Mass AG William Galvin has socked UBS (UBS) with a fraud lawsuit based on–what else?–emails, which allegedly show executives panicking as they saw the Auction Rate Securities market melting down and trying to save UBS from losses by jamming the ARS into client accounts. UBS has protested its innocence, saying it always puts clients first, and has implied that it will fight the allegations in court.
UBS won’t fight the allegations in court, of course: It will settle with the AG and pay a fine of a few hundred million dollars, and then it will try to knock down the inevitable investor lawsuits one by one. It will win some–in cases where clients were clearly aware that ARS were not, in fact, “cash”–and it will lose some. And at the end of the day, it will roll the whole ARS mess into another multi-billion-dollar write-off and go about its business.
Here’s what it should do instead:
Offer to buy all the ARS it sold to clients back at 95% of face value. Clients who need the cash can take the deal and get most of their money back. Clients who don’t need the cash and are willing to wait (possibly forever) for the ARS market to come back can hang on and pray.
Why should UBS do this?
Not because of the AG’s allegations (we’ll reserve judgement on those until we hear UBS’s side of the story). It should buy back the ARS because it gave its clients wretched financial advice.
The ARS debacle is not a case of speculation gone wrong (gambling on gold futures, for example–the risks of which may or may not have been fully appreciated but should have been obvious). The ARS mess is a case of the firm assuming it could give clients a free lunch: higher returns than cash without additional risk. One of the most fundamental principles of investment management is that you can’t get something for nothing. The higher interest ARS provided was received in exchange for the risk that the ARS market would do just what it is doing right now: shut down.
Did UBS know the market would shut down? Almost certainly not. But for clients who wanted to hold “cash,” the ARS risks weren’t worth taking–and UBS as an institution should have known that.
If UBS wants the world to believe that clients really do come first, it should take responsibility for its selling ARS as cash–and do the right thing by making clients (almost) whole. The billions the firm will spend writing down the value of the ARS in its own account probably won’t exceed the billions it will spend fighting and settling the ARS-related lawsuits. More importantly, it will be money that is far better spent.
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