New York sues UBS, alleges auction-rate fraud

NEW YORK (Reuters) - New York State sued UBS AG on Thursday, accusing the Swiss bank of committing a "multi-billion dollar fraud" by steering broker clients into auction-rate securities that became impossible to sell once the credit market tightened.

The lawsuit, filed by New York State Attorney General Andrew Cuomo, accuses UBS of deceptively selling auction-rate securities as cash equivalents.

These long-term securities are issued by municipalities, student-loan companies and mutual funds, and interest rates are set through weekly or monthly auctions.

The lawsuit said that at least seven UBS executives dumped $21 million in auction-rate securities that they held in personal accounts as the credit market began showing signs of trouble, and that the bank continued to sell those securities.

UBS "continued the fraud after they knew the fraud was revealed for what it was," Cuomo said at a news conference. "Top executives jumped ship as soon the securities market started to collapse, leaving thousands of customers holding the bag."

Cuomo said that in February more than 50,000 UBS customers across the United States held more than $25 billion in the illiquid securities. The Attorney General's office did not sue individuals, but Cuomo said the investigation was continuing.

UBS said it would defend itself against the charges.

"It is frustrating that the New York Attorney General has filed this complaint while we have been fully engaged in good faith negotiations," the bank said.

UBS said it conducted an internal probe of alleged sales of personal holdings of auction-rate debt by its executives.

"While UBS does not believe that there was illegal conduct by any employee, we have found cases of poor judgment by certain individuals and are evaluating appropriate disciplinary measures," the bank said.

NATIONWIDE SWEEP

The lawsuit is the first to arise from the state's investigation into how brokerages handled the $330 billion auction-rate market. In April, Cuomo sent subpoenas to 18 brokers and banks.

These securities were popular among investors because they offered higher yields than money-market funds and were seen as equally liquid.

The market for auction-rate securities froze when investors, spooked by the tightening credit market, stopped buying them. Wall Street firms, which long provided liquidity, were overwhelmed by selling and one by one they stopped propping up the market with their own bids.

By late January auctions began to fall apart, and suddenly securities promoted as cash-equivalents became impossible to liquidate. At the same time, issuers such as New York's Port Authority were forced to pay higher rates.

Massachusetts and Texas have also taken legal actions against UBS, contending it continued to promote auction-rate securities as safe when they knew they were risky.

Earlier this week, the Texas state securities board said in a notice that it was considering at least partly suspending UBS AG from acting as a securities dealer in the state until Texans who invested in auction-rate securities get their money back.

Although at least seven other states are also investigating the sale of auction-rate securities, the legal assault by New York is the most serious threat faced by UBS because Cuomo asserts that his office has nationwide jurisdiction. He said that is because most U.S. firms operating across the country are based in or do business in New York City.

The lawsuit invoked the Martin Act, a powerful New York state law that gives the Attorney General broad authority for ensuring the integrity of securities trading. Former New York Attorney General Eliot Spitzer used that law to impose hefty fines and reforms on Wall Street firms after his investigations into mutual fund trading and analyst conflicts of interest.

Cuomo wants UBS to buy back auction rate securities from defrauded customers at face value, to disgorge any ill-gotten gains and pay restitution and other damages. Cuomo declined to estimate the extent of these damages.

"UBS is not alone in this scheme. There are other institutions which participated, but UBS is a major player," he said.

JUMPING SHIP

Starting in late 2007, the lawsuit said, UBS management became concerned about its auction-rate holdings and formed a working group.

The lawsuit contends that at least seven working group members sold $21 million of their personal auction-rate holdings after the group was formed.

During this period UBS looked for ways to pare down its own inventory of auction-rate securities, the lawsuit said. While many options were discussed, the one repeatedly implemented was increasing sales of auction-rates to UBS clients, according to the lawsuit.

As one key piece of evidence, the lawsuit cited a December 14, 2007, e-mail from "UBS's chief risk officer" to "UBS's CEO" discussing his concerns about the auction-rate market.

A copy of that e-mail was also sent to an unnamed executive, who four days later liquidated all $250,000 of his own auction-rate securities. These markets began to break down in January.

The two officers were not identified by name and Cuomo's office declined to specify if they were group-level or subsidiary executives. A UBS spokeswoman said Marcel Rohner, group CEO at that time, was not the recipient of the e-mail.

UBS denied any claim that it engaged in a campaign to move its own auction-rate securities into private accounts. The bank notes it nearly doubled its inventory to about $11 billion during the first quarter, while its clients reduced their positions.

"UBS continued to support the auctions longer than any other major firm," said UBS, adding that it was trying to help clients with auction-rate securities.

Last week, UBS announced a plan to buy back as much as $3.5 billion in auction-rate securities from customers. Cuomo on Thursday dismissed that offer as insufficient.

"The resolution can't be that some guys get back some of their money, he said. "People want their money back. Not some of it. Not a little today and a little more tomorrow. My job is to get their money back."

UBS' New York-listed shares closed down 7 percent at $21 on the New York Stock Exchange on Thursday.

(Additional reporting by Martha Graybow; Writing by Martha Graybow; Editing by Phil Berlowitz, Toni Reinhold)