The U.S. Department of Justice reportedly is investigating UBS (NYSE: UBS) for possible fraudulent conduct in Puerto Rico. The investigation surrounds UBS’s U.S. and Puerto Rico broker-dealers’ sales of proprietary closed-end bond funds to Puerto Rico residents. Brokers purportedly used aggressive sales tactics to sell the UBS Puerto Rico bond funds to clients. Many investors have filed FINRA arbitration claims after the funds suffered more than $1 billion in losses. The criminal investigation is reported to involve whether UBS’s banking arm illegally loaned money to UBS clients in order fund even more bond fund purchases by clients. The investigation also seeks to determine whether UBS upper management was aware of the loans.

The securities in question were closed-end funds that invested in Puerto Rican municipal bonds and were managed by UBS’s asset management division. As fears grew that Puerto Rico was at risk of defaulting on its municipal debt, the values of the bond funds plummeted. The use of leverage within the funds exacerbated the losses. Many UBS clients were surprised by their enormous losses because the funds were marketed as seeking preservation of capital.

In May 2012, UBS paid $26.6 million to the SEC to settle charges of misleading investors regarding its Puerto Rico bond funds. A UBS internal investigation reportedly concluded that some brokers had failed to properly highlight the risks of the bond funds to smaller retail clients. UBS also reportedly found that at least one broker encouraged clients to take loans from UBS’s Utah-based banking affiliate, UBS Bank USA, and recommended that the clients use the loan proceeds to buy the UBS Puerto Rico bond funds. Our understanding is that UBS prohibited the use of margin loans to buy the funds and that the broker circumvented this rule by steering clients to the UBS bank to obtain loans. But the loan terms also prohibited the purchase of securities. Worse still, UBS Bank USA is not licensed to lend money in Puerto Rico. UBS attempted to address this problem by firing the broker and buying the loans from its Utah-based bank. UBS’s remedial measures may not help. “You can’t put the horse back in barn. We expect that FINRA arbitrators will find UBS’s conduct reprehensible,” said Dimond Kaplan & Rothstein, P.A. partner Jeffrey Kaplan.

Dimond Kaplan & Rothstein, P.A. currently represents approximately 100 Puerto Rico resident who have lost money in UBS Puerto Rico bond funds. Our firm is pursuing FINRA arbitration claims against UBS in an effort to recover our clients’ investment losses.

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