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January 10, 2013 at 09:18 AM
In recent enforcement news, an appeals court reinstated a suit against UBS subsidiaries by two Puerto Rico-based pension funds over a $757 million bond purchase.
Shareholder Suit Against UBS Reinstated by Appeals Court
The U.S. Court of Appeals for the First Circuit has reversed the 2011 decision of the U.S. District Court for the District of Puerto Rico in dismissing the shareholder lawsuit of two Puerto Rico-based pension funds, Unión de Empleados de Muelles de Puerto Rico AP Welfare Plan and Unión de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan, against UBS subsidiaries over the purchase of $757 million in bonds.
In 2010, the two plans filed a shareholder derivative suit against UBS Trust Co. of Puerto Rico, advisor to the plans, and UBS Financial Services of Puerto Rico, underwriter of the bonds, which were issued by Puerto Rico’s Employee Retirement Service (ERS).
The suit alleged that the UBS defendants manipulated trading by using the plans’ four investment funds—the Puerto Rico Fixed Income Fund II Inc., the Puerto Rico Fixed Income Fund III Inc., the Puerto Rico Fixed Income Fund IV Inc., and the Tax-Free Puerto Rico Fund II Inc.—to engineer the appearance of market interest in the bonds, which in actuality sold very little elsewhere.
UBS Financial had to find buyers for the bonds in order to make money, and UBS Trust advised the funds to buy them. However, within a year of the purchase by the retirement plans’ funds of $757 million worth of the bonds—a sufficient quantity to overweight the funds’ exposure—the value of the bonds fell by 10%, “dragging down the worth of the funds,” according to the court ruling.
At that point, the two plans filed their suit in the District of Puerto Rico. The suit named members of the funds’ board of directors as defendants as well as the UBS subsidiaries, and said that “a presuit demand [to the boards of directors of the funds] would have been futile.”
The complaint in shareholder actions is required to assert either that the corporation declined to protect its own interests after a suitable demand was made on the board of directors, or that such a demand would have been futile. The UBS subsidiaries moved to dismiss the derivative claims, saying that the two plans had inadequately pleaded demand futility in their suit. Their move was successful at first; the district court dismissed the plans’ derivative claims without prejudice for failure to properly plead demand futility with regard to the funds’ directors.
However, the appeals court looked at the pleadings “de novo” and found that, because of information provided on six of the eleven directors involved, there was indeed reasonable cause to believe that a presuit demand would have failed. The case was reinstated and may now proceed. FINRA Censures, Fines Firm $2.1 Million in Use of CDSs
GFI Securities LLC was censured by FINRA and fined $2,100,000, and two of its registered principals and two of its registered reps were suspended and fined for their actions in using credit default swaps (CDSs). Michael Scott Babcock and Donald Patrick Fewer, registered principals, were fined $100,000 each; Stephen Falletta and Lainee Dale Steinberg, registered representatives, were fined $200,000 and $125,000, respectively.
Without admitting or denying the allegations, the respondents consented to the sanctions and to the entry of findings that a client sought to reduce its brokerage costs by proposing that the broker it used to effect certain CDSs forgo charging the client commissions when it was the counterparty whose bid had been hit or whose offer had been lifted by the other counterparty.
The findings stated that through a series of communications, Steinberg and a broker at another member firm coordinated their respective firms’ responses to the proposal and discussed an alternative fee schedule that might be proposed to the client. The broker convinced GFI to give the client aggressor-only terms on CDS index transactions and CDSs associated with a particular country, rather than the blanket concession the client requested.
The findings also stated that another client also sought aggressor-only terms on CDS transactions from GFI and other CDS brokers. Steinberg and Falletta coordinated GFI’s response to the client with another broker’s response on his firm’s behalf, so the client did not get the blanket aggressor-only terms it had sought. The findings also included that other clients proposed a new fee schedule or reduction of fees on CDS transactions. The proposals precipitated a flurry of communications among brokers at affected firms, including Babcock and others at GFI, to collaborate with competitors to defeat the clients’ proposals.
One client circulated a modified proposal that provided for higher commissions than its original proposal, which GFI and the other firms accepted. The other client agreed to accept price reductions that were smaller than it had originally proposed.
FINRA found that through these numerous communications, GFI sought to frustrate its customers’ efforts to obtain brokerage services at rates reflecting a bona fide competitive market. FINRA also found that, through these same communications, Babcock, Fewer, Falletta and Steinberg sought to frustrate GFI’s customers’ efforts to obtain brokerage services at rates reflecting a bona fide competitive market.
