Bloomberg News

Merrill, UBS Commit Fraud on Swaps, Lombardy Tells U.K. Court

June 28, 2011

June 28 (Bloomberg) -- Bank of America Corp.’s Merrill Lynch unit and UBS AG committed fraud and made “an unfair profit” through hidden fees charged on swaps, according to U.K. court filings by the Italian region of Lombardy, which must set aside millions of euros to cover potential Greek bond losses.

Both banks “deliberately failed to disclose the implicit costs of the transaction, intending to derive an advantage” from the region’s “inexperience and ignorance,” lawyers for Lombardy said in court filings this month.

The region was responding to lawsuits filed by Merrill Lynch and UBS at the High Court in London last July. The banks are seeking confirmation that derivatives contracts with the region, home to Italy’s financial capital Milan, are valid.

The case centers on a 2002 agreement between the banks and the region that changed the way Lombardy would repay a $1 billion 30-year bond. Under the deal, Lombardy was to make the payments in installments instead of a so-called bullet repayment when the bond matured. The banks set up a fund to invest the city’s payments in securities, such as sovereign bonds, until the debt matured. Lombardy said in a statement yesterday it will set aside 153 million euros ($218 million) for potential losses on Greek bonds held in the fund.

Lombardy claims Merrill hid 59.39 million euros in costs from the region, and that UBS hid 35.95 million euros on the $1 billion deal. The costs were “abnormal and exorbitant,” because “a reasonable or normal implicit cost of the sinking fund was nil,” the region said. If the costs were known, Lombardy wouldn’t have entered into the transaction, it said.

‘Truffa’ Claim

UBS, and its banker Gaetano Bassolino, Merrill and its banker Daniele Borrega committed “truffa,” Lombardy said in the filing, using the Italian word for fraud.

“I was 25, had recently graduated, and had a junior role on the desk at the time of the transactions,” Bassolino said. A spokeswoman for UBS declined to comment further.

Borrega, who like Bassolino was authorized by the U.K. securities regulator at the time of the deals, declined to comment through a bank spokesman. A spokesman for the region also declined to comment.

“The crime of truffa is committed where a bank employee does not accurately reveal all the elements of the financial operation proposed to a client and thereby knowingly gains an advantage for the bank,” according to Lombardy’s filing.

A probe by Milan’s prosecutor found the banks hid 95 million euros in fees when they sold the region derivatives. The prosecutor dropped his investigation last year because it would have breached the statute of limitations.

Diversifying Risk

The region also said it’s concerned that the banks, which are still managing the fund, aren’t meeting the requirements by sufficiently diversifying the risk.

Lombardy agreed that Merrill Lynch could invest in securities such as corporate bonds that might be less liquid than government bonds and that the fund could have “certain leveraged positions,” the banks have said in filings. The municipality also agreed to pay Merrill Lynch the difference between the market value of bonds and their principal value in the event of a default, Merrill said in a court filing.

Lombardy “was acting for its own account and had made its own independent decisions to enter the transaction and as to whether the transaction was appropriate or proper for it based upon its own judgment,” Merrill Lynch said in its lawsuit.

--Editors: Christopher Scinta, Steve Bailey

To contact the reporters for this story: Elisa Martinuzzi in Milan at emartinuzzi@bloomberg.net; Lindsay Fortado in London at lfortado@bloomberg.net.

To contact the editors responsible for this story: Edward Evans at eevans3@bloomberg.net; Anthony Aarons at aaarons@bloomberg.net.


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