UBS Employee Refers to CDOs as Vomit

Representing Investors Nationwide

In a recent Wall Street Journal article, an email produced in a civil court case against UBS, an employee referred to Collateralized Debt Obligations (CDOs) as “vomit.” The evidence indicates UBS employees were aware of the problems in the CDO market and were actively trying to unload the debt on unsuspecting fund managers and retail investors. The full WSJ article appears below:

In the summer and fall of 2007, as the credit crunch deepened, some U.S. employees at UBS AG became increasingly concerned about billions of dollars of debt securities inventoried on the bank’s books and wanted to find a way to unload them, according to emails in a court case.

A judge issued a decision this week that said there was evidence UBS had an “awareness that … high-grade securities on its hands would soon turn into financial toxic waste” as it tried to persuade a hedge fund to but CDOs. Above, the UBS in Zurich in July. “OK still have this vomit?” one UBS employee asked.

The email emerged in a lawsuit against UBS, alleging that the Swiss bank found at least one place to sell the problem securities: Stamford, Conn., hedge fund Pursuit Partners LLC.

Documents filed in the Connecticut court case provide one of the more complete windows into how UBS allegedly scrambled internally to find ways to alleviate the financial pain that worsened throughout 2007 thanks to the deteriorating mortgage market. They also add to a debate that continues across Wall Street and beyond about bankers’ culpability in the financial crisis.

This week, Connecticut Superior Court Judge John F. Blawie issued a decision that said there was evidence to show that UBS ultimately had an “awareness that … high-grade securities on its hands would soon turn into financial toxic waste” as it tried to persuade Pursuit to buy debt securities known as collateralized debt obligations, or CDOs.

The hedge fund says it invested in three CDOs and had losses of $35.5 million. Pursuit has alleged that it sought steady cash flow and required that it be sold only investment-grade securities, or ones that provide relatively low risk of default. UBS did sell Pursuit investment-grade securities but knew that the securities were about to be downgraded, Pursuit alleges.

Pursuit initially filed a complaint against UBS in March 2008. It subsequently asked the court to require UBS to set aside money or assets to cover Pursuit’s losses, which the judge granted on Tuesday when he ordered that the bank set aside $35.5 million to cover a potential judgment against it in the case. UBS says that the order was preliminary and that the firm intends to prevail in the case.

Judge Orders UBS to Set Aside $35 Million in Hedge- Fund Case As part of a three-day hearing on that request this past April, more details came to light, including information provided by former UBS bond salesman Robert Morelli. A lawyer for Mr. Morelli, Dane Butswinkas, declined to comment.

Until the spring of 2007, UBS had been seen as a conservative bank that specialized in private banking. But in 2006 and 2007, UBS also ramped up in selling and trading debt securities to better compete with Wall Street and London firms.

In May 2007, the first hint of trouble with this strategy came in the wake of losses at in-house hedge fund Dillon Read Capital Management, a UBS shareholders report noted.

That month, according to the judge’s ruling, UBS “had reason to believe that Moody’s was changing its methodology and that would result in the downgrading of certain asset-backed securities.” A Moody’s spokesman said the firm had no comment on the judge’s decision.

On July 11, 2007, Moody’s said it would review for possible downgrade a small percentage of the universe of CDOs, just after it cut ratings on subprime-mortgage bonds — the building blocks for many CDOs.

Mr. Morelli sent an email on that day telling colleagues to “put today in your calendar.” Mr. Morelli later said in the case the day “was essentially the beginning of the end of the CDO business, meaning the bonds were getting downgraded, they were probably going to get downgraded further, and we were going to lose a lot of money,” according to a court transcript cited in Judge Blawie’s decision.

On July 26, UBS instructed employees to “reduce cdos … no need to publicly relay this,” the decision says. That day, Pursuit started its purchases from UBS.

On Aug. 28, Mr. Morelli said in an email that he had “sold more crap to Pursuit,” according to the decision. On Sept. 24, as the October downgrades neared, an unnamed UBS employee emailed a UBS banker and referred to CDO inventory on UBS’s books. “OK still have this vomit?” the employee asked. Pursuit’s last purchase came on Oct. 1.
Starting Oct. 11, Moody’s downgraded ratings on more subprime-mortgage bonds. Pursuit’s securities were completely wiped out by early 2008.

The judge said Pursuit and its lawyers had established probable cause to back up a claim that UBS employees “were in possession of material nonpublic information regarding imminent ratings downgrades on the Notes it sold” to Pursuit.

“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,” he wrote.

The attorney’s at Colling Gilbert Wright & Carter are investigating and filing FINRA arbitration claims against UBS and other brokerage firms that sold structured notes (PPNs, PPPNs and RONs) backed by Lehman Brothers and other toxic debt to retail investors. If you lost money in a UBS structured products, please contact our offices for a free case evaluation. Thank you.

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