We have known for more than two years that UBS misled its customers when it sold them so-called “100% Principal Protection Notes” issued by Lehman Brothers. Now, according to a handful of former UBS financial advisors who have reached out to us, it turns out the firm also misled its own brokers.
Since shortly after Lehman Brothers filed for bankruptcy in September 2008, we have been hearing essentially the same story from dozens of UBS customers from coast to coast. These were conservative investors, many with a long history of investing in CDs, municipal bonds and the like. Their brokers came to them with a pitch for so-called “100% Principal Protection Notes.” This was a no-lose proposition, they said. The customers could potentially realize some modest upside during a rocky market, and the worst that could happen was that once the notes reached maturity, they would get just their principal back with no gain. Many customers were never even told that Lehman was the issuer of the notes, let alone that the notes were just a naked promise—an “unsecured obligation” of Lehman.
We all know what happened next. These deceptively named notes protected nothing, and investors’ entire principal went up in smoke when Lehman folded. Conservative investors whose brokerage firm had convinced them this investment was “guaranteed” were left holding the bag, while UBS pocketed tens of millions in underwriting fees on the $1 billion in Lehman notes it helped issue.
Here’s where things really get interesting. As the two-year anniversary of Lehman’s failure has come and gone, and as UBS’s arbitration losses keep piling up, we have come to learn that UBS customers weren’t the only ones being deceived. UBS executives consistently painted a rosy picture of Lehman, encouraging their financial advisors to continue selling these notes to their best customers and lulling them into holding the notes even when alarm bells began to ring in the spring and summer of 2008.
Brokers have reported that senior management told them to take comfort in the ratings agencies’ “high marks” for Lehman and reassured them that their due diligence was thorough. Meanwhile, the higher-ups must have tracked the market’s true measure of default risk: credit default swap spreads (in short, the price of insuring against a Lehman default). Even as Lehman’s spreads exploded, the executives apparently soft-pedaled the impact of this information, telling their brokers that UBS believed Lehman was on solid footing.
According to these disillusioned brokers, when they told their bosses that they were worried about Lehman in the wake of the Bear Stearns collapse, the execs reassured them that the firms were entirely different. In truth, they must have seen and worried about the parallels.
As UBS’s own investment bank was reducing its exposure to Lehman—a fact the world now knows from UBS press releases—UBS analysts issued research reports discouraging retail investors from selling out of their Lehman investments—even as late as September 2008!
Some brokers caught on to the executives’ game and got their customers out in time to avoid catastrophe. For most, they bit on their company’s pitch hook, line and sinker. They remained in the dark until it was too late.
These brokers are hopping mad at UBS, their books having been burned as a result of their own firm’s deceit. Along with their (often former) customers, they have joined the club no one wants to be a member of: Victims of UBS.
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What UBS did in the US, Credit Suisse practiced in Switzerland. It is estimated that Credit Suisse sold principal-protected Lehman notes worth about 700 million Swiss Francs in Switzerland alone. The clients were mostly small savers with little or no experience in capital markets. Just as UBS, Credit Suisse failed to inform the customers about the true nature of these products.
Just look at the factsheet of a Lehman note sold be Credit Suisse. In the section entitled “risks” you will find neither “Lehman” nor “creditworthiness of the issuer” nor anything similar. Instead – throughout the whole document – you will encounter five times the promise “principal protected” – but not a single time in conjunction with Lehman, at least not explicitly.
What in my view proves the accusation of deception is the fact that in a sales brochure issued by Credit Suisse, these opportunity notes carry the risk label “low” (page 15 of the brochure entitled “Anlegen und Vorsorgen”), whereas in the disclaimer of such a note, there is talk of “high” risks. It is obvious that one text was written by marketing people and the other by legal staff and that Credit Suisse failed to reconcile the two.
The version the relationship managers stuck to is of course the first one, as you could see from the e-mail sent by my relationship manager. He recommends the Lehman note as an alternative to a fixed deposit and claims that it is FULLY principal-protected (capital letters by Credit Suisse). No mention of Lehman, issuer or issuer risk.
In the mean-time, Credit Suisse was forced to buy back about 150 Mio. Swiss Francs worth of these notes – not by our financial market supervisory authority, which is totally useless, but by public pressure. This is of course barely more than 20% of what Credit Suisse had sold.
In 2010, Credit Suisse was still advertising structured products on its website with the slogan “Protect your portfolio against unexpected risks with structured derivatives.” The Opportunity Note that was then presented featured repeated emphasis on one-hundred-percent capital protection without a single mention of issuer risk. The Opportunity Note was then awarded a lovely “low” risk value. However, one look at the fine-print disclaimer of such an Opportunity Note would immediately reveal the phrase “These investment products are complex structured derivatives and involve a high degree of risk.” Depending on whether the print is large or small, the risk ranges from low to high; sometimes the Opportunity Note protects against unexpected risks, sometimes it involves a high degree of risk in itself.
Even the brochure “Special Risks in Securities Trading” by the Swiss Bankers Association – a brochure which is sent to the customers when they open up a depot, i.e. years before they may actually buy a principal-protected product or, depending on the circumstances, also afterwards – even this brochure fails to explain the relationship between issuer risk and principal protection. As a matter of fact, this brochure even cements what principal protection means to the layman anyway:
“What is the maximum possible loss?
The maximum possible loss for the buyer of a structured product with capital protection is the difference between the purchase price and the amount of the capital protection.”
Special Risks in Securities Trading, Swiss Bankers Association, Edition 2001 (in use until 2008), p. 14
Let’s hope that justice will one day prevail in both the US and Switzerland.
The true key to me in all of this – and the major fact being ignored by the State AG’s as well as the regulators. UBS should be charged with fraud.
Not only did they lie to their employees and trade against their customers – THEY WERE PERFORMING THE REPO 105’S to help HIDE LEH DEBT in Europe, while KNOWINGLY selling worthless PPN to their RETAIL INVESTORS IN THE US!
Both functions – the Repo 105’s and the selling of the Structured Notes – was handled by the I-Bank. Someone at that place is in a Risk cpacity and can see what was going on. They CANNOT claim they didn’t know.
I wish some State Attorney General can do this math properly and force a settlement as they did with the floaters. (which were not nearly as eggregious and the only reason UBS & others agreed to settle is because they knew they wouldn’t lose money – this is a guaranteed loss to them)
At least they should be forced to make us the deficit from the bankrupcy settlement – which is around 24-cents on the dollar.