UBS Sued Over Auction Rate Securities

As expected, the New York State Attorney General has filed a lawsuit against Swiss banking giant UBS for allegedly pushing everyday investors into buying troubled <"">auction rate securities.   Just days later, UBS announced that it was suspending David Shulman, its U.S. fixed income unit head and global head of municipal securities.  Though UBS would not comment on the reason’s for Shulman’s suspension, he was in charge of the auction rate securities business for the bank.

Auction rate securities are long-term corporate bonds, municipal bonds and preferred stock on which the interest rates are reset periodically based on bids submitted through securities firms. Generally, rates are reset every  seven, 14, 28 or 35 days. Because they can be sold during weekly or monthly auctions, banks and brokerages often touted auction rate securities as short-term investments or cash equivalents.  

Unfortunately, because of the crisis in the credit markets,  auctions of these securities haven’t been successful because of worries that bond insurers guaranteeing many of the $330 billion in outstanding auction bonds would be downgraded. has also reported that brokers such as Goldman Sachs Group Inc. and Citigroup Inc. also purposely permitted the auctions for preferred securities, which aren’t insured, to fail by not committing their own capital to sales when there weren’t enough bidders.  As a result, the market for auction rate bonds has pretty much vanished, leaving a lot of investors holding auction rate securities they once thought were safe vehicles with no way to sell them.

The New York lawsuit, filed last Thursday, charges UBS  with falsely marketing and selling auction-rate securities as safe, cash-equivalent investments at a time when the market for these securities was in danger of collapsing.  The Attorney General’s office said that its investigation also revealed top UBS executives sold off approximately $21 million of their personal holdings of auction rate securities, after they learned of troubles in this segment of the market.

New York Attorney General Andrew Cuomo said the aim of the lawsuit was  to get UBS to buy back the securities at their face value. Cuomo also said that his office continues to investigate a number of other financial institutions and their actions regarding auction rate securities.

This is not the first state lawsuit filed against UBS.  In June, Massachusetts state securities regulators filed a civil suit against the firm.  In that filing, the state disclosed showed several emails between Shulman and UBS executives that it claimed showed the bank suffered from conflicts of interest in its activities in the $300bn auction rate securities market, which collapsed in February.

Under pressure from regulators recently, UBS agreed to repurchase up to $3.5 billion of tax-exempt auction-rate securities from clients, package them and sell new debt backed by those securities to money-market funds.   In May, UBS also agreed to return $37 million to the Massachusetts Turnpike Authority and 17 municipalities that invested in auction rate securities.  They were not permissible investments under the municipalities’ official investment mandates.

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