Three Strikes and You’re Out for UBS

Regardless of risk, Wall Street will sell whatever products to whomever it wants whenever it likes.

That’s the lesson learned from this week’s sanction of UBS Financial Services (UBS) by Finra, the brokerage industry’s regulatory body. On Monday, Finra whacked UBS, one of the nation’s largest securities firms, ordering it to pay a $2.5 million fine and restitution to some clients. According to Finra, the firm misled investors who bought something called “100% Principal-Protection Notes” issued by Lehman Brothers.

Such notes are known on Wall Street as structured products. These products are usually an investment strategy linked to derivatives. Until 10 years ago or so, typically only sophisticated institutional investors bought structured products, but then Wall Street began selling them to retail customers. And that’s when the carnage began.

UBS repeatedly disregarded Lehman’s dire financial condition when it sold the notes, according to Finra. Remember, Lehman Bros. declared bankruptcy in September 2008, and it was evident to many in the investment business for months before then that the firm could be heading right for the ash heap.

That March, Bear Stearns collapsed, and the Fed engineered its sale to J.P. Morgan. That sent off the alarm bells about Lehman, whose business model most closely resembled that of Bear Stearns. Was it next to fail, the Street wondered? Accordingly, UBS reviewed its structured products closely, “especially Lehman,” Finra said. Then, it resumed selling the “Principal Protection Notes.”

A few months later, the news got worse.

In June 2008 alone, Lehman said it was posting a $2.8 billion loss for its second quarter, seeking another $6 billion in new capital and firing its chief financial officer and president.

Did this prevent UBS and its brokers from selling the “Principal-Protection Notes?” Did it cause UBS to warn the thousands of customers to whom it had already sold these notes in the prior months?  Of course not.

Along with its lousy due diligence, UBS sold the notes to many investors regardless of how much risk they wanted to carry. All customers, even those with conservative risk profiles, could buy the Lehman notes that were linked to broad stock indexes such as the S&P 500.

And not only did UBS clients get shafted, but UBS brokers were never trained to understand the way the Lehman notes worked.

“The aforementioned inadequacies in (UBS’) educational and marketing material may have resulted in some financial advisers having misunderstood the product,” Finra said. “Further, based on these (advisers’) misunderstanding of the product, certain (advisers) in turn may have communicated inadequate and/or incorrect information to some firm customers.”

So that’s three strikes for UBS. First, it disregarded the signs of imminent danger around Lehman.  Then, it sold them to investors with absolutely no desire to take on such risk.  And finally, it failed to train its brokers to comprehend how the product worked.

In baseball, it’s three strikes and yer out. Maybe it’s time for Wall Street to follow the same rule and have UBS take a seat on the bench.

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