By Anne Sherry, J.D.
UBS Financial Services knew about significant risks of a complex options trading strategy, but its advisers were not adequately trained and supervised to ensure those risks were communicated to clients, according to a settled SEC order. Without a registration statement or other formal offering document for the investments, UBS advisors and their clients depended on the written materials UBS prepared, which did not include information about the risk of significant losses. UBS will pay a $17.4 million penalty and $7.2 million in disgorgement and interest (In the Matter of UBS Financial Services Inc., Release No. 34-95168, June 29, 2022).
The “Yield Enhancement Strategy” (YES) is an options trading strategy designed by a team at Credit Suisse to generate income from an existing portfolio of securities. As a short volatility strategy, YES has potential to generate modest returns during periods of low market volatility, but it has significant downside risk in periods of high volatility. In 2015, UBS recruited the team from Credit Suisse, paying them $50 million upfront and benefiting from their book of about 300 clients’ accounts with $1 billion invested in YES. According to the SEC, legacy Credit Suisse advisors and clients understood the downside risks but certain UBS advisors and clients did not.
The team at UBS marketed the strategy as having historically generated gains of three to five percent per year, and while it did acknowledge historical losses of up to 11 percent in a single month, it characterized this as a profit opportunity analogous to “hurricane insurance.” (The SEC order suggests that this characterization was not malicious; due to a lack of understanding of the product, advisors believed what they were saying.) Six hundred more clients signed on, increasing the amount invested in YES by about $2 billion.
UBS recognized internally the importance of training to ensure advisors satisfied their fiduciary obligations but it did not actually train them adequately on the YES strategy. While UBS calculated downside risk of YES daily for each client account and included charts illustrating the risk in internal reports, it did not share this information with financial advisors or clients. The Forms ADV it provided to YES investors informed clients that they need to select a “Mandate” (the amount of collateral at risk) but did not further explain or quantify the downside risk of YES.
In early 2018 as market volatility rose, YES clients began experiencing losses. The strategy lost 13 percent in December 2018 and 18 percent for the calendar year. This surprised many financial advisors, as well as many clients, who closed their YES accounts. The SEC found that UBS willfully violated the antifraud provision of the Advisers Act, as well as the requirements to adopt and implement reasonably designed compliance policies and procedures.
Osman Nawaz, Chief of the Division of Enforcement’s Complex Financial Instruments Unit, observed: “Complex products can present unique risks, and the SEC will remain vigilant and continue to take action to protect those who invest in these products from misconduct.”
This is Release No. 34-95168.