The Securities and Exchange Commission on Tuesday charged UBS Financial Services Inc. of Puerto Rico and two executives with making misleading statements to investors, concealing a liquidity crisis, and masking its control of the secondary market for 23 proprietary closed-end mutual funds.
UBS Puerto Rico agreed to settle the SEC’s charges by paying $26.6 million that will be placed into a fund for harmed investors.
According to the SEC’s order instituting settled administrative proceedings against UBS Puerto Rico, the firm knew about a significant “supply and demand imbalance” and discussed the “weak secondary market” internally.
However, UBS Puerto Rico misled investors and failed to disclose that it controlled the secondary market, where investors sought to sell their shares in the funds.
UBS Puerto Rico significantly increased its inventory holdings in the closed-end funds in order to prop up market prices, bolster liquidity, and promote the appearance of a stable market. However, UBS Puerto Rico later withdrew its market price and liquidity support in order to sell 75 percent of its closed-end fund inventory to unsuspecting investors, the SEC said.
The SEC instituted contested administrative proceedings against UBS Puerto Rico’s vice chairman and former CEO Miguel A. Ferrer and its head of capital markets Carlos J. Ortiz.
“Let me be absolutely clear; I cannot comprehend why and how I am involved in such controversy. I have done nothing wrong, violated no law, and at all times have acted in the best interest of our customers,” Ferrer said in a statement. “The fund offerings, to which the SEC has referred, were and are sound investments that have provided our customers with favorable returns.”
“Over the 50 years that I have labored in the financial industry, my guiding principle has been to look after the best interest of the investing public,” he added. Although the easier course for me would have been to settle with the SEC, I feel strongly that the suit is wholly without merit, and I intend to vigorously defend the claims. I will prevail.”
Meanwhile, Ortiz said the SEC’s claims that investors were misled or mistreated “is unfounded.”
“Throughout my 27-year career, I have always worked to improve the quality and transparency of information available to financial advisors and their clients. I will vigorously contest these allegations,” he said.
Robert Khuzami, director of the SEC’s division of enforcement said in the agency’s statement that “UBS Puerto Rico denied its closed-end fund customers what they were entitled to under the law — accurate price and liquidity information, and a trading desk that did not advantage UBS’s trades over those of its customers.”
Eric I. Bustillo, Director of the SEC’s Miami Regional Office, added, “We will aggressively prosecute firms that use conflicts of interest for their own financial gain.”
According to the SEC’s order, starting in 2008, UBS Puerto Rico solicited thousands of retail investors by promoting the closed-end funds’ market performance and continuously high premiums to net asset value (up to 45 percent) as the result of supply and demand in a competitive and liquid secondary market.
When investor demand began to decline, UBS Puerto Rico sought to maintain the illusion of a liquid market by buying shares into its own inventory from customers who wished to exit the market. Despite a falling market, UBS Puerto Rico continued to sell shares by conducting primary offerings in order to grow its closed-end fund business.
Throughout this period, UBS Puerto Rico failed to disclose the true state of the market to investors, the regulatory agency said.
According to the SEC’s order, UBS Puerto Rico’s parent firm determined in the spring of 2009 that UBS Puerto Rico’s growing closed-end fund inventory represented a financial risk, and directed the firm to reduce its inventory by 75 percent to reduce that risk and “promote more rational pricing and more clarity to clients . . . [so] prices transparently develop based on supply and demand.” To accomplish the reduction, UBS Puerto Rico executed a plan dubbed “Objective: Soft Landing” in one document, which included:
Undercutting numerous marketable customer sell orders to “eliminate” those orders and liquidate UBS Puerto Rico’s inventory first, preventing customers from selling their shares.
Not disclosing that UBS Puerto Rico was drastically reducing its inventory purchases.
Soliciting customers to sell recently purchased primary offering shares back to the closed-end fund companies, so UBS Puerto Rico could then sell closed-end funds to those customers from its highest inventory positions.
UBS Puerto Rico also increased solicitation efforts to further reduce its inventory while making misrepresentations and failing to disclose UBS Puerto Rico’s withdrawal of secondary market support.
According to the SEC’s order against Ferrer and Ortiz, Ferrer made misrepresentations and did not disclose numerous material facts about the closed-end funds.
For example, although Ferrer was well aware of the supply and demand imbalance and privately discussed UBS Puerto Rico’s growing inventory and support of the market, he caused UBS Puerto Rico to conduct new primary closed-end fund offerings while directing financial advisors to represent to customers that the market was experiencing “low volatility” and providing “superior returns.”
Ferrer also repeatedly made misleading statements about closed-end fund market prices and touted that the funds would always trade at high premiums to net asset value, even while UBS Puerto Rico was substantially reducing its inventory and causing huge investor losses, the SEC said.
Meanwhile, the SEC said, Ortiz falsely represented that closed-end fund shares were priced based on supply and demand while in reality he and the firm concealed the inventory increases and rarely changed prices, allowing UBS Puerto Rico to promote the façade of a liquid, stable market.
“As UBS Puerto Rico was reducing its inventory in 2009, Ortiz touted increased closed-end fund secondary market liquidity and superior price performance to investors at a UBS investor conference,” the agency said.
At the same time, Ortiz was executing UBS Puerto Rico’s inventory reduction scheme that involved “eliminat[ing]” marketable customer sell orders to dump UBS Puerto Rico’s inventory first, putting UBS Puerto Rico’s interests ahead of their customers’ orders.
UBS Puerto Rico agreed to settle the SEC’s charges, agreeing to pay $11.5 million in disgorgement, $1.1 million in prejudgment interest, and a penalty of $14 million.
In addition to the monetary relief, the SEC’s order censures UBS Puerto Rico, directs it to cease-and-desist from committing or causing any further violations of the provisions charged, and orders the firm to comply with its undertaking to retain an independent consultant at UBS Puerto Rico’s expense.
Among other things, the independent consultant will review the adequacy of UBS Puerto Rico’s closed-end fund disclosures and trading and pricing policies, procedures, and practices. UBS Puerto Rico shall abide by the determinations of the consultant and adopt and implement all recommendations.