Ah yes, the perennial margin dispute finds its way onto yet another court docket. Once again we are confronted with the clash between what a customer thinks and expects, on the one side of the legal caption, and what a brokerage firm discloses and disclaims, on the other side of the "versus."
Cast Of Characters
WC Capital Management, LLC ("Willow Creek") is the general partner and manager of Willow Creek Capital Partners, L.P. ("WCCP") and Willow Creek Short Biased 30/130 Fund, LP. ("WCSB"). WCCP and WCSB are two "long/short" investment partnerships that generally invested in securities of companies with a sub-$1 billion market capitalization. In early 2007, UBS agreed to act as Willow Creek's prime broker, and as a result of that capacity, UBS provided to WCCP and WCS:
Account agreements between UBS and Willow Creek provided that UBS could demand additional collateral from Willow Creek:
[i]f at any time any of the UBS Entities has reasonable grounds for insecurity with respect to [Willow Creek's] performance of any of the Contracts or its Obligations, any of the UBS Entities may demand . . . adequate assurance of due performance by [Willow Creek] within 24 hours . . . . The adequate assurance of performance may include . . . the delivery by [Willow Creek] to [UBS] of additional property as Collateral.
The Client Account Agreements also required that Willow Creek "maintain in and furnish to the Accounts such margin . . . as is required by Applicable Law and such greater amounts as the UBS Entities may in their sole discretion require." Upon opening its accounts, Willow Creek received a UBS Disclosure Statement, which, in part, asserted that:
It is [UBS]'s policy to review periodically any account as to which it has credit concerns in light of the value of the assets in the account . . . . Each account with a debit balance is reviewed on an individual basis with consideration given to factors such as market conditions generally at the time, marketability of the securities in the account, frequency of the activity in the account, duration of the account and concentration of particular securities in the account. Different weight may be given these factors by [UBS], and on the basis of its review, [UBS], in its sole discretion, may require additional collateral, above the amount required by the rules of the self regulatory agencies, as security for your obligations to [UBS]. . .
. . .
[UBS] can increase its "house" maintenance margin requirements at any time and is not required to provide you with advance written notice. These changes in [UBS] policy often take effect immediately and may result in the issuance of a maintenance margin call. Your failure to satisfy the call may cause the member to liquidate or sell securities in your account(s).
In keeping with the nature of the prime broker relationship, Willow Creek relied on UBS's extension of margin credit to leverage its existing capital when acquiring securities. In return, Willow Creek paid UBS margin interest, fees, and commissions. As such, everyone was happy until, well, you know how it goes, until everyone was unhappy. When the relationship started in 2007, the markets were still flying high; however, as you may recall, that party ended with a thud - the mother of all thuds for this generation of investors.
In December 2008, UBS notified Willow Creek that WCCP's account was in the second day of a margin call for approximately $6.85 million. Two days later, UBS sent Willow Creek a new document entitled "Prime Broker Margin Levels" ("Margin Levels I"), which described UBS' Prime Brokerage Unit's margin rules and disclosed, for the first time, a number of variations on prior policies. Notwithstanding the changes in Margin Levels I, Willow Creek met the December 2008 margin call.
In February 2009, UBS informed Willow Creek that WCCP's account had about a $13 million margin call, and UBS then sent Willow Creek a revised version of its Prime Broker Margin Levels document ("Margin Levels II"), which included revised policies causing a significant increase in required collateral, such, that the customer felt compelled to liquidate some holdings and abandon some hedging strategies in order to meet the call. Willow Creek felt blindsided by what it viewed as UBS's arbitrary changes of material terms of its margin agreements, and, in the end, the customer blamed UBS for saddling it with a $25 million loss.
On April 10, 2010, Willow Creek, WCCP, and WCSB filed a Complaint in the Southern District Court of New York ("SDNY") against UBS Securities, LLC and UBS AG that alleged UBS had violated Securities and Exchange Commission ("SEC") Rule 10b-16 by failing to disclose its actual margin rules and by failing to provide timely prior written notice before it revised those margin rules.
Rule 10b-16 - Disclosure of Credit Terms in Margin Transactions
a. It shall be unlawful for any broker or dealer to extend credit, directly or indirectly, to any customer in connection with any securities transaction unless such broker or dealer has established procedures to assure that each customer:
1. Is given or sent at the time of opening the account, a written statement or statements disclosing
i. the conditions under which an interest charge will be imposed;
ii. the annual rate or rates of interest that can be imposed;
iii. the method of computing interest;
iv. if rates of interest are subject to change without prior notice, the specific conditions under which they can be changed;
v. the method of determining the debit balance or balances on which interest is to be charged and whether credit is to be given for credit balances in cash accounts;
vi. what other charges resulting from the extension of credit, if any, will be made and under what conditions; and
vii. the nature of any interest or lien retained by the broker or dealer in the security or other property held as collateral and the conditions under which additional collateral can be required: Provided, however, That the requirements of this Paragraph (a)(1) will be met in any case where the account is opened by telephone if the information required to be disclosed is orally communicated to the customer at that time and the required written statement or statements are sent to the customer immediately thereafter: And provided, further, That in the case of customers to whom credit is already being extended on the effective date of this section, the written statement or statements required hereunder must be given or sent to said customers within 90 days after the effective date of this Rule; and
2. Is given or sent a written statement or statements, at least quarterly, for each account in which credit was extended, disclosing
i. the balance at the beginning of the period; the date, amount and a brief description of each debit and credit entered during such period; the closing balance; and, if interest is charged for a period different from the period covered by the statement, the balance as of the last day of the interest period;
ii. the total interest charge for the period during which interest is charged (or, if interest is charged separately for separate accounts, the total interest charge for each such account), itemized to show the dates on which the interest period began and ended; the annual rate or rates of interest charged and the interest charge for each such different annual rate of interest; and either each different debit balance on which an interest calculation was based or the average debit balance for the interest period, except that if an average debit balance is used, a separate average debit balance must be disclosed for each interest rate applied; and
iii. all other charges resulting from the extension of credit in that account: Provided, however, That if the interest charge disclosed on a statement is for a period different from the period covered by the statement, there must be printed on the statement appropriate language to the effect that it should be retained for use in conjunction with the next statement containing the remainder of the required information: And provided further, That in the case of "equity funding programs" registered under the Securities Act of 1933, the requirements of this Paragraph (a)(2) will be met if the broker or dealer furnishes to the customer, within 1 month after each extension of credit, a written statement or statements containing the information required to be disclosed under this paragraph.
b. It shall be unlawful for any broker or dealer to make any changes in the terms and conditions under which credit charges will be made (as described in the initial statement made under paragraph (a) of this section), unless the customer shall have been given not less than thirty
1. days written notice of such changes, except that no such prior notice shall be necessary where such changes are required by law: Provided, however, That if any change for which prior notice would otherwise be required under this paragraph results in a lower interest charge to the customer than would have been imposed before the change, notice of such change may be given within a reasonable time after the effective date of the change.
In considering the parties' arguments, SDNY determined that UBS had
In light of the above, SDNY found that UBS did not need to disclose the precise, complex formulas it uses to calculate its collateral requirements. Additionally, SDNY declined to interpret Rule 10b-16(b) as requiring UBS to provide advance notice to Willow Creek before it changed its margin rules(in apparent contradistinction to its credit terms and conditions). Accordingly, SDNY granted UBS's motion for judgment on the pleadings; and, thereafter, the case founds its way on appeal before the Second Circuit.
Second Circuit Appeal
On April 1, 2013, the United States Court of Appeals for the Second Circuit AFFIRMED the dismissal by SDNY. The Second Circuit conceded that Rule 10b-16(a) requires disclosure of a broker's policies regarding circumstances that may trigger a margin call. That being said, the Circuit concurred with SDNY's finding that UBS's disclosures did not violate the disclosure requirements of of the Rule even though UBS did not expressly disclose the more complex formulas it employed to calculate plaintiffs' collateral requirements. Additionally, the Second Circuit found that under the Rule, UBS was not required to provide advance notice to customers before it changed its margin policies. WC Capital Mgmt. LLC v. UBS Sec. LLC,Plaintiff-Appellant -AND - Willow Creek Capital Partners, L.P., and Willow Creek 22 Short Biased 30/130 Fund, L.P. , Plaintiffs-Counter-Defendants-Appellants, v. UBS Securities, LLC . and UBS, AG, Defendants-Counter-Claimants-Appellees (2nd Circuit, 11-122-CV, April 1, 2013).
Willow Creek contended that UBS violated Rule 10b-16(a) when the firm failed to establish adequate procedures to ensure that its customers would receive the required disclosures, and it exercised its discretion in an arbitrary and capricious manner when it made the disputed margin call. The Second Circuit noted that the SEC's Amicus Brief:
[M]akes a persuasive argument in support of UBS's interpretation of the Rule. First, it explains that Rule 10b-16 is purely a disclosure rule that does not require brokers to adopt particular margin policies; it requires only that firms that do adopt such policies provide useful guidance to investors. Second, the SEC maintains that more detailed disclosures regarding margin requirements may not be useful to investors because brokerage firms may change their margin policies without notice, thereby increasing the risk that investors will rely on outdated standards. As the SEC puts it, investors are better served by the disclosure of relevant factors with an explicit warning that the brokerage firm can impose different requirements at any time. . .
The Circuit Court and the SEC characterized the initial disclosure requirements of Rule 10b-16(a) as serving
In deeming UBS's policies and procedures as furthering the dual purposes of the Rule, the Circuit Court found that because the Initial Disclosure Statement listed the general terms and conditions and also invited the investor to get more specific information about those terms, Willow Creek could not plausibly claim that it was deceived. Further, the Circuit Court noted that Willow Creek had received all the relevant disclosure documents and had failed to allege any plausible injury arising from UBS's alleged failure to establish disclosure procedures.
Willow Creek argued that in violation of the Rule 10b-16(b)'s advance notice provision, UBS had failed to provide at least thirty days written notice to customers in advance of "any changes in the terms and conditions under which credit charges will be made." Moreover, Willow Creek asserted that that UBS's margin rules were relevant conditions relating to credit charges, and that UBS failed to provide the requisite written notice of the revisions to its margin rules.
The Circuit Court disagreed and pointedly noted that margin policies and credit charges are two separate concepts. Margin policies were cited as governing the amount of collateral an investor must provide, not the amount or timing of fees or the methods of calculating interest on the loan. Because margin maintenance requirements are not plainly "credit charges" as that term is commonly understood, the Rule did not require advance written notice when a broker changes those requirements. In a nutshell, UBS was required to disclose to its customer its margin interest rates and methodology for calculating margin interest; but UBS was not required to provide advance notice of the amount of required margin.
Bill Singer's Comment
Talk about parsing words, slicing and dicing language with a razor, and coming up with a result that seems to defy logic but, if you think about it, sort of makes sense. Ya gotta love the practice of law!
All of which reminds me of my grandmother. When the family would go out for dinner, we would invariably wind up at some restaurant that offered a prix fixe dinner. Let's just say that this occurred in the 1950s and 1960s and imagine that you paid $10 for a appetizer, main course, dessert, and beverage. My grandmother, a somewhat petite woman with a modest appetite, would eat her appetizer, sort of make it through the bulk of the main course, and then announce that she was stuffed - however, she would still order a slice of pie. More often than not, after the dessert was placed in front of her, she would either take a solitary bite or leave it untouched. Having observed for a few years this curious behavior of ordering something but not eating it, I finally asked my grandmother why she ordered the dessert if she was too full to eat it. Her reply was "Your father paid $10 for three courses. What? They should come out ahead?"
If you think about my grandmother's explanation, there is quite a bit of logic in it. On the other hand, don't think too much about that logic because it becomes circular and may drive you crazy. Of course, if you think too much about Willow Creek v. UBS, the courts' logic may also drive you nuts.
READ the full-text Second Circuit Decision
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