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UBS to Pay $50 Million to Settle SEC Charges of Misleading CDO Investors


Washington D.C., Aug. 6, 2013 —

The Securities and Exchange Commission today charged UBS Securities with violating securities laws while structuring and marketing a collateralized debt obligation (CDO) by failing to disclose that it retained millions of dollars in upfront cash it received in the course of acquiring collateral for the CDO.

UBS agreed to pay nearly $50 million to settle the SEC’s charges.

The SEC’s investigation found that UBS received $23.6 million in upfront payments in the process of acquiring credit default swaps (CDS) as collateral.  Rather than transferring this cash to the CDO when the collateral was transferred, UBS retained the full amount of upfront payments in addition to its disclosed fee of $10.8 million.  Not only did UBS go on to market the deal using materials that omitted any reference to its retention of the upfront payments, but the materials inaccurately represented that the CDO had to acquire all collateral at either fair market value or the price it was acquired by UBS.  This representation was inaccurate because the CDO did not receive the $23.6 million in upfront cash kept by UBS as an additional undisclosed fee, and the collateral was not acquired at fair market value.

“UBS kept $23.6 million that under the terms of the deal should have gone to the CDO for the benefit of its investors,” said George S. Canellos, Co-Director of the SEC’s Division of Enforcement.  “In doing so, UBS misrepresented the nature of the CDO’s collateral and rendered false the disclosures about how that collateral was acquired.”

According to the SEC’s order instituting settled administrative proceedings, UBS structured the CDO known as ACA ABS 2007-2 in mid-2007.  ACA Management was collateral manager for the CDO.  The collateral for the CDO consisted primarily of CDS on subprime residential mortgage-backed securities (RMBS).  The CDS essentially operated as a kind of insurance against certain defaults in the underlying RMBS.  As the “insurer,” the CDO received monthly premiums from the CDS collateral.  The premiums were in turn used to make required payments to bondholders of the CDO.

According to the SEC’s order, ACA solicited bids on the CDS collateral, with those offering the highest yields becoming the winning bidders.  Typically, the collateral manager would seek to achieve the highest yield in the form of periodic interest payments, known as a running spread.  However, for this particular CDO, UBS and ACA agreed that ACA would seek bids for yield in two components: a fixed running spread plus upfront cash payments in the form of “points” like those on a mortgage.  The running spread plus the upfront points combined to equal the yield on the CDS. 

According to the SEC’s order, as a result of the bidding process, ACA ended up acquiring CDS having upfront payments totaling $23.6 million.  These payments were made to UBS as part of the process of acquiring collateral for the CDO.  From the outset, UBS employees working on the CDO intended for UBS to retain the upfront cash.  Early in the structuring, the head of the U.S. CDO group at UBS stated, “Let’s see how much money we can draw out of the deal.” Similarly, the manager of UBS’s CDO syndicate book viewed the CDO as an “arbitrage opportunity” for UBS to make trading gains when selling the assets into the CDO.  In early May 2007, after the CDO was partially ramped using CDS with upfront points, UBS employees discussed two ways to retain the upfront points: 1) contributing the upfront points to the CDO and arranging to have the CDO pay them back to UBS on a fully disclosed basis, or 2) simply keeping the upfront points without disclosing their retention to prospective investors.  After consulting with UBS in-house counsel, UBS CDO desk employees ultimately decided in favor of an undisclosed retention of the upfront points, which was inconsistent with the industry standard.  And when UBS structured prior deals with upfront points, the points had been transferred to the CDO at closing.  

According to the SEC’s order, the offering circular for ACA ABS 2007-2 stated that the CDO had to acquire all collateral “on an ‘arm’s-length basis for fair market value.”  The CDO’s indenture contained the same requirement, and ACA’s collateral management agreement required it to seek best execution on behalf of the CDO.  UBS and ACA together prepared an asset list in connection with UBS’s effort to market the CDO to investors beginning in mid-May 2007.  The asset list was distributed to prospective investors, and it did not contain any reference to the upfront points.  Inaccurate information similarly was provided to the CDO’s directors.  The marketing materials disclosed a fee to UBS of approximately $10.8 million, but made no reference to the $23.6 million in upfront points being retained by UBS.

In the settlement, UBS agreed to pay disgorgement of the $23.6 million in upfront payments as well as the disclosed fee of approximately $10.8 million plus prejudgment interest of approximately $9.7 million and a penalty of $5.7 million.  Without admitting or denying the SEC’s findings, UBS consented to the entry of an order finding that it violated Section 17(a)(2) and Section 17(a)(3) of the Securities Act of 1933, and negligently caused ACA to violate Section 206(2) of the Investment Advisers Act of 1940.

The SEC’s investigation was conducted by Lara Shalov Mehraban, David Stoelting, Sharon Bryant, Tracy Sivitz, Kristine Zaleskas, Joshua Pater, and Kenneth Gottlieb of the New York Regional Office.


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