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Regulation and Compliance > Federal Regulation > FINRA

FINRA, SEC Wallop UBS Puerto Rico With $33.5M in Penalties Over Closed-End Funds

By James J. Green

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The Financial Industry Regulatory Authority today censured UBS Financial Services of Puerto Rico (UBSPR) for supervisory failures and fined the UBS subsidiary a total of $18.5 million, with the Securities and Exchange Commission adding $15 million in disgorgement, interest and penalties against UBSPR in the same case.

FINRA charged UBSPR with shirking its supervisory responsibilities by failing to ensure the suitability of transactions in Puerto Rico closed-end funds (CEFs) for certain clients, and for encouraging certain clients to open lines of credit (LOCs) to purchase more shares of Puerto Rican CEFs.

FINRA says the poor supervision persisted “for more than four years,” with UBSPR failing to “monitor the combination of leverage and concentration levels in customer accounts to ensure that the transactions were suitable given the customers’ risk objectives and profiles.”

In settling the case, UBSPR neither admitted nor denied the charges.

Those closed-end funds were heavily invested in Puerto Rican bonds, which have plummeted in value, especially in August, “requiring the customers to pay down a portion of the loans or risk having their investments liquidated,” the SEC said in a statement.  

The SEC charges that UBSPR and a branch officer, Ramiro Colon, failed to supervise a registered rep, Jose Ramirez, in UBSPR’s Guaynabo branch office. It was Ramirez, the SEC says, who encouraged clients to invest in UBSPR-affiliated closed-end funds using money the clients borrowed from a UBSPR-affiliated bank — UBS Bank USA.

UBSPR and the bank prohibited using such loans to purchase securities, and the practice exposed investors to losses while producing profits for the former UBSPR broker, the SEC alleged.

UBSPR agreed to settle the SEC case by paying $15 million that will be placed into a fund for investors harmed in the fraud.

In a separate action, the SEC filed a complaint in Puerto Rico federal court against Ramirez for increasing his compensation by $2.8 million by “having certain customers use proceeds from lines of credit with UBS Bank USA to purchase additional shares in UBSPR closed-end mutual funds.”

The SEC alleges that Ramirez told customers to transfer money from their lines of credit to an outside bank account “to evade detection” before depositing the funds into their UBSPR brokerage accounts and purchasing the closed-end funds.

The branch manager, Colon, was fined $25,000 and was suspended from his supervisory role for a year. UBSPR agreed to settle with FINRA as well by paying $7.5 million in fees and $11 million to help reimburse 165 investors who FINRA said “were forced to realize losses on their CEF positions.”

In a statement, Brad Bennett, FINR’s executive vice president of enforcement, said UBS Puerto Rico “operated in a unique economy and ultimately failed to tailor its supervisory systems to its specific business needs.” According to FINRA, in Puerto Rico’s “unique economy” retail customers “typically maintained high levels of concentration in Puerto Rican assets and often used those highly concentrated accounts as collateral for cash loans. Despite UBS PR’s knowledge of these common practices, it failed to adequately monitor concentration and leverage levels to identify whether certain customers’ CEF transactions were suitable in light of the increased risks in their existing portfolio.”

Residents of Puerto Rico tend to concentrate their holdings in securities like the island’s municipal bonds because income derived from Puerto Rico sources is exempt from U.S. federal taxes.

As reported in January by ThinkAdvisor’s Melanie Waddell, 2015 Regulatory and Examination Priorities Letter, FINRA said it was concerned with retail customers’ use of leverage through securities-backed lines of credit.

— Check out Puerto Rico Loophole Utilized by UBS Targeted by House Lawmaker  on ThinkAdvisor.

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