UBS AG was attempting to liquidate an $11 billion ``albatross'' of auction-rate bonds by selling the debt to individual investors as the market for the securities started to collapse, according to company e-mails.
While executives at the Zurich-based bank identified the hazards of auction-rate securities in August, they simultaneously began to ``mobilize the troops,'' holding more than a dozen conference calls with salesmen and giving them new marketing materials to promote the bonds, according to e-mails from David Shulman, the head of UBS's municipal securities group. ``The pressure is on to move inventory,'' he said in an Aug. 30 note.
The e-mails between Shulman and UBS executives were disclosed in a lawsuit filed yesterday by Massachusetts Secretary of State William Galvin, who claimed the bank committed fraud by selling the bonds as the equivalent of money market securities without disclosing to investors that the $330 billion market was lurching toward a breakdown. Investors who own the bonds now can't get their money.
UBS officials considered pulling out of the auction-rate market, where yields are set through periodic bidding, as early as September, five months before the company stopped supporting the programs, the e-mails show. The bank accumulated bonds by acting as a buyer of last resort to prevent auctions it managed from failing. Yields are set through auctions every seven, 28 or 35 days.
Demand Evaporates
``I have legal looking into options to exit some business lines,'' Shulman wrote on Sept. 6 to Panagiotis Koutsogiannis, a risk manager at the firm in London. ``We are looking into discounting the paper to distribute as well as potentially resigning from supporting as senior manager.''
Demand for auction-rate bonds evaporated last year as corporate cash managers stopped buying after an accounting ruling determined that they should be classified as long-term, not short-term, investments. Companies liquidated $70 billion of auction-rate securities in the last half of 2007, according to Chicago-based Treasury Strategies, which consults with companies on money management.
Investors, who viewed the securities as money-market instruments, also began to flee because much of the market was insured by companies facing losses from guaranteeing subprime mortgage-related debt.
Securities firms that supported the auctions for almost two decades abandoned the market in February, causing thousands of auctions to fail. Issuers such as the Port Authority of New York & New Jersey were left paying penalty rates as high as 20 percent and investors got stuck with bonds they couldn't sell.
SEC, State Probes
The U.S. Securities and Exchange Commission and at least nine state regulators are investigating how banks sold the bonds.
``Here you've got these e-mails, and that could give prosecutors a more favorable forum,'' said John Coffee, a Columbia University professor who specializes in corporate law.
Karina Byrne, a spokeswoman for UBS in New York, said in a statement yesterday the bank was ``disappointed'' with Galvin's complaint and ``will defend the specific allegations.''
Zurich-based UBS is cutting 5,500 jobs, shutting businesses at the investment-banking unit and trying to stem client defections after posting the highest net losses in the subprime crisis of any bank in the world. The U.S. Justice Department is also investigating whether it may have helped clients evade American taxes.
Increasing Risks
The bank sold $42 billion of auction-rate securities for municipalities and student loan corporations between 2002 and 2007, second to New York-based Citigroup Inc., according to data compiled by Thomson Reuters. The bank earned fees from underwriting and managing the auctions.
Galvin is seeking to force UBS to liquidate all the auction-rate bonds it sold to investors in Massachusetts, which he estimated totals $190 million. He is also probing Merrill Lynch & Co. and Bank of America Corp.
``The increasing risks that developed in 2007 were known to the financial services firms that sold them, but were not disclosed to investors who bought them,'' said J. Boyd Page, an attorney at Page Perry LLC in Atlanta specializing in securities fraud.
`Huge Albatross'
UBS's auction-rate holdings began to balloon last August, frequently topping a $2.1 billion-limit set by its risk management department, according to Galvin's investigation. Shulman, who is based in New York, was pressured to unload $1 billion as the firm looked to free up capital, the e-mails show.
``This is a huge albatross,'' Shulman wrote in an Oct. 31 e-mail, referring to the growing inventory. Shulman, who didn't return calls seeking comment yesterday, is 46 according to voter registration and campaign finance records obtained by Bloomberg News. He isn't personally being sued by Galvin.
UBS increased marketing efforts to individual investors in August. Financial managers were paid 40 percent of the marketing fee from the periodic auctions, according to e-mails.
Shulman sold his own auction-rate holdings last year, telling Galvin during a deposition that was released as part of the documents that his ``risk tolerance'' changed.
UBS managers and financial advisers in the wealth management division held 15 conference calls to discuss sales between Aug. 22 and Feb. 15, according to Galvin's investigation. When the market collapsed in February it was holding as much as $11 billion of the debt, the documents show.
``We need to move this paper and have to explore all angles possible,'' Shulman said in a Dec. 11 e-mail to Paul Wozniak, co-head of the student loan group at UBS. ``We need to do this as quickly as possible.''
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