By Bradley Keoun and David Scheer
Nov. 3 (Bloomberg) -- UBS AG, Switzerland's largest bank, faces dozens of claims in the U.S. from clients who bought ``100 percent principal protected notes'' issued by Lehman Brothers Holdings Inc. that are now almost worthless.
Six attorneys hired to represent clients in the cases say UBS brokers touted the so-called structured notes as low-risk investments and failed to emphasize they were unsecured obligations of Lehman, which filed for bankruptcy in September. State regulators are fielding so many calls about Lehman's notes they're considering a task force to investigate the sales, said Rex Staples, general counsel for the North American Securities Administrators Association Inc., a group of 67 state and provincial regulators based in Washington.
``The sales pitches were that it's good for retirement accounts, and good for the safe, fixed-income part of people's portfolios as an alternative to owning stocks, because it's less risky,'' said Seth Lipner, a lawyer in Garden City, New York, hired by two holders of Lehman notes sold by UBS, including a 65- year-old accountant who says he lost $1.4 million in retirement savings. ``Of course, it turned out to be more risky.''
Any awards for investors would add to the financial industry's burgeoning costs for compensating individuals who bought supposedly safe investments that crumbled in the credit crunch. Banks and securities firms, including Zurich-based UBS, Citigroup Inc. and Merrill Lynch & Co., already have had to swallow more than $3.6 billion in fines and market losses on auction-rate securities they had to buy back from clients under orders from the U.S. Securities and Exchange Commission and regulators in New York, Massachusetts and other states.
UBS Woes
UBS had to take a charge of $900 million related to the auction-rate probe. It is also being investigated by the SEC for the sale of derivatives and investment contracts to state and local governments, and the Internal Revenue Service is looking into whether it improperly helped U.S. clients evade taxes.
Kristopher Kagel, a UBS spokesman in New York, said the bank ``properly sold'' Lehman's structured notes to its clients.
``The offering materials clearly identified Lehman as the issuer and discussed all the relevant risks and features of the product,'' Kagel said.
A state task force on structured notes would be similar to the one convened earlier this year that investigated the auction- rate market. Regulators have been concerned about structured notes for some time and ``now the complaints are beginning to come in at a fairly rapid clip,'' Staples said.
He declined to say whether UBS was a target of complaints.
Structured Notes
Structured notes, sometimes marketed as ``structured equities'' or ``hybrid financial instruments,'' are constructed by banks and Wall Street firms from a combination of bonds, stocks, commodities, currencies and derivatives. About a third of the $114 billion sold last year in the U.S. promised full or partial principal protection.
The banks, which rely on market borrowings to finance their loans, trades and investments, sold more structured notes to retail clients as the credit crisis made plain-vanilla bonds more expensive to issue in institutional debt markets. Sales of the notes quadrupled in the U.S. during the past four years, according to data compiled by London-based research firm mtn-i.
About $8 billion of Lehman structured notes were outstanding as of September, including $2.8 billion sold this year, mtn-i reported. The New York-based firm was selling the notes as late as August, while it was racing to find capital weeks before being swept away by what Chief Executive Officer Richard Fuld, 62, called a ``financial tsunami.''
Worth 14 Cents
UBS, the fifth-biggest brokerage firm in the U.S., sold about $1 billion of Lehman's structured notes in America, according to Kagel. The largest brokerages -- Merrill Lynch, Citigroup's Smith Barney and Morgan Stanley -- weren't big distributors of Lehman's notes because they mostly sell their own products, said a person with knowledge of the matter.
Lehman's Sept. 15 bankruptcy leaves holders of the notes waiting in line with other senior unsecured creditors for what's left of their money. Notes with full principal protection are trading at 10 cents to 14 cents on the dollar, according to New York-based SecondMarket, which provides a marketplace for securities that are illiquid, or barely trade.
The Lehman bankruptcy also put a damper on the structured- notes market, with new issuance in the U.S. slowing to about $98 million a day in the 45 days following Lehman's bankruptcy, compared with about $263 million a day in the year through Sept. 15, according to mtn-i.
Hong Kong Protests
The business took another blow in early October when the Federal Deposit Insurance Corp. said it plans to exclude ``derivative-linked products'' and ``debt paired with any other security'' from the bank-debt guarantees offered as part of the government's plan to stabilize financial markets.
The growing number of irate investors in the U.S. adds to those from Hong Kong, Singapore and Taiwan who have demanded refunds from banks that sold structured notes linked to Lehman. DBS Group Holdings Ltd., Southeast Asia's largest bank by assets, said on Oct. 22 that about 4,700 investors in Singapore and Hong Kong may lose their entire investment in Lehman notes. The Singapore-based bank estimates it may have to pay as much as S$80 million ($54 million) to compensate noteholders.
About 200 protesters marched through Hong Kong's financial district on Oct. 31, stopping at banks that sold Lehman notes, the Associated Press reported. They held signs that read: ``Major bank fraud'' and ``My money gone, I don't want to live.''
`Off the Hook'
In the U.S., investors are starting to come ``out of the woodwork'' after learning in quarterly statements that their Lehman investments are almost wiped out, said Jeffrey Kaplan, a Miami lawyer who specializes in securities-arbitration claims.
``Our phone is ringing off the hook,'' Kaplan said. ``The vast majority of calls we've taken are investors with accounts at UBS.''
Scott Silver, an attorney in Coral Springs, Florida, said he was hired by more than 40 clients after he issued an Oct. 8 press release announcing his willingness to investigate claims on behalf of buyers of Lehman structured notes. Some investors had read stories about the Hong Kong claims, he said.
``People are livid,'' Silver said. ``They feel that the investment was misrepresented to them. They didn't appreciate that it was tied to the credit risk of Lehman Brothers.''
Jacob Zamansky, a securities-arbitration lawyer in New York, said he has been retained by at least five clients who collectively purchased ``several million dollars'' of structured notes issued by Lehman.
Clients `Crushed'
``There were a lot of notes sold through UBS,'' Zamansky said. ``Clients are telling me that these were pitched as relatively safe instruments. The principal was protected and the only variable would be in the rate of return that was received. It appears that there were misrepresentations.''
James Sallah, a securities-arbitration lawyer in Boca Raton, Florida, said he's been contacted by ``dozens of clients'' and retained by a local 74-year-old doctor whose $5 million account at UBS dropped by 50 percent, including $400,000 of losses on Lehman structured notes.
``You've got people who wanted preservation of capital and now have just gotten crushed,'' Sallah said.
Investor arbitration claims filed with the Financial Industry Regulatory Authority in Washington have increased this year for the first time since they peaked in 2003 after the Internet-led stock-market bubble burst. There are claims for losses on preferred shares in Fannie Mae and Freddie Mac, the mortgage- finance companies seized by the U.S. government, and for bond mutual funds, including Charles Schwab Corp.'s YieldPlus Fund.
Finra Claims
Almost 3,470 arbitration cases were filed with Finra this year through September, exceeding the 3,238 during all of 2007. Finra doesn't break out how many of those claims involved structured notes.
Rulings in arbitration hearings may hinge on how brokers explained the products, whether risks were disclosed in writing and whether clients had the sophistication to understand them, said Jill Gross, director of the Investor Rights Clinic at Pace University School of Law in White Plains, New York.
``Arbitrators tend to be dubious of investors who claim their brokers told them information that was directly contradicted by written materials, even if it was in the fine print,'' Gross said. ``The customer is required in many jurisdictions to read the written materials, and often anything in writing trumps the oral statements that were made.''
That's an argument members of the Structured Products Association are likely to make, said Keith Styrcula, chairman of the New York-based industry group whose members include UBS, Merrill and other structured-notes issuers.
`Buyer-Beware Scenario'
``Bankruptcy risk is inherent in any investment involving a corporate entity in the U.S.,'' Styrcula said. ``If you don't understand that it's a note, and you're not reading the prospectus, then that's a buyer-beware scenario.''
Lipner, the Garden City lawyer who's also a law professor at Baruch College in New York, said one of his clients bought Lehman notes issued in February that came with a brochure promising that ``at maturity, you will receive a cash payment equal to at least 100 percent of your principal.'' The last in a list of 13 risk factors was: ``An investment in the notes will be subject to the credit risk of Lehman Brothers.''
He expects awards may be bigger in cases stemming from the credit crisis because arbitration panelists may have more sympathy for the losers: conservative investors who asked their brokers for investments that protected their principal.
``The tech sales played to people's greed,'' Lipner said. ``Here, what they sold appeared to be safe and therefore played to people's fears.''
To contact the reporters on this story: Bradley Keoun in New York at bkeoun@bloomberg.net; David Scheer in New York at dscheer@bloomberg.net
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