Sale of Complex Notes to Retail Investors Costs UBS $15 Million

UBSMany retail investors are unfamiliar with reverse convertible notes, implied volatility and embedded derivatives. According to the SEC, however, from 2011 through 2014, UBS Financial Services Inc. (UBS) sold more than half a billion dollars of reverse convertible notes (RCNs) to approximately 8,700 retail investors. Many of these purchasers had little or no relevant investing experience, and were not familiar with complex structured products. A large percentage of these investors had previously communicated to UBS that they had modest incomes and net worth, and had moderate or conservative investment objectives. UBS registered representatives recommended nearly all of these transactions in RCNs.

The SEC alleged that UBS failed to properly educate and train its registered representatives with regard to these structured products. Without adequate education and training, some UBS registered representatives made unsuitable recommendations to purchase RCNs to their retail customers. The SEC charged UBS with a failure to supervise under Exchange Act §15(b)(4)(E) and with engaging in course of business that operated as a fraud or deceit on the purchasers in violation of Securities Act §17(a)(3).

Without admitting or denying wrongdoing, UBS agreed to disgorge approximately $8.2 million, along with prejudgment interest of $798,316, as well as to pay a civil penalty of $6 million. The SEC noted that UBS promptly undertook remedial acts and cooperated with the Commission staff.

Single stock-linked RCNs are complex structured products issued by financial institutions as unsecured debt obligations that are linked to the performance of an underlying single stock. These RCNs pay a higher interest rate than conventional debt from the same issuer because they include an embedded derivative that effectively provides a synthetic put on the underlying stock. In addition to the higher yield, however, investors take on the risks normally associated with debt instruments, such as interest rate changes and issuer default, as well as the additional risks presented by changes in the value of the asset underlying the notes.

According to the SEC, UBS did not properly educate and train its representatives to adequately understand the risk and characteristics of the product, including relevant volatility concepts and the role that volatility played in the selection of the securities underlying the RCNs. Michael J. Osnato, chief of the Enforcement Division’s Complex Financial Instruments Unit, stated that “[w]hen it comes to complex financial products, investors are especially dependent upon firms making sure their financial advisors comprehend the potential risks and rewards of the investments they are recommending.  The SEC takes a dim view of firms that fall short in their obligations.”

In the Matter of UBS Financial Services Inc., SEC Release No. 34-78958 (Sept. 28, 2016).