UBS Financial Services Inc. has agreed to settle charges brought by the Financial Industry Regulatory Authority, or FINRA, alleging that UBS failed to supervise a stockbroker who stood on both sides of multiple municipal bond trades to and from his customers’ retail accounts.
FINRA Imposed $300,000 Fine & censured UBS
The stockbroker engaged in the practice of high-volume, short-term transactions, called in-and-out trading, often effected through cross-trading in municipal bonds that were intended for long-term holding. Although the broker and UBS earned transaction compensation on these trades, they resulted in losses to a number of customers, according to a letter of acceptance waiver and consent signed by the firm on Sept. 23.
The AWC says the broker dealer lacked a reasonable system to supervise trading in municipal bonds by its registered representatives from November 2004 through September 2006, the period the broker made the problematic in-and-out trades.
This is not the firm’s first fine. According to the relevant disciplinary history contained in the AWC, the firm also created some problems for itself connected to the 2008 financial crisis. In April 2011, UBS submitted an AWC consenting to censure and a fine $2.5 million for its sale of “100% Principal Protection Notes” issued by Lehman Brothers from March through June 2008. UBS also agreed to pay $8.5 million in restitution to certain clients who bought these notes. Many analysts say it was Lehman’s failure and bankruptcy that finally pushed the financial system over the cliff.
FINRA Sanctions UBS
FINRA sanctioned UBS for failure to supervise and failure to provide adequate training to financial advisors in connection with the Lehman notes. UBS also failed to establish written supervisory procedures for the marketing and sale of the Lehman notes, particularly in light of what was happening in the financial world at the time. The firm also failed to analyze the suitability of the Lehman notes for certain UBS customers, the AWC says.
Also, in June 2009, UBS submitted an AWC in which it was censured and fined $100,000 for supervisory failures that allowed unsuitable short-term sales of closed-end funds purchased at the funds’ initial public offerings. Despite being aware that short-term trading of such funds was generally unsuitable, the UBS supervisory system did not detect and prevent unsuitable short-term trading that resulted in customer losses of more than S2 million.
Disciplinary History of UBS
The firm’s complete disciplinary history can be found in FINRA public dislcosure records.
Regarding the AWC signed by UBS on Sept. 23, the firm’s failure to supervise cross-trading in municipal bonds violated Municipal Securities Rulemaking Board, or MSRB, Rule G-27, the AWC says. UBS lacked adequate policies and procedures to monitor this type of trading, and it failed to follow-up on “red flags” indicating that the stockbrokers was perhaps using customer accounts to engage in excessive and unsuitable cross-trading of municipal bonds.
The warning signs included multiple “exception reports” generated by the UBS compliance department that indicated a pattern of improper short-term bond trading, the AWC says.
Without admitting or denying FINRA’s factual findings, UBS submitted the AWC to settle the alleged violations on the condition that FINRA would not bring any future actions against the firm or its affiliates based on the same facts, the AWC says. FINRA accepted the AWC on Sept. 30.
The rule in question, MSRB Rule G-27, requires member firms to establish and maintain a system to supervise the municipal securities activities of its employees. The system must including written procedures and be reasonably designed to achieve compliance with applicable securities laws and regulations, as well as MSRB rules.
During the roughly two-year period at issue, the AWC says that UBS had no such system in place, and thus failed to supervise the broker who allegedly engaged in the in-and-out trading.
The broker worked in the Los Angeles branch office of UBS from January 2002 through September 2006. The broker was high-producing, with high-net-worth clients who gave the broker discretionary trading authority in many instances, the AWC says.
From late 2004 until leaving the firm in 2006, the broker exercised discretion to engage in short-term trading of municipal bonds for at least ten of these customer accounts. According to the AWC, the many trades of bonds between accounts were suspicious because the broker the stood on both sides of the trades and reaped an clear economic benefit not share by the customers whose accounts were being used.
Although UBS marked these trades for further investigation because of the reports from its compliance department, the firm did not do enough given the nature of the warnings. Because of these failures, the broker was able to engage in a pattern of excessive cross-trading, the AWC says.<
The firm did have a policy in place regarding cross-trades set forth in two UBS compliance bulletins. The first bulletin applied to all cross-trades and stated that “At least one side of the cross transaction must result from a bona fide unsolicited customer order,” as quoted in the AWC.
The second compliance bulletin — pertaining to taxable fixed income and municipal bond trades — delineated an exception to the general policy in the first bulletin. The exception says that a broker may “solicit both sides of a cross transaction if such a cross would be beneficial to both clients,” as quoted in the AWC.
UBS provided no written or verbal guidance as to the criteria use to determine whether a cross-trade is beneficial to both clients, however. Nor did it say who was supposed to make the call. Therefore the standard to trigger the exception to the prohibition on cross trading was unclear.
The branch manager in Los Angeles determined that the cross trades in question were beneficial to customers on their face because customers were not charged the normal fee associated with transactions. The branch manager never went beyond this superficial assessment. If he had, the AWC says, he could have discovered that a number of the cross-trades benefitted only the broker, and not the retail customers.
As for red flags, in 2004, the firm conducted a review of one week of trading on the Los Angeles Municipal Bond Desk. This was one of the regularly scheduled audits of business units within the wealth management group.
The audit was completed on Nov. 7, 2004, and a letter was sent to the Los Angeles branch manager as well as two senior managers of the wealth management group. The letter noted that the broker was conducting discretionary trades without the supervisory controls in place to monitor whether the cross trading was inappropriate.
The March 2005 letter referred the matter to the compliance department, and identified follow-up measures that were never fully executed. The compliance department conducted two reviews of the broker’s cross trading, but the Los Angeles branch managers failed to adequately review them to determine if they were appropriate.
The second review, completed in August 2005, contained details about cross-trade transactions from June through July of that year that were clearly held short-term. Moreover, all six accounts involved in these trades showed negative results, the AWC says.
Despite these serious red flags, branch management in Los Angeles again took only a cursory look, the AWC says. They selected 12 cross trades at random and asked the broker to explain. The broker said the trades were part of a bond-swap strategy wherein municipal bonds were sold prior to maturity for a trading loss, and another was purchased. The branch manager accepted this explanation without further inquiry. For instance, the branch manager never asked the broker to identify the bonds purchased for the customer after the first bond was sold.
Although the audit resulted in a decision to review these cross trades on a monthly basis, and the compliance department continued to generate monthly reports, they were never given to the Los Angeles branch, the AWC says.
In December 2005, the UBS legal department started yet another review of this cross trading, but the review was pending when the broker left the firm in September 2006.
UBS — along with its predecessor Paine Webber & Co. — has been a broker dealer registered with FINRA since October 1936. The full-service brokerage firm’s U.S. division has its headquarters in Weehawken, N.J., and has about 385 active branch offices across the country. The firm employs about 4,665 registered financial advisors.
Guiliano Law Group
The practice of Nicholas J. Guiliano, Esq., and The Guiliano Law Group, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost to unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.