indexno.og'4^.j6'4b 2 5...
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SUPREME COURT OF THE STATE OF NEW YORKCOUNTY OF NEW YORK CITY
HSH Nordbank AG,
Plaintiff,
-against-
UBS AG and UBS Securities LLC,
Defendants.
TO THE ABOVE NAMED DEFENDANTS:
NEWYORKCOUNTY CLERKS OFFICE
Index No.Og'4^.J6'4B 2 5 2008
SUMMONSNOT COMPAREDWITH COPY FILE
YOU ARE HEREBY SUMMONED to answer the complaint in this action and to
serve a copy of your answer on the Plaintiffs' attorney within twenty (20) days after the service of
this summons, exclusive of the day of service (or within thirty (30) days after the service is complete
if this summons is not personally delivered to you within the State ofNew York); and in case of your
failure to appear, judgment wilt be taken against you by default for the re I ief demanded.
Plaintiff designates New York County as the place of trial . The basis of the venue
designated is CPLR § 501 because the parties contractually agreed venue could lie in this Court.
Venue is also proper here because many of the acts by Defendants giving rise to Plaintiffs claims
occurred in this County and State.
Dated: New York, New YorkFebruary 25, 2008
QUINN E NUELQUGES,LLP
By: - .W.Peter -CalamarYPhilippe Z. Selendy51 Madison Avenue, 22nd FloorNew York, New York 10010(212) 849-7000
Attorneysfor Plaintiffs
SUPREME COURT OF THE STATE OF NEW YORKCOUNTY OF NEW YORK CITY
FISH Nordbank AG,
Plaintiff,
-against-
UBS AG and UBS Securities LLC,
Defendants.
Index No.
COMPLAINT
Plaintiff HSH Nordbank AG ("HSH") (as successor of Landesbank Schleswig-
Holstein, as described below) by its attorneys, Quinn Emanuel Urquhart Oliver & Hedges LLP,
for its Complaint herein against UBS AG and UBS Securities LLC (collectively "UBS"), alleges
as follows:
NATURE OF ACTION
This action arises out of the wrongful conduct of defendant UBS in connection
with its offering and sale to Plaintiff HSH of a $500 million interest in the North Street 2002-4
CDO ("North Street 4"), a collateralized debt obligation arranged, underwritten and managed by
UBS.
2. In 2001, HSH, then a regional German bank with little familiarity with
international structured finance, wanted to invest funds in a diversified portfolio of international
assets with an emphasis on real estate related credit. To this end, HSH sought an expert,
professional credit manager to expand its portfolio. But instead of providing the expertise and
advice HSH expected, UBS exploited the structure for its own ends, at HSH's expense, in
violation of its contractual and fiduciary duties.
61159/2413315.1
3. UBS originally proposed the CD4-based structure ofNorth Street 4 as a
supposedly efficient vehicle for a conservative, relatively low-return investment in securities
backed mainly by U.S. real estate assets. UBS specifically represented to HSH that HSH's
interest would be in very high credit quality paper issued by the CDO, as reflected in its
predominantly AAA rating. UBS assured HSH that, as an investor in the senior tranches of
North Street 4, HSH would have the further protection of structural subordination, with UBS
taking a proportion of the lower priority, higher-risk positions in the capital structure of North
Street 4.
4. In addition, UBS represented that the CDO would be backed by a reference pool
of stable, investment grade collateral . In particular, UBS represented that it had used a similar
structure in prior transactions, and that the structure would allow UBS to build up a collateral
pool of U.S. real estate-related securities. UBS aggressively marketed its expertise in selecting
and managing collateral, specifically representing that it would "[s]elect credits back[ed] by
assets with no foreseeable credit problems" and "[s]elect credits that are viewed as stable or have
potential to improve over time." HSH trusted UBS' expertise and relied upon UBS'
representations as to the structure and collateral of North Street 4 in agreeing to make its $500
million investment.
5. UBS pitched the quality of the Reference Pool collateral to HSH in several ways.
First, UBS represented that it would select collateral based upon its asset management expertise,
using the same methodology that it would use to select assets for its own account. Second, UBS
represented that the credit quality of the collateral would not only be investment grade, but
specifically selected with the objective of long-term credit stability (in other words, with very
low risk of default). Third, UBS agreed, in a separate contract, to use a Commitments
61159!2413315.1 2
Committee with the objective of (and with compensation dependent upon) ensuring the long-
term stability of the credit quality of the collateral. The use of this oversight committee was
particularly important to HSH because UBS represented that it would align the interests of UBS
and HSH and allow HSH to benefit from UBS' investment expertise.
6. Notwithstanding its representations, duties, and contractual commitments to HSH,
UBS evidently regarded North Street 4 not as an investment platform but as an opportunity to
defraud HSH. UBS knowingly and deliberately created a compromised structure based upon less
desirable collateral, allowing UBS to realize a day-one closing profit of up to $120 million at the
expense of HSH. On information and belief, UBS compounded its wrongful initial gains by
making collateral substitutions in direct and knowing contravention of its representations that it
would make changes in the Reference Pool only with an objective of enhancing or maintaining
stable credit quality. Indeed, within just one year, under the guise of shifting to real estate based
investments, UBS more than doubled the profit it extracted at the expense of HSH, to a
staggering $275 million. As a direct result of UBS' fraudulent acts and willful breaches of duty,
HSH has suffered a decline in the value of its investment in North Street 4 now in excess of $275
million.
PARTIES
7. Plaintiff HSH Nordbank AG is a commercial bank incorporated in Germany with
twin headquarters in Hamburg and Kiel. HSH was established on June 2, 2003, as the result of
the merger between Hamburgische Landesbank and Landesbank Schleswig-Holstein (LB Kiel).
Prior to this merger, in March 2002, LB Kiel invested in North Street 4.
8. Defendant UBS AG is a global and diversified investment bank that was created
in July 1998 by the merger between Union Bank of Switzerland and Swiss Bank Corporation.
61159124133151 3
UBS AG is incorporated in Switzerland, with principal headquarters in Basel and with
substantial offices in New York City . With UBS Securities LLC, UBS AG acted as the initial
purchaser (underwriter) and arranger ofNorth Street 4. UBS AG also acted as the counterparty
and credit protection buyer on the credit default swap with North Street 4 and the manager of the
Reference Pool collateral upon which the credit default swap was based; and controlled the
membership of the Commitments Conunittee with the stated objective of ensuring the stable and
high credit quality of the Reference Pool collateral.
9. Defendant UBS Securities LLC (as successor to UBS Warburg LLC) is a
subsidiary of UBS AG. UBS Securities LLC is the administrator of North Street 4 and also was
designated to select the credits for the swap Reference Pool. With UBS AG, UBS Securities
LLC also acted as initial purchaser of North Street 4.
JURISDICTION AND VENUE
10. This Court has jurisdiction under CPLR § 301 because the parties agreed to
subject themselves to the jurisdiction of this Court on matters relating to North Street 4 pursuant
to Section 9.08 of the parties' Reference Pool Side Agreement dated March 5, 2002.
11. Venue is proper under CPLR § 501 because the parties agreed in Section 9.08 of
the Reference Pool Side Agreement that venue for all matters relating to North Street 4 could lie
in this Court. Venue is also proper here because UBS has substantial offices in New York City,
and many of the wrongful acts alleged herein occurred in New York County, New York.
FACTUAL ALLEGATIONS
A. Structure of North Street 4 and Credit Default Swap With 1BS.
12. This case concerns North Street 4, a CDO arranged and managed by UBS in
March 2002, and a related credit default swap, based on a $3 billion Reference Pool of securities,
61159/2413315.1 4
between the CDC and UBS. CDO securities are customized financial products that vary
according to both the structural features of the CDO as well as the underlying collateral. In
general, the collateral of CDOs are debt securities (such as bonds, loans, or other obligations)
which generate a stream of cash flows in the form of interest payments as well as return of
principal. The cash flow from the collateral is used to repay the CDO's obligations to its
investors; the purchase of a CDO security thus is a purchase of a right to participate in the
cashflows from the CDO collateral portfolio.
13. North Street 4 is a hybrid CDO, which takes a position in the underlying
securities both through physical assets and derivative contracts. North Street 4 takes a position
in the Reference Pool through a credit default swap between the CDO and UBS. A credit default
swap is a means of transferring the risk of default on an underlying obligation--called a
"reference credit"--from one party to another. One party, the protection seller, agrees to assume
the risk of loss on the reference credit in exchange for a stream of premium payments from the
other party, the protection buyer for the period of the swap. If the reference credit defaults on its
principal or interest obligations, then the protection seller must pay the amount of the shortfall.
The protection seller, by assuming the risk of loss, takes a long position on the reference credit.
Whether the assumption of risk by the protection seller in exchange for the premium is a good
investment will depend upon the credit quality of the. referenced securities, and specifically the
risk and severity of any defaults, and the amount of the premium paid.
14, Here, under the terms of the credit default swap, North Street 4 (as the protection
seller) assumed the risk of default on a $3 billion Reference Pool of debt securities selected by
UBS. In other words, North Street 4 was obligated to pay UBS (as the protection buyer) the
amount of any shortfall in scheduled interest or principal repayments by any security in the $3
61159/2413315.1 5
billion Reference Pool (up to a defined limit). The success of an investment in North Street 4
thus depended directly upon the credit quality of the Reference Pool. If UBS selected stable,
investment grade collateral for inclusion in the Reference Pool, as it promised, North Street 4
would have been much less likely to be forced to make payments to UBS under the credit default
swap and it would have profited from the premium paid periodically under the swap; conversely,
if UBS selected unstable or poorly performing securities, North Street 4 (as seller) would have to
pay UBS any shortfall in principal or interest obligations from the Reference Pool collateral.
UBS affirmatively represented that--despite the conflicts of interest created by its differing roles
as both manager of the Reference Pool collateral and swap counterparty--it would select only
"credits backed by assets with no foreseeable credit problems" and that "are viewed as stable or
have potential to improve over time." The performance of North Street 4 securities turned upon
the truthfulness of this fundamental representation by UBS.
15. An investor's return in North Street 4 also turns, in part, upon the investor's
structural position in North Street 4. A basic purpose of a CDO is to resecuritize risk: To create
securities with defined risk profiles that differ from that of the underlying collateral in the CDO.
This is achieved by creating a hierarchical, tranched structure in the CDO. The cashflows from
the CDO's collateral--here, the premium from North Street 4's credit default swap with UBS--are
divided, according to defined rights, among the tranches of the CDO, in a waterfall fashion. The
senior tranches of the structure are at the top of the "waterfall," with the first rights to receive
principal and interest if there is a shortfall, and thus the highest credit quality (i.e., the lowest
likelihood to be affected by problems in the underlying collateral). The mezzanine debt tranches
are junior in priority, and therefore more risky, while the lowest, equity tranche is entitled to all
residual cash flows (after North Street 4 pays its obligations to all the more senior tranches) but
61159P2413315.1 6
also stands in the first loss position. The presence of these inferior tranches creates structural
subordination that insulates the more senior tranches from losses -- here, specifically, any
payments North Street 4 must make under the credit default swap because of shortfalls in the
Reference Pool. Because HSH wanted a conservative investment , it purchased only the more
senior tranches of North Street 4 , accepting lower returns for the added protection of this
structural subordination.
16. An underwriter and CDO arranger like UBS typically sells the tranches in a CDO
by means of an offering circular which describes, among other things, the structural features of
the CDO, the collateral in which the CDO is permitted to invest, and the authority of the CDO
collateral manager to effect changes in the collateral portfolio. In this case, UBS not only
prepared an offering circular but took the unusual step of simultaneously entering into a side
agreement with HSH, the Reference Pool Side Agreement, which UBS represented would further
align the interests ofUBS with that of North Street 4 by creating additional obligations for UBS
with respect to the selection of the reference credits.
B. UBS Induces HSH to Invest $500 Million in North Street 4.
17. In 2001 , LB Kiel sought to invest $500 million in a diversified pool of investment
grade corporate and real-estate-related securities with the primary objective of preservation of
capital.
18. In May 2001, UBS representatives including Oliver Takacs and Dan Cook met
with LB Kiel representatives Juergen Bruhn and Rainer Helms at LB Kiel's offices in Kiel,
Germany. At the meeting, HSH presented its objectives and intent to invest in stable credit
quality securities, and its desire to take advantage of UBS' experience and investment expertise.
61159/2413315.1 7
19. UBS then undertook to develop an appropriate investment structure for LB Kiel.
UBS proposed a synthetic CDO similar to prior transactions in its North Street program, but with
features specifically tailored to fit LB Kiel's requirements.
20. UBS knew that LB Kiel was a publicly owned regional bank principally serving
northern Germany. LB Kiel thus had little or no relevant experience in structured products such
as synthetic CDOs. UBS, by contrast, was a major player in global capital markets with a
worldwide reach. UBS thus heavily promoted its own capabilities and experience. For example,
in a June 1, 2001, presentation sent to LB Kiel, UBS described itself as a "leading global asset
manager" with a track record of twelve structured finance deals, four of which were over $1
billion, all with strong performance.
21. As a conservative yet inexperienced investor in this area, LB Kiel devoted several
months of due diligence to evaluating the UBS proposals. From the start, LB Kiel focused on
the composition of the portfolio collateral as the fundamental basis of the transaction. UBS
repeatedly represented that the collateral in the Reference Pool would be stable and highly
unlikely to default (and therefore trigger payments by the CDO under the swap). For example, in
June 2001 and January 2002, UBS sent marketing materials to LB Kiel representing that UBS
would select credits for the Reference Pool only if they were "backed by assets with no
foreseeable credit problems" and only if UBS viewed the credits "as stable or [with] potential to
improve over time." UBS and LB Kiel also discussed the use of a special Commitments
Committee that would have dedicated responsibility for ensuring the stable credit quality of the
Reference Pool assets, and thus provide LB Kiel with the benefit of UBS' asset-management
expertise and analytics, both of which LB Kiel, as a Northern German regional player, lacked.
6115912413315.1 8
22. In a rune 15, 2001 e-mail to Juergen Bruhn and Rainer Helms of LB Kiel, Paul
Heyman ofUBS further represented that the Reference Pool "is a portfolio UBS deems to have
favorable relative value and positive credit outlook." Mr. Heyman claimed that the structural
protections to be built into North Street 4 would satisfy any ratings agency. Mr. Heyman further
represented that the interests of LB Kiel and UBS would be aligned in North Street 4, despite the
different position of UBS on the credit default swap, because UBS would hold interests in North
Street 4 both junior and senior to those of LB Kiel: "This credit position, BOTH SENIOR AND
JUNIOR to the rated notes, strongly aligns the interest of UBS with rated note investors."
23. In a further meeting in Kiel in August of 2001, UBS representatives including
Oliver Takacs and Ken Karl again marketed their proposed North Street CDO structure to LB
Kiel. UBS described North Street 4 as an opportunity for LB Kiel to participate in cash flows
generated from asset-backed securities ("ABS") and other securities, and presented studies
showing that ABS were more stable than corporate bonds with similar credit ratings, yet
provided a return that was slightly greater. LB Kiel informed UBS that it wanted as much
information as possible on the underlying collateral in the proposed Reference Pool, both at the
closing of the transaction and thereafter. LB Kiel also stated that it expected to be informed of
the basis for any post-closing substitutions of collateral, in part to further its own asset
management expertise. Finally, LB Kiel repeatedly sought assurances that UBS' interest in the
transaction would be aligned with that of LB Kiel to ensure that UBS would manage the
selection of credits in a manner favorable to the North Street 4 investors . The UBS
representatives responded that its asset management responsibilities were the basis of the
transaction, that UBS' reputation depended upon its proper management of the credits in the
Reference Pool, and that LB Kiel should rely upon UBS' expertise and analytics in this area.
61159/2413315.1 9
UBS agreed to a further meeting in New York City at which LB Kiel could meet the persons
who would be responsible for managing the Reference Pool, and gain a greater understanding of
UBS' process of collateral selection.
24. LB Kiel representatives , including Mr. Bruhn, met with UBS representatives,
including Wayne King and Ken Karl, at the UBS offices in New York City in late October of
2001. At the meeting, UBS reviewed its process of collateral analysis and selection and
substitution, a process it represented would be fully transparent to LB Kiel, and introduced LB
Kiel to various asset managers. UBS specifically represented to LB Kiel that UBS, through the
Commitments Committee, would exercise its asset-management skills and expertise to substitute
collateral in North Street 4 in advance of ratings agency downgrades--as UBS said it had done in
prior North Street CDO transactions. In connection with this meeting, UBS provided LB Kiel
with a presentation (the "October 2001 presentation") in which it specifically stated that the
objective of the Commitments Committee would be to "select assets with stable or improving
credit profiles, carefully monitor the credit status of each asset, and avoid downgrades by
replacing deteriorating credits with assets that demonstrate an improved credit profile." As UBS
intended, LB Kiel considered this active management of the Reference Pool to ensure stable
credit quality to be a strongly positive aspect of the transaction, and a protection against asset
deterioration. UBS discussed the role of the Commitments Committee, and represented that the
Committee would allow collateral substitutions in the Reference Pool only based upon a written
presentation by UBS analysts, and with the paramount objective of protecting credit quality.
UBS also assured LB Kiel that UBS' authority to change the securities in the Reference Pool
would allow UBS to remove securities with a declining profile from the swap before they
61159/2413315.1 10
triggered any protection payments. UBS claimed there were rigorous criteria to ensure that
substitutions would improve, and not degrade, the credit quality of the Reference Pool.
25. UBS repeatedly assured LB Kiel that the North Street 4 vehicle was a proven and
successful investment platform to limit credit volatility for conservative investors like LB Kiel.
In the October 2001 presentation to LB Kiel, UBS explained that, under its North Street RLN
program (of which North Street 4 would be a part), UBS had structured and administered three
CDOs with the same structure as North Street 4, and that each was performing extremely well.
UBS stated in the presentation: "In a deteriorating economic environment, with record corporate
investment grade credit deterioration, the North Street RLN program has maintained a consistent
and improved credit profile." UBS repeated these assurances in a January 2002 presentation to
LB Kiel that also emphasized the success of the North Street RLN program.
26. On February 27, 2002, at a further meeting between LB Kiel and UBS in New
York City, UBS walked through its asset selection and substitution process in greater detail, even
performing a mock run of the Commitments Committee--using a demonstrative analyst report
evaluating reference credits and featuring a discussion of the responsible asset-managers at UBS.
As UBS intended, the meeting impressed LB Kiel with UBS' expertise and the degree to which
UBS would commit its investment management services to the effective management of the
Reference Pool. UBS also gave details on certain of the assets that it intended to select for the
Reference Pool upon closing of North Street 4 and related credit default swap.
27. In reliance on these representations, on March 5, 2002, LB Kiel entered into the
Reference Pool Side Agreement with UBS and invested $500 million in debt securities issued by
North Street 4.
61159/2413315.1 11
C. The Credit Default Swap With UBS.
28. At closing, North Street 4 and UBS entered into a $3 billion credit default swap.
Under the terms of the credit default swap, UBS shifted the default risk exposure on $3 billion
(principal amount) of referenced credits to North Street 4, up to an aggregate exposure of $574
million. In return, UBS agreed to make periodic premium payments to North Street 4.
Under the credit default swap agreement and the Reference Pool Side Agreement, UBS was
responsible for managing the securities in the Reference Pool, including the selection and
substitution of reference credits. UBS' ability to select and substitute collateral, however, was
subject to specific limitations applicable to each Reference Credit as well as the overall
creditworthiness of the Reference Pool. For example, the limitations on UBS' Substitution
Authority include that (i) the credits cannot be rated less than BBB, (ii) the Reference Pool as a
whole has to have an average rating that exceeds BBB+, and (iii) all substitutions are subject to
the Reference Pool Side Agreement. UBS also should have been--but was not--constrained by
its material representations as to how it would exercise its selection and substitution authority to
enhance and maintain stable credit quality in the Reference Pool.
D. North Street 4 Classes of Securities.
29. In return for its $500 million cash investment, LB Kiel was issued, in the
aggregate, $500 million in principal in several classes of North Street 4 debt securities. LB Kiel
was issued the following classes of debt securities and coupon amounts, in order of seniority,
with the following credit ratings from Fitch and yields, expressed as the London Interbank
Offered Rate ("LIBOR"), a risk-free lending rate, plus a percentage of the principal amount of
the note:
Class A Notes $353 million principal, rated AAA, at LIBOR plus .8%
61159/2413315.1 12
Class B Notes $40 million principal, rated AA, at LIBOR plus 1.25%
Class C Notes $46 million principal , rated A, at LIBOR plus 1.8%
Class D Notes $61 million principal , rated BBB+, at LIBOR plus 3.35%
(Collectively, the "Notes".) Of the Notes, 71 percent were rated AAA, the highest rating issued
by Fitch, and just $61 million, or 12 percent, were rated less than A. Along with those very high
credit ratings, the relatively low yields on the Notes underscore LB Kiel's expectation that, as
UBS represented, these were low-risk investments consistent with LB Kiel's conservative
investment objectives.
30. North Street 4 used the proceeds received from LB Kiel to invest in a low-risk
note (the "Kiel Note") as security for any obligation under the credit default swap with UBS.
31. According to UBS' offering circular for North Street 4, the amount of
subordination to the LB Kiel interests constituted $74 million: $25 million principal of Class E
junior notes , rated BBB by Fitch, at LIBOR plus 4%, and $49 million face of income notes
(equity). UBS represented to LB Kiel that it invested the entire face amount of the Class E Notes
and $39 million of the equity, with $10 million of equity invested by third parties.
32. Contrary to UBS' rune 15, 2001 , representation that UBS and LB Kiel had aligned
interests because UBS had positions "BOTH SENIOR AND JUNIOR to the rated notes," there is
no tranche superior to the interests of HSH in the structure. On information and belief, North
Street 4 in fact issued only $574 million in debt and equity tranches , of which the $74 million in
Class E Notes and equity were subordinate to LB Kiel's $500 million senior position. While the
CDO had the capacity to issue additional securities, it never did so. Thus, with the exception of
the unfunded Senior Swap Notes at the top of the structure, LB Kiel held (and HSH now holds)
61159/2413315.1 13
the top four tranches of North Street 4, with UBS holding the junior Class E Notes and (together
with "other" investors) the equity tranche.
33. It is now apparent, in other words, that LB Kiel funded $500 million out of the
$574 million of securities the CDO issued--with UBS holding at least $64 million of the residual
interests and a supposed "other" investor holding the remaining $10 million interest.
E. The Reference Pool Side Agreement.
34. At the March 5, 2002 closing of North Street 4, LB Kiel and UBS simultaneously
entered into a Reference Pool Side Agreement, consistent with the parties' prior agreement and
understanding regarding the use of an internal UBS supervisory committee to act as monitor and
ensure that UBS would exercise its selection and substitution authority consistent with the
paramount requirement of maintaining stable credit quality. As the Reference Pool Side
Agreement recites on its face, UBS agreed to the use of the Commitments Committee "in
consideration of [LB] Kiel agreeing to purchase the [North Street 4] Notes." The Reference Pool
Side Agreement, and the related obligations assumed by UBS, were a precondition to LB Kiel's
agreement to make its $500 million investment in North Street 4.
35. Under the terms of the Reference Pool Side Agreement, UBS agreed to establish
the Commitments Committee as of the Closing Date. The Commitments Committee was to be
comprised of a Chairman and six other members, each of whom "shall have expertise in credit
matters with respect to the asset categories in the Reference Pool." The Commitments
Committee was to remain in place "until the extinguishment in full of the Kiel Notes."
36. The Reference Pool Side Agreement does not purport to be exhaustive of the
Commitments Committee's obligations or procedures. It does require, among other things, that:
(a) the Chairman' s "compensation and performance evaluation shall, among other factors, be
6115912413315.1 14
determined by reference to the credit performance of the Reference Pool"; (b) the Commitments
Committee "shall ratify all necessary rules and procedures for the process of making decisions
regarding the Reference Pool"; (c) the Commitments Committee must meet "on a daily basis or
as necessary to review Substitution proposals or trends in the credit quality of the specific
Reference Obligations"; (d) the Commitments Committee must "review the credit status of all
Reference Obligations on a quarterly basis"; (e) "[e]ach Reference Obligation shall be monitored
on a day-to-day basis by an assigned credit analyst"; and (f) credit analysts are to report to the
Commitments Committee on "trends in the credit quality of specific Reference Obligations."
37. As represented by UBS, the fundamental responsibility of the Commitments
Committee was to ensure that UBS would exercise its control over the Reference Pool to protect
the interests of HSH--i.e., to select only stable or improving credits for inclusion in the pool, and
thus avoid risks of default that would trigger obligations under the credit default swap. Indeed,
even after the deal closed, UBS continued to affirm that the goal of the Committee was to protect
the health of the Reference Pool- In presentations given to HSH from August 2003 and March
2005, UBS stated that the Commitments Committee was designed to select assets with "stable or
improving credit profiles" and to "take proactive measures with respect to the reference credits to
avoid downward credit migration." UBS also confirmed that the vote of the Chairman "plus any
two members not a part of the trading group for the proposed asset" was required to authorize
substitutions into the Reference Pool.
38. It is now clear , of course , that UBS never intended that the Commitments
Committee exercise that function , and, on information and belief, UBS has not even maintained
the basic procedural requirements contemplated by the Reference Pool Side Agreement.
F. UBS' Adverse Selection and Substitution of Reference Pool Collateral.
61159/2413315.1 15
39_ Far from the alignment of interests it promised, UBS has from the beginning used
its analytics and expertise against LB Kiel (and now HSH) and the CDO by deliberately
selecting inferior quality reference credits for the $3 billion Reference Pool. UBS could only
gain by shifting risks to North Street 4, even though it owned Class E and equity positions; those
are risks UBS had anyway as the owner of the securities in the Reference Pool for the swap. The
only party likely to lose any capital on the credit default swap was LB Kiel--and whatever LB
Kiel (and now HSH) lost would run to UBS' direct benefit. Thus UBS, through its control over
the selection and substitution of securities in the Reference Pool, had the ability simply to
determine the amount ofLB Kiel's losses--and UBS' profits--through its adverse selection of
collateral to include in the Reference Pool, subject only to its representations and contractual
commitments to LB Kiel over how UBS would manage its collateral selection.
40. UBS misused this power from the very beginning. On information and belief,
UBS realized up to a $120 million gain as of the Closing Date--an amount far in excess of any
reasonable arbitrage from structuring the transaction--reflecting a substantial and immediate
impairment to the value of the HSH Notes. That degradation of the Reference Pool resulted in
an expected loss that substantially or entirely eliminated the represented structural subordination
($74 million in the Class E Notes and equity) that was supposed to protect the LB Kiel
investment in the senior tranches of North Street 4.
41. UBS' ability to make such adverse selections of reference credits, notwithstanding
the offering circular requirement of "minimum [credit] rating of each Reference Obligation.
BBB," is well-understood today. It is now commonly known that banks such as UBS routinely
engaged in ratings arbitrage: The systematic selection of credits for inclusion in structured
products where such credits had the requisite credit rating for the structure, but traded at wide
61159/2413315.1 16
spreads for that rating. This "ratings lag" reflects the market's understanding, evidenced by the
lower value of the security, of a deterioration in credit quality in advance of rating agency
downgrades.
42. Four months after closing , as of July 2002, even UBS' own valuations of LB
Kiel's securities in North Street 4 reflected a significant decline. UBS valued each class of
securities at a discount to the par value at issuance , as follows: Class A 95.5%; Class B 94%;
Class C 94%; Class D 85.5.%. The 4.5 percent drop in the AAA-rated senior tranche of North
Street 4 over just the 4-month period from closing reflected a highly unusual deterioration at the
time , especially for AAA-rated securities.
43. UBS continued its deliberate selection of unstable collateral--through which it
stood to profit on the credit default swap--after the closing of North Street 4. In particular, UBS
made multiple substitutions of collateral for the express purposes of (a) transferring additional
default risk off its own balance sheet and onto North Street 4, and, on information and belief, (b)
profiting through taking short positions in its trading book against the very reference credits that
it selected for inclusion in the Reference Pool. As a direct result of this conduct, within the two-
year anniversary of the closing of North Street 4, the profit UBS had extracted from North Street
4 had more than doubled, to $275 million.
44. UBS also violated the formal Reference Pool guidelines , including, among other
things, violating (a) the requirement that all collateral be rated at minimum BBB, investment
grade; (b) the Reference Pool weighted average rating and rating factor requirements ; (c) the
requirement that the Reference Pool contain no more than 10% of CMBS/ABS with a servicer
rating below S2; and (d) the corporate pool rating factor.
61159/2413315.1 17
45. The pattern of adverse substitutions accelerated in July 2005, when UBS
announced that responsibility for managing the Reference Pool would be transferred from UBS'
internal Principal Finance Group to Dillon Read Capital Management ("DRCM"), a wholly
owned subsidiary of UBS. UBS represented that the transfer to DRCM, which was finalized on
June 5, 2006, was intended to separate UBS' asset management business and its broker dealer
business in order to avoid any appearance of conflict of interest. That transfer of responsibility
did not, however, eliminate the conflicts of interest resulting from UBS' different positions as
manager of the Reference Pool and counterparty on the credit default swap. To the contrary, on
information and belief, DRCM used its control over the Reference Pool in connection with its
own trading strategies, which were directly contrary to the interests of HSH, as the owner of the
Notes. (As described above, HSH was established on June 2, 2003, as the result of the merger
between Hamburgische Landesbank and LB Kiel.)
46. In duly 2006, HSH challenged the selection of certain Reference Credits for the
Reference Pool as inconsistent with the Reference Pool guidelines . After being confronted by
HSH, Peter Hamik ofDRCM even admitted, in an email to Katharine Bruhn of HSH on July 19,
2006, that some of the selections "should not have happened," and that someone "got carried
away" in attempting to use the North Street deal to hedge DRCM's risk from other trades, in
blatant contravention of UBS' representations and duties to HSH. However, HSH thereafter did
not preclude DRCM from continuing to mismanage the Reference Pool, or from exploiting the
Reference Pool for ARCM's own trading strategies.
47. In February 2007, DRCM removed approximately $555 million of stable credits
from the Reference Pool and substituted in two securities, totaling approximately $555 million,
tied to an index based on the performance of securities related to subprime mortgages, known as
6115912413315.1 18
the ABX index. The securities represented $500 million of ABX-HE-A-06-02 and $55 million
of the ABX-HE-BBB-06-02 HEQ BBB(-). These two ABX index securities together are
believed to have represented the largest substitution in the history of the Reference Pool. They
also increased the Reference Pool's exposure to home equity loans by $49 million at a time when
the outlook on subprime mortgages was already negative..
48. Despite repeated requests from HSH, UBS has never been able to provide a
proper explanation for this substitution. Given that the credits that were removed from the
Reference Pool had been performing well and that the credits selected by DRCM to replace them
had a poor outlook, there appears to be no rationale for this action -- at least no rationale that
would favor the interests of HSH. But unbeknownst to HSH, DRCM was engaged in proprietary
trading relating to subprime mortgages at this time. Upon information and belief, DRCM made
these substitutions not because they would maintain the health of the Reference Pool, but to
cover its own losses. Indeed, DRCM's own valuation of the ABX securities at the time of the
substitution showed that they were performing poorly.
49. Unsurprisingly, the substitution of the ABX index securities had an immediate
adverse affect on the Reference Pool, and the damage to the Reference Pool only worsened.
Despite repeated complaints by HSH to remove the improperly-substituted ABX index securities
from the Reference Pool, UBS declined to remove the collateral even as the ABX index
continued to plummet. In April 2007, DRCM reported large losses in its subprime mortgage
trading book. In May 2007, UBS announced that it was closing DRCM, In August 2007, UBS
agreed to remove $ 150 million of the $555 million ofABX index securities from the Reference
Pool, but left the remaining $405 million of exposure untouched.
6115912413315.1 19
50. In the wake of these substitutions, the values of HSH's Notes, as calculated by
UBS itself, have dropped precipitously. On June 29, 2007, IJBS valued HSH's Class A Notes at
91.985 (as a percentage of par), its Class B Notes at 84.506, its Class C Notes at 71.801, and its
Class D Notes at 49.440, less than half their original value. Just a month later, the values had
dropped even further. As of July 31, 2007, UBS' own values for HSH's Notes were as follows:
For the Class A Notes 69.4, for the Class B Notes 49.3, for the Class C Notes 35, and for the
Class D Notes 35. On information and belief, even this valuation overstates the true value of
HSH's notes. But even so, according to UBS' own valuations, HSH's Notes have lost over $200
million in value since they were issued . Not surprisingly, in August 2007, UBS informed HSH
that it refused to provide any further valuations of the Notes.
51. HSH has repeatedly complained to UBS about its actions relating to North Street
4, including in face -to-face meetings in December 2006, June 2007, and August 2007. In none
of these meetings was UBS able to provide a satisfactory explanation for the problems in the
Reference Pool or for the ABX substitutions.
52. But during the second of these meetings , on June 13, 2007, UBS made an
astonishing disclosure: It stated it never operated the Commitments Committee as represented to
HSH, in direct breach of the parties' Reference Pool Side Agreement. UBS specifically told
HSH that, rather than implementing the procedural protections required under the parties'
agreement--commensurate with the scale of the HSH investment and the importance of impartial
evaluation of the credit quality of the Reference Pool--UBS ultimately allowed one individual to
make the decisions with respect to collateral selection and substitution. A committee of one, of
course, is no committee at all. With just one individual making decisions about the Reference
Pool, there was no oversight to protect against obvious conflicts of interest and no means to
6115912413315.1 20
ensure that substitutions were made in the best interest ofHSH, rather than in the narrow
interests of UBS. Indeed, with just one person constituting the "committee", the protections
which UBS promised HSH were entirely ineffective. This complete procedural breakdown
enabled the continued pattern of post-closing adverse substitutions of collateral right through
2007.
53. As a direct result of DUBS' multiple fraudulent acts , misrepresentations, and
omissions , as well as breaches of contract and fiduciary duty, the Notes have declined in value
by more than $275 million since they were purchased.
61159/2413315.1 21
CAUSES OF ACTION
FIRST CAUSE OF ACTION
(Breach of Contract)
54. HSH repeats and realleges the foregoing allegations as fully set forth herein.
55. This is a claim for breaches of contract brought against UBS.
56. On or about March 5, 2002, HSH entered into contracts with UBS to purchase
securities with well-defined characteristics, including as to credit quality, protection through
structural subordination , and collateral type, as set forth in North Street 4 Offering Circular and
UBS' related marketing materials , as well as a related contract for UBS to exercise its investment
management expertise to ensure the stable credit quality of the collateral in the Reference Pool.
57. UBS materially breached its contracts. In particular, UBS deliberately and
willfully did not deliver (a) true senior tranches in the North Street 4, because there was little or
no structural subordination as of the closing date; (b) securities with the credit quality as
represented by UBS and implied by the credit ratings, because, as UBS knew, the underlying
collateral in the Reference Pool was compromised and the credit ratings issued by the ratings
agencies did not reflect the actual credit quality of North Street 4 Notes; (c) the selection of a
Reference Pool with the stable credit quality as represented by UBS. To the contrary, UBS, for
its own profit and to the direct expense of HSH, created a compromised structure based on a
credit default swap protecting default risks on deteriorated collateral, such that the actual credit
quality of the North Street 4 tranches was significantly below that implied by their credit ratings
and yield. To the same end, UBS also knowingly failed to create the procedural protections
required by the Reference Pool Side Agreement against its conflicts of interest, and failed to
maintain a "Commitments Committee" or conduct the reviews required by the Reference Pool
61159/2413315.1 22
Side Agreement . Instead, UBS made multiple substitutions of collateral with adverse
consequences to the North Street CDO and to HSH in breach of its contractual obligations.
58. By contrast, HSH has performed all of the material conditions, covenants and
promises required to be performed in accordance with the terms and conditions of its contracts
with UBS, including its payment of $500 million into North Street 4.
59. HSH would not have agreed to purchase the North Street 4 notes absent UBS'
agreement to perform its obligations under the purchase agreement, credit default swap
agreement, Reference Pool Side Agreement, and its related representations to HSH. UBS'
breaches were material and have deprived HSH of the consideration HSH bargained for.
60. As a consequence, HSH should be awarded rescission of its contracts with UBS,
or, in the alternative, damages in an amount to be determined at trial but believed to be in excess
of $275 million.
SECOND CAUSE OF ACTION
(Fraud)
61. HSH repeats and realleges the foregoing allegations as though fully set forth
herein.
62. This is a claim for fraud against UBS.
63. Defendant UBS made material misleading and incomplete disclosures, and
omitted material information, in order to induce HSH to invest $500 million in North Street 4
securities, UBS is one of the largest financial institutions in the world and a global leader in
structured finance products, including CDOs, and specifically induced 14SH to rely upon its
greater knowledge and expertise in these areas. UBS intended and knew, or reasonably should
have known, that HSH in fact did rely upon UBS' investment management expertise. UBS
6115912413315.1 23
further knew, or reasonably should have known, that based on the parties' longstanding
relationship, HSH relied on UBS for truthful and accurate advice, guidance and representations.
64. UBS knew, or reasonably should have known, that HSH, a bank, was interested
only in extremely conservative, secure and stable investments. UBS knew, or reasonably should
have known, that HSH's principal investment criterion was principal preservation. UBS
misrepresented facts including that:
a. North Street 4 represented a conservative and secure investment;
b. UBS would place only stable , investment grade debt securities in the Reference
Pool;
UBS would substitute debt securities in the Reference Pool that were not
performing , or that were expected to be downgraded, with debt securities that would maintain or
improve the Reference Pool profile;
d. UBS would not substitute debt securities in the Reference Pool that were
performing well with debt securities that were expected to be downgraded or otherwise perform
poorly;
e. UBS would form a Commitments Committee that would operate consistent with
the parties' agreement, in addition to other protections promised by UBS;
f. UBS would maintain strict ethical walls to ensure that the decisions on the
Reference Pool would be made independently of UBS' proprietary interests;
g. UBS would manage the Reference Pool as if it represented UBS' own proprietary
book of business, and would protect HSH from the risk of defaults in the Reference Pool;
h. UBS was investing in tranches of North Street 4 both senior and lower to the
tranches purchased by HSH; and
6115912413315.1 24
HSH should rely on UBS to protect HSH from the risks of defaults, because under
the terms of North Street 4, the interests of UBS and HSH were aligned.
65. Each and every representation , as UBS knew at the time made , was false.
66. At the time it made these misleading and incomplete statements , UBS knew or
recklessly disregarded the fact that its statements were false or misleading. UBS made these
misleading and incomplete statements with the intent that HSH would rely on them.
67. UBS also failed to disclose material facts in order to induce HSH to invest in
North Street 4. UBS failed to disclose, for example, that:
a. UBS in fact stood to profit through the adverse selection of Reference Pool
collateral;
b. UBS intended to exercise its selection and substitution authority over the
Reference Pool to the detriment of North Street 4 and HSH;
c. CUBS in fact offloaded risks in unstable securities from its own books to North
Street 4;
d. UBS intended to and did take investment positions directly contrary to the
interests of North Street 4 and HSH;
e. the interests ofUBS and HSH were not in fact aligned , as UBS had
misrepresented, and UBS had a specific and direct conflict of interest in its position as manager
of the Reference Pool collateral and its position as counterparty to the credit default swap; and
f. UBS did nothing to manage that specific and direct conflict of interest but rather
instead exercised its authority over the Reference Pool solely in its own interests and directly
against the interests of HSH.
61159/2413315,1 25
68. UBS also failed to disclose that because HSH's investment in North Street 4
reflected significantly greater risk than HSH had been apprised, the credit quality implied by the
low yield on the Notes did not represent the actual, compromised quality as known to UBS.
69. UBS knew, or reasonably should have known, that HSH did not have access to
facts that were the subject of misleading or incomplete disclosures by UBS, or that UBS had
failed to disclose to HSH.
70. UBS had a duty to provide full and complete disclosures regarding these matters
because of its superior knowledge, expertise and relationship with HSH, and because UBS had
made incomplete and misleading partial disclosures.
71. UBS had a duty to disclose information that UBS knew or reasonably should have
known was important to FISH regarding North Street 4, but which was not available to FISH, and
regarding which UBS knew or reasonably should have known HSH was acting in reliance on
mistaken or incorrect information.
72. HSH was induced to purchase debt securities in North Street 4 in reasonable
reliance on the truthfulness, completeness and accuracy of UBS' statements.
73. HSH would not have purchased the debt securities in the absence of UBS'
fraudulent disclosures, and the parties should be returned to their original position prior to the
fraudulent disclosures.
74. As a result, HSH should be awarded rescission of its contracts with UBS or, in the
alternative, damages in an amount to be determined at trial but believed to be in excess of $275
million. HSH is also entitled to punitive damages in an amount to be determined at trial.
THIRD CAUSE OF ACTION
(Negligent Misrepresentation)
61159/2413315,1 26
75. HSH repeats and realleges the foregoing allegations as fully set forth herein.
76. UBS, one of the largest financial institutions in the world and a global leader in
structured finance products, including CDOs, has far greater knowledge and expertise in these
matters than does HSH, and specifically induced HSH to rely upon its greater knowledge and
expertise in these areas. UBS knew, or reasonably should have known, that HSH was relying on
UBS' expertise, experience and advice in such sophisticated investment matters.
77. UBS further knew, or reasonably should have known, that based on the parties'
relationship, HSH relied on UBS for truthful and accurate advice, guidance and representations.
UBS made misleading and incomplete disclosures and omitted material information in order to
induce HSH to agree to invest in North Street 4, as set forth above.
78. UBS also failed to disclose material facts in order to induce HSH to invest in
North Street 4, as set forth above.
79. UBS knew, or reasonably should have known, that HSH did not have access to
facts that were the subject of misleading or incomplete disclosures by UBS, or that UBS had
failed to disclose to HSH.
80. UBS had a duty to provide full and complete disclosures regarding these matters
because of its superior knowledge, expertise and relationship with HSH, and because UBS had
made incomplete and misleading partial disclosures.
81. UBS had a duty to disclose information that UBS knew or reasonably should have
known was important to HSH regarding North Street 4, but which was not available to HSH, and
regarding which UBS knew or reasonably should have known HSH was acting in reliance on
mistaken or incorrect information.
6115912413315.1 27
82. HSH was induced to purchase debt securities in North Street 4 in reasonable
reliance on the truthfulness, completeness and accuracy ofUBS' statements.
83. HSH would not have purchased the debt securities in the absence of UBS'
misrepresentations and omissions . As a'consequence , HSH should be awarded rescission of its
contracts with UBS, or, in the alternative, damages in an amount to be determined at trial but
believed to be in excess of $275 million.
FOURTH CAUSE OF ACTION
(Breach of Fiduciary Duties Owed to HSH)
84. HSH repeats and realleges the foregoing allegations as fully set forth herein.
85. UBS further knew, or reasonably should have known, that based on the parties'
longstanding relationship, HSH relied on UBS for truthful and accurate advice, guidance and
representations. In this regard, UBS undertook to provide such advice with a stated goal of
assisting HSH in obtaining experience and background in investing in these types of securities.
86. Because of its longstanding relationship and its undertaking to provide investment
advice and expertise to a party it knew had limited experience in the area, UBS established and
proceeded in a special relationship of higher trust with HSH. UBS knew that HSH was uniquely
and specially relying on it for its expertise and specific commitments to HSH in the selection of
Reference Entities for the North Street Swap and in its right to make substitutions of collateral in
the Reference Pool. UBS further knew, or reasonably should have known, that HSH, a regional
German state bank, was interested only in extremely conservative, secure and stable investments.
UBS knew, or reasonably should have known, that HSH's principal investment criterion was
principal preservation . UBS further knew, and indeed encouraged, HSH to rely on its experience
61159/2413315A 28
and expertise in the management of the Reference Pool, both to safeguard HSH's investment and
to provide HSH with its knowledge and expertise.
87. But instead of acting in the best interests of HSH and North Street 4 , UBS utilized
this investment as an opportunity to take default risk off its own balance sheet and, on
information and belief, profit by taking short positions against the very reference credits it
selected for inclusion in the Reference Pools.
88. As a result of UBS' conduct, HSH has been damaged in an amount to be
determined at trial but believed to be in excess of $275 million. HSH is also entitled to punitive
damages in an amount to be determined at trial.
FIFTH CAUSE OF ACTION
(Breach of Implied Covenant of Good Faith and Fair Dealing)
89. HSH repeats and realleges the foregoing allegations as fully set forth herein.
90. UBS and HSH entered into contracts as described above relating to the North
Street 4.
91. Implied in these contracts was a covenant that the parties would deal with each
other in good faith and would not engage in any conduct to deprive the other of the benefits of
that agreement.
92. UBS however, failed to perform its obligations to act in good faith by knowingly,
intentionally, in bad faith, and in secret, selecting reference entities for the North Street Swap
that have fundamentally compromised the Notes HSH purchased, charging an excessively high
price for the Notes HSH purchased, and setting an excessively low yield to be paid on the Notes
HSH purchased. UBS has further made multiple adverse substitutions of collateral in the
Reference Pool for its own benefit and not for the benefit of North Street 4 or HSH.
61159/2413315.1 29
93. Defendants' breach of the implied covenant of good faith and fair dealing has
substantially damaged HSH and has deprived it of the consideration it bargained for in entering
into this transaction . As a result HSH should be awarded rescission of the North Street 4
transaction, or, in the alternative, damages in an amount to be determined at trial, but believed to
be in excess of $275 million.
SIXTH CAUSE OF ACTION
(Unjust Enrichment and Constructive Trust)
94. HSH repeats and realleges the foregoing allegations as fully set forth herein.
95. Through its selection of unstable reference entities for the North Street Swap,
charging of an excessively high price for the Notes purchased by HSH, setting an excessively
low yield to be paid on the Notes purchased by HSH, making adverse substitutions and profiting
from wrongful short selling, UBS has received a monetary benefit to which it was not entitled.
96. UBS unjustly retained these ill-gotten gains and was therefore unjustly enriched at
HSH's expense.
97. Because UBS received and unjustly retained such monetary benefits from the
mismanagement of the Reference Pool of the North Street Swap, by which it was unjustly
enriched at HSH's expense, the parties should be returned to their original position prior to UBS'
misconduct. Moreover, UBS' ill-gotten gains should be held in a constructive trust for HSH.
SEVENTH CAUSE OF ACTION
(For an Injunction)
98. HSH repeats and realleges the foregoing allegations as fully set forth herein.
99. As a result of UBS's breach of contract, which continues to the present day, HSH
has suffered irreparable injury, and will continue to suffer irreparable injury, absent an injunction
61154!1413315.1 30
requiring UBS to establish a Commitments Committee that conforms with the requirements of
the Side Agreement or to manage its conflicts of interest as swap counterparty and manager of
the Reference Pool. Without a properly functioning Commitments Committee to monitor the
Reference Pool and the addition of an independent party to manage the conflicts of interest to
which UBS is subject, the credit quality of the Reference Pool will continue to decline due to
continued adverse substitutions and failures to remove deteriorating assets, resulting in
irreparable harm to HSH.
100. HSH will likely succeed on the merits of its claims against UBS.
101. The balance of the equities lie in HSH's favor.
EIGHTH CAUSE OF ACTION
(Conversion)
102. HSH repeats and realleges the foregoing allegations as fully set forth herein.
103. At all relevant times, HSH entrusted funds, through its investment in the Notes, to
UBS for specific, limited purposes.
104. By the actions alleged herein, UBS wrongfully converted funds that had been
entrusted to UBS for specific, limited purposes by HSH.
105. As a result of the conversion, HSH was damaged in an amount to be proved at
trial, but believed to be in excess of $275 million.
6115912413315.1 31
PRAYER FOR RELIEF
WHEREFORE, HSH demands judgment and permanent relief against Defendants as
follows:
(a) rescinding the North Street 4 transaction;
(b) in the alternative, awarding HSH damages in an amount to be determined at trial,
together with prejudgment interest at the maximum rate allowable by law;
(c) awarding HSH punitive damages together with its reasonable costs and expenses
incurred in this action, including, to the extent applicable, counsel fees;
(d) enjoining UBS from continuing to breach its contractual obligations, and specifically
requiring UBS to (1) operate the Commitments Committee as it is described in the Reference
Pool Side Agreement and (2) add an independent monitor to ensure that substitutions are made in
the interests of the CDO and HSH; and
(e) awarding HSH all other such relief as the Court deems just and proper.
DATED: New York, New YorkFebruary 25, 2008
QUINN EMANUEL URQUHART OLIVER &HEDGES, LLP
By:4,2 2,E.
Philippe Z. Selendy
51 Madison Avenue, 22nd FloorNew York, New York 10010-1601(212) 849-7000
Attorneys for Plaintiff
61159/2413315,1 32
COMPLAINT
Qu N EMANUEL URQUHART OLIVER & HEDGES, LLP
51 Madison Avenue, 22nd Floor
New York, New York 10010-1601(212) 849-7000
Attorneys Petitioner
.xs ^•y,r.^ 1