Knowing They Were Selling “Crap,” UBS under Siege in CDO Case

(September 17, 2009) – A case that will be of interest to all who purchased collateralized-debt obligations (CDOs) and other asset-backed securities from investment houses is working its way through the Connecticut court system.

UBS, the Swiss-based bank, is being sued by Pursuit Partners, a Stamford-based hedge fund, over the sale in 2008 of CDOs that quickly became worthless. Pursuit already has won a $35.5 million pre-judgment lien against UBS Securities and UBS AG, an amount equal to what the fund lost when investments it bought from the bank collapsed last October.

According to documents released in the discovery phase of the case, internal messages between UBS employees labeled such investments “crap” and “vomit.” UBS allegedly also knew of pending ratings downgrades that would severely mitigate the value of such instruments, but the CDOs were apparently still recommended to the hedge fund. According to lawyers involved in the suit, similar investments believed to be “crap” were likely pushed on others, including public pension plans.

UBS allegedly made the sale in order to get the securities—which it allegedly knew to be on the cusp of a downgrade—off their books. According to a pre-trial decision issued by Connecticut Superior Court Judge John F. Blawie, UBS had an “awareness that…high-grade securities on its hands would soon turn into financial toxic waste.” The firm, the Judge noted, “had reason to believe that Moody’s was changing its methodology and that would result in the downgrading of certain asset-backed securities.” Nevertheless, UBS continued to sell such securities to hedge funds and others from when this became apparent—May, says Blawie—until at least October 1, when Pursuit stopped buying.

Such a pre-judgment lien is likely to incite more lawsuits from those who feel they were sold CDOs and other such securities without complete disclosure of information. “I think the court’s finding of probable cause…is likely to prompt many purchasers of CDOs and similar instruments to commence lawsuits here in Connecticut against the sellers of such securities,” Harold Finn, of Stamford’s Finn, Dixon & Herling, told the Connecticut Law Tribune. “They haven’t been doing so heretofore.”

Lawyers for the plaintiffs agreed. “We’re pretty sure that this same kind of—to use UBS’s term—“crap” and “vomit” were sold to other hedge funds and pension funds, so the state of Connecticut, as well as hedge funds in Connecticut likely have been sold the same kind of CDOs,” said Gary S. Klein of Stamford’s Sandak Hennessey & Greco, counsel for the hedge fund.