On September 28, 2016, the U.S. Securities & Exchange Commission announced that it had imposed severe monetary penalties on UBS Financial Services in connection with the firm’s activities involving nearly $10.7 billion of stock-linked reverse convertible notes (“RCNs”) that had been sold to approximately 44,000 customer accounts between 2011 and 2014. (“In the Matter of UBS Financial Services Inc., Exchange Act Release No. 34-78958”)
The penalties, which included more than $9 million in disgorgement and a civil penalty of $6 million, were based on UBS having failed to develop and implement policies and procedures reasonably designed to educate and train its registered representatives in connection with RCNs so that they could adequately understand the risks and rewards of the product and could form a reasonable basis to make suitable recommendations to their customers.
Without adequate education and training, certain registered representatives made unsuitable recommendations in relation to the offer and sale of approximately 2,500 different RCNs to certain customers – many of whom had little or no relevant investing experience and had identified to UBS modest reported income and net worth, primarily moderate or conservative investment objectives, and some of whom were retired.
RCNs are a type of structured product issued by a financial institution as an unsecured debt obligation that is linked to the performance of an underlying single stock. RCNs are structured to pay a higher interest rate than conventional debt of the same issuer because of the inclusion of the embedded derivative that provides essentially a synthetic put on the underlying stock.
The UBS single stock-linked RCNs at issue in the SEC enforcement action involved certain complex structures, including: (1) Trigger Yield Optimization Notes; (2) Trigger Autocall Optimization Securities; (3) Trigger Phoenix Autocall Optimization Securities; (4) Airbag Yield Optimization Notes; and (5) Airbag Autocallable Yield Optimization Notes.
As noted in the SEC’s Enforcement Order, “UBS’s internal education and training primarily focused on describing the payouts for the various products and . . . it did not provide adequate training on certain important aspects of RCNs. For example, although the Structured Solutions Desk provided potential issuers with information regarding the RCN option features from the ‘investor’s perspective,’ internal educational materials lacked similar information. In addition, UBS’s internal educational materials did not describe sufficiently the role of implied volatility and the potential for breach in the selection of the equity securities underlying the RCNs. As a result, UBS registered representatives were not adequately educated and trained to understand adequately the risk and characteristics of the product, including relevant volatility concepts and the role that volatility played in the selection of the equity securities underlying the RCNs.”
If you are an individual or institutional investor who has any concerns about your accounts and/or investments with UBS Financial Services Inc., please contact us.