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Lending Practices of UBS Brokers in Puerto Rico Called Into Question

Swiss banking giant UBS has had its share of spotlight moments in recent years – and many have been anything but positive. Last year, the firm agreed to pay $1.5 billion to settle claims that UBS traders and managers had manipulated global benchmark interest rates. The bank also paid nearly $27 million in 2013 to settle accusations by the Securities and Exchange Commission (SEC) that it and two of its executives in Puerto Rico had made misleading statements to investors that the SEC said concealed a liquidity crisis in UBS funds.

Another blight on UBS’ record concerned former UBS trader Kweku M. Adoboli, who was sentenced in 2013 to seven years in jail after having been found guilty of fraud that subsequently led to a multibillion-dollar trading loss at UBS.

Now there appears to be more trouble brewing for UBS. This time it has to do with the bank’s business in Puerto Rico. Puerto Rico has long been a haven for the wealthy because residents do not pay federal income taxes. A number of big investment banks do business in Puerto Rico, but UBS is one of only a handful with a substantial team of brokers on the island. As reported in a recent story by Susanne Craig in the New York Times, UBS maintains five branches in Puerto Rico, with 132 brokers who manage money – roughly $10 billion – for the island’s wealthy investors.

In many instances, UBS put this money into mutual funds that the bank itself managed. Such a practice can be lucrative business as both the broker and the bank receive a commission on each sale, with the bank taking in a fee for managing the fund.

Because of recent economic woes in Puerto Rico, UBS customers have seen the value of their holdings fall dramatically. Many of these investors had bought heavily into highly leveraged bond funds run by UBS and were encouraged by its brokers to borrow even more money to invest in those funds, according to the New York Times story. In some cases, “money was lent improperly, exacerbating current losses, according to UBS employees in the region close to the situation, who spoke on the condition that they not be named because of a company policy against speaking to the news media.”

Now, a number of UBS clients have been forced to liquidate hundreds of millions of dollars in holdings in these funds in order to meet margin calls. UBS, meanwhile, says it has launched an internal investigation regarding the lending practices of some of its brokers in Puerto Rico.

One UBS broker reportedly already has been placed on administrative leave after recent claims came to light he had encouraged his clients to buy securities on lines of credit, which is in violation of the bank’s policy.

As reported in the New York Times story, UBS’ funds had once enjoyed strong returns for years and paid healthy dividends. The Tax Free Puerto Rico Fund II (total assets: $357 million) has a five-year return of 6.8 percent, according to UBS documents.

But in the face of Puerto Rico’s continuing economic downturn, UBS customers have seen the value of their holdings fall. The fund’s shares don’t trade on an exchange, but UBS documents show it had a per-share value of $6.16 in early September, down from $7.75 a share at the end of June. Brokers in the region say the fund’s value has fallen even further in recent weeks, according to the New York Times.

The funds that UBS manages are highly leveraged. According to the New York Times, the Tax Free Puerto Rico Fund II has a leverage ratio of 53%. That means for every dollar of a customer’s assets it holds, it has roughly another dollar of assets bought with borrowed money. UBS’s other Puerto Rico funds are similarly leveraged, according to firm documents.

By comparison, the average leverage ratio on funds similar to UBS’ in the United States is roughly 22%, according to Morningstar.

The New York Times story points out that UBS’ troubles on the island have been exacerbated by the fact that many clients took out margin loans to buy into the funds. (UBS brokers who encouraged the use of credit lines had good reason to do so; they receive commissions for securities bought on the credit lines and make additional money if the customer uses the credit line.)

The New York Times story goes on to report that according to local brokers and a lawyer representing some UBS clients who may sue UBS, some investors were encouraged by their brokers to borrow on credit lines.

You can read the entire New York Times story here.

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