New York sues UBS, alleges auction-rate fraud

New York State sued UBS on Thursday, accusing the Swiss bank of committing a "multi-billion dollar fraud" by steering broker clients into auction-rate securities that became impossible to sell once the credit market tightened.
The lawsuit, filed by New York State Attorney General Andrew Cuomo, accuses UBS of deceptively selling auction-rate securities as cash equivalents. These long-term securities are issued by municipalities, student-loan companies and mutual funds, and interest rates are set through weekly or monthly auctions.
The lawsuit said that at least seven UBS executives dumped $21 million in auction-rate securities that they held in personal accounts as the credit market began showing signs of trouble, and that the bank continued to sell those securities.
UBS "continued the fraud after they knew the fraud was revealed for what it was," Cuomo said at a news conference. "Top executives jumped ship as soon the securities market started to collapse, leaving thousands of customers holding the bag."
Cuomo said that in February more than 50,000 UBS customers across the United States held more than $25 billion in illiquid securities. The Attorney General's office did not sue individuals, but Cuomo said the investigation was continuing.
UBS said it would defend itself against the charges.
NATIONWIDE SWEEP
The lawsuit is the first to arise from the state's investigation into how brokerages handled the $330 billion auction-rate market. In April, Cuomo sent subpoenas to 18 brokers and banks.
These securities were popular among investors because they offered higher yields than money-market funds and were seen as equally liquid.
The market for auction-rate securities froze when investors, spooked by tighter credit, stopped buying them. Wall Street firms, which long provided liquidity, were overwhelmed by selling and one by one they stopped propping up the market with their own bids.
By late January auctions began to fall apart, and suddenly securities promoted as cash-equivalents became impossible to liquidate. At the same time, issuers such as New York's Port Authority were forced to pay higher rates.
Massachusetts and Texas have also taken legal actions against UBS, contending it continued promoting auction-rate securities as safe when they knew they were risky.
Cuomo wants UBS to buy back auction rate securities from defrauded customers at face value, to disgorge any ill-gotten gains and pay restitution and other damages. Cuomo declined to estimate the extent of these damages.
"UBS is not alone in this scheme. There are other institutions which participated, but UBS is a major player," he said.
JUMPING SHIP
Starting in late 2007, the lawsuit said, UBS management became concerned about its auction-rate holdings and formed a working group.
The lawsuit contends that at least seven working group members sold $21 million of their personal auction-rate holdings after the group was formed.
During this period UBS looked for ways to pare down its own inventory of auction-rate securities, and while many options were discussed, the one repeatedly implemented was increasing sales of auction-rates to UBS clients, the lawsuit said.
As one key piece of evidence, the lawsuit cited a Dec. 14, 2007, e-mail from "UBS's chief risk officer" to "UBS's CEO" discussing his concerns about the auction-rate market.
A copy of that e-mail was also sent to an unnamed executive, who four days later liquidated all $250,000 of his own auction-rate securities. These markets began to break down in January.
UBS denied any claim that it engaged in a campaign to move its own auction-rates into private accounts. The bank notes it nearly doubled its inventory to about $11 billion during the first quarter, while its clients reduced their positions.
"UBS continued to support the auctions longer than any other major firm," said UBS, adding that it was trying to help clients with auction-rate securities.
Last week, UBS announced a plan to buy back as much as $3.5 billion in auction-rate securities from customers. Cuomo on Thursday dismissed that offer as insufficient.
"The resolution can't be that some guys get back some of their money, he said. "People want their money back. Not some of it. Not a little today and a little more tomorrow. My job is to get their money back." (Reuters)