Administrative Proceeding: RBC Capital Markets

UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 9262 / September 27, 2011 SECURITIES EXCHANGE ACT OF 1934 Release No. 65404 / September 27, 2011 INVESTMENT ADVISERS ACT OF 1940 Release No. 3289 / September 27, 2011 ADMINISTRATIVE PROCEEDING File No. 3-14564 ORDER INSTITUTING In the Matter of ADMINISTRATIVE AND CEASE-AND- DESIST PROCEEDINGS PURSUANT TO RBC Capital Markets, LLC SECTION 8A OF THE SECURITIES ACT (formerly known as RBC Capital OF 1933, SECTION 15(b) OF THE Markets Corp.), SECURITIES EXCHANGE ACT OF 1934, AND SECTION 203(e) OF THE Respondent. INVESTMENT ADVISERS ACT OF 1940, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND A CEASE-AND-DESIST ORDER I. The Securities and Exchange Commission (“Commission”) deems it appropriate and in the public interest that public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 8A of the Securities Act of 1933 (“Securities Act”), Section 15(b) of the Securities Exchange Act of 1934 (“Exchange Act”), and Section 203(e) of the Investment Advisers Act of 1940 (“Advisers Act”) against RBC Capital Markets, LLC (“Respondent” or “RBCCM”). II. In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the “Offer”) which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission’s jurisdiction over it and the subject matter of these proceedings, which are admitted, Respondent consents to the entry of this Order Instituting Administrative and Cease-and- Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933, Section 15(b) of the Securities Exchange Act of 1934, and Section 203(e) of the Investment Advisers Act of 1940, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order (the “Order”), as set forth below. III. On the basis of this Order and Respondent’s Offer, the Commission finds1 that: Summary 1. These proceedings arise out of the sale of $200 million of credit-linked notes that were tied to the performance of synthetic collateralized debt obligations holding a portfolio of 100+ credit default swaps referencing corporate bond obligations (the “CDO Investments”).2 Respondent RBCCM, a U.S. broker-dealer affiliated with the CDO Investment arranger Royal Bank of Canada Europe Limited (“RBC Europe”), marketed and sold the CDO Investments to five school districts in Wisconsin (the “School Districts”) in three separate transactions between June and December 2006. 2. RBCCM violated Sections 17(a)(2) and 17(a)(3) of the Securities Act by negligently selling the CDO Investments to the School Districts, despite significant concerns within RBCCM about the suitability of the product for municipalities like the School Districts. These CDO Investments were unsuitable for the School Districts. RBCCM’s marketing materials also failed to explain adequately the risks associated with the CDO Investments. The School Districts lacked sufficient knowledge and sophistication to appreciate the nature of such investments. Respondent 3. RBC Capital Markets Corp., now known as RBC Capital Markets, LLC, was a Minnesota corporation headquartered in New York, New York.3 RBC Capital Markets Corp. merged with and into RBC Dain Rauscher Inc. in 2008 and changed its name to RBC Capital Markets, LLC in 2010. RBC Capital Markets Corp. has been registered with the Commission as a broker-dealer since 1936 and has been registered as an investment adviser since 1977. At all relevant times, RBCCM has been a wholly-owned indirect subsidiary of the Royal Bank of Canada. Other Relevant Entities 4. School District of West Allis-West Milwaukee (“WAWM”), Kenosha School District No. 1 (“Kenosha”), School District of Waukesha (“Waukesha”), Kimberly Area School District (“Kimberly”), and School District of Whitefish Bay (“Whitefish Bay”) (collectively, the 1 The findings herein are made pursuant to Respondent’s Offer of Settlement and are not binding on any other person or entity in this or any other proceeding. 2 For simplicity, this Order will refer to the credit-linked notes as “the CDO Investments” since the notes were a means of simulating an investment in a CDO. 3 As used herein, the name “RBCCM” refers to RBC Capital Markets Corp. and all predecessor and successor entities, including RBC Capital Markets, LLC. 2 “School Districts”) are school districts located in eastern Wisconsin. Each of the School Districts operates through a superintendent of schools, a business services department and a school board made up of seven to nine district residents elected to a term of three years. 5. Royal Bank of Canada Europe Limited (“RBC Europe”) is a United Kingdom bank, and is an indirect wholly-owned subsidiary of the Royal Bank of Canada. RBC Europe is not registered with the Commission in any capacity. RBC Europe acted as the arranger of the credit- linked notes in which the School Districts invested. 6. Royal Bank of Canada (“RBC”4) is a Canadian bank, and is the parent organization of RBCCM and RBC Europe. RBC is not registered with the Commission in any capacity, although some of its subsidiaries are registered broker-dealers or investment advisers. As a result of the structure of the CDO Investments, RBC was ultimately the counterparty to the transactions with the School Districts on the CDO Investments, meaning that it paid the promised interest on the CDO Investments and was the purchaser of default protection on the CDO portfolio. 7. Stifel, Nicolaus & Co., Inc. (“Stifel”), incorporated in Missouri, is a retail and institutional brokerage and investment banking firm based in St. Louis, Missouri. Stifel is registered with the Commission as a broker-dealer and investment adviser, and is the primary subsidiary of Stifel Financial Corp. On August 10, 2011, the Commission filed a civil injunctive action in the United States District Court for the Eastern District of Wisconsin, Case No. 02-11:755, against Stifel and one of its former employees, relating to the sale of the CDO Investments to the School Districts. Funding of School Districts’ OPEB Liabilities 8. In addition to providing their employees with traditional pensions, the School Districts had contractually agreed to provide former and current employees with other post- employment benefits (“OPEB”), such as healthcare and life insurance. Prior to 2005, the School Districts had not funded these OPEB liabilities, instead opting to pay them as they arose each year using money out of their annual operating budgets. Over time, the OPEB liabilities had grown significantly. 9. With the assistance of Stifel, the School Districts’ financial adviser, the School Districts explored investment opportunities as a way to fund their OPEB liabilities, specifically seeking investments rated AA- or higher by the rating agencies. 10. Stifel devised a plan whereby the School Districts would raise and contribute funds to OPEB trusts for investment, and then the OPEB trusts would borrow additional funds from a specific lender to leverage the School Districts’ contributions into a more sizable investment (the “GOAL Program”). Under the GOAL Program, most of the funds contributed by the School 4 There was significant cross-entity work done within Royal Bank of Canada’s corporate family for these transactions. For example, RBCCM served as the United States broker-dealer for the sale of the CDO Investments, RBC Europe was arranger of the CDO Investments, and Royal Bank of Canada employees also worked on the transaction. Royal Bank of Canada’s senior management team was also extensively involved in the review and approval of the transaction. This Order will refer to the corporate family generally as “RBC.” 3 Districts to the OPEB trusts would come from School District bond issuances, meaning that nearly the entire amount invested under the program would come from borrowed funds. The difference between the earnings from the investment and the costs of borrowing would be used to reduce the unfunded retiree benefits. 11. Stifel’s GOAL Program depended on the use of leverage to provide the School Districts with a meaningful return on their investment, since the spread between any investment rated AA- or higher and the School Districts’ costs of borrowing would be narrow. Indeed, traditional AA- investments such as corporate bonds did not provide sufficient yields in excess of the School Districts’ and the trusts’ costs of borrowing, causing Stifel to seek out nontraditional investments for the School Districts that could offer higher yields. 12. Stifel contacted RBCCM to discuss product offerings, including CDOs, that were rated AA- or higher that met the yield requirements of Stifel’s investment program for the School Districts. RBCCM informed Stifel that it could offer synthetic CDO Investments referencing corporate bond obligations that were rated AA- or higher and offered the requisite yields. Background of the CDO Investments 13. RBCCM sold the CDO Investments to the School Districts on three occasions, in June, September, and December 2006. The CDO Investments totaled $200 million, which included $37.3 million of funds contributed directly by the School Districts, and the remainder from the OPEB trusts’ borrowings. 14. A collateralized debt obligation is a type of asset-backed security collateralized by a pool of fixed income assets. CDOs are often structured into a hierarchy of tranches, with each tranche representing a different level of risk and return. The lowest tranche typically absorbs the first losses in the portfolio until investments in that tranche are completely eliminated. At that point, the next tranche typically would begin absorbing losses, if any. The highest tranche traditionally would not suffer any losses until all of the lower tranches had suffered total losses.

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