UBS Financial Services was ordered by a Finra arbitration panel yesterday to pay about $3.9 million to two investors who claimed the company had put them in a controversial managed accounts product that was speculative and unsuitable.

The Financial Industry Regulatory Authority panel said UBS was liable for about $2.9 million in compensatory damages and nearly $1 million in attorney’s fees after the clients, John and Elise Oren, accused the firm of fraud, negligence, negligent supervision and breach of contract related to a troubled financial product called the “Yield Enhancement Strategy,” also known as the “YES” strategy.

The product was designed as a market neutral or non-directional options strategy with limited upside and downside. It was supposed to generate returns by purchasing options on the S&P 500 index. The options overlay approach was based on an Iron Condor strategy, which includes four options—two bearish put options and two bullish call options, all with the same expiration dates—meant to keep the index’s returns from swinging too far in one direction or another.

John G. Rich and Christopher Keogh, two lawyers with Rich, Intelisano and Katz, wrote about the failure of the strategy in a blog:

“Although UBS marketed YES as an Iron Condor strategy, it was far from a symmetrical, low risk strategy,” Rich and Keogh wrote. “First, the combinations of puts and calls bought and sold were not symmetrical. UBS sold put options which were less out of the money than the call options, i.e., more likely to be exercised. UBS also bought put options which were further out of the money, i.e., less likely to be exercised, than the call options.” 

“Out of the money” refers to whether an option has no intrinsic value because its strike price requires the buyer to pay more than the value of the underlying stock in the case of a call option or sell for less than the value of the underlying security in the case of a put option.

Jeffrey Kaplan, an attorney with Dimond Kaplan and Rothstein in Miami, was the lawyer in another winning case earlier this year when he represented two trusts named for the late Irving Siegel. UBS was ordered to pay about $1.9 million in that case. He spoke to Financial Advisor about the product in February and said that the YES product lost 25% of an $8.5 million investment when the expectation was a limited 2% to 3% positive return.

UBS “recommended what was supposed to be a market neutral or non-directional options strategy, which was supposed to have limited upside and limited downside,” Kaplan told Financial Advisor. “But based on the evidence, instead it was an options strategy that made directional bets on the stock market that exposed investors to significant downside that was far greater than the potential upside.”

UBS has prevailed in about half the 30 or so arbitration cases so far, Kaplan said in a follow-up interview, though he said he had seen the wins get bigger. On March 24, Finra awarded B. Terry Bryant and Memorial Rock Investments L.P. about $1.2 million after the claimants said the risk of the YES strategy was misrepresented.

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