VIA ELECTRONIC MAIL

September 18, 2008

The Honorable Ms. Mary L. Schapiro Chairman Chief Executive Officer Securities and Exchange Commission FINRA 100 F Street, NE 1735 K Street, NW Washington, DC 20549 Washington, DC 20006-1500 [email protected] [email protected]

The Honorable William Francis Galvin The Honorable Andrew Cuomo Secretary of the Commonwealth Attorney General of State Massachusetts Securities Division Office of the Attorney General One Ashburton Place, 17th Floor The Capitol Boston, MA 02108 Albany, NY 12224-0341 (617) 727-3548 [email protected] [email protected]

Mr. Fred J. Joseph Colorado Securities Commissioner and President, North American Securities Administrators Association, Inc. 750 First Street, N.E., Suite 1140 Washington, D.C. 20002 [email protected]

RE: Recent Auction Rate Securities Settlements

Dear Ladies & Gentlemen:

In recent weeks, the Securities and Exchange Commission (SEC), New York State Attorney General, and various state securities divisions have issued press releases announcing agreements in principle to settle claims arising from the underwriting practices, auction process, offer, and sale of auction rate securities1 (ARS) by a number of wirehouse broker-dealer firms (Settlements).2 The Settlements follow the February 2008 collapse of the $330 billion auction rate securities market. The firms who served as lead managers, auction agents, and/or underwriters (Auction Managers) are alleged to have misrepresented ARS as safe, highly liquid investments equivalent to money market instruments and cash. In addition, the Auction Managers are alleged to have made inadequate disclosures concerning the liquidity of these securities. Furthermore, the Auction Managers are alleged to have continued to tout the purported liquidity of ARS to customers despite their awareness of the escalating liquidity risks in the weeks and months preceding the collapse of the ARS market. While the terms of the

1 An “auction rate security” is a debt or preferred equity security for which the coupon or dividend is reset through an auction at a set interval. 2 As of today’s date, settlements involving Citigroup Global Markets, Inc., UBS Securities LLC, , J.P. Morgan Chase & Co., Wachovia Securities, Lynch, Goldman Sachs, , and related entities have been announced. ARS Settlements September 18, 2008 Page 2

Settlements differ from agreement to agreement, all require the Auction Managers to purchase at par ARS held by the Auction Manager’ individual investor, charitable organization, and small business clients.

The Financial Services Institute3 (FSI) supports these regulatory efforts to bring liquidity to the ARS market. However, we are concerned that the Settlements fail to provide liquidity to all deserving retail investors. Specifically, the Settlements fail to provide relief to a significant number of retail investors who purchased ARS through independent or other broker-dealer firms who did not serve as underwriters, lead managers, or auction managers in the ARS market. In the absence of regulatory action, these investors are faced with a liquidity crisis and four unattractive options: (1) continue to hold the ARS, (2) sell the ARS at a discount from par on the very limited secondary markets, (3) borrow on margin to meet cash needs while continuing to hold the ARS, or (4) liquidate other investments to meet cash needs.4 Therefore, we urge you to consider carefully the needs of these retail investors as you negotiate the final terms of these Settlements and pursue other ARS enforcement matters against the Auction Managers.

Background on FSI Members The Settlements are of particular interest to FSI members. The independent broker-dealer (IBD) community has been an important and active part of the lives of American investors for more than 30 years. The IBD business model focuses on comprehensive financial planning services and unbiased investment advice. IBD members also share a number of other similar business characteristics. They generally clear their securities business on a fully disclosed basis; primarily engage in the sale of packaged products, such as mutual funds and variable insurance products; take a comprehensive approach to their clients’ financial goals and objectives; and provide investment advisory services through either affiliated registered investment adviser firms or such firms owned by their registered representatives. Due to their unique business model, IBDs and their affiliated financial advisors are especially well positioned to provide middle-class Americans with the financial advice, products, and services necessary to achieve their financial goals and objectives.

In the U.S., approximately 98,000 independent financial advisors – or approximately 42.3% percent of all practicing registered representatives – operate in the IBD channel.5 These financial advisors are self-employed independent contractors, rather than employees of the IBD firms. These financial advisors provide comprehensive and affordable financial services that help millions of individuals, families, small businesses, associations, organizations, and retirement plans with financial education, planning, implementation, and investment monitoring. Clients of independent financial advisors are typically “main street America” – it is, in fact, almost part of the “charter” of the independent channel. The core market of advisors affiliated with IBDs is clients who have tens and hundreds of thousands as opposed to millions of dollars to invest. Independent financial advisors are entrepreneurial business owners who typically have strong ties, visibility, and individual name recognition within their communities and client base. Most of

3 The Financial Services Institute, Voice of Independent Broker-Dealers and Independent Financial Advisors, was formed on January 1, 2004. Our members are broker-dealers, often dually registered as federal investment advisers, and their independent contractor registered representatives. FSI has 119 Broker-Dealer member firms that have more than 138,000 affiliated registered representatives serving more than 15 million American households. FSI also has more than 12,500 Financial Advisor members. 4 See the FINRA Investor Alert entitled “Auction Rate Securities: What Happens When Auctions Fail”. 5 Cerulli Associates Quantitative Update: Advisor Metrics 2007, Exhibit 2.04. Please note that this figure represents a subset of independent contractor financial advisors. In fact, more than 138,000 financial advisors are affiliated with FSI member firms. Cerulli Associates categorizes the majority of these additional advisors as part of the bank or insurance channel. ARS Settlements September 18, 2008 Page 3 their new clients come through referrals from existing clients or other centers of influence.6 Independent financial advisors get to know their clients personally and provide them investment advice in face-to-face meetings. Due to their close ties to the communities in which they operate their small businesses, we believe these financial advisors have a strong incentive to make the achievement of their clients’ investment objectives their primary goal.

FSI is the advocacy organization for IBDs and independent financial advisors. Member firms formed FSI to improve their compliance efforts and promote the IBD business model. FSI is committed to preserving the valuable role that IBDs and independent advisors play in helping Americans plan for and achieve their financial goals. FSI’s primary goal is to ensure our members operate in a regulatory environment that is fair and balanced. FSI’s advocacy efforts on behalf of our members include industry surveys, research, and outreach to legislators, regulators, and policymakers. FSI also provides our members with an appropriate forum to share best practices in an effort to improve their compliance, operations, and marketing efforts.

The Settlements are of particular interest to FSI member firms. In general, IBD firms participated modestly in the ARS market as custodians of accounts holding the securities or as distributors of the products to suitable retail investors. IBD firms whose clients hold ARS generally obtained them in one of two ways: (1) the ARS were purchased by the client through an account at an Auction Manager and the position was later transferred to an IBD firm account, or (2) they were sold the ARS by an IBD firm who served as a distributor of the securities. IBD firms who distributed ARS had little or no access to information regarding the deteriorating liquidity conditions in the ARS market in late 2007 and early 2008 and sold the ARS to their clients in good faith. Nevertheless, the recent press releases announcing the Settlements leave retail investors who purchased or hold ARS through IBD firms without the liquidity they need and deserve. No reasonable justification for excluding these investors from the settlements has been articulated in the press releases. Since FSI believes that discriminating against IBD retail investors in ARS securities is unjustifiable, FSI joins the Regional Bond Dealers Association’s call for the SEC, FINRA, NASAA, and the Office of the Attorney General of the State of New York to facilitate the liquidity of the ARS market for all retail investors.7 Our position is more fully described below.

The Case for Providing Liquidity to Retail Investors FSI urges securities regulators to consider the following as they finalize and negotiate the Settlements and other ARS enforcement matters:

• Auction Managers Control Relevant Information – Auction Managers do not merely oversee the underwriting and sale of new ARS to investors. Rather they are compensated to manage the ongoing periodic auction process. Auction Managers are the only broker-dealers associated with ARS that know the number of bidders at an auction, the individual and aggregate dollar amount of bids, the range of bid prices, whether there are sufficient bids by investors for the auction to succeed, and the clearing rates in successful auctions. Therefore, ARS auction process is, by its very nature, lacking in transparency. As a result, the Auction Managers possess information that is not readily available to retail investors, IBD broker-dealers, or other distributing firms.

6 These “centers of influence” may include lawyers, accountants, human resources managers, or other trusted advisors. 7 See Regional Bond Dealers Association’s August 15, 2008 letter at http://www.regionalbonddealers.com/pdf/RBDA_ARS_Letter_2.pdf. ARS Settlements September 18, 2008 Page 4

• The Settlements Suggest that Auction Managers Are Culpable – Auction Managers were the first to know of the deteriorating ARS market in late 2007 and early 2008. The Settlements indicate that the Auction Managers withheld this information from investors. There is no indication in the Settlements or industry press that this information was made public or even shared with broker-dealers seeking to purchase ARS on behalf of their retail clients. Instead, auction managers artificially supported otherwise failing auctions by bidding for their own positions. These actions created the impression that the market was operating to provide investors with the liquidity they expected and desired. By virtue of these misrepresentations, retail investors, independent broker- dealers, other distributing firms, and their affiliated financial advisors were denied access to information that was material to their investment decisions and recommendations.

• Unreasonable to Withhold Liquidity from this Class of Retail Investors – Many investors hold ARS in IBD firm brokerage accounts as the result of transferring their account from an Auction Manager broker-dealer firm. Investors’ disappointment with the failure of ARS market certainly contributed to some investors' decision to transfer their account from Auction Manager firms to other broker-dealer firms. Excluding these investors from the Settlements would be a purely arbitrary act with significant consequences for this class of investors. Other investors chose to purchase ARS via an existing brokerage account at an IBD or other broker-dealer. IBD and other distributing broker-dealer firms were not privy to the intimate details of the ARS auction process. Investors who chose to do business with these distributing firms were victims of the same misrepresentations as those who chose to hold their account at the Auction Manager firm. As a result, we believe excluding the customers of distributing broker-dealers from the liquidity solutions mandated by the Settlements cannot be justified upon any reasonable basis.

• Past Enforcement History – Many of the firms who are parties to the Settlements are recidivists. On May 31, 2006, the SEC settled with 15 wirehouse broker-dealers8 for violative practices relating to their ARS underwriting and auction practices.9 The SEC order found that, between January 2003 and June 2004, each firm engaged in one or more of the following practices that were not adequately disclosed to investors, which constituted violations of the securities law:

o Allowing customers to place open or market orders in auctions; o Intervening in auctions by bidding for a firm's proprietary account or asking customers to make or change orders in order to prevent failed auctions, to set a "market" rate, or to prevent all-hold auctions; o Submitting or changing orders, or allowing customers to submit or change orders, after auction deadlines; o Failing to require certain customers to purchase partially-filled orders even though the orders were supposed to be irrevocable; o Having an express or tacit understanding to provide certain customers with higher returns than the auction clearing rate; and o Providing certain customers with information that gave them an advantage over other customers in determining what rate to bid.

8 Among those involved in the settlement were Bear, Stearns & Co., Inc., Citigroup Global Markets, Inc., Goldman Sachs & Co., J.P. Morgan Securities, Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley & Co. Incorporated/ Morgan Stanley DW Inc., and Wachovia Capital Markets, LLC, and Banc of America Securities LLC. 9 See the SEC press release entitled “15 Broker-Dealer Firms Settle SEC Charges Involving Violative Practices in the Auction Rate Securities Market, Firms Ordered to Cease and Desist and to Pay Over $13 Million in Penalties,” at http://www.sec.gov/news/press/2006/2006-83.htm. ARS Settlements September 18, 2008 Page 5

According to the Settlements, many of these firms persisted in these practices despite SEC cease and desist orders. The continuation of these practices served to mislead investors and distributing broker-dealers into believing that the ARS market offered ready liquidity. Auction Managers engaging in a prolonged pattern of material misstatements and omissions in the offer and sale of ARS should not be allowed to avoid their obligations by virtue of investors' decision to use IBD firms to custody their assets and/or execute their trades.

• Settling Firms Are Prepared to Provide Liquidity – The ARS Auction Managers possess the financial wherewithal to offer relief to investors and should be held financially responsible for their actions. These firms are large financial institutions who profess to have the resources and ability to buy and hold large volumes of ARS. By contrast, many IBD firms who acted as distributing dealers are smaller firms without these financial resources. As a result, asking such firms to carry even smaller ARS positions or defend themselves against misguided arbitration claims related to ARS illiquidity would be excessively burdensome to these firms. We believe the only practical solution for making investors whole is to include the ARS customers of distributing firms in the Settlements with the Auction Managers.

Conclusion We commend and support your collective efforts to provide retail ARS investors with liquidity. However, we remain concerned that the announced Settlements unintentionally exclude many victims of the misrepresentations they seek to punish. We call on securities regulators to carefully consider the needs of these retail investors as they negotiate the final terms of the Settlements and pursue other ARS enforcement matters.

We would welcome the opportunity to work cooperatively with you to resolve the ARS liquidity crisis. If we can be of any assistance as you continue your efforts, please contact me at 770 980- 8487.

Respectfully submitted,

Dale E. Brown, CAE President & CEO