(Bloomberg) -- Walter Michaelsons career on Wall Street ended 19 years ago when he injured his neck in an auto accident in New York. Now he lives near the Gulf Coast in Naples, Fla., where he cares for his quadriplegic mother.
In July, he filed a lawsuit in federal court in Florida against UBS Group for selling him a complex financial product that he claims he didnt ask for, wasnt explained properly and lost him more than $100,000.
UBSs V10 Enhanced FX Carry Strategy was sold to individual investors like Michaelson, as well as to businesses and fund managers. It was pitched as a high-yielding foreign-exchange investment that used computer algorithms to minimize the risk of losses in periods of volatility, according to a document on the banks website. When the European debt crisis hit in mid-2010, the index to which the notes were tied lost 26% in two years, data compiled by Bloomberg show.
Now investigators at the Department of Justice are examining whether UBS traders shortchanged investors such as Michaelson by overcharging them when they carried out the currency trades needed to execute the strategy, according to people with knowledge of the matter. The probe of the lucrative and opaque world of so-called structured products sold by banks including UBS marks a widening of an investigation by regulators into the $5.3 trillion-a-day foreign-exchange market.
'FULL CONTROL'
The banks hold all the cards: They create these products, sell them and have full control over what they disclose about them, said Stephen Elam, a London-based lawyer at Cooke, Young & Keidan. In this environment, when interest rates are low and consumers are looking for improved investment returns, these products are inherently prone to mis-selling.
UBS said in a statement that the bank plans to defend itself vigorously against Michaelsons claims. A spokesman for Zurich-based UBS declined to comment about the Justice Department investigation.
As European bank stocks climbed last week, UBS slid 1.3% after news of the probe and as the firm warned that a surge in the Swiss franc and negative interest rates in the region may hurt profitability if they persist. UBS shares dropped 0.6% at 16.12 francs at 10:03 a.m. in Zurich trading. They have decreased about 5.6% this year.
The currency product not only generated sales commissions for the bank but also presented an opportunity to profit from the buying and selling of the underlying currencies. V10 was particularly profitable for UBS, according to two people with knowledge of the matter who said returns were circulated and discussed within the firm. The people asked not to be identified because they werent authorized to speak publicly.
V10 PROBE
The Justice Department is examining instant messages, interviewing traders and reviewing documents given to customers to determine whether the bank misrepresented the profit it was taking on the trades, one of the people said. Peter Carr, a Justice Department spokesman, declined to comment.
One of the issues with complex structured products that investors sometimes dont understand is that often the payoff is not just determined by a set of rules but also by the traders executing the strategy, said Neil Pearson, a University of Illinois College of Business finance professor who wrote an article titled The Dark Side of Financial Innovation.
In 2013, as regulators began investigating the foreign- exchange market, UBS looked into the V10 product, according to a person with knowledge of the matter.
FINRA COMPLAINT
The Swiss lender and five other banks paid $4.3 billion to regulators in the U.S., the U.K. and Switzerland in November in the first round of settlements from the probe. UBS is still under investigation by antitrust and criminal authorities, and 11 current and former employees, including staff on the structured-products desk, are facing enforcement action from the Swiss markets regulator, people with knowledge of the probe have said. That could include bans from the industry or disgorgement of profits, one said.
Michaelson, 56, withdrew his lawsuit last month and moved his claims to the Financial Industry Regulatory Authority, an industry group that arbitrates disputes with brokers, according to his lawyer, Christopher Vernon of Vernon Litigation Group in Naples. Vernon, who became Michaelsons lawyer in October, said these types of disputes are typically handled in arbitration.
UBS didnt file a response to Michaelsons lawsuit before it was withdrawn.
STARBUCKS PITCH
Investors in the structured product bought notes whose value was tied to an index called the V10. Marketing documents on UBSs website show how the index was calculated: First, currencies from the Group of 10 countries are ranked daily by their one-month interest rates. Using forward contracts, the bank bets that the three highest-yielding currencies will advance and the three lowest will decline. When volatility rises above a predetermined level, the positions are reversed.
Over coffee at a Starbucks near his house and in phone calls in 2009 and 2010, representatives from UBSs wealth- management office in Naples pressed Michaelson, who had an investment account at the bank, to take out a loan and invest it in the V10 product, according to the complaint filed in U.S. District Court in Ft. Myers, Florida.
Michaelson, who changed his name from Walter Mihailovich, was a trader in over-the-counter U.S. government bond options at NationsBank, a predecessor to Bank of America, when he was involved in a crash on the FDR Drive in Manhattan, according to Vernon. He was a Collier County co-chairman for Mitt Romneys 2008 presidential campaign. In 2009, he filed a lawsuit against Serbias privatization ministry in a dispute over a tender for a building-materials company.
TOTAL LOSSES
When Michaelson agreed with UBS to replace a $1 million home-equity loan he had from another bank, the paperwork was altered after he signed so he received a business loan instead of a personal one, he said in the complaint. That meant UBS could take collateral assets equal to five times the value of his home, according to the lawsuit.
UBS employees promised the V10 notes would give him annual returns of at least 7% and as much as 15% while preserving his capital, he claimed.
In mid-2010, Michaelson alleged, he received another call from UBS asking him to invest more in V10. After hearing that his investment was up $70,000, he instead decided to close the position and take his profits, at which point he was told he had in fact lost $127,000, he said in the complaint.
Michaelsons request to sell his V10 investment was delayed as staff at UBSs Naples office and at its trading desk in New York discussed how much they were willing to give him, according to the complaint. Meanwhile, UBS required Michaelson to repay the loan in full by mid-August 2010, he said.
Michaelson said his total losses from his dealings with UBS, including on V10, amounted to $350,000.
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