DOB: RBC Capital Markets - ARS Consent Order

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IN THE MATTER OF:

RBC CAPITAL
MARKETS CORPORATION


(CRD No. 31194)

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CONSENT ORDER

DOCKET NO. CO-10-7808-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, RBC Capital Markets Corporation (“RBC”), a subsidiary of Royal Bank of Canada, and formerly known as RBC Dain Rauscher Inc., is a broker-dealer registered under the Act with its main office at One Liberty Plaza, 165 Broadway, New York, New York;
 
WHEREAS, the Commissioner, through the Securities and Business Investments Division of the Department of Banking (“Division”), conducted an investigation pursuant to Section 36b-26(a) of the Act into the activities of RBC to determine whether it had violated, was violating or was about to violate any provisions of the Act or Regulations (“Investigation”);
 
WHEREAS, coordinated investigations into RBC’s activities in connection with RBC’s marketing and sale of auction rate securities (“ARS”) have been conducted by a multi-state task force;
 
WHEREAS, RBC has provided documentary evidence and other materials, and provided regulators with access to information relevant to their investigations;
 
WHEREAS, RBC has advised regulators of its agreement to resolve the investigations relating to RBC’s marketing and sale of ARS to certain investors;
 
WHEREAS, RBC has agreed, among other things, to reimburse certain purchasers of ARS;
 
WHEREAS, RBC has offered to reimburse certain eligible customers in Connecticut in excess of Twenty Two Million Dollars ($22,000,000);
 
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 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, 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 Sections 36b-15 and 36b-27 of the Act 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;

II. CONSENT TO WAIVER OF PROCEDURAL RIGHTS

WHEREAS, RBC, through its execution of this Consent Order, voluntarily waives the following rights:

1.
To be afforded notice and an opportunity for a hearing within the meaning of Sections 36b-15(f), 36b-27(a) and 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 itself of Sections 36b-15(f), 36b-27(a) and 36b-27(d)(2) of the Act and Section 4-177c(a) of the General Statutes of Connecticut;
3. To present its position in a hearing in which it 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, hereby enters this Consent Order.

III. JURISDICTION AND CONSENT TO ENTRY OF CONSENT ORDER

RBC admits the jurisdiction of the Commissioner and consents to the entry of this Consent Order by the Commissioner. RBC neither admits nor denies the Findings of Fact and Conclusions of Law contained in this Consent Order, and nothing in this Consent Order shall be construed as an admission of fraud by RBC.

IV. FINDINGS OF FACT

Auction Rate Securities

1.

Auction rate securities are long-term bonds issued by municipalities, corporations and student loan companies, or perpetual equity instruments issued by closed end mutual funds, with variable interest rates that reset through a bidding process known as a Dutch auction.

2. At a Dutch auction, bidders generally state the number of auction rate securities they wish to purchase and the minimum interest rate they are willing to accept.  Bids are ranked, from lowest to highest, according to the minimum interest rate each bidder is willing to accept.  The lowest interest rate required to sell all of the auction rate securities available at auction, known as the “clearing rate,” becomes the rate paid to all holders of that particular security until the next auction.  The process is then repeated, typically every 7, 28 or 35 days.
3. When there are not enough orders to purchase all of the auction rate securities being sold, a “failed” auction occurs.  In the event of a failed auction, investors cannot sell their auction rate securities.
4. As an underwriter of auction rate securities, RBC also acted as the managing broker-dealer for certain issues of auction rate securities.  When acting as sole manager, RBC was the only firm that could submit bids into the auction on behalf of its clients and/or other broker-dealers who wanted to buy and/or sell any auction rate securities.  When acting as lead manager, RBC was the primary firm that could submit bids into the auction, while other broker-dealers were able to submit orders on behalf of their clients as well.  RBC received revenue in connection with auction rate securities, including an underwriting fee representing a percentage of total issuance and a fee for managing the auctions.

RBC Made Misrepresentations to Certain Investors in Connection With
the Sale of Auction Rate Securities

5. RBC represented to certain of its customers that auction rate securities were highly liquid, safe, cash alternative investments.
6. These representations were misleading as to certain investors.  Auction rate securities were, in fact, different from cash and money market funds.  As discussed above, the liquidity of an auction rate security relied on the successful operation of the Dutch auction process.  In the event of a failed auction, investors could not sell their auction rate securities and were left holding long-term investments, not cash-equivalent securities.  Starting in the Fall of 2007, the auction rate securities market faced dislocation and an increased risk of failure.
7. Since the inception of the auction market, RBC submitted support bids, purchase orders for the entirety of an auction rate security issue for which it acted as the sole or lead broker.  Support bids were RBC proprietary orders that would be filled, in whole or in part, if there was otherwise insufficient demand in an auction.  When RBC purchased auction rate securities through support bids, those auction rate securities were then owned by RBC and the holdings were recorded on RBC’s balance sheet.  For risk management purposes, RBC imposed limits on the amounts of auction rate securities it could hold in inventory.
8. Because many investors could not ascertain how much of an auction was filled through RBC proprietary trades, investors could not determine if auctions were clearing because of normal marketplace demand, or because RBC was making up for the lack of demand through support bids.  Generally, investors were also not aware that the auction rate securities market was dependent upon RBC’s use of support bids for its operation.  While RBC could track its own inventory as a measure of the supply and demand for auction rate securities, ordinary investors had no comparable ability to assess the operation of the market.  There was no way for investors to monitor supply and demand in the market or to assess when broker-dealers might decide to stop supporting the market, which could cause its collapse.

By the Fall of 2007, the Auction Rate Securities Market Faced Dislocation

9. In August 2007, the credit crisis and other deteriorating market conditions strained the auction rate securities market.  Some institutional investors withdrew from the market, decreasing demand for auction rate securities.
10. The resulting market dislocation should have been evident to RBC.  RBC support bids filled the increasing gap in the demand for auction rate securities, sustaining the impression that the market was functioning.  As a result, RBC’s auction rate securities inventory grew significantly, requiring RBC to raise its risk management limits on its auction rate securities inventory several times.
11. From the Fall of 2007 through February of 2008, demand for auction rate securities continued to erode and RBC’s auction rate securities inventory reached unprecedented levels.  RBC was aware of the increasing strains on the auction rate securities market, increasingly questioned the viability of the auction rate securities market and planned for potential widespread market failure.  RBC did not disclose these increasing risks of owning or purchasing auction rate securities to all of its customers.
12. In February 2008, RBC and other firms stopped supporting most auctions.  Without the benefit of support bids, much of the auction rate securities market collapsed, leaving investors who had been led to believe that these securities were cash alternatives and liquid investments, appropriate for managing short-term cash needs, holding long-term or perpetual securities that could not be sold at par value.

V. CONCLUSIONS OF LAW

13. The Commissioner has jurisdiction over this matter pursuant to the Act.
14.
The Commissioner finds that RBC failed to reasonably supervise its agents and engaged in dishonest or unethical practices in the securities business; that this conduct violated Sections 36b-4(b) of the Act and Section 36b-31-6f(b) of the Regulations; and that grounds therefore exist to initiate administrative proceedings against RBC under Sections 36b-15(a) and 36b-27 of the Act;
15.
The Commissioner finds that this Consent Order and the following relief are appropriate, in the public interest, and consistent with the purposes fairly intended by the policies and provisions of the Act.

VI. CONDITIONS PRECEDENT

As conditions precedent to the entry of this Consent Order, RBC represents, through its execution of this Consent Order, that it has complied with the following requirements:

Definitions

1.

For purposes of these Conditions Precedent and this Consent Order, the following terms shall have the meanings specified:

a.   
“Eligible ARS” means auction rate securities purchased from or through RBC prior to February 11, 2008 into an account maintained in the custody of RBC at the time of purchase.
b. 
“Eligible Investors” means:  (i) Natural persons (including their IRA accounts, testamentary trust and estate accounts, custodian UGMA and UTMA accounts, and guardianship accounts) who directly purchased Eligible ARS; (ii) Government entities and non-profits including charities, endowments or foundations with Internal Revenue Code Section 501(c)(3) status with $25 million or less in assets in their accounts with RBC net of margin loans, as determined by the customer’s aggregate household position(s) as of October 8, 2008, that directly purchased Eligible ARS; (iii) Small Businesses that directly purchased Eligible ARS at RBC.  For purposes of this provision, “Small Businesses” shall mean RBC customers not otherwise covered in subparagraphs (i) and (ii) of this paragraph that had $10 million or less in assets in their accounts with RBC net of margin loans, as determined by the customer’s aggregate household position(s) as of October 8, 2008, or, if the customer was not a customer of RBC as of October 8, 2008, as of the date that the customer terminated its customer relationship with RBC.  Notwithstanding any other provision, “Small Businesses” does not include broker-dealers, banks acting as conduits for their customers, investment managers or other financial intermediaries or customers that had total assets of greater than $50 million as of October 8, 2008.  This Consent Order does not require that RBC purchase more than $10 million of auction rate securities from any Small Business.

Conditions Precedent and Representations by RBC

Buyback Offer

2. RBC shall have offered to buy back from Eligible Investors, at par plus accrued interest or dividends, if any, Eligible ARS that have failed at auction at least once between October 3, 2008 and June 30, 2009 (“Buyback Offer”).  The Buyback Offered remained open until June 30, 2009 (“Offer Period”).  RBC could extend the Offer Period beyond this date.
3. RBC shall have undertaken its best efforts to identify and provide notice to Eligible Investors who invested in Eligible ARS that had failed at auction at least once between October 3, 2008 and June 30, 2009 of the relevant terms of the multistate settlement, together with an explanation of what Eligible Investors were required to do to accept, in whole or in part, the Buyback Offer, by December 5, 2008.  RBC also undertook its best efforts to identify and provide notice of the relevant terms of the multistate settlement to such Eligible Investors not previously identified.
4. To the extent that any Eligible Investor who invested in Eligible ARS that had failed at auction at least once between October 3, 2008 and June 30, 2009 had not responded to the Buyback Offer, RBC undertook its best efforts to provide any such Eligible Investor with a second written notice on or before 45 days before the end of the Offer Period informing them of the relevant terms of the multistate settlement, notifying such Eligible Investor of the impending expiration of the Offer Period, describing the state of the auction rate securities market at that time, and explaining the consequences of failing to sell their auction rate securities to RBC prior to the expiration of the Offer Period.
5. Eligible Investors could accept the Buyback Offer by notifying RBC at any time before 5:00 p.m. Eastern Standard Time, June 30, 2009, or such later date and time in the event RBC extended the Offer Period.  For Eligible Investors who accepted the Buyback Offer within the Offer Period, RBC shall have purchased the Eligible ARS on or before the next scheduled auction date that occurred after three (3) business days following RBC’s receipt of notification.
6. RBC shall have established, and maintained through June 30, 2009, (a) a dedicated toll-free telephone assistance line, with appropriate staffing, to provide information and to respond to questions concerning the multistate settlement; and (b) a public Internet page on its corporate Website(s), with a prominent link to that page appearing on RBC’s relevant homepage(s), to provide information concerning the terms of the multistate settlement and, via the telephone assistance line, together with an e-mail address or other reasonable means of communication, to respond to questions concerning the terms of the multistate settlement.

Relief for Eligible Investors Who Sold Below Par

7. By May 31, 2009, RBC shall have undertaken its best efforts to identify any Eligible Investor who sold Eligible ARS below par between February 11, 2008 and October 8, 2008 and shall have paid such Eligible Investors the difference between par and the price at which the Eligible Investor sold the Eligible ARS.  RBC will have undertaken its best efforts to identify and pay, as soon as reasonably possible, any Eligible Investors identified thereafter who sold Eligible ARS below par between February 11, 2008 and October 8, 2008.

Reimbursement for Related Loan Expenses

8. RBC shall have undertaken its best efforts to identify Eligible Investors who took out loans from RBC between February 11, 2008 and May 31, 2009 that were secured by Eligible ARS that were not successfully auctioning at the time the loan was taken out from RBC, and who paid interest associated with the auction rate securities based portion of those loans in excess of the total interest and dividends received on the auction rate securities during the duration of the loan.  No later than May 31, 2009, RBC shall have reimbursed such customers for such excess expense, plus reasonable interest thereon.

Consequential Damages Arbitration Process

9. RBC shall have consented to participate in a special arbitration (“Arbitration”) for the exclusive purpose of arbitrating any Eligible Investor’s consequential damages claim arising from the Eligible Investor’s inability to sell Eligible ARS.  RBC shall have notified Eligible Investors of the terms of the Arbitration process through the notice described in paragraph VI.3.
10. The Arbitration shall be conducted by a single public arbitrator (as defined by section 12100(u) of the NASD Code of Arbitration Procedures for Customer Disputes, eff. April 16, 2007), under the auspices of FINRA.  RBC shall pay all applicable forum and filing fees.
11. Any Eligible Investors choosing to pursue such claims in the Arbitration shall bear the burden of proving that they suffered consequential damages and that such damages were caused by their inability to access funds invested in Eligible ARS.  In the Arbitration, RBC shall be able to defend itself against such claims; provided, however, that RBC shall not contest liability for the illiquidity of the underlying auction rate securities position or use as part of its defense any decision by an Eligible Investor not to borrow money from RBC.
12. Eligible Investors electing to use the special arbitration process described herein would not be eligible for punitive damages, or for any other type of damages other than consequential damages.
13. All customers, including but not limited to Eligible Investors who avail themselves of the relief described in this Consent Order, could pursue any remedies against RBC available under the law.  However, Eligible Investors electing to utilize the special arbitration process described above would be limited to the remedies available in that process and would not be able to bring or pursue a claim relating to Eligible ARS in another forum.

Municipal Issuers

14. By May 31, 2009, or five business days following the entry of this Consent Order by the Commissioner, whichever is later, RBC will have refunded or shall refund to municipalities (which, for avoidance of doubt, do not include student loan securitization vehicles or closed-end mutual funds) underwriting fees the issuers paid to RBC for the refinancing or conversion of their auction rate securities that occurred after February 11, 2008, where RBC acted as underwriter for the primary offering of the auction rate securities between August 1, 2007 and February 11, 2008.

Institutional Investors

15. RBC shall have endeavored and will continue to endeavor to work with issuers and other interested parties, including regulatory and governmental entities, to expeditiously provide liquidity solutions for non-natural person investors not covered by Sections VI.1.b.(ii) and VI.1.b.(iii) above that purchased auction rate securities from RBC (“Institutional Investors”).

Reports to NASAA

16. Within 45 days of the end of each month, beginning with a report covering the period beginning October 8, 2008 and ending April 30, 2009 (due on June 15, 2009) and continuing monthly through and including a report covering the month ended December 31, 2009 (due on February 16, 2010), RBC shall have submitted a monthly written report detailing the efforts in which RBC had engaged and the results of those efforts with respect to RBC’s institutional investors’ holdings in ARS.  The report shall have been submitted to a representative specified by the North American Securities Administrators Association, Inc. (“NASAA”).  Beginning in June 2009, upon the request of NASAA, RBC shall have met quarterly with a designated NASAA representative to discuss RBC’s progress with respect to its obligations described in these Conditions Precedent.  Such quarterly meetings shall have continued until no later than December 2009.  The reporting or meeting deadlines set forth above were subject to amendment with written permission from a designated NASAA representative.

VII. CONSENT ORDER

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

IT IS HEREBY ORDERED THAT:

1.
This Consent Order concludes the investigation by the Division and any other action that the Commissioner could commence under the Act on behalf of Connecticut as it relates to RBC’s marketing and sale of auction rate securities to RBC’s Eligible Investors as defined herein.
2.
This Consent Order is entered into solely for the purpose of resolving the referenced multi-state investigation, and is not intended to be used for any other purpose.
3.
RBC shall CEASE AND DESIST 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, RBC shall pay to the “Treasurer, State of Connecticut”, by electronic funds transfer or wire transfer, the sum of Thirty Three Thousand Four Hundred Three and 22/100 Dollars ($33,403.22) as an administrative fine.
5.
In the event another state securities regulator determines not to accept RBC’s state settlement offer in connection with the multi-state investigation referenced herein, the total amount of the Connecticut payment shall not be affected, and shall remain at Thirty Three Thousand Four Hundred Three and 22/100 Dollars ($33,403.22).
6.
To the extent that RBC agrees to any subsequent settlement with any NASAA jurisdiction arising out of the above-referenced coordinated investigations pertaining to RBC’s marketing and sale of Eligible ARS to Eligible Investors as described herein, which subsequent settlement includes a term or terms analogous to the terms herein, but which are more favorable to Eligible Investors in such NASAA jurisdiction than those terms identified herein, the subsequent more favorable settlement term or terms shall, upon the Commissioner’s request, be incorporated by reference into this Consent Order and become equally applicable to Connecticut Eligible Investors.
7. RBC shall not, collectively or individually, seek or accept, directly or indirectly, reimbursement or indemnification, including, but not limited to, payment made pursuant to any insurance policy, with regard to any or all of the amounts payable pursuant to paragraph 4 above.
8. If payment is not made by RBC, or if RBC defaults in any of its obligations set forth in this Consent Order or fails to abide by its representations set forth herein, the Commissioner may vacate this Consent Order, at his sole discretion, upon ten (10) days notice to RBC, and without opportunity for administrative hearing.
9. This Consent Order is not intended to indicate that RBC or any of its 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.
10. 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 RBC including, without limitation, the use of any e-mails or other documents of RBC or of others for the marketing and sale of auction rate securities to investors, nor does it limit or create liability of RBC, or limit or create defenses of RBC to any claims.
11. Nothing herein shall preclude Connecticut, its departments, agencies, boards, commissions, authorities, political subdivisions and corporations, other than the Commissioner and only to the extent set forth in paragraph VII.1 above, (collectively, “State Entities”) and the officers, agents or employees of State Entities from asserting any claims, causes of action, or applications for compensatory, nominal and/or punitive damages, administrative, civil, criminal, or injunctive relief against RBC in connection with the marketing and sale of auction rate securities by RBC.
12. This Consent Order shall not disqualify RBC or any of its affiliates or current or former employees from any business that they otherwise are qualified or licensed to perform under applicable state law, and this Consent Order is not intended to form the basis for any disqualification.
13. 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 principals.
14. This Consent Order shall be binding upon RBC and its successors and assigns as well 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 RBC 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 RBC 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 19th day of July 2010.      Howard F. Pitkin 
    Banking Commissioner 


CONSENT TO ENTRY OF ORDER

I, Richard Chase, state on behalf of RBC Capital Markets Corporation, that I have read the foregoing Consent Order; that I know and fully understand its contents; that I am authorized to execute this Consent Order on behalf of RBC Capital Markets Corporation; that RBC Capital Markets Corporation agrees freely and without threat or coercion of any kind to comply with the terms and conditions stated herein; and that RBC Capital Markets Corporation voluntarily consents to the entry of this Consent Order, expressly waiving any right to a hearing on the matters described herein.  RBC Capital Markets Corporation 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 RBC Capital Markets Corporation shall pay pursuant to the foregoing Consent Order.     

 
RBC Capital Markets Corporation
  
           
By: ______/s/___________________________
Name: Richard T. Chase
Title: Managing Director & General Counsel

 
State of: New York

County of:  New York

On this the 15th day of July, 2010, before me, Helena Han, the undersigned officer, personally appeared Richard T. Chase, who acknowledged himself/herself to be the General Counsel of RBC Capital Markets Corporation, a corporation, and that he/she, as such General Counsel, being authorized to do so, executed the foregoing instrument for the purposes therein contained, by signing the name of the corporation by himself/herself as General Counsel.
 
In witness whereof I hereunto set my hand.
 

_________/s/________________________
Notary Public
Date Commission Expires: August 23, 2012
  

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