April 11, 2011 / 4:20 PM / 8 years ago

UPDATE 3-UBS fined for playing down Lehman risk to clients

* FINRA: Brokers did not understand risks of Lehman notes

* Lehman went bankrupt on Sept. 15, 2008 (Adds detail from interview with FINRA enforcement chief; adds background)

By Jonathan Stempel and Joseph Giannone

NEW YORK, April 11 (Reuters) - UBS AG UBSN.VX was ordered by Wall Street’s brokerage regulator to pay nearly $11 million to settle charges it misled customers about the risks of owning Lehman Brothers LEHMQ.PK debt in the months before the U.S. investment bank went bankrupt.

The Financial Industry Regulatory Authority on Monday said UBS agreed to pay a $2.5 million fine and reimburse its customers for $8.25 million. UBS did not admit nor deny wrongdoing in agreeing to settle.

“This matter underscores a firm’s need to be clear and comprehensive in disclosing risks of the structured products it sells to retail investors,” FINRA enforcement chief Brad Bennett said.

FINRA said UBS and its brokers failed between March and June 2008 to emphasize that Lehman’s “100% principal-protection notes” were unsecured, meaning that payment was not guaranteed. The obligation for due diligence and customer disclosures is not diminished when securities sold by one firm are managed or underwritten by another firm, FINRA said.

Investigators said that these notes were sold to investors seeking low risk but attracted to high yields. FINRA’s settlement said UBS sold $16.2 million of these notes between mid-March — after Bear Stearns was acquired by JPMorgan Chase (JPM.N) in a U.S. government-backed rescue — and June 2008.

The notes were sold to 764 unique accounts with either a “conservative” risk profile or a “moderate” profile and a net worth of $1 million or less. UBS generated $228,630 in fees and commissions from these sales, FINRA said.

Lehman filed for Chapter 11 protection on Sept. 15, 2008, the largest bankruptcy in U.S. history. That event wiped out the value of the notes and sparked a wave of arbitration claims by investors.

(For an August 2010 story on the expected surge in Lehman-note cases against UBS, click on [ID:nN25273736])

FINRA said UBS failed to emphasize that the “principal protection” was subject to credit risk of the underwriter, which was Lehman in this case.

It said the Swiss bank also failed to properly advise brokers how a widening of credit default swap spreads, a measure of perceived risk of owning debt, could affect Lehman’s financial strength.

UBS brokers “did not even understand the complex products they were selling,” he added.

Karina Byrne, a UBS spokeswoman, said the bank is “pleased” to settle the case, which concerned “a limited number of investors who purchased certain Lehman principal protection notes during a discrete 3 1/2 month period of time.”

She said a “significant majority” of UBS’s sales of Lehman structured products were conducted properly.

Bennett, in an interview later on Monday, said UBS should not play down its obligation to have reconsidered the risks inherent in unsecured Lehman notes in the months that followed the March collapse of rival bank Bear Stearns.

“Lehman Brothers was in a critical period after the Bear Stearns sale to JPMorgan. Those were a key 3 1/2 months. They can’t just be on automatic pilot,” Bennett said.

Under the terms of the deal, conservative accounts recover 100 percent of their losses while the moderate accounts receive 50 percent, but can keep the notes and also realize some value in bankruptcy, FINRA said.

Lehman proposed a reorganization plan in January that pays creditors roughly $60.1 billion, or 18.6 cents on the dollar. A creditor group led by hedge fund Paulson & Co and the California Public Employees’ Retirement System proposed an alternative plan that would pay some creditors more.

UBS in January said its U.S. brokerage unit lost $35 million in the fourth quarter, after it set aside $159 million ahead of legal expenses related to its sales of auction-rate securities and Lehman notes. (Editing by Steve Orlofsky and Andre Grenon)

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