“UBS AG Yield Optimization Notes with Contingent Protection linked to the common stock of Lehman Brothers Holdings Inc. ‘” (hereinafter referred to as “the Notes”) sold by UBS Financial Services, Inc. circa 2007-2008 have been described as the worst investment ever (or at least one of the worst investments ever) by some securities practitioners
The Financial Industry Regulatory Authority (FINRA), which is charged with regulating brokerage firms, refers to this type of investment as a Reverse Convertible. As FINRA explains, reverse convertibles “often involve terms, features and risk that can be difficult for individual investors and investment professionals alike to evaluate.” FINRA Notice to Members 10-09. FINRA further states that, given the put option component of reverse convertibles, firms that do not limit reverse convertibles to accounts approved for options trading “should be prepared to demonstrate the basis for allowing investors with accounts not approved for options trading to purchase reverse convertibles.” UBS failed to heed that warning, which first appeared in 2005 (NASD NTM 05-57).
Notwithstanding FINRA’s cautions, the Notes were described to investors by UBS as a way to enhance yield. They represented an exotic indebtedness of UBS AG. The Notes were said to have a maximum annualized payout of 20%, or 10% for their 6-month duration. An investor was to obtain this “enhanced” return because the investment was not in ordinary notes. The actual performance of the investment was tied to Lehman stock. Making matter even more confusing, the Notes come with what UBS called “contingent protection,” a device that was supposed to protect the investment if Lehman’s stock price fell.
Even though these securities were UBS Notes, representing UBS’s indebtedness ? and even though UBS never defaulted on its debt ? when Lehman Brothers filled bankruptcy, the Notes became worthless, and investors lost all their principal.
There are three main reasons why this is one of the worst (if not the worst) investments ever: First, investors thought they were buying a note, and the risk of total loss of their principal was not disclosed to them. While investors were told that their “return” would vary with Lehman’s stock price, they were led to believe that the existence of “contingent protection” would prevent loss of principal. Thus, while their return might vary, their principal would be protected. That turned out not to be correct. Under the “contingency,” the protection disappeared if Lehman’s price fell too much. This was not apparent to investors, and UBS did not explain it.
Second, UBS did not disclose the true nature of this investment. When UBS’s marketing terms like “Yield Optimization,” “Reverse Convertible,” and “Contingent Protection” are stripped away, this UBS proprietary investment product was actually combination of a coupon UBS Note and a series of esoteric option combinations, involving multiple layers of long and short put options. Most investors did not have the experience or the educational background to understand these esoteric, complex, option-based Notes and were unable to evaluate whether it was a good investment or not.
The same is true of the UBS brokers. They had no reasonable basis for selling these reverse convertibles, because they too lacked the background to evaluate this investment, its risks, returns and pricing. They too could not make an informed comparison to other investments. It was just too complex. A Nobel Prize was awarded to the finance expert who first explained the model for evaluating whether an option is fairly-priced. One would need a complex application of that model (the Black-Scholes model) to determine whether the investment UBS created and sold was fairly-priced.
Third, UBS sold this Lehman-based investment while hiding its own corporate concerns about Lehman’s future and UBS’ own efforts to avoid the risk of a Lehman bankruptcy. UBS’s had a negative fundamental view of Lehman. UBS was concerned about Lehman’s risk-taking exposure that continued to increase, and it regarded Lehman as vulnerable. UBS had a duty to disclose its own negative view of Lehman to investors before selling them the Notes, but it definitely did not.
J. Boyd Page, the senior partner of Page Perry, said: “Investors in these toxic notes are urged to take action if they haven’t already done so. Investors who were sold these Lehman-linked notes in 2007 and 2008 are beginning to reach, or may have already reached, the four year anniversary of the purchase date. Further delay could result in timeliness issues.”
“UBS knew that Lehman was in trouble as far back as October 2007, but they continued to sell Lehman structured products anyway, ignoring the ever-growing risk,” Mr. Page observed, adding: “Not only weren’t they candid with the public, they weren’t candid even with their own brokers.”
“These are highly complex products; they are too complex for ordinary investors to evaluate. We have been very successful in proving that,” attorney Seth E. Lipner noted.
Page Perry, a law firm based in Atlanta, Georgia, is co-counsel with Mr. Lipner and his Garden City, New York law firm, Deutsch & Lipner, in representing investors in arbitrations involving reverse convertibles and other structured notes sold by UBS.