UBS Will Take No Action Against Former Company Officials and Other Web Notes

UBS Will Take No Action Against Former Company Officials and Other Web Notes

In a public report that makes for some interesting reading, UBS on October 14, 2010 released a statement disclosing that though its own investigation had concluded that "what happened should not have been allowed to happen," the company will take no legal action against its former directors and offices for losses the company suffered during the U.S subprime meltdown that forced a government bailout of the company. The company's write-down of mortgage related assets exceeded $50 billion.

The company's October 14 statement can be found here and the report itself, which was undertaken pursuant to the May 2010 recommendation of the Swiss Federal Assembly, can be found here.

The report includes a number of critical findings, including an assessment that the company's "growth strategy" was "not planned in a sufficiently systematic manner," which contributed to the bank's losses. The management incentives at the time encouraged company officials to seek revenue "without taking appropriate consideration of the risks."

The report also concludes that there company lacked a "uniform approach" to risk and that risk control was "based too heavily on statistical models." As a result, and "despite warning," the company "falsely believed" that is U.S. real estate investments were both valuable and sufficiently hedged, though there was "no comprehensive or continuous assessment" of the overall risk profile of the cross-border wealth management business.

The report also concluded that there were "failures with regard to the training and instruction" of some employees, and that the company "did not implement an effective system of supervisory and compliance controls necessary to convey a clear and consistent expectation that full compliance with applicable internal controls and U.S. legal requirements."

Despite these shortcomings, the company's Board concluded, as part of the reporting process, that it is not in the company's interests to pursue legal claims against the former directors and officers.

In its October 14 statement, the company explains that among the reasons the Board decided not to pursue claims is that "the chances of any such proceedings being successful" is "more than uncertain." The Board also took into account that these kinds of actions "last many years, generate high costs, lead to negative informational publicity and thus hamper UBS's efforts to restore its good name.'

The statement also notes that pursuing claims against "could weaken UBS's legal position in pending cases, regardless of whether the former management is ever found to be liable." The report itself goes on to note that UBS is the subject of class action proceedings in the U.S. and that "by litigating against its former directors and officers inSwitzerland, UBS would negatively impact its position in these class action proceedings in the US, in particular because, under US rules, the US plaintiffs could claim that thisis an admission that they had in fact acted improperly."

The report emphasizes that there had been no findings of criminal misconduct. The report states finally that "the Board of Directors is opposed to any attempt by third parties to file actions against former directors and officers or to pursue actions at the company's expense. In the event that individual shareholders were to propose a vote at the general meeting for a resolution in favor of filing a claim at the company's expense, the Board would consider it its duty to recommend that such a proposal be rejected."

Finally, the report is accompanied by an external report prepared by University of Zurich Law Professor Peter Forstmoser, who concluded that though there is "a sufficient basis to initiate legal proceedings against former individual directors or officers," the Board's decision not to pursue legal claims is not only "appropriate," but it is also "necessary," taking into account the overall interests of the company and its shareholders.

The Dow Jones Newswire October 14, 2010 article about the UBS report notes that two UBS executives have returned pay from the 2007 to 2009 time frame totaling $73.7 million. The article also quotes a representative of one shareholder group as "disappointed" that the UBS Board decided not to pursue a civil lawsuit against the former directors.

Discussion

I can imagine a school of thought amongst a certain type of investor who might be outraged that the company is doing nothing to pursue claims against the individual former directors and officers who were responsible for the operational shortcomings identified in the report as having caused the bank's enormous losses. I can also imagine this same type of investor complaining that this is the type of cozy, protect-your-old-buddies mentality that allow problems to arise the first place.

But at the same time, there is something quite instructive and perhaps even refreshing in the report's consideration whether the postulated claim would actually help or hurt the company. There is something to the idea that this type of litigation, which can drag on for years and can be enormously expensive, does more harm than good. Indeed, if all prospective corporate and securities litigation were forced to endure this same type of scrutiny, and had to withstand the question whether the lawsuit would help or hurt the company and its investors on whose behalf it supposedly is filed, there would almost certainly be significantly less corporate and securities litigation.

The report's justification for taking no action against the former company officials is of course pertinent to the company and to investors who remain invested in the company and interested in the company's future. Investors who lost money as a result of the events analyzed in the report and who are no longer invested in the company may continue to feel aggrieved, but they can hardly complain that the company has refused to pursue any claims since those investors would not have benefited either.

Where investors may be most concerned is the Board's statement that the Board will oppose any shareholder proposals seeking claims against the former officials. That is really the point where this report and the Board's conclusions do seem defensive. On the other hand, if the Board really believes it is not in the company's interest for those kinds of claims to be pursued, then the Board's statement on this issue is simply consistent with the overall conclusion about where the company's interests lie.

The Hits Just Keep on Coming: One of the most distinct trends to emerge in connection with recent securities lawsuit filings was the sudden surge during 3Q10 in securities class action lawsuits filed against for-profit education companies. On Friday, October 15, 2010, plaintiffs; lawyers announced the filing of yet another securities suit involving a for-profit education company, in this case Strayer Education.

According to the press release, the Complaint, which was filed in the Middle District of Florida against the company and certain of its directors and officers, alleges that the defendants:

failed to disclose that: (i) the Company had engaged in improper and deceptive recruiting and financial aid lending practices and, due to the government's scrutiny into the for-profit education sector, the Company would be unable to continue these practices in the future; (ii) the Company failed to maintain proper internal controls; (iii) many of the Company's programs were in jeopardy of losing their eligibility for federal financial aid; and (iv) as a result of the foregoing, defendants' statements regarding the Company's financial performance and expected earnings were false and misleading and lacked a reasonable basis when made.

The allegations in the Strayer lawsuit are similar to the allegations in the actions previously filed against other for-profit educational institutions in recent months. As detailed further here, these cases all relate back to a congressionally-initiated investigation involving federally backed student loans.

By my count, a total of seven different for-profit education companies have been sued in securities class action lawsuits since mid-August. These seven securities suits represent about five percent of the roughly 136 securities class action lawsuits that have been filed so far in 2010.

Yet Another Mortgage Mess: The headlines on the business pages have been dominated recently with tales of the mortgage documentation mess that is choking the mortgage foreclosure process. But according to Felix Salmon's October 13, 2010 post on his Shedding No Tiers blog, there is yet another mortgage-related mess, relating to disclosures surrounding the mortgage-backed securities that the investment banks sold to investors at the peak of the housing bubble.

According to Salmon, it "turns out that there's a pretty strong case" that the investment banks "lied to investors in many if not most of these deals."

Salmon comments relate to a process the investment banks followed as they assembled the pools of mortgages for securitization. As the banks acquired mortgages, they relied on outside service providers to test the mortgages in effect reunderwriting the mortgages according to the standards the origination entities were supposed to have used in creating the mortgages.

In reviewing documents submitted to the Financial Crisis Inquiry Commission, what Salmon determined is that in reunderwriting the mortgages, the outside service providers sometimes rejected the mortgages at an astonishingly high rate - in the specific example Salmon cites, the reviewer rejected 45% of the mortgages reviewed.

It is what happened next that really troubled Salmon. According to Salmon, rather than telling the originator that the pool wasn't good enough, the investment banks would instead renegotiate the amount of money they were paying for the pool. And, Salmon adds dramatically, "this is where things get positively evil."

Salmon contends that because the investment banks knew they would be selling the mortgages rather than keeping them, they "had an incentive to buy loans they knew were bad," because the banks could go back to the originator and get a discount. The advantage afforded the investment banks is that "the less money they paid for the pool, the more profit they could make when they turned it into mortgage bonds and sold it off to investors."

The "scandal," according to Salmon, is that "the investors were never informed of the results" of the outside service providers' tests. The banks didn't pass the discounts along to the investors, who were "kept in the dark" about the tests, about the poor results, and about the discounts. The banks, according to Salmon, were "essentially trading on inside information about the loan pool: buying it low (negotiating a discount from the originator) and then selling it high to people who didn't have that crucial information."

Salmon followed up his initial provocative post with some an interesting follow-up post as well.

More Failed Banks: This past Friday night, the FDIC took control of three more banks, bringing the 2010 year-to-date number of failed banks to 132. The latest three were not in any of the real estate disaster areas like Georgia, Florida, Illinois or California, but rather involved banks in America's heartland. Two of the three were in Missouri and the third was in Kansas.

Since January 1, 2008, there have been a total of 297 failed banks. During that period, there have been six bank failures in Kansas and ten in Missouri. The states that lead with the highest number of failed banks during that period are Georgia (44), Florida (41), Illinois (37) and California (32).

Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.