SEC Fines UBS for Undisclosed FX Trading Strategy in Connection with Structured Notes | Practical Law

SEC Fines UBS for Undisclosed FX Trading Strategy in Connection with Structured Notes | Practical Law

The SEC entered into a settlement agreement, under which it fined UBS AG a total of $19.5 million for engaging in impermissible FX trading strategies in connection with certain structured notes that were not disclosed to investors in the notes.

SEC Fines UBS for Undisclosed FX Trading Strategy in Connection with Structured Notes

by Practical Law Finance
Published on 21 Oct 2015 • USA (National/Federal)
The SEC entered into a settlement agreement, under which it fined UBS AG a total of $19.5 million for engaging in impermissible FX trading strategies in connection with certain structured notes that were not disclosed to investors in the notes.
On October 13, 2015, the SEC entered into a settlement agreement, under which it fined UBS AG (UBS) a total of $19.5 million for engaging in impermissible FX trading strategies in connection with certain structured notes that were not disclosed to investors in the notes.
UBS offered and sold to about 1,900 retail investors approximately $190 million of structured medium-term notes linked to a proprietary FX trading strategy called the V10 Currency Index with Volatility Cap (V10). The notes had a three-year term, paid no interest, and entitled investors to a cash payout at the end of the term based on the performance of the V10. V10 was a proprietary UBS index that measured the performance of a hypothetical algorithmic trading strategy that was designed to exploit trends in G10 FX forward rates by:
  • Going long in times of low volatility in the three highest yielding G10 currencies and short in the three lowest yielding G10 currencies, using six-month forward contracts.
  • Designating a "switch day" when the market transitioned from low to high volatility, upon which the trading strategy would reverse to go short in the three highest yielding G10 currencies and long in the three lowest yielding G10 currencies.
To hedge its obligations under the notes, UBS purchased positions that mirrored the hypothetical positions held by the V10 index.
The notes were sold to investors under automatic shelf registration statements between January 13, 2009 and November 24, 2010 (prospectuses), and together with statements made to and for the public, the prospectuses emphasized that the underlying trading strategy of V10 was transparent, systematic and calculated using market prices. In one document, UBS stated that:
UBS will determine the market price of the foreign exchange forward contracts underlying the Index. The foreign exchange contracts underlying the Index are foreign exchange forward contracts traded in the over-the-counter-market with terms of up to approximately six months. The prices of such contracts used to calculate gains and losses from notional settlement of hypothetical positions will be based on the market prices at 3:00 p.m. London time (or shortly thereafter taking into consideration available prices for the number of foreign exchange forward contracts that would need to be hypothetically settled as a result of such determination), on the applicable valuation date.
However, the SEC alleged that the conduct of UBS ran contrary to its disclosures. The SEC alleged that, among other things, UBS employees in Switzerland engaged in three types of conduct that either did negatively impact or could have negatively impacted prices used to calculate the V10, including:
  • A UBS employee acting as an intermediary added markups to hedge transactions executed on switch days, which led to prices being used to calculate the index that were not consistent with market prices. There was no legitimate business purpose for the markups.
  • The FX spot desk at UBS added undisclosed spreads to internal hedging transactions on switch days. The spreads were determined by the discretion of the FX spot desk and the spreads were incorporated into the index calculation, which were not reflective of market prices.
  • The FX spot desk traded in advance of certain hedging transactions shortly before executing potentially market-moving internal V10 hedging transactions.
According to the SEC, UBS's failure to disclose these aspects of the V10 trading strategy to investors rendered the published prospectuses misleading. Moreover, UBS's failure to apprise its US employees of the decisions and policies in Switzerland indicated negligence on the part of UBS.
The SEC concluded that UBS violated Section 17(a)(2) of the Securities Act, which prohibits obtaining money though false or misleading statements in the offering of securities (for more information on Securities Violations, see Practice Note, Liability Provisions: Securities Offerings).
UBS was required to pay a total of $19.5 million in damages. Disgorgement constituted $11.5 million of the fine (with $5.5 million of that being used to compensate V10 investors) and the remaining $8 million fine was issued as a civil monetary penalty.