More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- Disaster Recovery Plans and Succession Planning RIAs owe a fiduciary duty to clients to prepare for disasters and other contingencies. If an RIA does not have a disaster recovery plan, clients financial well-being may be jeopardized. RIAs should also engage in succession planning, ensuring a smooth transaction if an owner or principal leaves.
UBS on Tuesday agreed to pay nearly $50 million to settle charges by the Securities and Exchange Commission that a brokerage unit violated securities laws while structuring and marketing a collateralized debt obligation (CDO) and by failing to disclose that it retained millions of dollars in upfront cash it received in the course of acquiring collateral for the CDO.
The SEC’s investigation found that UBS Securities, a brokerage unit of the Zurich-based parent bank, 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, the SEC says that UBS retained the full amount of upfront payments in addition to its disclosed fee of $10.8 million.
George Canellos, co-director of the SEC’s Division of Enforcement, said in a statement that “UBS kept $23.6 million that under the terms of the deal should have gone to the CDO for the benefit of its investors.” In doing so, “UBS misrepresented the nature of the CDO’s collateral and rendered false the disclosures about how that collateral was acquired.”
Without admitting or denying the SEC’s findings, 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.
Said the SEC: “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, the SEC says, 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.
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—the same company that managed the failed CDO for Goldman Sachs—was collateral manager for the UBS structured 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, the SEC says. 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 SEC says that 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.