As reported in Market Watch, the Financial Industry Regulatory Authority (FINRA) announced today that it has censured and fined UBS Financial Services Incorporated of Puerto Rico (UBS PR) $7.5 million for supervisory failures related to the suitability of transactions in Puerto Rican closed-end funds (CEF). In addition, FINRA ordered UBS to pay approximately $11 million in restitution to 165 customers who realized losses on their CEF positions.
FINRA found that for more than four years, UBS failed to monitor the combination of leverage and concentration levels in customer accounts to ensure that the transactions were suitable given the customers’ risk objectives and profiles creating suitability violations. The firm failed to implement a reasonably designed system to identify and prevent unsuitable transactions in light of the unique Puerto Rican economy, in which retail customers typically maintained high levels of concentration in Puerto Rican assets and often used those highly concentrated accounts as collateral for cash loans. Despite UBS PR’s knowledge of these common practices, it failed to adequately monitor concentration and leverage levels to identify whether certain customers’ CEF transactions were suitable in light of the increased risks in their existing portfolio.
Brad Bennett, FINRA Executive Vice President of Enforcement, said, “UBS of Puerto Rico operated in a unique economy and ultimately failed to tailor its supervisory systems to its specific business needs. Despite the fact the firm was very familiar with the unusual characteristics of its retail accounts, it did not supervise these transactions properly to prevent customers’ heightened exposure to risk.”
In this case, UBS solicited certain customers to open lines of credit collateralized by their securities accounts. If the customer’s account value fell below the required collateral level, the customer received a “maintenance call” and was required to deposit additional assets or liquidate securities to meet the call. Where an LOC is collateralized by a diversified account, a customer may have a variety of securities that s/he can liquidate to meet a maintenance call. However, the risk of investor loss is increased when an LOC is collateralized by a highly concentrated account – and due to the unique benefits of Puerto Rican assets for Puerto Rican residents, UBS PR customer accounts were typically highly concentrated in CEF shares. The market events of Aug. 2013 caused the value of many CEF shares to plummet, and customers who received maintenance calls were forced to realize substantial losses in order to meet them.