SEC Investigates Structured Notes, Fines UBS for Misstatements

The Securities & Exchange Commission has settled its first ever enforcement action focusing on misstatements concerning structured notes, with UBS AG agreeing to pay $19.5 million without admitting or denying liability. In connection with the announcement, SEC Director of Enforcement Andrew Ceresney told reporters there were other active investigations involving structured notes.

Structured Notes are a type of complex debt securities product that is pegged to the performance of other instruments. The SEC issued an Investor Bulletin warning about potential risks of structured notes in January, 2015. Among the issues identified by the SEC are credit risk (the risk the investment bank issuing the instrument will not pay), complicated payoff structures, and liquidity issues (the inability to trade or sell them in the market).

In August, the SEC issued a risk alert after reviewing sales of a large number of structured notes in an examination of broker-dealers at ten firms. The alert identified issues such as mischaracterizing the underlying product, targeting inappropriate individuals and substantial price movements downward shortly after selling them to retail clients.

The specific issue at issue in UBS involved misstatements concerning the performance of the structured note. The product measured an algorithmic trading strategy designed to identify and exploit trends in G10 foreign exchange forward rates. UBS told investors that the trading strategy tied to the notes was transparent but failed to warn investors that UBS was hedging the trades at a cost of about five percent of the index price.

This seems like an area that is ripe for tips by whistleblowers to the SEC. The Dodd-Frank Act provides for rewards to a whistleblower when their information results in monetary sanctions of at least $1 million and they meet the laws eligibility requirements.

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