UBS-Lehman Note Case a Potential Bellwether for All Banks

CMS notes sold by Shanghai Commercial Bank were the same as those sold by UBS.

by: Jake Zamansky December 08, 2009 Jake Zamansky

One of the accomplishments I’m most proud of is the 2001 settlement I negotiated for a client who trusted the bogus research of former Merrill Lynch analyst Henry Blodget. That award caught the attention of then New York Attorney General Eliot Spitzer and ultimately resulted in the $1.4 billion settlement where nearly a dozen Wall Street firms were required to pay for issuing conflicted research. Sadly, Spitzer allowed firms to settle without admitting any wrongdoing, which limited the arbitration recoveries of other investors who mistakenly trusted Blodget.

I’m now optimistic that the arbitration award I won on behalf of a client of mine in South Carolina will prove to be another significant case with similar far-reaching consequences for Wall Street as my Blodget settlement. The case was covered in Saturday’s Wall Street Journal.

The award relates to Lehman Brothers “100 Percent Principal Protected Notes” that UBS (UBS) sold to my client. UBS sold more than $1 billion of these notes to retail investors, my client’s award is the first arbitration ruling relating to them in the country. In addition to ordering UBS to reimburse my client for a significant portion of her principal, the panel also required UBS to pay interest, plus all related expenses, including attorneys’ fees.

The potential implications of the arbitration panel’s findings are significant. If the South Carolina ruling proves to be a bellwether, UBS’s ultimate liability could be staggering, particularly given that the firm was forced to take a $900 million writedown relating to its sale of auction rate securities. Though UBS was by far the biggest peddler of the Lehman notes, countless other Wall Street firms sold them as well as other structured notes, and they, too, may face significant liability.

UBS’s sale of Lehman notes has caught the attention of New Hampshire securities regulators. New Hampshire alleged in a June filing that UBS engaged in “dishonest and unethical” business practices selling the Lehman notes, causing New Hampshire investors to lose $2.5 million. The North American Securities Administrators Association (NAASA) has said it was considering convening a task force on the Lehman notes, and I have strong reason to suspect the SEC also is looking into the matter.

Contrary to what common sense would suggest, the Lehman “100 Percent Principal Protected Notes” were anything but “principal protected.” They were essentially high-risk unsecured bonds that were entirely dependent on Lehman’s ability to make good on them. When the UBS broker sold my client her Lehman notes in April 2008, there already was good reason to be concerned about Lehman’s creditworthiness. Bear Stearns had failed a month earlier because of its exposure to subprime loans and speculation was rife that Lehman would fail for the same reason.

But my client’s UBS broker assured her that her notes had virtually “no risk” of losing principal and had the potential upside of earning a whopping 20.66 percent return in 18 months if the stock market performed within certain parameters. As Lehman’s demise increasingly became more likely in the summer of 2008, my client’s UBS broker repeatedly assured her that her notes were safe and dissuaded her from selling them at a loss as she wanted to do.

My South Carolina client is a hard-working individual who lost a sizeable portion of her net worth when the tech bubble burst. She made it clear to her UBS broker that she wanted only the most conservative investments and she had good reason to believe that in buying the Lehman notes the protection of her principal was a “sure thing.” Fortunately, the South Carolina arbitration panel understood that UBS deceived her and acted accordingly. The finding of fraud will be extremely helpful in other related cases.