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UBS Fails to Disclose Risk of Auction-Rate Securities to its Investors

In a lawsuit filed yesterday by Massachusetts Secretary of State William Galvin, the head of UBS AG’s municipal securities group David Shulman is alleged to have exchanged emails with UBS executives that discussed how the bank should promote its failing auction-rate bonds as money market securities.  UBS attempted to shift its burden of $11 billion in auction-rate bonds by selling them to investors.

The emails also indicate that UBS almost pulled out completely from the auction rate market nine months ago, but instead bought out bonds in order to prevent the auctions it managed from failing. These emails came after the fact that UBS executives recognized the high risk of auction-rate securities in August. Despite these warning signs, the emails indicated that UBS faced pressure to free up capital because it had an overload ($10 billion) of auction-rate holdings. 

Galvin holds UBS responsible for committing fraud for not informing investors that the auction-rate market was collapsing. Galvin also plans to have UBS liquidate its auction-rate bonds, which adds up to $190 million, so investors can get their money back.   

Last year, the popularity of auction-rate bonds decreased significantly for securities firms (who are typically the buyers) in the auction-rate market because the bonds were reclassified as long-term investments rather than money-market instruments. Many investors are now left with bonds that will not sell and are having to pay high penalty rates. 

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