Financial advisors with a massive wealth manager bought and held an expressly short-term product for more than a year in hundreds of clients accounts, according to the SEC.
UBS Financial Services agreed to pay $8.1 million in disgorgement, interest and a civil penalty after the regulator alleged that the wirehouse’s advisors placed 1,882 accounts in an exchange-traded note called the iPath S&P 500 VIX Short-Term Futures ETN for extended periods between January 2016 and January 2018, according to the July 19 order. It’s the sixth firm ordered to pay significant settlements under the SEC Division of Enforcement’s exchange-traded product sweep after the first wave of cases in November.
The notes of caution should have been hard to miss, according to the SEC, whose offer of settlement notes that Barclays’ prospectus included words to that effect, as did internal guidance from UBS and, of course, the label “short-term” in the name of the fund, which has the ticker VXX. Regardless, the firm enforced fewer restrictions against the complex products in its advisory accounts than among brokerage clients and many of the clients whose portfolio held VXX for longer periods lost more than three quarters of their investment, according to the SEC.
“Advisory firms must protect clients from inappropriate investments in complex financial products,” Daniel Michael, chief of the Enforcement Division’s Complex Financial Instruments Unit, said in a statement. “We will continue to scrutinize firms’ policies and procedures related to these risky products, and we will take action when they are inadequate.”
UBS didn’t admit or deny the allegations as part of its settlement and, in taking action before investigators approached the firm about its VXX practices and procedures, stood out from the five other firms charged in the previous case.
“After fully cooperating with the SEC, UBS is pleased to have resolved this matter related to the firm’s policies and procedures for one product in one of its discretionary trading programs between 2016 and 2018,” spokeswoman Erica Chase said in an emailed statement. “As the SEC acknowledged, UBS proactively reviewed and removed the product from its program before being contacted by the SEC.”
In another step the firm undertook prior to the investigation, UBS in September 2017 began enforcing a concentration limit of no more than 3% of an account’s assets on the firm’s main advisory platform, investigators say. Before then, UBS didn’t have the correct CUSIP number in its system to be able to flag the transactions correctly, according to the SEC. Another earlier flaw in its procedures enabled advisors to violate the firm’s concentration limit for up to six months before terminating the account, investigators say.
On the brokerage side of its business, UBS blocked advisors from selling VXX on an unsolicited basis to clients unless they had an aggressive risk profile and a net worth of at least $1 million, which it raised to $10 million in 2017, according to the SEC. For clients it was serving in a fiduciary capacity during the three-year span, though, UBS enabled them “to purchase VXX for advisory clients without equivalent restrictions,” the SEC says. It did, however, require the advisors to take training that explained why the product doesn’t work for the long term and prohibited those with less than five years of experience from selling the notes, the settlement states.
To its credit, UBS officials caught on to the fact that the advisors “were not using VXX properly” and halted sales in its main advisory accounts in October 2017, according to the SEC.
Unfortunately for the firm’s clients, those safeguards didn’t prevent the allegedly unsuitable sales. At least 38 advisors had excess concentrations of VXX in 637 advisory accounts during the time when the firm didn’t have the correct CUSIP number, according to the SEC. Other advisors simply “had a flawed understanding of the appropriate use of VXX and the associated risks,” since they stated that “they viewed VXX as a hedge against an anticipated period of equity market volatility or a market downturn,” the settlement states.
“They did not identify an investment time horizon, or take sufficient steps to understand whether negative roll yield would limit or eliminate any potential investment gains, as demonstrated in the commodity futures-linked securities training module,” the document states. “Other than the presidential election of 2016, none of the FAs testified that they anticipated a market correction based on a specific, near-term event.”
In November, the SEC’s Office of Compliance Inspections and Examinations took the rare step of issuing a staff statement about the first wave of cases involving “VIX-related” and other complex exchange-traded products. The examiners alerted wealth managers to their supervisory obligations under the SEC’s Regulation Best Interest and the fiduciary duty.
“Under these standards, a financial professional recommending a complex or risky product should apply heightened scrutiny to understand the terms, features and risks of the product and whether such product fits within the client or customer’s risk tolerance and specific-trading objective, and whether it would require daily monitoring by the investor or the financial professional,” OCIE staff said. “A recommendation by a firm’s financial professionals is a recommendation of the firm.”
Despite UBS’ undertakings, the SEC settlement includes a censure, disgorgement and interest of $112,274 and a penalty of $8 million that will go to the allegedly harmed investors.