The Securities and Futures Commission of Hong Kong has publicly reprimanded and fined UBS AG HK$400 million (US$51.35 million) for the transgressions of its wealth management division. It says that it has disciplined the bank for overcharging its HNW customers and failing to run its internal controls properly.

The SFC has authorised UBS to do business in Type 1 (dealing in securities), Type 4 (advising on securities),Type 6 (advising on corporate finance), Type 7 (providing automated trading services) and Type 9 (asset management) regulated activities.

Details of the case

Between 2008 and 2017, according to the SFC, UBS overcharged its clients by increasing the spread after execution of trades without their knowledge and by charging them fees in excess of standard disclosures or rates. The alleged overcharge amounted to approximately HK$180 million or US$23.1 million and it affected about 5,000 clients' accounts, all of them managed in Hong Kong, in about 28,700 transactions.

Between 2008 and 2015, the SFC says that it was normal for the client advisors (CAs) and client advisors’ assistants (CAAs) in UBS’s wealth management division to increase the spread charged to clients after the execution of trades (this was known as a post-trade spread increase or PTSI) in bonds and structured notes. The regulator avers the following.

UBS failed to tell its clients enough about the execution price and the charges that it made in bond and structured-note trades.

In circumstances where the execution price achieved in the market was better than the limit order price placed by the client in buy or sell trades (known as price improvement), the client advisors and their assistants allegedly increased the spread in UBS’s Client Order Processing System (COPS) after the execution of trades for clients in order to retain the price improvement for UBS without agreements with, or disclosures to, the clients.

On some occasions, the CAs and CAAs allegedly misreported the execution price or spread to the clients. In some other cases, the SFC says that they falsified quarterly statements issued to financial intermediaries who were authorised to trade for   clients by misreporting the spread amounts to conceal the overcharges.

The use of PTSI to retain Price Improvement for UBS was found in trades for clients contracted under various types of accounts. The account types involving PTSI practices include General Advisory, Active Portfolio Advisory (APA) Flat Fee, APA Advisory Fee, UBS Advice, Discretionary Mandate (DM) and FIM (financial intermediaries) Desk.

A long list of grave offences

The SFC is of the view that the act of increasing spread after trades to capture the benefit of price improvement unbeknown to HNW clients demonstrates UBS’s failures to:

• act honestly, fairly, with due skill, care and diligence and in the best interests of its customers in accordance with General  Principles 1 and/or 2 (the regulator seems unsure which) and paragraph 3.10 of the Code of Conduct for Persons Licensed by or Registered with the SFC;
• make adequate disclosures about the monetary benefits received and relevant material information to clients in line with General Principle 5 and paragraphs 8.3 and 8.3A of the code;
• avoid conflicts of interest and treat clients fairly in accordance with General Principle 6 and paragraph 10.1 of the code;
• ensure that any representations made and information provided to clients were accurate and not misleading, as dictated by paragraph 2.1 of the code;
• ensure that the charges, mark-ups or fees affecting clients were fair and reasonable and characterised by good faith in accordance with paragraph 2.2 of the code;
• execute clients' orders on the best available terms, as per paragraph 3.2; and
• give every client adequate information about the services he received, including the nature and scope of fees, penalties and  other charges in accordance with paragraph (1)(c) of the Appendix to the Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC (the Internal Control Guidelines).

The SFC has stated: "The relevant conduct was a dishonest means through which UBS took profits from its clients without agreement with or disclosure to them. Dishonesty is further  evidenced in the misreporting of the execution price and/or spread charged to certain non-FIM clients and financial intermediaries, as well as the falsification of quarterly statements issued to the financial intermediaries."

Failures of control

The SFC has, moreover, detected systemic internal control deficiencies, which are as follows.

Inadequate policies and procedures. UBS allegedly lacked clearly defined and written policies and procedures to govern the way in which it handled clients' orders, plus policies and procedures to manage conflicts of interest between CAs and clients in accordance with the SFC's expectations. Adequate policies and procedures governing pricing and disclosure, spread charged and best execution were allegedly absent.

Inadequate system controls. For the purpose of taking the benefit of price improvement in the form of additional spread, UBS allowed CAs or CAAs (the regulator is unsure which) to effect PTSI manually before 2012. In 2012, it used COPS to permit the CAs or CAAs sole discretionary control over post-execution spread amendments, thereby allowing them to unilaterally determine the final spread charges to clients. The COPS system change facilitated the improper use of PTSI by the CAs or CAAs to retain price improvement. This was another alleged manifestation of UBS’s failure to establish and keep up proper system controls to prevent and detect errors, omissions and other improper activities in respect of trades on behalf of clients.

An absence of supervision. The SFC maintains that UBS's management was not good at supervising desk heads in their job of supervising client advisors. These desk heads, it says, failed to spot problems with 'conduct' and the poor ethical decisions that client advisors were making. As a result, the firm neither prevented nor detected the resulting misconduct.

An absence of training for staff. UBS stands accused of failing to provide adequate training and guidance to its client-facing staff in the areas of (a) order taking and pricing disclosure, (b) their obligations to execute clients' orders on the best available terms and (c) the fair treatment of clients.

Various CAs and CAAs who misbehaved believed that it was acceptable for UBS to benefit from price improvement. Client-facing staff and their supervisors did not appear to understand the importance of their primary obligations to treat clients fairly and achieve best execution on behalf of those clients.

Failures of the “first and second lines of defence function,” a clumsy allusion to the obligation that modern regulators place on financial firms to spot risks, offset those risks, oversee risk management, comply with regulatory rules and appoint internal auditors. During the fateful decade, according to the SFC, both the Location Risk Unit (in the first line of defence) and Compliance (in the second line of defence) did not settle conflicts of interest between CAs/CAAs and their clients properly and failed to spot the risks that were arising from the way in which UBS was taking orders, pricing and disclosing information to clients. As a result, they failed to prevent or detect the misconduct.