UBS has agreed to pay $50 million to settle Securities and Exchange Commission charges that it violated securities laws while structuring and marketing a collateralized debt obligation (“CDO”) by failing to disclose that UBS kept $23.6 million in upfront cash received while acquiring collateral for the CDO, known as ACA ABS 2007-2, in mid-2007. UBS retained the full amount of these upfront payments – plus its disclosed fee of $10.8 million – when it transferred the collateral to the CDO. Marketing materials for the CDO failed to disclose that UBS retained the substantial upfront payments, and falsely stated that the CDO had to acquired its collateral “on an ‘arm’s-length basis’ for fair market value,” or at the price the collateral was acquired by UBS.
“UBS kept $23.6 million that under the terms of the deal should have gone to the CDO for the benefit of its investors,” said George S. Canellos, Co-Director of the SEC’s Division of Enforcement. “In doing so, UBS misrepresented the nature of the CDO’s collateral and rendered false the disclosures about how that collateral was acquired.”
According to the SEC’s order instituting administrative charges, UBS structured the CDO, known as ACA ABS 2007-2, in mid-2007. The CDO’s collateral manager was ACA Management, and the primary collateral for the CDO was CDS on subprime residential mortgage-backed securities (RMBS). The CDS basically acted like insurance against certain defaults in the underlying RMBS. As the “insurer,” the CDO received monthly premiums from the CDS collateral, which were used make requisite payments to bondholders of the CDO.
The SEC alleged that ACA solicited bids on the CDS collateral, and those offering the highest yields became the winning bidders. As a result of the bidding process, ACA acquired CDS with upfront payments totaling $23.6 million, which were made to UBS as part of the process of acquiring collateral for the CDO. ACA employees were aware that UBS would not transfer the upfront points to ACA ABS 2007-2.
From inception, UBS employees working on the CDO intended for UBS to retain the upfront cash, according to the SEC. For example, early in the structuring process, the head of the U.S. CDO group at UBS stated, “Let’s see how much money we can draw out of the deal.” In addition, the manager of UBS’s CDO syndicate book viewed the CDO as an “arbitrage opportunity” for UBS to make trading gains when selling the assets into the CDO.
Further, in early May 2007, after the CDO was partially ramped using CDS with upfront points, UBS employees discussed two ways to retain the upfront points: 1) contributing the upfront points to the CDO and arranging to have the CDO pay them back to UBS on a fully disclosed basis, or 2) simply keeping the upfront points without disclosing their retention to prospective investors. UBS CDO desk employees ultimately decided in favor of an undisclosed retention of the upfront points, which was inconsistent with the industry standard and UBS practice in prior deals.
In settling the SEC charges, UBS agreed to pay disgorgement of the $23.6 million in upfront payments and the disclosed fee of approximately $10.8 million plus prejudgment interest of approximately $9.7 million and a penalty of $5.7 million. Without admitting or denying the SEC’s findings, UBS consented to the entry of an order finding that it violated Section 17(a)(2) and Section 17(a)(3) of the Securities Act of 1933, and negligently caused ACA to violate Section 206(2) of the Investment Advisers Act of 1940.
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