Swiss bank UBS (UBS) agreed to pay nearly $50 million to the Securities and Exchange Commission, in a deal that exemplifies how structured finance players in the pre-crisis era were able to play fast and loose with the rules.
The SEC said UBS violated securities laws while structuring and marketing a collateralized debt obligation (CDO). The bank still faces extreme challenges when dealing with its legacy assets.
Basically, UBS, while not admitting wrongdoing, failed to disclose the retention of $23.6 million in upfront cash it received to acquire the residential mortgage-backed securities (RMBS) used as collateral.
“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. Instead, UBS hung on to the cash without properly disclosing the move.
UBS structured the CDO known as ACA ABS 2007-2 in mid-2007. ACA Management managed the collateral, primarily credit default swaps (CDS) on subprime RMBS. CDS is a form of credit enhancement, an insurance against loss, which helped such deals earn the high credit ratings which drove investor interest.
According to the SEC’s order, the offering circular for ACA ABS 2007-2 stated that the CDO had to acquire all collateral “on an ‘arm’s-length basis for fair market value.”
However, ACA played much, much closer.
ACA solicited a bid and actually ended up acquiring CDS having upfront payments totaling $23.6 million, something UBS capital markets desk managers did not disclose, despite the opposite being industry standard.
"Early in the structuring, the head of the U.S. CDO group at UBS stated, 'Let’s see how much money we can draw out of the deal',” according to the SEC. "Similarly, 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."
Marketing materials disclosed a fee to UBS of approximately $10.8 million, but made no reference to the $23.6 million in upfront points being retained by UBS.
In the settlement, UBS agreed to pay disgorgement of the $23.6 million in upfront payments as well as the disclosed fee of approximately $10.8 million plus prejudgment interest of approximately $9.7 million and a penalty of $5.7 million.