July 25 (Bloomberg) — UBS AG said it was “honest and ethical” in its marketing of auction-rate securities, according to the bank’s reply to a lawsuit filed last month by Massachusetts Secretary of State William Galvin accusing it of fraud.

UBS, the second-largest underwriter of municipal auction- rate securities in the U.S. after Citigroup Inc., said it had grounds to believe the auction-rate bonds it sold “were suitable for clients.” It also said in its reply that it has “taken substantial measures” to help investors trapped since the auction-rate market collapsed in February and to assist issuers restructuring the debt.

“Contrary to the allegations, UBS is committed to serving the best interests of its clients,” the Zurich-based bank said in the filing dated July 17, obtained from Galvin’s office. The bank is being represented by the law firm Debevoise & Plimpton LLP in New York, according to the filing.

State and federal regulators began probing Wall Street’s marketing of auction-rate securities after investment banks abandoned the $330 billion market, permitting thousands of auctions to fail and leaving investors unable to sell the debt. Municipalities, closed-end funds and student loan organizations sold the long-term bonds, and the banks ran the auctions where the interest rates were reset every week or month.

In addition to individuals, at least 435 publicly traded companies hold the securities, with 247 of them writing down the value of their holdings since the market collapsed, resulting in losses of $2.18 billion, according to a survey by Pluris Valuation Advisors LLC in New York.

State Complaints

Regulators in Massachusetts, New York and Texas filed formal complaints against UBS demanding the bank offer to buy back at face value the securities it sold. Galvin is still probing Merrill Lynch & Co. and Bank of America Corp. while New York Attorney General Andrew Cuomo, in announcing a suit against UBS yesterday, said he is continuing his investigation of the bank and other brokers, refusing to rule out more lawsuits against firms or executives.

Galvin in his lawsuit filed on June 26 alleged UBS told investors the long-term bonds were “safe, liquid cash alternatives,” as demand waned for the securities last year. He said UBS “stepped up” a campaign to sell the debt as the market softened and its own holdings of the securities grew to more than $11 billion.

“The statements at issue were not false or misleading at the time they were made,” UBS said in its reply. “Any misrepresentations or omissions were made in good faith,” the bank said, adding that “respondents’ actions were honest and ethical.”

Bank Bids

The bank said that between January 2006 and February 2008 it submitted “support bids” for municipal and student loan securities in 30,144 auctions and that the bids were filled 25,877 times, representing 85.8 percent of the auctions.

The bank said its securities division began in June 2006 to share the fees that issuers paid it to run the auctions with the division overseeing the financial advisers, paying “a blended rate across products of 20 basis points as a distribution credit” for the advisers to sell the bonds. A basis point is 0.01 percentage point.

Galvin, citing e-mails obtained through his investigation, alleged that the bank executives increased pressure on financial advisers to sell securities they knew weren’t liquid investments. Galvin and Cuomo also found instances where those same executives sold their own holdings of the securities as the market faltered.

Auction-Rate Disclosure

“UBS denies knowledge or information sufficient to form a belief as to what each individual UBS customer was told about ARS by the customer’s financial adviser or otherwise, except states that the firm made available to financial advisers and investors certain materials that contained disclosures about ARS,” the bank said in its reply.

The bank also said that investors earned higher yields from the securities “than those provided by money-market or Treasury investments, while at the same time enjoying liquidity” until February.

U.S. prosecutors and regulators are separately investigating allegations that UBS helped wealthy U.S. citizens conceal $20 billion in assets and evade income taxes. The company reported a net loss of 25.4 billion Swiss francs ($25.6 billion) in the nine months through March, more than any other bank hit by the global credit-market contraction.

To contact the reporter on this story: Michael McDonald in Boston at mmcdonald10@bloomberg.net.