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UBS Settlement Marks Widening Criminal Investigation Into Municipal Bonds

UBS Investment Bank's offices at 299 Park Avenue

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BLOOMBERG-By William Selway and Martin Z. Braun – May 6, 2011 11:31 AM ET

A UBS AG (UBSN) banker wanted to win an investment deal with a Rhode Island municipality that was to be awarded to the highest bidder. Instead of offering the best price, he secretly split half of UBS’s $1.4 million profit with another bank to get the rival to back off.

The 2002 transaction with the unidentified municipality, described in documents tied to UBS’s $160 million settlement with the U.S. Justice Department and the Securities and Exchange Commission this week, shows the expanding arc of a criminal investigation that has taken more than four years.

“My guess is they’re going to be looking at the other big banks next,” said Mark Rosman, a partner at the law firm Wilson Sonsini Goodrich & Rosati in Washington and a former assistant chief of the national criminal enforcement section of the Justice Department’s antitrust division.

UBS followed Bank of America in settling a probe prosecutors say spanned more than a dozen Wall Street banks, insurers and advisers. Settlement documents and court records cite several unidentified companies, a sign that more cases are coming.

‘Active and Ongoing’

“The investigation is active and ongoing,” said Christine Varney, the Justice Department’s antitrust chief, in a press conference May 4. “When every municipality that has been victimized by this conspiracy receives restitution, we will conclude.”

The case has revealed that Wall Street, during the same years when it was sowing the seeds of the financial crisis, was also cheating cities, states and school districts across the U.S. and using the unregulated derivatives markets to hide the kickbacks paid in the schemes.

UBS, whose settlement came after four of its former bankers were charged in the case. One of them, Mark Zaino, last year pleaded guilty to fixing prices when brokering municipal- investment deals by submitting intentionally losing bids at auctions run by Los Angeles-broker CDR Financial Products. UBS allegedly entered into separate trades with another bank that were used to funnel kickbacks to CDR. Zaino agreed to cooperate in the probe.

The Justice Department also indicted Peter Ghavami, the former co-head of UBS’s municipal derivatives group and two colleagues, Gary Heinz and Michael Welty. The three are fighting the charges.

Returning Money

UBS has been cooperating with the probe and, as part of the agreement, is returning money to about 100 municipalities in 36 states that were victims of the conspiracy. Bank of America also agreed to cooperate with federal investigators in exchange for leniency.

UBS, Switzerland’s largest bank, is also among 16 banks under investigation by European antitrust regulators, who are probing whether they manipulated the daily London interbank offered rate, a benchmark lending rate.

In November, James Hertz, a former JPMorgan Chase & Co. (JPM) banker also admitted involvement, and agreed to cooperate. Three former employees of a General Electric Co. (GE) unit are fighting charges in the case.

JPMorgan, in a quarterly filing today, said it was cooperating with the bid-rigging investigations by the Justice Department and SEC, as well as the U.S. Internal Revenue Service and Office of the Comptroller of the Currency. The New York- based bank said it wanted to resolve the probes “on a negotiated basis.”

Competitive Bidding

The government investigation centers on the investments that cities, towns and states make with a portion of the $400 billion they raise by selling bonds each year. The investments allow them to earn a return on the borrowed money until they need the cash, which reduces the cost of public works projects.

Federal regulations encourage local officials to award the investment contracts by competitive bidding. Localities rely on previously unregulated financial advisers to run the auctions.

The Justice Department alleges financial companies paid kickbacks to advisers to run sham auctions so they could win the public money to invest at below-market rates. Court records also show that the banks used the derivatives market, which at the time was largely unregulated, to funnel kickbacks to advisers in return for rigging the bidding.

UBS, which got out of the municipal-bond underwriting business in 2008, ran auctions for the investment contracts on behalf of its customers and also bid at auctions run by others.

In one instance described in the SEC’s complaint against UBS, the bank allowed an investment-contract seller –identified only as Provider C — to pick up an additional $100,000 on a transaction with a Colorado health-care provider.

In return, UBS received an additional fee of $75,000 from the winner, which a banker described as “some profit sharing,” according to the SEC complaint.

To contact the reporters on this story: William Selway in Washington at wselway@bloomberg.net; Martin Braun in New York at mbraun6@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net

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