N.H. sues UBS over securities

Complaint is 1st on behalf of bond issuer

New Hampshire regulators yesterday filed a lawsuit against UBS Securities, alleging the firm defrauded a different kind of victim in the auction-rate scandal: an issuer of the bonds that have ensnared investors since February.

The New Hampshire Bureau of Securities Regulation alleged the Swiss bank misled a New Hampshire student-loan agency about the auction-rate market. UBS violated its fiduciary duty to the lender, a longtime client, the bureau alleged, by encouraging it to continue to issue debt through the auction market when UBS knew the market was verging on collapse.

"It's very clear to us that UBS was managing its way out of this auction-rate market," said Mark Connolly, director of the securities bureau. But UBS "was not fully informing their client about the risks," he said.

UBS last week agreed to a $19 billion settlement with federal and state regulators, the largest in a nationwide probe of the auction-rate market. The firm pledged to buy back those investments from 40,000 investors who bought the bonds of student lenders and other issuers, and to pay $150 million in fines.

The New Hampshire lawsuit - the first such complaint brought on behalf of a bond issuer UBS advised - is separate from that settlement. The investment bank said it would defend itself against the new claims.

"This complaint attempts to link a single client interaction with overall market conditions which affected all student-loan issuers, and as such we believe there is no basis for these specific allegations," UBS said.

UBS did warn the lender, the New Hampshire Higher Education Loan Corp., about trouble in the market months before it crashed and long before buyers of the bonds were ever told.

As previously reported by the Globe, UBS told the New Hampshire loan group by mid-December last year the auction-rate market was faltering. The lender's executives signed an agreement that took effect Dec. 17, to pay dramatically higher interest on its bonds in the event the market did fail, to keep attracting investors. The agreement was disclosed in a memo to investors posted on the lender's website.

But UBS's warnings did not go far enough, the lender's attorney said. Stephen Weyl, a partner at the law firm Hinckley, Allen & Snyder, which serves as the agency's general counsel, said UBS had an obligation to disclose that it saw the auction-rate market's problems as long-term, not temporary.

"If they had come and said, 'We think the auction-rate market is going away forever, we're making plans to get out of the market,' then we would have had a very different reaction to events," Weyl said.

As a result of having its bonds frozen since February, the New Hampshire lender had to curtail private student loans in March because it could not raise money. In 2007, it made $67 million in private loans to about 6,000 students. It is currently making federally-backed student loans, thanks to a line of bank credit.

Auction-rate securities are a form of debt that student lenders and other nonprofits used to fund their operations because it was inexpensive. For years, rates on the bonds were reset at weekly or monthly auctions, which drew investors looking for returns slightly better than money market funds. But on Feb. 13, auction markets all shut down, as troubled credit markets spooked investors and Wall Street's giants all decided to stop supporting the trading.

States and federal regulators have recently obtained major settlements from investment firms involved in the auction-rate market. Just yesterday, New York Attorney General Andrew M. Cuomo disclosed settlements with Morgan Stanley & Co. and JPMorgan Chase & Co., in which the firms agreed to buy back $7 billion in investments and to pay a total of $60 million in fines. Altogether, investment firms have agreed to buy back $27 billion in auction-rate bonds so far in deals with regulators.

René A. Drouin, the New Hampshire student lender's chief executive, said the group complained to New Hampshire securities officials about UBS within the past two weeks.

Lawsuits filed by Massachusetts and New York regulators against UBS allege executives at the firm were selling their own holdings in auction-rate securities at the same they were encouraging UBS brokers to keep selling them to customers.

Drouin said the New Hampshire student-loan agency had relied on UBS's advice for 11 years, to issue $1.5 billion in auction-rate securities. He said UBS persuaded the lender to continue signing agreements to help shore up the bond sales, instead of advising the lender to get out of the auction-rate market.

"UBS apparently had another agenda, and they had more information than they let us know," Drouin said.

Beth Healy can be reached at bhealy@globe.com.