Browsing December 7th, 2009
A Significant Award Relating To UBS’s Lehman “100 Percent Principal Protected Notes”
One of the accomplishments I’m most proud of is the 2001 settlement I negotiated for a client who trusted the bogus research of former Merrill Lynch analyst Henry Blodget. That award caught the attention of then New York Attorney General Eliot Spitzer and ultimately resulted in the $1.4 billion settlement that nearly a dozen Wall Street firms were required to pay for issuing conflicted research. Sadly, Spitzer allowed firms to settle without admitting any wrongdoing, which limited the arbitration recoveries of other investors who mistakenly trusted Blodget.
I’m optimistic that the arbitration award I won, covered in Saturday’s Wall Street Journal, on behalf of a client of mine in South Carolina will prove to be another significant case with similar far-reaching consequences for Wall Street as my Blodget settlement. The award relates to Lehman Brothers “100 Percent Principal Protected Notes” that UBS sold to my client; UBS sold more than $1 billion of these notes to retail investors, my client’s award is the first arbitration ruling relating to them in the country. In addition to ordering UBS to reimburse my client for a significant portion of her principal, the panel also required UBS to pay interest, plus all related expenses, including attorneys’ fees.
The potential implications of the arbitration panel’s findings are significant. If the South Carolina ruling proves to be a bellwether, UBS’s ultimate liability could be staggering, particularly given that the firm was forced to take a $900 million writedown relating to its sale of auction rate securities. Though UBS was by far the biggest peddler of the Lehman notes, countless other Wall Street firms sold them as well as other structured notes, and they, too, may face significant liability.
UBS’s sale of Lehman notes has caught the attention of New Hampshire securities regulators. New Hampshire alleged in a June filing that UBS engaged in “dishonest and unethical” business practices selling the Lehman notes, causing New Hampshire investors to lose $2.5 million. The North American Securities Administrators Association (NAASA) has said it was considering convening a task force on the Lehman notes, and I have strong reason to suspect the SEC also is looking into the matter.
Contrary to what common sense would suggest, the Lehman “100 Percent Principal Protected Notes” were anything but “principal protected.” They were essentially high-risk unsecured bonds that were entirely dependent on Lehman’s ability to make good on them. When the UBS broker sold my client her Lehman notes in April 2008, there already was good reason to be concerned about Lehman’s creditworthiness. Bear Stearns had failed a month earlier because of its exposure to subprime loans and speculation was rife that Lehman would fail for the same reason.
But my client’s UBS broker assured her that her notes had virtually “no risk” of losing principal and had the potential upside of earning a whopping 20.66 percent return in 18 months if the stock market performed within certain parameters. As Lehman’s demise increasingly became more likely in the summer of 2008, my client’s UBS broker repeatedly assured her that her notes were safe and dissuaded her from selling them at a loss as she wanted to do.
My South Carolina client is a hard-working individual who lost a sizeable portion of her net worth when the tech bubble burst. She made it clear to her UBS broker that she wanted only the most conservative investments and she had good reason to believe that in buying the Lehman notes the protection of her principal was a “sure thing.” Fortunately, the South Carolina arbitration panel understood that UBS deceived her and acted accordingly. The finding of fraud will be extremely helpful in other related cases.
Calling Bank of America and the SEC to the Carpet
I am pleased to see Judge Jed Rakoff, who’s decision it was not to approve Bank of America’s SEC settlement, shared my disbelief and outrage over the $33 million fine levied against Bank of America for the serious allegation that the bank’s management may have conspired to hide billions of dollars in bonus payments and losses. This is an important first step, but doesn’t get to the root problem.
As reported, Bank of America’s management team was so concerned about the upcoming shareholder vote to approve the merger with Merrill Lynch, that they decided to withhold the disclosure of $2 billion in losses at Merrill until after shareholders approved the deal. Bank of America contends the loss was not “material.” If that weren’t enough, the SEC contended that Bank of America hid from its shareholders the fact that it would pay Merrill Lynch employees up to $5.8 billion in bonuses before the merger closed.
Judge Rakoff made his suspicions clear in his order as he wroteDespite the public importance of this case, the proposed consent judgment would leave uncertain the truth of the very serious allegations made in the complaint,” and that “the proposed consent judgment in no way specifies the basis for the $33 million figure or whether any of this money is derived directly or indirectly from the $20 billion in public funds previously advanced to Bank of America as part of its ‘bailout.’” He will hold an “evidentiary hearing” on Monday.
Judge Rakoff’s order sends an unambiguous warning to the SEC that tougher sanctions are necessary. I applaud his gumption.
Failure to disclose material information to shareholders is a serious allegation and shouldn’t be brushed aside with an easy settlement. What will be difficult to comprehend is how the decision to hide the bonus payments and losses came to be. In all likelihood, Bank of America consulted with outside attorneys, accountants and compensation experts. Not only does the SEC’s settlement let Bank of America off the hook, it allows those that fueled the fire to get off scott free.
Judge Rakoff’s hearing on Monday will likely force settlement renegotiations and will be a black eye for the SEC. Hopefully it will make the agency’s enforcement division be more aggressive during settlement negotiations. Still, the entire system needs to be addressed.
When the SEC forces a corporation to settle, the fines it levies should be felt by a fraud’s perpetrators and those that failed to detect it. Therefore, instead of fines coming out of shareholder’s equity, it should come directly out of the bonus pool. And those that advised on decisions which were found to be fraudulent should be held equally accountable.
Judge Rakoff’s decision to reexamine Bank of America’s settlement with the SEC is the right decision. But we still have a long road ahead to making SEC enforcement actions more of a deterrent.