By Brooke Masters

and Haig Simonian

News yesterday that employees in UBS’s wealth management division in London made unauthorised trades that cost clients more than $42m could not have come at a worse time for the Swiss bank.

Not only has UBS been hit by the third-largest fine ever by the UK Financial Services Authority, but the details of the improper trading could well make already skittish clients more nervous about the bank’s wealth management division.

Hit hard by the financial crisis, UBS has already spent much of the year embroiled in a bitter legal battle with the US authorities over the activities of some private bankers catering out of Switzerland for rich US offshore clients.

According to the FSA final notice yesterday, UBS’s internal controls were so weak that a desk head and three other employees were able to place up to 50 unauthorised foreign exchange and precious metals trades a day for a period of two years without being caught. “These employees were able to take advantage of UBS’s inadequate systems and controls, giving them free rein to make unauthorised trades with customer money,” said Margaret Cole, FSA enforcement director.

The employees took advantage of rules that let them place orders and wait 24 hours before specifying which account they were trading for. They were also allowed to bundle together a batch of trades into a single trade with an “averaged” price, hiding the results of individual punts.

The FSA said the employees would place trades and waited to see the resulting performance before allocating where the losses (and in some cases profits) would go. They also “persuaded” customers with liquid funds to “lend” them to other clients using documents “intended ... to give the lending customers the impression that the loan had been approved by UBS” when it had not, the final notice said. Many of the victims used UBS’s “retained mail” service and did not receive timely statements, so they were unaware that their accounts were being used for trading, the notice said. UBS did not require employees to keep a checklist of the documents received for clients using that service.

The problems only came to light when a whistleblower complained to an internal money laundering officer in December 2007. The FSA fined UBS £8m ($13.2m), but the total would have been £10m had the bank not qualified for a partial early settlement discount. Simon Morris of law firm CMS Cameron McKenna said the case serves as “a clear message to all wealth managers. All trades must be suitable and checked for suitability. Every bank and fund manager needs to ensure that trades of this nature are pre-authorised and trading activity is periodically reviewed.”

UBS has substantially upgraded its controls and risk management since the problems were discovered. “This sanction arises from control failings within our UK International Wealth Management business, dating back to 2007, as identified in the FSA’s Final Notice and in respect of which UBS has already taken full remedial steps,” the bank said in a statement that also noted it “deeply regrets this incident”.

UBS was forced to pay a $780m penalty to settle the US criminal tax case and surrender the names of more than 4,700 clients. It then decided to terminate relationships with all of the accounts involved.Clients have since been running for the exits and UBS’s private banking operations have beenhaemorrhaginglosing client funds at a dramatic rate. Since the first quarter of 2008 clients have withdrawn funds totalling SFr165bn ($162bn). In 2008, the group reported a net loss of almost SFr20bn. For the first three quarters of this year, losses have amounted to nearly SFr4bn.