DOB: UBS Auction Rate Securities Consent Order

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IN THE MATTER OF:

UBS SECURITIES LLC
CRD No. 7654

AND

UBS FINANCIAL SERVICES INC.
CRD No. 8174

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CONSENT ORDER

DOCKET NO. CO-10-7506-S

I. PRELIMINARY STATEMENT

WHEREAS, the Banking Commissioner (“Commissioner”) is charged with the administration of Chapter 672a of the General Statutes of Connecticut, the Connecticut Uniform Securities Act (“Act”), and Sections 36b-31-2 to 36b-31-33, inclusive, of the Regulations of Connecticut State Agencies promulgated under the Act (“Regulations”);
 
WHEREAS, UBS Securities LLC and UBS Financial Services Inc. (collectively, the “UBS Entities”) are broker-dealers registered in the state of Connecticut;
 
WHEREAS, the Commissioner, through the Securities and Business Investments Division (the “Division”) of the Department of Banking, conducted an investigation pursuant to Section 36b-26(a) of the Act into the activities of the UBS Entities to determine whether either or both of them had violated, were violating or were about to violate any provisions of the Act or Regulations (“Investigation”);
 
WHEREAS, coordinated investigations into the UBS Entities’ activities in connection with certain of the UBS Entities’ sales of financial instruments known as auction rate securities (“ARS”) to retail and other customers have been conducted by a multistate task force (“Task Force”);
 
WHEREAS, the UBS Entities have advised regulators of their agreement to resolve the investigations relating to their sale and marketing of ARS to retail and other customers;
 
WHEREAS, in connection with the Findings of Fact and Conclusions of Law contained in this Consent Order, the UBS Entities agree, inter alia, to reimburse certain purchasers of ARS, and to pay a total fine of Seventy Five Million Dollars ($75,000,000) to all the jurisdictions represented by the Task Force;
 
WHEREAS, the UBS Entities agree to implement certain changes with respect to their sales of ARS to retail and other customers, and to make certain payments;
 
WHEREAS, Section 36b-15(a) of the Act authorizes the Commissioner to revoke any registration if, inter alia, the Commissioner finds that (1) the order is in the public interest, and (2) the registrant has engaged in dishonest or unethical practices in the securities business, including abusive sales practices in the business dealings of such registrant with current or prospective customers or clients or if the registrant has failed to reasonably supervise its agents;
 
WHEREAS, Section 36b-27(a) of the Act authorizes the Commissioner to order any person who has violated, is violating or is about to violate any provision of the Act or any regulation, rule or order adopted or issued under the Act to cease and desist from such violation;
 
WHEREAS, Section 36b-27(d) of the Act authorizes the Commissioner to impose a fine of up to One Hundred Thousand Dollars ($100,000) per violation against any person who has violated any provision of the Act or any regulation, rule or order adopted or issued under the Act;
 
WHEREAS, Section 36b-31(a) of the Act provides, in relevant part, that “[t]he commissioner may from time to time make . . . such . . . orders as are necessary to carry out the provisions of sections 36b-2 to 36b-33, inclusive”;
 
WHEREAS, the UBS Entities have offered to purchase auction rate securities in excess of $574.5 million from certain eligible customers in Connecticut;
 
WHEREAS, Section 36b-31(b) of the Act provides, in relevant part, that “[n]o . . . order may be made . . . unless the commissioner finds that the action is necessary or appropriate in the public interest or for the protection of investors and consistent with the purposes fairly intended by the policy and provisions of sections 36b-2 to 36b-33, inclusive”;
 
WHEREAS, an administrative proceeding initiated under Section 36b-15 of the Act and Section 36b-27 of the Act, as amended, would constitute a “contested case” within the meaning of Section 4-166(2) of the General Statutes of Connecticut;
 
WHEREAS, Section 4-177(c) of the General Statutes of Connecticut and Section 36a-1-55(a) of the Regulations of Connecticut State Agencies provide that a contested case may be resolved by consent order, unless precluded by law;
 
WHEREAS, the UBS Entities and their affiliates, in furtherance of their desire to resolve this matter with the Commissioner, have provided the Division with documentation that they have made a contribution of Three Hundred Thousand Dollars ($300,000) to NW3C for the purpose of training Connecticut regulatory and law enforcement personnel, under the auspices of the Connecticut Police Academy and/or the Police Officer Standards and Training Council, in the investigation and prosecution of administrative, civil and criminal violations of law governing financial, banking, corporate and securities matters, with a special emphasis on the use of technology to investigate identity theft, Internet fraud and other financial crimes.  Such funds shall not be used to pay for the salaries or benefits of employees of NW3C, the Connecticut Police Academy and/or the Police Officer Standards and Training Council, but may be used for other purposes consistent with this paragraph and without limitation as to time of expenditure;

II. CONSENT TO WAIVER OF PROCEDURAL RIGHTS

WHEREAS, the UBS Entities, through their execution of this Consent Order, each voluntarily waive the following rights:

1.
To be afforded notice and an opportunity for a hearing within the meaning of Sections 36b-15(f) and 36b-27(a) of the Act and Section 36b-27(d)(2) of the Act and Section 4-177(a) of the General Statutes of Connecticut;
2.
To present evidence and argument and to otherwise avail themselves of Sections 36b-15(f) and 36b-27(a) of the Act and Section 36b-27(d)(2) of the Act and Section 4-177c(a) of the General Statutes of Connecticut;
3. To present their respective positions in a hearing in which each is represented by counsel;
4. To have a written record of the hearing made and a written decision issued by a hearing officer; and
5. To seek judicial review of, or otherwise challenge or contest the matters described herein, including the validity of this Consent Order;

NOW THEREFORE, the Commissioner, as administrator of the Act and of the Regulations, hereby enters this Consent Order.

III. JURISDICTION AND CONSENT TO ENTRY OF CONSENT ORDER

1.
The UBS Entities each admit the jurisdiction of the Commissioner, neither admit nor deny the Findings of Fact and Conclusions of Law contained in this Consent Order, and consent to the entry of this Consent Order by the Commissioner.

IV.  RESPONDENTS

2. UBS Securities LLC (“UBS Securities”) has been registered as a broker-dealer under the Act since at least August 1991;
3. UBS Financial Services Inc. (“UBS Financial Services”) has been registered as a broker-dealer under the Act since December 1, 1970;

V. FINDINGS OF FACT

A.  How the UBS Entities Marketed and Sold ARS to Their Clients

UBS Wealth Management’s FAs Represented ARS to Clients as Safe,
Liquid, Cash Alternatives to Money-Market Instruments

4. Customers of the UBS Entities in Connecticut were sold ARS and, in most instances, were told they were safe, liquid money-market instruments.
5.
Many customers of the UBS Entities were told that the interest rates on these instruments were set periodically through the functioning of deep, liquid, fully functioning auctions that had never failed for 20 years.  Some were not told about the auction process at all, but simply thought they were buying short-duration instruments.
6.
Many customers of the UBS Entities were not told that the auction rate product available to them was limited, for the most part, to ARS that UBS Securities underwrote.
7. Many customers of the UBS Entities were not apprised of the risks of ARS, including the risk of failed auctions or a market freeze.
8.
Many customers of the UBS Entities were not told that UBS Securities had a policy of placing support bids in every auction for which it was the sole or lead broker-dealer, that UBS Securities routinely intervened in the auction markets to set the interest rates, that certain potential conflicts of interest existed between the UBS Entities and their customers, that in August 2007 UBS Securities changed its policy of placing support bids in every auction for which it was lead broker-dealer and allowed some of the ARS it had underwritten to fail, or that after November 2007 the UBS Entities were actively considering scenarios that included ceasing their practice of supporting their auctions.
9.
After the UBS Entities decided to stop supporting their auctions, these clients were informed that the market for these instruments had frozen and that they no longer held liquid short-term instruments but instead held instruments with long or perpetual maturities for which no market existed.  Many of those instruments are no longer valued at par on UBS Financial Services’ account statements.

UBS Entity Financial Advisors Who Sold ARS to Clients Understood them to be
Safe, Liquid Cash Alternatives or Money Market Instruments

10.
The UBS Financial Services Financial Advisors (“FAs”) that the task force interviewed had not received any specific instruction or compliance training from the UBS Entities with respect to ARS.
11.
The FAs that the task force interviewed did not have even the most basic understanding of how ARS worked until after the UBS Entities pulled out of their auctions in February 2008.

The UBS Entities Did Not Provide Their Financial Advisors With Any
Mandatory Training With Respect to ARS

12. The UBS Entities did not provide their FAs with mandatory training regarding ARS.
13.
In testimony provided to the Task Force, the Director of Product Management for UBS Financial Services (“Director of Product Management”) indicated a wide range of information that FAs should know prior to selling ARS to customers, including who the issuer is, what type of auction rate security it is, what the credit quality is, how the auction process works, and that a customer bid may or may not get filled for that auction.
14.
However, the UBS Entities did not provide mandatory training or specifically instruct their FAs to apprise themselves of this information or provide customers with the information.

The UBS Entities Marketed ARS to Clients as Safe, Liquid Instruments

15.
Clients of the UBS Entities with whom the Task Force spoke uniformly stated that ARS had been marketed to them as completely liquid, safe money-market type instruments.
16.
UBS Financial Services posted on its public website a marketing piece “Cash & Cash Alternatives Addressing Your Short-term Needs,” which included Auction Preferred Stock and Variable-Rate Demand Obligations as a cash alternative.
17.
Similarly, in August 2007, the UBS Entities circulated “Investment Intelligence” magazine, which is “a quarterly ‘statement stuffer’ that is sent to all [UBS Financial Services] retail clients and available to employees on the intranet.”  The featured topic was “Planning Your Retirement Cash Flow Strategy.” The feature included Auction Preferred Stock, Auction Rate Certificates, and Variable-Rate Demand Obligations as cash alternatives.  It also invited customers to request a copy of Putting Liquidity to Work:  A Guide to Cash Alternatives, which is a brochure the UBS Entities made available to Financial Advisors to provide to clients starting in 2004, and which was posted on a firm external website in October 2007.  This Guide identified a number of risks relating to ARS, including the risk of auction failure, the UBS Entities’ routine support of the auctions, the lack of any obligation that the UBS Entities continue to support the market, and the conflicts of interest arising from the UBS Entities’ multiple roles in the auction market.

ARS Were Listed Under the Heading “Cash Alternatives / Money Market Instruments”
on UBS Financial Services’ Client Statements Through January
2008

18.
Through January 2008, the client statements issued to retail customers listed APS under the heading: “Cash Alternatives/Money Market Instruments.”
19.
In the February 2008 client statements, UBS Financial Services had removed the heading “cash alternatives/money market instruments” from its client statements.  ARS were then referred to as “cash alternatives/other.”
20.
For the May 2008 and subsequent statements, the heading on UBS Financial Services’ account statements under which ARS appeared was changed again to “fixed income/ARS.”
21.
Student-loan auction rate certificates (“Student Loan ARCS”) had been listed under the heading “Cash Alternatives/Municipal Securities.”  This heading has now been changed to “Fixed Income/ARS.”


The UBS Entities Did Not Disclose Key Aspects of Their ARS Program to Clients

22.
The UBS Entities did not have any mandatory disclosures regarding ARS that its FAs were required to make.
23.
On this topic, the Director of Product Management testified that FAs were not required by any specific policy to inform clients of the possibility that auctions might fail.  He said that he did not believe that FAs were required to inform clients that UBS Securities routinely intervened in the auction markets to prevent failure and to place a ceiling on clearing rates.  He also testified that UBS Financial Services’ FAs were not informed that UBS Securities’ inventory of ARS had exceeded the $2.5 billion cap, though FAs would have been able to tell that UBS Securities’ inventory was growing rapidly in January and February 2008 through the trading systems available to them.

B.  The UBS Entities' ARS Program Was At Odds With How It Was Being Promoted
to Clients and Financial Advisors


Background on Mechanics of ARS

Dutch Auction Process

24.

A Dutch auction is a competitive bidding process used to determine rates of interest on an instrument on each auction date.  Bids are submitted to the auction agent by the investors interested in buying or selling their securities.  The auction agent matches purchase and sale bids and the winning bid is the highest price (equivalent to the lowest rate) at which the auction clears.  At the auction a holder may submit one of the following orders:

Hold Order – the holder wishes to continue to hold a position regardless of rate.

Hold Rate Order or Bid Order
– the holder only wishes to continue to hold a position or purchase a new position if the new rate is equal to or higher than a specified rate.

Sell Order
– directs the broker-dealer to redeem the position at par regardless of the new rate.

25.
References to ARS herein shall include three separate categories of instruments: APS of closed-end funds, municipal auction rate certificates, and Student Loan ARCS.

Types of Auction Rate Securities

Auction Preferred Shares ("APS")

26.
APS are equity instruments without a stated maturity issued by closed-end funds.  They are collateralized by the assets in that fund and typically receive ratings from the major rating agencies.  Interest rates are intended to be set in a Dutch auction process with auction cycles typically of 7 or 28 days.  Typically, they have a maximum rate above which the interest rate cannot be set in an auction.

Municipal Auction Rate Certificates

27.
Municipal auction rate certificates (“Municipal ARCS”) are debt instruments (typically municipal bonds) issued by governmental entities with a long-term nominal maturity and a floating interest rate that is intended to be reset through a Dutch auction process.  They receive long-term ratings from the major rating agencies and are often backed by monoline insurance.

Student Loan-Backed Auction Rates Certificates

28.
Student Loan-backed auction rate certificates (“Student Loan ARCS”) are long-term debt instruments issued by trusts which hold student loans.  Interest rates are intended to be set in a Dutch auction process, and typically they have a maximum rate above which the interest rate cannot be set in an auction. They receive long-term ratings from the major rating agencies.

The UBS Entities' ARS Program

Underwriting

29. UBS Securities was one of the largest underwriters of Municipal ARCS and Student Loan ARCS.
30. UBS Securities was a large underwriter of APS until it ceased underwriting those shares in 2005 or 2006.
31. UBS Securities’ compensation for underwriting ARS was typically one percent of the amount underwritten.
32.
UBS Securities competed with other investment banks to provide low-cost financing to issuers.  Its ability to do so was a key factor in its ability to generate additional underwriting business.

Broker-dealer Agreements

33. For the ARS that it underwrote, UBS Securities typically served as a manager of those auctions.
34. UBS Securities often served as lead manager, but sometimes served as co-manager of auctions with other large broker-dealers.
35.
UBS Securities’ management responsibilities were typically set forth in an agreement called a broker-dealer agreement that it entered into with the issuer.
36. UBS Securities’ compensation under those broker-dealer agreements was typically 20-25 basis points annualized of the amount managed.
37.
UBS Securities shared a portion of its management fee with UBS Financial Services and its Financial Advisors in connection with the sale of ARS to customers of UBS Financial Services.

Distribution of ARS by UBS Financial Services

38. UBS Financial Services served as the primary distribution model for the ARS that UBS Securities underwrote.
39. Most of the ARS that were sold to clients of UBS Financial Services came from UBS Securities’ ARS program.
40. UBS Financial Services did not do its own due diligence to discern whether particular ARS were quality instruments to be offered to its retail clients.
41.
The Director of Product Management testified that since joining UBS Financial Services in 2005, he could not recall any instance in which UBS Financial Services had rejected or declined to distribute to its customers an ARS product underwritten by UBS Securities.
42. FAs received a portion of 25 basis points annualized, calculated based on the total amount of ARS in which their clients were invested.
43.
Those FAs would have received no commission if they had put those same investors in a standard money market fund offered by the UBS Entities.

UBS Securities Routinely Placed Support Bids in Order to Prevent Failed Auctions

44. On all of the auctions for which it was the sole or lead broker-dealer, UBS Securities placed support bids to ensure that the auctions would not fail.
45.
According to information provided by the UBS Entities to the Task Force, in auctions for APS from January 1, 2006 through February 28, 2008, UBS Securities submitted support bids in 27,069 auctions.  The support bids were drawn upon in order to prevent a failed auction 13,782 times, which represented 50.9 percent of those auctions.
46.
According to information provided by the UBS Entities to the Task Force, in auctions for Municipal ARCS and student-loan backed ARCS from January 1, 2006 through February 28, 2008, UBS Securities submitted support bids in 30,367 auctions.  The support bids were drawn upon in order to prevent a failed auction 26,023 times, which represented 85.7 percent of those auctions.
47.
If UBS Securities had not placed support bids in auctions, the UBS Entities’ auction rate program would have failed.

The UBS Entities' Setting of Interest Rates

Price Talk

48.
Prior to every auction for which it was the sole or the lead broker-dealer, UBS Securities engaged in price talk.  Price talk consisted of a range of bids that UBS Securities transmitted to UBS Financial Services’ FAs indicating where UBS Securities expected the auctions to clear.

Setting Interest Rates by Placing Bids

49. UBS Securities influenced interest rates directly by submitting buy and sell bids from its own inventory.
50. The Short Term Desk frequently set the rate at which the auction would clear.
51. In the Fall of 2007, UBS Securities raised the interest rates it set on ARS in part in response to a buildup of inventory of ARS (discussed below).
52.
In contrast to the understanding that retail investors were given that the interest rates on these securities were actually set through the auction process, the Head of Short-Term Trading put it as follows:  “We are making pricing decisions based on our ability to attract investors while managing issuer client relationships and will continue to do so in efforts to move securities.”

In August 2007, the UBS Entities Intentionally Allowed Certain of Their Auctions to Fail

53.
In August 2007, a number of broker-dealers, including UBS Securities, failed some of their auctions for certain auction products that were issued in private placements relating to the CDO market and certain auction products issued by monoline insurance companies.
54. In August 2007, UBS Securities intentionally allowed the auctions for sixteen (16) CUSIPS to fail.
55. These same auctions continued to fail in the Fall of 2007.

The UBS Entities' Inventory of ARS Increased Substantially
from August 2007 through mid-February 2008

Inventory Increased Beyond Cap Imposed by Risk Management

56.
The UBS Entities’ inventory of ARS, which was added to each time the UBS Entities supported an auction that otherwise would have failed, began to increase after the auction failures in August 2007.
57. The UBS Entities’ risk-control division imposed limits on the amount of auction rate inventory that UBS Securities could hold.
58. When the inventory obtained by supporting auctions was reached, the Short-Term Desk had to request from risk-management an increase in that cap.
59. The UBS Entities’ support of the auctions caused their inventory of ARS to increase even more in 2008.

Pushback from Risk Management

60.
In the fall of 2007 and the beginning of 2008, the UBS Entities’ risk management group was beginning to express concerns about the increase in the buildup of ARS.  Risk management expressed these concerns in the context of the short-term desk’s repeated requests to take on inventory of ARS above the caps imposed by risk management.
61.
For example, an email dated August 15, 2007, from an employee in the investment bank’s risk function (who worked with the investment bank’s Chief Risk Officer in the Americas), stated:  “Limited extension [of permission to operate over peak auction rate security inventory limit] granted for one night. There is little tolerance for increased inventory firm wide; please continue to price aggressively to keep inventory down.”

The UBS Entities Attempted to Limit the Buildup of Auction Rate Securities Inventory by
(a) Increasing Their Marketing Efforts to FAs and (b) Putting a Short-Term Fix On Certain Student Loan ARCS

Enhanced Marketing Efforts for ARS

62. As the ARS inventory of UBS Securities began to grow, the Global Head of the Municipal Securities Group led an effort to sell more of that inventory.
63. This effort began in August 2007 and continued until the UBS Entities pulled out of the market in February 2008.
64. The UBS Entities’ primary distribution channel for ARS were UBS Financial Services FAs.
65.
A concerted marketing effort was made to get the FAs to sell ARS.
66.
In early 2008, in response to the substantial decrease in corporate cash demand for ARS, UBS Financial Services began an education campaign for the FAs to ensure that FAs understood the true credit quality of the ARS.

Waivers of Maximum Rates on Student-Loan Backed Auction Rate Certificates

67.
The maximum rate at which Student Loan ARCS could reset was too low to compensate investors for the perceived risk of those instruments during the period between August 2007 and February 2008.  Many APS suffered from a similar flaw.
68.
These maximum rates were well known to UBS Securities since UBS Securities had built them into the instruments in order to make them more palatable to their underwriting clients.
69.
The maximum rates often allowed the issuers to obtain a higher rating on the product, in part because capping the interest rate on the product allowed them to satisfy the cash flow stress-tests of the rating agencies.
70.
As investors shied away from ARS after the August 2007 auction failures, the inventory of UBS Securities began to grow substantially, and it was necessary to keep raising interest rates in order to move the paper.
71.
However, as those interest rates began to approach the maximum rates on the securities with restrictive maximum rates, UBS Securities began an effort to get issuer clients to agree to a temporary increase in maximum rates and to seek waivers from the rating agencies in order to allow the interest rates on those instruments to rise to a level where those instruments could clear the market, until the market recovered or UBS Securities could work with issuers to restructure.
72. Those waivers were short-term in nature, and many that had been obtained in 2007 were set to expire in early 2008.
73.
UBS Securities became very concerned that when these waivers expired, these instruments would hit the maximum rate and the rate would reset to a level that would not be appealing to investors, thus requiring UBS Securities to take on even more Student Loan ARCS.
74. In January 2008, UBS Securities continued to seek waivers of the maximum rates from issuers.
75.
The UBS Entities did not disclose concerns with respect to maximum rates of Student Loan ARCS to investors.
76.
Moreover, FAs were not aware of these features and did not explain them to customers.

After August 2007, the UBS Entities’ Concerns Regarding ARS Intensified, Causing the UBS Entities to Debate Their Ongoing Role In The Auction Markets

77.
After August 2007, there was an ongoing dialogue within the firms’ organization as to the condition of the auction markets, with particular emphasis on Student Loan ARCS.
78.
In the Summer and Fall of 2007, the UBS Entities began a balance sheet reduction program, which required all divisions, including the short-term desk, to contribute to liquidity creation and balance sheet reduction.
79.
By early December 2007, it became clear that many institutional buyers were no longer interested in ARS.
80.
On December 12, 2007, the Head of Flow, Sales and Trading sent an email to the Global Head of Municipal Securities in which he stated:  “The auction product does not work and we need to use our leverage to force the issuers to confront this problem our options are to resign as remarketing agent or fail or?”
81.
Of note, that same day (December 12, 2007), the Global Head of Municipal Securities sold his remaining personal shares of ARS while at the same time continuing to engage in enhanced marketing efforts to clients.  He subsequently explained that he made these sales because “my risk tolerance from a credit perspective was - was something that drove me to want to sell” ARS.
82. A student loan task force was set up at the UBS Entities in mid-December 2007.
83.
In addition to the student loan task force, in December 2007, a working group was convened to discuss the broader condition of the UBS Entities’ ARS Program.  According to the UBS Entities’ response to interrogatories propounded by the Task Force, “In late 2007, UBS formed a working group that addressed the general market conditions for ARS, as well as UBS’ continued role in ARS auctions.”
84. The working group held meetings on December 21, 2007, January 4, 2008, January 18, 2008, February 1, 2008 and February 29, 2008.
85.
The working group discussed, among other things, the buildup in inventory of ARS and strategies for exiting the auction markets.

The UBS Entities’ Conflicted Role in Serving Underwriting Clients Versus Acting in the Best Interests of Retail Wealth Management Clients

86.
The UBS Entities’ auction rate program, in which they actively managed to influence the interest rates on ARS (which interest rates, in theory, should have been set by auctions), put them in a fundamentally conflicted role.
87.
On one hand, as set forth in detail above, one or more of the UBS Entities often needed to raise interest rates in order for auction paper to clear.
88.
On the other hand, if interest rates were raised too high, one or more of the UBS Entities ran afoul of their underwriter clients, who had been promised low-cost financing.
89.
Many UBS Financial Services investors were unaware of this conflict, as it was never disclosed to them.
90.
Many retail purchasers of UBS Entity auction rate paper thought that the interest rates were set by the auction markets, not by the UBS Entities’ setting of the interest rates resulting from their balancing the needs of underwriting clients (which are the greatest source of revenue for these products) and the need to move the product so that its inventory did not grow too large.
91.
This conflict became more acute when the auction markets began to crumble.  If UBS Securities did not raise rates enough, there would not be sufficient buying interest and UBS Securities would have to take more auction rate paper onto its books.  If UBS Securities raised rates too high, the auction results could significantly increase the cost of financing to UBS Securities’ issuer clients.

UBS Financial Advisors Were Not Apprised of this Back Story

92.
As the auction rate market began to show some stress in August 2007, which then gained intensity through the end of 2007 and January 2008, many customers were not informed of any of the problems in the ARS market.
93.

Up through at least February 8, 2008, and in connection with updates to FAs of events occurring in the auction rate market, FAs were informed as follows:

  
The public auction market continues to clear hundreds of auctions daily, with lead-broker-dealers frequently bidding to clear auctions where needed.  While broker-dealers are not obligated to bid in auctions, we do not have reason to change our current practice when UBS is lead underwriter.  We will continue to monitor developments so that we responsibly serve our clients and shareholders.


94.
This message came one day after the Global Head of Municipal Securities, in a February 7, 2008 email to certain UBS Entity personnel on whether the UBS Entities were contemplating failing auctions, described the auction rate securities market as “clock ticking-not sustainable.”
95.
In contrast to the sales of personal holdings of ARS by the Global Head of Municipal Securities in August and December 2007, customers who were kept in the dark about the UBS Entities’ concern about the viability of the program and the UBS Entities’ wavering commitment to the program, found themselves stuck.

UBS Failed Its Auctions On February 13, 2008

96.
UBS Financial Services’ FAs kept selling ARS through February 12, 2008.
97.
On February 13, 2008, without any notice to its customers who had purchased ARS, the UBS Entities failed their auctions for ARS.

VI. CONCLUSIONS OF LAW

1. The Commissioner has jurisdiction over this matter pursuant to the Act.
2.
The UBS Entities’ Failure to Supervise.  As described in the Findings of Fact above, the UBS Entities’ failure to reasonably supervise their agents is a violation of Section 36b-31-6f (b) of the Regulations.
3.
The UBS Entities Engaged in Dishonest and Unethical Practices.  As described in the Findings of Fact above, the UBS Entities, in connection with the offer, sale or purchase of ARS, directly or indirectly engaged in dishonest or unethical practices.  As a result, the UBS Entities violated Sec 36b-4(b) of the Act.
4. The Commissioner finds the following relief appropriate and in the public interest.

VII. CONSENT ORDER

On the basis of the Findings of Fact, Conclusions of Law, and the UBS Entities’ consent to the entry of this Consent Order,

IT IS HEREBY ORDERED THAT:

1.
This Consent Order concludes the Investigation by the Commissioner, and, except as provided in Paragraphs VII.19 of this Consent Order, precludes any other action that the Commissioner could commence under the Act and the Regulations as it relates to the UBS Entities’ marketing and sale of ARS as described herein.  The Commissioner’s August 5, 2009, Notice regarding “Opportunity To Show Compliance With Legal Requirements For Retention of Broker-Dealer Registrations” (“Notice”) is fully resolved by this Consent Order and the UBS Entities have no further obligations with respect to the Notice.
2.
This Consent Order is entered into solely for the purpose of resolving the above referenced multi-state investigation, and is not intended to be used for any other purpose.
3.
The UBS Entities shall refrain from violating the Act or any regulation or order under the Act, and shall comply with the Act, its regulations and any order under the Act.
4.
Within ten (10) days after the entry of this Consent Order by the Commissioner, the UBS Entities shall pay to the “Treasurer, State of Connecticut”, by electronic funds transfer or wire transfer, the total sum of Two Million Ninety Eight Thousand Seven Hundred Ninety Two and 26/100 Dollars ($2,098,792.26) as an administrative fine.
5.
UBS shall take, or be able to demonstrate that it has taken, certain measures (the “Eligible Customer Remedial Measures”) with respect to current and former customers as those measures relate to “Eligible ARS” as defined below.
6.
Eligible ARS.  For purposes of this Consent Order, “Eligible ARS” means ARS that failed at least once in auctions between August 8, 2008 and October 7, 2008.
7.

Eligible Customers.  As used in this Consent Order, an “Eligible Customer” is any current or former customer of one or both UBS Entities (not including (i) broker-dealers or (ii) banks acting as conduits for their customers) who opted in to the relief provided pursuant to this Consent Order and who meets any of the following criteria:

a.   
Held Eligible ARS at either of the UBS Entities as of February 13, 2008, or in DVP accounts as of February 13, 2008, for which the UBS Entities had bidding rights; or
b.
Purchased Eligible ARS at the UBS Entities between October 1, 2007 and February 12, 2008, and transferred those ARS out of the UBS Entities prior to February 13, 2008;

8.

Offer periods.

a.   
First Offer Period.
 
i.
No later than October 31, 2008, the UBS Entities shall have offered to purchase at par Eligible ARS from all Eligible Customers who:

(a) Meet the criteria under Paragraphs VII.7.a or VII.7.b;

(b) Are either: i. Individual customers, or ii. charities, endowments or foundations with Internal Revenue Code Section 501(c)(3) status; and

(c) Have less than $1 million in assets at the UBS Entities as determined by the investor's aggregate household asset position at UBS on August 8, 2008.

(d) In cases in which investor classification under this subsection is ambiguous, such classification will be determined by the UBS Entities in the exercise of reasonable good faith judgment.  

ii. This First Offer Period shall remain open until January 4, 2011.
  
b.
Second Offer Period.
i.
No later than January 2, 2009, the UBS Entities shall have offered to purchase at par Eligible ARS from all Eligible Customers who:

(a) Meet the criteria under Paragraphs VII.7.a or VII.7.b; and are:  i. Individual customers, ii. Charities, endowments or foundations with Internal Revenue Code Section 501(c)(3) status, or iii. Small businesses (entities with less than $10 million in assets with the UBS Entities as of August 8, 2008)
ii. Notwithstanding any other provision, institutional customers who have represented they have total assets of greater than $50 million, or who otherwise are determined to have assets greater than $50 million, as of August 8, 2008, are covered by the Third Offer Period (described in Paragraph VII.8.c of this Consent Order) and not by the Second Offer Period.
iii. In cases in which investor classification under this subsection is ambiguous, such classification will be determined by the UBS Entities in the exercise of reasonable good faith judgment.
iv. This Second Offer Period will remain open until January 4, 2011.
 

c. Third Offer Period – Institutional Customers.
i.
No later than June 30, 2010, UBS shall offer to purchase at par Eligible ARS from all remaining Eligible Customers who meet the criteria under Paragraphs VII.7.a and VII.7.b.
 
d. This Third Offer Period will remain open until July 2, 2012.

9.

Customer Notification and Opt In Procedures.

a.   
Initial Notice.  The UBS Entities represent, through their execution of this Consent Order, that they have sent or will send notice (“ARS Settlement Notice”) to each Eligible Customer.  The ARS Settlement Notice shall inform or shall have informed the customers that they could opt in to the Eligible Customer Remedial Measures within thirty (30) days after the mailing date of the ARS Settlement Notice (“Initial Opt In Period”).  
b. Second Notice and Opt In.  To the extent that any Eligible Customer does not or did not opt in during the Initial Opt In Period, the UBS Entities shall provide, or be able to demonstrate that they have provided, any such customer with a second written notice within seven (7) business days of the expiration of the Initial Opt In Period.  The UBS Entities will give, or be able to demonstrate that they have given, customers thirty (30) days following the mailing date of the second written notice to notify the UBS Entities that such customers are opting in to the Eligible Customer Remedial Measures.  This Consent Order does not require the UBS Entities to purchase the ARS of any customer that was mailed the ARS Settlement Notice but did not opt in to the Eligible Customer Remedial Measures.  Any customer who does not or did not opt in to the Eligible Customer Remedial Measures may pursue any other remedies against either or both of the UBS Entities available under the law.   
c.
Customer Assistance Line and Internet Page.  The UBS Entities represent through their execution of this Consent Order that they have established, and have maintained through December 31, 2009, (i) a dedicated toll-free telephone assistance line, with appropriate staffing, to provide information and to respond to questions concerning the Eligible Customer Remedial Measures; and (ii) a public Internet page on the UBS Entities’ corporate Web site(s), with a prominent link to that page appearing on the UBS Entities’ relevant homepage(s), to provide information concerning the Eligible Customer Remedial Measures and, via an e-mail address or other reasonable means, to respond to related questions.  The UBS Entities shall continue to maintain the toll-free telephone assistance line and Internet web page until their obligations under this Consent Order with respect to Eligible Customers located in Connecticut are fulfilled.


10.

Purchase Procedures.

a.   
Customers Eligible Under Paragraph VII.8.  For customers eligible for an offer under Paragraph VII.8 who opt in, or have opted in, to the Eligible Customer Remedial Measures:
 
i.
UBS Entity Offer.  The UBS Entities shall offer to purchase, or be able to demonstrate that they have offered to purchase, their Eligible ARS at par plus any accrued and unpaid dividends/interest during the relevant timeframe specified in Paragraph VII.8.  These customers may enter a sell order to sell their Eligible ARS at par to the UBS Entities at any time during the relevant timeframe. 
ii. Discretionary Sales on Behalf of Customers.  Starting on the business day following the date that a customer opts in, or has opted in, to the Eligible Customer Remedial Measures, the UBS Entities shall be authorized to exercise discretion on such customer’s behalf to effect sales or other dispositions of Eligible ARS, including but not limited to secondary sales.  The UBS Entities shall make customers whole at par (plus any accrued and unpaid dividend/interest) if any such disposition occurs below par. Any such discretion shall be exercised by UBS solely for the purpose of facilitating restructurings, dispositions, or other par solutions for customers.  The UBS Entities represent that the purpose of this aforementioned discretion is to permit the UBS Entities to mitigate potential damages while still returning par to customers.  In addition, starting on the business day following the date on which a customer opts in, or has opted in, to the Eligible Customer Remedial Measures, the UBS Entities shall be authorized to exercise reasonable discretion to purchase at par Eligible ARS that are tax-exempt Auction Preferred Stock issued by closed-end funds. 
iii. Written Notice of Expiration.  Thirty (30) days before the expiration of each relevant timeframe set forth in Paragraph VII.8, the UBS Entities shall provide written notice to those customers eligible under Paragraph VII.8 who have not sold their Eligible ARS to the UBS Entities.  This written notice shall notify the customers about the impending expiration of the relevant timeframe, describe the state of the ARS market at that time, and explain the consequences of failing to sell their ARS to the UBS Entities prior to the expiration of the relevant timeframe. 
b.
Returning ARS to the UBS Entities’ Custody.  Because the Eligible ARS must be in the UBS Entities’ custody prior to the UBS Entities being able to purchase such ARS, the customer must return the Eligible ARS to the UBS Entities’ custody before placing an order to sell the Eligible ARS to the UBS Entities.  To this end, the UBS Entities shall use their best efforts to assist those customers qualifying for the Eligible Customer Remedial Measures described herein who have transferred ARS out of the UBS Entities’ custody in returning Eligible ARS to the UBS Entities’ custody, and shall not charge such customers any fees relating to, or in connection with, the return to the UBS Entities, or custodianship by, the UBS Entities of such Eligible ARS. 


11.
Customer Priority.  The UBS Entities agree that neither will take advantage of liquidity solutions for its own inventory without making them available, as soon as practicable, to its customers that opted in to the Eligible Customer Remedial Measures and who hold the same CUSIP(s) of ARS in their accounts.  This obligation shall continue until June 30, 2010.
12. Relief for Customers Who Sold Below Par.  The UBS Entities shall use their best efforts to identify any such Eligible Customers who sold Eligible ARS below par between February 13, 2008 and September 15, 2008.  Through their execution of this Consent Order, the UBS Entities represent that, by October 31, 2008, they shall have paid any Eligible Customer so identified the difference between par and the price at which the customer sold the Eligible ARS, plus reasonable interest thereon.  The UBS Entities shall promptly pay any such customer identified after October 31, 2008. 
13. Refund of Refinancing Fees to Municipal Issuers.  Through their execution of this Consent Order, the UBS Entities represent that, by June 30, 2009, they shall have refunded to municipal issuers those underwriting fees each issuer paid to the UBS Entities for the refinancing or conversion of ARS that occurred after February 13, 2008, where one or more of the UBS Entities acted as underwriter for both the primary offering of ARS between August 1, 2007 and February 12, 2008, and the refunding or conversion of the ARS after February 13, 2008. 
14.
Negative Carry on Prior ARS Loan Programs.  With respect to each customer who took out a loan from one or both of the UBS Entities (directly or indirectly) using the firm’s prior ARS loan programs since February 13, 2008, the UBS Entities shall promptly reimburse the customer for any excess interest costs associated with such loan when compared to the interest paid on average on the Eligible ARS that are the subject of the loan, plus reasonable interest thereon.

15.

Purchase from Certain Additional Customers.

a. Subject to the limitations described in paragraphs VII.15.d. and VII.15.e. with respect to former UBS Entity customers who are individuals; charities, endowments or foundations with Internal Revenue Code Section 501(c)(3) status; or small businesses (entities with less than $10 million in assets with the UBS Entities other than institutional customers who have represented that they have total assets of greater than $50 million, or otherwise are determined to have assets greater than $50 million, as of August 8, 2008), and who purchased Eligible ARS at the UBS Entities on or after January 1, 2000 and transferred the Eligible ARS from the UBS Entities before February 13, 2008 and continue to own the Eligible ARS, the UBS Entities shall offer to purchase the customer’s Eligible ARS at par plus any accrued and unpaid dividends/interest, provided such customer has contacted or contacts the UBS Entities to request that the UBS Entities purchase the Eligible ARS. 
b. Within thirty (30) days following the Commissioner’s entry of this Consent Order, the UBS Entities shall offer to purchase Eligible ARS from each customer eligible under paragraph VII.15.a. who is recorded as having contacted the UBS Entities prior to the entry of this Consent Order by the Commissioner. 
c. For each customer eligible under paragraph VII.15.a. who contacts the UBS Entities after this Consent Order is entered by the Commissioner, within thirty (30) days of the UBS Entities’ receipt of the customer’s request, the UBS Entities shall offer to purchase Eligible ARS from such customer. 
d. The Eligible ARS must be in the custody of the UBS Entities prior to the UBS Entities being able to purchase such ARS under this section.  Former customers who are eligible under this section must return the Eligible ARS to their prior UBS Entity account or, in the case of former accounts that have been purged, to new UBS Entity accounts opened by the customer.  The UBS Entities shall not charge such customers any fees relating to or in connection with the return to the UBS Entities of such Eligible ARS. 
e.   
The obligations of the UBS Entities under paragraph VII.15.a. will expire after the UBS Entities have purchased Eligible ARS pursuant to paragraph VII.15.a. with a total value of $200 million (the “Purchase Obligation”).  The Purchase Obligation includes sums paid to any customer eligible under these provisions as well as any similar provisions with any other state.  Customers covered by paragraph VII.15.c. will be prioritized based on date of receipt of claim.  The Purchase Obligation also will include any amounts the UBS Entities paid to customers covered by paragraph VII.15.a. prior to the entry of this Consent Order.  Furthermore, the UBS Entities’ obligation under paragraph VII.15.a. will be stayed during any period that the sum paid and/or offered to be paid pursuant to paragraph VII.15.a. equals or exceeds $200 million. 
f.
The UBS Entities will require each customer accepting a purchase offer under paragraph VII.15. to provide the UBS Entities with a full release of claims as a condition to the UBS Entities’ agreement to repurchase, and such requirement shall not be construed as a violation of, or otherwise prohibited by, this Consent Order. 


16.
Best Efforts.  The UBS Entities represent, through their execution of this Consent Order, that, notwithstanding the UBS Entities’ obligations pursuant to Paragraph VII.8.c, the UBS Entities, no later than December 31, 2009, have used their best efforts to provide liquidity solutions at par for UBS Entity institutional customers (not including (i) broker-dealers or (ii) banks acting as conduits for their customers) by, among other things, facilitating issuer redemptions, and/or restructurings.

17.

Reports and Meetings.

a. Reports.  The UBS Entities represent, through their execution of this Consent Order that, beginning on January 2, 2009, and then monthly after that, they have submitted and will continue to submit to a representative specified by the North American Securities Administrators Association, Inc. (“NASAA”) a written report detailing their progress with respect to the Eligible Customer Remedial Measures described herein and other related obligations.
b. Meetings.  The UBS Entities represent, through their execution of this Consent Order that, beginning in March 2009, and concluding in December 2009, they offered to meet quarterly with a designated NASAA representative to discuss their progress with respect to the Eligible Customer Remedial Measures and other related obligations; and that they addressed any concerns expressed by the NASAA representative at any quarterly meeting held during such period. 
c. The reporting or meeting deadlines set forth above may be amended with written permission from a designated NASAA representative. 


18.

Special Arbitration Process.

a. The UBS Entities shall consent to participate, at the customer’s election, in the special arbitration procedures described below.  Under these procedures, an arbitration process, under the auspices of the Financial Industry Regulatory Authority (“FINRA”), will be available for the exclusive purpose of arbitrating consequential damages claims by individual (non-institutional) Eligible Customers who meet the criteria under paragraphs VII.8.a and VII.8.b. above. 
b.   
Applicable procedures.
 
i.
Arbitrator.  The special arbitrations will be conducted by a single public arbitrator.
ii. Forum and Filing Fees.  The UBS Entities shall pay all forum and filing fees with respect to customer claims eligible for the special process.
iii. Proof.  Eligible Customers will bear the burden of proving by a preponderance of the evidence the existence and amount of consequential damages suffered as a result of the illiquidity of the Eligible ARS.  Although the UBS Entities will be able to defend themselves against such claims, the UBS Entities shall not argue against liability for the illiquidity of the underlying ARS position.  Furthermore, the UBS Entities will not use as part of their defense the customer’s decision not to borrow money from either or both UBS Entities prior to September 15, 2008. 
iv. Other Damages.  Eligible Customers who elect to use the special arbitration procedures provided for in this Consent Order shall not be eligible for punitive damages, or any other type of special damages other than consequential damages. 
v. Applicability of FINRA Procedures.  The special arbitrations shall be subject to the rules and procedures adopted by FINRA for such arbitrations to the extent such rules and procedures are not inconsistent with the NASAA Special Arbitration Procedures provision relating to Relief Available, or the terms and provisions specified herein. 


19. Ability to Take Additional Actions.  The Commissioner will discontinue all investigations of the marketing and sale of Auction Rate Securities by the UBS Entities as described herein, and, except to the extent necessary to enforce compliance with this Consent Order, will withdraw and/or not commence any enforcement or other proceeding under the Act against the UBS Entities in connection with their marketing and sale of Auction Rate Securities as described herein. 
20. Customer’s Rights Not Limited.  Nothing in this Consent Order is intended to or shall be construed to limit existing rights of any customer and/or former customer of either or both UBS Entities to pursue claims such customer may have against either or both UBS Entities, including but not limited to any proceedings available to customers under FINRA rules and/or the FINRA Special Arbitration Process outlined in VII.18 above. 
21. UBS AG.  In consideration of the Commissioner entering into this settlement as reflected in this Consent Order, UBS AG will satisfy the financial obligations to customers herein on behalf of UBS Financial Services, Inc. and UBS Securities LLC. 
22.
Subsequent Investor Relief.  To the extent that either of the UBS Entities agrees to any subsequent settlement and/or Model Order with NASAA pertaining to their respective marketing and sale of Auction Rate Securities, which includes a term or terms analogous to the terms herein which are more favorable to investors than those terms identified herein, the subsequent term or terms shall be incorporated by reference into this agreement and become equally applicable to Connecticut investors. 

23.

Additional Considerations

a. If payment is not made by the UBS Entities, or if the UBS Entities default in any of their respective obligations set forth in this Consent Order, the Commissioner may vacate this Consent Order, at the Commissioner’s sole discretion and without opportunity for administrative hearing, after providing the UBS Entities with notice and an opportunity to cure the default(s) within thirty (30) days after the date of the notice. 
b. This Consent Order is not intended to indicate that the UBS Entities or any of their affiliates or current or former employees shall be subject to any disqualifications contained in the federal securities laws, the rules and regulations thereunder, the rules and regulations of self regulatory organizations or various states’ securities laws, including any disqualifications from relying upon the registration exemptions or safe harbor provisions.  In addition, this Consent Order is not intended to form the basis for any such disqualifications.
c. For any person or entity not a party to this Consent Order, this Consent Order does not limit or create any private rights or remedies against the UBS Entities, including, without limitation, the use of any e-mails or other documents of the UBS Entities or of others for the marketing and sale of ARS to investors, limit or create liability of the UBS Entities, or limit or create defenses of the UBS Entities to any claims.  Furthermore, nothing in this Consent Order shall affect the UBS Entities’ ability to defend themselves against claims in litigation.
d. This Consent Order shall not disqualify the UBS Entities or any of their affiliates or current or former employees from any business that they otherwise are qualified or licensed to perform under applicable securities laws of the State of Connecticut.  In addition, this Consent Order is not intended to form the basis for any such disqualifications.
e. This Consent Order and any dispute related thereto shall be construed and enforced in accordance with, and governed by, the laws of the State of Connecticut without regard to any choice of law principles.
f. This Consent Order shall be binding upon each of the UBS Entities, their respective successors and assigns, as well as the successors and assigns of relevant affiliates with respect to all conduct subject to the provisions herein and all future obligations, responsibilities, undertakings, commitments, limitations, restrictions, events, and conditions.



NOW THEREFORE, the Commissioner enters the following:

1. The Findings of Fact, Conclusions of Law and Consent Order set forth above, be and are hereby entered;
2. Entry of this Consent Order by the Commissioner is without prejudice to the right of the Commissioner to take enforcement action against either or both of the UBS Entities based upon a violation of this Consent Order or the matters underlying its entry, if the Commissioner determines that compliance with the terms herein is not being observed or if any representations made by the UBS Entities and reflected herein are subsequently discovered to be untrue; and
3. This Consent Order shall become final when entered.


 
So ordered at Hartford, Connecticut,      _______/s/_________
this 26th day of May 2010.      Howard F. Pitkin 
    Banking Commissioner 


CONSENT TO ENTRY OF ORDER

We, James E. Odell and Alan J. Brudner, state on behalf of UBS Securities LLC, that we have read the foregoing Consent Order; that we know and fully understand its contents; that we are authorized to execute this Consent Order on behalf of UBS Securities LLC; that UBS Securities LLC agrees freely and without threat or coercion of any kind to comply with the terms and conditions stated herein; and that UBS Securities LLC voluntarily consents to the entry of this Consent Order, expressly waiving any right to a hearing on the matters described herein.  UBS Securities LLC further agrees that it shall not claim, assert, or apply for a tax deduction or tax credit with regard to any state, federal or local tax for any administrative monetary penalty that UBS Securities LLC is obligated to pay pursuant to the foregoing Consent Order.     

 
     UBS Securities LLC
  
           
By ______/s/__________________
James E. Odell
  Managing Director 

 
On this 17 day of May 2010, personally appeared James E. Odell, signer of the foregoing Consent Order, who, being duly sworn, did acknowledge to me that he was authorized to execute the same on behalf of UBS Securities LLC, a limited liability company, and acknowledged the same to be his free act and deed, before me.
 

_________/s/________________________
Notary Public
My Commission Expires: January 21, 2011

     
 
     UBS Securities LLC
  
           
By ______/s/__________________
Alan J. Brudner
  Managing Director 

 
On this 14 day of May 2010, personally appeared Alan J. Brudner, signer of the foregoing Consent Order, who, being duly sworn, did acknowledge to me that he was authorized to execute the same on behalf of UBS Securities LLC, a limited liability company, and acknowledged the same to be his free act and deed, before me.
 

_________/s/________________________
Notary Public
My Commission Expires:  1-11-2014
 

CONSENT TO ENTRY OF ORDER

We, Thomas C. Naratil and Mark Shelton, state on behalf of UBS Financial Services Inc., that we have read the foregoing Consent Order; that we know and fully understand its contents; that we are authorized to execute this Consent Order on behalf of UBS Financial Services Inc.; that UBS Financial Services Inc. agrees freely and without threat or coercion of any kind to comply with the terms and conditions stated herein; and that UBS Financial Services Inc. voluntarily consents to the entry of this Consent Order, expressly waiving any right to a hearing on the matters described herein.  UBS Financial Services Inc. further agrees that it shall not claim, assert, or apply for a tax deduction or tax credit with regard to any state, federal or local tax for any administrative monetary penalty that UBS Financial Services Inc. is obligated to pay pursuant to the foregoing Consent Order.     

 
     UBS Financial Services Inc.
  
           
By ______/s/__________________
Thomas C. Naratil
  Managing Director 

 
On this 11 day of May 2010, personally appeared Thomas C. Naratil, signer of the foregoing Consent Order, who, being duly sworn, did acknowledge to me that he was authorized to execute the same on behalf of UBS Financial Services Inc., a corporation, and acknowledged the same to be his free act and deed, before me.
 

_________/s/________________________
Notary Public
My Commission Expires: 2/17/2014

     
 
     UBS Financial Services Inc.
  
           
By ______/s/__________________
Mark Shelton
  General Counsel and Managing Director 

 
On this 11 day of May 2010, personally appeared Mark Shelton, signer of the foregoing Consent Order, who, being duly sworn, did acknowledge to me that he was authorized to execute the same on behalf of UBS Financial Services Inc., a corporation, and acknowledged the same to be his free act and deed, before me.
 

_________/s/________________________
Notary Public
My Commission Expires: 2/17/2014

  

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