Does UBS Have Controls Worth Banking On?

October 2011
By Dawn Taylor, CFE

UBS trader Kweku Adoboli was recently charged by UK authorities with fraud and false accounting for allegedly making unauthorized trades that resulted in a $2.3 billion loss for the Swiss banking group.

According to a statement released by the UK Financial Services Authority (FSA), the FSA and the Swiss Financial Market Supervisory Authority (FINMA) are launching an investigation into the scandal to determine the details of the unauthorized trading and the control failures that allowed the activity to occur. The investigation will include an assessment of the overall strength of UBS's controls to prevent unauthorized or fraudulent trading activity in its investment bank.

UBS appears to be launching its own internal investigation into its controls. In a memo to staff, quoted by Bloomberg News, UBS's head of investment banking, Carsten Kengeter, acknowledged the difficulty in achieving an impenetrable system, but vowed not to rest until controls were "as watertight as possible.”

If UBS interim CEO Sergio Ermotti's sentiment, expressed in a separate staff memo and published by The Wall Street Journal, is any indicator, the investment bank has a long way to go to achieve "watertight" controls. Here's what Ermotti had to say: "Risk and operational systems did detect unauthorised or unexplained activity, but this was not sufficiently investigated nor was appropriate action taken to ensure existing controls were enforced."

Assuming that Ermotti's statement is accurate and that the "unauthorised or unexplained activity" he refers to is that which resulted in the $2.3 billion loss, one might question what role UBS's tone at the top and corporate culture played in Adoboli's approach to trading — for tone and culture comprise the foundation of an internal control system.

Mr. Ermotti has provided a glimpse into UBS's possible tone and culture, but the following timeline of settlements and convictions offers a more panoramic view:

January 2006 — UBS agrees to pay the New York Stock Exchange and New Jersey and Connecticut state regulators $49.5 million to settle allegations that some of its brokers engaged in deceptive market timing transactions involving mutual funds to shareholders' detriment, and that it failed to adequately supervise them. As part of the settlement, UBS also agrees to takes steps to better supervise its advisors and to ensure compliance with its own policies against market timing. The market timing transactions were alleged to have occurred from September 1999 until at least December 2002, and to have involved brokers in at least seven UBS branch offices.

February 2006 — UBS reaches an agreement in principle to pay as much as $89 million to settle class-action wage-and-hour claims filed against it on behalf of UBS Financial Advisors and Financial Advisor trainees for incorrectly classifying them as exempt.

July 2007 — In a settlement reached with the state of New York, UBS agrees to reimburse customers $21.3 million and to pay a $2 million penalty for allegedly steering customers into a brokerage program that was unsuitable given their circumstances. Specifically, UBS was alleged to have used its position of trust to lure customers into fee-based accounts when commission-based accounts would have been more appropriate.

November 2008 — Mitchel Guttenberg, a former executive at UBS, is sentenced to 78 months' imprisonment and ordered to forfeit $15.81 million in alleged illegal profits for his role in an insider trading scheme. Guttenberg was found to have sold material, nonpublic information regarding impending changes in UBS analysts' securities recommendations between December 2001 and August 2006.

December 2008 — In a settlement with the Securities and Exchange Commission (SEC), UBS agrees to restore $22.7 billion to its customers for allegedly misrepresenting the liquidity risks related to auction-rate securities (ARS). According to the SEC, UBS touted the ARS as safe, highly liquid investments that were comparable to money markets, when in fact they were subject to considerable liquidity risk. When ARS market conditions deteriorated in late 2007 and early 2008, UBS customers were left holding billions of dollars in illiquid ARS.

February 2009 — UBS agrees to pay $780 million in fines, interest, and restitution to avoid U.S. prosecution on a charge of conspiring to defraud the United States by helping 17,000 U.S. taxpayers to evade taxes. In addition, UBS agrees to implement an internal control program. UBS admitted to fostering tax evasion from 2000 to 2007, often by helping tax payers to open accounts in the name of sham entities.

May 2011 — UBS enters into a settlement agreement with the DOJ for alleged anticompetitive conduct in the municipal bond investments market and agrees to pay $160 million in restitution, penalties, and disgorgement to federal and state agencies. As part of its agreement with the DOJ, UBS admits that from 2001 through 2006, certain former UBS employees entered into unlawful agreements to manipulate the bidding process and rig bids on municipal investment contracts.

Unfortunately, these actions stand in stark contrast to the values the company claims to hold, as evidenced in the following value statement UBS published on its website.

These three values shape the behavior of everyone at UBS as they work to reach our firm's vision:

Truth
 

We behave with respect and integrity.  

We are accurate, realistic, and accountable.  

We always act fairly and abide by the law.  

Clarity
  

We make it easy to do business with UBS.  

We are concise, precise, and to the point. We are reliable and consistent.
 

Performance
  

We will always give our best.  

We will perform to the highest professional standards.  

We will lead the market through superior service and execution.

 

Given the lackadaisical approach to its control environment displayed by UBS in the past, it's no wonder that the company had problems. And until UBS (and many other companies) make much needed changes to their tone and culture, chances are that we can expect to see more of the same.

Dawn Taylor, CFE, is a research specialist for the ACFE. Contact Dawn at dtaylor@acfe.com.


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