When UBS sells crap and vomit

By Felix Salmon
September 10, 2009
writes about here. It's a fun read, and I've uploaded it here. Neither of the parties to the case comes out smelling of roses: Pursuit seems to have completely missed the triggers in the CDOs despite two of its principals reading the offering memoranda, and as for UBS, well, the judge puts it very well:

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My colleague Matt Goldstein has got his hands on the judgment in the UBS vs Pursuit case which the WSJ writes about here. It’s a fun read, and I’ve uploaded it here. Neither of the parties to the case comes out smelling of roses: Pursuit seems to have completely missed the triggers in the CDOs despite two of its principals reading the offering memoranda, and as for UBS, well, the judge puts it very well:

The court takes UBS employees at their word when they referenced their Notes, these purported “investment grade” securities which they sold, as “crap” and “vomit”, for UBS alone possessed the knowledge of what their product, their inventory, was truly worth.

I’m not at all sure that Pursuit is going to win this case — this is just a prejudgment remedy asking UBS to put up $35 million in case it loses. The key to the case is insider knowledge on the part of UBS: it seems that senior UBS employees were in close contact with Moody’s and were informed that the CDOs in question were about to be downgraded. Since UBS knew that the notes would be wiped out in the event of a downgrade, they then went to great lengths to sell the CDOs before the downgrade happened.

The judge has thrown out most of the complaints that Pursuit made against UBS, leaving only one or two for UBS to defend; the bank, in turn, has said that it “is confident that it will prevail on the merits of the case”. But even it if does prevail, UBS has been revealed as being extremely sleazy at best. And it would be fair for anybody dealing with the UBS fixed-income desk to assume that they’re being ripped off, and treat any proffered paper with extreme prejudice.


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Well of course, if UBS issued the notes then why wouldn’t Moody’s be in close contact? As is well-known, Moodys existed to serve the issuers of these bad boys, and who would bite the hand thats feeding record profits?

It seems odd the notes were not on a ‘negative watch’, if indeed, the downgrades happened shortly after they were purchased. Then again, the NRSRO just downgrade bonds to crap without notice quite regularly (Lehman is a shining example).

I would not preclude other fixed income desks from that classification. He who controls the information knows more than you can ever possibly run on Bloomberg or Intex models.

Posted by Griff | Report as abusive

It really is a fun read. My favourite part is the internal email from November 2007 boasting: “we protect our super seniors the best”. Yeah, that worked out well for them.

Posted by Ginger Yellow | Report as abusive

Griff, the notes were downgraded because of a (pre-publicised) methodology change for the sector, not because of deterioration in the specific portfolio (although obviously the portfolio was deteriorating). Pursuit do not come out of this looking much better than UBS, to be honest. I think the case is going to hinge on exactly how much non-public information UBS had on the details of the methodology change. Basically, (pretty much) everyone in the market was taken by surprise by the scale of the downgrades that resulted. It seems that Pursuit was gambling that any downgrades would be relatively small, and that their below-par investment would be money good (the criteria Pursuit originally gave UBS are quite telling – these weren’t naifs looking for an ultra safe investment). When the downgrades turned out to be extremely steep, the gamble backfired. Now it certainly seems that UBS knew more than they let on, but without more court-mandated disclosure it’s hard to tell how much.

Posted by Ginger Yellow | Report as abusive

The funniest part of this case is that UBS tried to sell these to Pursuit earlier in the year, gave them all the documents, and admitted that they had triggers (which were spelled out in the documents) and didn’t fit what Pursuit was looking for. Then later in the year, UBS said “sure, these fit what you’re looking for” without any change in the CDOs or Pursuit’s terms, and Pursuit said “sure, we’ll buy them”.

The judge threw out any charges based on fraud by UBS in their statements to Pursuit because Pursuit got exactly what the documents said they were going to get (terrible CDO tranches), but it’s still pretty funny that UBS would pull this and Pursuit would fall for it.

Posted by najdorf | Report as abusive

Indeed. My suspicion, though it’s hard to tell from the detail given in the ruling, is that UBS came back with a bigger discount and Pursuit figured they didn’t care that much about the triggers at that price. It’s only a guess, though. Also possible is that they just didn’t read the documents thoroughly and only said they did for legal reasons.

Posted by Ginger Yellow | Report as abusive

To be fair, though, its hard to say that UBS was behaving any worse than the other investment banks in this regard. The entire industry shows a level of sneering contempt for its customers that wouldn’t be tolerated anywhere else. The numerous published insider stories of stock and bond trading desks confirm this.

Personally, I’d be suspicious dealing with any investment bank’s bond desk. As the old saying goes, “If you don’t know who the fool in the room is, its you.”

Posted by quanticle | Report as abusive

Ginger, appreciate the clarification. I always enjoyed those “methodology changes” the rating agencies employed..it sounds better than “new method = CYA”

Posted by Griff | Report as abusive