UBS Under Criminal Probe For Fraud In Puerto Rico

UBS (NYSE:UBS) is reportedly under investigation by the U.S. Department of Justice (DoJ) as well as the Securities and Exchange Commission (SEC) for alleged fraud in Puerto Rico. ^[1] The Swiss bank has been under fire from its wealth management clients in the island since late last year, when investment products sold aggressively by its brokers resulted in huge losses, prompting a series of lawsuits against it. The ongoing investigation seeks to find the truth in these lawsuits that claim that the bank’s lending arm extended credit illegally to the clients so that it could invest more cash into its own bond funds.

The Swiss bank is likely to pay millions to settle the charges it faces in the wake of the legal backlash from the issue. The investigation also does not help UBS’s falling reputation in Puerto Rico, where it manages assets of around $10 billion for clients – giving it a large share of the island’s wealth management industry.



We maintain a $21.50 price estimate for UBS’s stock, which is about 15% higher than its current market price.

See our complete analysis of UBS here

Puerto Rico’s tax policies have made it an attractive base for millionaires around the globe – also making it an important market for the world’s biggest wealth managers. UBS has a sizable presence in the region, with its operations in Puerto Rico housed under its Wealth Management Americas business segment. The Swiss bank had 132 brokers running five branches on the island and managing roughly $10 billion in client assets in late 2013. ((UBS Brokers in Puerto Rico Create Headache for the Bank, The New York Times, Oct 2 2013))

But it has been a bumpy ride for UBS over the recent years. In May 2012, the bank paid $26.6 million to the SEC to settle charges of misleading investors against it. ^[2] An internal investigation by the bank unearthed an even bigger problem with the operations in the region, as its brokers were found to be selling investment products to not just seasoned investors but also to smaller retail investors without highlighting the risks involved.  Additionally, a broker was found guilty of encouraging wealthier clients to take on loans illegally as credit lines instead of margin loans to invest in several products. To make matters worse, these loans were made by UBS Bank USA, based in Utah, which is not licensed to lend in Puerto Rico. The bank fixed these problems by firing the broker and selling the loan portfolio in question to its brokerage in Puerto Rico.

The proprietary products in question were closed-end funds which invested in Puerto Rican municipal bonds and were managed by UBS itself. As these funds were doing quite well in prior to 2013, they found ready takers. But as the region’s economy was hit, the funds quickly started losing value and resulted in millions in losses for the investors. The legal backlash exposed UBS’s irregular lending practices in the region, as the bank’s own conditions mention that these loans cannot be used for investing in securities. As a part of their ongoing investigation, the DoJ and SEC are trying to ascertain whether employees higher up in the bank’s management structure had knowledge of the issue.

The investigation will most likely result in additional payouts for the bank in the near future, adding to expenses for UBS’s Wealth Management Americas division. The long-term impact of this will also be seen as a reduction in wealth management assets for the bank in the region. You can gauge how a smaller-than-expected growth in assets managed by its Americas operation will impact UBS’s share price by making changes to the chart below.

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Notes:

1. Exclusive: UBS faces criminal probe for Puerto Rico bond fund sales – lawyers, Reuters, Jun 19 2014 [↩]
2. SEC Charges UBS Puerto Rico and Two Executives with Defrauding Fund Customers, SEC Newsroom, May 1 2012 [↩]

UBS Under Criminal Probe For Fraud In Puerto Rico