The CEFs consist primarily of Puerto Rican bonds that produce tax-free interest income to Puerto Rican residents if certain requirements are met. By way of background, UBS Trust Company of Puerto Rico (“UBS Trust”) serves as the asset manager and administrator of the CEFs, while UBS PR is the broker-dealer for trading CEF shares. UBS PR marketed the CEFs in Puerto Rico. The CEFs have lost significant value in recent years and have become the subject of, inter alia, enforcement action by the Securities and Exchange Commission (“SEC”). According to published reports, investors’ losses could have been driven by UBS’s role as underwriter and market-maker for certain Puerto Rico debt offerings.
For instance, in 2008, UBS PR underwrote a number of bond offerings made by a Puerto Rican government entity while serving as that entity’s financial advisor. The bonds were of a low quality — rated just above junk level — yet UBS Trust purchased many of these bonds for the CEFs. As reported by Bloomberg News, certain legal experts have characterized UBS Trust and UBS PR’s joint efforts as “a blatant series of conflicts of interest” that are “designed to put money in UBS’s pocket at the expense of its clients.”
Additionally, according to the SEC, throughout 2008 and 2009 UBS PR falsely represented to investors that CEF share prices were the result of market forces such as supply and demand, even though CEF share prices were set solely at the discretion of UBS PR’s trading desk and UBS PR was artificially supporting the secondary market in CEF shares by maintaining a very large CEF inventory. In fact, as the SEC has alleged, in mid-2008 a significant supply and demand imbalance developed in the secondary market for CEFs as investors placed sell orders in increasing numbers. Rather than reducing the price of CEF shares, UBS PR allegedly addressed the imbalance by increasing its CEF inventory from $37 million to $50 million by late 2008. At the same time, UBS PR is alleged to have generated investor demand in the CEFs by promoting their high returns and low risk and volatility, but failed to disclose to investors that CEF share prices and liquidity were increasingly dependent upon UBS PR’s support of the CEF secondary
market.
As further set forth in SEC documents, UBS PR took notice of the persistent “product fatigue” causing the weak demand in the secondary market. In early 2009, UBS PR’s parent company determined that UBS PR’s CEF holdings posed too great a financial risk, and instructed it to reduce its CEF inventory. The SEC has alleged that in order to effect this reduction, UBS PR implemented a plan called “Operation: Soft Landing,” in which UBS PR systematically sold its CEF shares at prices marginally lower than pending customer sell orders, rendering the customer sell orders unmarketable. At the same time, UBS PR increased its efforts to solicit new customers without disclosing the lack of market liquidity or how secondary market prices were being set. As a result of its sell-off of CEF shares, UBS PR sold 75% of its CEF holdings over six months while the price of certain CEFs fell by 10% to 15%.
Multiple actions have been filed against UBS PR and related entities alleging financial harm as a result of the various aspects of the CEF scheme. On May 1, 2012, the SEC charged UBS PR and two UBS PR executives with making misrepresentations and omissions of material facts to retail customers regarding the secondary market liquidity and pricing of the CEFs in violation of United States securities laws. Without admitting or denying the claims, UBS PR agreed on the same day to pay a total of $26.6 million to settle the SEC’s action. The two executives, however, challenged the SEC’s claims, and on October 29, 2013 the SEC action against them was dismissed.
Kessler Topaz Meltzer & Check, LLP is continuing to investigate potential claims relating to UBS’s involvement in CEFs. The firm held an educational seminar in Puerto Rico with two other firms to discuss UBS’s role in selling CEFs. The seminar was attended by more than 400 people.