It's hardly any secret that regulators are carefully examining e-mail archives to uncover wrongdoing, but the recent settlement that regulators reached with UBS Financial Services reveals just how critical the electronic paper trail has become to some investigations and exactly how costly it can be when a firm doesn't retain those records.
The broker/dealer unit of European banking giant UBS AG, UBS Financial Services, agreed on Jan. 12 to pay $49.5 million to New Jersey regulators and the New York Stock Exchange to settle charges of illegal market timing. The malfeasance, regulators say, occurred between 1999 and 2002 at the Paramus, N.J., branch of UBS Financial Services when it was UBS PaineWebber, as well as six other locations. The firm neither admitted nor denied the charges.
Brokers named in the case include Christopher Chung and William Savino. Both men left UBS in January 2002 for a brokerage unit of Merrill Lynch, where they ran into additional trading abuse allegations. Chung and Savino, court records show, placed close to 16,000 short-term mutual fund trades on behalf of the New York hedge fund Millennium Partners to generate nearly $10 million for UBS, making them two of the firm's top 10 producers. During the relevant period, fund firms issued 150 stop letters and nearly 1,000 trade rejections to UBS naming Chung and Savino, records indicate.
Also named in the case are brokers Carolyn Song Pegg and Scott Shedden. Together, records indicate, they accounted for 244,000 market-timing transactions that earned $11 million for UBS. Over the market-timing period, fund firms issued a combined 1,050 stop letters to UBS naming Song Pegg and Shedden.
In separate news from the New Jersey Attorney General last week, the notorious hedge fund Canary Capital Partners agreed to pay $10 million for its leading role in the scandal. Officials would not comment on the timing of the settlement, which comes more than two years after its managing principal, Edward Stern, struck a $40 million plea bargain with New York Attorney General Eliot Spitzer over late-trading and market-timing allegations. New Jersey officials did say, however, that Stern has been cooperating with ongoing investigations by the New Jersey A.G. into the securities industry in the Garden State and will continue to do so going forward. In addition, Stern and Canary agreed to a 13-year suspension from broker/dealer and investment advisor activities.
While the UBS penalty is the largest securities fraud settlement New Jersey has ever collected and adds to the nearly $4 billion regulators have claimed from fund companies and their intermediaries since the scandal broke in 2003, it is perhaps of particular note because of the degree to which it takes the firm to task for not retaining important e-mails. For instance, the Securities and Exchange Commission rang up a brokerage unit of Bank of America last year for not sufficiently retaining its e-mails, but the $1 million fine it paid pales in comparison to the penalty UBS will shoulder.
According to court documents, the Weehawken, N.J.-based unit could not provide a number of internal and external e-mails produced between September 1999 and August 2001 that concerned market-timing activities. The firm did not disclose to regulators until June 2005 that it had not retained the documents, which disadvantaged their investigation by limiting the understanding of what might have been occurring at the firm during that time.
Furthermore, regulators argue, the missing e-mails precluded investigators from reviewing communication from the highest levels of UBS management about market timing during a critical period.
Although New Jersey officials admit that clearer securities laws regarding e-mail retention were only recently added to the Securities Exchange Act of 1934, they noted that UBS violated the spirit of a records regulation that's been on the books for many years.
"These kinds of companies must retain certain records, and the position we would take is that they would have had to retain the missing e-mails," said Franklin L. Widmann, chief of the bureau of securities for New Jersey. "That's what they paid for in the penalty."
UBS, which isn't commenting on the case beyond acknowledging the settlement, has since installed and proven a more robust system for recordkeeping. It also disciplined managers and employees with knowledge of the illegal market timing and fired Shedden in 2003.
Nonetheless, observed Victor Siclari, a partner with Reed Smith in Pittsburgh, it remains unclear for many firms, especially broker/dealers, which e-mails must be kept and how far back the archive must go. The Investment Adviser Act of 1940 and the 34 Act, he said, provide different guidelines.
"The SEC has not articulated in an administrative action or interpretive release exactly what the rule is, so it's difficult to determine what should be saved," Siclari said. "As a result, you have some fund firms out there saving everything, which poses an extremely large burden on a firm's operational infrastructure."
While it would be helpful for the SEC to define the rule in detail, as well as separate broker/dealers from other regulated parties, Siclari added, he isn't optimistic. "With an interim [investment management division] director right now, you can hardly expect anything novel to come out soon," he said.
The UBS court documents also reveal the formative role that e-mails can play in an investigation. The 30,000 e-mails that regulators were able to retrieve from UBS clearly show that the firm's management was aware that market timing was continuing, despite warnings from fund firms and a company-wide memo from UBS executives in December 2001 that ordered an end to all market timing.
"Our investigation revealed that UBS Financial Services failed to reasonably supervise certain brokers," said New Jersey Attorney General Peter C. Harvey.
For example, on June 27, 2001, an operations department manager sent an e-mail to a sales and marketing colleague confirming that Chung and Savino were using multiple accounts on behalf of Millennium Partners to disguise their activities.
"On a daily basis," the unnamed e-mail reads, "we receive multiple letters, e-mails and irate phone calls from various mutual fund companies detailing the continued timing activity for these [brokers]. Requests to discontinue timing are fairly common.
"However, once kicked out by the fund, these [brokers] redeem their assets at the request of the fund and simply repurchase the same fund again for the same client under a new PaineWebber account number. We believe this is done so that the fund will not recognize the new PaineWebber account."
But no action was taken to stop the pair, who even went on to enter into a $26.5 million sticky-asset agreement on behalf of Millennium Partners with Johannesburg-based Investec Asset Management, which in August 2001 brought UBS an upfront commission of $530,000. Management was aware of that, too, court records show.
Perhaps more alarming, however, are the e-mails involving Song Pegg. Song Pegg's managers repeatedly made her aware that funds were objecting to her market timing, but the managers never took further action.
An April 27, 2001 e-mail from an unnamed branch manager to Song Pegg reads: "I have received two calls today from American Funds and Aetna. Both ask that we open no new accounts and they are restricting existing accounts. They do not want to deal with any form of circumvention to keep the business going. They are also targeting you, not just the clients."
Shortly afterwards, branch management allowed Song Pegg to open 95 new accounts to shield her identity and those of her clients, records show. Then, in June 2001, a manager in operations e-mailed a manager in sales and marketing that she "recently opened a number of accounts that are timing." The e-mail even noted that it was in violation of an April memo that placed a moratorium on her timing activities in American Century funds. Another reminder was sent in July, which Song Pegg responded to by placing another 422 trades with American Century.
New Jersey's Widmann said the correspondences provided his office with a roadmap to implicating UBS management for its negligence.
"It's how you put the story together," he said.
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