One of the most devastating, insidious aspects of the UBS Financial Services Puerto Rico closed end bond fund implosion relates to the losses associated with purchases on margin or credit. While the losses in the funds are devastating enough, the amplification of the losses due to the loans made by UBS to clients (through the direct recommendation of UBS financial advisors) has resulted in cataclysmic events for UBS clients including the complete wiping out of accounts.
A primer on margin…A brokerage firm can lend a client money against the value of certain stocks, bonds and mutual funds in a client’s portfolio. That borrowed money is called a margin loan, and can be used to purchase additional securities or to meet short-term financial needs. Customers of brokerage firms who sign a margin agreement can borrow up to 50% of the purchase price of marginable investments. Said another way, investors can use margin to purchase potentially double the amount of marginable securities than they could using cash.
Why did brokers at UBS recommend purchases of UBS Puerto Rican bond funds on margin? Two reasons…first, margin allowed brokers to purchase additional shares of mutual funds like the Tax Free Puerto Rico Fund II which led to additional commissions directly from buying additional shares. If a client purchased $500,000 of the Tax Free Puerto Rico Fund II in his or her brokerage account, margin, or credit, could allow the client to buy an additional $250,000 of the fund, thereby increasing the broker’s commissions by 50%. Secondly, most brokerage firms share some of the margin interest a client pays to the firm with the financial advisor. This therefore creates a second incentive for the financial advisor to recommend margin to a client.
The margin/credit loans recommend by UBS financial advisors to purchase the closed end Puerto Rico funds that have imploded in many instances were grossly unsuitable. Recommendations by financial advisors have to be appropriate for clients given their age, actual investment objectives, financial resources and other related factors. In many instances, UBS financial advisors were recommending margined purchases of the closed end Puerto Rican bond funds without taking into consideration clients’ actual needs and more importantly, the ability to accept the potential losses that could occur. Few of our clients had the ability to sustain not just an initial 50% loss on the funds but then the resulting amplification of those losses due to margin or credit.
Even more importantly, the margin loans were major supervisory red flags for UBS’s branch managers in Puerto Rico, along with the firm’s compliance and supervision. FINRA and the SEC have hit brokerage firms in the past that didn’t reasonably supervise the purchases and sales of securities on margin. For example, Merrill Lynch was fined $400,000 by FINRA in July of 2012 where part of the fine was for recommending the “unsuitable use of margin to finance customers’ purchasers and sales of securities.” Merrill’s fine was also in part because it ignored red flags of the “unsuitable use of margin.” SunTrust Investment Securities was fined $900,000 in 2010 because the firm allowed the “unsuitable use of margin” and “there was almost no review of trades placed on margin” and the firm did not utilize margin specific exception reports that would help alert principals to significant margin balances.” Sound familiar?
In our FINRA arbitration lawsuits against UBS, we are alleging the recommendation of the funds themselves were unsuitable as well as the additional recommendations to take out credit or margin loans to purchase additional shares. To learn about suing to recover securities fraud losses for unsuitable investment recommendations on margin by UBS financial advisors through FINRA arbitration claims, please call us at 312.332.4200 or visit our law firm website at www.InvestmentFraud.PRO