Double Dealing: How UBS Profited From Lehman’s Accounting Duplicity
One of the recurring themes of my blog posts is that it’s nearly impossible to orchestrate financial wrongdoing of significant magnitude without the complicity of major financial institutions. Banks and brokerage firms almost invariably put their financial interests ahead of their clients, and any investor who believes otherwise should take the time to read this complaint by Massachusetts Secretary William Galvin alleging fraud in connection with Merrill Lynch’s sale of auction rate securities. While Galvin’s complaint relates to Merrill, the countless allegations about how that firm failed its customers are pretty typical of how Wall Street treats its clients.
The Lehman bankruptcy examiner’s report made public last week further documents how Wall Street firms are quick to aid and abet wrongdoing. To dress up its balance sheet, Lehman engaged in a myriad of “Repo 105″ transactions, a financial legerdemain that allowed the company to raise cash by parking assets at rival overseas firms and booking the sham swaps as “sales.” This accounting hocus pocus, while not permissible under U.S. rules, was deemed kosher in the UK providing that Lehman orchestrated repo transactions through its London-based subsidiary and with non-U.S. banks. The examiner’s report makes clear that the foreign banks that facilitated Lehman’s sham sales were very much aware of the firm’s “desperation” to create the illusion that it had significantly shed assets and reduced its leverage. For those not well versed in accounting, allow me to explain in simpler but cruder terms about what transpired: About a half dozen foreign banks played an active role in helping Lehman put some heavy duty lipstick on a pig.
One of Lehman’s most active beauticians was UBS. UBS reportedly transacted approximately $10 billion in Repo 105 deals with Lehman, likely garnering the firm tens of millions of dollars in interest payments relating to the sham sales. But UBS had another reason to help Lehman deceive investors about its flailing financial health. During the period Lehman was orchestrating its “Repo 105″ transactions, UBS’s retail brokers were aggressively peddling to their customers a product deceptively known as Lehman Brothers “100 Percent Principal Protected Notes.” Although UBS marketed these notes to investors as being “risk free,” they were in fact extremely risky unsecured IOUs whose repayment was entirely dependent on Lehman’s financial solvency. UBS paid its brokers high commissions to sell the risky Lehman notes to unsuspecting investors, which explains why the sales force successfully unloaded more than $1 billion of the paper. When Lehman collapsed, its notes instantly became nearly worthless.
UBS’s sale of the Lehman notes was questionable even before the bankruptcy examiner’s disclosure. New Hampshire’s securities regulator charged in a filing last June that UBS engaged in “dishonest and unethical” 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 it’s my understanding the SEC is also looking into the matter. I recently won a significant arbitration award on behalf of a client in South Carolina who bought Lehman notes from a UBS broker; it was the first arbitration decision relating to UBS’s sale of Lehman notes, and my office has more than a dozen pending.
Rest assured, UBS is going to have to account for why it continued to aggressively market Lehman notes to retail customers as highly conservative investments while on the institutional side facilitating transactions that were designed to mask Lehman’s troubled financial condition. Ernst & Young, Lehman’s auditor, also has some “accounting” to do; that firm, as it happens, also is UBS’s auditor. It will be interesting to learn how UBS booked the assets that Lehman “sold” the firm.
Individual investors owe Lehman bankruptcy examiner Anton Valukas a tremendous debt of gratitude. His report lays out in painstaking detail Wall Street’s fundamentally dishonest ways and makes clear the industry cannot be trusted to regulate itself. Individual investors also should note that in early 2007, the year Lehman began its financial shenanigans, Charles Schumer and Michael Bloomberg, respectively New York’s senior senator and Mayor, issued this report by McKinsey & Company saying that the U.S. markets were fast losing ground to the UK because they were overly regulated. As Lehman’s “Repo 105″ transactions were only permissible in the UK and not the US, we obviously shouldn’t be looking to that country for a regulatory model worth emulating.
Ironically, a significant number of investors who bought Lehman notes from UBS reside in the UK. Fortunately for them, they can file arbitration claims in the US to seek redress.