are issued by municipalities, student-loan companies, closed-end funds and non-profit institutions such as a hospital.

The first signs of distress in the $330 billion auction market appeared in February, when investment banks that once supported the auctions for the securities pulled back their support and no longer stepped in as a buyer of last resort. Investors holding the securities were then left with an illiquid product that they previously thought was a safe, cash-alternative investment. In the end, thousands of investors no longer had access to their money to finance a new home, retire, pay for their children’s college education or do any of the things they previously planned.

The Devil is in the E-mails

In the complaint filed June 26 by William F. Galvin, secretary of the Commonwealth of Massachusetts, UBS is accused of defrauding investors by marketing and selling auction-rate securities as cash equivalent, ultra-safe investments. The lawsuit also charges that UBS knowingly unloaded auction-rate securities on individual investors in an attempt to minimize its own exposure to the impending risks of the securities.

Galvin's assertions apparently are backed up by UBS' own e-mails. When the credit markets began a downward spiral last summer, corporations - major buyers of auction-rate securities - were beginning to sell, according to Morgenson's article. New buyers needed to be found or UBS, as the underwriter and auction manager, would be left holding the securities. Already having taken billions of dollars in subprime-related write-downs onto its books - only Citigroup has taken more - the Switzerland-based bank had to get out of the auction-rate securities fiasco and fast.

As reported in Morgenson's New York Times' column and affirmed in the Massachusetts complaint against UBS, e-mail messages among UBS executives became rampant during the fall leading up to the auction-rate market's collapse. “As you can imagine during these stressful times, the pressure is on to move our inventory,”wrote David Shulman, who is the global head of fixed income distribution at UBS. “I am aware that JPM [JPMorgan Chase] and Citi [Citigroup] are on all ’alert‚ in the same fashion with their retail groups.”

Another high-level UBS executive, Joel P. Aresco, stated in a Nov. 15 e-mail: “Why the continual increase in the inventory of auction-rate securities? What measures are being taken to reduce this exposure?”

About a month later, Shulman wrote: “I am pushing every angle here to move product.”

Coincidentally, some of the “product” Shulman was pushing had to do with his own auction-rate investments. As of Dec. 12, Shulman had dumped all of his ARS holdings.


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