UBS faces $1 billion in Puerto Rico cases after settling

UBS has settled a key case with regulators over allegedly failing to rein in a free wheeling local sales force that included a broker known as "The Whopper" that generated big commissions by pushing dangerously leveraged debt in their home base of Puerto Rico. The firm now faces $1 billion in pending arbitration claims from clients who say the wealth manager's pumped-up sales culture caused abusive practices. 

UBS agreed to SEC and FINRA fines for a total of $33 million to settle charges over its alleged failure to supervise its broker network. The SEC says the firm failed to take action before clients lost millions of dollars from brokers pushed them into inappropriately high exposure debt financed holdings of tax-free Puerto Rico debt.

The findings of the case will become legal fodder for both sides in ongoing cases involving hundreds of account holders claiming they lost money from UBS brokers stuffing their accounts with the U.S Territory's deteriorating debt with easy loan financing and other inappropriate sales tactics. 

"It will be window dressing in some cases," Lars Soreide of Soreide Law Group Soreide Law Group , said in relation to the regulators' action this week."It will be extremely compelling in others and not very relevant in a lot of others."

The charges were damaging for UBS, but some of the findings of the SEC and FINRA investigators can be seen as supportive. The case showed that the broker regarded as a star in UBS operation was concerned enough about company rules that he concealed his client transactions and defending them before the branch manager. But the record also shows laxity in following up on complaints.

The Whopper's secretive plan

To be sure, the SEC sees the broker as a rogue trader who actively misled UBS. The agency charged the former broker, Jose Ramirez, 56, for allegedly steering clients to circumvent rules to build his assets. 

When the market for the Puerto Rico investments collapsed in 2013, customers were surprised to learn that the funds Ramirez sold them were subject to margin calls because they included leveraged loans, triggering big losses when the funds were sold at "fire sale" prices. The margin calls for the single broker who came to be known as "The Whopper" amounted to $37 million, investigators said.

The broker was fired by UBS last year and faces federal court charges for his role. The SEC did not disclose the form of further action. Ramirez's former branch manager, Ramiro L. Colon III, agreed to pay a $25,000 penalty and be suspended from a supervisory role for one year for failing to supervise and escalate any suspicions to higher-up UBS management.

Regulators: UBS should have known

The fact UBS might not have known about the bad practices does not put the firm in the clear. In such cases, it's enough for regulators to say it "should have known." Securities lawyers say the cost of the UBS compliance failure continues to mount, with the new regulatory censures adding more stress to its defense against pending claims. 

"Each side will put their own spin on this," said Jeffrey Kaplan, of Dimond, Kaplan & Rothstein Dimond, Kaplan & Rothstein. The cases will add fuel for both sides to continue in their arbitrations. The rulings by SEC and FINRA are certain to surface, though the cases will be decided largely by the set of facts in each case.

Cooperation limits damage

Lawyers said UBS helped its position with regulators through its willingness to clean up its compliance program by bolstering broker training and tightening its monitoring and managing of accounts. The SEC made a very public statement last month that its policy going forward would be to go after individuals more aggressively, suggesting firms will benefit by giving up wrongdoers. 

While the case will not have a direct impact on many of the arbitration cases there is material to be mined by lawyers making the case that UBS compliance failed to protect clients from risks. The SEC case exposed the use of letters of credit on the part of many others at the firm. FINRA's decision, meanwhile, pointed to another widespread practice that plaintiff lawyers will cite: The firm did little amid signs of inappropriately high levels of money to going into a single investment vehicle that was a leveraged UBS fund of tax-free Puerto Rican municipal bonds.

Andrew Ceresney, director of the SEC’s Division of Enforcement, said UBS failed on two levels. It lacked a compliance system "designed to detect misconduct by employees under their supervision.” In addition, it did not do enough to explain the risk of putting risky leveraged investments in a non-diversified portfolio. 

The case goes beyond the classic failure to discipline the "hot hand" at the firm who cuts corners and follows edgy practices. The SEC made the case that UBS blinked in its compliance effort as it raked in large profits on the island. 

Puerto Rico's boom to bust story 

UBS's spokeswoman Karina Byrne conceded that the boom and bust cycle caught many people by surprise, including UBS but also other major broker dealers. As one of the biggest long-term players in the island's economy, UBS has been hit hardest by the downturn. "There was a lot of pride in owning Puerto Rico investments," UBS spokeswoman Karina Byrne said. "It was that, and the lure of tax-free money and years of strong performance. ... The downturn suddenly mired the clients into deep losses, pushing some to the brink, leading to a huge wave of arbitration claims."

The firm's public regrets are tempered by the years of success it has had as the top broker-dealer on the island. It reflects other cases where firms' compliance unit is the unwelcome guest at the table when everyone is riding a winning streak. "The company made money at every level. Packaging the bonds, selling funds, managing clients' money," said Soriede. "It created a difficult environment for compliance." When losses piled up, and the clients' claims surface, those who lost say the dealer was cutting the deck. The cases will be heard for years to come, and the compliance effort that fell down will cost UBS for years to come.
Richard Satran is a financial journalist covering daily and emerging issues for Thomson Reuters Regulatory Intelligence.

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