By Chris Vernon
On the two year anniversary of its collapse and bankruptcy filing, many contend that Lehman Brothers hid the full extent of its problems from the outside world until the bankruptcy. While this may be true with respect to main street investors, don’t let Wall Street fool you into thinking that its major players didn’t see it coming.
One example of Wall Street’s detailed knowledge of Lehman’s problems well in advance of its bankruptcy involves the Union Bank of Switzerland, commonly known as UBS. This is significant to us as retail investors because UBS, like some other financial institutions on Wall Street, used this knowledge to its own advantage rather than protect its own clients or the investing public.
Although it would be impossible to detail all of what UBS knew about Lehman in this short commentary, some of what we have pieced together during our investigation is detailed below. This intimate knowledge that UBS had of Lehman was due to its relationship as a lender of short term and collateralized loans to Lehman.
In 2007, UBS discussed a possible merger with Lehman.1 During that period, more than 75 percent of Lehman’s overall equity —more than $100 billion— was concentrated in risky mortgage and real estate assets. So large was the amount of Lehman’s illiquid assets during this period that Lehman employees referred to their balance sheets as “dead assets schedules.”2 During this period, UBS also became aware that Lehman’s credit default swap (“CDS”) spread — the cost to insure a loan to Lehman against default — increased dramatically.
Throughout this same period, UBS was heavily recommending and selling “structured notes” issued by Lehman to its own clients. Although “structured notes” are very complicated products not understood by many financial advisors, much less retail investors, these products are for the most part unsecured and illiquid medium term loans to Lehman.
While urging its own client base to effectively loan money to Lehman on an unsecured basis through illiquid structured notes, UBS was using its own firm money to make fully collateralized short term loans to Lehman, charging outrageously high interest rates. These Repo 105 loans by UBS to Lehman are now the focus of an SEC investigation of Lehman.3 UBS was able to charge such high interest rates on these loans because it was aware of Lehman’s severe financial problems and resulting desperate need for the Repo 105 loans. 4
Through the spring of 2008, UBS continued to capitalize on Lehman’s problems by charging Lehman shocking rates of interest for fully collateralized short term loans.5 Simultaneously, UBS continued to profit from the recommendation and sale of Lehman “structured notes” – which were loans to Lehman by UBS clients that were unsecured, longer term, and far less appealing in terms of likely returns than the “Repo 105” loans that UBS was making to Lehman.
How outrageous was UBS’s behavior? By way of example, while still selling Lehman structured notes to its own clients, UBS charged the now “desperate” Lehman an interest fee of $186 million on a very short term and fully collateralized multi-billion dollar loan.6 If this short term loan return were annualized, it would equate to a return to UBS of more than 150 percent annual interest on the loan. As one of Lehman’s own employees said in early 2008, “Everyone knows 105 is an off balance sheet mechanism so counterparties are looking for ridiculous levels” to try to squeeze Lehman .7
Although the collateral and return disparities between the loan deals that UBS made for its clients and the loan deals that UBS made for itself are very troubling, it was the liquidity disparity that became especially significant in the summer of 2008 leading up to Lehman’s bankruptcy. Specifically, UBS clients holding the Lehman structured notes recommended by UBS were effectively unable to sell or liquidate these notes until they matured. In contrast, over the summer of 2008, UBS significantly reduced its weekly Repo 105 loans it had made to Lehman.
For the foregoing reasons, the Lehman bankruptcy in September of 2008 had a far greater impact on UBS’s clients than on UBS itself. When Lehman declared bankruptcy, UBS investors who had invested in Lehman structured notes were left standing at the back of the line with the unsecured creditors in the Lehman bankruptcy and will likely recover little of their original investment. In contrast, after the Lehman bankruptcy announcement, UBS issued a press release8 regarding its limited exposure due to its loans and other transactions with Lehman. Based on our investigation, it appears that while UBS was systematically shedding its own exposure to Lehman debt, it was continuing to develop and pitch Lehman structured notes with so-called principal protection to its own client base.
UBS’s public statement earlier this year that the Lehman Bankruptcy Report does not show that the “counterparties such as UBS acted inappropriately” is dubious. The Lehman Bankruptcy Report was designed to look into the activities of Lehman, not other financial institutions on Wall Street, like UBS. In reality, the Lehman Bankruptcy Report represents further evidence that firms such as UBS took advantage of the Lehman situation for their own benefit, while utterly failing their own clients.
Christopher Vernon is a Naples based attorney with the law firm Vernon Healy. He advocates for the rights of investors throughout the United States and abroad—both in and out of the courtroom and arbitration hearing room. Mr. Vernon currently holds an AV rating by Martindale-Hubbell, has been repeatedly recognized by his peers in The Best Lawyers in America, and has also been consistently recognized in the Florida editions of the Super Lawyers publication. Mr. Vernon has spoken at both national securities and national trial attorney conventions and has also conducted continuing education in the U.S. and abroad for CPAs, CFAs, CFPs, investment professionals, board certified business litigation lawyers and board certified trust and estate lawyers. Mr. Vernon has also provided training for and been retained as an expert by government agencies on securities matters.
-----------1 See Lehman Brothers Examiners Report dated March 11, 2010, Volume 8, Page 52
2 Lehman Brothers Examiners Report Volume 3, Page 842
3 See “SEC Homes In on Lehman, 'Funds of Funds'.” The Wall Street Journal. September 10, 2010
4 See Lehman Brothers Examiners Report Volume 3, Page 880 Footnote 3382
6 Id. (reference to email LBEX-DOCID 3207903)
7 Lehman Brothers Examiners Report Volume 3, Page 881
8 See UBS Press release from September 16, 2008
Disclosure: No positions.