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From Securities Regulation Daily, October 13, 2015

UBS penalized $19.5 million for negligence on structured note offerings

By Amanda Maine, J.D.

In its first ever case involving misstatements and omissions by an issuer of structured notes, the SEC announced that it settled charges with Swiss financial services company UBS AG. The SEC alleged that UBS lacked effective polices ensuring that those responsible for the offering documents of certain structured notes knew that other employees were engaging in hedging and markup conduct that negatively impacted the value of a currency index to which the notes were tied (In the Matter of UBS AG, Release No. 33-9961, October 13, 2015).

Hedging practices. Between December 2009 and November 2010, UBS offered and sold $190 million of structured notes, which were linked to a proprietary foreign exchange (FX) trading strategy called the V10 Currency Index with Volatility Cap (V10). The offering documents for the notes stated that the V10 provided investors access to a “transparent and systematic currency trading strategy.” This trading strategy would use market prices to calculate the financial instruments underlying the index, the offering documents stated.

Despite these representations, UBS employees in Switzerland engaged in conduct that could negatively impact the pricing inputs used to calculate the V10, according to the SEC. This conduct included a UBS employee acting as an intermediary who added markups to hedge transactions executed on switch days; the UBS FX spot desk adding undisclosed spreads to internal transactions undertaken to hedge UBS’s exposure to V10 instruments; and the UBS FX spot desk engaging in several trades shortly before executing potentially market-moving, internal V10 hedging transactions, the SEC alleged.

According to the SEC, the markups and hedging trades resulted in market prices not being used consistently to calculate the V10 index, causing the index to be depressed by 5 percent, which resulted in $5.5 million in investor losses. The conduct that led to these losses was not disclosed in the offering documents. In addition, the SEC alleged that UBS was negligent because it lacked effective policies and procedures that would have made UBS employees in the United States and in London aware that UBS employees in Switzerland were engaging in this behavior that negatively impacted the pricing inputs used to calculate the V10.

Charges and settlement. The SEC instituted administrative proceedings against UBS, alleging that UBS’s negligence and the use of materially misleading statements in the offering documents violated Securities Act Section 17(a)(2). As part of a settlement, UBS agreed to pay disgorgement and prejudgment interest of $11.5 million, $5.5 million of which will be distributed to V10 investors to cover their losses. It also agreed to pay a civil penalty of $8 million and to cease and desist from further violations of Section 17(a)(2).

According to SEC Chair Mary Jo White, “This first-of-its-kind case involving misstatements and omissions by a structured notes issuer shows that the SEC continues its commitment to pursue wrongdoing across the securities industry in order to better protect investors.”

UBS did not admit or deny the SEC’s allegations. The SEC’s order acknowledged UBS’s “substantial cooperation” with SEC staff, including providing it with information resulting from UBS’s internal investigation and making arrangements for key witnesses in Europe to travel to the U.S. for interviews. The SEC also considered remedial measures undertaken by UBS, including centralizing and improving the systems and controls relating to the operations, calculation and administration of indices, in determining to accept UBS’s offer of settlement.

The release is No. 33-9961.

Companies: UBS AG.

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