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According to Reuters, UBS AG (UBS - Analyst Report) – Switzerland’s largest bank in terms of assets – consented to a settlement worth $49.8 million with the U.S. Securities and Exchange Commission (SEC) to compensate investors for misleading them with a housing market related collateralized debt obligation (CDO). The settlement amount includes $23.6 million of upfront cash, $10.8 million of disclosed fee, $9.7 million of interest and a $5.7 million fine.

The Allegations

The aforementioned payment will resolve the investigation of ACA ABS 2007-02 CDO - created in mid 2007 by UBS.  According to the SEC, the CDO resulted in losses worth $130 million for outside investors following liquidation in June the next year.

CDOs typically repackage bonds and other assets into new securities. These are not traded on a public exchange, allowing firms like UBS to generate fees through brokering deals between buyers and sellers. However, CDOs have performed miserably since these were invested in securities comprising sub-prime mortgages, which are known to have larger-than-average risk of defaulting in the market. Eventually, the market downturn ruined the investment banker's expectations, resulting in huge losses for common investors.

According to the SEC, securities law were violated by UBS as the Swiss bank set aside $23.6 million upfront cash, received while acquiring credit default swaps as security for the CDO. Moreover, the bank inadequately disclosed the amount as cost of acquiring the collateral, which would have been transferred to the CDO for the gain of investors.

Though UBS agreed to the settlement, it denied the allegations. According to UBS’ spokeswoman, the settlement would conclude all SEC investigations associated with the Swiss Bank’s structuring and marketing of CDOs backed by residential mortgage-backed securities (RMBS).

Recently, UBS announced the settlement of a lawsuit filed by the Federal Housing Finance Agency (FHFA), which had accused the former of misrepresenting mortgage-backed securities (MBS). The Swiss banking major shelled out roughly $885 million for the settlement. FHFA had accused UBS of misrepresenting MBS documents to Fannie Mae and Freddie Mac.

Others Facing Similar Issues

Among others, The Goldman Sachs & Co. (GS - Analyst Report) agreed to pay $550 million to settle similar charges in 2010, followed by JPMorgan Chase & Co. (JPM - Analyst Report), which faced similar charges in Jun 2011 and paid $153.6 million.

Moreover, Citigroup Inc. (C - Analyst Report) agreed to pay $285 million over the CDOs, but U.S. District Judge in Manhattan, Jed Rakoff rejected the settlement with the SEC concluding that the facts and figures submitted by Citigroup were unsatisfactory.  All these cases had intricate investments called collateralized debt obligations, backed largely by mortgage securities.

Legal Woes Continue

Trouble has been brewing for banks for quite sometime now owing to fraudulent representations and breach of contract tied to RMBS. Banks face several other charges related to the sale of defective mortgage securities.

Litigation overhangs have been a common problem for major banks since the financial meltdown. In effect, these lawsuits are expected to tarnish their reputation and financials over time. However, investors and other financial institutions bearing the brunt of these faulty practices are expected to be fairly compensated.

Conclusion

With the settlement of the lawsuit, UBS plans to move forward with its business strategies. Moreover, pending lawsuits can further trigger financial hassles while tarnishing the company’s image. Therefore, it is in the interest of the company to resolve such matters at the earliest.

Currently, UBS carries a Zacks Rank #4 (Sell).

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