UNITED STATES OF AMERICA
In the Matter of
| ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND A CEASE-AND-DESIST ORDER PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933 AND SECTIONS 15(b)(4) AND 21C OF THE SECURITIES EXCHANGE ACT OF 1934|
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b)(4) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against UBS Financial Services Inc. ("Respondent").
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the "Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over Respondent and the subject matter of these proceedings, Respondent consents to the entry of this Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b)(4) and 21C of the Securities Exchange Act of 1934 ("Order"), as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds that:1
Respondent UBS Financial Services Inc. is a broker-dealer headquartered in New York, New York, and is registered with the Commission pursuant to Section 15(b) of the Exchange Act.
During 2001 and 2002 (the "relevant period"), Respondent sold shares issued by mutual funds without providing certain customers with the reductions in front-end loads, or sales charges, also known as "breakpoint" discounts, described in the prospectuses of the funds. According to data submitted to NASD by Respondent, Respondent is estimated to have failed to give certain customers breakpoint discounts totaling approximately $4,621,768 during the relevant period. By failing to disclose to certain customers that they were not receiving the benefit of applicable breakpoint discounts, Respondent violated Section 17(a)(2) of the Securities Act. Further, because Respondent did not charge these customers the correct sales loads as set forth in the mutual funds' prospectuses, and also did not disclose in confirmations the remuneration Respondent received from the sales loads charged to these customers, Respondent violated Rule 10b-10 under the Exchange Act.
Mutual fund costs borne by investors generally fall into two categories: sales charges collected directly from shareholders for specific transactions (such as a purchase, redemption, or exchange) and fees and operating expenses imposed continuously on the fund assets.2 A "front-end load" is an industry term for a sales charge that certain fund principal underwriters or distributors charge at the time an investor buys shares. When an investor buys shares with a front-end load, the front-end load portion of the offering price is not invested in the fund, but instead is paid to the fund's principal underwriter or distributor. When the purchase is made through a broker-dealer, the fund's principal underwriter or distributor pays a part of the front-end load amount to the broker-dealer that sold the fund shares to the investor. Typically, front-end loads for shares of equity funds start at 4% to 5.75%.
A fund may offer different classes of shares. Typically, shares denominated as "Class A" charge a front-end load. Other classes (e.g., Class B, Class C, etc.) have differing sales charge and expense characteristics.3 "No-load" funds do not have any front-end or deferred sales charges.
Mutual funds that sell shares charging front-end loads usually offer discounts at certain pre-determined levels of investment, which are called "breakpoints." Front-end loads and breakpoints can vary among funds within a fund complex or across fund complexes. For example, a mutual fund might charge an investor 5.75% of the sales price for purchases of less than $50,000, but reduce the sales charge to 4.75% for investments between $50,000 and $99,999. An investor can usually procure discounts on sales charges at investment levels of $50,000, $100,000, $250,000, and $500,000. At the $1 million investment level, generally there is no sales charge.
The specific terms and conditions under which breakpoint discounts may become available are determined by the mutual funds, and can vary. Generally, an investor can procure a breakpoint discount through either a single purchase large enough to reach a breakpoint, or multiple purchases in a single mutual fund or any of the funds in a fund complex, the aggregate value of which is large enough to reach a breakpoint. In reaching a breakpoint, an investor is typically permitted to aggregate transactions made by certain family members and transactions in certain other related accounts, e.g., retirement accounts. An investor may aggregate purchases over time to meet applicable breakpoint thresholds through a "right of accumulation" ("ROA") or "letter of intent" ("LOI"). An investor may be eligible for a discount through an ROA by aggregating the amount of his or her current purchase with the amount of certain prior purchases. An LOI is a written statement of intent by the investor to purchase a certain amount of mutual fund shares over what is usually a thirteen-month period.
Mutual funds are required to disclose the schedule of available breakpoints in their prospectuses and disclose how an investor may qualify for breakpoints either in the prospectuses or in their statements of additional information, both of which are filed with the Commission on Form N-1A. Mutual funds generally incorporate by reference into their prospectuses the information included in their statements of additional information.
Broker-dealers who sell fund shares to retail customers must disclose breakpoint discount information to their customers and must have procedures reasonably designed to ascertain information necessary to determine the availability and appropriate level of breakpoints. A failure to do so can result not only in the customer being deprived of a benefit to which he or she is entitled, but also in the broker-dealer and representative receiving increased commissions at the customer's expense. See In the Matter of Application of Harold R. Fenocchio for Review of Disciplinary Action Taken by the NASD, 46 SEC 279 (1976) (registered representatives "had a responsibility to make certain that a letter of intent was filed with the mutual fund or, at the very least, to inform the clients of their rights of accumulation"). Because of the large number of mutual funds offering different discounts and employing different criteria for determining breakpoint eligibility, many broker-dealers have experienced operational challenges and other difficulties in assuring that customers consistently receive the applicable discounts. Nevertheless, each broker-dealer is responsible for exercising due care, based on information reasonably ascertainable by the broker-dealer, to provide the appropriate breakpoint discounts.
From November 2002 through January 2003, the Commission, NASD, and the New York Stock Exchange reviewed thousands of mutual fund transactions at forty-three broker-dealers that sold mutual fund shares with front-end loads. Examiners found widespread failures to deliver breakpoint discounts to eligible customers among the transactions reviewed.
As a result of the examination findings, in March 2003 NASD directed broker-dealers that processed 100 or more automated purchases of Class A mutual fund shares with front-end loads in either 2001 or 2002 to conduct a "self-assessment" of their record of delivering breakpoint discounts to customers, based on the customers' accounts and related accounts held at the broker-dealer. The self-assessment was designed to produce a statistically significant sample that would allow NASD to assess the scope of overcharges at individual member firms and to gauge the scope of the problem across the industry as a whole.
The self-assessments showed that most firms did not consistently deliver applicable breakpoint discounts to eligible mutual fund share purchasers. Overall, discounts were not delivered in about one out of five eligible transactions.4 The statistical analysis directed by NASD reflected that broker-dealers, in the aggregate, failed to deliver at least $86 million in breakpoint discounts to eligible customers in 2001 and 2002.
Based on the self-assessment data submitted by Respondent, the statistical analysis directed by NASD reflected to a 90% level of confidence that (1) Respondent failed to give its customers appropriate breakpoint discounts in 30.03% of eligible mutual fund transactions in 2001-2002, and (2) this resulted in missed breakpoints that would have reduced customers' charges by at least $4,621,768 on their purchases of mutual fund shares with front-end loads during the relevant period.
Section 17(a)(2) of the Securities Act prohibits material misstatements and omissions in any offer or sale of securities. Negligent conduct can violate Section 17(a)(2). E.g., SEC v. Hughes Capital Corp., 124 F.3d 449, 453 (3d Cir. 1997). Respondent violated Section 17(a)(2) of the Securities Act by failing to disclose to certain purchasers of front-end load mutual fund shares during the relevant period that the prices they paid for their investments did not reflect the breakpoint discounts on sales loads to which they were entitled under the terms described in the prospectuses and statements of additional information of the relevant mutual funds. See In the Matter of Robert J. Check, 49 SEC 1004 (1988) (finding violations of Section 17(a)(2) based, in part, on "generalized statistical data" showing widespread failure to provide breakpoint discounts).
Rule 10b-10 provides, in relevant part, that it is unlawful for a broker-dealer to effect any transaction for the customer's account unless the broker-dealer, at or before completion of the transaction, provides the customer with written notification disclosing "[t]he amount of any remuneration received or to be received by the broker from such customer in connection with the transaction..." 17 C.F.R. 240.10b-10(a)(2)(i)(B). The confirmations Respondent sent to customers for purchases of mutual fund shares during the relevant period did not disclose the remuneration Respondent received from front-end sales loads. Further, in those situations in which Respondent failed to apply the applicable breakpoint discount, disclosures in fund prospectuses concerning sales loads and the availability of breakpoint discounts were not, by themselves, sufficient to fully inform customers what they were paying for their shares. 5 As a result, Respondent violated Rule 10b-10 under the Exchange Act.
As a result of the conduct described above, Respondent willfully violated Section 17(a)(2) of the Securities Act, and Rule 10b-10 under the Exchange Act.6
In anticipation of the institution of these proceedings and a related disciplinary action by NASD, Respondent has agreed to pay a total penalty of $ 4,621,768, one-half of which will be paid pursuant to this order, and one-half of which will be paid pursuant to NASD's related order.
In addition, pursuant to Respondent's Letter of Acceptance, Waiver and Consent ("AWC") submitted to NASD to resolve the related disciplinary action, the Respondent has agreed to undertake certain remedial and corrective measures related to providing refunds to customers who did not receive appropriate breakpoint discounts. These measures include: (a) providing written notification to each customer who purchased front-end load mutual fund shares through Respondent, for the period specified by the AWC, that the firm experienced a problem delivering breakpoint discounts, and that, as a result, the customer may be entitled to a refund; (b) performing a trade-by-trade analysis of all front-end load mutual fund purchases of $2,500 or more, for the period specified by the AWC, which review would encompass all other purchases during that same time period, regardless of dollar amount, by such customers; (c) undertaking vigorous efforts to locate each customer so identified as entitled to a refund and promptly making refunds to all customers who did not receive all applicable breakpoint discounts; and (d) providing a report on Respondent's refund program to NASD.
In determining whether to accept Respondent's Offer, the Commission has considered the related NASD action, including the penalty that Respondent has agreed to pay to resolve that action, and the remedial actions that Respondent will undertake for the benefit of affected investors pursuant to the NASD action.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in Respondent UBS Financial Services Inc.'s Offer.
Accordingly, it is hereby ORDERED:
A. Pursuant to Section 15(b)(4) of the Exchange Act, that Respondent is censured;
B. Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that Respondent shall cease and desist from committing or causing any violations and any future violations of Section 17(a)(2) of the Securities Act, and Rule 10b-10 under the Exchange Act;
C. Within 10 days of the entry of this Order, Respondent shall pay a civil money penalty in the amount of $2,310,884 to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (D) submitted under cover letter that identifies UBS Financial Services Inc. as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Lawrence A. West, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street N.W., Washington, D.C. 20549-0801;
D. Respondent shall pay disgorgement and prejudgment interest, which obligation shall be satisfied by compliance with the customer refund program summarized in Section V above, and more fully set forth in NASD's related order; and
E. Not later than 6 months after the date of this order, unless otherwise extended by the staff of the Commission for good cause shown, Respondent's chief executive officer shall certify in writing to the staff of the Commission that Respondent has implemented procedures, and a system for applying such procedures, that can reasonably be expected to prevent and detect failures by Respondent to provide appropriate breakpoint discounts for which customers are eligible on purchases of front-end load mutual funds, based on information reasonably ascertainable by Respondent.
By the Commission.
Jonathan G. Katz
1 The findings herein are made pursuant to Respondent's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.
2 Annual operating expenses are not charged directly to investors but are deducted from fund assets. These expenses include the management fee, an ongoing charge paid to an investment adviser who manages the fund's assets and selects its portfolio of securities. Some funds charge a Rule 12b-1 fee, named for the rule under the Investment Company Act of 1940 that authorizes mutual funds to pay for distribution expenses, including sales charges used to compensate sales professionals for selling fund shares, directly from a fund's assets. In addition, a fund may also pay a service fee to compensate sales professionals, or other service providers, for ongoing services to investors or their accounts. In addition, all mutual funds incur brokerage and other transaction-related costs that are borne indirectly by the investors in the funds.
3 For example, Class B shares generally carry "contingent deferred sales charges," which means that a charge is assessed if shares are redeemed within a certain number of years after purchase. Class B and Class C shares generally impose higher 12b-1 fees, but impose no front-end load.
4 For purposes of the self-assessment, "eligible transactions" were automated purchases of Class A shares of at least $2,500 in which a sales charge of 1% or more was charged to the customer and a breakpoint discount was applicable.
5 When it adopted Rule 10b-10 in 1977, the Commission stated that if information regarding the "source and amount" of the remuneration is contained in a prospectus delivered to a customer, then broker-dealers do not have to repeat the information in a confirmation. Of course, if a broker-dealer received remuneration which was not disclosed in the prospectus, that remuneration would be required to be separately disclosed on a confirmation. See Securities Exchange Act Release No. 13508 (May 5, 1977). The funds' prospectuses disclosed that the customers were entitled to certain breakpoint discounts, which they did not receive. The confirmations did not correct this prospectus representation and were therefore misleading.
6 "Willfully" as used in this Order means intentionally committing the act which constitutes the violation, see Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). There is no requirement that the actor also be aware that he is violating one of the Rules or Acts.
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