UBS to Pay $34M to Settle Broker Misconduct Charges

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WASHINGTON – UBS Financial Services, Inc. of Puerto Rico agreed to pay $34 million to settle charges by FINRA and the SEC that it failed to supervise the suitability of transactions in Puerto Rican closed-end fund shares, as well as a former broker who had customers invest in those CEFs using money borrowed from an affiliated bank.

The SEC ordered UBS to pay the SEC $15 million in penalties, disgorgement of ill-gotten gains, plus interest. The firm will pay $7.5 million in fines to FINRA, as well as $11 million in restitution to 165 customers who suffered losses in closed-end fund positions.

Separately, the SEC sued Jose G. Ramirez, Jr., 56, a former broker registered in UBS's Guaynabo branch now residing in Fulton, Md., for making at least $2.8 million by having customers use proceeds from lines of credit with UBS Bank USA to purchase additional shares in UBS closed-end funds. Ramirez misled investors and tried to evade detection, the SEC said in its complaint, which was filed Tuesday in the U.S. District Court for the District of Puerto Rico. He also lied to his branch manager, the SEC said.

"We allege that Ramirez sold tens of millions of dollars of closed-end funds to certain customers while lying to them about the safety of his risky leverage strategy and, as a result, those UBSPR customers suffered significant losses," said Eric Bustillo, director of the SEC's Miami regional office.

Ramirez's former branch manager, Ramiro L. Colon 3rd, 49, who is still employed by UBS but no longer serves in a supervisory capacity, settled charges in an administrative proceeding that he failed to reasonably supervise the former broker by agreeing to pay a $25,000 penalty and be suspended from a supervisory role for one year.

"Broker-dealers like UBS Puerto Rico must have effective procedures in place designed to detect misconduct by employees under their supervision," said SEC's director of enforcement Andrew Ceresney. "UBSPR lacked reasonable systems for ensuring compliance with the firm's prohibition on loan recycling and to ensure that brokers adequately conveyed the risks involved in lines of credit."

UBS neither admitted nor denied the charges. But a UBS spokesperson said "We're pleased to have resolved these matters with the SEC and FINRA with respect to separate inquiries initiated in early 2014. We remain dedicated to serving our customers during this difficult economic time for the Commonwealth." The firm would not comment on Ramirez, saying it terminated his employment in January 2014.

The FINRA and SEC charges are related to closed-end funds, 23 of which UBS offered investors since 1995. Nine of them are co-managed by UBS and 14 are sole-managed. UBS was the primary underwriter for the 23 CEFs, which are not registered with the SEC but are instead incorporated and organized under the laws of the Commonwealth of Puerto Rico.

Puerto Rico securities provide residents of the territory with major tax advantages, including  an exemption from U.S. estate and gift taxes. The securities also generally provide a triple tax benefit. As a result, UBS's customer accounts were typically highly concentrated in CEF shares, such that, a single market event affecting the value of the shares could significantly decrease their total account value.

Certain of UBS's customers with modest net worth and conservative investment objectives invested 75% or more of their account assets in CEF shares, despite the downward spiral of Puerto Rico's financial condition and its growing debt, according to FINRA. In total, the self-regulator found 165 customers with conservative investment objectives and $2 million or less in assets had accounts more than 75% concentrated in highly-leveraged CEF shares.

FINRA found that, between Jan. 1, 2009 through July 31, 2013, UBS failed to monitor the combination of leverage and concentration levels in customer accounts to ensure transactions were suitable for customers' risk objectives and profiles. The firm failed to implement a reasonably designed system to identify and prevent unsuitable transactions, given Puerto Rico's economy and the fact that retail customers typically maintained high levels of concentration in the territory's assets and often used the accounts as collateral for cash loans.

By mid-August 2013, the Puerto Rico bond market suffered a massive decline in market value, FINRA said. By the end of that year, most CEF shares and Puerto Rico munis lost between 20% and 50% of their value. On Feb. 4, 2014, a rating agency cut the territory's general obligation debt to "junk" status, the self-regulator noted.

"UBS of Puerto Rico operated in a unique economy and ultimately failed to tailor its supervisory systems to its specific business needs," said Brad Bennett, FINRA executive vice president of enforcement. "Despite the fact the firm was very familiar with the unusual characteristics of its retail accounts, it did not supervise these transactions properly to prevent customers' heightened exposure to risk."

Around 2003, UBS Bank USA (BUSA), a Salt Lake City, Utah-based, Federal Deposit Insurance Corp.-insured industrial bank affiliated with UBS, began offering UBS brokerage customers a non-purpose line of credit through UBS at no initial cost to the customers and at interest rates below interest rates charged for margin loans. Registered representatives were incentivized to offer the lines of credit in part because they received compensation based on an additional production credit and, in 2013, credit for net new assets when an LOC was drawn upon.

The SEC alleges that from 2011 through 2013, Ramirez offered and sold millions of dollars of CEFs to customers whole soliciting them to use lines of credit to purchase securities and fraudulently misrepresenting the risks of this strategy to them.  USB policy and the customers' agreements with BUSA did allow customers to use proceeds from the LOCs to purchase securities and Ramirez knew this, the SEC said. 

Ramirez also falsely claimed he explained to customers that BUSA could demand repayment of the loans at any time and that, if the value of the pledged collateral fell below maintenance requirements, BUSA could require customers to deposit additional collateral and/or sell the pledged collateral to repay the loans.

The SEC said an operations manager at UBS raised questions about one of Ramirez's customer's transactions. Colon asked Ramirez about it who strenuously denied any impropriety. Colon reviewed the customer profile and discussed it with the complex administrative manager, but did not conduct any further investigation. But Colon knew that Guaynabo branch customers had $475 million in total LOCs as of July 2013, nearly double those in UBS's Hato Rey headquarters, the SEC said.

Given this disparity, "Colon should have looked further into Ramirez's performance, the SEC said.

The collapse of the Puerto Rico bond market in 2013 hit investors hard and they began calling and meeting with UBS representatives, including Colon, about maintenance calls. The investors told Colon that Ramirez convinced them to use proceeds from LOCs to reinvest in additional CEF shares without informing them of the risks of doing so. As a result of the complaints, UBS conducted an internal investigation.

Lynn Hume is the Washington, D.C., bureau chief for the Bond Buyer.

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